Fault Lines

By: Doug Noland | Sat, Apr 20, 2013
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More pressure on commodities, commodity currencies, commodity economies and equities.

Yet another fascinating week - and one more week of anecdotes confirming the global Bubble thesis.

I have vivid memories of reading a Financial Times article back from early-1998 that detailed the massive growth in ruble derivative transactions written by the Russian Banks. Russia was front and center in my macro analysis back then. While reading the article, I recall exclaiming "I think they've blown themselves up."

I saw Russia as an increasingly fragile Bubble at the time, having become acutely vulnerable to huge "hot money" outflows and Credit collapse after the catastrophic financial and economic crisis wreaked bloody havoc throughout South East Asia in 1997. Yet, a complacent market view was taking hold that the IMF and global central banks had things well under control. No way would the West ever allow a Russian collapse, or so they thought. I saw the huge build up in ruble derivatives as a likely Fault Line. If Russia succumbed, the ruble would tumble, its banks would be on the hook for unmanageable derivative losses and the sovereign would face potential meltdown. The leveraged speculators were big in Russia at the time.

I believe it was in early-2007, when my focus was squarely on an increasingly vulnerable mortgage finance Bubble. The Financial Times' Gretchen Morgenson began writing about the $1 TN of subprime CDOs (collateralized debt obligations) that Wall Street had created during 1996. And I remember thinking, "Unbelievable, this is even worse than I suspected." Subprime derivatives had created another historic financial Fault Line.

Memories of previous Fault Lines were jogged this week by a bevy of informative Financial Times articles (touching upon what I consider key potential Fault Lines). First, there was an article by Michael Stothard, "Naked CDS Ban Fuels Bank Funding Fears." "It's called the law of unintended consequences. Last November, European regulators were fed up with hedge funds using the derivatives market to bet against sovereigns so they imposed a ban on outright speculation... Six months on from the ban on buying naked sovereign CDS protection - where the investor does not own the underlying government bond - it is clear that negative bets against large financials have emerged as a partial replacement... In the first quarter volumes fell 35% to $168bn from the fourth quarter of last year, according to the DTCC, the swaps data warehouse. In the same period the volumes traded on the iTraxx Senior Financial index, one of the most liquid European indices encompassing some of the largest banks in the region, have nearly doubled from $252bn to $400bn, according to the DTCC."

And there was "China Local Authority Debt 'Out of Control,'" by the Financial Times' Simon Rabinovitch: "A senior Chinese auditor has warned that local government debt is 'out of control' and could spark a bigger financial crisis than the US housing market crash. Zhang Ke said his accounting firm, ShineWing, had all but stopped signing off on bond sales by local governments as a result. 'We audited some local government bond issues and found them very dangerous, so we pulled out,' said Mr Zhang, who is also vice-chairman of China's accounting association. 'Most don't have strong debt servicing abilities. Things could become very serious.' ...Mr Zhang said many local governments had invested in projects from public squares to road repairs that were generating lacklustre returns, and so were relying on financing rollovers to pay back their creditors. 'The only thing you can do is issue new debt to repay the old... But there will be some day down the line when this can't go on.' Mr Zhang added that he grew alarmed when smaller towns and counties discovered that investment vehicle bonds were an easy way to raise financing. 'This evolution was quite frightening,' he said."

And the third of the Fault Line Trifecta, "Japanese Easing Plays Havoc with JGBs," by Ben McLannahan of the Financial Times: "So much for Haruhiko Kuroda's plans to ease the flow of credit. Since the new governor of the Bank of Japan shouldered his 'big bazooka' two weeks ago, promising to buy up more government bonds than ever to drive down the cost of borrowing, yields have risen at every point along the country's 30-year sovereign debt curve, prompting some banks to charge more for loans. At the same time, trading volumes in Japanese government bonds - or JGBs - have collapsed, sending volatility to record highs and threatening the ability of the world's most indebted government to keep funding itself at the world's lowest rates. An auction last week of 30-year bonds was 'horrendous', in the words of one strategist... Net annual asset purchases by the BoJ have risen to nearly 15% of nominal gross domestic product, notes Nomura, making Mr Kuroda's 'new phase' of easing significantly bigger than any equivalent operation around the world... Amid the 'shock and awe' of this radical policy shift, investors in Japan's Y914tn ($9.4tn) government bond market, the world's second-largest, have 'lost their bearings', says Naka Matsuzawa, chief Japan rates strategist at Nomura in Tokyo... 'For now, the easing programme that was announced with such fanfare must be judged a failure,' says Jun Ishii, chief fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities."

Unfettered global Credit coupled with government fiscal and monetary excess has been inflating major Bubbles going back to Japan's runaway 1980's Credit Bubble. Japanese and global policymakers have recently resorted to unmatched and untested stimulus measures with unknown consequences. And, today, mounting Bubble fragility can be discerned from all corners of the globe. Never have I seen a backdrop with Multiple Major Fault Lines.

Many profess - and it sounds pretty appealing in theory - that a moderate amount of fiscal and monetary stimulus helps grease the "post-Bubble" economic wheels. Yet inflationary cycles over time have a way of casually drifting way beyond the moderate. In reality, supposed "post-Bubble" reflations actually work predictably to inflate only bigger Bubbles. I would argue strongly that at some point along the way excessive amounts of stimulus begin fomenting exponential growth in latent instability. And I'll add that once every few generations such dynamics become global in nature.

Today, such instability is on conspicuous display - particularly in Europe, Japan and China. Here at home, it remains for now more latent, masked by huge deficit spending, zero rates and after significant portions of US credit risk have been nationalized with federal guarantees (e.g. residential mortgage, student lending). And the more aggressive the stimulus the more various parties will try to position for competitive advantage. This sets the stage for inevitable instability, conflict and upheaval.

It's an especially inopportune time for a speculative Bubble in European financial CDS/insurance. With French and German economies succumbing to recession, the region's already troubled banking system remains susceptible to further asset quality deterioration. In Germany, in particular, I fear several years of ultra-low rates and financial inflows have nurtured unappreciated Bubble fragilities (DAX down 3.7% this week!). Meanwhile, the Draghi OMT backstop has incentivized the speculators back into the region's financial markets (including higher yielding Eastern European debt). Bank debt and related derivative insurance markets appear to be a focus of speculative activities.

In my old "booming town along the river" analogy, the speculative Bubble in flood insurance worked miraculously - that is until torrential rains incited a panic to reinsure and offload risk that ended in market illiquidity and failure. The European financial sector has a plethora of unresolved issues - economic, financial, regulatory and political. Will the euro even survive? How will the costs of future bailouts be divided? What about the German and northern countries' move to have bank investors and large depositors contribute to bailouts? It's a troubling backdrop. Meanwhile, Draghi and global central bank measures have only further distorted markets and boosted speculative excess. When greed turns to fear and Europe's markets again fall under duress, I'll be carefully monitoring the functioning of bank and financial CDS markets. I worry about illiquidity.

China is a historic Bubble in the midst of what I refer to as the "terminal phase of blow-off excess." Previous CBBs have noted the explosion in Chinese Credit since the 2008 global financial crisis. Enormous (and un-quantified) amounts of local government obligations - perhaps significant amounts intermediated through China's ballooning "shadow banking" system - appear a systemic weak link. Apparently, much of this potentially problematic debt is integral to a historic real estate Bubble. It is, then, noteworthy that a top Chinese accountant warned this week that local debt is "out of control."

Perhaps Chinese authorities do today have things under control. They may even have yet another big stimulus program ready to implement on command. But I suspect the popular view is too complacent. Actually, I believe the Chinese missed the timing for reigning in Bubble excess before it was too late - by a number of years. As an analyst of Credit, financial and economic Bubbles, things just don't get more fascinating - or any more intriguing. Historic Credit expansion, historic inflationary manifestations (runaway asset Bubbles, wealth inequalities, price distortions, corruption, environmental degradation, etc.), historic risk intermediation, historic economic imbalances - and a general sanguine view domestically and internationally that the central planners can successfully manage their way through it all. Wow.

Deflation risk continues to garner considerable attention. Some have argued that Japan's "beggar they neighbor" yen devaluation policy is imposing deflationary pressures upon its neighbors/competitors. Others would argue that the ECB needs to join the "money" printers to spur Europe out of the doldrums. I tend to view global finance and economies as extraordinarily complex systems. From my perspective, a confluence of recent factors has placed global reflation dynamics in heightened jeopardy.

Basically, highly inflated and correlated securities markets worsen global economic and financial fragility. In this regard, I would contend the confluence of Draghi's "bazooka", incredible QE from the Fed and BOJ, general global monetary largess, and the Chinese accommodating a runaway Credit expansion has actually only further destabilized global markets and economies. Global policy efforts have further weakened key global Fault Lines.

During the Great Depression, contemporary economic thinkers debated whether it was previous over-investment or mal-investment that was most responsible for deflation. Others pinpointed boom-time speculative shenanigans as a leading culprit that set the stage for bursting Bubbles, price collapses and financial ruin. The "Austrians" distinguished themselves for their keen understanding of how boom-time Credit excess had distorted patterns in both spending and investment - ensuring inevitable economic adjustment and hardship.

Over the years, I've highlighted the thinking of the old codgers (including Andrew Mellon) in the late-twenties that had witnessed enough boom and bust cycles during their lifetimes to confidently warn of impending collapse. They were convinced that attempts by our central bank to sustain a protracted inflationary boom (that commenced with the "Great War") would risk destroying both the economy and the Credit system. These are Dr. Bernanke's disdained "Bubble poppers."

Well, we've been witnessing similar dynamics in real time. The more "money" central banks inject into the global system, the more this liquidity inflates and distorts securities markets. The greater the stimulus employed to combat deflation risk, the more the over- and mal-investment, especially in China and Asia. The more aggressively activist central banks work to inflate liquidity and market levels, the more encompassing the pool of global speculative finance working to profit from desperate policy measures. The more intensively policymakers in the U.S., Europe, Japan, China and elsewhere work to sustain ("terminal") late-cycle global Credit excess, the more prominent the inequitable redistribution of wealth to a relatively small group of beneficiaries. We're deeply into the phase where massive liquidity injections receive little real economy bang for the buck.

From this perspective, global policymakers are fighting like crazy in a battle they cannot win. And perhaps that's what the markets are just beginning to indicate. Maybe, in what would be a shock to us all, global "reflation" is actually more a lost cause. Further pumping of asset Bubbles only sets the stage for bigger pops. And could air leaking out of the global commodities trade prove the first crack in the global Bubble? The commodities bull market has certainly attracted huge speculative activity, as well as having evolved into a major economic force for thousands of companies and scores of economies around the globe. Along the way, commodities players - speculators, companies and countries - have used a lot of leverage.

The true scope of borrowings and leverage employed all along the commodities/resources chain is unknown. We can safely assume it has been considerable. Hence, there is potential for commodities-related de-risking and de-leveraging dynamics to be impactful for global liquidity and risk-taking more generally. And it's the nature of Bubble dynamics that deterioration in the liquidity backdrop for one segment tends over time to impede liquidity for another segment - and then another. We already know Europe is weak, China is overheated and Japan is playing with fire. With this in mind, it's time to closely monitor a disconcerting number of potential Fault Lines around the globe.

 


For the Week:

The S&P500 declined 2.1% (up 9.1% y-t-d), and the Dow fell 2.1% (up 11.0%). The Morgan Stanley Consumer index added 0.5% to an all-time record high (up 19.3%), and the Utilities gained 1.0% (up 16.4%). The Banks lost 2.4% (up 7.0%), and the Broker/Dealers dropped 3.2% (up 14.9%). The Morgan Stanley Cyclicals were hit for 3.8% (up 6.9%), and Transports fell 1.8% (up 13.7%). The S&P 400 MidCaps fell 2.4% (up 9.9%), and the small cap Russell 2000 dropped 3.2% (up 7.4%). The Nasdaq100 fell 2.7% (up 4.5%), and the Morgan Stanley High Tech index sank 4.5% (up 2.2%). The Semiconductors dropped 3.8% (up 8.6%). The InteractiveWeek Internet index fell 3.7% (up 7.0%). The Biotechs gained another 2.3% (up 24.1%). With bullion down $79, the HUI gold index was hit for 10.9% (down 39.6%).

One-month Treasury bill rates ended the week at 4 bps and 3-month rates closed at 5 bps. Two-year government yields were little changed at 0.23%. Five-year T-note yields ended the week up 2 bps to 0.71%. Ten-year yields declined a basis point to 1.71%. Long bond yields were down 4 bps to 2.88%. Benchmark Fannie MBS yields were little changed at 2.44%. The spread between benchmark MBS and 10-year Treasury yields widened one to 73 bps. The implied yield on December 2014 eurodollar futures was unchanged at 0.47%. The two-year dollar swap spread was little changed at 14 bps, while the 10-year swap spread was down one to 17 bps. Corporate bond spreads widened. An index of investment grade bond risk increased 2 to 84 bps. An index of junk bond risk rose 9 to 407 bps. An index of emerging market debt risk gained 10 to 288 bps.

Debt issuance slowed. Investment grade issuers included Wells Fargo $3.25bn, JPMorgan $3.0bn, Autozone $500 million, Hartford Financial Services $300 million, Novant Health $250 million, and Virginia Mason Medical Central $136 million.

Junk bond funds saw inflows of $242 million (from Lipper). Junk issuers included Rosetta Resources $700 million, Pinnacle Foods $350 million, and Carpintero Finance $138 million.

I saw no convertible debt issued.

International issuers included Lukoil International Finance $2.0bn, Softbank $2.5bn, Telefonica Emisiones $2.0bn, Denmark $1.5bn, Bank of Nova Scotia $1.25bn, Odebrecht Finance $1.05bn, Kommunalbanken $900 million, Neder Waterschapsbank $700 million, Wind Acquisition $550 million, Nomos Bank $500 million, Sinopec $500 million, BPCE $500 million, China Oil $350 million, Ferreycorp $300 million and Metalsa SA $300 million.

Italian 10-yr yields fell 10 bps to 4.21% (down 29bps y-t-d). Spain's 10-year yields declined 7 bps to 4.60% (down 67bps). German bund yields slipped one basis point to 1.25% (down 7bps), and French yields declined a basis point to 1.79% (down 21bps). The French to German 10-year bond spread was unchanged at 54 bps. Ten-year Portuguese yields dropped 20 bps to 5.98% (down 77bps). Greek 10-year note yields rose 6 bps to 11.12% (up 65bps). U.K. 10-year gilt yields were down 6 bps to 1.66% (down 16bps).

The German DAX equities index sank a notable 3.7% for the week (down 2.0% y-t-d). Spain's IBEX 35 equities index declined 1.6% (down 3.1%). Italy's FTSE MIB slipped 0.1% (down 3.2%). Japanese 10-year "JGB" yields ended the week 3 bps lower to 0.57% (down 21bps). Japan's Nikkei gave back 1.3% (up 28.1%). Emerging markets were mixed to lower. Brazil's Bovespa equities index dropped another 1.9% (down 11.5%), and Mexico's Bolsa sank 2.7% (down 2.1%). South Korea's Kospi index declined 0.9% (down 4.5%). India's Sensex equities index jumped 2.6% (down 2.1%). China's Shanghai Exchange rallied 1.7% (down 1.1%).

Freddie Mac 30-year fixed mortgage rates declined 2 bps to a 13-week low 3.41% (down 49bps y-o-y). Fifteen-year fixed rates were down a basis point to 2.64% (down 49bps). One-year ARM rates added one basis point to 2.63% (down 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 2 bps to 3.94% (down 53bps).

Federal Reserve Credit jumped $35.1bn to a record $3.241 TN. Fed Credit expanded $455bn over the past 28 weeks. In the past year, Fed Credit expanded $375bn, or 13%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $675bn y-o-y, or 6.5%, to a record $11.082 TN. Over two years, reserves were $1.427 TN higher, for 15% growth.

M2 (narrow) "money" supply fell $26.3bn to $10.491 TN. "Narrow money" expanded 6.5% ($644bn) over the past year. For the week, Currency was little changed. Demand and Checkable Deposits jumped $31.3bn, while Savings Deposits dropped $54bn. Small Denominated Deposits declined $1.5bn. Retail Money Funds declined $0.8bn.

Money market fund assets dropped $27.5bn to a 22-week low $2.595 TN. Money Fund assets were up $12bn from a year ago.

Total Commercial Paper outstanding declined $6.2bn this week to $1.016 TN. CP has declined $66bn y-t-d, while having expanded $83bn, or 8.9%, over the past year.

Currency and 'Currency War' Watch:

April 20 - Bloomberg: "The Chinese yuan is set to strengthen as rising inflows of speculative capital add to pressure on the currency, the head of a Ministry of Commerce research institute said. 'Hot money is flowing into China, and that will push up the yuan exchange rate,' Huo Jianguo, president of the Chinese Academy of International Trade and Economic Cooperation... said... The yuan had its biggest weekly gain in six months after People's Bank of China Deputy Governor Yi Gang said the daily trading band that's been limiting appreciation against the U.S. dollar since October may be widened. The largest jump in foreign-exchange reserves in almost two years in the first quarter adds to signs capital inflows are increasing."

April 19 - AFP (Veronica Smith): "The Group of 24 emerging and developing countries called on the central banks in rich countries to guard against spillovers that could wreak havoc on their economies. The G24, which includes emerging powers Brazil, India and South Africa that are driving global economic growth, laid the blame for the stuttering global recovery on the advanced economies. 'We remain concerned about the fragility and pace of the global recovery because of the protracted difficulties and uncertainties in many advanced economies, including the euro area and the United States... We call on advanced economies to take into account the negative spillover effects on the emerging and developing countries of prolonged unconventional monetary policies.'"

The U.S. dollar index gained 0.5% to 82.71 (up 3.7% y-t-d). For the week on the upside, the South Korean won increased 1.2% and the Taiwanese dollar gained 0.5%. For the week on the downside, the South African rand declined 3.1%, Swedish krona 2.9%, Australian dollar 2.2%, Brazilian real 2.1%, New Zealand dollar 2.0%, Norwegian krone 2.0%, Mexican peso 1.5%, Canadian dollar 1.3%, Japanese yen 1.2%, British pound 0.7%, Swiss franc 0.7%, the euro 0.5% and Danish krone 0.4%.

Commodities Watch:

The CRB index fell 1.4% this week (down 4.0% y-t-d). The Goldman Sachs Commodities Index dropped 2.5% (down 6.0%). Spot Gold sank 5.3% to $1,404 (down 16.2%). Silver was hit for 12.8% to $23 (down 24%). May Crude dropped $3.28 to $88.01 (down 4%). May Gasoline declined 1.0% (unchanged), while May Natural Gas jumped 4.4% (up 32%). July Copper sank 6.1% (down 13%). May Wheat declined 0.8% (down 9%), and May Corn fell 1.0% (down 7%).

U.S. Bubble Economy Watch:

April 18 - Los Angeles Times (Alejandro Lazo): "The median home price in Southern California rose about $25,000 in March alone to hit $345,500, underscoring the region's fast-paced recovery. That represented an 8% increase from February and a 23.4% jump from a year earlier. It was the eighth consecutive double-digit increase and the highest level for the median since July 2008, according to... DataQuick. The robust gains, driven by a low inventory of homes for sale, more 'move up' purchases and fewer foreclosures, should help solidify a recovery that began last year."

April 19 - Wall Street Journal (Deborah Solomon): "A panel of top financial regulators is targeting mortgage real-estate investment trusts as a potential risk to the U.S. financial system, the latest example of Washington's growing concern with market bubbles. Next week, the Financial Stability Oversight Council, a panel comprising the top U.S. financial regulators, is expected to cite mortgage REITs as a source of market vulnerability in its annual report... Mortgage REITs, which are publicly traded financial companies that borrow funds to invest in real-estate debt, have seen their assets quadruple to more than $400 billion since 2009."

April 16 - Bloomberg (Sarah Mulholland): "Trading in securities linked to education loans has more than doubled this year as unprecedented central-bank stimulus blunts concern that the most debt-laden generation to exit college will fail to meet its obligations. Volumes climbed to $7.5 billion in the first quarter from $3.7 billion during the corresponding period in 2012, according to Deutsche Bank AG, pushing the extra yield investors demand to own bonds tied to student loans instead of U.S. Treasuries to the lowest since September 2007."

April 18 - Bloomberg (Christine Idzelis): "The pace of collateralized loan obligations being raised in the U.S. this year will probably level off after surging in the first quarter, according to Fitch Ratings. More than $26 billion of CLOs were sold in the first three months of 2013, more than four times the $6 billion in the same period last year..."

April 16 - Bloomberg (Mike Lee and Edward Klump): "U.S. drillers that set up rigs amid the rolling farmland of eastern Ohio on projections underground shale held $500 billion of oil are packing up. Four of the biggest stakeholders in untapped deposits known as the Utica Shale have put up all or part of their acreage for sale, as prices fall by a third in some cases... 'The results were somewhat disappointing,' said Philip Weiss, an analyst with Argus Research in New York. Early data show 'it's not as good as we thought it was going to be.'"

Federal Reserve Watch:

April 17 - Reuters: "The Federal Reserve should remain focused on inflation and resist putting more weight on its employment mandate, a top U.S. central bank official said... St. Louis Fed President James Bullard, in a speech, cited research by Federico Ravenna and Carl Walsh that suggests 'price stability remains the policy advice even in the face of serious labor market inefficiencies.' Unlike most central banks in the developed world, the Fed is tasked with maintaining price stability and achieving full employment. Since the deep recession, it has eased policy to unprecedented levels to lower the unemployment rate, which last month was 7.6%. 'The idea that the Fed should put more weight on unemployment ... may be highly counter-productive,' Bullard, an inflation hawk and a voting member of the Fed's policy committee this year, said..."

April 17 - Bloomberg (Aki Ito): "Federal Reserve Bank of Chicago President Charles Evans said he is 'optimistic' about U.S. growth in 2013 and next year, while cautioning that the economy still needs record monetary stimulus. 'I don't think we should be complacent' about the economic outlook, Evans said... 'Unemployment is unacceptably high.' ...Evans, who votes on the FOMC this year, told reporters after the speech that he expects the Fed to keep the asset-purchase plan in place until at least late this year. 'I would not be surprised if we end up doing this until late 2013, ultimately ending the program in 2014 at some point,' he said."

April 16 - Bloomberg (Aki Ito and Joshua Zumbrun): "Two voting members of the Federal Reserve's policy-setting panel stressed the need to maintain record stimulus to keep the expansion going, and they cited a job-market slowdown as evidence of risks to the economy. The slowest payrolls growth in nine months in March 'underscores the need to wait and see how the economy develops before declaring victory,' William C. Dudley, president of the Federal Reserve Bank of New York, said... The need for continued stimulus also found support from Fed Vice Chairman Janet Yellen... she said she doesn't see 'pervasive evidence of rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would threaten financial stability.'"

Global Bubble Watch:

April 18 - Financial Times (Chris Giles): "Extraordinarily loose monetary policy risks sparking credit bubbles that threaten to tip the world back into financial crisis, the International Monetary Fund warned... In its global financial stability report, the fund cautioned that policy reforms were needed urgently to restore long-term health to the financial system before the long-term dangers of monetary stimulus materialised. Without more progress, the IMF said 'the global financial crisis could morph into a more chronic phase, marked by a deterioration of financial conditions and recurring bouts of financial instability'."

April 16 - Bloomberg (Sandrine Rastello): "The International Monetary Fund trimmed its global growth forecast and urged European policy makers to use 'aggressive' monetary policy as a second year of contraction leaves the euro area's recovery lagging behind the rest of the world. The global economy will expand 3.3% this year, less than the 3.5% forecast in January, after 3.2% growth in 2012..., cutting its prediction for this year a fourth consecutive time. The... IMF sees the 17-country euro area shrinking 0.3%..., with France joining Spain and Italy in contracting."

April 17 - Bloomberg (Simon Kennedy and Steve Matthews): "The slump in gold may hand activist central bankers more reasons to pursue the easy monetary policy that helped drive up the metal's price in the first place. Among many explanations for the biggest drop in more than 30 years: a fourth annual global growth scare as data disappoint from China to the U.S. and investors fold long-held bets that monetary stimulus will ultimately unleash inflation. Other reasons for the drop range from a view that the price reached so-called technical levels to concerns that Cyprus could start a rush by indebted nations to sell their supplies of the metal."

April 16 - Bloomberg (Craig Torres and Simon Kennedy): "Central banks are setting new expectations for monetary policy that may be hard to reverse as they slide deeper into the realms of fiscal policy. To save their economies from debt crises or slow growth, the Bank of Japan is uniting with a new government by aiming to lift inflation to 2% by 2015, and the European Central Bank stands ready to purchase bonds of stressed nations. The Bank of England now has more room to ignore price pressures and is discussing with politicians how to ease credit further, while the Federal Reserve has extended more than $1 trillion worth of unprecedented credit to a single industry: housing. The defense for activism is that monetary authorities need to protect their inflation goals from the possibility of Japan- style disinflation if governments don't boost demand. The risk is they're left doing the work of those governments -- or even financing them, creating precedents they may be pressured to extend or repeat in the future. 'Central banks have to be very careful in what they're doing,' Axel Weber, chairman of UBS AG, told Bloomberg... 'There is a challenge that their independence may be undermined simply because they're getting closer to fiscal policy and politics.'"

April 18 - Bloomberg (Susanne Walker): "Treasury Inflation-Protected Securities tumbled after a record $18 billion auction of the notes attracted the lowest demand in more than four years... Yields on benchmark 10-year notes traded at almost to the lowest level in four months. Three regional Federal Reserve bank presidents said a further decline in U.S. inflation below the Fed's 2% goal may signal a need for more accommodation."

April 18 - Bloomberg (Sridhar Natarajan): "Investors who put a record $18 billion into leveraged-loan funds this year as a hedge against rising interest rates would need to see benchmark borrowing costs jump almost 1 percentage point before they benefit. Derivative traders bet rates won't rise for more than two years. While loans offer floating rates, more than 75% of the $430 billion raised by companies in the last year from non- bank lenders pay a minimum of about 1.2% till the London interbank offered rate rises above that mark..."

April 16 - Bloomberg (Neil Callanan): "Billionaire property investors David and Simon Reuben can develop what's likely to become the U.K.'s most expensive home after winning approval for a plan to convert a former members-only club near London's Ritz Hotel... The building, once home to both a prince and a British prime minister, could sell for more than 200 million pounds ($306 million) after renovation, said Jonathan Hewlett, head of... Savills Plc."

Global Credit Watch:

April 17 - Reuters (Karolina Tagaris): "A 10 billion euro aid deal to save Cyprus from bankruptcy has been thrown into fresh uncertainty with news that the country's fractious parliament will vote on the final package. The surprise vote has only just been scheduled, and early signs are that nearly half the members of the 56-seat parliament may oppose the bailout, seen as vital to keep Cyprus in the euro zone. The tiny opposition Greens Party said... its sole parliamentarian would vote to reject the deal, becoming the first party to announce its intentions."

April 17 - Bloomberg (Sandrine Rastello): "As much as 20% of non-bank corporate debt in the weakest euro-area economies is unsustainable and may force companies to cut dividends and sell assets, dealing further blows to investor confidence, the International Monetary Fund said. Businesses in Italy, Spain and Portugal have the largest 'debt overhang,' according to the IMF's Global Financial Stability Report... Strains in the corporate sector may also hurt banks' asset quality, the report showed. 'Firms in the euro-area periphery have built a sizable debt overhang during the credit boom, on the back of high profit expectations and easy credit conditions,' the IMF said. Now they 'face the challenge of reducing the debt overhang in an environment of lower growth and higher interest rates, in part related to financial fragmentation in the euro area.'"

China Bubble Watch:

April 16 - Bloomberg: "Moody's... lowered its outlook for China's credit rating to stable from positive, saying the nation has made less progress than anticipated in reducing risks from local-government debt and credit expansion. 'Structural reforms' under the new leadership may not be sufficient over the next 12 to 18 months to justify an upgrade, Moody's said... The comments add to concerns that risks are building up that may harm growth in the world's second-largest economy... 'Effective macro-prudential regulation of the financial system and the advancement of a broad range of reforms will likely be necessary to prevent the build-up of imbalances which could increase the risks of a hard landing for the economy,' ... At the same time, official figures may not "represent the full extent" of risks from local-government financing vehicles, while "elevated growth in credit," increasingly driven by so- called shadow banking, is a risk to the economy, Moody's said.

April 17 - Financial Times (Simon Rabinovitch): "A senior Chinese auditor has warned that local government debt is 'out of control' and could spark a bigger financial crisis than the US housing market crash. Zhang Ke said his accounting firm, ShineWing, had all but stopped signing off on bond sales by local governments as a result of his concerns. 'We audited some local government bond issues and found them very dangerous, so we pulled out,' said Mr Zhang, who is also vice-chairman of China's accounting association. 'Most don't have strong debt servicing abilities. Things could become very serious... It is already out of control,' Mr Zhang said... Local government debts soared after 2008, when Beijing loosened borrowing constraints to soften the impact of the global financial crisis. Provinces, cities, counties and villages across China are now estimated to owe between Rmb10tn and Rmb20tn ($1.6tn and $3.2tn), equivalent to 20-40% of the size of the economy."

April 17 - Bloomberg: "China's media regulator stepped up controls on news organizations' use of social media, including barring the retransmission of content from overseas media and websites without permission... The rules also ban the publication of rumors, urge reporters to focus on 'positive' publicity and prohibit the publication of materials from freelance writers, civil-society groups and commercial organizations without approval, it said."

April 15 - Bloomberg: "China's home sales rose 69% in the first quarter as buyers rushed into the market before local governments implemented property curbs. The value of homes sold climbed to 1.2 trillion yuan ($194bn) from a year earlier... That was the biggest first-quarter increase in three years. Overall real estate sales, including commercial buildings, rose 61% to 1.4 trillion yuan from last year. 'Quite a lot of buyers bought homes as they expected local governments would issue harsh property curbs,' said Zhao Zhenyi... analyst at Industrial Securities Co."

April 16 - Bloomberg: "All real estate markets are local, says the industry axiom, one that China's central government is painfully aware of as its efforts to rein in home prices are undermined by uncooperative municipal authorities. Former Premier Wen Jiabao, in his final endeavor to make housing affordable, set an April 1 deadline for higher down payments and interest rates for second-home loans in cities with 'excessively fast' price gains and ordered stricter enforcement of taxes on sales. Thirty-five provincial-level cities responded with measures insufficient to curb prices that climbed 150% from 2003 to 2012. 'The local governments are just making a gesture to show they are following the orders,' said Ding Shuang, a senior China economist with Citigroup... 'Some of the targets are almost like jokes. The government's enforcement of policies will be compromised.' Local officials lack the resolve to cool the market because proceeds from land sales contribute about a quarter of their fiscal income and are needed to fund infrastructure and other spending."

April 18 - Bloomberg: "China's property rebound gathered pace in March as new home prices in the southern city of Guangzhou jumped the most in more than two years, underscoring concerns that a bubble may be building. Guangzhou prices rose 11.1% from a year earlier while those in Beijing climbed 8.6% and Shanghai posted a 6.4% increase... all showing the biggest gains since January 2011... Prices rose in 68 of 70 cities tracked by the government, the most since September 2011. 'Today's data shows demand is still strong, especially in major cities; the government's measures in the past didn't work,' Shen Jian-guang... economist at Mizuho Securities Asia Ltd., said... 'Home prices will continue to rise because local governments are refraining from fully implementing the measures.'"

April 16 - Bloomberg: "China's longest streak of expansion below 8% in at least 20 years is sending a message to suppliers and investors around the world to get used to slower growth in the second-biggest economy. The 7.7% increase in first-quarter gross domestic product from a year earlier marked the first time in data going back two decades that four periods in a row have seen growth of less than 8%. The figure released yesterday by the National Bureau of Statistics in Beijing was also the worst miss of analyst estimates since the third quarter of 2008... A sustained shift to a lower-growth gear would affect everything from iron-ore demand in Australia to the fortunes of companies including carmaker General Motors Co., who are counting on China to drive profits."

April 18 - Dow Jones: "Despite lower-than-expected gross domestic product growth in the first quarter, China will steer clear of major stimulus measures, senior advisers to China's policymakers suggested... China reported GDP growth of 7.7% year-on-year in the first quarter, down from 7.9% in the final quarter of 2012, and below market forecasts of 8.0% growth. But this is no cause for panic, according to Zhang Yansheng, a member of the academic committee of the National Development and Reform Commission, the government's powerful economic planning agency. 'The target is 7.5% growth and the first quarter was 7.7%,' Mr. Zhang said... 'Why would we need to stimulate growth?' Meanwhile, high levels of new lending in the first quarter rang alarm bells for some economists, with China's central bank reporting 6.2 trillion yuan ($1 trillion) in new finance in the period."

April 17 - Bloomberg (Ehren Goossens): "LDK Solar Ltd.'s failure to fully pay notes this week has raised the prospect of China's second solar-industry failure this year as the company needs to repay a loan 10 times larger by June. The world's second-biggest maker of wafers that convert sunlight into power couldn't repay all of the $23.8 million of dollar-denominated convertible bonds that matured on April 15..."

Japan Watch:

April 17 - Financial Times (Ben McLannahan): "So much for Haruhiko Kuroda's plans to ease the flow of credit. Since the new governor of the Bank of Japan shouldered his 'big bazooka' two weeks ago, promising to buy up more government bonds than ever to drive down the cost of borrowing, yields have risen at every point along the country's 30-year sovereign debt curve, prompting some banks to charge more for loans. Amid the 'shock and awe' of this radical policy shift, investors in Japan's Y914tn ($9.4tn) government bond market, the world's second-largest, have 'lost their bearings', says Naka Matsuzawa, chief Japan rates strategist at Nomura... If volatility remains elevated for much longer, analysts warn that value-at-risk models may force investors to liquidate JGB holdings, pushing yields higher... 'For now, the easing programme that was announced with such fanfare must be judged a failure,' says Jun Ishii, chief fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities."

Asia Bubble Watch:

April 16 - Bloomberg (Cynthia Kim): "South Korea unveiled a 17.3 trillion won ($15.4bn) supplementary budget to support exporters pressured by a weaker Japanese currency and revive an economy that grew last year at the slowest pace since 2009. The package will boost growth by 0.3 percentage points and create 40,000 jobs, the Finance Ministry said..."

Latin America Watch:

April 19 - Bloomberg (Cristiane Lucchesi and Francisco Marcelino): "The Brazilian overnight loan market between banks is shrinking as the biggest lenders have pulled back, affecting the rate tied to $865 billion of securities and mutual funds, said two people with direct knowledge of the matter. Large banks are instead following central bank directives to purchase longer-term securities from smaller lenders... The average number of daily transactions in the interbank market fell to 16.8 last month from as many as 47.2 in January 2011... while volume dropped to 1.85 billion reais ($916.3 million) from 10.2 billion reais."

Europe Watch:

April 17 - Dow Jones (Brian Blackstone and Matthew Karnitschnig): "Germany's top central banker warned that Europe's debt crisis will take as much as a decade to overcome, dismissing the view expressed by some political leaders that the worst of the crisis is over. ...Bundesbank President Jens Weidmann signaled that the European Central Bank could reduce interest rates if economic and inflation data suggest it is warranted. But he warned that such a move wouldn't turn around the euro bloc's economic fortunes, instead pinning responsibility on elected leaders to find ways to kickstart growth and channel money to small businesses. Mr. Weidmann praised the agreement between Cyprus and its international lenders for a 10-billion-euro ($13.1bn) bailout that includes steep losses for large depositors of Cypriot banks. Though the deal isn't a blueprint for others, it established the principle of a 'pecking order' for stakeholders of banks to bear the costs of their investment decisions, he said... 'Everyone is asking what more can the central bank do instead of asking what other policy makers can contribute... A point that I think is important to make--perhaps less for my central bank colleagues than for finance ministers--is that the medication monetary policy makers administer only cures the symptoms and that it comes with side-effects and risks,' Mr. Weidmann said."

April 17 - Bloomberg (Tommaso Ebhardt): "European car sales are sliding to a 20-year low after German concerns over the ongoing debt crisis sent demand plunging last month in the region's biggest economy and removed the main buffer protecting automakers. Registrations in March fell 10% to 1.35 million vehicles, the 18th consecutive monthly decline, with Germany's auto market plummeting 17%... First-quarter deliveries in the region dropped 9.7% to a record low 3.1 million cars. 'The car boom in Germany has come to an end," said Hans- Peter Wodniok, an analyst at Fairesearch GmbH & Co. 'People have stopped buying cars as consumers are much less confident of the future, especially after the latest decision on Cyprus.'"

Italy Watch:

April 18 - Bloomberg (Lorenzo Totaro and Andrew Frye): "Pier Luigi Bersani said he will resign as head of Italy's Democratic Party after he failed to form a government and persuade lawmakers to endorse his choice for president eight weeks after winning a partial victory in national elections... According to a statement on the party's website, the resignation will be effective after the presidential election is completed."

April 16 - Bloomberg (Elisa Martinuzzi and Sergio Di Pasquale): "Prosecutors in Siena, Italy are seizing about 1.8 billion euros ($2.3bn) of assets from Nomura Holdings Inc. as part of a probe into Banca Monte dei Paschi di Siena SpA's use of derivatives to hide losses. The sequestration is linked to allegations of fraud and usury, prosecutors said... Monte dei Paschi has alleged Nomura colluded with its former managers to devise one of two derivatives in 2008 and 2009 that hid total losses of much as 557 million euros."

Spain Watch:

April 18 - Bloomberg (Charles Penty): "A Spanish economic slump now in its sixth year is stoking concern the nation needs more than the 41 billion euros ($54bn) that it sought from European partners to bail out its banks. 'Spain should ask for the full 100 billion euros that's on offer from Europe,' said Cesar Molinas, a partner at private equity firm CRB Inverbio in Madrid. 'The more the economy worsens, the more the capital base of the banks will get eroded and there is still a lot of cleaning up to be done.' Spanish lenders had 162 billion euros of bad loans in February, equivalent to 10.4% of the credit in the economy... Losses make it harder for banks to bolster the economy by lending to businesses."

April 17 - Bloomberg (Sharon Smyth): "A 285-unit apartment complex in Parla, less than half an hour's drive from Madrid, should be an ideal target for investors seeking cheap property in Spain. Unfortunately, two thirds of the building generates zero revenue because it's overrun by squatters. 'This is happening all over the country," said Jose Maria Fraile, the town's mayor, who estimates only 100 apartments in the block built for the council have rental contracts, and not all of those tenants are paying either. 'People lost their jobs, they can't pay mortgages or rent so they lost their homes and this has produced a tide of squatters.'"

Germany Watch:

April 18 - Bloomberg (Tommaso Ebhardt and Dorothee Tschampa): "Daimler AG and other global automakers, already predicting a drop in European deliveries of as much as 5% this year, will probably have to lower their forecasts after demand in Germany dropped the most in 2 1/2 years last month... A sudden plunge in the German auto market, which accounts for 25% of the region's deliveries, is prompting companies to increase discounting, in turn pressuring earnings. Deliveries in Europe's largest economy are set to decline to 3.04 million cars this year, 20% below the 2009 peak..."

April 16 - Bloomberg (Jana Randow): "German investor confidence declined more than economists forecast in April, suggesting the recovery in Europe's largest economy may struggle to gain momentum. The ZEW Center for European Economic Research... said its index of investor and analyst expectations, which aims to predict economic developments six months in advance, fell to 36.3 from a three-year high of 48.5 in March... Business sentiment weakened in March amid renewed concerns about the sovereign debt crisis and the recession in the euro area, Germany's largest export market."

April 16 - Bloomberg (Patrick Donahue): "Chancellor Angela Merkel said that austerity in the euro area will claim victims as European leaders struggle to resolve the debt crisis, though the pain will be worth it to regain sustainable economic growth. The German leader dismissed the notion that increasing debt is necessary to generate growth... 'We know that there will have to be victims from this in many countries,' Merkel told a forestry conference... 'But I believe that in the long term we'll have to have a growth strategy without always having to pile on debt.'"

April 19 - Bloomberg (Tony Czuczka): "Data suggesting that people in Spain, Cyprus and Greece are richer than Germans understate the level of prosperity in Germany, Chancellor Angela Merkel said. 'The statistics are distorted,' Merkel said... Many more people in southern euro-area countries own homes as a type of old-age insurance than in Germany, and the data exclude Germans' retirement entitlements and assets abroad, she said. Debate about differences in household wealth in Europe was stoked by headlines in German media on a European Central Bank report... that showed households in Cyprus with median net wealth of 266,900 euros ($349,320), the second- highest in the euro area behind Luxembourg. Germany, at 51,400 euros, ranked last among the 15 euro countries surveyed."

April 19 - MarketNews International: "German Finance Minister Wolfgang Schaeuble called on the European Central Bank to reduce the amount of liquidity in the Eurozone, according to an interview in the German business weekly Wirtschaftswoche... 'There is a lot of money in the market, in my view too much money... I could only welcome it if the ECB would try to use the leeway to reduce the large liquidity a bit.' Too much liquidity could create new asset price bubbles, he warned."

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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