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Bubbles & Schemes

July 25, 2014

Cracks appearing in junk bonds?

The “economic sphere” versus “financial sphere” analytical framework has in the past been a CBB focal point. Over recent years I have not given this type of analysis the attention it deserves. Conventional analysis holds that the real economy drives the performance of the markets. During bull markets, pundits fixate on every little indicator supposedly corroborating the optimistic view. These days, the bulls trumpet strong underlying profit growth as supporting ever higher stock prices.

Especially in this Age of Unfettered Finance, I’m convinced that the “financial sphere” commands the “economic sphere.” Profits are generally a byproduct of strong underlying growth in finance – hence a lagging indicator. Corporate earnings will appear absolutely stellar at market peaks – as Credit flows freely and financial conditions remain ultra-loose. Profits will be lousy at market bottoms, when risk aversion and attendant tight financial conditions dominate.

Going back now more than twenty years, one of my primary analytical objectives has been to identify, study and monitor the underlying finance fueling booms in markets and economic activity. Fundamental analytical issues include: What is the nucleus of the underlying Credit expansion? Whose balance sheets/liabilities are growing? What is the nature of prevailing financial flows? How stable are the underlying Credit and flow dynamics? What is the role of policymaking and government market intervention? Are there major market misperceptions and resulting mispricings?

Today’s consensus view holds that the economy and markets are sound – robust even. The economy is finally emerging from a difficult post-Bubble period, with the markets appropriately valued based on improving fundamentals. Central bankers and pundits alike assure us that markets have not succumbed to yet another Bubble. Top officials at the Fed and ECB have both recently stated that underlying Credit growth and market leverage are inconsistent with a problematic Bubble backdrop.

I have repeatedly identified troubling parallels between the past twenty year cycle and the protracted boom that ended with the 1929 stock market crash. Having extensively studied the late-twenties period, I was repeatedly struck by how virtually everyone was caught unaware of acute underlying financial and economic fragilities. “How could they have not seen it coming?,” I often asked myself. It all makes clearer sense to me now.

Importantly, this has been a particularly prolonged Credit and speculative cycle (exceeding even the historic 1914-1929 boom). Similar to 1929, everyone has become numb to the scope of Credit excess, speculative leveraging and economic maladjustment. Back in the sixties, Alan Greenspan was said to have pointed responsibility for the financial collapse and resulting Great Depression on a misguided Federal Reserve that had repeatedly placed “coins in the fuse box” to sustain the Twenties boom.

Clearly, a protracted period of repeated central bank market interventions will solidify the notion that adroit policymakers have everything under control. And given enough time – and sufficient inflation in Credit and financial asset markets – price distortions will become deeply systemic – if not commonly appreciated. Importantly, protracted booms create cumulative deleterious effects that, by the nature of things, go completely unappreciated even in the face of precarious “terminal phase” Bubble excess.

I titled a presentation back in early-2000, “How Could Irving Fisher Have been so Wrong?” Only days before the great 1929 crash, the leading American economist at the time famously stated: “Stock prices have reached what looks like a permanently high plateau. I do not feel there will be if ever a 50 or 60 point break from present levels…”

Fisher and about everyone else at the time were oblivious to underlying financial and economic fragilities. With this in mind, I will touch upon what I believe are sources of potential vulnerability. In particular, my focus is on potentially unstable Credit and financial flows – the “financial sphere”.

First of all, Credit financing asset speculation is inherently unstable. Broker call loans and various leveraged structures proved catastrophic in the 1929 crash and subsequent financial meltdown. During booms, speculative leveraging engenders their own self-reinforcing liquidity abundance. But as we saw firsthand during the 2008/09 fiasco, the cycle’s vicious downside, with the forced unwind of speculative leverage, pressures market liquidity and asset prices in a self-reinforcing market crash. Contemporary central banking has regressed to little more than a scheme intent upon bolstering securities and asset prices.

It is my view that the current amount of global speculative leverage across securities and asset markets is surely unprecedented – stocks, bonds, EM, real estate, collectables, etc. The global leveraged speculating community has grown significantly since the ’08 crisis, while there has been a proliferation of instruments, vehicles and funds that boost returns through the use of embedded leverage. Anecdotes suggest global “carry trade” speculative leverage has inflated to unprecedented extremes, certainly bolstered by central bank currency/liquidity manipulation (the U.S., Japan and China at the top of the list). And I worry that booming markets for ETFs and derivatives (of all stripes) ensure the utilization of massive amounts of leverage (along with trend-reinforcing “dynamic trading” hedging strategies).

At the same time, record margin debt and booming “repo” markets suggest speculative leverage from traditional sources remains as prominent as ever. What are the ramifications for system stability from record quantities of stocks and bonds at record high prices underpinned by record amounts of speculative leverage?

Sheila Bair penned an interesting op-ed in Friday’s Wall Street Journal: “The Federal Reserve’s Risky Reverse Repurchase Scheme.” I appreciate the analysis and particularly the notion of a “scheme.” I actually believe that there is a critically important evolution that occurs during protracted Credit and speculative cycles. In simple terms, over time runaway financial and economic booms transforms from a Bubble dynamic to one more akin to a sophisticated financial scheme.

Importantly, mounting financial and economic fragility fosters progressive government intrusion throughout the markets and real economy. Resulting market instability and poor economic performance then provoke only more meddlesome government “activism.” As we’ve witnessed over the past six years, massive fiscal spending has bolstered the economy and inflated corporate profits. Meanwhile, central bank interest-rate manipulation, market intervention and massive “money” printing incited risk-taking and incentivized speculative leveraging. If the great American economist Hyman Minky were alive today, he would undoubtedly label this one of history’s most outrageous episodes of "Ponzi Finance."

It’s certainly no coincidence that we’ve been witnessing a proliferation of financial jerry-rigging. The loosest financial conditions imaginable have spurred record stock buybacks that have bolstered equities prices, while goosing earnings-per-share (EPS). Other popular methods of financial engineering include “tax inversions,” master limited partnership and various other tax avoidance schemes that work to inflate equity market valuation. Government and central bank largesse has also incited a historic M&A boom that will leave a legacy of problem debt.

It’s surprising that there has not been more concern regarding conspicuous excess throughout the corporate debt market. Corporate borrowings are notoriously cyclical and potentially disruptive. One can look back to the late-eighties corporate debt boom and resulting early-nineties bust. Then there were late-nineties excesses that left a legacy of problematic telecom debt, along with a severe tightening of Credit conditions. Yet those excesses were left in a trail of dust by the 2006/07 corporate lending fiasco that played prominently in the subsequent financial crisis.

So let’s take a brief look under the hood of today’s corporate debt boom (beyond record issuance of bonds - risky and otherwise). From the Fed’s Z.1 “flow of funds” report we see that non-financial corporate borrowings increased at a seasonally-adjusted and annualized rate (SAAR) $873bn during Q1, up sharply from 2013 Q4 and at a pace surpassing even 2007’s record $862 growth in corporate debt. It is worth noting that the two-year 2012-2013 corporate debt expansion of $1.45 TN surpassed the $1.42 Trillion gain from 2006-2007. And while we’re at it, the 1998-1999 lending boom saw corporate debt increase $801bn and the 1987-1988 Bubble posted growth of $395bn. Some would argue that the 9% (or so) pace of corporate debt growth over the past nine quarters remains below 2007’s 13.6%, 1998’s 10.8% and 1987’s 10.4%. I would counter that today’s record low corporate borrowing costs work to somewhat temper overall growth in corporate Credit. Excesses – including issuance and mispricing - are greater than ever.

The cyclical boom and bust dynamic saw Credit expansion slow rapidly during the early nineties, with corporate debt actually contracting 2.3% in 1991 (and growing only 0.8% in ’02). Booming corporate debt growth was cut in half by 2001, and then expanded only 1.3% in 2002 and 2.0% in 2003. Corporate borrowings were also cut in half in 2008, before contracting 3.1% in 2009 (expanding only 1.7% in 2010). Importantly, corporate debt is prone to cyclicality and instability.

Returning to “financial sphere” analysis, I discern latent fragility. Sure, Q1 total non-financial sector Credit expanded SAAR $2.113 TN (up from 2013’s $1.812 TN), surpassing my $2.0 TN bogey for Credit sufficient to drive a maladjusted economic structure. But the federal (SAAR $874bn) and corporate (SAAR $873bn) sectors accounted for the vast majority of system Credit expansion. And I believe both Credit booms have been heavily impacted by central bank QE liquidity injections. After all, Fed holdings expanded SAAR $911bn during Q1, after surging $1.086 TN in 2013. Importantly, we’re now only a few months away from the end of QE.

July 25 – Financial Times (Vivianne Rodrigues and Michael Mackenzie): “Junk bonds are on track for their worst monthly return in nearly a year, with investors fretting the era of easy US central bank money is at an end and calling time on a bull run for one of the market’s riskier asset classes. Years of quantitative easing by the Federal Reserve have driven investors into bonds, real estate and equities, sparking concerns of looming asset price bubbles. Junk-rated debt, in particular, has attracted record inflows and generated robust returns for investors prepared to bet on bonds sold by companies with the lowest credit ratings.”

July 25 – Wall Street Journal (Katy Burne and Chris Dieterich): “Investors are selling junk bonds at the fastest pace in more than a year, as fresh interest-rate fears and geopolitical turmoil amplify valuation concerns following a long rally. Prices on bonds issued by lower-rated U.S. companies tumbled to a three-month low this week… Investors yanked $2.38 billion from mutual funds and exchange-traded funds dedicated to junk bonds in the week ended Wednesday, the largest weekly withdrawal since June last year, said… Lipper. That came on the heels of $1.68 billion that poured out the week before. Companies have taken note, with some borrowers delaying scheduled debt sales and others canceling planned deals. New issuance is on track for its slowest month since February, according to… Dealogic.”

I suspect that the end of QE could very well send shudders throughout the corporate debt marketplace, and I would furthermore expect the initial tightening of financial conditions to manifest with the marginal “junk” borrowers. Especially after hundreds of billions have flooded into high-yielding vehicles (certainly including the ETF complex), an abrupt reversal of flows would spell Credit tightening trouble. Further, any meaningful deterioration in corporate Credit Availability would have negative ramifications for an overextended stock market Bubble. As I have written previously, with QE winding down the securities markets are increasingly vulnerable to a destabilizing bout of “risk off.” It wouldn’t require a major de-risking/de-leveraging episode to dramatically alter the marketplace liquidity backdrop.

There is another element of “financial sphere” analysis that I believe could play a major role in unappreciated latent fragilities: Integral to the “global government finance Bubble” thesis is that excesses today encompass the world and virtually all asset classes. While not readily apparent, I believe there are various international financial flows that today stoke asset inflation and Bubbles – flows that could prove especially destabilizing in the event of globalized financial tumult. Myriad flows originating from the likes Japan, China, overheated EM Credit systems and elsewhere unobtrusively inject liquidity and drive price gains throughout our stocks, bonds, real estate and the real U.S. economy more generally.

July 16 Wall Street Journal (Min Zeng) “China Plays a Big Role as U.S. Treasury Yields Fall – Record Chinese Purchases of Treasurys Help Explain U.S. Bond Rally.” “Investors wrestling with the mysterious U.S. bond rally of 2014 got a clue about where to look: China. The Chinese government has increased its buying of U.S. Treasurys this year at the fastest pace since records began more than three decades ago… The purchases help explain Treasurys' unexpectedly strong rally this year… The world's most-populous nation boosted its official holdings of Treasury debt maturing in more than a year by $107.21 billion in the first five months of 2014… “

July 9 – Los Angeles Times (Tim Logan): “A record amount of foreign money is flowing into the U.S. housing market… Overseas buyers and new immigrants accounted for $92 billion worth of home purchases in the U.S. in the 12 months ended in March… That’s up 35% from the year before, and the most ever. Nearly one-fourth of those purchases came from Chinese buyers. And the place they're looking most is Southern California… The report highlights the growing effect of global capital on some local housing markets. The $92 billion amounts to 7% of all money spent on homes in the U.S. during those 12 months, and nearly half of it was concentrated in a handful of cities, including Los Angeles.”

Perhaps it’s coincidence that the ECB is commencing a major new liquidity operation just as the Fed’s QE winds down. Clearly, the “Draghi plan” to bolster fragile European peripheral debt markets should be viewed as a sophisticated financial scheme. Thus far, the Bank of Japan (BOJ) shows no indication that its “money” printing scheme is ending anytime soon. And despite all the talk that the Chinese were serious about financial and economic reform, they apparently took one alarming look at rapidly unfolding systemic fragilities and opted to let their historic Bubble run. The Chinese Bubble is a government-dictated financial scheme of epic proportions.

So it’s become an equally fascinating and alarming global dynamic: a multifaceted global scheme to support massive amounts of debt, inflated securities markets and a grossly maladjusted global economic structure. Worse yet, it’s a global scheme held together by various governments that are increasingly engaged in heated geopolitical strife. In the end, “Ponzi Finance” financial schemes boil down to games of confidence.

So I’ll attempt the briefest responses to the above noted key questions: What is the nucleus of the underlying Credit expansion? Answer: Non-productive government debt, speculative leverage and borrowings to support financial engineering. Whose balance sheets/liabilities are growing? Answer: The Fed’s and Treasury’s, along with corporate America. What is the nature of prevailing financial flows? Answer: Financial speculation – chasing yields and inflating securities prices. How stable are the underlying Credit and flow dynamics? Answer: I believe highly unstable and susceptible to changing market perceptions and faltering confidence. What is the role of policymaking and government market intervention? Answer: Profound impact on all markets and the real economy. Are there major market misperceptions and resulting mispricings? Answer: Confidence in both ongoing liquidity abundance and the power of central banks has fostered profound systemic mispricing throughout securities and asset markets on a global basis. Is the backdrop consistent with a momentous financial scheme? Absolutely.


For the Week:

The S&P500 was unchanged (up 7.0% y-t-d), while the Dow declined 0.8% (up 2.3%). The Utilities slipped 0.7% (up 10.7%). The Banks gained 1.2% (up 3.4%), and the Broker/Dealers rose 1.1% (down 1.0%). The Transports added 0.5% (up 13.9%). The S&P 400 Midcaps declined 0.5% (up 4.7%), and the small cap Russell 2000 slipped 0.6% (down 1.6%). The Nasdaq100 gained 0.6% (up 10.4%), and the Morgan Stanley High Tech index added 0.3% (up 7.9%). The Semiconductors sank 4.2% (up 15.3%). The Biotechs rallied 0.8% (up 17.9%). With bullion slipping $4, the HUI gold index declined 0.5% (up 22.3%).

One- and three month Treasury bill rates closed the week at 2.5 bps. Two-year government yields added a basis point to 0.49% (up 11bps y-t-d). Five-year T-note yields were unchanged at 1.67% (down 7ps). Ten-year Treasury yields declined two bps to 2.47% (down 56bps). Long bond yields fell five bps to 3.24% (down 73bps). Benchmark Fannie MBS yields increased a basis point to 3.20% (down 41bps). The spread between benchmark MBS and 10-year Treasury yields widened three to a four-month high 73 bps. The implied yield on December 2015 eurodollar futures increased 1.5 bps to 1.06%. The two-year dollar swap spread increased one to 20 bps, and the 10-year swap spread was up slightly to 12 bps. Corporate bond spreads were mostly wider. An index of investment grade bond risk increased one to 59.5 bps. An index of junk bond risk jumped nine to a two-month high 321 bps. An index of emerging market (EM) debt risk fell nine to 259 bps.

Debt issuance was slow. Investment-grade issuers included Ebay $3.5bn, Daimler Finance $2.5bn, Citigroup $2.0bn, Manufacturers & Traders Trust $1.7bn, Capital One $1.25bn, Liberty Mutual $750 million, Broadcom $600 million and Conagra $550 million.

Junk funds saw outflows jump to a one-year high $2.3bn (from Lipper). Junk issuers included Micron Technology $1.15bn, Regency Energy Partners LP $700 million, Citgo Petroleum $650 million, Alliance Data Systems $600 million, Aston $440 million, Kosmos Energy $300 million and Clearwater Paper $300 million.

I saw no convertible debt issues this week.

International dollar debt issuers included Brazil $3.5bn, Export-Import Bank of China $3.0bn, CDP Financial $2.0bn, Nederlandse Waterschapsbank $1.5bn, GNL Quintero $1.1bn, Capsugel $880 million, Tunisia $500 million, Greenko $550 million, Senegal $500 million, Nightinggale Finance $350 million, GCX $350 million and International Bank of Reconstruction & Development $300 million.

Ten-year Portuguese yields dipped two bps to 3.64% (down 249bps y-t-d). Italian 10-yr yields fell six bps to 2.71% (down 141bps). Spain's 10-year yields dropped six bps to 2.54% (down 161bps). German bund yields slipped a basis point to 1.15% (down 78bps). French yields declined two bps to a record low 1.55% (down 101bps). The French to German 10-year bond spread narrowed a basis point to 41 bps. Greek 10-year yields sank 31 bps to 5.92% (down 250bps). U.K. 10-year gilt yields were unchanged at 2.57% (down 45bps).

Japan's Nikkei equities index rose 1.6% (down 5.1% y-t-d). Japanese 10-year "JGB" yields declined about a basis point to 0.54% (down 21bps). The German DAX equities index declined 0.8% (up 1.0%). Spain's IBEX 35 equities index jumped 3.4% (up 9.8%). Italy's FTSE MIB index gained 1.6% (up 11.1%). Emerging equities were mostly strong. Brazil's Bovespa index jumped 1.4% (up 12.3%). Mexico's Bolsa added 0.2% (up 3.9%). South Korea's Kospi index increased 0.7% (up 1.1%). India’s bubbly Sensex equities index was up another 1.9% (up 23.4%). China’s Shanghai Exchange jumped 3.3% (up 0.5%). Turkey's Borsa Istanbul National 100 index rose 2.3% (up 24.2%). Russia's MICEX equities index increased 0.3% (down 7.7%).

Freddie Mac 30-year fixed mortgage rates were unchanged at 4.13% (down 18bps y-o-y). Fifteen-year fixed rates were up three bps to 3.26% (down 13bps). One-year ARM rates were unchanged at 2.39% (down 26bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates one basis point lower at 4.56% (down 14bps).

Federal Reserve Credit last week expanded $14.7bn to a record $4.364 TN. During the past year, Fed Credit inflated $871bn, or 25.1%. Fed Credit inflated $1.553 TN, or 55%, over the past 89 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $1.0bn to $3.311 TN. "Custody holdings" were down $43bn year-to-date, while posting a one-year increase of $33.5bn.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $816bn y-o-y, or 7.3%, to a record $12.024 TN. Over two years, reserves were $1.574 TN higher for 15% growth.

M2 (narrow) "money" supply jumped $54.5bn to a record $11.415 TN. "Narrow money" expanded $718bn, or 6.7%, over the past year. For the week, Currency increased $2.1bn. Total Checkable Deposits surged $47.1bn, and Savings Deposits gained $2.5bn. Small Time Deposits added $1.7bn. Retail Money Funds were little changed.

Money market fund assets slipped $2.0bn to $2.563 TN. Money Fund assets were down $156bn y-t-d and dropped $59bn from a year ago, or 2.2%.

Total Commercial Paper slipped $2.4bn to $1.026 TN. CP was down $20bn year-to-date, while gaining $29bn over the past year, or 2.9%.

Currency Watch:

The U.S. dollar index gained 0.6% to 81.029 (up 1.2% y-t-d). For the week on the upside, the South African rand increased 1.3%, the South Korean won 0.3%, the Swedish krona 0.3% and the Australian dollar 0.1%. For the week on the downside, the New Zealand dollar declined 1.5%, the Canadian dollar 0.7%, the Danish krone 0.7%, the Swiss franc 0.7%, the euro 0.7%, the British pound 0.7%, the Japanese yen 0.5%, the Norwegian krone 0.4%, the Brazilian real 0.2% and the Singapore dollar 0.1%.

Commodities Watch:

The CRB index added 0.3% this week (up 6.5% y-t-d). The Goldman Sachs Commodities Index increased 0.5% (up 0.3%). Spot Gold dipped 0.3% to $1,307 (up 8.4%). September Silver fell 1.2% to $20.64 (up 7%). September Crude was little changed at $102.09 (up 4%). August Gasoline added 0.2% (up 3%), while August Natural Gas sank 4.3% to an almost eight-month low (down 11%). September Copper rallied 1.8% (down 5%). September Wheat recovered 1.1% (down 11%). September Corn dropped another 2.2% to a four-year low (down 14%).

U.S. Fixed Income Bubble Watch:

July 25 – Wall Street Journal (Katy Burne and Chris Dieterich): “Investors are selling junk bonds at the fastest pace in more than a year, as fresh interest-rate fears and geopolitical turmoil amplify valuation concerns following a long rally. Prices on bonds issued by lower-rated U.S. companies tumbled to a three-month low this week… Investors yanked $2.38 billion from mutual funds and exchange-traded funds dedicated to junk bonds in the week ended Wednesday, the largest weekly withdrawal since June last year, said… Lipper. That came on the heels of $1.68 billion that poured out the week before. Companies have taken note, with some borrowers delaying scheduled debt sales and others canceling planned deals. New issuance is on track for its slowest month since February, according to… Dealogic.”

July 25 – Financial Times (Vivianne Rodrigues and Michael Mackenzie): “Junk bonds are on track for their worst monthly return in nearly a year, with investors fretting the era of easy US central bank money is at an end and calling time on a bull run for one of the market’s riskier asset classes. Years of quantitative easing by the Federal Reserve have driven investors into bonds, real estate and equities, sparking concerns of looming asset price bubbles. Junk-rated debt, in particular, has attracted record inflows and generated robust returns for investors prepared to bet on bonds sold by companies with the lowest credit ratings.”

July 22 – Bloomberg (Sridhar Natarajan): “The prospect of 8% yields can drown out a lot of warnings when central bankers keep talking up the need for easy-money policies to spur the economy. That’s what investors in the junk-rated loan market were offered by Formula One, two days after the Federal Reserve said lax underwriting standards are setting up buyers of the debt for losses due to higher defaults. In exchange, investors of the CVC Capital Partners Ltd.-controlled racing company’s loans would accept a lesser claim on assets and weaker protections that may lead to greater losses if Formula One ever defaults. While the Fed is trying to contain the risk-taking unleashed by its own extraordinary stimulus, investors are showing an increased willingness to sacrifice safeguards for higher returns as benchmark interest rates remain close to zero for a sixth year. That’s allowed some of the least-creditworthy borrowers to raise $20.6 billion of the junior-ranked debt known as second-lien loans this year, eclipsing 2013’s record pace.”

July 24 – Bloomberg (Sarah Mulholland): “Buyers of asset-backed bonds are embracing newcomers to gain a little more yield and snapping up debt guaranteed by everything from chicken-wing sales to computer leases. Hooters of America LLC, the chain best known for the skimpy tank tops worn by its waitresses, and the lending arm of computer maker Dell Inc. are among debut issuers this month helping to push sales of asset-backed debt to the highest in five years.”

July 22 – Bloomberg (Lisa Abramowicz): “It just doesn’t pay to try to be a superhero in the bond market right now. The potential gains are increasingly small on the most-popular notes, such as U.S. Treasuries. Meanwhile, sentiment is souring in more speculative corners, like Russian bonds and high-yield U.S. debt. So, many are simply waiting for a more inspiring time to place their bets. Trading in U.S. government bonds has dropped 25% in the past few weeks from the comparable period last year… Investment-grade and junk-bond trading have plunged 17% and 8%, respectively, since the end of the second quarter…”

U.S. Bubble Watch:

July 25 – Wall Street Journal (Jesse Newman and Tony C. Dreibus): “Tumbling corn prices are sowing fears that many U.S. farmers will suffer their first losses in years and the agricultural economy could face its first sustained slump in a decade. Corn prices have plunged nearly 30% in the past three months to their lowest point since 2010… Prices of other crops have fallen sharply as well, with soybeans trading near 2½-year lows and wheat near four-year lows… Signs of strain already are evident in the Midwest. Farmland values in some regions have begun to dip after a yearslong boom, and demand for farm equipment has slipped. Deere & Co., the world's largest seller of farm equipment, reported a 9.5% decline in its second-quarter profit in May and said U.S. sales of farm and landscaping equipment would decline between 5% and 10% this year…. ‘A lot of money has evaporated,’ said Matt Bennett, who farms 3,000 acres in Windsor, Ill. ‘It's going to be hard not just on farmers, but also the guys who build sheds" and "sell pickup trucks.’”

July 22 – Bloomberg (Prashant Gopal and Jody Shenn): “During his third deployment in Afghanistan, Air Force Staff Sgt. Claude Hunter was so eager to return to the U.S. and buy a house that he signed a contract for a property that his agent showed him over Skype. Hunter got back in time to close the deal, paying $219,000 in May for the four-bedroom Waldorf, Maryland, house that he financed with a U.S. Department of Veterans Affairs mortgage. It didn’t require a down payment. ‘On Facebook, my friends have started posting: ‘I got my VA loan, I got my house,’’ said Hunter, 31. ‘Everybody is just ready. A lot of them have done their jobs overseas and are coming home.’ America’s fragile housing recovery is getting a boost from military buyers using VA mortgages as the U.S. draws down troops after more than a decade of combat in Iraq and Afghanistan. About 4.7 million full-time troops and reservists served during the wars and many are now able to take advantage of one of the easiest and cheapest paths to homeownership. The program’s share of new mortgages, at a 20-year high, is also increasing as other types of government-backed loans have grown more costly.”

Central Banker Watch:

July 25 – Bloomberg (David Goodman): “Two years since European Central Bank President Mario Draghi’s historic promise to defend his currency bloc, there are signs bond investors are growing too complacent under his protection. While Draghi’s pledge, backed up with unprecedented policy action, held the euro region together, recent price moves suggest it also immunized investors against risk. The average yield on bonds from Europe’s most-indebted nations touched a record low yesterday, even after the downing of a passenger plane over Ukraine, an escalation of conflict in Gaza and financial woes at Portugal’s Espirito Santo Group. ‘It’s been an exercise in central banks desensitizing markets,’ Marc Ostwald, a strategist at ADM Investor Services International…, said… ‘It’s a dictated complacency because globally there is a huge amount of liquidity. Everyone views everything as a localized problem.’”

Europe Watch:

July 25 – Bloomberg (Stefan Riecher): “German business confidence dropped more than economists predicted to the lowest level since October as weaker growth and escalating tensions in Ukraine weigh on the outlook for Europe’s largest economy. The Ifo institute’s business climate index, based on a survey of 7,000 executives, fell to 108 from 109.7 in June, marking the third straight monthly decline… Today’s report follows a series of weak economic data for Germany that included industrial production dropping for a third month in May, factory orders falling more than economists expected and retail sales decreasing for a second month.”

Global Bubble Watch:

July 25 – Bloomberg (Kartikay Mehrotra): “The European Union and dozens of countries around the globe warned that World Trade Organization talks risked falling apart as India seeks to renegotiate part of a breakthrough agreement reached last year. WTO members are striving to pass part of a package of deals reached last December in Bali by a July 31 deadline. Indian Prime Minister Narendra Modi, who took power in May, will block the process until he receives further assurances that he can expand food subsidies without penalty…”

July 24 – Bloomberg (Nina Glinski): “The Federal Reserve may have scope to keep interest rates at zero for longer than investors anticipate as inflation stays muted and a 2014 slowdown prolongs the labor-market recovery, the International Monetary Fund said. The IMF cut its U.S. growth forecast for this year to 1.7% from 2% predicted in June, citing a first-quarter contraction, after a 1.9% advance last year… ‘Even with that relatively good growth outlook, we still see there’s a lot of slack in the economy,’ Nigel Chalk, deputy director of the IMF’s western hemisphere department, said…”

July 24 – UK Telegraph (Ambrose Evans-Pritchard): “Chief economist Olivier Blanchard says fund is watching financial markets ‘like a hawk’ because world economy is still too fragile to withstand interest rate rises. Ultra-low interest rates around the world are fuelling financial bubbles and pushing investors into overvalued assets, the International Monetary Fund has warned in a marked shift of policy. ‘Financial markets have been very optimistic in recent months. Frankly, we’re seeing some prices that are very high compared with what is happening the real economy,’ said Gian Maria Milesi-Ferretti, the fund’s deputy director. ‘We don’t think there is a generalised bubble but this is something we have to watch closely. In a world of very low interest rates there is an incentive to take on risk and hunt for yield, and that can lead to excesses,’ he said.”

July 25 – Bloomberg (Alastair Marsh): “Bond buyers are pouring record amounts of money into exchange-traded funds in Europe that buy debt as central bank largess boosts demand and makes investors less willing to part with their fixed-income assets. Investors deposited more than $16 billion into ETFs that purchase debt from high-yielding corporate notes to sovereign bonds, almost quadruple the amount in the same period last year…”

July 23 – Bloomberg (Sridhar Natarajan and Katie Linsell): “Junk-bond buyers are showing signs of indigestion after snapping up a record $361 billion of the debt at the lowest yields on record. Speculative-grade bonds from the U.S. to Europe and Asia are set to post losses this month for the first time since last August after high-yield debt funds suffered the biggest weekly withdrawal of 2014. Winoa SA, the French producer of abrasives for metalworking, scrapped a bond offering in Europe yesterday amid the turmoil. The pushback is stifling junk-bond issuance in July after an unprecedented first half of sales. Investors who piled into the debt amid extraordinary central bank stimulus and a sixth year of near-zero interest rates in the U.S. are being jolted out of complacency by intensifying risks from Ukraine to Gaza.”

July 21 – Financial Times (Madison Marriage): “Hedge fund managers expect to deliver some of their worst returns since the financial crisis this year, amid rising concerns over stretched equity market valuations and signs of rising geopolitical tension. Nearly two-thirds of hedge fund managers are anticipating full year returns of 6% or less, according to Preqin…, which surveyed 150 hedge funds collectively managing $380bn of assets. Of these, 44% expect a full-year return of 5% or less. This would represent one of the worst years in terms of investment performance since 2008… The industry suffered negative returns of -5.2% in 2011, but it recorded double digit gains in 2009 and 2010, and was up 6.4% and 9.1% in 2012 and 2013 respectively.”

EM Bubble Watch:

July 21 – Financial Times (Elaine Moore): “Emerging and frontier market countries have borrowed a record amount of money in capital markets in the first half of this year, even as central bankers warn that ‘debt market euphoria’ could be storing up trouble for the future. International sovereign bond sales by emerging markets reached $69.47bn in the first six months of the year, a jump of 54% on the same period in 2013. The increase makes 2014 a record year for emerging market government debt issuance so far… The figures do not include Chinese government debt, which is not issued in international markets.”

July 21 – Bloomberg (Ben Bain and Isabella Cota): “Mexico’s riskiest companies have almost doubled their bond sales abroad this year as surging demand for junk debt sends borrowing costs to a record low. Lender Unifin Financiera SAPI’s offering last week pushed sales of speculative-grade dollar notes from the country to $3.5 billion, a 92% increase from the same period last year and the most since 2011… As the Federal Reserve pledges to keep interest rates near zero, companies in developing countries including Mexico are turning to debt markets to exploit global demand for higher-yielding assets. Yields on junk-rated Mexico corporate debt have tumbled 0.76 percentage point this year and touched an unprecedented 5.23% this month… Average yields in emerging markets have dropped 0.65 percentage point in the same span.”

Geopolitical Watch:

July 25 – Associated Press: “The movement of Russian heavy caliber artillery systems across the border into Ukraine is ‘imminent’, the Pentagon said Friday, saying Russia is escalating the military action there. Col. Steve Warren… said the U.S. has seen the powerful rocket systems moving closer to the Ukraine border and they could be put into the hands of Russian-backed separatists as soon as Friday… U.S. officials warned this week that they had new evidence that Russia intended to deliver heavier and more powerful multiple rocket launchers to the separatist forces in Ukraine… Warren also said that Russia continues to fire artillery across the border into Ukraine."

July 25 – Reuters (Natalia Zinets): “Ukraine’s prime minister has launched what promises to be a bitter election campaign that could divide pro-Western parties and complicate their efforts to fight pro-Russian rebels in the country's east. Prime Minister Arseny Yatseniuk, a key interlocutor of the West during months of turmoil, announced on Thursday that he would quit, saying parliament was betraying Ukraine's army and people by blocking reforms supported by Western backers. His move, following the exit of two parties from the ruling coalition, amounted to the start of a campaign for seats in a legislature still packed with former allies of pro-Russian President Viktor Yanukovich… ‘History will not forgive us,’ Yatseniuk told parliament…, in what analysts said was the first campaign speech for the party led by Yulia Tymoshenko, a rival of President Petro Poroshenko, who was elected to replace Yanukovich in May.”

July 25 – Financial Times (Anjli Raval): “While markets have been focused on the latest geopolitical flashpoint involving Russia and Ukraine – the downing of Malaysia Airlines flight MH17 – an unresolved dispute between the two countries over natural gas has continued to simmer in the background. Gazprom, the Russian gas exporter, cut deliveries for domestic use by Ukraine in June after a bitter row over unpaid bills. Ukraine has, so far, continued to send gas to EU member states through the pipelines that cross its territory. But analysts are concerned that could change if a deal is not reached between the two countries soon – an increasingly likely prospect as the conflict in eastern Ukraine takes new turns… The latest developments echo similar disputes in 2006 and 2009 when natural gas flows to Europe were reduced during freezing weather."

July 25 – Bloomberg (Olga Tanas and Anna Andrianova): “Russia’s central bank unexpectedly increased borrowing costs for a third time this year as the intensifying conflict over Ukraine and the threat of wider sanctions squeeze the economy and undercut the ruble. The central bank in Moscow increased its one-week auction rate to 8% from 7.5%...”

July 25 – Bloomberg (Golnar Motevalli): “Hundreds of thousands of Iranians rallied nationwide today to protest Israel’s military strikes on Gaza, which have targeted Hamas militants who are backed by Iran. Demonstrators pledged solidarity with Palestinians and chanted slogans of ‘Death to Israel’ and ‘Death to America.’ …Iran each year marks Quds Day, using the Arabic name for Jerusalem, to show its support for the Palestinians.”

China Bubble Watch:

July 21 – Financial Times (Jamil Anderlini): “China’s total debt load has climbed to more than two and a half times the size of its economy, underscoring the difficult challenge facing Beijing as it seeks to spur growth without sowing the seeds of a financial crisis. The total debt-to-gross domestic product ratio in the world’s second-largest economy reached 251% at the end of June, up from just 147% at the end of 2008, according to a new estimate from Standard Chartered bank. Such a rapid build-up is far more of a concern than the absolute level of debt, since increases of that magnitude in such a short period have almost always been followed by financial turmoil in other economies… This growing dependency shows no sign of being reversed, with the debt-to-GDP ratio increasing by 17 percentage points in just the last six months… compared to an increase of about 20 percentage points for all of last year.”

July 23 – Bloomberg: “China avoided a second default in its onshore corporate bond market, easing concern that financial-market instability could spread as debt rises and growth slows in the world’s second-largest economy. Huatong Road & Bridge Group Co. paid all principal and interest on 400 million yuan ($65 million) of notes today… Speculation is mounting that nonpayments will increase in China’s $4.2 trillion bond market as policy makers try to balance the risk of letting weaker companies fail and ensuring market stability… Huatong was making efforts to raise the funds, with help from local governments and bond underwriters, company official Geng Naizhuang said… July 18.”

July 21 Reuters (Kevin Yao): “Policy insiders are concerned that China's ambitious reform agenda is being sidelined by a focus on stimulus to meet the government's growth target, delaying the planned overhaul of the world's second-largest economy. The government unveiled plans for some of the most comprehensive reforms in nearly 30 years last November, but since then has only made incremental changes as a rapid slowdown in the economy dominated policymaking in the first half of 2014. Sources at government think-tanks involved in policy discussions said enough had been done to support growth, and now expected to see some progress on economic reforms. ‘On policy, we don't need to prescribe a strong medicine,’ said Xu Hongcai, senior economist at China Centre for International Economic Exchanges, a well-connected think-tank in Beijing.”

July 23 – Bloomberg: “The eastern Chinese city of Suzhou isn’t even the biggest in Jiangsu province, yet it’s joining a national rush for the sky with what’s slated to become the world’s third-tallest building. By 2020, China may be home to six of the world’s 10 highest skyscrapers… Developers finished 37 structures higher than 200 meters, or about 50 stories, in China last year, the most in the world… China is witnessing a skyscraper boom, with lesser-known cities like Suzhou vying to erect ever-bigger structures and counting on the prestige and potential commercial benefit those mega-buildings may bring. Construction has been fueled by a tripling in property values since 1998 and government policy that moved 300 million people -- almost the entire population of the U.S. -- into cities since 1995.”

July 23 – Reuters (David Stanway): “China is readying an assault on the ‘fortress economies’ of local governments by creating a super region around Beijing, with proposals that sources suggest will be more aggressive than so far has been publicly revealed. The plans, expected to be considered by Cabinet on Wednesday, will be the first time that standards for customs, tax, pollution and industry have been unified across local government areas, the sources say. Combining bloated Beijing, the smog black spot of Hebei province and the port city of Tianjin will create a region with a population of 110 million and an economy the size of Indonesia's in a move that encapsulates President Xi Jinping's ambition to overhaul the world's second-largest economy. By challenging the power of local leaders, Xi wants to produce better allocations of wealth and investment, and get an environmental dividend.”

Japan Watch:

July 22 – Bloomberg (Masahiro Hidaka and Toru Fujioka): “More than a year after securing support at the Bank of Japan for unprecedented monetary stimulus, Governor Haruhiko Kuroda has yet to persuade most board members that they have the power to achieve their inflation target. A majority of the nine members disagree with Kuroda’s view that flooding the economy with cash is sufficient to get stable 2% gains in consumer prices… The ideological gap, masked in public remarks by most board members, underscores why some reflationist lawmakers are still pushing for legislation that would hold the BOJ responsible for delivering on its target. Debate may become more public should calls for expanded asset purchases escalate in face of inflation falling short of the goal next year.”

July 24 – Bloomberg (Masaaki Iwamoto and Keiko Ujikane): “Japan’s exports unexpectedly fell in June to swell the trade deficit more than forecast, dragging on an economy squeezed by a sales-tax increase in April. Exports shrank 2% from a year earlier… Imports rose 8.4% to leave a shortfall of 822.2 billion yen ($8.1bn)… Exports fell 1.7% by volume, showing the yen’s 16% drop against the dollar since Prime Minister Shinzo Abe came to power in December 2012 has failed to boost outward shipments. They remain 23% lower by value than a peak in March 2008…”

Europe Watch:

July 23 – Reuters: “Rioforte said on Tuesday it has requested protection from creditors in Luxembourg where it is registered, becoming the second holding company of Portugal's troubled Espirito Santo banking family to do so after failing to pay off debts. Espirito Santo International, which owns Rioforte, said on Tuesday Luxembourg authorities had accepted its request for creditor protection that it filed on Friday.”


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