Equity market internals have turned increasingly unsettled.
In last Wednesday’s press conference, Janet Yellen upset the markets with her comment suggesting that the Fed might commence rate adjustments as early as six months after it concludes its latest QE program. Several officials have since tried to reassure market participants that the Fed has not moved forward its plans to raise rates. Even hawkish Fed officials went to pains to communicate that rate moves were not in the immediate offing.
Clearly, the Fed’s strategy is to do its utmost to reduce market uncertainty. The FOMC is moving forward methodically to wind down its balance sheet operations, while telegraphing an ultra-cautious rate policy (future, future little “baby steps”).
The Fed has good reason to worry about the markets and fret the issue of “uncertainty.” And it’s difficult to envisage a more transparent – and market-friendly - interest rate policy. When markets are in a good mood, it’s virtual nirvana. Financial markets – in particular stocks and corporate Credit – can enjoy splendid market excess without concern that the Fed might choose to “lean against the wind” of destabilizing speculation. And for the Fed to actually get rates to what would be considered “slamming on the brakes” – harsh enough to puncture powerful market Bubbles – well, that would be years away (most likely never).
Yet I would argue the notion that the Fed is capable of bridling market uncertainty is a Bubble mirage. Thus far, our central bank has been successful in keeping the markets focused on rate policy. Meanwhile, a great uncertainty furtively lurks: What will the end of Fed “money” printing mean for U.S. and global markets, the emerging economies and the U.S. and global economies more generally?
The entire QE (quantitative easing) issue/analysis is incredibly fascinating. Since September 2008, the Fed’s balance sheet has ballooned from about $900bn to $4.227 TN. If tapering runs its expected course, QE will end late this year with the Fed’s balance sheet near $4.5 TN. This would leave the latest round of QE totaling almost $1.7 TN, with the Fed’s balance sheet having expanded (a parabolic) 60% in two years. This would also place total Fed asset growth at $3.6 TN, or 400%, in six years.
And why do I posit that the notion of the Fed harnessing uncertainty is a mirage? Because the Fed doesn’t have a clue as to the consequences of the $3.6 TN of liquidity it has pumped into the markets since 2008. And I don’t say this flippantly. Best I can tell, the Federal Reserve has not even attempted a comprehensive study of how this massive liquidity injection has flowed through the Treasury and MBS markets, U.S. financial markets more generally, global markets and financial systems, and economies at home and abroad. They have just remained determined to keep pumping it out there, supposedly to fight heightened deflationary forces. The Bernanke Fed had a theory.
In admittedly superficial analysis (from my perspective), I’ve in past analyses tried to differentiate the widely-divergent effects of QE1, QE2 and (“open-ended”) QE3. Past analysis tried to explain how QE1 was largely a shift of positions from leveraged players onto the Fed’s balance sheet. While this had a profound impact on sentiment, it didn’t really function as a direct injection of liquidity into the markets. QE2, on the other hand, was injected directly into a marketplace with a powerful propensity (“inflationary bias”) for purchasing/speculating in U.S. fixed income and the emerging markets. QE2 fueled “blow off” excesses, proving most destabilizing for EM markets and economies. QE3 has been an altogether different creature. With bond and EM Bubbles having already begun to falter, the Fed’s (along with the BOJ’s) liquidity onslaught predominantly spurred speculative “blow off” dynamics in U.S. equities and corporate debt.
When addressing QE effects, Fed speakers (and papers) focus on basis point declines in Treasury and MBS yields, along with adjustments in the structure of term premiums (the yield curve). Dr. Bernanke’s theories held that Fed “money” printing could ensure a rising rate of inflation (i.e. central banks could inflate away problematic debt loads). Now, as the biggest QE yet begins to wind down, most notions of how Fed “money” printing operations actually function are (over)due for a thorough reexamination. After all, in the face of what will be $1.6 TN of new liquidity, bond yields rose and CPI declined. Stocks, on the other hand, went on a historic moonshot. In corporate Credit, it became 2007 reincarnate.
When the Fed was discussing its so-called “exit strategy” back in 2011, I was writing there would be “No Exit.” Well, the Fed has since doubled the size of its balance sheet. And I just don’t see how the Fed can inflate liquidity from $900bn to $4.5 TN and then just shut down the “printing presses” – that is, without some major consequences for the general liquidity backdrop. The history of monetary inflations provides unequivocal support for this view.
Conventional thinking, well, it simply could not see things more differently. Most believe that QE has had minimal effect, so ending the program will be inconsequential. The bulls (these days that means just about everybody) believe stock prices have been driven higher by robust earnings. The economic recovery has seen a superior economic structure generate outsized corporate profits. The economy drives the markets – and not vice versa. From this viewpoint, QE is for the most part insignificant.
The commonly held view of limited QE impact is driven by another momentous “flow of funds” misperception. Even top Federal Reserve officials these days believe that QE has thus far exerted minimal impact because Fed “liquidity” has been sitting inertly as “reserves” on the banking system balance sheet. I say “another” misperception, because I am constantly reminded of how the profound market impacts of Fannie, Freddie and the FHLB went unrecognized for years (especially 1994-2004) during a protracted Bubble period. The view then was that “only banks create money and Credit.” Somehow, a historic inflation in GSE Credit unfolded with barely a notice from Wall Street analysts or the Fed. The view today is that there is little impact from the Fed’s balance sheet so long as QE is held as “reserves” by the banks.
There is definitely confusion on the issue of “flow” versus “level” analysis. In QE operations, the Fed “Credits” accounts with new purchasing power as it consummates purchases of Treasury and MBS securities in the marketplace. Essentially, the Fed creates new electronic liabilities (“IOUs”) that provide immediate liquidity/purchasing power (“money”) to the seller of securities. Importantly, these liabilities will exist until the Fed liquidates securities and uses the proceeds to pay down its IOUs. To be sure, Fed operations dictate the “level” of its liabilities. Moreover, these liabilities by design are held by financial institutions that have a clearing relationship with the Fed, largely U.S.-operated financial institutions.
At a point in time, the “level” of “reserves” liabilities created by the Fed will be held as banking system assets (it’s just “accounting”). But this basically tells us nothing in regard to the transactions that took place between the Fed’s purchase and the eventual deposit of this liquidity into the banking system. Moreover, the “level” of “reserves” informs us nothing about the “flows” – flows that could be in the hundreds of billions or more on an intra-day basis (who knows?). And it is these transactional “flows” that have profound impacts on market dynamics and pricing.
From my perspective, it’s all rather obvious that the greatest QE3 impact has been the stoking of Bubbles in U.S. equities and corporate Credit. I’ve used the example of the Fed purchasing Treasuries and MBS from a rather large “bond” fund suffering redemptions. In this case, Fed liquidity would then be used to fund bond investor outflows that find their way to, say, a major U.S. equities ETF. The ETF then uses this liquidity to buys stocks, providing the sellers the liquidity to buy other securities (or things). Another example would have Fed liquidity accommodating a rotation of hedge fund positions from bonds to equities. In this example, a hedge fund might sell a (underperforming) 10-year Treasury note to purchase an outperforming Facebook stock. And if the seller is Mark Zuckerberg, a chunk of his sales proceeds will boost California and federal income tax receipts (quickly spent by both governments). Zuckerberg’s employees can use stock sale proceeds to buy homes and luxury automobiles (and planes!). And Zuckerberg can use booming Facebook stock as currency to buy companies in a hotly contested industry acquisition boom.
And with 2013/early-2014 too reminiscent of Nasdaq 1999, one should not understate the role QE3 has played in stoking another historic Bubble and “arms race” throughout the broadly-defined “technology” sector. The mad dash for hits, clicks, likes, advertising dollars and revenues throughout “social media,” the “cloud,” 3D printing, solar, etc. even surpasses 1999 – whether the bulls are willing to admit as much or not. At this point, it’s a full-fledged mania (again).
It’s ironic – and I believe really important. The Bernanke Doctrine holds that the Fed’s printing press can basically guarantee a rising general price level. Meanwhile, QE1-3 liquidity has ensured that only more and bigger companies from Silicon Valley to China to “Hollywood” provide a virtually limitless supply of smartphones, computers, tablets and electronic gadgets, along with a plethora of downloadable content and services. Throughout the markets and the real economy, it’s all leading to unusual price instabilities (which the Fed is expected to counter – of course, with only more QE).
As much as it is reminiscent of the late-nineties, the more apt comparison is to the Roaring Twenties. Major technological innovation throughout the 1920’s had unappreciated consequences for the economic structure and price dynamics more generally. Misunderstanding the forces behind the downward pressure on many prices, the Federal Reserve remained too highly accommodative for too long. In the process, the Fed harbored a prolonged period of deep economic maladjustment, while fostering a historic speculative financial Bubble.
From my reading of history, central banks must be especially diligent with respect to monetary stability (“money” and Credit) during periods of profound technological and financial innovation. Repeating mistakes from the Twenties, the Fed and global central bankers have again done the exact opposite (for a long time now).
From my perspective, the downward pressure on the general consumer price level has been exacerbated by QE3. But this is foremost a “supply” issue as opposed to “deflation.” And as much as the Fed speaks of its 2% inflation “mandate” – and as much as the markets assume this mandate will eventually justify QE4 – low inflation should be recognized at this point as predominantly a global issue. The Fed and its now grossly bloated balance sheet do not - and will not - control CPI.
Surprisingly, there is little insightful discussion on an issue of such critical importance. As such, I found interesting comments this week from Mario Draghi worthy of highlighting below.
Question: “To what extent do you (the ECB) have a symmetric (inflation) target and, if so, why not act now to achieve the inflation target of 2.0%?”
ECB President Mario Draghi (speaking Wednesday in Paris): “I actually claim that our targets remain symmetric. The question we should ask is not (about) immediate inflation or immediate low inflation, but a medium-term assessment of inflation. And we should ask which factors are causing inflation to be low. And if we do this exercise we will discover that a great percentage of the factors that keep inflation low don’t have to do with our own euro-area economy. Consider for example, the inflation rate in July 2012 – that was 1.9% and now its 0.7% in the latest data. Two-thirds of that decline is due to the price of energy. Another way to look at this is the appreciation of the exchange rate. That by itself impinges on inflation by between 0.4% and 0.5%. Also, when you look at exactly why is inflation low in the euro-area you see that a good deal – if you exclude energy, taxes and food prices - you see that a good deal of the decline in core inflation has taken place in the so-called stressed countries. Which makes you think that it’s actually a relative price adjustment. Because in these countries’ prices were out of balance – out of equilibrium and clearly these countries had huge imbalances. And we can see the results of this because the so-called stressed countries now are actually showing current account surpluses, trade surpluses and much better economies. So some of this rebalance is taking place. Also let me add, that if you put this in perspective, you see that inflation is actually low globally. In the United States, in spite of the fact they are well more advanced than we are in their recovery, inflation… was not different from what it was in the euro-area three or four months ago. And not to mention Japan of course – or other parts (of the world), even the UK now is low. So, like one of my colleagues said, if you see that demand goes up and price goes down, that is not demand but it’s supply (dictating price). And so the concern for this assessment in the medium-term is different from what it would be if it were an inflation generated by demand factors… But again, you ask us the question “do we have any evidence that people are actually postponing their spending plans with a view to buy the same commodities at lower prices later on” – which is the definition of deflation. We don’t see any evidence of that. When we look at the percentage of commodities that (have seen prices) grow at or less than 1% or even decline… we see that the percentages, even in some stressed countries, are way lower than what they were in Japan, for example the late nineties and into 2000. So right now, we think the risks of having deflation are limited. That we have a medium-term assessment. In both cases, both if inflation were too high or were too low, we’d have to charge it through our medium-term. It would not be an instant decision.”
For the Week:
The S&P500 declined 0.5% (up 0.5% y-t-d), while the Dow added 0.1% (down %). The Utilities advanced 1.2% (up 7.7%). The Banks dropped 1.7% (up 3.2%), and the Broker/Dealers sank 3.7% (down 2.1%). The Morgan Stanley Cyclicals were down 0.9% (up 0.4%), and the Transports fell 0.9% (up 0.7%). The broader market was hit. The S&P 400 Midcaps dropped 1.6% (up 1.2%), and the small cap Russell 2000 sank 3.5% (down 1.0%). The Nasdaq100 fell 2.2% (down 0.6%), and the Morgan Stanley High Tech index declined 1.5% (up 2.0%). The Semiconductors fell 0.9% (up 7.9%). The Biotechs sank 6.7% (up 7.6%). With bullion down $39, the HUI gold index was hit for 4.8% (up 13.7%).
One-month Treasury bill rates ended the week at 3 bps, and three-month bills closed at 4 bps. Two-year government yields were up 3 bps to 0.45% (up 7bps y-t-d). Five-year T-note yields rose 4 bps to 1.75% (up one basis point). Ten-year yields declined 2 bps to 2.72% (down 31bps). Long bond yields were down 6 bps to 3.55% (down 42bps). Benchmark Fannie MBS yields were unchanged at 3.44% (down 16bps). The spread between benchmark MBS and 10-year Treasury yields widened 2 to 72 bps. The implied yield on December 2014 eurodollar futures declined 2.5 bps to 0.325%. The two-year dollar swap spread declined 2 to 12 bps, while the 10-year swap spread was little changed at 12 bps. Corporate bond spreads were mixed. An index of investment grade bond risk was little changed at 70 bps. An index of junk bond risk jumped 25 bps to 340 bps. An index of emerging market (EM) debt risk dropped 15 bps to 300 bps.
Debt issuance was mixed, though with a notably strong week of junk issuance. Investment-grade issuers included Bank of America $7.6bn, Mastercard $1.5bn, U.S. Bank National Association $1.4bn, PNC $1.0bn, United Air $950 million and SLM Corp $850 million.
Junk bond funds saw outflows of $196 million (from Lipper). Junk issuers included WMG Acquisition Corp $935 million, Calumet Specialty Products $900 million, Nielsen Finance $750 million, Jones Energy $500 million, Kindred Healthcare $500 million, Jeffries Financial $425 million, SunGard Availability Services $425 million, Entegris $360 million, Guitar Center $325 million, William Lyon Homes $150 million and Wideopenwest Financial $100 million.
Convertible debt issuers included Solazyme $500 million and HomeAway $350 million.
International dollar debt issuers included Sumitomo Mitsui Financial $1.75bn, Columbus International $1.25bn, Export Development Canada $1.0bn, Royal Bank of Scotland $1.0bn, Canadian Natural Resources $1.0bn, Cemex Finance $1.0bn, Suncorp-Metway $850 million, MDC Partners $735 million, Videotron $600 million, Instituto de Credito Oficial $500 million, Fondo Mivivienda $300 million, Caisse Centrale Desjardins $550 million and Minerva $300 million.
Ten-year Portuguese yields fell another 22 bps to a four-year low 4.04% (down 209bps y-t-d). Italian 10-yr yields dropped 11 bps to 3.30% (down 82bps). Spain's 10-year yields fell 12 bps to 3.24% (down 91bps). German bund yields declined 8 bps to 1.55% (down 38bps). French yields dropped 9 bps to 2.06% (down 49bps). The French to German 10-year bond spread narrowed one to 51 bps. Greek 10-year note yields sank 24 bps to 6.67% (down 175bps). U.K. 10-year gilt yields dipped 2 bps to 2.72% (down 30bps).
Japan's Nikkei equities index rallied 3.2% (down 9.8% y-t-d). Japanese 10-year "JGB" yields rose 3 bps to 0.63% (down 12bps). The German DAX equities index rallied 2.6% (up 0.4% y-t-d). Spain's IBEX 35 equities index gained 2.7% (up 4.2%). Italy's FTSE MIB index jumped 2.5% (up 13.3%). Emerging equities markets were mostly up big. Brazil's Bovespa index jumped 5.0%, with a two-week gain of 10.7% (down 3.4%). Mexico's Bolsa was little changed (down 6.3%). South Korea's Kospi index rose 2.4% (down 1.5%). India’s Sensex equities index jumped 2.7% (up 5.5%). China’s Shanghai Exchange ended the week down 0.3% (down 3.5%). Turkey's Borsa Istanbul National 100 index surged 7.0% (up 1.9%). Russia's RTS equities index jumped 3.6% (down 10.6%).
Freddie Mac 30-year fixed mortgage rates jumped 8 bps to a 10-week high 4.40% (up 83bps y-o-y). Fifteen-year fixed rates were up 10 bps to 3.42% (up 66bps). One-year ARM rates declined five bps to 2.44% (down 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 27 bps to a six-month high 4.71% (up 64bps).
Federal Reserve Credit expanded $13.2bn last week to a record $4.187 TN. During the past year, Fed Credit expanded $999bn, or 31.4%. Fed Credit inflated $1.375 TN, or 49%, over the past 72 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week recovered $50.2bn to $3.256 TN (3-week decline of $65bn). "Custody holdings" were down $35bn from a year ago.
M2 (narrow) "money" supply grew $12.2bn to a record $11.150 TN. "Narrow money" expanded $707bn, or 6.8%, over the past year. For the week, Currency increased $4.9bn. Total Checkable Deposits dropped $59.1bn, while Savings Deposits jumped $69.8bn. Small Time Deposits declined $2.2bn. Retail Money Funds slipped $1.0bn.
Money market fund assets declined $3.2bn to a 23-week low $2.643 TN. Money Fund assets were up $14bn, or 0.5%, from a year ago.
Total Commercial Paper rose $6.1bn to $1.025 TN. CP was down $20bn year-to-date, while increasing $4.0bn over the past year, or 0.4%.
March 28 – Bloomberg (Fion Li): “The yuan traded in Hong Kong fell for a third week as Premier Li Keqiang warned of increasing downward pressure on the economy and the central bank set the onshore reference rate at a six-month low… Premier Li said that China can’t ignore the ‘difficulties and risks’ to the economy… The comments, which were made at a March 26 meeting, also expressed confidence that growth will be in a ‘reasonable range.’”
March 25 – Bloomberg (Liz Capo McCormick and Ye Xie): “Too much volatility for emerging-markets currencies -- and not enough in the developed world -- is stinging traders. Increasing swings in exchange rates from Turkey to Hungary are wiping out profits in the carry trade, where investors buy higher-yielding assets funded by currencies with lower borrowing costs. Volatility in Group of Seven markets is receding as central banks hold interest rates at record lows and telegraph their next policy moves, confusing funds relying on trending movements for trading signals. ‘It has been a double whammy,’ Jon Stein, a managing director at Astor Janssen Partners, a financial advisor and consultancy, said… ‘You cannot find trending opportunities among the G-10 currencies. And in the emerging markets, there’s still a lot of uncertainty.'”
The U.S. dollar index was little changed at 80.18 (up 0.2% y-t-d). For the week on the upside, the South African rand increased 3.0%, the Brazilian real 2.8%, the Australian dollar 1.8%, the New Zealand dollar 1.5%, the Canadian dollar 1.5%, the Singapore dollar 1.3%, the Mexican peso 1.2%, the South Korean won 1.1%, the British pound 0.9%, the Norwegian krone 0.8% and the Taiwanese dollar 0.3%. For the week on the downside, the Swedish krona declined 1.2%, the Japanese yen 0.6%, the Swiss franc 0.4%, the Danish krone 0.3% and the euro 0.3%.
The CRB index jumped 1.9% this week (up 8.9% y-t-d). The Goldman Sachs Commodities Index gained 1.5% (up 2.9%). Spot Gold fell 3.0% to $1,295 (up 7.4%). May Silver dropped 2.6% to $19.79 (up 2%). May Crude gained $2.21 to $101.67 (up 3%). April Gasoline added 1.0% (up 5%), and May Natural Gas jumped 4.4% (up 6.0%). May Copper rallied 3.1% (down 11%). May Wheat added 0.3% (up 15%). May Corn jumped 2.7% (up 17%).
U.S. Fixed Income Bubble Watch:
March 27 – Bloomberg (Brian Chappatta): “Buyers of debt issued by bankrupt Detroit or junk-rated Puerto Rico are finding it pays to have bond insurance. The backing is even more valuable after upgrades of units of Assured Guaranty Ltd. and MBIA Inc. Insured local debt beat the $3.7 trillion municipal market last year for the first time since 2007, before the companies lost their top credit grades during the financial crisis. Standard & Poor’s last week raised subsidiaries of Assured to AA, the third-highest level, and MBIA’s National Public Finance Guarantee Corp. to AA-, one step lower.”
March 27 – Bloomberg (Sridhar Natarajan): “Investors just can’t get enough of exchange-traded funds that buy junk-rated loans. After more than tripling their assets in 2013, the loan funds are now growing four times as fast as the rest of the $262 billion market for fixed-income ETFs… The biggest leveraged-loan ETF, Invesco Ltd.’s $7.4 billion PowerShares Senior Loan Portfolio, has already amassed almost a billion dollars in new money this year. The popularity of speculative-grade loans, which have rates that rise with benchmarks, has soared with debt investors seeking shelter from higher borrowing costs as the Federal Reserve moves up its rate-increase projections. While the demand has been a boon for ETFs that invest in loans to the neediest companies, it’s also prompted regulators to warn that excesses which contributed to the credit crisis may be creeping back.”
March 28 – Bloomberg (Jessica Summers): “Corporate bond sales in the U.S. are poised for the slowest first quarter in three years after yields rose on upheaval in emerging markets and global growth concerns, restraining borrowers. Petroleo Brasileiro SA, the most indebted oil company, and Cisco Systems Inc., the world’s biggest maker of network routers and switches, led offerings of about $405.6 billion for the first quarter through today, the least since $403 billion issued in the similar period of 2011…”
Federal Reserve Watch:
March 22 – Bloomberg (Craig Torres and Jeff Kearns): “Federal Reserve Governor Jeremy Stein said monetary policy should be less accommodative when bond markets are overheated even if it raises the risk of higher unemployment. The remarks suggest financial stability should receive strong consideration as the Fed pursues its two mandates -- stable prices and maximum employment -- because financial crises can do so much damage to jobs and growth. ‘All else being equal, monetary policy should be less accommodative -- by which I mean that it should be willing to tolerate a larger forecast shortfall of the path of the unemployment rate from its full-employment level -- when estimates of risk premiums in the bond market are abnormally low,’ Stein said… The Fed governor took office on May 30, 2012, and has been one of the Fed Board’s intellectual leaders on the relationship between monetary policy and financial stability.”
March 28 – Reuters (Carey Gillam): “A top Federal Reserve official who has often warned of the risks of keeping U.S. interest rates too low for too long said on Friday she wants to see how winding down the Fed’s massive bond-buying stimulus goes before setting out any path for rate hikes. ‘I don't think it would be fair to say I have a date in mind or a path in mind,’ for the appropriate timing of the Fed's first rate increase, Kansas City Federal Reserve Bank President Esther George told the Central Exchange… ‘We are in a place now where we have to be very careful and think about how we are beginning to withdraw stimulus.’ …On Friday she said she continues to support the Fed's reductions in bond-buying, and she also supports the decision to base any raise rates on a ‘wide range’ of factors rather than use a specific unemployment rate benchmark. But she also made clear that she differs from the majority of her Fed colleagues in wanting to keep rates near zero for a ‘considerable time’ after bond-buying ends, and below normal even once employment and inflation reach healthier levels. ‘The risk I see is being too low for too long,’ she said.”
U.S. Bubble Watch:
March 24 – Bloomberg (Lu Wang): “In one corner of the U.S. equity market, investor enthusiasm is exceeding the frenzy of the Internet bubble. Small-cap shares tracked by the Russell 2000 Index have rallied for seven straight quarters, the longest stretch ever, sending valuations 26% above levels at the height of the 1990s rally. Gains… have pushed the gauge up 248% since the bull market began five years ago, leaving price-earnings ratios about three times as high as for shares in the Standard & Poor’s 500 Index. Surging small-caps were cited by Federal Reserve Governor Daniel Tarullo last month as one reason policy makers should ensure they’re not creating systemic risk in financial markets.”
March 28 – Bloomberg (Sridhar Natarajan): “For all the warnings from the Federal Reserve over excessive risk-taking as loan growth soars to levels last seen just before the crisis, bankers still have 10 trillion reasons to lend. That’s the dollar amount that banks hold in deposits in the U.S., which exceeded the value of all loans by a record $2.5 trillion last month. Banks are amassing more cash even as lending to U.S. companies this quarter is poised to increase by the most since 2007… The lending surge reflects confidence among the nation’s banks to extend credit as the Fed scales back its monetary support of the U.S. economy…”
March 25 – Wall Street Journal (Josh Mitchell): “The surge in student-loan debt in recent years has been driven disproportionately by borrowing for graduate school amid a weak economy and an open spigot of government credit, according to a report that raises questions about the broader debate about how to resolve Americans' growing burden. The typical debt load of borrowers leaving school with a master's, medical, law or doctoral degree jumped an inflation-adjusted 43% between 2004 and 2012, according to… the New America Foundation… That translated into a median debt load… of $57,600 in 2012. The increases were sharper for those pursuing advanced degrees in the social sciences and humanities, versus professional degrees such as M.B.A.s or medical degrees that tend to yield greater long-term returns… By comparison, the typical student-debt burden of borrowers leaving school with a bachelor's degree climbed 39% over the same period, to $27,000 in 2012.”
March 25 – Wall Street Journal (Josh Barbanel): “Park Avenue soon will have a new limestone tower to join the ranks of the street's architecturally noteworthy buildings, from Lever House to the Seagram Building. Unlike those glass office buildings in the modern International Style, the 51-story building at 520 Park Ave. will feature vertical mansions clad in traditional stone at the edge of a neighborhood real-estate people have begun to call ‘Billionaires Row.’ …The building will join at least seven other condominium towers under construction or planned near or along 57th Street in Midtown, raising a concern by some brokers too many mega-condos may be coming on line in what has been the city's hottest real estate sector. It also will have a penthouse priced at considerably more than $100 million… ‘It is a new market category, it is being called Billionaire’s Row,’ said Jonathan Miller, an appraiser and market analyst and president of Miller Samuel… He said the demand for hard assets in the U.S. is so strong—especially among international buyers—that the market is likely to remain warm far into the future.”
March 28 – Bloomberg (Alex Sherman): “The megarich are dominating U.S. megadeals. Seven of the 15 U.S. takeover bids worth more than $10 billion since January 2013 were initiated by firms founded and controlled by one of the 200 wealthiest men in the world… Last month Facebook Inc.’s Mark Zuckerberg, who has a net worth of $27.1 billion, made a $19 billion offer for messaging service WhatsApp Inc., and this week agreed to buy virtual reality firm Oculus VR Inc. for at least $2 billion.”
March 25 – Bloomberg (Megan Durisin): “Competitive eater and restaurant owner Jamie McDonald had no problem downing almost a dozen 11.5- ounce hamburgers in 10 minutes, or 9 pounds, 7.4 ounces of pulled pork. It’s the cost of the meat that’s making him gag. McDonald, who used $70,000 of his eating-contest prizes since 2012 to open Bear’s Smokehouse BBQ last June in Windsor, Connecticut, plans to raise menu prices 10% to limit the profit squeeze on 5,000 pounds (2.27 metric tons) of weekly meat purchases. His bill reached $12,000 as beef costs jumped 30% in six months and pork surged 20% in March.”
March 25 – Bloomberg (Rakteem Katakey): “The Crimean crisis is poised to reshape the politics of oil by accelerating Russia’s drive to send more barrels to China, leaving Europe with pricier imports and boosting U.S. dependence on fuel from the Middle East. China already has agreed to buy more than $350 billion of Russian crude in coming years from the government of President Vladimir Putin. The ties are likely to deepen as the U.S. and Europe levy sanctions against Russia as punishment for the invasion of Ukraine. Such shifts will be hard to overcome. Europe, which gets about 30% of its natural gas from Russia, has few viable immediate alternatives. The U.S., even after the shale boom, must import 40% of its crude oil, 10.6 million barrels a day that leaves the country vulnerable to global markets. The alternatives to Russia also carry significant financial, environmental and geological challenges. Canada’s oil sands pollute more than most traditional alternatives, while Poland’s promising shale fields have yet to be unlocked. The biggest oil finds of the past decade are trapped under the miles-deep waters offshore Brazil and West Africa.”
March 28 – Bloomberg (Krystof Chamonikolas): “Ukrainian benchmark bonds extended the longest rally in almost a year after the nation won International Monetary Fund aid to avert a default. The dollar-denominated bonds due April 2023 have risen for nine straight days, pushing the yield down 2.13 percentage points to a two-month low of 8.78%...”
Global Bubble Watch:
March 28 – Bloomberg (Michael J. Moore): “Goldman Sachs Group Inc. President Gary Cohn said prices in global markets don’t reflect the risks from geopolitical conflicts such as Russia’s annexation of Crimea. ‘For the last six to 12 months, markets for some reason have been ignoring a lot of the geopolitical risk,’ Cohn, 53, said… ‘Russia, Crimea, Ukraine: this is not the first or newest geopolitical risk we’ve had in the last year or so.’ Cohn cited tensions between China and Japan as well as continuing violence in the Middle East as risks that haven’t halted a climb in global equities over the last 12 months. Investors with a lot of cash have felt pressure to deploy it, preventing a sustained downturn in prices, he said. ‘Anytime we get any sell-off in the market, there’s new investors coming into the market, so we haven’t seen that repricing,’ Cohn said. Investors are saying, ‘I’ve got to put cash to work, and maybe these situations are going to be with us for a long time, and I can’t sit on cash at the bank earning no return forever,’ he said.”
March 24 – Bloomberg (Lindsay Fortado and Jesse Westbrook): “The U.K.’s largest hedge funds are getting even bigger, with 20 firms controlling 82% of the assets under management, the country’s markets regulator said. The growing size of hedge funds creates a need for better oversight of the industry, the Financial Conduct Authority said… ‘With nearly 20% of global assets under management here, it is important that people have confidence in how we regulate this market,’ Clive Adamson, the FCA’s head of supervision, said. ‘The challenge from us to the industry is to ensure that it operates to the highest standards of integrity.’ While global hedge fund assets rose 17% in 2013 to a record $2.63 trillion, the industry is becoming increasingly polarized as smaller firms struggle to raise money. Last year, 904 hedge funds shut down, the highest total since 2009, according to… Hedge Fund Research Inc. About $470 billion of assets are managed by hedge funds in the U.K., and 450 of the firms are registered with the regulator. The FCA survey includes data from 49 firms, which manage $481 billion globally, and from 106 funds, with assets of $345 billion.”
EM Bubble Watch:
March 23 – Bloomberg (Dan Hart): “Vice Minister of Finance Zhu Guangyao said the U.S. Federal Reserve will begin boosting interest rates within six months after exiting ‘unconventional’ monetary policy, and that will have a ‘significant impact’ on the U.S. and world economy, Market News International reports. Zhu told China Development Forum this weekend ‘we believe at the Fed meeting this October, the exit of their quantative easing will complete.”
China Bubble Watch:
March 27 – MarketNews International: “Chinese premier Li Keqiang has spoken of the difficulties of using macro-economic tools, calling for greater reliance on the market to support economic growth. China National Radio broadcast the premier telling provincial governors that retail sales growth is "stable", though some provinces are seeing slowing growth. ‘We are trying to stimulate market forces and social creativity, particularly given that it's relatively difficult for the government to use macro-policy tools now. We must rely more on the market,’ Li told provincial governors.”
March 24 – Bloomberg: “China’s manufacturing industry weakened for a fifth straight month, according to a preliminary measure for March…, deepening concern the nation will miss its 7.5% growth target this year. The Purchasing Managers’ Index from HSBC Holdings Plc and Markit Economics dropped to 48.1, compared with the 48.7 median estimate… ‘The old growth engine is losing steam,’ said Chen Xingdong, chief China economist at BNP Paribas SA in Beijing…”
March 24 – Bloomberg: “The pace of migration of rural Chinese to cities, a dynamic hailed by Premier Li Keqiang as key to the nation’s development, is set to slow by a third in coming years, deepening economic-growth concerns. A government report released this month projected a 6.3 percentage-point rise in the share of people living in cities from 2013 to 2020 -- down from a 9.4-point gain the previous seven years… ‘In the past 30 years we turned farmers into factory workers, triggering massive gains in productivity and hence growth,’ said Ken Peng, Asia Pacific investment strategist at Citigroup Inc.’s private-bank business in Hong Kong. ‘Now those gains are diminishing.’”
March 27 – Bloomberg: “China’s benchmark money-market rate surged by the most since January after the central bank withdrew more funds from the banking system. The People’s Bank of China sold 20 billion yuan ($3.2bn) of 28-day repurchase agreements at a yield of 4% and 32 billion yuan of 14-day repos at 3.8%... That brought the week’s withdrawals to a net 98 billion yuan, the biggest outflow since the period ended Feb. 28… The seven-day repurchase rate, a gauge of funding availability in the interbank market, jumped 95 bps… to 4.84%... ‘The central bank doesn’t want liquidity to be too loose,’ said Song Qiuhong, an analyst at Shunde Rural Commercial Bank… ‘If it keeps the current pace of draining, rates will climb further. Liquidity is usually tighter in the second quarter than in the first.’”
March 25 – Bloomberg: “It has been labeled a ‘blood- sucking vampire’ by a prominent commentator on state-run television. Executives at China’s largest banks have called for regulators to curb its rapid expansion. The focus of this ire is Internet financing, specifically Yu’E Bao, the fund pioneered nine months ago by Alibaba Group Holding Ltd.’s online-payment affiliate Alipay. Its ease of use, involving a few taps on a smartphone, has drawn deposits from 81 million customers, more than the population of Germany, as they chase returns higher than China’s banks can offer. The total exceeded 500 billion yuan ($80bn) as of Feb. 28…, double the amount reported by Alipay in mid-January. At least six other technology firms, including Baidu Inc. and Tencent Holding Ltd., have embraced Internet financing with similar products offering returns as high as 10% and threatening to drain more cash from China’s banking system. Bank executives, unable to stop the outflow of their cheapest source of funding because interest rates on comparable deposits are fixed by the government at 0.35%, are calling for more regulation, saying that lack of oversight and risks related to account security, yield volatility and liquidity management threaten China’s financial stability.”
March 28 – Bloomberg: “The collapse of a Chinese developer in a city south of Shanghai foreshadows a shakeout among the nation’s almost 90,000 real estate companies as the government reins in credit and the housing market slows… Developers have proliferated since China began allowing private home ownership in 1998, causing a surge in demand and a rally in residential prices. For years, homebuilders binged on easy credit from banks and shadow financing from non-banks at higher interest rates. Now many developers are struggling with debt as thousands of apartment buildings across the country sit empty and the government abstains from providing further stimulus for the economy… CBRE estimates there are about 30,000 ‘true’ developers, not including construction and project companies. ‘That is far too many, even for a country as large as China. Consolidation needs to take place.’ …The effort to contain surging home prices comes after they climbed 60% since the government’s 4 trillion yuan of fiscal stimulus in 2008 to bolster the economy after the global financial crisis.”
March 25 – Bloomberg (Fion Li): “China is headed for a 'mini crisis’ in its local-government debt market as economic reforms lead to the first defaults, according to a former adviser to the People’s Bank of China. ‘It will be a partial, controllable and mini crisis,’ Li Daokui told reporters… ‘There’s tremendous room for the central government to fix the problems in local government debt. Defaults must be allowed to restructure the debt, which will definitely happen as part of the reform measures in the second half of this year.’ …China’s town and cities took on debt to pay for subways, sewage works and roads to help finance a 4 trillion yuan ($646bn) stimulus package unveiled by the government at the height of the global financial crisis in November 2008… Those borrowings are still climbing and refinancing is growing costlier as default risk builds amid slowing growth in the world’s second-largest economy. The amount owed by local governments jumped 253% since 2008, Nomura Holdings Inc. estimated…, and official figures indicate the total increased to 17.9 trillion yuan by June 30 from 10.7 trillion yuan at the end of 2010.”
March 24 – Bloomberg: “Pollution in Beijing rose to nearly 10 times levels considered safe by the World Health Organization, triggering warnings to avoid outdoor activity. The concentration of PM2.5 -- the small particles that pose the greatest risk to human health -- hit 242 in the Chinese capital as of 3 p.m., a U.S. Embassy monitor said. The WHO recommends 24-hour exposure to PM2.5 levels of less than 25… In a speech today, International Monetary Fund Managing Director Christine Lagarde said bad air quality, water shortages and desertification pose a ‘serious risk to the next stage of China’s development.’ ‘As with many countries around the world, China’s economic success came at a price -- increasing inequality and increasing environmental damage,’ Lagarde told the China Development Forum.”
March 26 – Bloomberg (Caroline Chen and Simeon Bennett): “As China’s top officials pledge to declare war on smog, a World Health Organization report said 40% of the 7 million people killed by air pollution globally in 2012 lived in the region dominated by that country. The report released today found that air pollution caused more deaths worldwide than AIDS, diabetes and road injuries combined… Chinese Premier Li Keqiang earlier this month said that air pollution is a top priority for the nation’s authorities. A March 19 study by Columbia University and Chongqing Medical University, meanwhile, found that babies whose mothers were exposed to a Chinese coal-fired power plant had poorer learning and memory skills.”
March 26 – Bloomberg: “China expanded an annual property survey that helps shape policies to more than 300 cities amid growing concern of oversupply in smaller cities, according to people with knowledge of the matter. China’s National Development and Reform Commission, the country’s economic planner, issued notices ordering the survey be expanded to cities at the prefecture level and above, more than quadruple the 70 cities where it was carried out in previous years… Premier Li Keqiang this month said the government will regulate the housing market ‘differently in different cities’ to take into account local conditions… ‘This shows that the government has realized the risks in smaller Chinese cities, and expanding to more cities will help them know better about the market,’ said Liu Yuan, a Shanghai-based researcher at Centaline Property Agency Ltd., China’s biggest real estate brokerage.”
March 25 – Bloomberg (Rachel Evans): “China Construction Bank Asia Corp. is marketing a sale of dollar-denominated bonds, testing demand for the nation’s bank debt after the cost of insuring similar notes jumped the most in Asia this year… Investor perceptions of risk for China Development Bank Corp., Export-Import Bank of China and Bank of China Ltd. worsened the most since Dec. 31 among 40 investment-grade borrowers in an Asia gauge excluding Japan. China may encounter ‘serious’ cash flow problems and needs good liquidity control for the next two years, according to remarks made by former China Banking Regulatory Commission Chairman Liu Mingkang in today’s Shanghai Securities News.”
March 25 – Bloomberg: “Agricultural Bank of China Ltd., the nation’s third-largest lender by market value, posted profit growth that weakened for a second consecutive quarter as a government credit crackdown curbed loan expansion… Agricultural Bank’s profit growth slowed as the government seeks to contain excessive credit supply and capacity in an economy that this month had its first onshore bond default. Competition for deposits has intensified as savers shift money to alternative products with better returns… Loans to small business rose 24% in 2013 from a year earlier to 813.3 billion yuan, helping drive overall lending up by 12% to 7.2 trillion yuan. Loan growth in 2012 was 14%”
March 24 – Bloomberg: “Defaults in China’s $1.8 trillion trust industry are triggering protests and spurring calls from legal experts for clearer rules on sales of investment products. Li Taishan, a customer of China Construction Bank Corp., said a saleswoman from the lender in the northern province of Shanxi convinced him to invest 3 million yuan ($484,000) in a trust product with a 10% indicated return by calling it risk-free. Two buyers of another failed plan, marketed by Industrial & Commercial Bank of China Ltd. and partially bailed out in January, said salesmen told them it was totally safe, even though documents state there is the chance of losses. China is cracking down on its shadow-banking industry, where finance companies lend with less transparency, as inefficient allocation of capital slows the world’s second- largest economy and threatens social unrest.”
March 24 – Bloomberg: “As many as 30 investors in Jilin Province Trust Co.’s Songhuajiang River Nov. 77 trust product gathered in front of the Beijing headquarters of China Construction Bank Corp., which marketed the product. Investors demand full repayment of principal and interest by Jilin Trust and CCB… Jilin Trust said through its PR company that it’s waiting for news concerning restructuring of Shanxi Liansheng… Li Taishan, an investor from Jinzhong, Shanxi, who invested 3 million yuan in the product, says, ‘We are here to communicate with CCB. We’ve been cheated out of our hard-earned money by CCB.’”
March 28 – Bloomberg (Christopher Shimamoto and Toru Fujioka): “Japan will speed up deployment of government cash in coming months as a surprise drop in consumer spending in February triggered concern the nation’s long-awaited inflation is now damaging purchasing power. Finance Minister Taro Aso told reporters that data showing a slump in household expenditure two months before the first sales-tax increase since 1997 was a problem, and Prime Minister Shinzo Abe’s administration will pour 40% of outlays for the next fiscal year into the April-June quarter.”
March 25 – MarketNews International (Johanna Treeck): “European Central Bank Governing Council member Jens Weidmann said that macroprudential instruments should be the first line of defence against emerging financial market stability risks but that monetary policy cannot turn a blind eye either. In an exclusive interview with MNI, conducted Friday, Weidmann said the Eurotower may have to refocus its second pillar so as to better gauge emerging risks. ‘One lesson from the crisis is that although consumer prices appear to be stable, financial stability risks can accumulate and in turn affect price stability,’ Weidmann said… ‘But monetary policy cannot turn a blind eye to financial stability risks either. Monetary policy cannot simply stand by and watch the next financial crisis emerge and then try to clear up the debris after the bubble has burst with easy money,’ he asserted.”
March 26 – Bloomberg (Angeline Benoit): “Prime Minister Mariano Rajoy is running out of time to make good on his pledge to complete an overhaul of Spain’s economy. With an election due by November 2015, the government is showing wavering resolve to tackle the European Union’s second-highest jobless rate or revamp the tax system after pushing through unpopular measures including a labor-law reform and public sector wage cuts… ‘What threatens Spain is an Italian scenario, where the recovery doesn’t gather enough speed to gain momentum,’ said Fernando Fernandez, a professor at IE business school in Madrid and a former International Monetary Fund economist.”
- Bear Case
QE, Uncertainty and CPI
March 28, 2014 posted by Doug Noland
Equity market internals have turned increasingly unsettled.
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