Kuroda's Gambit

By: Doug Noland | Fri, May 24, 2013
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Air leaks out of Japanese stocks and bonds and global Bubbles suddenly appear more vulnerable.

For centuries, economic thinkers have grappled with money and Credit. Invariably, analytical interest ebbs and flows right along with boom and bust cycles. And during periods of keenest interest, there's a common recurring question that's been asked through the ages: "How could a period of economic advancement and prosperity that looked so promising and enduring come to such a dreadful end?" The answer too often is some variation of how money and Credit run amuck over the course of the boom.

It's a challenge to place contemporary monetary analysis into historical context. After all, we're talking about extraordinary financial and economic innovation; unmatched integration of global economic and financial systems; unprecedented global financial excess and imbalances; experimental central bank doctrine and unprecedented monetary stimulus. It's uncharted waters virtually across the board, which naturally evokes quite divergent views and analytical perspectives. Surging asset markets have largely squelched one side of the debate, while providing a fancy megaphone to the other.

Increasingly, "enlightened" is used to describe today's experimental central bank policymaking, especially in the context of using open-ended quantitative easing operations to support asset prices and economic activity. I'll take the other side of the analytical debate. I view contemporary central bank doctrine as essentially an experiment in attempting to contain the monetary instability that has consistently sealed the fate of boom-time prosperity over many generations. Especially during the past nine months, this whole endeavor of suppressing monetary disorder has begun to run amuck.

What began with the Greenspan Fed's pegging of short-term rates and accommodating non-bank Credit growth during the early-nineties has evolved into massive global central bank monetization of debt and the injection of Trillions of liquidity into international securities markets. What was a $40bn hedge fund industry to begin the nineties has morphed into a multi-Trillion global pool of speculative finance and a remarkably sophisticated "leveraged speculating community."

Last month I titled a CBB "Things Have Gone Too Far," a week after "Kuroda Leapfrogs Bernanke." I and others view the Bank of Japan's "shock and awe" reflationary strategy as an historic Gambit. Mr. Kuroda seeks to jumpstart economic growth by using the prospect of an inflationary jolt to spur spending and investment. The Bank of Japan has appeared to support a much weaker yen, while believing its aggressive bond purchases would place an ongoing ceiling on bond yields. But with debt approaching 240% of GDP and its financial institutions large (leveraged) holders of low-yielding government debt, a spike in market yields would both impair Japan's financial system and thrust its fiscal position into precarious debt trap dynamics. Playing with fire.

Initially, the global speculators were not too concerned with eventual outcomes. Their focus was on the BOJ's massive liquidity injections, yen weakness and prospects for Japanese institutions and retail investors to flee Japan in search of higher returns elsewhere. Suddenly, another $80bn or so was combined with the Fed's $85bn monthly quantitative easing for liquidity injections unlike anything ever experienced by booming global markets. Global equities went into melt-up mode, global sovereign yields in melt-down and risk premiums generally collapsed to multi-year lows - in the face of a weakening global economic backdrop and mounting fragilities. Corporate debt issuance, already at record pace, inflated to even further extremes - including deteriorating quality at record low yields!

Well, Financial Euphoria too often proves fleeting. The current bout may have already begun to dissipate. Monetary policy that was to propel securities prices higher is suddenly viewed in somewhat different light. The Wall Street Journal went with the headline "Fed Leaves Market Guessing" for John Hilsenrath's take on Bernanke's testimony and the plethora of conflicting comments from various Fed officials.

Best I can tell, the Fed may begin to "taper" or they may instead choose to increase the size of QE. Could be soon but maybe not. It's "data dependent," although that data may be the unemployment rate or GDP or CPI or something else. When the Fed eventually decides to "taper" - they may then decide to reverse course depending, again, on various factors that no one can clearly articulate because there's no consensus view as to how to manage this phase of the monetary experiment.

And the higher stock prices climb, the more convinced participants are that the Fed will not allow a market accident. The more euphoric the market backdrop, the more confident the marketplace is that the securities markets are "too big to fail" - that the Fed will be there providing liquidity abundance irrespective of the data. As always, monetary inflations are as seductive as they are difficult to control.

I'll stick with the view that the Bernanke Fed told a fib last summer when it tied QE to the unemployment rate. They were responding to heightened global financial and economic fragility, while justifying their astonishing "money printing" operation by linking it to the high jobless rate and the notion of lost economic potential. The Fed and global central banks fueled asset Bubbles that further diverged from weak economic fundamentals. As a result, monetary policy is now even more securely entrapped by financial and economic fragilities. And while the financial media was fixated on Bernanke and confusing Fed communications, perhaps a bigger near-term market risk began to unfold this week in Tokyo.

Japan's Nikkei equities index was hammered 7.3% on Thursday. After trading as high as 15,943 mid-week, the index briefly touched 14,000 on Friday before ending the week at 14,612. Notably, the Japanese government debt market has of late made their equity market appear relatively stable. Trading as low as 55 bps early in the month, Japan's 10-year JGB yields traded briefly at 1.0% Thursday before aggressive BOJ buying forced yields back down to 82 bps by week's end.

Some headlines were of the type that makes traders edgy. "Japan Economy Chief Warns Against Panic Over Stock Sell-off." "Kuroda Struggles with Communication as Japan Rates Rise." "Kuroda Promises to Stabilize Bond Market." The triggering of circuit breakers in the JGB market is becoming a hallmark of Kuroda's brief tenure, and I would not be surprised if extreme market volatility persists for some time to come.

When a fledgling central bank chief - in the midst of a radical and untested experiment in monetary inflation - promises to stabilize a nearly $14 TN bond market, well, it's time to begin worrying. And my guess is that's exactly what some of the hedge funds and sophisticated leveraged players began to do this week. Time to begin taking some chips off the table.

The Kuroda Gambit was seen unleashing enormous amounts of liquidity upon global markets. At least this perception was spurring a collapse of sovereign yields and risk premiums around the globe. Those caught short melting up risk markets were forced to run for cover - virtually everywhere. Those hedging various risks were forced to throw in the towel, while those cautiously underinvested in rapidly rising markets had little choice but to throw caution to the wind ("capitulate"). Radical BOJ measures pushed already over-liquefied, speculation rife and highly unsettled markets over the edge into speculative blow-off type dislocations.

If the Kuroda Gambit does not live up to the advertised global liquidity bonanza, then some major market adjustments will be in order. Importantly, there have been indications that the sophisticated market operators (and others) moved to front-run the onslaught of Japanese liquidity. European markets, in particular, were viewed as likely to be on receiving end of a Japanese flight out of yen into higher yielding debt instruments. Italian and Spanish 10-year yields collapsed about 100 bps during April, in the face of ongoing economic deterioration. Sinking yields supported strong rallies in Italian, Spanish and European equity markets. Credit default swap (CDS) prices collapsed throughout Europe - for sovereigns, corporates and financials.

Notably, Italy sovereign CDS prices dropped from 308 on April 1st to 219 as of Wednesday (May 22). CDS for Spain sank from 307 to 204. But as JGB yields late this week gyrated and Japanese stocks reversed sharply lower, the ill-effects were transmitted immediately to Europe. During Thursday's and Friday's sessions, Italy CDS surged 32 bps and Spain CDS jumped 31 bps. Portugal CDS jumped 37 bps in two sessions. In similarly sharp reversals, bank and financial CDS prices jumped sharply to end an unsettled week. Italian stocks were hit for 3.7% in two sessions and Spanish stocks fell 2.3% (3.7% for the week). And after spiking to record highs on Wednesday, Germany's DAX equities index reversed course and sank 2.6% in two sessions.

Financial Euphoria-induced perceptions of endless liquidity are prone to abrupt market reassessments. As such, a few Friday Bloomberg headlines caught my attention: "Dealers Absorbing Junk Bonds as ETF Demand Drops"; "Corporate Bond Sales Slow in Europe on Fed Stimulus Speculation"; "Dollar Bond Sales Slump in Asia as Costs Leap on Stimulus Doubts." "Glencore Leads Company Bond Sales in U.S. as Issuance Falls 36%."

And no analysis of unsettled global markets would be complete without addressing ongoing currency market volatility. Thursday and Friday sessions saw the yen rally 2% against the dollar. Generally, the emerging currencies continue to trade poorly. The Colombian peso fell 2.0% this week, with the Chilean peso and Mexican peso 1.5% lower. The Indian rupee fell 1.4%, the South Korean won 0.9%, the Philippine peso 1.0% and the Peruvian new sol 1.4%. The so-called commodities currencies remained under pressure. The South African rand was hit for another 1.8%. The Brazilian real fell 0.8%, the Australian dollar 0.8% and the Canadian dollar 0.4%.

The unfolding Chinese slowdown and fragility story saw additional corroboration. China's manufacturing PMI fell back below 50 (contracting) for the first time in seven months. There were as well several news items (see "China Bubble Watch") pointing toward an unfolding government crackdown on currency speculation and financial excess. Chinese government officials are now working on a tightrope as they attempt to contain runaway Credit and speculative excesses while not pushing an already slowing (and deeply maladjusted) economy into a downward spiral.

Commodities prices generally remained under pressure. The Goldman Sachs Commodities index fell 1.2% this week, increasing 2013 declines to 3.4%. Crude oil dropped 2.2%. Curiously, Lumber futures declined another 2% this week, having now dropped about a third from March highs. Nickel, Soybeans, Cocoa, Palladium and Coffee all declined this week.

Here at home, the stock market was resilient, while other indicators pointed to tinges of heightened risk aversion. Ten-year Treasury yields jumped above 2.0% for the first time since March. Curiously, benchmark MBS yields jumped 13 bps to the highest level in a year. After beginning the month at 2.28%, MBS yields ended the week at 2.82%. And after dropping to the lowest level since 2007, junk bond CDS prices jumped 19 bps in two sessions.

There is little doubt that Fed policies have again fostered huge amounts of speculative leveraging throughout the U.S. Credit system. The spike in MBS yields and the widening of MBS spreads may portend a more cautious approach to risk in a very important segment of the U.S. Credit market. Moreover, a pronounced de-leveraging in MBS (and, potentially, other Credit instruments) would counterbalance the Fed's $85 billion monthly injections.

It's no surprise that investors/speculators in U.S. equities are determined to stick with the bullish thesis and disregard more global macro issues (it's worked to this point!). Yet this unfolding Kuroda Gambit drama could prove too significant to ignore. The perception holds that the Fed's $85bn will ensure ample bull market liquidity for at least the next several months.

The overall bullish take on marketplace liquidity could prove too complacent if things begin to unwind in Tokyo. And by unwind I mean that Japan bond market fragility forces a change of tack by the Kuroda BOJ. A spike in yields could prove highly destabilizing, with a bond and stock market crash not out of the question. Or perhaps the BOJ will work out an agreement with major Japanese institutions to ensure their support for low yields. The BOJ may need institutions to fall in line and stop selling bonds and the yen. Such an understanding might support a stronger yen, with less liquidity seeking higher yields overseas.

It would appear that there are now viable scenarios that are potentially problematic for the leveraged players - and for the Financial Euphoria that erupted around the globe. Perhaps an overdue bout of de-risking and de-leveraging actually commenced this week. At the minimum, the markets were reminded that there is as well a downside to all this central bank dependency and Bubble-inducing liquidity.

 


For the Week:

The S&P500 declined 1.1% (up 15.7% y-t-d), and the Dow slipped 0.3% (up 16.8%). The Morgan Stanley Cyclicals were down 1.3% (up 16.6%), and the Transports fell 2.3% (up 20.5%). The Morgan Stanley Consumer index fell 1.3% (up 21.8%), and the Utilities sank 3.5% (up 10.2%). The Banks slipped 0.4% (up 18.7%), and the Broker/Dealers dropped 3.0% (up 28.7%). The S&P 400 MidCaps fell 1.9% (up 16.4%), and the small cap Russell 2000 declined 1.2% (up 15.9%). The Nasdaq100 lost 1.3% (up 12.4%), and the Morgan Stanley High Tech index dropped 1.8% (up 10.8%). The Semiconductors fell 1.9% (up 20.2%). The InteractiveWeek Internet index dropped 2.3% (up 16.1%). The Biotechs declined 1.2% (up 28.2%). With bullion recovering $27, the HUI gold index rallied 3.8% (down 42.5%).

One-month Treasury bill rates ended the week at two bps and 3-month rates closed at four bps. Two-year government yields were up slightly to 0.25%. Five-year T-note yields ended the week up 6 bps to 0.89%. Ten-year yields rose 6 bps to 2.01%. Long bond yields were little changed at 3.17%. Benchmark Fannie MBS yields jumped a notable 13 bps to 2.82% (12-month high). The spread between benchmark MBS and 10-year Treasury yields widened 7 to 81 bps. The implied yield on December 2014 eurodollar futures increased 3.5 bps to 0.525%. The two-year dollar swap spread rose one to 16 bps, and the 10-year swap spread increased about 2 to 15 bps. Corporate bond spreads widened. An index of investment grade bond risk increased 5 to 76 bps. An index of junk bond risk jumped 29 to 371 bps. An index of emerging market debt risk rose 15 to 282 bps.

Debt issuance remained strong. Investment grade issuers included CF Industries $1.5bn, Glencore $5.0bn, PPL Capital Funding $1.15bn, Bank of America $1.0bn, Kimberly-Clark $850 million, International Lease Finance $550 million, Pricoa Global Funding $500 million, Analog Devices $500 million, Memorial Production Partners $400 million, Principal Life $300 million, National Rural Utility Cooperative $250 million, Entergy Arkansas $250 million and Helios Leasing $140 million.

Junk bond funds saw outflows of $123 million (from Lipper). Junk issuers included Concho Resources $1.55bn, B&G Foods $700 million, Midstates Petroleum $700 million, Commscope Holdings $550 million, Provident Funding $540 million, Cinemark $530 million, US Airways $500 million, SIWF $470 million, GETCO Financing $305 million, Springleaf Finance $300 million, Sabra Health Care REIT $200 million, Vantage Oncology $250 million, Century Aluminum $250 million and Legacy Reserves $250 million.

Convertible debt issuers included Sunpower Corp $300 million.

The long list of international dollar debt issuers included Intelsat Jackson $2.635bn, Morocco $2.25bn, Deutsche Bank $2.5bn, Caisse D'Amort $2.5bn, Vedanta Resources $$1.7bn, Skandinaviska Enskilda $1.5bn, Westpac Banking $1.25bn, Kommunalbanken $1.15bn, Elan $850 million, MTS International Funding $500 million, AON $250 million, and Grupo Famsa $250 million.

Italian 10-yr yields jumped 24 bps to 4.13% (down 37bps y-t-d). Spain's 10-year yields were up 21 bps to 4.40% (down 87bps). German bund yields rose 10 bps to 1.43% (up 11 bps), and French yields gained 8 bps to 1.94% (down 6bps). The French to German 10-year bond spread narrowed 2 to 51 bps. Ten-year Portuguese yields jumped 28 bps to 5.46% (down 129bps). Greek 10-year note yields surged 60 bps to 8.65% (down 182bps). U.K. 10-year gilt yields added a basis point to 1.89% (up 7bps).

The German DAX equities index declined 1.0% for the week (up 9.1% y-t-d). Spain's IBEX 35 equities index sank 3.7% (up 1.2%). Italy's FTSE MIB fell 4.0% (up 3.8%). Japanese 10-year "JGB" yields ended the week up 4 bps to 0.82% (up 4bps). Japan's wild Nikkei equity index slumped 3.5% (up 40.6%). Emerging markets were mostly lower. Brazil's Bovespa index rallied 2.3% (down 7.5%), while Mexico's Bolsa sank 3.1% (down 7.3%). South Korea's Kospi index declined 0.7% (down 1.2%). India's Sensex equities index sank 2.9% (up 1.4%). China's Shanghai Exchange increased 0.3% (up 0.9%).

Freddie Mac 30-year fixed mortgage rates jumped 8 bps to 3.59%, with a three-week gain of 24bps (down 19bps y-o-y). Fifteen-year fixed rates were up 9 bps to 2.77% (down 27bps). One-year ARM rates were unchanged at 2.55% (down 20bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 4 bps to 4.00% (down 40bps).

Federal Reserve Credit surged $33.4bn to a record $3.337 TN. Fed Credit expanded $551bn over the past 33 weeks. Over the past year, Fed Credit expanded $494bn, or 17.4%.

M2 (narrow) "money" supply increased $12.7bn to a record $10.553 TN. "Narrow money" expanded 6.6% ($656bn) over the past year. For the week, Currency increased $2.5bn. Demand and Checkable Deposits added a billion, and Savings Deposits gained $9.8bn. Small Denominated Deposits slipped $1.8bn. Retail Money Funds rose $2.1bn.

Money market fund assets jumped $19.5bn to $2.601 TN. Money Fund assets were up $37bn from a year ago, or 1.4%.

Total Commercial Paper outstanding jumped $19.8bn this week to $1.033 TN. CP has declined $32bn y-t-d, while having expanded $25bn, or 2.5%, over the past year.

Currency and 'Currency War' Watch:

The U.S. dollar index slipped 0.7% to 83.70 (up 4.9% y-t-d). For the week on the upside, the Japanese yen increased 1.9%, the Swiss franc 1.2%, the euro 0.7%, the Danish krone 0.7%, the Swedish krona 0.7%, the New Zealand dollar 0.4%, the Norwegian krone 0.4% and the Taiwanese dollar 0.2%. For the week on the downside, the South African rand increased 1.8%, the Mexican peso 1.5%, the South Korean won 0.9%, the Australian dollar 0.8%, the Brazilian real 0.8%, the Singapore dollar 0.4%, the Canadian dollar 0.4%, and the British pound 0.3%.

Commodities Watch:

The CRB index declined 0.9% this week (down 3.4% y-t-d). The Goldman Sachs Commodities Index fell 1.2% (down 3.4%). Spot Gold recovered 2.0% to $1,387 (down 17.2%). Silver was up 0.6% to $22.50 (down 26%). July Crude was down $2.14 to $94.15 (up 3%). June Gasoline fell 2.3% (up 3%), while June Natural Gas jumped 4.5% (up 26%). July Copper dropped 0.8% (down 10%). July Wheat gained 2.1% (down 10%), and July Corn increased 0.7% (down 6%).

U.S. Bubble Economy Watch:

May 19 - Financial Times (Tracy Alloway and Nicole Bullock): "US banks are making riskier corporate loans as they seek to boost their flatlining profits and fight off tough competition from other lenders and the booming bond market, regulators, analysts and banking executives have warned. The amount of business loans made by US banks jumped to $1.55tn at the start of May, up 10% compared with the same period last year... But intense competition to extend financing to US companies means that some banks are dramatically cutting the terms and interest rates at which they offer the business loans. 'Every 10 years or so, banks make some horrible mistake and it usually starts with easy money,' said Mike Pinto, vice-chairman of M&T Bank..."

May 23 - Bloomberg (Prashant Gopal): "About 22 million Americans may lack enough home equity to move, keeping property listings tight and limiting sales as the housing market recovers, Zillow Inc. said. Forty-four percent of homeowners with mortgages owed more than their properties are worth or had less than 20% equity in the first quarter... Those people probably are locked in to their residences, because listing a house and purchasing a new one generally requires equity of at least 20% to meet costs such as a down payment and broker fee... 'Looking at the effective negative-equity rate could explain why recent, healthy declines in the number of underwater borrowers haven't yet translated into more homes for sale,' Zillow Chief Economist Stan Humphries said... 'Things like real estate agents' fees and a down payment for the next home traditionally come out of the proceeds from the prior home's sale. Without enough equity, these costs will instead have to come out of a homeowner's pocket, leaving many still stuck.'"

May 23 - Bloomberg (John Hechinger): "Overdue student loans reached an all-time high as students struggle to find work after college, according to a government report renewing alarms about the rising burden of higher-education debt. Eleven percent of student loans were seriously delinquent -- at least 90 days past due -- in the third quarter of 2012, compared with 6% in the first quarter of 2003... Almost 30% of 20- to 24-year-olds aren't employed or in school, the study found. The research is being released amid concern in Congress and President Barack Obama's administration about rising college costs and $1 trillion in outstanding student loans, the largest category of consumer debt besides mortgages."

May 24 - Bloomberg (Angela Greiling Keane): "The collapse of a U.S. interstate highway bridge north of Seattle highlights the deteriorating state of the country's infrastructure, even following $48.1 billion in economic stimulus funds and a 2007 fatal bridge failure in Minnesota. While the cause of yesterday's collapse of a section of the Interstate 5 bridge spanning the Skagit River in Washington state isn't yet known, the failure calls attention to the inability of authorities to replace or fix aging structures. The 607,380 bridges in the U.S. are an average age of 42 years old, with one in nine rated 'structurally deficient,' according to the American Society of Civil Engineers..."

Federal Reserve Watch:

May 23 - Bloomberg (Joshua Zumbrun): "The 21 primary dealers that trade securities directly with the Federal Reserve Bank of New York, said that confusion about the central bank's intentions for its bond-buying program is reducing the policy's effectiveness. The dealers' views were shared with the New York Fed in a survey of primary dealers that the Federal Open Market Committee reviewed at their April 30-May 1 meeting. A diversity of Fed speakers expressing different views has left the primary dealers unsure of the central bank's intentions... 'Some dealers noted that the dispersion of views expressed by FOMC participants as to how the FOMC would make decisions regarding the future pace of asset purchases has decreased clarity around the program... Of these dealers, several suggested that the differing views on monetary policy may reduce the policy's effectiveness.'"

May 23 - Bloomberg (Aki Ito): "Federal Reserve Bank of San Francisco President John Williams, emphasizing the need for policy flexibility, said any move to reduce the pace of the central bank's bond buying could be followed by an increase should the economy weaken again. 'Even if we do adjust downward our purchases, it doesn't mean we're now in some autopilot of moving in the same direction,' Williams, 50, said... 'You could even imagine a scenario where we adjust it downward based on good data and then adjust it back' if the economy weakened... 'We can adjust it down some, watch how things progress from there, and then adjust it again one way or the other,' Williams... said..."

May 22 - Bloomberg (Joshua Zumbrun): "Federal Reserve Bank of New York President William C. Dudley said policy makers will know in three to four months whether the economy is healthy enough to overcome federal budget cuts and allow the central bank to begin reducing record stimulus. 'I don't really understand very well how the tug-of-war between the fiscal drag and the improving economy are going to sort of work their way out,' Dudley said... 'Three or four months from now I think you're going to have a much better sense of, is the economy healthy enough to overcome the fiscal drag or not.'"

May 21 - Bloomberg (Joshua Zumbrun): "Federal Reserve Bank of New York President William C. Dudley said he has not decided whether the Fed's next move should be to enlarge or shrink its bond buying program as he called for a fresh look at its eventual retreat from record asset purchases. 'Because the outlook is uncertain, I cannot be sure which way -- up or down -- the next change will be,' Dudley said..."

May 22 - Bloomberg (Craig Torres): "Federal Reserve Chairman Ben S. Bernanke the U.S. economy remains hampered by high unemployment and government spending cuts, and that raising interest rates or reducing asset purchases too soon would endanger the recovery. 'A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further,' Bernanke said...at the Joint Economic Committee of Congress... Monetary policy is providing 'significant benefits,' he said. Bernanke is leading the most aggressive economic stimulus in the Fed's 100-year history in an effort to spur growth and reduce an unemployment rate that stands at 7.5% almost four years into a recovery from the longest and deepest recession since the Great Depression."

May 21 - Bloomberg (Jeff Kearns): "Federal Reserve Bank of St. Louis President James Bullard said the central bank should continue its bond buying because it's the best available option for policy makers to boost growth that is slower than expected. The purchases known as quantitative easing should be maintained because financial markets indicate that they are improving financial conditions and can be adjusted based on how the economy changes, Bullard... said... 'Quantitative easing is closest to standard monetary policy, involves clear action and has been effective,' Bullard said. The panel should continue the program while adjusting the rate of purchases appropriately in view of incoming data on both real economic performance and inflation.'"

May 23 - Bloomberg (Steve Matthews and Scott Hamilton): "Federal Reserve Bank of St. Louis President James Bullard said he wants to continue the current pace of bond purchases as long as falling inflation is a concern. 'My own forecast is that it would be a little closer to target by now, so I am a little bit nervous about the fact that inflation has been low and has been trending down,' Bullard said... 'I would like to get some reassurance from the data that it's going to turn around and go back toward target before we start tapering' bond purchases by the Fed."

May 21 - Bloomberg (Jeff Kearns and Jeff Black): "Federal Reserve Bank of St. Louis President James Bullard said Europe risks an extended period of low growth and deflation like Japan's unless the European Central Bank acts with an aggressive quantitative easing program. 'You should worry about it, and then take policy action to avoid it,' Bullard said... 'You want to be pretty sure that you don't get stuck in that situation, and one way to get stuck would be to be passive in this situation and not take some aggressive action to try to get inflation back.'"

May 23 - Bloomberg (Jennifer Ryan): "Harvard University economist Martin Feldstein says the Federal Reserve's quantitative easing program 'has put the U.S. economy in a very dangerous position... it's going to be very hard for them to unwind or even to slow down... we're in a very precarious position... What we're looking at is a bubble in bond prices'."

Global Bubble Watch:

May 24 - Bloomberg (Toru Fujioka): "Haruhiko Kuroda may need to talk his way out of a paradox he helped create. Installed as Bank of Japan chief in March, Kuroda aims to unlock borrowing and spending by lifting inflation expectations and wages after 15 years of deflation. Market volatility partly triggered by the BOJ's record bond-buying now threatens to sap business and consumer confidence and weaken the campaign to reflate the world's third-biggest economy. At a press briefing on May 22, Kuroda said that gains in yields could be expected as the economy improved, after saying previously that the central bank aimed to lower interest rates. The next day, 10-year government bond yields reached the highest level in a year... 'Kuroda failed to calm the market - he couldn't deliver a decisive message today,' said Hideo Kumano, executive chief economist at Dai-ichi Life Research Institute... and a former central bank official. 'Markets are still trying to understand who Kuroda is and how he will address problems.'"

May 23 - Bloomberg (Keiko Ujikane, Andy Sharp and Masahiro Hidaka): "Japan's economy minister said there's no reason to be perturbed by today's sell-off in the nation's stocks, as the recent surge in equities was faster than expected and the economy is steadily recovering. 'There's no need to be perturbed as the Japanese economy is recovering soundly,' Akira Amari told reporters... 'We will closely watch market movements.' Amari spoke after Japan's Topix Index of equities tumbled 6.9%... Volatility also hit the bond market today, with a surge in 10-year government-debt yields to the highest level in more than a year prompting the central bank to inject liquidity."

May 24 - Bloomberg (Katie Linsell): "Sales of corporate bonds in Europe fell to the lowest in nearly two months this week as concern the Federal Reserve will taper asset purchases roiled markets. U.K. tour operator Thomas Cook Group Plc and... Gecina SA were among companies that sold 8.4 billion euros ($10.9bn) of bonds, down from 19.5 billion euros last week..."

May 24 - Bloomberg (Lisa Abramowicz): "Wall Street banks are expanding holdings of speculative-grade bonds as prices fall from record highs with investors retreating from exchange-traded funds that buy the debt. The 21 primary dealers that do business with the Federal Reserve increased their net positions in junk-rated debt by 37% to $7.7 billion in the two weeks ended May 15..."

May 24 - Bloomberg (Rachel Evans and Benjamin Purvis): "Sales of U.S. dollar-denominated bonds by Asian issuers slumped more than 70% this week as yields rose the most in almost four months. Vedanta Resources... led $2.1 billion of new sales in the region outside Japan, the least since the week ending April 5... Yields climbed 13 bps to 4.4% as of yesterday, on track for the biggest weekly rise since the start of February..."

May 23 - Financial Times (Robin Wigglesworth): As far as financial follies go, tulip mania takes some beating. But future economic historians may look back at the time when investors financed a convention centre in Rwanda as the moment that the rush into emerging market bonds became frothy. Despite a large chunk of Rwanda's budget coming from overseas aid - some of which was withheld last year after it was accused of backing rebels in neighbouring Congo - investors rushed to get a slice of the country's inaugural $400m bond last month. The proceeds are largely to be used to pay for a new conference centre in Kigali... Even investment bankers that orchestrate these bond sales are becoming concerned that the market is overly frothy as cash-rich fund managers seek out any securities that still offer some yield - almost irrespective of the risks. 'I hate to say this, but in five years' time a lot of this will get hammered,' concedes one. Another senior banker who considered pitching for Rwanda's bond mandate says he decided against it because 'we couldn't look investors in the eyes and tell them it's a good deal'."

May 22 - Bloomberg (Jesse Westbrook): "Hedge funds' returns have stayed 'lackluster' this year, with the $2.3 trillion industry trailing the gains of the Standard & Poor's 500 Index by about 10 percentage points, according to Goldman Sachs Group Inc. Hedge funds gained 5.4% on average through May 10, compared with a 15.4% rise for the S&P 500... Hedge-fund managers have been hurt in 2013 by their bearish wagers on stocks, with 'popular' shorts... rising more than the broader equity market... Fewer than 5% of the hedge funds tracked by... Goldman Sachs are beating the S&P 500 or a typical mutual fund that buys stocks of the biggest U.S. companies. A 'multi-year trend of lackluster hedge-fund returns continues in 2013,' the analysts wrote. 'Strong long performance was not enough to outweigh the drag from popular short positions.'"

May 20 - Bloomberg (Alexis Xydias): "The most-indebted U.S. companies are rallying more than any time in almost four years compared with the rest of the stock market amid the broadest rally since at least 1995. Federal Reserve interest rates near zero and the expanding economy are allowing Standard & Poor's 500 Index companies with the lowest working capital, smallest earnings and highest debt ratios to reduce borrowing costs and avoid default. The stocks surged 27% this year, almost double the gains for businesses with the most cash and least borrowing..."

May 23 - Bloomberg (Lu Wang, Nikolaj Gammeltoft and Cecile Vannucci): "A record drop in the cost of bearish bets on U.S. stocks and surging call-option trading shows speculators grew in confidence after the Standard & Poor's 500 Index climbed to a record. The Credit Suisse Fear Barometer, which measures the relative cost of S&P 500 bearish options over bullish ones three months from now, has plunged 35% in May, heading for the biggest monthly decline in data going back to 1994."

Global Credit Watch:

May 23 - Bloomberg (Victoria Stilwell): "Bonds of U.S. retailers from Target Corp. to Wal-Mart Stores Inc. are posting their worst losses since 2006 amid smaller consumer paychecks and slowing growth in the U.S. economy even as the broader corporate debt market generates gains... The retailers' securities have tumbled 1.6% this month through May 21, heading for their biggest monthly loss since the height of the credit crisis in October 2008."

May 19 - Wall Street Journal (Matt Wirz): "Default rates aren't likely to rise tomorrow, next month or even next year, but when they do, loan investors are going to have fewer protections, and potentially lower recoveries, than in default cycles past, according to... Moody's... The reason is that junk-rated companies are selling record levels of covenant-lite loans that lack the typical protections afforded to lenders. As covenant-lite loan sales become more widely accepted by investors, more lower-quality companies are taking advantage of the trend... 'This is a remarkable environment where there's enormous demand for yield,' says Christina Padgett, head of leveraged loan research at Moody's. 'There's not a whole lot of new issuers so leveraged loan borrowers in the market are able to get an excess amount of covenant flexibility compared to what they would get in any other market.' Covenant-lite loan issuance hit $80 billion in the first quarter, about the same as the full-year total for 2012, according to Thomson Reuters."

May 22 - Bloomberg (David Holley and Matt Robinson): "Moody's... is warning a covenant bubble is emerging as investor protections weaken on speculative-grade bonds and loans with unprecedented Federal Reserve stimulus sending buyers to riskier debt. A Moody's index of covenant quality on bonds rose to 3.94 in the last three months from 3.74 a year earlier... a reading of 5 is the weakest and 1 is the strongest. Debt with the weakest level of protections from borrowers rated B1 or lower accounted for 35% of offerings this year through April, compared with 29% in the corresponding period of 2012. Borrowers are taking advantage of investors searching for high yields with the Fed holding interest rates at about zero for a fifth year. Yields on a Bank of America Merrill Lynch index for junk bonds reached an all-time low of 5.98 percent this month from as high as 22.65% in December 2008. 'You're seeing lower yields and weaker covenants for lower-rated credits,' Christina Padgett, an analyst at Moody's... said... 'Robust issuance of covenant-light loans and high-yield bonds with weak investor protections suggest a covenant bubble that could leave fixed-income investors vulnerable in a credit cycle downturn.'"

May 23 - Bloomberg (Brian Chappatta): "Investor confidence in U.S. municipal debt is the highest in three years even as Moody's... warns that local-government credit quality is set to weaken for the 18th straight quarter. It cost the annual equivalent of as little as $133,000 this month to protect $10 million of local bonds for 10 years through credit-default swaps... That's the cheapest since April 2010. The municipal market isn't alone in benefiting from bets on economic growth. The cost of contracts linked to U.S. corporate debt is close to the lowest since 2007, and for Western European sovereign obligations it's the cheapest since 2010."

China Bubble Watch:

May 21 - Bloomberg (Kyle Stock): "Goldman Sachs is selling its remaining stake in Industrial and Commercial Bank of China—at a discount, no less. The news should worry anyone long on China's banking sector. After all, it's not often that Goldman is willing to offload anything for 2.5% less than recent market rates, which is what its $1.1 billion sale of ICBC shares amounts to. A number of indicators show that Chinese banks might be slightly rotten, or at least overripe. Last quarter was the sixth straight period in which non-performing loans climbed in the country... Meanwhile, Chinese lenders are sweetening deals in the face of competition. Among the nation's 3,800 lenders (of which ICBC is the largest), net interest margin fell to 2.57% in the first quarter, from 2.75% in the preceding period."

May 23 - Bloomberg: "China's manufacturing is contracting in May for the first time in seven months, adding to signs that economic growth is losing steam for a second quarter. The preliminary reading of 49.6 for a Purchasing Managers' Index... compares with a final 50.4 for April and the 50.4 median estimate in a Bloomberg News survey... 'The slowdown is really bad,' said Ken Peng, a BNP Paribas SA economist based in Beijing. 'It's a big probability now that China's GDP growth rate in the second quarter will be lower than in the first quarter,' he said..."

May 23 - Bloomberg: "New rules from China to control capital inflows are likely to end commodity-financing deals, hurting the short-term outlook for copper, analysts at Goldman Sachs Group Inc. wrote... The regulations from the State Administration of Foreign Exchange, effective from June, will probably mean an end to Chinese use of copper as a tool to enable interest rate arbitrage, Goldman said... The clampdown follows severe discrepancies in China's trade data in the first four months that aroused suspicions about companies using trade deals to evade capital controls and take advantage of interest-rate arbitrage between China and overseas."

May 22 - Bloomberg: "Some Chinese banks have stopped issuing letters of credit for copper importers after a government crackdown on hot-money inflows, the National Business Daily reported... Importers have sometimes used copper shipments primarily to gain letters of credit from banks, which they then used for other investments, the newspaper said, citing bankers it didn't identify. The China Banking Regulatory Commission's Shenzhen branch on April 24 urged banks to crack down on 'irregular trading activities' as some trading companies created paper transactions in which copper sometimes never left warehouses, to take advantage of interest-rate arbitrage between China and overseas... The practice has also been used to get letters of credit from banks outside China in foreign currencies such as U.S. dollars, and then to bring these funds into the country to invest in higher-yielding yuan-denominated assets... This has contributed to gains in the yuan, it said."

May 23 - Bloomberg: "China's foreign-exchange regulator told banks to improve checks of customer documents related to special trade zones amid speculation that the areas have been exploited to disguise capital inflows as exports. Banks shouldn't provide cross-border payment services to companies in the so-called bonded zones that aren't pre- registered with the foreign-exchange authority..."

May 23 - Bloomberg: "China will tighten rules on bond sales by polluters, local government financing vehicles with higher debt levels and companies in industries with overcapacity as the government seeks to redirect the economy. The National Development and Reform Commission, which approves bond sales by entities that local governments set up to finance projects, ordered greater scrutiny for bond sale applications from LGFVs with asset-liability ratios above 65% and credit ratings below AA+... China has been seeking to control borrowing by local governments while stabilizing growth, on concerns that a slowdown may trigger defaults and saddle banks with bad loans. Local governments may have more than 20 trillion yuan ($3.26 trillion) of debt, former Finance Minister Xiang Huaicheng said..., almost double the level disclosed in a 2011 report by the National Audit Office. Local authorities need to pay about 1 trillion yuan a year in interest on their 15 trillion yuan of outstanding debt, including bank loans and bonds, according to Lan Shen... economist at Standard Chartered Plc."

Japan Bubble Watch:

May 24 - Financial Times (Ben McLannahan) "Haruhiko Kuroda vowed on Friday to do more to steady Japan's bond market, as another rocky day's trading cast doubt over the effectiveness of the across-the-board effort to reflate the world's third-largest-economy. The Bank of Japan governor said that the central bank would continue to do its best to curb volatility in bond yields, which have fluctuated wildly since the bank shook up its monetary easing programme last month. 'Through dialogue with the market and more flexible operations, we will ensure the stability of financial and capital markets,' Mr Kuroda told a seminar... His comments came as the BoJ stepped into the market to buy bonds for a second consecutive day. On Thursday, as fears over rising bond yields sparked a 7.3% fall in the Nikkei stock index, the BoJ was forced to supply Y2tn ($20bn) of funds to nervous investors."

May 21 - Bloomberg (David Holley and Matt Robinson Masaki Kondo, Mariko Ishikawa and Hiroko Komiya): "Investors are starting to flee what used to be the slowest-moving major debt market after Bank of Japan Governor Haruhiko Kuroda's stimulus caused price swings to increase by the most in the world this year. Price volatility for Japanese government bonds has surged 2.6 percentage points this year to 3.66%, the biggest advance among 26 sovereign-debt markets tracked by Bloomberg... 'The BOJ's aim was to spur portfolio rebalancing by keeping bond yields low, but it now faces the chance of triggering that in an unintended way by increasing volatility,' said Shogo Fujita, the chief Japanese bond strategist in Tokyo at Bank of America Merrill Lynch... 'It's ironic --they may accomplish their goal, but not quite in the way they intended.'"

Asia Bubble Watch:

May 24 - Bloomberg (Chinmei Sung and Yu-Huay Sun): "Taiwan lowered the economic growth forecast for this year... Central banks from Australia to South Korea and Europe have cut interest rates in recent weeks amid signs global growth is faltering... Taiwan's monetary authority 'will likely hold steady despite sustained weakness as rates are already in accommodative territory,' Katrina Ell, an economist at Moody's Analytics in Sydney, said... 'The central bank is worried about inflating already-elevated property prices.'...The economy grew a revised 3.97% in the fourth quarter, the statistics bureau said... It cut its 2013 growth estimate to 2.4% from 3.59%..."

Latin America Watch:

May 22 - Bloomberg (Nacha Cattan): "Mexico's retail sales surprised analysts in March by contracting for a second consecutive month... Sales fell 2.4% from a year earlier..., compared with the median estimate for an increase of 0.3%... It was the first back-to-back decline in sales since the 2009 recession, following February's 2.6% drop... Gross domestic product grew at the slowest pace in more than three years in the first quarter...while industrial production tumbled 4.9% in March from a year earlier."

May 21 - Bloomberg (Jonathan Levin): "Mexico's attempt to solve the country's housing shortage by constructing millions of new homes far from city centers has crippled the nation's homebuilders and fueled record foreclosures. For Antonio Diaz, a former investment banker with Banco Santander SA, it's an opportunity. Diaz's company, backed by a venture-capital firm whose funders include JPMorgan Chase & Co. and the Soros Economic Development Fund, is buying foreclosed homes for as little as 60% of face value, refurbishing them and then selling them for up to 90% of a new home price."

Global Economy Watch:

May 20 - Bloomberg (Tracy Withers and Elisabeth Behrmann): "Rising home prices will increase the pressure on the Reserve Bank of New Zealand to raise interest rates, Finance Minister Bill English said. 'These households heading into quite high debt to buy highly priced houses need to be aware at some stage the RBNZ will increase interest rates, particularly if the housing market keeps growing at rapid rates,' English said... Low interest rates have helped fuel demand for property, raising prices at the fastest pace since 2007 and prompting the central bank to signal its concern about the risks if the housing bubble bursts."

May 24 - Bloomberg (David Fickling and Michael Heath): "Ford Motor Co. Falcons, driven by Mel Gibson in Australia's 1979 movie 'Mad Max,' have rolled off a Melbourne production line for 53 years. Now, like Max's 'last of the V-8s,' their days are numbered. Ford, in Australia since 1925, said yesterday it will close its local manufacturing plants in October 2016... The villain has been Australia's dollar: Up 77% versus the yen since October 2008, it has helped send Japanese car imports to a record and sales of domestically made vehicles down 18% in four years. Ford's local President... said that costs are double those in Europe and four times those of its Asian divisions..."

Germany Watch:

May 24 - Dow Jones (William Horobin) "European Central Bank Governing Council member Jens Weidmann said Thursday he wishes the Bank of Japan luck with their strong monetary easing, warning that in general terms central banks must avoid being caught in the trap of funding governments. 'I wish the Japanese good luck in their experiment, they certainly have a challenge of debt sustainability,' Mr. Weidmann, who also heads the Deutsche Bundesbank, said... Mr. Weidmann noted that Japan buys around 70% of government debt, so only a small share is privately bought. He warned against central banks getting caught in a situation of fiscal dominance, where they become subject to the constraints of fiscal policy. 'The problem is that the central bank can come into a situation where it cannot free itself from the embrace of fiscal policy,' he said."

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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