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Transitions

February 14, 2014

"Risk on" strikes a comeback.
  

Representative Frank Lucas: “…When we undo quantitative easing, what is the effect going to be on things like farm land prices or stock market prices or, for that matter, equities?”

Federal Reserve chair Janet Yellen: “I would agree that one of the channels by which monetary policy works is asset prices, and we have been trying to push down interest rates, particularly longer term interest rates. Those rates do matter to the valuation of all assets, both stocks, houses, and land prices. And so I think it is fair to say that our monetary policy has had an effect of boosting asset prices. We have tried to look carefully at whether or not broad classes of asset prices suggest Bubble-like activity. I’ve not seen that in stocks generally speaking. Land prices I would say suggest a greater degree of overvaluation.”

Lucas: “Because, from the perspective of a number of us the concern about the old analogy - about the put your finger in the balloon and it pops out somewhere else - are concerns that we would potentially, unintentionally of course, create a Bubble similar to what we went through in housing a decade ago, either in farmland prices, or somewhere else. And the consequence of that is just most unnerving. Your predecessor once, in response to a question from me when I asked, ‘when will you know to undo the quantitative easing?’ His response was, ‘we'll know’. And my question then was, well if you didn’t know when the problem was coming, how are you going to know when the problem is fixed to undo? So, I appreciate the challenges you face. I certainly wouldn’t want your job. But then it took us two and a half years to do a farm bill too.”

Yellen: “Well, we will watch asset prices very closely and recognize they can be a sign of excesses that are developing.”

Representative Patrick Murphy: “The collapse of the housing bubble and resulting financial crisis devastated the global economy and cost Americans $17 trillion worth of wealth. Many of us assign responsibility for low interest rates and lax capital and leverage standards to the Federal Reserve and then chairman Greenspan. While I do not believe the Fed caused the crisis, its policies certainly helped fuel the Bubble. In June 2009, you said that higher short-term interest rates might have slowed the unsustainable increase in housing prices. With the benefit of hindsight, would measures to slow the housing bubble have been appropriate?”

Yellen: “I mean, certainly the collapse of housing in the Bubble were devastating and at the heart of the financial crisis. So, of course, yes, with the benefit of hindsight, policies to have addressed the factors that led to that Bubble would certainly have been desirable. I think a major failure there was in regulation and in supervision, and not just in monetary policy. So, I would say going forward, while I certainly recognize - and my colleagues do - that an environment of low interest rates can incent the development of Bubbles. And we can’t take monetary policy off table as a tool to use to address it – it’s a blunt tool. And macro-prudential policies many countries do things like impose limits on loan-to-value ratios - not because of safety and soundness of individual institutions - but because they see a housing Bubble form and they want to protect the economy from it. We can consider tools like that, and certainly supervision and regulation should play a role and their more targeted policies.”

Murphy: “The reason I ask is would you be willing and open to pushing for policies to prevent another catastrophe, if it means the slowing or deflating an asset Bubble? And to sort of follow-up to that, are you seeing any Bubbles out there now or anything you’re concerned about?”

Yellen: “Nothing is more important than avoiding another financial crisis like the one that we just lived through. So, it’s an immensely high priority for the Federal Reserve to do what we can to identify threats to financial stability. One approach that we’re putting in place in part through our Dodd-Frank rulemakings is simply to build a financial system that is much more resilient to shocks. The amount of capital in the largest banking organizations is doubled. We do have a safer and sounder system, and that’s important. But detecting threats to financial stability, we are looking for those threats. I’d say my general assessment at this point is that I can’t see threats to financial stability that have built to the point of flashing orange or red… We don’t see a broad-based buildup, for example, in leverage or very rapid Credit growth. Asset prices generally do not appear to be out of line with traditional metrics. But this is something we're looking at very, very carefully.”

Post-hearing headlines were for the most part consistent: “Yellen to Stay the Course.” “Yellen to Investors: Expect Continuity at the Fed.” And from the Financial Times: “Yellen’s Promise of ‘Continuity’ Lifts Equities and Treasury Yields.”

The markets apparently loved Yellen’s first “Humphrey Hawkins” testimony before the House Committee on Financial Services. Listening intently, it didn’t strike me as all too impressive. Yet the new Fed chair won the day with congeniality, perseverance and, most importantly, a keen focus on maintaining (market-pleasing) policy “continuity.”

The Fed’s activist reflationary policies have been wonderful for asset markets for going on five years. And, sure enough, Dr. Yellen sounded just like her predecessor. She answered the typical questions almost verbatim to Bernanke. They share the same academic mindset and analytical framework. I even winced when she repeated Bernanke’s explanation that global interest rates have remained low because of “an excess of savings over investment.” Yellen doesn’t see problematic excess or Bubbles, or troubling leverage or Credit growth. Apparently the Fed’s balance sheet doesn’t count. For me, it’s all become too reminiscent of the “deer in the headlights” backdrop from late in the mortgage finance Bubble period.

This issue of “continuity” at the Federal Reserve is actually an intriguing one. On the one hand, the markets are comforted with a slow and predictable taper that will see QE continue through most if not all of 2014. Moreover, Yellen parroted Bernanke in leaving open the possibility of extending or even increasing QE. In the world of short-term focused speculative markets, it was all good and business as usual.

Meanwhile, at the Federal Reserve there are incipient indications of policy discontinuity. Yellen may hope to press on with the “Bernanke doctrine,” but other senior Fed officials have different ideas. The so-called policy “hawks” are determined to end the Fed’s balance sheet (“money” printing) operations. Even some centrists are already questioning the economic “threshold” regime. The hawk camp seems emboldened and ready to shift Fed policy back in the direction of traditional policymaking tools and doctrine. The non-doves can these days point to myriad indications of financial excess. The “hawks” can make a strong case that the risks of open-ended QE significantly outweigh the by now depleted benefits.

Federal Reserve Bank of Dallas President Richard Fisher and Federal Reserve Bank of Philadelphia President Charles Plosser have taken the lead in pushing back against the Bernanke doctrine. Interestingly, on Thursday Loretta Mester, a top advisor to Plosser at the Philadelphia Fed, was named President of the Federal Reserve Bank of Cleveland. And with Esther George presiding at the Federal Reserve Bank of Kansas City, there appears a strong nucleus of Federal Reserve Presidents that I expect to play a critical role in framing the policy debate going forward.

Seemingly lost in the discussion is that Dr. Bernanke emerged onto the scene in 2002 with a radical monetary policy framework. Two post-Bubble crisis periods provided fertile ground for the Bernanke doctrine. There was as well a further consolidation of power around the Fed chairman and his close circle. I also believe the global nature of the 2008 crisis and its aftermath further wrested policymaking power to a small cadre of global central bankers. Especially when I listen to recent speeches by Plosser and Fisher, I sense a desire within the Fed system to return to traditional monetary policy doctrine and a more traditional decentralized power structure.

February 14 – Bloomberg (Jason Scott): “The world needs to adjust to the Federal Reserve’s tapering, Australian Treasurer Joe Hockey said, backing a stimulus reduction by the U.S. that sparked market turmoil and emergency measures in some emerging markets. ‘It’s not something that hasn’t been foreshadowed,’ Hockey said… The world can no longer rely on methadone every day. Sooner or later we need to wean ourselves off and that’s what tapering is about… Our own central banks have the responsibility to act in our own national interests… It’s a balancing act. The U.S. Fed can speak for itself, but I don’t see any systemic difficulties in developing nations.’”

Transition at the Fed is an unfolding story, as is how this all will impact global markets. From my perspective, the key issue for two decades now has been the steady intrusion of central banks and governments into contemporary “money” and Credit along with the asset markets. What began with pegging short-term interest-rates evolved into virtual control over the pricing and allocation of system finance. Especially with the 2008 crisis, unprecedented monetary and fiscal stimulus led to historic market distortions on a global basis (“global government finance Bubble”). I’ll further argue that government intrusion into the marketplace “went parabolic” back in 2012 with Draghi’s “do whatever it takes,” immediately followed by open-ended QE from the Fed and then similarly massive QE from the Bank of Japan. Push-back is now coming on multiple fronts.

February 14 – Dow Jones (Christopher Lawton): “The German Constitutional Court’s recent decision to refer questions concerning the European Central Bank’s unlimited bond buying scheme to a top European court shows the program pushes the boundaries of its mandate, the president of Germany's central bank said Friday. Earlier this month, Germany's top court referred questions regarding the legality of the program to the European Court of Justice in Luxembourg, but not before criticizing it as a power grab. Speaking at an event in Bremen, Jens Weidmann, president of the Deutsche Bundesbank, said the court’s decision showed that it shares the concerns previously voiced by Germany's central bank, which has starkly opposed the program since its founding. ‘The court's declaration shows just how far the Eurosystem has stretched the boundaries of its mandate with its announcement to purchase unlimited government bonds of individual member states, if necessary,’ Mr. Weidmann said… The ECB and other central banks will face political challenges to pulling back on their loose policy, he said. The more that the euro zone becomes accustomed to ‘cheap money,’ the more it becomes a substitution for needed structural reforms.”

With the resignation of Prime Minister Enrico Letta, Italy will soon have its fourth government in two years. But with Italian 10-year yields at 3.69% and Italy's equities (FTSE MIB) already up 7.7% in 2014, markets greet the most recent bout of political instability with a smile. Italy is today a poster child for Weidmann’s ‘cheap money’ becoming a substitute for structural reform.

And while on the subjects of Transitions, government intrusion in finance, and “cheap money” distortions, there were more rumblings this week out of the Chinese Credit system. In particular, there were more trusts in trouble, apparently more bailouts, and additional questions surrounding the stability of China’s “shadow banking system” (see “China Bubble Watch”). There was also further evidence that risk aversion is becoming more acute throughout the corporate debt market. Spreads for riskier corporate bonds were said to move to the widest levels in two years.

The “Bernanke doctrine” held that readily available “helicopter money” allowed the Fed to disregard asset Bubbles, while ensuring the U.S. avoided the type of policy mistakes that led to The Great Depression. The Draghi ECB’s “do whatever it takes” was in response to what was viewed as an existential threat to the euro and European integration. Japan’s “Abenomics” monetary inflation was seen as necessary to escape the scourge of twenty years of deflation.

The way I see things, individual policymakers around the globe have believed that reflationary policy benefits greatly outweighed the risks for their respective systems. In the process, however, the old “fallacy of composition” came into play. Concerted “do whatever it takes” “money” printing, market intervention and other reflationary measures in massive proportions inflated an unwieldy historic global Bubble. China has been at the heart of the global Credit Bubble.

February 14 – Bloomberg: “Chinese banks’ bad loans increased for the ninth straight quarter to the highest level since the 2008 financial crisis, highlighting pressures on asset quality and profit growth as the world’s second-largest economy slows… Chinese banks are struggling to keep soured loans in check and extend earnings growth as the slowing economy and government efforts to curb shadow financing make it harder for borrowers to repay debt. Standard & Poor’s… said this week that loan quality will decline in 2014 as banks remain at risk from debt-laden local government financing vehicles and manufacturers with too much capacity… Chinese banks added 89 trillion ($14.6 TN) yuan of assets, mostly through loans, in the past five years, equivalent to the entire U.S. banking industry’s, CBRC data show. By comparison, U.S. commercial banks held $14.6 trillion of assets at the end of September…”

China today illustrates all the key perilous facets of Credit Bubble excess: self-reinforcing over-issuance and mispricing of Credit; government market intrusions, interventions and attendant risk misperceptions; gross misallocation of financial and real resources; overinvestment and malinvestment on an epic scale; corruption, malfeasance and obfuscation; systemic dependency on ever-increasing amounts of high-risk Credit creation; and policymaker confusion and lack of resolve to deal forcefully with Bubble excess.

China’s “shadow banking” problem today encapsulates the inherent risks of contemporary “money” (“financial claims perceived as safe and liquid stores of nominal value”), most prominently money’s dangerous attribute of virtually insatiable demand. Incredible amounts of perceived safe “money” have flowed freely into risky Credits, while people have no idea what they’ve invested in. Credit risk has been further elevated by system-wide Credit excess, resource misallocation and corruption. The historic scope of the Bubble was made possible because of the faith Chinese have in their government and government-backed banking system – as well on an international basis by the perception that Chinese policymakers have everything under control (within a backdrop of massive QE and seemingly unlimited liquidity).

There was a crucial policy debate from the late-twenties that has become increasingly pertinent, especially for Beijing and Washington. In the “Roaring Twenties” there was recognition within policy circles that heightened speculation was fostering financial excess including Credit financing speculative trading and other ventures. At the same time, heightened economic vulnerability and downward pricing pressures had policymakers searching for ways to direct Credit into productive investment and away from speculation. Yet, at the end of the day, the intensity of 1927-1929 “terminal phase” speculative excess ensured that liquidity and Credit flowed disproportionately to inflating market Bubbles. Thoughts, efforts and hopes that policy measures could redirect finance away from market Bubbles and to the real economy ended in complete and utter failure.

The Fed hopes to avoid market turbulence through a protracted QE taper coupled with highly accommodative forward rate guidance. Chinese officials hope to tighten finance oh so gingerly as to restrain Credit excess and asset inflation, while ensuring sufficient Credit to sustain strong economic growth and social stability. I contend that Washington and Beijing are both dealing with late-twenties style “terminal phase” asset and speculative Bubbles. The problem is that “terminal” excess can inflict a tremendous amount of systemic damage in a relatively condensed amount of time. Both the Fed and Beijing seek respective peaceful and continuous Transitions. In reality, time is of the essence.   



For the Week:

The S&P500 jumped 2.3% (down 0.5% y-t-d), and the Dow rose 2.3% (down 2.6%). The broader market was strong. The S&P 400 Midcaps surged 2.9% (up 0.3%), and the small cap Russell 2000 advanced 2.9% (down 1.2%). The Utilities surged 3.4% (up 5.8%). The Banks advanced 1.6% (down 0.6%), and the Broker/Dealers jumped 2.2% (down 2.4%). The Morgan Stanley Cyclicals were up 2.8% (down 1.2%), and the Transports increased 0.9% (down 1.3%). The Nasdaq100 jumped 2.9% (up 2.0%), and the Morgan Stanley High Tech index rose 2.5% (up 2.1%). The Semiconductors surged 4.5% (up 4.5%). The Biotechs jumped 4.1% (up 13.0%). With bullion jumping $51, the HUI gold index surged 11.1% (up 22.8%).

One-month Treasury bill rates ended the week at one basis point and three-month bills ended at 2 bps. Two-year government yields added a basis point to 0.31% (down 7bps y-t-d). Five-year T-note yields rose 5 bps to 1.525% (down 22bps). Ten-year yields increased 6 bps to 2.74% (down 29bps). Long bond yields added 2 bps to 3.70% (down 27bps). Benchmark Fannie MBS yields jumped 7 bps to 3.42% (down 19bps). The spread between benchmark MBS and 10-year Treasury yields widened one to 68 bps. The implied yield on December 2014 eurodollar futures declined one basis point to 0.32%. The two-year dollar swap spread increased 2 to 14 bps, while the 10-year swap spread declined 2 to 11 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined 3 to 64 bps. An index of junk bond risk fell 14 bps to 317 bps. An index of emerging market (EM) debt risk declined 4 bps to 337 bps.

Debt issuance slowed. Investment-grade issuers included JPMorgan $4.25bn, Capital One $2.0bn, Bank of America $1.75bn, CIT $1.0bn, HCP $350 million, and Fifth Street Finance $250 million.

Junk bond funds saw inflows of $1.5bn (from Lipper). Junk issuers included Griffon $600 million, Hunt Companies $525 million, Fresenius US Finance $300 million, Vander Intermediate $252 million, Diamond Foods $230 million, and Meritor $225 million.

Convertible debt issuers included AMAG Pharmaceuticals $175 million, Canadian Solar $150 million, and Imperial Holdings $140 million.

International dollar debt issuers included International Bank of Reconstruction & Development $5.0bn, Barclays Bank $2.75bn, Inter-American Development Bank $2.0bn, Slovenia $3.5bn, European Bank of Reconstruction & Development $1.65bn, Kommunalbanken $1.65bn, Turkey $1.5bn, Bank Nederlandse Gemeenten $1.5bn, British Telecom $1.3bn, Rentenbank $1.0bn, B Communications $800 million, Ineos Group $590 million, Nostrum Oil & Gas $400 million, Playa Resorts $375 million and Stena International $350 million.

Ten-year Portuguese yields added a basis point to 4.94% (down 119bps y-t-d). Italian 10-yr yields were unchanged at 3.69% (down 44bps). Spain's 10-year yields were little changed at 3.59% (down 56bps). German bund yields increased 2 bps to 1.68% (down 25bps). French yields rose 4 bps to 2.28% (down 28bps). The French to German 10-year bond spread widened 2 to 60 bps. Greek 10-year note yields fell 17 bps to 7.59% (down 83bps). U.K. 10-year gilt yields jumped 8 bps to 2.79% (down 23bps).

Japan's Nikkei equities index declined 1.0% (down 12.1% y-t-d). Japanese 10-year "JGB" yields fell 2 bps to 0.58% (down 14bps). The German DAX equities index surged 3.9% (up 1.2% y-t-d). Spain's IBEX 35 equities index gained 0.6% (up 2.2%). Italy's FTSE MIB index jumped 3.8% (up 7.7%). Emerging equities markets were mostly higher. Brazil's Bovespa index increased 0.3% (down 6.4%), and Mexico's Bolsa gained 0.5% (down 4.7%). South Korea's Kospi index was up 0.9% (down 3.5%). India’s Sensex equities index was little changed (down 3.8%). China’s Shanghai Exchange rallied 3.5% (unchanged). Turkey's volatile Borsa Istanbul National 100 index increased 0.4% (down 4.3%)

Freddie Mac 30-year fixed mortgage rates rose 5 bps to 4.28% (up 75bps y-o-y). Fifteen-year fixed rates were unchanged at 3.33% (up 56bps). One-year ARM rates gained 4 bps to 2.55% (down one basis point). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 4 bps to 4.38% (up 24bps).

Federal Reserve Credit jumped $10.5bn last week to a record $4.073 TN. During the past year, Fed Credit expanded $1.056 TN, or 35%. Fed Credit inflated $1.263 TN, or 45%, over the past 66 weeks.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $744bn y-o-y, or 6.8%, to $11.703 TN. Over two years, reserves were $1.452 TN higher for 14% growth.

M2 (narrow) "money" supply jumped $14.9bn to a record $11.058 TN. "Narrow money" expanded $626bn, or 6.0%, over the past year. For the week, Currency was little changed. Total Checkable Deposits surged $109.4bn, while Savings Deposits sank $93.0bn. Small Time Deposits declined $1.8bn. Retail Money Funds added $0.6bn.

Money market fund assets increased $8.0bn to $2.713 TN. Money Fund assets were up $32bn, or 1.2%, from a year ago.

Total Commercial Paper increased $1.3bn to $991 billion. CP was down $55bn year-to-date and declined $94bn over the past year, or 8.7%.

Currency Watch:

The U.S. dollar index fell 0.7% to 80.14 (up 0.1% y-t-d). For the week on the upside, the British pound increased 2.1% the South Africa rand 1.9%, the Norwegian krone 1.6%, the South Korean won 1.0%, the Australian dollar 0.8%, the New Zealand dollar 0.8%, the Singapore dollar 0.7%, the Swedish krona 0.7%, the Swiss franc 0.6%, the Canadian dollar 0.5%, the Japanese yen 0.5%, the Danish krone 0.4%, the euro 0.4% and the Mexican peso 0.3%. For the week on the downside, the Brazilian real declined 0.4% and the Taiwanese dollar slipped 0.1%.

Commodities Watch:

February 12 – Bloomberg: “China’s imports of copper and iron ore climbed to a record in January as demand increased from buyers who used the commodities as collateral to get credit. Shipments of copper advanced 53% to 536,000 metric tons from a year earlier while purchases of the steel-making ingredient increased 32% to 86.83 million tons… ‘Financing could continue to drive significant imports as China’s central bank is unlikely to abandon its tightening bias unless growth disappoints,’ said Sijin Cheng, a commodities analyst at Barclays…”

February 10 – Bloomberg: “Gold consumption and production in China expanded to records as prices that slumped into a bear market spurred sales of jewelry and bars, underlining a shift in global demand from west to east. Bullion increased. Usage surged 41% to 1,176.4 metric tons in 2013 from the year before… China probably overtook India as the largest user last year, according to the producer-funded World Gold Council, which highlighted the eastward shift in global demand as holdings in exchange-traded products contracted by a record.”

The CRB index gained 1.2% this week (up 4.7% y-t-d). The Goldman Sachs Commodities Index gained 0.8% (up 1.2%). Spot Gold jumped 4.1% to $1,319 (up 9.4%). March Silver surged 7.4% to $21.42 (up 10.6%). March Crude added 42 cents to $100.30 (up 2%). March Gasoline rose 2.1% (up 1%), and March Natural Gas jumped 9.2% (up 23%). March Copper increased 0.9% (down 4%). March Wheat jumped 3.6% (down 1%). March Corn increased 0.2% (up 6%).

U.S. Fixed Income Bubble Watch:

February 11 – Financial Times (Tracy Alloway and Vivianne Rodrigues): “The shadows are growing in the corporate bond market as investors turn to derivatives to buy and sell. An increasingly illiquid cash bond market is behind the shift, with banks starting to withdraw from market making. The move to the shadow market has been pronounced in recent weeks. Prices for cash bonds have stayed relatively stable, but debt derivative prices have veered sharply upwards as investors and traders rush to hedge their assets or bet on their performance… The jump in the derivatives index stands in contrast to the subdued price action in the cash index of similar debt… The difference in these performances highlights a dramatic shift in the nature of the corporate bond market, one of the biggest fixed income markets in the world. Liquidity in cash positions has dried up as banks have retreated from the business of trading bonds, encouraging investors to use ‘synthetic’ derivatives to more easily change their positions in the debt.”

February 10 – Bloomberg (Brian Chappatta): “Puerto Rico’s downgrade to junk by a second ratings company is set to realign $13 billion of debt in Barclays Plc indexes that serve as benchmarks for most municipal mutual funds. The company’s broadest muni index requires that for issuers with three ratings, two must be investment grade. The U.S. commonwealth was cut to junk by Standard & Poor’s on Feb. 4 and by Moody’s… three days later. Puerto Rico bonds represent 2.5% of the $1.28 trillion Barclays benchmark… The downgrades will alter benchmarks used by 82% of municipal mutual funds, including nine of the 10 largest, Morningstar Inc. data show.”

February 12 – Bloomberg (Brian Chappatta and Michelle Kaske): “Puerto Rico plans what may be a record sale of junk-rated municipal bonds as the struggling U.S. commonwealth moves to allay Wall Street doubts that it can access capital markets. The general-obligation deal will take place by mid-March, Government Development Bank Chairman David Chafey said… Though officials plan to borrow $2 billion through bonds, lawmakers are working on a bill authorizing as much as $3.5 billion of general obligations… If the deal exceeds $1.2 billion, it would be a record junk borrowing in the $3.7 trillion municipal market… After the rating reductions, ‘you have the loss of investment-grade mutual funds and the question becomes where demand comes from,’ said Matt Fabian, a managing director at… research firm Municipal Market Advisors. ‘You’re relying on opportunistic investors and high-yield funds.’”

February 14 – Financial Times (Andrew Bolger): “Investors have been warned by Fitch that losses from the next leveraged finance default cycle may be significantly in excess of previous cycles. The agency said this reflected weakening new-issue rating mix in bond and loan markets as leverage levels rise and covenants become increasingly lax, notably in the US but also in Europe. ‘Knowledge of insolvency regimes will be critical to cross-border investors when determining recovery and pricing in relative creditor rights,’ said Sharon Bonelli, Fitch’s managing director in US corporates. Fitch estimated high yield bond and loan volumes reached about $3tn at the end of 2013 across rated European and US markets, and said the UK, Germany and France were the jurisdictions with the most speculative grade bond and loan market issuers in Europe.”

February 11 – Financial Times (Vivianne Rodrigues): “The global sell-off in risk assets is taking some of the shine off US junk bonds after a multiyear rally that has kept yields on the securities near historical lows. As US stocks have eased from record highs and volatility jumped in the aftermath of the rout in emerging markets, investors have started to redeem money from mutual funds and exchange traded funds that track junk-rated debt. Late last week Lipper… said investors had pulled a further $972m from those funds and ETFs that bet on junk bonds in the week ending February 5, bringing total withdrawals so far this year to $1.4bn. Investors favoured funds that invest in corporate bonds with higher credit quality and US Treasury securities.”

February 10 – Bloomberg (Charles Mead and Alex Barinka): “International Business Machines Corp.’s borrowing costs are rising even as those of its peers fall, underscoring concerns that the world’s largest seller of computer services is struggling to find its place in the cloud. IBM sold 10-year bonds last week with a 3.625% coupon, exceeding the cost of similar-maturity 3.375% notes issued in July even as average yields for debt in the company’s AA rating tier contracted.”

Federal Reserve Watch:

February 12 – Bloomberg (Caroline Salas Gage and Jeff Kearns): “Federal Reserve Bank of St. Louis President James Bullard said the Fed will probably signal the path for interest rates based on ‘qualitative’ judgments of the economy, moving away from a pledge to begin considering higher rates when unemployment falls below 6.5%. Policy thresholds -- committing the Fed to record low rates so long as the outlook for inflation doesn’t exceed 2.5% and unemployment is 6.5% or higher – ‘have been very useful’ and ‘served their purpose’ by anchoring interest-rate expectations when unemployment was ‘much higher,’ Bullard said… The jobless rate unexpectedly declined in January to 6.6%..., just above the Fed’s 6.5% threshold for considering an increase in the benchmark interest rate. ‘We all knew the day would arrive when the unemployment rate would go through the threshold,’ and the ‘natural thing to do’ is to switch to more qualitative guidance, he said.”

February 11 – Bloomberg (Steve Matthews): “Federal Reserve Bank of Dallas President Richard Fisher says… that ‘fault in our economy lies not in monetary policy but in a feckless federal government.’ ‘Fiscal policy is not only not an ally of U.S. growth, it is its enemy… the most vital organ of our nation’s economy —- the middle-income worker -- is being eviscerated.’ Fisher reiterates that there is little ‘efficacy derived from additional expansion of the Fed’s balance sheet. This is why I’ve been such a strong proponent of dialing back our large-scale asset purchases.’”

U.S. Bubble Watch:

February 12 – Bloomberg (Liz Capo McCormick): “Increased use of equities collateral in the U.S. market for borrowing and lending securities may heighten regulators focus on the risks of rapid asset sales disrupting financial markets, according to Fitch… Repurchase agreements, known as repos, backed by equities rose 40% during the year ended Jan. 10… Rising equity-collateral usage combined with a slide in repos backed by government securities pushed equities share to 9.6% of the $1.55 trillion tri-party repo market in January, up from 5.7% a year earlier, Fitch said… ‘One reason for the equity-backed repo increase is because of the higher yield available on them, that is, from the lenders perspective,’ Robert Grossman, managing director of macro credit research at Fitch… said… ‘All other things being equal, in a distressed market the nongovernment collateral can have more liquidity issues. One of the policy issues on the horizon is fire-sale risk.’”

February 12 – Bloomberg (Michelle Jamrisko and Ilan Kolet): “Five years into the U.S. economic expansion, inflation shows little sign of picking up as prices rise more slowly for goods and services from automobiles to medical care, complicating the Federal Reserve’s drive to guide the economy away from the precipice of deflation. The personal consumption expenditures price index, minus food and energy costs, rose 1.2% in 2013, matching 2009 as the smallest gain since 1955. Of 27 categories of goods and services in the gauge, 18 showed smaller price increases over the past two years… The slowdown has been broad-based, with durable goods such as autos, nondurables like clothing and services including health care all playing a role… ‘There’s a lack of pricing power in most areas of the economy,’ said Laura Rosner, an economist at BNP Paribas… and a former researcher at the New York Fed. ‘In certain months we see weakness in medical care, and then that passes on to apparel prices in other months. It’s a weakness that never quite fades.’”

February 13 – Bloomberg (Shobhana Chandra): “Sales at U.S. retailers declined in January by the most since June 2012 amid bad weather and uneven progress in the labor market, signaling the economy was off to a slow start in 2014.”

February 12 – Bloomberg (Michael McDonald): “Donations to U.S. colleges and universities rose 9% to a record $33.8 billion in the year through June as stock market gains fueled giving. Stanford University led all institutions… The school… raised $931.6 million in donations, after setting a single-year record in 2012 by collecting more than $1 billion.”

February 11 – Bloomberg (Prashant Gopal): “Prices for single-family homes rose in 73% of U.S. cities in the fourth quarter, fewer than in the previous three months, as surging values in the past two years started to reduce affordability. The median transaction price for an existing home climbed from a year earlier in 119 of 164 metropolitan areas measured… In the third quarter, 88% of markets had increases… Values have been rising faster than incomes, particularly in the West, the Realtors group said.”

February 13 – Los Angeles Times (Andrew Khouri): “Southern California home buyers continue to turn their backs on an expensive market with few houses for sale. Home prices fell 3.8% in January compared with December… DataQuick reported… The price decline, coupled with falling sales, revealed a market that has lost momentum after an explosive price run-up in the first half of 2013. ‘Buyers are not overpaying,’ said Broker Derek Oie, owner of Century 21 the Oie Group… ‘They know the market has changed.’ January's median home price, $380,000, is the lowest since May. The year-over-year gain — prices rose 18.4% since January 2013 — is the smallest increase since November 2012. In the six-county Southland, 14,471 new and resale condos and houses changed hands last month, a three-year low for a January… Sales were 9.9% below January 2013 levels and have now fallen year-over-year for four consecutive months. ‘The pause is related to a deterioration in affordability,’ said Stuart Gabriel, director of UCLA's Ziman Center for Real Estate. ‘The urgency to buy has essentially evaporated.’”

February 10 – Bloomberg (Elizabeth Campbell): “Record-high U.S. beef prices offer little comfort to California rancher Kevin Kester, whose family has been raising cattle since 1867. He’s just trying to avoid losing his herd to the state’s worst drought ever. The dry spell withered pastures on Kester’s 22,000-acre ranch near Paso Robles, 175 miles (282 kilometers) north of Los Angeles, forcing him to sell 20% of his cows to avoid extra hay-feeding costs… Without rain in the next 60 to 90 days, Kester said he’ll sell all his cows. ‘Purchasing hay is unsustainable financially,’ Kester, 58, said… ‘Neighbors and friends in our part of the state are selling most or all of their cows because they don’t have any other options. Unfortunately, there will be way too many of them that end up going out of business permanently.’”

Global Bubble Watch:

February 10 – Financial Times (Henny Sender): “China’s vast development bank has begun asking some international clients to postpone drawing down previously committed credit lines, in moves that highlight how strains on the country’s financial system are reverberating abroad. Regulators in China have been trying to rein in rapid credit growth by making it harder for banks to move assets off their balance sheets, and by pushing up the cost of borrowing in the money market. This crackdown has been aimed in large part at the country’s shadow banks… But the impact has been felt throughout the financial sector, even hurting China Development Bank, a lender fully owned by the state. CDB has asked several foreign clients in recent months to delay drawing down lines of credit that had previously been offered, according to individuals with direct knowledge of the matter.”

February 13 – Dow Jones (Fiona Law): “Debt-thirsty Chinese property developers are flocking to the bond market, selling more debt than their North American counterparts combined. Real-estate companies from the world's No. 2 economy have issued $7.9 billion worth of bonds so far this year, according to Dealogic… Although the amount is a tad less than the record $8.0 billion sold a year earlier, it exceeds the $7.6 billion sold by U.S. and Canadian property firms so far this year. The U.S. is in the second spot with $5.7 billion…”

February 13 – Bloomberg (Katya Kazakina): “Francis Bacon’s painting of his lover fetched 42.2 million pounds ($70.3 million) at Christie’s in London today, including fees, the highest price paid for a single-panel work by the artist. The 6-foot-tall 1966 canvas, ‘Portrait of George Dyer Talking,’ depicts a male figure contorted on a stool underneath a bare light bulb in the middle of a room with curved, lilac walls that evoke an arena.”

EM Bubble Watch:

February 14 – Bloomberg (Ye Xie): “Less than two months into 2014, global investors pulled more money out of emerging-market stock and bond funds than the total amount they retracted last year. Investors withdrew $4.5 billion from funds in the week through Feb. 12, extending the total outflow this year to $29.7 billion, according to Barclays Plc, which cited… EPFR Global. In 2013, a total of $29.2 billion left funds investing in emerging-market assets. Capital outflows are showing no signs of abating even as stocks and currencies from developing nations rose this month following the biggest equity losses in January since 2009.”

February 12 – Bloomberg (Ye Xie and John Detrixhe): “Foreign-exchange reserves are emerging as the latest battleground between traders and developing nations trying to stem the worst rout in their currencies since 2008. Nations with the smallest reserves to fend off currency speculators will continue to see their exchange rates under pressure, options prices show. Of the 31 major currencies tracked by Bloomberg, traders are most bearish on Argentina’s peso, Turkey’s lira, Indonesia’s rupiah and South Africa’s rand, while the forwards market signals that Ukraine’s hryvnia will fall 20 percent in a year. ‘If you start to burn too quickly through your foreign reserves, it’s an ominous sign -- and of course in the forex market, they smell blood,’ Robbert Van Batenburg, the director of market strategy at broker Newedge Group…, said… ‘It creates this domino effect.’”

Brazil Watch:

February 13 – Bloomberg (Francisco Marcelino): “Banco do Brasil SA, Latin America’s largest bank by assets, said fourth-quarter profit fell 24%, missing analysts’ estimates, as provisions for bad loans and expenses climbed… Banco do Brasil, led by Chief Executive Officer Aldemir Bendine, 50, said its fourth-quarter provisions rose 15% to 4.19 billion reais… The federally controlled bank expects net interest income to grow between 3% and 7% this year, while lending will expand 14% to 18%... The loan book climbed 19% to 692.9 billion reais in 2013 from a year earlier…”

February 11 – Bloomberg (Gerson Freitas Jr., Anna Edgerton and Matthew Malinowski): “Brazilian soybean and corn growers will reap less than previously forecast as heat and drought harm crops in several parts of the country, the government said. Corn output is estimated at 75.5 million metric tons, down from 79 million forecast last month… The dry spell may affect forecasts further in future reports, Conab President Rubens Rodrigues dos Santos told reporters in Brasilia. The worst drought and heat in decades is threatening farm output, pastures, hydro-dam reservoirs and home water supplies in the world’s top soybean-exporting country and second-biggest shipper of corn.”

February 10 – Bloomberg (Blake Schmidt): “A drought that’s reduced water levels of Sao Paulo’s main reservoir system to the lowest in a decade is saddling bond investors in Brazil’s largest water and sewage company with the worst losses in seven months. Cia de Saneamento Basico do Estado de Sao Paulo’s notes due 2016 have fallen 1.43 cents in the past month… as the company offers discounts to consumers who conserve water in a move Moody’s… projects may cut profit by 11%... The driest December and January in Sao Paulo on record has left four reservoirs used by Sabesp at 19.6% capacity and fueled speculation the government may impose water-rationing measures.”

China Bubble Watch:

February 10 – Bloomberg (Steve Matthews): “China’s central bank signaled that volatility in money-market interest rates will persist and borrowing costs will rise, underscoring the risk of defaults that could weigh on confidence and drag down growth. ‘When the valve of liquidity starts to tame and curb excessive credit expansion, money-market rates, or the cost of liquidity, will reflect that,’ the People’s Bank of China said… ‘The market needs to tolerate reasonable rate changes so that rates can be effective in allocating resources and modifying the behavior of market players.’ The near-default of a shadow-banking product last month and two cash crunches last year highlight the challenge for policy makers pursuing twin goals of deregulating interest rates and reining in an unprecedented credit boom. Higher and more volatile interbank borrowing costs may squeeze speculative and wasteful lending even as it leaves some banks and debt providers with funding difficulties.”

February 11 – Bloomberg: “China’s banking regulator ordered some of the nation’s smaller lenders to set aside more funds to avoid a cash shortfall, three people with knowledge of the matter said, signaling rising concern that defaults may climb. China Banking Regulatory Commission branches asked some city commercial banks and rural lenders to strengthen liquidity management this year, the people said…”

February 10 – Bloomberg: “The extra cost to borrow for China’s riskiest companies is at the highest in 20 months as soaring interest rates heighten concern the nation will experience its first onshore bond default. The yield gap on five-year AA- notes over AAA debt jumped 27 bps last month to 224, the most since June 2012… Ratings of AA- or below are equivalent to non-investment grades globally, according to Haitong Securities… The failure of coal companies to meet payment deadlines for trust products has increased concern over debt defaults, with the equivalent of $53 billion of bonds sold by renewable energy, construction materials, metals and mining companies due in 2014.”

February 13 – Reuters (Gabriel Wildau): “Six Chinese trust firms have lent more than 5 billion yuan ($824.6 million) to a delinquent coal company, state media reported on Friday, raising the prospect of further defaults in China's so-called shadow banking system. In addition, investors in a trust product already in default have pledged to seek repayment not only from the trust firm itself, but also from China Construction Bank, the country's second-largest lender, which acted as sales agent for the high-yield investment products issued by Jilin Province Trust Co Ltd... Bankers have warned that China's lenders are exposed to vast swathes of loans extended by their non-bank partners and sold to bank clients as off-balance-sheet wealth management products. Though banks are not legally responsible for repaying investors in such cases, they may face pressure to do so in order to maintain their reputations and uphold social stability. ‘A few days ago, we went looking for CCB. CCB's leader in Shanxi still says it's not his responsibility. In the end, if they really don't take responsibility, we'll go to CCB and fight a war to the last drop of blood,’ the paper quoted an unnamed product investor as saying.”

February 14 – Bloomberg: “China Development Bank Corp., the nation’s largest policy lender, will lend Shanxi Liansheng Energy Co. 2 billion yuan ($330 million) so it can repay funds from trust products, the 21st Century Business Herald reported. The loan is part of a restructuring plan created to help the coal miner repay debts after falling prices for the fuel and expansion into the cement, real estate and power industries eroded its ability to do so…”

February 12 – Bloomberg (Steve Matthews): “The singling out of three debt types most at risk by the People’s Bank of China has prompted Nomura Holdings Inc. to warn that rising borrowing costs will make it even harder to avoid a default by these issuers. The PBOC will enhance monitoring of local government financing vehicles, industries with overcapacity and property developers to prevent default risks from spreading, according to its fourth-quarter policy report issued on Feb. 8… ‘The three industries singled out by the PBOC are the most likely to have defaults this year,’ Zhang Zhiwei, Nomura’s… chief China economist, said… ‘Individual LGFV defaults will happen this year, but are unlikely to lead to a systemic financial crisis as the central government is expected to intervene.’”

February 13 – Bloomberg (Francisco Marcelino): “China’s trust assets surged 46% in 2013 to a record 10.9 trillion yuan ($1.8 trillion), underscoring investor interest in products that pay more than bank deposits even as default risks mount. About 20 billion yuan of trust products had repayment difficulties in 2012, accounting for 0.27% of the industry’s assets at that time, the China Trustee Association said… Asset quality is ‘quite sound and systemic risks are impossible’ with 9.06 billion yuan of reserves set aside, the association said.”

February 12 – Financial Times (Josh Noble): “A Chinese mining company, whose flamboyant boss made headlines for spending $11m on his daughter’s wedding, has defaulted on a $50m trust loan, underlining the stresses in China’s vast shadow banking system. The investment product, which was backed by loans to coal miner Liansheng Resources, failed to repay investors on Friday… Though this tranche – the fourth of six – is now technically in default, investors may yet see some of their money returned under a restructuring of the company. Liansheng has previously failed to repay investors on earlier tranches of maturing trust loans, having borrowed a total of Rmb1bn ($165m). The fortunes of Liansheng and its charismatic founder, Xing Libin, have been a mirror of the rise and fall of China’s coal mining sector. Mr Xing was reported to have bought mining rights for the ‘price of a cabbage’, before building his company into a big player in the sector.”

February 11 – Wall Street Journal (Lingling Wei and Paul Mozur): “China’s technology giants are marching onto the turf of the country’s state-controlled banks, soaking up tens of billions of dollars' worth of investor money. Now, Chinese regulators are taking notice. China's central bank is leading a government effort to stem potential risk from a new generation of popular online Chinese investment products… Officials are looking to develop regulations aimed squarely at products offered by an affiliate of e-commerce giant Alibaba Group… as well as by rivals Tencent Holdings Ltd. and Baidu Inc. The products offer higher yields than bank deposits and are easy to access with smartphones and other gadgets. But some Chinese officials worry that investors often don’t know where their money is being placed… The worries come amid broader concerns about potential disruptions in China's vast but opaque shadow banking system.”

February 13 – Wall Street Journal (Aaron Back): “Sooner or later, someone in China's trust-products universe is going to lose real money. Weeks after a hasty bailout was arranged for a troubled Chinese trust product, another shadow lender, Jilin Trust, has failed to make payments on tranches of an investment product that came due over the past few months. Jilin is set to miss another payment next week. Once again the product in question is linked to a troubled coal miner, and was sold to investors by one of China's big four state banks, in this case China Construction Bank. The product's six tranches amount to nearly 1 billion yuan, or around $165 million… Bernstein Research estimates that about 40% of the nearly 10 trillion yuan ($1.649 trillion) in trust products outstanding will mature this year. The trust companies themselves are thinly capitalized, with an equity base equivalent to 2.6% of assets under management. A feedback loop could form: Investors steer clear of new trust products, and trust companies are then unable to roll over old loans to stressed borrowers, causing more defaults… The China Trustee Association says 35% of trust assets are invested in the infrastructure, energy, mining and real-estate sectors. Nomura economist Zhiwei Zhang reckons the true proportion is over 50%.”

February 10 – Wall Street Journal (Shen Hong): “Borrowing costs for Chinese companies are rising strongly, a shift that could herald weaker corporate profits, slower economic growth and even the first defaults by increasingly indebted corporations on the mainland. Driven by a surge in borrowing in recent years, Chinese companies amassed an estimated $12.1 trillion worth of debt at the end of last year, according to Standard & Poor's. That compares with an estimated $12.9 trillion for U.S. businesses, now the world's most indebted. The ratings company estimates that debt at Chinese companies is poised to exceed the U.S. total this year or next. ‘The leverage in the corporate sector is already very high and does pose a latent risk to the entire economy,’ said Shuang Ding, an economist at Citigroup… Challenges for companies are mounting as the government tightens credit and investors demand higher yields to fund borrowers.”

February 12 – Financial Times (Lucy Hornby): “China land sales hit a record $672bn in 2013 following a lull the previous year, providing more evidence that the country’s property market is once again in full throttle. But although construction activity is likely to bolster the economy in 2014, there are signs that land sales could slow, weakening local governments’ ability to raise money. Land sales hit Rmb4.1tn…, eclipsing the previous record of Rmb3.5tn in 2011. Land zoned for real estate use, which accounts for about one-quarter of zoned land sales, rose by nearly 27% year-on-year."

February 12 – Bloomberg: “China’s export and import growth unexpectedly accelerated in January, defying signs the world’s second-largest economy will slow while fueling speculation that fake shipments are resurfacing. Overseas shipments rose 10.6% from a year earlier…, a pace that may be distorted by false invoices and holidays and compares with the median projection of economists for a 0.1% gain. Imports advanced 10%, leaving a trade surplus of $31.9 billion, the widest for January since 2009.”

February 13 – Bloomberg (Francisco Marcelino): “Passenger-vehicle sales in China last month rose less than analysts estimated, adding to signs that the world’s second-largest economy is slowing. Wholesale deliveries of cars, multipurpose vehicles and SUVs climbed 7% to 1.8 million units last month… That’s the lowest growth since sales fell in February 2013… Growth in the world’s largest auto market is slowing as anti-pollution and austerity campaigns spread.”

India Watch:

February 10 – Bloomberg (Anto Antony and Anoop Agrawal): “Moody’s… predicts India’s tighter credit-assessment rules will boost soured debt at banks from a decade high, while Fitch… sees higher interest rates fueling defaults. Reserve Bank of India regulations taking effect on April 1 require lenders to take steps to identify potential distressed assets early and work with each other to restructure them or face penalties. The cost of insuring the debt of State Bank of India against non-payment for five years rose 92 bps in the past year to 295…”

Latin America Watch:

February 12 – Bloomberg (Eric Martin and Carlos Manuel Rodriguez): “Mexico’s central bank said… it is monitoring pressures that may fan consumer prices after the balance of risks for inflation deteriorated. Inflation rates will be higher than the upper limit of the 2% to 4% target in some months of the second half of this year…, the central bank said in its quarterly inflation report…”

Europe Watch:

February 12 – MarketNews International (Johanna Treeck): “European Central Bank Governing Council member Jens Weidmann said… that a central bank of a monetary union needs strict limits to its flexibility to ensure independence. …Weidmann underlined the importance of an independent central bank able to ensure price stability for economic prosperity. ‘Especially in a complex construct like the European Monetary Union, the independent central bank needs fixed boundaries to its flexibility - such the prohibition of monetary financing - to avoid its independence being called into question,’ Weidmann said. ‘Only then it is guaranteed that the goal of price stability will not become secondary to securing government solvency even in time of crises,’ Weidmann, who also heads the Bundesbank, added.”

February 11 – Financial Times (Hugh Carnegy): “France is in danger of missing its deficit reduction targets, risking a ‘serious blow’ to the country’s financial credibility, the national auditor has warned. In a sobering counter to President Fran├žois Hollande’s latest pledge to cut France’s big public spending and tax bill, the Cour des Comptes called on the Socialist government to make a bigger effort to reverse the rise in public debt, set to top 95% cent of national income this year. ‘Any further delay in the consolidation of the public finances will translate into a worrying divergence with our European neighbours, a large amount of new debt and would be a serious blow to the financial credibility of France,’ said Didier Migaud, the body’s president. He said France’s debt level was in the ‘danger zone’, adding that a 1 percentage point rise in interest rates would add €2bn a year to an annual interest charge already running at €52bn.”


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