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HFT, Rigged Markets and The Man

April 4, 2014

Initial indications of greed giving way to fear.
  

April 3 – Bloomberg (Silla Brush): “The U.S. Commodity Futures Trading Commission is reviewing futures markets to ensure high-speed trading isn’t violating the law, acting CFTC Chairman Mark P. Wetjen told reporters… ‘I don’t have the impression at the moment that futures markets are rigged,’ Wetjen said… He was responding to comments by Michael Lewis, author of the book ‘Flash Boys,’ that investors are being robbed by traders using advanced computers to jump ahead of their trades.”

Charles Schwab stated that “High-frequency trading is a growing cancer that needs to be addressed… High-frequency traders are gaming the system, reaping billions in the process and undermining investor confidence in the fairness of the markets.”

I’m definitely no fan of high-frequency trading (HFT). Still, it’s difficult for me to get all that worked up on this particular issue. I guess I’ve seen too much during my going on 25 years in the financial markets. This week Michael Lewis created a firestorm with his assertion that markets are “rigged.” Are they rigged? There is clearly a prevailing “rigging” element, yet the high-frequency traders are bit players. HFT is symptomatic. They’re not the “cancer.”

Credit is inherently unstable. Always has been. History has also clearly demonstrated that stock markets are prone to destabilizing bouts of exuberance, intense speculation and spectacular boom and bust cycles. Nurture a Credit system dominated by marketable instruments and you’ve created a highly unstable Credit mechanism. Allow marketable securities to inflate to 400% of GDP and you’ve created highly unstable financial and economic systems. Push everyone into a securities market Bubble and then you’re really trapped. Policymaker rationalizations and justifications even foster the delusion that rigging markets is good and reasonable policy.

As noted above, I’ve witnessed too much. I recall 1993 “bond” market excesses as if they were yesterday. Late-eighties (“decade of greed”) excess – junk bonds, M&A, S&L fiasco, coastal real estate Bubbles, etc. left the U.S. banking system deeply impaired. Fed chair Greenspan cleverly fashioned a steep yield curve to covertly bail out the banks, in the process providing the fledgling hedge fund industry a speculative profit windfall. Seemingly, market rigging had worked miracles. Then a little 25 bps “baby step” rate increase in February 1994 unleashed bloody havoc throughout Treasury, MBS and derivatives markets (not even to mention Mexico).

The early-nineties was a critical period for the interplay between policymaking and increasingly speculative financial markets. The activist Greenspan Federal Reserve promoted market-based Credit (MBS, ABS, securitizations, derivatives, etc.) to help compensate for the banking system’s incapacity to provide sufficient Credit to the real economy. The symbiotic relationship between the leveraged players and GSE securities took root. But as 1994 demonstrated, all this New Age speculative leverage was acutely susceptible to interest-rate uncertainty, de-leveraging and a highly unstable (boom & bust) liquidity dynamic.

I was never comfortable with the Fed’s push to so-called “transparency.” For me, it was fundamental to the “Maestro” assuming too much control over the financial markets. Indeed, never had a central bank enjoyed such dominance over finance. Greenspan could spur stock and bond market rallies (wealth creation!) with a simple utterance on rate policy. For the economy as a whole, Credit Availability and, more generally, “financial conditions” became chiefly dictated in the securities markets – and the Fed chairman had powerful new levers to govern market behavior.

Greenspan moved forward with transparently pegging short-term interest rates. Moreover, he made it clear that he would allow the markets to run on the upside (pro-Bubble) while promising to aggressively cut rates and inject liquidity if markets faltered to the downside (Bubbles burst). The hedge fund community took off, the GSEs took off, derivatives took off, “Wall Street finance” took off and a historic Credit Bubble took flight. Stocks, bonds, derivatives and system Credit all became “rigged” to the upside. The markets buckled briefly in 1998 (the LTCM collapse) and on a somewhat more extended basis in 2000; potential critical market junctures that were rectified through progressively more aggressive market intervention.

The 2008 crisis was another critical juncture in a financial Bubble that had inflated to systemically dangerous proportions. The “rigged” market throughout mortgage finance collapsed with predictable consequences for the leveraged players, asset markets and real economy. The Fed and Washington rushed to bail out a system that had clearly turned highly dysfunctional and maladjusted. Bernanke moved aggressively with his “helicopter money” and “government printing press.” Fatefully, Washington took an even larger role throughout the economy and markets.

Oblivious to its previous policy failures, the Federal Reserve’s “rigging” of the financial markets became only more prominent and purposely conspicuous. Since 2008 the Fed has ballooned its balance sheet from $900bn to $4.3 TN with the stated intention of inflating stock and bond prices. They took their market liquidity backstop role to a whole new level. The Fed has also taken interest-rate “transparency” into uncharted waters. This is all part and parcel to the “rigged” financial markets I worry deeply about.

When I started with my career in the markets, the hedge fund industry was thought to be less than $40bn. It had grown 10-fold by (party like it’s) 1999. Estimates have hedge fund assets surpassing $3.0 TN this year. “Sovereign wealth funds” weren’t a force in the nineties. The exchange-traded fund (ETF) industry didn’t even exist. These days, after doubling in four years, ETF assets total $2.4 TN. A headline from the upcoming weekend’s Financial Times caught my eye: “High Drama in Murky Link Between ETFs and HTF.” And when it comes to “murky links,” I suspect the equities derivative marketplace is today bigger and more impactful than ever. Over recent years, there has been a proliferation of instruments and products that make it so easy to jump on board the raging bull. There are these days Trillions of speculative finance playing little more than trend-following strategies. The market is going up – the Fed is ensuring it goes up – so buy. Leverage makes for higher returns.

From my perspective, government rigging the cost and quantity of finance for more than 20 years guarantees that lots of unsavory things are going to develop (fester). For one, asset prices throughout the system will be subject to gross mispricing. Risk misperceptions will become deeply entrenched. To be sure, pegged rates and liquidity backstops incentivize leveraged speculation. Those best at playing the game – particularly the champions at anticipating monetary policy – grow to incredible size. Those with the best government connections (in the U.S., Europe, Asia and EM) have a decided advantage over the rest of us. And as a limited number of powerful market operators dominate, traditional market trading dynamics give way to speculation more akin to a poker game (with chips piling up on one side of the table – the unsuspecting up against “the family”). There was clear justification for the government moving aggressively (Glass-Steagall) to rein in the big and powerful financial institutions after the devastating collapse of the “Roaring Twenties” Bubble.

And as the media fixated this week on HFT, market internals seemed to indicate some concern for the health of the U.S. stock market Bubble. Friday’s trading session began with yet another S&P500 record high – but ended with some blood on the street. Many prominent Bubble stocks were under intense selling pressure.

In market analysis over the years, I’ve noted the “crowded trade” dilemma. Too much speculative (“hot money”) finance gravitating to one sector or asset class significantly alters the nature of the marketplace. Trading becomes more speculative, prices increasingly unstable and the market in general much more prone to boom and bust dynamics. QE3 ensured a major influx of destabilizing “hot money” and a highly speculative U.S. equities market akin to one gigantic “crowded trade.” The bulls have enjoyed a great run. At least in the high-flyers, the downside of “price instability” has rather quickly become a pressing issue.

Federal Reserve Bank of Dallas President Richard Fisher offered valuable insight Friday in remarks before the Asia Society in Hong Kong. I’m providing extensive excerpts, but I strongly encourage readers to study his entire speech available at the Dallas Fed’s website. Mr. Fisher has risen to become a dominant force in the evolving monetary policy debate. He’s now “The Man.” There was even mention Friday on CNBC of the possibility of a future Fisher Fed Chairmanship. Count me as a strong supporter. For now, it’s encouraging to pull sound monetary policy thinking from a U.S. policymaker.

From Richard Fisher’s “Forward Guidance,” April 4, 2014: “The Fed’s large-scale asset purchases dramatically and more broadly impacted credit markets. The U.S. credit markets are awash in liquidity. As of March 14, our par holdings of fixed-rate MBS exceeded 30% of the outstanding stock of those securities… We now own just shy of 24% of the stock of Treasury coupon securities. Having concentrated our purchases of Treasuries further out on the yield curve, and done so in size, we have driven nominal interest rates across the credit spectrum to lows not seen in over a half century.

This has allowed U.S. businesses to restructure their balance sheets, manage their earnings per share through share buybacks financed with bargain-basement debt issuance, bolster stock prices through enhanced dividend payouts and position themselves for financing growth once they see the whites of the eyes of greater certainty about their economic future. By driving nominal interest rates to half-century lows, we have also reduced the hurdle rate by which future cash flows of publicly traded businesses are discounted. Thus, through financial engineering, we have helped bolster a roaring bull market for equities: The indexes for stocks have nearly tripled from the lows reached in March 2009.

Alongside these signs of rebound have been some developments that give rise to caution. I have spoken of these in recent speeches, echoing concerns I have raised in FOMC discussions: The price-to-earnings (PE) ratio of stocks is among the highest decile of reported values since 1881. Bob Shiller’s inflation-adjusted PE ratio reached 26 this week as the Standard & Poor’s 500 hit yet another record high. For context, the measure hit 30 before Black Tuesday in 1929 and reached an all-time high of 44 before the dot-com implosion at the end of 1999… Since bottoming out five years ago, the market capitalization of the U.S. stock market as a percentage of the country’s economic output has more than doubled to 145%—the highest reading since the record was set in March 2000. Margin debt has been setting historic highs for several months running and… now stands at $466 billion. Junk-bond yields have declined below 5.5%, nearing record lows…. In my Federal Reserve District… bankers are reporting that money center banks are lending on terms that are increasingly imprudent.

The former funds manager in me sees these as yellow lights. The central banker in me is reminded of the mandate to safeguard financial stability… At the current reduction in the run rate of accumulation, the exercise known as QE3 will terminate in October (when I project we will hold more than 40% of the MBS market and almost a fourth of outstanding Treasuries)…

Enter Forward Guidance. This is no small matter. Quantitative easing has made life easy not only for corporate treasurers and homeowners and consumers burdened by debt, but also for money market operators. It has run up the price of stocks and bonds mostly in straight-line fashion, and it has taken volatility out of the marketplace, allowing market operators and their clients to profit with little effort. The question of when and under what conditions the FOMC will begin to raise the base rate off the floor is understandably of intense interest.

Research papers have addressed this subject. For example, some academic economists draw on Greek mythology to distinguish different techniques for crafting forward guidance, making a distinction between Odyssean and Delphic forms of guidance. The Odyssean model involves committing to a policy rule or to a criterion for choosing between different policy alternatives. Policymakers tie themselves to the mast of this rule or criterion, sacrificing some of their short-run freedom of action in order to achieve what they hope will be superior outcomes over the long term…

Commitments come in lots of different flavors and styles, and forward guidance isn’t necessarily helpful or wise just because it’s Odyssean. Tying yourself to the mast isn’t an especially good idea if your ship is sinking, or if enemy forces are directing fire toward your deck. Committing to a particular path for the funds rate, or to a time schedule for funds-rate liftoff, is not something in which I or many of my colleagues have any interest…

My own view is that commitments aren’t always credible, especially if they purport to extend far into the future… As a general rule, then, the further into the future a commitment extends, the vaguer it tends to be. Along these lines, the FOMC periodically reiterates its commitment to do what it is legally mandated to do: pursue full employment, price stability and a stable financial system…

Delphic forward guidance is less binding than Odyssean guidance. Like the responses of the oracle of Apollo at Delphi, it is more obscure, more enigmatic. It amounts to saying, ‘Here’s what we think we are going to want to do if the economy evolves as we currently expect.’ Delphic guidance clarifies your current thinking about future policy without making any promises—even contingent promises. Our current FOMC statement is chock-full of Delphic guidance…

As a former practitioner, I can tell you that market operators prefer Odyssean guidance to Delphic guidance, and within the Odyssean model, tend to prefer inflexible, calendar-based guidance to guidance that’s either conditional or qualitative. Life in my former incarnation would naturally be much more pleasant if I could dial in the specific dates and levels of interest rate movements. But as a central banker, I am haunted by a comment made by Winston Churchill in 1926, shortly before things began to unravel in the global financial markets. Speaking at the Waldorf Hotel in London, he said: ‘In finance, everything that is agreeable is unsound and everything that is sound is disagreeable.’

I worry that the predictability of calendar-based commitments can quite possibly be unsound in two key dimensions. First, the quantitative moorings may be misplaced—especially given shifts in economic relationships following the worst downturn since the Great Depression. Second, I question if it is sound policy to remove all uncertainty or volatility from the market. I wonder whether being totally predictable may, at best, lead to a false complacency that can too easily be upset should we need to change course. At its worst, I fear calendar-based commitments can lead, perversely, to market instability by encouraging markets to overshoot, as they appear to be doing in some quarters at present… The point is: Forward guidance can be a complicated monetary policy tool…

This is the very best we can offer you… Those who think we can be more specific in stating our intentions and broadcasting our every next move with complete certainty are, in my opinion, clinging to the myth that economics is a hard science and monetary policy a precise scientific procedure rather than the applied best judgment of cool-headed, unemotional decision-makers.”




For the Week:

The S&P500 ended a volatile week up 0.4% (up 0.9% y-t-d), and the Dow gained 0.6% (down 1.0%). The Utilities added 1.1% (up 8.9%). The Banks increased 0.4% (up 3.5%), while the Broker/Dealers fell 1.7% (down 3.8%). The Morgan Stanley Cyclicals jumped 2.0% (up 2.4%), and the Transports rose 1.6% (up 2.3%). The S&P 400 Midcaps gained 0.7% (up 1.8%), and the small cap Russell 2000 increased 0.1% (down 0.9%). The Nasdaq100 declined 0.9% (down 1.5%), and the Morgan Stanley High Tech index fell 0.8% (up 1.3%). The Semiconductors added 0.3% (up 8.3%). The Biotechs declined 0.3% (up 7.3%). With bullion recovering $9, the HUI gold index was up 0.7% (up 14.5%).

One-month Treasury bill rates ended the week at 3 bps, and three-month bills closed at 2 bps. Two-year government yields were down 2 bps to 0.41% (up 3bps y-t-d). Five-year T-note yields fell 5 bps to 1.70% (down 5bps). Ten-year yields were unchanged at 2.72% (down 31bps). Long bond yields were up 4 bps to 3.43% (down 39bps). Benchmark Fannie MBS yields were down 2 bps to 3.43% (down 18bps). The spread between benchmark MBS and 10-year Treasury yields narrowed 2 to 71 bps. The implied yield on December 2014 eurodollar futures declined 2 bps to 0.305%. The two-year dollar swap spread was little changed at 13 bps, and the 10-year swap spread was unchanged at 12 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined 3 bps to 67 bps. An index of junk bond risk fell 6 bps to 334 bps. An index of emerging market (EM) debt risk dropped 10 bps to 290 bps.

Debt issuance was strong. Investment-grade issuers included Citigroup $2.25bn, MidAmerican Energy $1.2bn, MassMutual $750 million, MIT $550 million, Duke Energy $1.0bn, Sunoco Logistics Partners Operations LP $1.0bn, Blackstone $500 million, New York Life Global $425 million, Union Electric $350 million, National Rural Utilities Cooperative $325 million, Yale $250 million and Sandalwood $120 million.

Junk bond funds saw inflows of $493 million (from Lipper). Junk issuers included NRG Energy $1.0bn, Crown Castle $850 million, Infor Software $750 millon, Enquest $650 million, Interpublic Group $500 million, Realogy Group $450 million, Exterran Partners $350 million, Beazer Homes $325 million, Prospect Capital $300 million, First Wind Capital $275 million, Lonestar Resources $220 million, Cogent Communications $200 million and Michael Baker $150 million.

Convertible debt issuers this week included 51job $350 million.

International dollar debt issuers included Sinopec Group $4.25bn, Saudi Electricity $2.5bn, International Bank of Reconstruction & Development $2.25bn, Nordea Bank $2.25bn, Deutsche Bank $2.25bn, Bombardier $1.8bn, Costa Rica $1.0bn, YPF Sociedad Anonima $1.0bn, Kommunivest Sverige $1.0bn, Siam Commercial Bank $750 million, BBVA BAncomer $750 million, JBS Investments $750 million, Tullow Oil $650 million, Avianca Holdings $550 million, Shinhan Bank $500 million, Agromercantil $300 million, Kimberly-Clark Mexico $250 million and Barclays Bank $200 million.

Ten-year Portuguese yields sank 19 bps to a four-year low 3.85% (down 240bps y-t-d). Italian 10-yr yields dropped 13 bps to 3.17% (down 96bps). Spain's 10-year yields declined 9 bps to 3.15% (down 100bps). German bund yields were little changed at 1.55% (down 38bps). French yields declined 3 bps to 2.03% (down 53bps). The French to German 10-year bond spread narrowed 3 to 48 bps. Greek 10-year note yields sank 53 bps to 6.15% (down 227bps). U.K. 10-year gilt yields fell 4 bps to 2.69% (down 33bps).

Japan's Nikkei equities index rallied 2.5% (down 7.5% y-t-d). Japanese 10-year "JGB" yields added 2 bps to a two-month high 0.65% (down 9bps). The German DAX equities index gained 1.1% (up 1.5% y-t-d). Spain's IBEX 35 equities index surged 3.4% (up 7.7%). Italy's FTSE MIB index gained 3.2% (up 16.9%). Emerging equities markets were mostly higher. Brazil's Bovespa index rose 2.6%, with a three-week gain of 13.6% (down 0.8%). Mexico's Bolsa gained 1.4% (down 5.0%). South Korea's Kospi index increased 0.4% (down 1.2%). India’s Sensex equities index was little changed (up 5.6%). China’s Shanghai Exchange ended the week up 0.8% (down 2.7%). Turkey's Borsa Istanbul National 100 index jumped 5.0% (up 7.1%). Russia's RTS equities index gained 1.0% (down 8.1%).

Freddie Mac 30-year fixed mortgage rates added a basis point to a 10-week high 4.41% (up 85bps y-o-y). Fifteen-year fixed rates gained 5 bps to a 12-week high 3.47% (up 73bps). One-year ARM rates increased one basis point to 2.45% (down 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up another 8 bps to an almost seven-month high 4.79% (up 78bps).

Federal Reserve Credit increased $4.7bn last week to a record $4.191 TN. During the past year, Fed Credit expanded $1.000 TN, or 31.4%. Fed Credit inflated $1.381 TN, or 49%, over the past 73 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week jumped $37.8bn to $3.294 TN (4-week decline of $60bn). "Custody holdings" were little changed from a year ago.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $778bn y-o-y, or 7.1%, to a record $11.732 TN. Over two years, reserves were $1.446 TN higher for 14% growth.

M2 (narrow) "money" supply jumped $20.0bn to a record $11.170 TN. "Narrow money" expanded $706bn, or 6.8%, over the past year. For the week, Currency increased $4.5bn. Total Checkable Deposits fell $20.2bn, while Savings Deposits jumped $37.1bn. Small Time Deposits slipped $1.4bn. Retail Money Funds were little changed.

Money market fund assets fell $13.1bn to a 24-week low $2.630 TN. Money Fund assets were about unchanged from a year ago.

Total Commercial Paper jumped $8.4bn to $1.034 TN. CP was down $12bn year-to-date, while increasing $32bn over the past year, or 3.1%.

Currency Watch:

April 2 – Bloomberg (John Detrixhe, Nikolaj Gammeltoft and Sam Mamudi): “Forget the equity market. For high-frequency traders, the place to be is foreign exchange. Firms using the ultra-fast strategies getting scrutiny thanks to Michael Lewis’s book ‘Flash Boys’ account for more than 35% of spot currency volume in October 2013, up from 9% in October 2008, according to consultant Aite Group LLC. It’s the opposite of equities, where their proportion shrank to 50% in 2012 from 66% four years ago, according to Rosenblatt Securities Inc. As brokers get better at cloaking orders and volume shrinks in stocks, speed trading remains a growth business in the $5.3 trillion foreign-exchange market, where authorities on three continents are examining the manipulation of benchmarks…”

The U.S. dollar index gained 0.3% to 80.42 (up 0.5% y-t-d). For the week on the upside, the South Korean won increased 1.5%, the Brazilian real 1.1%, the Taiwanese dollar 0.8%, the Canadian dollar 0.7%, the Mexican peso 0.5%, the Australian dollar 0.5%, the South African rand 0.1% and the Norwegian krone 0.1%. For the week on the downside, the Swedish krona declined 0.8%, the New Zealand dollar 0.7%, the Swiss franc 0.6%, the Japanese yen 0.5%, the British pound 0.4%, the euro 0.3% and the Danish krone 0.3%.

Commodities Watch:

The CRB index slipped 0.1% this week (up 8.8% y-t-d). The Goldman Sachs Commodities Index declined 0.8% (up 2.0%). Spot Gold rallied 0.7% to $1,305 (up 8.2%). May Silver increased 0.8% to $19.95 (up 3.0%). May Crude slipped 53 cents to $101.14 (up 3%). May Gasoline dipped 0.2% (up 5%), and May Natural Gas declined 1.0% (up 5%). May Copper fell 0.6% (down 11%). May Wheat sank 3.7% (up 11%). May Corn gained 2.0% (up 19%).

U.S. Fixed Income Bubble Watch:

April 3 – Financial Times (Tracy Alloway, Michael Mackenzie and Arash Massoudi): “On a mild spring day in New York, representatives from Citigroup set out to introduce investors to the bank’s new subprime securitisation platform. This might sound like a scene plucked from 2007, at the height of the credit bubble that eventually sparked the financial crisis, but Citi’s ‘roadshow’ began only this week… In doing so, Citi is aiming to tap into a wave of investor demand for higher-yielding securities created from sliced-and-diced loans that it makes to riskier borrowers. The planned sale is symptomatic of a wider development in credit markets as the thirst for increased returns has led to fears about possible overheating and provoked public soul-searching by central bankers. Parts of Wall Street’s securitisation machine have shifted into higher gear, while sales of junk-rated bonds have surged and lending to highly-leveraged companies has surpassed its pre-2008 level… Central bankers have been debating whether monetary policy should take into account asset bubbles ever since the low interest rates cultivated under Alan Greenspan were blamed for herding investors into riskier investments in the years preceding 2008. However, in recent months, that debate has become increasingly public as credit markets continue their upward trajectory… Banks sold $161.8bn worth of leveraged loans in the first quarter of 2014, according to S&P Capital IQ data. That is below the $189bn sold last year in the same period, but still ranks as one of the highest quarterly levels ever recorded.”

April 3 – Bloomberg (Kristen Haunss): “The biggest month in sales of collateralized loan obligations since 2007 is easing concern that new regulations designed to limit risk-taking will damp demand for funds that package junk-rated loans. After CLO issuance plummeted in January, sales rebounded and jumped to $10.8 billion last month, according to Wells Fargo…, the biggest monthly volume since May 2007. The market for CLOs, which helped finance some of the biggest leveraged buyouts in history, are under increasing regulatory and legislative scrutiny as issuance ballooned to a six-year high of $82 billion last year. While March’s boost wasn’t enough to keep first-quarter sales from declining, deals are now being structured to comply with rules aimed at making the financial system safer and prompted Wells Fargo to increase its CLO issuance forecast for 2014.”

April 1 – Barron’s (Michael Aneiro): “Leveraged loans remain in vogue with investors, and the first quarter of 2014 produced $276 billion of leveraged loan issuance, the third-highest quarterly total since Thomson Reuters LPC began tracking the loan market in 1987. The only two quarters with higher tallies both came last year. ‘A limited supply of M&A deals coupled with strong investor demand set the stage for a slew of refinancings, which drove the bulk of lending activity in 1Q14 as issuers cut costs and pushed out maturities,’ said Ioana Barza, director of analytics, Thomson Reuters LPC, who noted that the $180.5 billion of leveraged refinancings last quarter represented a 22% rise from the prior quarter. This near-record issuance comes as the covenants, or investor protections, that govern such loans continue to weaken."

April 1 – Bloomberg (Charles Mead and Matt Robinson): “Lenders from JPMorgan… to Bank of America Corp. warned that corporate-bond buyers were in for another year of rising yields that would erode returns. China, the polar vortex and Vladimir Putin are upending those forecasts. Bonds of companies worldwide tracked by Bank of America Merrill Lynch indexes returned 2.7% in the first quarter through March 31, compared with a 1.42% gain for the MSCI World Index of stocks, the first time the debt beat equities since the second quarter of 2012… ‘It wasn’t perhaps the one-way bet that people thought it was,’ said Andrew Chorlton, a… money manager for a Schroders Plc unit that oversees more than $90 billion. Bonds beating stocks is ‘contrary to what virtually every investment bank you care to mention had on their outlooks for 2014.’”

Federal Reserve Watch:

April 4 – Reuters (Michael Flaherty): “The U.S. Federal Reserve must avoid being locked into calendar-based policy commitments and instead ensure its forward guidance is flexible enough to allow it to respond to changing conditions, a top Fed official said… Dallas Federal Reserve Bank President Richard Fisher said he worried that predictable commitments were unsound policy as they could lead to false complacency and market instability. ‘I question if it is sound policy to remove all uncertainty or volatility from the market,’ Fisher… said… ‘At its worst, I fear calendar-based commitments can lead, perversely, to market instability by encouraging markets to overshoot, as they appear to be doing in some quarters at present,’ Fisher said… ‘Those who think we can be more specific in stating our intentions and broadcasting our every next move with complete certainty are, in my opinion, clinging to the myth that economics is a hard science,’ Fisher said. Fisher said markets and investors often sought to infer specific dates and targets from guidance, even though the Fed was only explaining its thinking without making any promises. ‘The FOMC is seeking to make sure that we have a sustained recovery without giving rise to inflation or market instability. We will conduct monetary policy accordingly,’ Fisher said. ‘Regardless of the way we may finally agree at the FOMC to write it out or have Chair Yellen explain it at a press conference, we really cannot say more than that.’”

April 2 – Bloomberg (Jeff Kearns): “Federal Reserve Bank of Atlanta President Dennis Lockhart says reversing course on the trimming to Fed bond buying ‘requires a substantial deterioration of economic conditions which I certainly do not anticipate.’ Tapering of so-called quantitative easing ‘should continue and play out over the course of this year and we will try to shape economic conditions using the policy rate and forward guidance,’ Lockhart says… Main consideration is ‘the ability to begin to shrink the balance sheet and to neutralize those excess reserves,’ and ‘the tools exist and area already well proven to do that…’”

April 4 – Bloomberg (Craig Torres and Michelle Jamrisko): “Federal Reserve officials were told in December 2008 that they would have to buy ‘very large’ quantities of U.S. Treasury and housing-agency debt to have an impact on the economy as they considered alternatives to cutting interest rates that were heading toward zero. ‘The evidence suggests that this policy tool could have the desired effects, but that the scale of the purchases would have to be very large,’ a team of Fed staff economists said… According to the documents, staff estimated that a purchase of $50 billion of longer-term Treasury securities, or about 1% of all marketable Treasury debt held by the public, would lower the yield on 10-year notes ‘somewhere between 2 and 10 bps.’”

U.S. Bubble Watch:

April 1 – Bloomberg (Thomas Black and Richard Clough): “The polar vortex that blanketed big swaths of the U.S. with snow this winter is also giving cover to companies seeking to explain why earnings rose last quarter at the slowest pace in almost two years. Freezing temperatures and mountains of snow in the first three months of 2014 kept shoppers indoors, grounded flights and made it harder for shippers to fill product orders… Earnings at Standard & Poor’s 500 Index companies rose an estimated 1.1% in the first quarter, according to analysts’ estimates compiled by Bloomberg, slower than the 8.8% increase in the previous three months and the lowest rate since the second quarter of 2012.”

March 29 – Los Angeles Times (Tim Logan): “This time last year, investment firms raced to buy dozens of single-family homes in neighborhoods from Fontana to South Los Angeles to lease them out, transforming the mom-and-pop rental business into a Wall Street juggernaut. The flood of cash helped spark a steep rise in prices, drawing criticism for pushing families out of the market. But now the firms themselves have all but stopped buying in Southern California, the latest evidence that home prices have hit a ceiling. The professional investors no longer see bargains here. The real estate arm of Blackstone Group, the largest buyer, has cut its California purchases 90% over the last year… ‘Private capital made a lot of money early, and now they’re starting to pull back,’ said Dave Bragg, who heads residential research at Green Street Advisors… ‘Home prices are up significantly, and houses are definitely less attractive.’ …Experts say an expanding supply should help usher in a healthier housing market, with a better balance between buyers and sellers. That's a stark change from last year, when buyers faced bidding wars. All the activity drove the region's median home price up to $385,000 by last June, a record 28% increase over the same month a year earlier, according to San Diego research firm DataQuick. But prices have since been flat in Southern California… ‘Prices have gotten to the stage where we cannot buy a house, renovate it, rent it and still make a reasonable return,’ said Peter Rose, a spokesman for Blackstone, which owns roughly 41,000 rental houses nationwide. ‘There was a moment in time where it made sense.’ Among the 20 firms buying the most California real estate since January 2012, purchases are down more than 70% compared with last year in each of the last four months, according to DataQuick.”

April 1 – Bloomberg (Oshrat Carmiel): “Manhattan apartment sales surged in the busiest start to a year since 2007, setting price records as buyers vied for a limited supply of homes for sale and deals were completed at new high-end developments. Sales of co-ops and condominiums in the first quarter jumped 35% from a year earlier to 3,307, according to… appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate. The median price climbed 19% to $972,428, while the average price per square foot rose 24% to $1,363, the highest in 25 years of record-keeping. Price gains are accelerating in a market where the inventory of homes for sale plummeted to record lows three times in the past year as buyer demand increased. Of the deals completed in the first quarter, 38% were at or above the asking price, up from 17% a year earlier, according to Jonathan Miller, president of… Miller Samuel. ‘We’re finally at a point where you’re seeing the chronic lack of supply push prices higher,’ Miller said… ‘The market really isn’t fun for the buyer.’ …Transactions at newly constructed buildings set a record, averaging $1,834 a square foot, the firms said. Many new condo towers have larger units and are aimed at luxury buyers. Completed deals at Extell Development Co.’s One57 in Midtown, as well as downtown’s One Madison and Chelsea’s Walker Tower, all averaged more than $3,000 a square foot… The quarter’s two sales for more than $40 million were both penthouses in new developments… Older properties weren’t left behind. Resale prices averaged $1.47 million, a 19 percent jump from a year earlier, Heym said.”

April 1, 2014 – New York Times (Michelle Higgins): “The Manhattan real estate market got off to a robust start in the first three months of the year, as signed contracts for ultraluxury apartments in new developments began to close, many with multimillion-dollar price tags… The flurry of activity at the top pushed the number of sales to a seven-year high for the quarter and sent the average price per square foot soaring to a record $1,363, according to… Douglas Elliman brokerage firm. Low inventory, high demand and a shift toward larger units in new luxury developments contributed to higher prices. The median price of a condominium jumped 13.4% during the first quarter from the same period last year, setting a record at $1,355,000, according to the Elliman report. ‘This is the first time that we’ve seen this spike in price,’ said Diane M. Ramirez, the chief executive of Halstead Property, which reported that the average price for an apartment in Manhattan set a record at $1,715,741 during the first quarter, up 30% compared with a year ago.’ …Over all, the median sales price rose 18.5% to $972,428 in the first quarter compared with the same time last year, which is about 5% below the 2008 peak.”

April 2 – Bloomberg (Christine Maurus): “Sales of U.S. vacation homes jumped 30% in 2013, while the share of investor purchases declined, the National Association of Realtors said… Vacation-home sales totaled 717,000, up from 553,000 in 2012… Investment-home sales fell 8.5% to about 1.1 million transactions. Purchases of vacation homes accounted of 13% of all deals in 2013, the biggest share since 2006.”

Ukraine/Russia Watch:

April 4 – Bloomberg (Gabrielle Coppola): “Ukraine’s credit rating was cut by Moody’s…, which said escalating political tensions and the withdrawal of Russian financial support are weakening the country’s fiscal strength. Moody’s lowered the rating one level to Caa3, two steps above default, with a negative outlook. The cut takes into account an agreement with the International Monetary Fund to provide ‘near term liquidity relief,’ according to a report… The Russian takeover of Ukraine’s Black Sea Crimean peninsula has reignited Cold War tensions with the U.S. and Europe and rattled financial markets. Ukraine’s debt may rise to the equivalent of 60% of its economic output by the end of the year from 40.5% in 2013, Moody’s said. It forecast the economy may shrink as much as 10% in 2014.”

Global Bubble Watch:

March 31 – Bloomberg (Michael P. Regan): “Pity the poor folks who have to write letters to investors on behalf of equity-focused hedge funds this month. Various measures of performance indicate the alternative investment vehicles may have a lot of explaining to do in March. The Global X Guru Index ETF, which aims to mimic returns of the top hedge-fund stock holdings, has lost 2% this month for its worst performance versus the Standard & Poor’s 500 Index since it was created in 2012. Stocks tracked by Deutsche Bank AG with the highest concentration of hedge fund ownership were down 4.5% from March 7 through last week, while the S&P 500 was down 1%. Meanwhile, a Goldman Sachs Group Inc. measure of hedge funds’ favorite stocks to bet against has risen almost 3% this year, which is not what you want to see if you are short those stocks.”

April 3 – Financial Times (Josh Noble in Hong Kong and Simon Rabinovitch): “Investors are turning increasingly bullish on Chinese markets, just as they take a more bearish view of the country’s economy. Why? Fund managers are banking on stimulus from Beijing and have piled into financials, railways, and cement stocks to play that theme. The latest data set did little to calm nerves about the economy. A factory survey conducted by Markit showed activity at an eight-month low in March…”

April 2 – Bloomberg (Leslie Picker and Elena Popina): “Sky-high valuations mixed with murky corporate structures often scare off investors. That’s less so if the companies are from China. From microblogging site Weibo Corp. to real-estate website Leju Holdings Ltd., China-based companies have announced more than $2.5 billion of U.S. initial public offerings in 2014… That’s the most since the fourth quarter of 2007, when Chinese stocks in the U.S. peaked before losing almost two-thirds of their value. The rush isn’t slowing soon. Alibaba Group Holding Ltd. is preparing to file this month for the biggest IPO since at least 2012. Investors, who have been rewarded with an average 88% gain for buying Chinese IPOs last year, are taking risks that would make many stock buyers wary: The companies are approaching the U.S. market with valuations that are as much as 10 times higher than their American counterparts. Many use a legal structure that’s raised concerns among regulators, and have accounting practices that don’t always line up with those in the U.S. By poking holes both areas…”

EM Bubble Watch:

April 3 – Bloomberg (Matthew Malinowski and Raymond Colitt): “Brazil’s central bank signaled it is ready to end the world’s longest monetary tightening cycle as economic growth falters ahead of presidential elections. The bank’s board… raised the benchmark Selic rate to 11% from 10.75%... Policy makers removed language that had appeared in the previous statement about continuing to raise interest rates. Dilma Rousseff is expected to run for re-election in October after delivering the slowest economic growth of any president since Fernando Collor, who resigned over corruption charges in 1992.”

March 31 – Bloomberg (David Yong and Judy Chen): “The specter of default in China’s trust loans market is deepening the distress of property developers that also borrowed in dollars. Eighteen companies owing $15.2 billion, from behemoth China Vanke Co. to junk-rated Glorious Property Holdings Ltd., have ‘material exposure' in excess of 10% to trust financing, a form of non-bank lending that’s helped homebuilders proliferate in China, Moody’s… said. This year alone, the number of bonds from Chinese developers considered distressed based on their yields has almost doubled to 18. Part of China’s $7.5 trillion shadow-banking system, trust financing has been key to fueling the nation’s 10 percent annual growth rate in the past decade by providing easy credit to companies considered too risky by banks. After trust loans to the property, solar, coal and other industries tripled in the past three years to 10.9 trillion yuan ($1.8 trillion), bondholders are becoming increasingly alarmed as the government reins in lending, housing demand cools and the economy slows.”

April 1 – Bloomberg (Alaa Shahine and Selcuk Gokoluk): “Turkish Prime Minister Recep Tayyip Erdogan risks upending the lira’s best run in more than a year. Erdogan’s victory in the March 30 local election spurred the lira to a three-month high yesterday, helping it post a quarterly gain for the first time since 2012. Celebrating his win, the premier vowed to pursue foes he blames for a graft probe that roiled markets and led to cabinet resignations. That pledge prompted analysts at banks including Commerzbank AG and Deutsche Bank AG to predict that the currency rally may be short-lived, with political tensions set to persist. Erdogan’s threat to pursue opponents adds to ‘fundamental risks’ facing Turkey, including slower economic growth and high inflation, said Thu Lan Nguyen, a currency strategist at Commerzbank in London. The premier’s pledge signals the risk of ‘renewed escalation of political infighting, in particular, if Erdogan takes drastic measures to fight his opposition,’ she said…”

April 2 – Bloomberg (Ali Berat Meric, Benjamin Harvey and Isobel Finkel): “Bussing tables at a busy Ankara kebab restaurant, Yunus Mutevelli says Turks are more concerned with the money going into their own wallets than those of ministers caught up in corruption scandals. While a daily deluge of leaked wiretaps over the past three months sought to portray Prime Minister Recep Tayyip Erdogan as a micro-managing kleptocrat, voters credit him with improving their quality of life. The result: his Justice and Development Party, or AKP, trounced the opposition in local elections to extend its 12-year undefeated streak at the polls. ‘We owe a debt of gratitude to Erdogan, and we try to pay back that debt with our votes,’ Mutevelli, 27, said… ‘As long as the services continue, our votes will continue going to Erdogan,’ he added, citing handouts of food and coal to the poor by the Ankara municipality.”

China Bubble Watch:

April 3 – Bloomberg (Matthew Malinowski and Raymond Colitt): “China’s debt is poised to keep expanding faster than the economy through at least 2016, testing the limits of a credit-driven growth model that’s already exceeded the imbalances in Japan before its lost decade. The combined ratio of government, corporate and household debt to gross domestic product is set to climb to 236.5% in 2016 from 225% last year, based on median estimates in a Bloomberg News survey… The responses reflect skepticism that the Communist Party is prepared to allow the long-term deleveraging flagged by the central bank, as leaders focus on preventing an economic slowdown and sustaining employment. China’s debt-to-GDP ratio is already higher than India’s, Brazil’s and Russia’s and JPMorgan Chase & Co. says it’s surpassed the level in Japan that preceded that nation’s financial crisis.”

April 1 – Bloomberg: “Chinese manufacturing gauges pointed to weakness in the world’s second-biggest economy that could prompt the Communist Party leadership to roll out additional support measures. A Purchasing Managers’ Index fell to 48 in March, the lowest reading since July, from 48.5 in February, HSBC Holdings Plc and Markit Economics said… The reports underscore what Premier Li Keqiang last week called ‘difficulties and risks’ as he tries to control surging debt, default dangers and pollution that threatens to stoke public discontent.”

April 4 – Wall Street Journal (Dinny McMahon): “Xie Daoliang's business survives by trading almost exclusively in a virtual currency, but not by choice. Mr. Xie makes bulldozer treads and other parts for heavy machinery. These days, when he makes a sale he seldom gets paid in cash. Instead, he gets a piece of paper with a value printed on it and a promise from a bank that it will pay at an arranged point in the future. In China's economic slowdown, businesses are having troubles paying suppliers, and banks are getting shy about lending, so cash is scarce. The notes—a form of IOUs known as acceptance drafts – are increasingly being used instead, and Mr. Xie says they really get around… ‘At the moment, there’s no cash. It’s all just bills,’ says Mr. Xie… ‘It's unreasonable.’ Acceptance drafts, which are similar to postdated checks but are guaranteed by a bank or state-owned enterprise, have been a fixture of trade in China for years. But corporate treasurers, chief financial officers, people at small loan firms and analysts say that as the economy slows, cutting into companies’ sales, the bills are being passed around more and more. Driving the exchange of paper, analysts say, is an unwillingness, or inability, by banks to meet demand for cash loans, especially from smaller companies. ‘The credit transmission mechanism is breaking, or even broken,’ said Leland Miller, president of the China Beige Book, a quarterly survey of Chinese businesses and banks. ‘Firms are having a difficult time getting access to funding, and for small firms it's extraordinarily difficult.’”

April 3 – MarketNews International: “In speeding up slum clearance and providing tax breaks to China's smallest companies, China’s State Council is doing the bare minimum to shore up a flagging economy. Some have seen the measures, which also include broadening financing channels for investment in public housing, as an echo of the ‘mini stimulus’ package which was announced during a similar period of faltering growth in July last year. But they fall far short of the more aggressive measures that some in the market had expected and indicate that the new leadership is taking a more cautious approach to economic management than the previous government as it focuses on reform and avoiding a repeat of the abuses of the past. ‘Investors will be making a big mistake and bad investment decisions if they use old thinking to judge this new government,’ said a trader with a bank based in southeastern China.”

March 31 – Bloomberg: “Amid the cluster of half-built brick townhouses surrounded by budding peach groves on the outskirts of Fenghua city, south of Shanghai, workers last week could be seen taking down metal scaffolding and hauling away steel plates. They had heard the news about ‘Cement Shen,’ the nickname of the developer whose Zhejiang Xingrun Real Estate Co. became insolvent this month with 3.5 billion yuan ($563 million) in debt… Authorities detained founder Shen Caixing and his son for illegal fundraising, Xu Mengting, director of the government information office, said… ‘The developer owed us hundreds of thousands of yuan’ for scaffolding and steel, said workers Xie and Wang… ‘We are taking these materials back for now, because there’s no work here.’ The insolvency may portend difficult times ahead for small developers. China has almost 90,000 of them nationwide, National Bureau of Statistics data show. As new-home price growth slows in China and cash-flow conditions tighten, more local builders like Xingrun will face defaults, Fitch… Hong Kong-based analyst Andy Chang wrote…”

April 2 – Bloomberg: “The Chinese steel industry’s ability to survive 1 billion yuan ($161 million) of losses per month without more defaults is under threat as a slump in iron ore and the yuan undermines a key source of financing. The currency has weakened 2.5% this year and a measure of exchange-rate swings reached a record, prompting Goldman Sachs Group Inc. to predict funding that uses the steelmaking ingredient as collateral will drop over the next two years due to foreign-exchange hedging costs… Chinese steelmakers, which account for almost half of the world’s production, can ill afford a funding squeeze as an industry association reported 43% of them made losses in January amid an 8.6% slump in demand from a year earlier… ‘Private steelmakers will see very significant operational problems and funding issues this year, so we could see another default,’ Sangyun Han, a Hong Kong-based credit analyst at Standard & Poor’s Ratings Services, said… ‘Higher volatility of the currency is another negative factor in their financing in addition to volatile iron ore prices and weak demand.’”

April 3 – Bloomberg: “China’s one-year interest-rate swaps touched the highest level in almost a month after the central bank drained cash from the financial system for an eighth week. The People’s Bank of China absorbed 90 billion yuan ($14.5bn) issuing 14- and 28-day repurchase agreements today… That took this week’s net withdrawal to 62 billion yuan…”

March 31 – Bloomberg (Fion Li): “China’s short-term bond yields are sliding at the fastest pace in five years as speculation builds that monetary policy will be loosened to combat what Premier Li Keqiang says are “difficulties and risks” for the economy. The yield on the government’s two-year bonds tumbled 93 bps this quarter to 3.41%, ChinaBond data show. That would be the biggest decline since a 214 bps drop in the final three months of 2008, when global credit markets seized after Lehman Brothers Holdings Inc. collapsed. The average yield on local currency sovereign debt in emerging markets fell six basis points since Dec. 31 to 5.50%..."

April 2 – Bloomberg (Foster Wong): “Hong Kong’s syndicated loan market enjoyed a record first quarter as Chinese companies shunned local financing in favor of cheaper offshore funds. Lending in the city surged 41% to $20.8 billion in the first three months compared with a year earlier, the busiest start since Bloomberg starting tracking the data in 1999. Volumes in China shrank 45% to $5.8 billion, the worst first quarter in four years. Onshore borrowing costs for the nation’s top-rated companies jumped 30 bps to 5.89% in March, the biggest monthly rise since November, ChinaBond data show.”

Japan Watch:

April 4 – Wall Street Journal (Jacob M. Schlesinger): “For a year, the Bank of Japan’s new leadership has drawn surprisingly little flack while executing a self-proclaimed aggressive ‘regime change,’ breaking from a decade of more cautious policymaking. Now the repudiated old guard is striking back, publicly ringing alarm bells about the lurking dangers of a massive money-printing program… Kunio Okina, a long-time BOJ official widely considered Japan’s most influential monetary economist in the 1990s and 2000s, delivered a speech Friday dissecting what he called ‘the Achilles’ heel of Abenomics,’ a reference to the economic revival plan of Prime Minister Shinzo Abe. Abenomics relies heavily on turbocharging the restrained monetary policy long advocated by Mr. Okina and his disciples. In the speech, Mr. Okina warned about longer-term risks from the policies launched in April 2013 by Mr. Abe’s handpicked Bank of Japan governor, Haruhiko Kuroda… At one point in the speech, Mr. Okina compared current Japanese economic policy to the recent disastrous experience of Zimbabwe, which was plagued by rampant inflation and colossal government debt.”

April 3 – Bloomberg (Keiko Ujikane): “Japanese banks are the most keen to lend companies money in 17 years. Corporate treasurers don’t need the cash. A Bank of Japan index measuring the prevalence of mid-sized companies saying banks are willing to make loans rose to 19 in March, the highest since June 1997… Yet demand for loans from businesses remains below levels before the global financial crisis, other central bank data show. The BOJ’s unprecedented monthly buying of about 7 trillion yen ($67bn) of sovereign notes has flooded Japan’s markets with funds to encourage banks to boost lending… Companies… have built buffers since the financial crisis with total cash holdings of non-financial Topix index members reaching the equivalent of $636 billion in latest filings, from $417 billion in March 2007…”

April 2 – Bloomberg (Toru Fujioka and Keiko Ujikane): “Japanese Prime Minister Shinzo Abe’s bid to rid the economy of 15 years of deflation got a boost, as companies forecast sustained price gains. The inflation rate will be 1.5% in a year’s time and 1.7% in three years and in five years, according to average forecasts in a Bank of Japan survey… The data give the central bank another reason to hold off from any immediate additional monetary easing as it assesses the blow to economic growth from yesterday’s sales-tax increase.”

Europe Watch:

April 4 – MarketNews International (Craig Torres and Michelle Jamrisko): “EU Economics and Monetary Affairs Commissioner Olli Rehn and ECB Governing Council member Jens Weidmann warned against giving France more time to meet its deficit targets… In excerpts of the interviews…, the two top officials warned that granting France additional leeway to meet its deficit goals would set a bad example for other EU member states. ‘If France or any other large member state were to be granted more flexibility, this would immediately be used as a reference for other member states,’ Rehn told the paper, noting France had already received two delays. ‘How we deal with one country has a clear impact on what we can ask of other countries. That is why it is especially important that we stick to the rules and don't fiddle about with them,’ Rehn said. Weidmann, who also heads Germany's Bundesbank, said it would be up to Germany's government to support the EU Commission in its efforts to take a hard line with France. ‘What counts now is that the European Commission interprets the existing agreements strictly and is supported in this by the [German] government,’ Weidmann told the paper.”

April 1 – Bloomberg (Angeline Benoit and Emma Charlton): “Europe’s two-speed economy was underscored in data today showing strengthening in the German labor market just as Italy’s jobless rate reached a record. Overall euro-area unemployment was at 11.9% in February, lower than the 12% median forecast… In Italy it rose to 13%, while in Germany the locally defined jobless rate for March stayed at the lowest in at least two decades. The divergence between the region’s third-biggest and largest economies highlights the challenge faced by the European Central Bank’s Governing Council as it meets this week to assess the need for stimulus and gauge the risk of deflation at a time when consumer prices are increasing at about a quarter of the pace that officials would like.”


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