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Introducing "Government Finance Quasi-Capitalism"

August 17, 2013

Bond yields shoot to two-year highs and equities take notice

This week’s CBB evolved from notes prepared for a presentation I was to give. Instead, a lively Q&A session developed and I never got to my notes. So, I’ll take this opportunity to share analysis that introduces “Government Finance Quasi-Capitalism.”

Federal Reserve Bank of St. Louis President James Bullard (February 21, 2013): “Let me just talk a minute about Jeremy Stein’s speech – governor Stein is a Harvard finance professor – surely one of the leading finance people in the world… The first point to make would be that – my main take away from the speech - he pushed back some against the ‘Bernanke doctrine.’ The Bernanke doctrine has been that we’re going to use monetary policy to deal with normal macro-economic concerns and then we’ll use regulatory policy to try to contain financial excess. And Jeremy Stein’s speech said, in effect, ‘I’m not sure that you’re always going to be able to take care of the financial excess with the regulatory policy.’ And in a key line, he said, ‘Raising interest rates is a way to get into all the corners of the financial markets that you might not be able to see or you might not be able to attack with the regulatory approach…” The Fed has been talking about asset bubbles since the ‘irrational exuberance’ speech which was 1996. So it’s nothing new. We had a big bubble in the nineties. A big bubble in the two thousands. Those two bubbles ended very differently. The Fed’s been talking, talking, talking about this. So it’s certainly been a concern. It is a concern today. But it’s like nothing new. This has been going on for 20 years. Frankly, there aren’t good answers because we don’t have great models of financial instability.

The Fed has been talking about bubbles for 20 years. I’ve been diligently studying bubbles and Money & Credit for longer. I’m here with a sense of humility. After all, I’m again relegated to wearing the proverbial “dunce cap,” as I persevere through my third major bull market, “new era” and “new paradigm.”

The great American economist Hyman Minsky is best known for “stability is destabilizing” and the “Financial Instability Hypothesis” – the evolution of finance from “hedge finance” to “speculative finance” and finally to highly unstable “Ponzi finance.”

Minsky delineated the “Stages of Development of Capitalist Finance”: “In both Keynes and Schumpeter the in-place financial structure is a central determinant of the behaviour of a capitalist economy. But among the players in financial markets are entrepreneurial profit-seekers who innovate. As a result these markets evolve in response to profit opportunities which emerge as the productive apparatus changes. The evolutionary properties of market economies are evident in the changing structure of financial institutions as well as in the productive structure… To understand the short-term dynamics of business cycles and the longer-term evolution of economies it is necessary to understand the financing relations that rule, and how the profit-seeking activities of businessmen, bankers and portfolio managers lead to the evolution of financial structures.

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.”

Commercial Capitalism: “The essence of commercial capitalism was bankers providing merchant finance for goods trading and manufacturing. Financing of inventories but not capital investment." 

Early economic thinkers focused on seasonal monetary phenomenon. Credit and economic cycles were prominent, although relatively short in duration.

Finance Capitalism: “Industrial Revolution and the huge capital requirements for durable long-term capital investment… The capital development of these economies mainly depended upon market financing. Flotations of stocks and bonds – securities markets, investment bankers and the Rothchilds, JP Morgan and the other money barons… The great crash of 1929-1933 marked the end of the era in which investment bankers dominated financial markets.”

Managerial Capitalism: “During the great depression, the Second World War and the peace that followed government became and remained a much larger part of the economy… Government deficits led to profits – the government took over responsibility for the adequacy of profits and aggregate demand. The flaw in managerial capitalism is the assumption that enterprise divorced from banker and owner pressure and control would remain efficient… As the era progressed, individual wealth holdings increasingly took the form of ownership of the liabilities of managed funds…

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 Minsky wrote “Today’s financial structure is more akin to Keynes’ characterization of the financial arrangements of advanced capitalism as a casino.

The above quotes were from a Minsky paper published in 1993. That year was notable for the inflation of a major bond market speculative Bubble. This Bubble began to burst on February 4, 1994 when Fed raised rates 25bps.

I still view 1994 as a seminal year in finance. The highly leveraged hedge funds were caught in a bond Bubble; there were serious derivative problems; and speculative deleveraging was having significant global effects, most notably the financial and economic collapse in Mexico.

I was monitoring these market developments closely back in 1994. According to FOMC transcripts, the Fed at the time recognized their role in helping to fuel stock and bond Bubbles. While the bond market suffered through a bout of serious de-leveraging turmoil, I was anticipating more problematic systemic liquidity issues impacting the real economy and stock market. Things unfolded differently.

Keenly following developments and data, it was not long before I recognized that Fannie Mae, Freddie Mac and the Federal Home Loan Banks (FHLB) were acting as “buyers of last resort” in the marketplace. GSE assets expanded an unprecedented $150bn, or 24%, in 1994. That same year, total GSEs securities (debt and MBS) increased an unmatched $292bn. Essentially, the GSEs had evolved from operating chiefly as insurance companies (backing securitizations) to assuming the critical role of quasi-central banks, willing to pay top-dollar for debt securities during periods of acute market stress.

The rapid expansion of the “leveraged speculating community” and the timely arrival of the GSE liquidity backstop fundamentally altered finance. Instead of a burst Bubble disciplining the hedge funds and enterprising Wall Street firms, the leveraged players were emboldened by a newfound GSE backstop, the Treasury’s bailout of Mexico and Greenspan’s doctrine of aggressive “activist” asymmetrical policy responses.

With the Fed and GSEs having so skewed market incentives, financial speculation ran wild. A series of spectacular booms and busts were commenced, including South East Asia, Russia, Argentina and U.S. and global tech stocks. The wheels almost came off in 1998. The Nobel laureate hedge fund Long Term Capital Management (LTCM) – with egregious leverage and Trillions of derivatives spanning the globe – almost brought the global financial system to its knees. Time for another bailout. Becoming an even more powerful market liquidity backstop, GSE assets inflated $305bn in 1998. That year saw total GSE securities jump $474bn. In the post-LTCM bailout speculative melee year 1999, GSE securities increased $593bn.

All in all, the nineties saw GSE assets jump almost four-fold during the decade from $450bn to $1.7 TN. Total GSE securities inflated from $1.3 TN to $3.9 TN. The combination of bailouts, liquidity backstops and speculative leveraging provided a most fertile environment for the expansion of “Wall Street finance.” During the decade, outstanding asset-backed securities (ABS) jumped from $200bn to $1.3 TN. Securities broker/dealer assets rose from $236bn to $1.0 TN. Fed funds and repurchase agreements jumped from $360bn to $925bn. Hedge fund assets inflated ten-fold from $40bn to $400bn. After doubling in the year following the LTCM bailout, the “technology” Bubble burst in 2000. During 2000-2001, GSE securities inflated another $1.0 TN.

I began posting the CBB in late-1999. I was absolutely convinced finance had been fundamentally altered, with momentous ramifications. From my research, I believed developments were unique in financial history: for the first time, global finance was expanding without limits to either its quantity or quality. The Fed, GSEs, “Wall Street finance” and global central banks had fundamentally changed how finance operated – and, importantly, how finance was interacting with the real economy. There had been decisive changes in financial market incentives. And the resulting new financial apparatus provided unlimited cheap finance that was primarily directed to the assets markets. This fundamentally altered our economy’s underlying structure.

In 2001, developments compelled me to update Minsky’s “stages of development of Capitalistic Finance:” “Money Manager Capitalism” had evolved into what I termed “Financial Arbitrage Capitalism.” Traditional money management had given way to the rise of sophisticated market-based financial instruments and financing arrangements. In particular, the new financial and policy backdrop had created auspicious market incentives and financial rewards for leveraging in high-yielding ABS and MBS. This fostered a proliferation of spread trade and myriad sophisticated derivative strategies – all working to fuel asset inflation and Bubbles. Importantly, enormous easy-money speculative profits were increasingly divorced from economic returns in the real economy. Finance, generally, was becoming progressively detached from the real economy.

In response to late-cycle “Money Manager Capitalism” developments, Minsky commented: “We must recognize that evolution is not necessarily a progressive process: the financing evolution of the past decade may well have been retrograde.” From my perspective, “Financial Arbitrate Capitalism” and the attendant financial Bubble were leading to historic economic maladjustment – surely fostering debt-financed overconsumption and the de-industrialization of our economy.

I first began warning of the Mortgage Finance Bubble in CBBs back in 2002. With mortgage Credit expanding at double-digit rates, this fledgling Bubble had already achieved a strong inflationary bias. Dr. Bernanke emerged on the scene with radical theories of an electronic “government printing press” and “helicopter money.” His so-called “post-Bubble” “mopping up” monetary inflation was destined for greatness. As the Fed’s reflationary expedient, mortgage debt proceeded to double in just over six years. The rest is history – the “Financial Arbitrage Capitalism” that took hold with a vengeance in the early-nineties hit the wall with the 2008/09 bursting of the mortgage finance Bubble. Another round of increasingly desperate “post Bubble” “moping up” reflationary measures unleashed incredible fiscal and monetary stimulus on an almost worldwide basis.

In an April 2009 CBB, I began chronicling the “global government finance Bubble.” This Bubble has made it to the foundation of contemporary "money" and Credit – to the perceived safest Credit instruments. At home and abroad, governments and central banks have assumed prevailing roles in both the markets and real economies.

For some time now, I have strongly believed we are in the midst of history’s greatest and most dangerous Bubble. As an analyst of Bubbles, I’ve often quipped that they tend to go in unimaginable extremes – “and then they double.” I have also posited that the more systemic the Bubble the less obvious is becomes. In 2009, I fully expected the Fed/global central banks to throw everything they had at the crisis. Yet I never expected the ECB to commit to open-ended buying of troubled debt. I never imagined four years later the Fed would resort to $85bn monthly monetary inflation – with similar amounts from the Bank of Japan - in a non-crisis environment. The Fed went from preparing exit strategies with its assets at $2.5 TN – to providing market assurances of no exit with its balance sheet on the way to $4.0 TN.

After doubling mortgage debt in about six years, our system then doubled federal debt in four. I never imagined this amount of non-productive debt could be issued at historically low market yields. Instead of protesting, exuberant markets fell in love with reflationary measures.

Globally, it’s been a period of unprecedented Credit and speculative excess. Attendant maladjustment has been most pronounced throughout the “emerging markets”. China has had four years of “terminal” Credit Bubble excess to wreak financial and economic havoc. Similar dynamics have severely impaired “developing” economies and Credit systems, certainly including India and Brazil. For going on five years now, there’s been ample confirmation of the “granddaddy of them all” Bubble thesis. And in contrast to 2008, the next serious bout of turmoil will not be a private-debt crisis. It will arrive with few policy options other than even more desperate “money printing.”

After much contemplation, I’ve decided it’s again appropriate to update Minsky’s “Stages of development of Capitalist finance.” A couple decades of Financial Arbitrage Capitalism left deep scares in the financial system. The federal government was compelled to essentially nationalize mortgage Credit. To sustain market confidence in the massive overhang of private-sector Credit has required ongoing unprecedented fiscal and monetary stimulus.

Financial Arbitrate Capitalism has also left a deeply maladjusted economic system. It’s an economic structure that requires enormous ongoing Credit expansion (neighborhood of $2 TN annually). The economy is highly unbalanced, with ultra-loose “money” spurring record securities prices and the return of bidding wars in some housing markets – while Detroit files for bankruptcy and 47 million receive food stamps. It’s an economy that runs perpetual trade and Current Account Deficits. The financial backdrop incentivizes stock buybacks, special dividends and cost cutting – as opposed to investment in productive plant and equipment.

I’ll posit that evolution to a consumption and services-based economic structure is an evolution to Credit gluttony. With households highly leveraged and the private sector unable to expand Credit sufficiently to power our structurally deficient economic structure, Credit expansion/inflation it is left to the federal government and the Federal Reserve.

This backdrop has spurred massive Federal deficits, zero interest rates, and unprecedented central bank monetization. Washington policies spur further wealth redistribution and, I would argue, wealth destruction. I’m going to call the new “Minsky Stage” – “Government Finance Quasi-Capitalism” (GFQC).

The government now essentially determines market yields throughout the entire Credit system. The government now basically insures system mortgage Credit and sets mortgage borrowing costs. Massive federal deficits and low Fed-dictated borrowing costs sustain inflated corporate earnings and cash-flows. The Fed has come to believe it is within its mandate to inflate securities and asset prices. It has crushed returns on saving instruments. Amazingly, the Fed believes it is within its mandate to dictate that savers flee the safety of deposits and other “money” for the risk markets.

“Government Finance Quasi-Capitalism” exacerbates fragilities. It fosters ongoing Credit excesses including a historic expansion of non-productive government debt. GFQC and the resulting flow of finance exacerbate imbalances and economic maladjustment. Accordingly, resulting financial and economic fragilities ensure an even bigger role for Washington in the real economy and for the Federal Reserve in the financial markets.

With securities markets near record highs, it has become popular to refer to “enlightened” policymaking. As a student of monetary history, I see the seductive workings of the monetary inflation expedient. And once commenced, it always assumes increasing control. The expansion of government finance ensures dependency on fiscal deficits and central bank “money printing.” Inflating securities prices, highly speculative and distorted financial markets, and economic maladjustment ensure ongoing fragilities. “Government Finance Quasi-Capitalism” ensures the over-issuance of mispriced finance, the misallocation of resources and a resulting deficient real economy. The widening gulf between weak fundamentals and monetary inflation-induced market Bubbles creates a highly unstable, uncertain and precarious backdrop. All seem to ensure only greater government intrusion, control and stagnation. And I’ll conclude, as I often do, by stating that I hope my analysis is flawed.


For the Week:

The S&P500 fell 2.1% (up 16.1% y-t-d), and the Dow declined 2.2% (up 15.1%). The Morgan Stanley Consumer index dropped 2.7% (up 21.1%), and the Utilities sank 4.4% (up 5.6%).  The Banks declined 1.0% (up 26.2%), and the Broker/Dealers fell 1.1% (up 40.9%).  The Morgan Stanley Cyclicals were 1.4% lower (up 20.5%), and the Transports were down 1.6% (up 20.1%).  The S&P 400 MidCaps dropped 2.6% (up 18.2%), and the small cap Russell 2000 fell 2.3% (up 20.6%).  The Nasdaq100 declined 1.4% (up 15.5%), and the Morgan Stanley High Tech index lost 1.3% (up 14.9%).  The Semiconductors dropped 2.0% (up 20.4%).  The InteractiveWeek Internet index fell 2.3% (up 22.0%).  The Biotechs sank 4.7% (up 29.6%).  With bullion gaining $62, the HUI gold index surged 12.9% (down 39%).

One-month Treasury bill rates ended the week at 3 bps and three-month bill rates closed at 4 bps. Two-year government yields gained 4 bps to 0.34%. Five-year T-note yields ended the week up 21 bps to 1.56%. Ten-year yields surged 25 bps to a two-year high 2.83%. Long bond yields jumped 22 bps to 3.85%. Benchmark Fannie MBS yields rose 27 bps to 3.63%. The spread between benchmark MBS and 10-year Treasury yields widened 2 to 80 bps. The implied yield on December 2014 eurodollar futures increased 7 bps to 0.66%. The two-year dollar swap spread increased 2 to 19 bps, while the 10-year swap spread was little changed at 17 bps. Corporate bond spreads widened. An index of investment grade bond risk increased 6 bps to a six-week high 81 bps. An index of junk bond risk jumped 26 to a six-week high 406 bps. An index of emerging market debt risk declined 6 to 323 bps.

Debt issuance was strong.  Investment grade issues included Burlington Northern $1.5bn, Viacom $3.0bn, Cenovus Energy $800 million, Virginia E&P $585 million, JPMorgan $750 million, Jersey Central P&L $500 million, CA Inc $500 million, Paccar $500 million, Broadridge Financial $400 million, Southwestern Public Services $400 million, Prudential $1.0bn, Commonwealth Edison $350 million, Lincoln National $350 million, Westar Energy $250 million, Sierra Pacific Power $250 million, Amtrust Financial $250 million, McCormick $250 million, Georgia Power $200 million, and Kayne Anderson MLP $175 million.

Junk bond funds saw outflows of $388 million (from Lipper). Junk issuers this week included American Tower $1.25bn, Access Midstream Partners $750 million, Foresight Energy $600 milion, T-Mobile $500 million, Windstream $500 million, TW Telecom $450 million, RR Donnelley $400 million, Crestview $350 million, ACI Worldwide $300 million, Flexi-Van Leasing $265 million, Nustar Logistics $200 million, Shingle Springs Casinos $260 million, Cogent Communications $240 million, and Medical Properties Trust $550 million.

Convertible debt issuers included JDS Uniphase $575 million and Rambus $120 million.

International dollar debt issuers included BNP Paribas $1.25bn, Kommunivest $500 million, Bolivia $500 million, International Finance Corp $500 million, Korea Finance $500 million, Life Finance $187 million and Korea Development Bank $110 million.

Ten-year Portuguese yields fell 20 bps to 6.37% (down 38bps y-t-d). Italian 10-yr yields were unchanged at 4.19% (down 32bps). Spain's 10-year yields dropped 14 bps to 4.36% (down 91bps). German bund yields jumped 20 bps to 1.88% (up 56bps), and French yields rose 16 bps to 2.39% (up 39bps). The French to German 10-year bond spread narrowed 4 to 51 bps. Greek 10-year note yields declined 10 bps to 9.62% (85bps). U.K. 10-year gilt yields surged 24 bps to 2.70% (up 88bps).

Japan's volatile Nikkei equities index added 0.3% (up 31.3% y-t-d). Japanese 10-year "JGB" yields ended the week unchanged at 0.76% (down 2bps). The German DAX equities index increased 0.6% for the week (up 10.2%). Spain's IBEX 35 equities index gained 1.0% (up 8.0%). Italy's FTSE MIB jumped 2.9% (up 8.6%). Emerging markets were mixed. Brazil's Bovespa index jumped 3.3% (down 15.4%), while Mexico's Bolsa fell 1.4% (down 3.8%). South Korea's Kospi index rallied 2.1% (down 3.9%). India’s Sensex equities index declined 1.0% (down 4.3%). China’s Shanghai Exchange gained 0.8% (down 8.8%).

Freddie Mac 30-year fixed mortgage rates were unchanged at 4.40% (up 78bps y-o-y). Fifteen-year fixed rates added a basis point to 3.44% (up 59bps). One-year ARM rates jumped 5 bps to 2.67% (down 2bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 4 bps to 4.64% (up 42bps).

Federal Reserve Credit jumped $31.0bn to a record $3.566 TN. Fed Credit expanded $780bn during the past 45 weeks. Over the past year, Fed Credit was up $672bn, or 23.6%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $717bn y-o-y, or 6.9%, to a record $11.183 TN. Over two years, reserves were $1.047 TN higher, for 10% growth.

M2 (narrow) "money" supply expanded $21.9bn to a record $10.784 TN. "Narrow money" expanded 7.8% ($782bn) over the past year. For the week, Currency increased $0.7bn. Total Checkable deposits slipped $2.3bn, while Savings Deposits jumped $26.7bn. Small Time Deposits declined $2.2bn. Retail Money Funds dipped $0.9bn.

Money market fund assets dropped $44.6bn to $2.622 TN. Money Fund assets were up $49bn from a year ago, or 1.9%.

Total Commercial Paper outstanding rose $15.9bn this week to $1.004 TN. CP has declined $62bn y-t-d and $7bn, or 0.7%, over the past year.

Currency and 'Currency War' Watch:

August 16 – Bloomberg (Jeanette Rodrigues): “India’s rupee sank to a record on concern recent steps to steady the currency will prompt foreigners to rethink investment plans amid speculation the U.S. will pare stimulus next month. Bonds and stocks plunged.”

August 16 – Bloomberg (Gabrielle Coppola and Josue Leonel): “Brazil’s real tumbled the most in 15 months after Finance Minister Guido Mantega said a weaker currency was good for local industry, deepening a selloff sparked by concern the U.S. will curb monetary stimulus. The real depreciated 2.2% to 2.3925 per dollar at the close of trading in Sao Paulo, the worst performance among all currencies tracked by Bloomberg. The real lost 5% this week. Swap rates on the contract due in January 2015 rose 27 bps… to 10.33%. Brazil’s currency has lost 15% in the past three months, boosting the cost of imports and adding to inflation that already exceeds central bank targets.”

The U.S. dollar index added 0.2% to 81.257 (up 1.9% y-t-d). For the week on the upside, the British pound increased 0.8%, the New Zealand dollar 0.8%, and the Taiwanese dollar 0.1%. For the week on the downside, the Brazilian real declined 5.0%, the South African rand 2.7%, the Mexican peso 2.3%, the Japanese yen 1.4%, the Norwegian krone 1.1%, the Singapore dollar 1.0%, the Canadian dollar 0.5%, the Swiss franc 0.4%, the Australian dollar 0.2%, the Swedish krona 0.2%, the South Korean won 0.1%, the euro 0.1% and the Danish krone 0.1%.

Commodities Watch:

The CRB index jumped 2.5% this week (down 0.9% y-t-d). The Goldman Sachs Commodities Index rose 2.4% (up 0.5%). Spot Gold rallied 4.8% to $1,377 (down 17%). Silver surged 14.2% to $23.37 (down 23%). September Crude gained $1.49 to $107.46 (up 17%). September Gasoline rose 2.0% (up 8%), and September Natural Gas advanced 4.3% (up 1%). December Copper gained 1.6% (down 8%). September Wheat slipped 0.4% (down 19%), while September Corn gained 1.7% (down 32%).

U.S. Fixed Income Bubble Watch:

August 16 – Bloomberg (Daniel Kruger): “Holdings of Treasuries in China, the largest foreign lender to the U.S., fell in June for the first time in five months amid discussion by Federal Reserve officials about slowing the pace their bond purchases. China’s stake dropped by $21.5 billion in June, or 1.7%, to $1.276 trillion… The pullback by China comes as overseas holdings of Treasuries have grown $26.8 billion, or 0.5% this year, the slowest pace since a 2.8% decline in the first six months of 2006. Treasuries have lost 3.1% this year…, headed for the worst performance since 2009.”

August 16 – Bloomberg (Brian Chappatta): “Cook County, home to Chicago, had the rating on $3.7 billion of general-obligation bonds cut one level to A1 by Moody’s… because it faces ‘formidable hurdles’ in fixing its pension system. The county of 5.2 million, the second-most-populous in the U.S., is the latest issuer in Illinois to have its rating cut by Moody’s.”

Global Bubble Watch:


August 15 – Financial Times (Tracy Alloway and Arash Massoudi): “Parts of the booming market for exchange traded funds risk worsening broader market sell-offs or triggering crashes, according to two studies released this week. The reports, from the Federal Reserve and Fitch Ratings, come weeks after a sharp sell-off in fixed income sparked scrutiny of certain ETFs and the structure of the industry, which has grown to a market worth more than $2tn. ETFs allow investors quick and easy exposure to a range of assets that might otherwise be difficult to access. But the two reports warn that certain of the investment tools – corporate bond ETFs and so-called ‘leveraged ETFs’ – could destabilise broader markets. ETFs that seek to replicate the performance of corporate bonds risk intensifying a sell-off in the underlying debt, according to… Fitch. Increased ETF trading volumes might ‘amplify overall bond market volatility, as redemptions of ETFs can, in turn, drive selling in the underlying bonds’, Fitch analysts including Robert Grossman and Martin Hansen wrote…”

Bursting EM Bubble Watch:

August 14 – Wall Street Journal (Rogerio Jelmayer and Matthew Cowley): “Brazil's government-run Banco do Brasil SA is pressing ahead with its rapid increase in lending, urged on by the government, even as the economy slows and its private-sector rivals hold back. President Dilma Rousseff and her administration have pressed government lenders including Banco do Brasil to lend more to help jump-start weak economic growth. Low unemployment, rising salaries and ample credit have fueled strong consumer demand, while industry has contracted. Some investors fear that Banco do Brasil, Latin America's largest bank by assets, could be storing up trouble for the future. The economy is showing little sign of a strong recovery, and unemployment levels have started to lift off their recent historical lows. That could lead to more defaults on the new loans Banco do Brasil made during the slowdown.”

August 13 – Bloomberg (Boris Korby and Julia Leite): “More Brazilian issuers are under the threat of rating downgrades than in any other Latin American nation as a sluggish economy erodes the creditworthiness of companies from Petroleo Brasileiro SA to Gol Linhas Aereas Inteligentes SA. Twenty-six borrowers with about $104 billion in dollar- denominated debt have negative outlooks on their credit grades from Moody’s…, Standard & Poor’s or Fitch… That’s three times the number of Mexican companies that may have their ratings cut and almost double the number of Brazilian companies in line for upgrades…”

August 14 – Bloomberg (Rajesh Kumar Singh and Archana Chaudhary): “Power company bonds are India’s worst performing this year as failures in fuel supply inflate coal-import bills and lengthen project delays. Dollar notes sold by electricity generators and distributors lost an average 5.1% through Aug. 12…”

August 16 – Bloomberg (Zahra Hankir): “Egypt’s benchmark bonds headed for the steepest three-day drop in more than a year as the Muslim Brotherhood urged supporters to protest the killing of hundreds in a crackdown that led the government to impose emergency rule. The 5.75% dollar-denominated notes maturing April 2020 fell 4.4% in the past three days.”

Global Credit Watch:

August 16 – Bloomberg (Peter Millard and Rodrigo Orihuela): “Bond investors are writing off an October interest payment from Eike Batista’s OGX Petroleo & Gas Participacoes SA, with the oil producer in jeopardy of running out of cash this month. OGX’s $1.06 billion of notes due 2022 sank 3.5 cents to 14.99 cents on the dollar yesterday after the company said cash reserves plunged 72% last quarter… The bonds have fallen 82% this year, the most in emerging markets, as OGX’s creditors lose confidence in its ability to pay them back as cash dwindles and losses deepen.”

China Bubble Watch:

August 14 – Bloomberg: “China will push ahead with efforts to cull excess industrial capacity a year earlier than planned even as economic expansion slows, and will promote spending on information products to stabilize growth, an official said. The government will complete by the end of 2014 its overcapacity reduction plan for the five years through 2015, and will seek to cut further outdated capacity, China National Radio said…, citing Industry Minister Miao Wei. Premier Li Keqiang has avoided economy-wide stimulus and instead issued targeted policies, including tax breaks and support for small companies, while curbing overcapacity and reining in financial risks to aid economic restructuring.”

August 16 – Bloomberg: “China performed live-fire military exercises in the East China Sea as part of drills the army said were routine, as tensions simmered with Japan over islands in the area claimed by both countries. The military is conducting 10 days of exercises off the coast of Liaoning province… Four Chinese ships entered Japanese waters around the islands, Japan’s coast guard said… The exercises risk further inflaming strains between the two countries a day after China filed a diplomatic protest yesterday over three Japanese cabinet ministers’ visit to a Tokyo shrine seen as a symbol of Japan’s past military aggression.”

Japan Watch:


August 12 – Bloomberg (Keiko Ujikane and Toru Fujioka): “Japan’s economy slowed more than forecast in the second quarter as businesses cut investment, undermining gains in consumer and government spending that helped reduce deflationary pressures. Gross domestic product rose an annualized 2.6% from the three months through March, when it climbed 3.8%... The median of 32 estimates was for a 3.6% gain… The report adds to the debate on whether Japan is strong enough to sustain a planned 3 percentage point bump in the sales tax in April, with Prime Minister Shinzo Abe deciding in coming months on whether to proceed. While consumers continue to propel Japan’s rebound, companies have yet to commit to the Abenomics project, paring capital spending for a sixth straight quarter.”

August 15 – Bloomberg (Naoto Hosoda): “Japan’s preliminary estimate this week that GDP grew at seasonally adjusted annualized pace of 2.6% in 2Q, down from 3.8% in 1Q, is credit negative, Moody’s… says in its Credit Outlook report. Ebbing growth momentum at such an early stage of Prime Minister Shinzo Abe’s economic revitalization strategy jeopardizes its success, according to Moody’s…”

August 13 – Bloomberg (Isabel Reynolds and Takashi Hirokawa): “The bureaucracy that oversaw Japan’s postwar economic boom and a two-decade stagnation faces the biggest threat to its power since the U.S. occupation as Prime Minister Shinzo Abe seeks to seize control of ministries’ most senior appointments. Chief Cabinet Secretary Yoshihide Suga, 64, is leading the initiative, years after he got an education in civil servants’ sway when they frustrated his move as internal affairs minister to shift revenue between regions. The proposal in debate in the ruling Liberal Democratic Party would give the Cabinet Secretariat oversight of top bureaucrats’ promotions. The plan would open a path to accelerating change as Abe, 58, readies steps from strengthening the military to bringing Japan into the U.S.-led Trans Pacific Partnership trade bloc and paring agriculture regulation.”

India Watch:


August 15 – Bloomberg (Jeanette Rodrigues and Ye Xie): “India increased efforts to stem the rupee’s plunge and stop capital outflows that are pushing the economy towards its biggest crisis in more than two decades. The Reserve Bank of India, whose Governor Duvvuri Subbarao steps down next month, cut the amount local companies can invest overseas without seeking approval to 100% of their net worth, from 400%... Residents can remit $75,000 a year versus the previous $200,000 limit… Policy makers’ moves since July to tighten cash supply, restrict currency derivatives and curb gold imports have failed to arrest the rupee’s slump to record lows as they struggle to attract capital to fund a record current account deficit. The rupee has weakened 28% in the past two years, the biggest tumble since the government pledged gold reserves in exchange for loans from the International Monetary Fund in 1991. ‘I don’t think this fixes India’s problem, at best it restricts about $5 billion of flows annually, which doesn’t make a dent,’ Bhanu Baweja, the global head of emerging market cross asset strategy at UBS AG, said… ‘The minute you restrict outflows, people will start legitimately speaking in terms of capital controls, although these are only on locals and not on foreign investors.’”

August 16 – Bloomberg (Rajhkumar K Shaaw): “Indian stocks plunged, with the benchmark index dropping the most in almost two years, amid concern that government efforts to stem the rupee’s slide to a record low will curb economic growth. State Bank of India fell 3.3% to the lowest level in four years. ICICI Bank Ltd. slumped 5.2%. Bharat Heavy Electricals Ltd., India’s biggest power-equipment maker, plunged to the lowest level in eight years… ‘The cost that we are paying as an economy for the stabilization of the rupee is too high, because it has not helped the rupee as much but has harmed the economy,’ Rashesh Shah, chairman of Edelweiss Financial Services Ltd., said… ‘Currency is a fight that very few central banks in the world have been able to conquer.’”

August 15 – Bloomberg (Kartik Goyal): “Indian inflation accelerated more than economists estimated in July as a plunge in the rupee stoked import costs, adding pressure on the central bank to sustain efforts to support the currency. The wholesale-price index rose 5.79% from a year earlier, the fastest pace in five months… The Reserve Bank of India raised two interest rates last month and the government this week stepped up efforts to curb a record current-account deficit, striving to stem the rupee’s 10.3% drop versus the dollar in 2013. Costlier credit imperils economic expansion and poses a policy challenge for incoming central bank head Raghuram Rajan, according to Credit Analysis & Research Ltd. in Mumbai.”

Asia Watch:

August 13 – Bloomberg (Sungwoo Park and Chisaki Watanabe): “Record temperatures across North Asia have killed dozens and pushed electricity grids to near breaking point, forcing governments to introduce emergency measures as more of the same heat is forecast. Air-conditioning in South Korea’s public buildings has been shut off as the government yesterday warned of power shortages. China has opened air-raid shelters as makeshift cooling stations, while thousands in Japan have been hospitalized for heatstroke. ‘We are in a critical situation where, if any single power generator goes wrong, we will have to resort to rolling blackouts just like we did in 2011,’ Yoon Sang Jick, South Korea’s minister of trade, industry and energy, said… Shanghai hit a record 40.8 degrees Celsius (105 degrees Fahrenheit) on Aug. 7… as the city endured its hottest summer in 140 years. In southern Japan, temperatures in Shimanto city peaked at 41 degrees Celsius yesterday, the highest ever recorded in the country…”

Europe Crisis Watch:

August 15 – Bloomberg (Mark Deen): “The bond-market calm that has descended on the euro area in the run-up to next month’s German election masks unresolved conflicts that have frustrated the region’s leaders for more than three years. Greece needs more debt relief, the International Monetary Fund says; Portugal is struggling to exit its support program; Spanish Prime Minister Mariano Rajoy is battling corruption allegations and calls to resign; France faces unrest as Socialist President Francois Hollande follows through on his promise to cut pension-system losses. ‘There is a European ability to turn down the volume on problems when elections are looming,’ said Ludovic Subran, chief economist at Euler Hermes, a Paris-based credit insurer. ‘You can feel that the tough questions have been postponed.’”

August 14 – Bloomberg (Angeline Benoit and Jeff Black): “The euro area’s economy emerged from a record-long recession in the second quarter, led by Germany and France, amid the first sustained period of financial-market calm since the start of the debt crisis. Gross domestic product in the 17-nation euro area rose 0.3% in the April-June period after a 0.3% contraction in the previous three months… Germany and France, the euro area’s two largest economies, both showed faster-than-projected expansions in the quarter. While the overall outlook has improved, the recession pushed the unemployment rate to a record and parts of southern Europe remain mired in a slump, with more than half of young people in Spain and Greece out of work. ‘We’re not seeing a recovery, it’s only a stabilization,’ said Sylvain Broyer, Chief Eurozone Economist at Natixis in Frankfurt. ‘What we need is a pick-up in productive investment and I don’t see that yet. You would need a good three to four quarters of positive growth in the euro area to expect the unemployment rate to edge down.’”

Germany Watch:


August 15 – Bloomberg (Patrick Donahue): “Chancellor Angela Merkel warned against the perils of excessive debt as she began campaigning for Germany’s Sept. 22 election, seeking to defend her lead in the polls to clinch a third term… ‘We’ve seen what can happen if you accumulate too much debt,’ Merkel said. Higher borrowing costs spur rising interest rates, putting businesses in danger, she said. ‘Then you have unemployment -- and at that point you have a spiral.’ Struggling to speak above a group of opposition Social Democratic youth protesters blowing whistles and chanting ‘Merkel out,’ the chancellor said her Christian Democrats are the best guardians of Germany’s economy and labor market.”


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