Dovish or Hawkish

By: Doug Noland | Fri, Dec 20, 2013
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Fed provides impetus for year-end equities mark-up, while things deteriorate in China.

Where to begin... The Bernanke Fed commenced the first step toward reining in the unprecedented expansion of our central bank's balance sheet. Equities loved it. The Dow Jones Industrial Average surged 293 points on the Fed announcement, while the S&P 500 gained 1.66% to trade to a new all-time high. A Wall Street Journal blog headline read: "Fed's 'Very Dovish Tapering' Spurs Rally."

It was a curious market response. U.S. equities surged on a "dovish" Fed, while the Treasury market seemed to view the Fed move in more "hawkish" light. Ten-year Treasury yields rose 3 bps this week to 2.89%, the high since September. More interestingly, a notable curve flattening saw five-year Treasury yields surge 15 bps to 1.68%. Even two-year yields rose 5 bps to 0.38%.

Emerging markets (EM) also reacted cautiously to the "dovish" news. A headline from Bloomberg: "Emerging Stocks Head for Longest Weekly Losing Streak Since June." Notably, Chinese stocks were hammered. The Shanghai Composite was hit for 5%, suffering a 9-day losing streak called the longest since 1994.

Key EM currencies were under heavy selling pressure. The Turkish lira was hit for 2.5% this week (see "Turkey Watch" below), the Brazilian real 2.4%, the Argentine peso 2.1% and the Mexican peso 0.7%. Asian currencies were also under notable pressure. The Thai baht declined 1.7%, the Malaysian ringgit 1.6%, the Taiwanese dollar 1.1%, the Indonesia rupiah 0.9%, the Singapore dollar 0.9%, the Japanese yen 0.9%, the South Korean won 0.8% and the Philippine peso 0.8%.

Turkish (lira) 10-year sovereign bond yields surged 57 bps this week to 9.92%, the high since the summer crisis period. Brazil's (real) 10-year yields jumped 41 bps to 13.20%. Reminiscent of May/June, market yields were generally on the rise around the globe.

Why would U.S. stocks respond so differently to the Fed's taper than Treasuries, EM and global market yields? The "Core vs. Periphery" analytical framework continues to be of value. A key speculative dynamic has been in play for much of 2013: In a world awash in QE liquidity, cracks in Treasury and EM Bubbles spur "core" Bubble excess in equities and corporate debt. An intensely speculative equities market can look to another 10 months and, presumably, another $500bn of QE and see sufficient liquidity to keep the game going. Treasury and EM markets, having already suffered in spite of the Fed's Trillion dollar liquidity injections, see liquidity waning with the beginning of the end to the Fed's historic balance sheet expansion.

The FOMC statement and Bernanke's press conference were both generally viewed as "dovish." The Fed provided "candy" with its extended forward guidance. There was significant focus on below-target inflation, which has become music to the speculators' ears ("QE forever!"). Amazingly, the Fed has essentially promised the markets short-rates will be held near zero for the minimum of a couple more years. The Fed believes (hopes) such guidance will anchor long-term yields as it winds down its aggressive balance sheet expansion (QE). Hard to believe it'll be that easy.

December 18 - MarketNews International (Steven Beckner): "In his presumably final press conference as Federal Reserve Chairman Ben Bernanke extolled the ongoing benefits of large-scale asset purchases, but he also recognized their limits. Yes, he said in response to a question from MNI, bond buying has its benefits and will continue to support the economy even as it is scaled back, but it also has its costs and its risks. That is a significant recognition on the part of the soon-to-retire chairman... [Beckner questioning Bernanke] 'To what extent has that calculation already changed? To what extent did that effect today's decision? And going forward, looking on the cost side,... to what extent will...threats to financial stability come in to play as well as the potential for losses on the Fed's own portfolio?' Bernanke began his reply by repeating that the FOMC thinks of asset purchases as 'a secondary tool behind interest rate policy. And we do think that the cost benefit ratio particularly as the assets on the balance sheet get large that it moves in a way that's less favorable.' Among the costs are 'managing the exit from that' large balance sheet, he said."

My own view is that QE3 has gone altogether differently than how top Fed officials anticipated. In particular, Treasury yields have moved higher, while a speculative melt-up in equities has spurred renewed Bubble concerns. Some of Bernanke's comments suggested growing caution: "We look at the possibility that asset purchases have led to bubbly pricing in certain markets or in excessive leverage or excessive risk taking." There was as well a notable degree of humility: "I think, for example, that an important difference between asset purchases and interest rate policy is that asset purchases work by affecting what is called a term premium which is essentially the additional part of the interest rate which investors require as compensation for holding longer term securities. We don't understand very well what moves the term premium..."

More than affecting the term structure of interest rates, QE3 has fueled major equities market inflation while stoking destabilizing speculation. One could argue that QE eased what would have been a quite problematic (bursting Bubble) reversal of flows out of fixed income funds, instruments and related products. On the cost side, Fed liquidity largely financed 2013's "great rotation" from bonds to bubbling stocks (as well as corporate debt). Essentially, systemic Bubble risk was compounded.

For 2014, it's reasonable for the apprehensive bond market to fear continuing outflows in a backdrop of waning QE. Meanwhile, the ebullient stock market can rejoice in its status as the best (only?) game in town in a world where the global pool of speculative finance - commanded by trend-following and performance-chasing dynamics - is measured in the multi-Trillions (and counting).

From Bernanke comments and the FOMC statement I discerned subtle confirmation of what I believe is a desire within the Fed system to end its experiment in massive asset purchases. Of course, they seek to gingerly manage this key inflection point in monetary policy/history. But, in true Bubble Dynamic form, "gingerly" is tantamount to a green light for market Bubble speculation. You're either willing to remove the punchbowl or you're not. Telling the intoxicated you're going to modestly reduce the alcohol content of their drinks and then shut the bar down completely in a few hours is not likely to elicit the desired behavior (unless you're fine with drunkenness).

Meanwhile, stocks continue with their speculative moonshot, in the process further widening the major divergence that has developed between inflated asset prices and uncertain global economic prospects. Perhaps the Fed remains in denial. But the benefits of QE have become minimal at best, while the rapidly escalating costs include a powerful stock market Bubble. Conventional "Bubble" analysis focuses on valuation. I focus instead on market dynamics and the propensity for Bubble markets to become more unwieldy over time, especially when accommodated by loose monetary policy. Our misguided central bank has, once again, nurtured a major problem.

Interestingly, chairman Bernanke was very specific that the QE wind-down would be dependent upon economic performance. I didn't hear reference to the Fed being willing to "push back" against a "tightening of financial conditions." There is a subtle but perhaps very important distinction to be made.

When the markets responded negatively to the Fed's initial move (back in May) to prepare the marketplace for tapering, Bernanke and other Fed officials immediately backtracked. The markets took this as a yet another signal that the Fed would use ongoing and open-ended QE as necessary to backstop the markets. This market perception was bolstered by the inclusion of a "tightening of financial conditions" reference in the FOMC's September meeting statement. I read this as code for "markets we have your back." These code words have gone missing.

Truth be told, promising a liquidity backstop to highly-speculative markets is a dangerous, risky business. I believe the Fed has come to better appreciate this dynamic in late-2013 and has subtly begun to adjust the way in which it addresses this key issue. If I am correct, this is a major policy development. From my analytical perspective, the perception of a liquidity backstop can have a profound impact on risk-taking in the markets, especially by the hedge funds and others within the leveraged speculating community.

Let's return to the issue of "forward guidance." The Fed now wants to shift policy focus away from asset purchases and back to managing interest rates and market rate expectations. This sounds reasonable enough, and the big market operators are for now content to play along. But market prices are determined by the preponderance of liquidity inflows versus outflows. "Money" drives markets. Fed "money" has for a while now been the powerful force dominating both asset prices and market dynamics. So let there be no doubt, there will be profound market impacts if the Fed follows through with its plan to wind down its "money" printing operations. Moreover, there will be major market ramifications if the Fed is less freely willing to commit to backstopping the markets. These major market impacts encompass domestic as well as international markets.

Importantly, prospects for reduced global liquidity will continue to impact the "marginal" borrower, the marginal "markets" and the marginal "economies" (at the "periphery"). After about five years of "terminal phase" Bubble excess, EM financial and economic fragilities are today, and for the foreseeable future, a serious issue. There was confirmation of this thesis back in May and June. There is added confirmation of late. The reversal of flows away from EM will be an ongoing problematic issue. Moreover, this faltering Bubble dynamic is compounded by the magnetic-pull of Fed and BOJ-induced "developed" equities market Bubbles.

And as "money" ("hot" and otherwise) packs up to exit EM, "developing" central banks on the margin turn sellers of Treasuries, bunds and sovereign debt more generally. Global yields are pushed higher. One should not understate the market importance of a reversal of fortunes for EM central banks, after bolstering markets with Trillions of debt purchases over recent years. And with irrepressible EM central bank buying no longer supporting global bond prices, the status of the Fed's market backstop becomes absolutely critical. If the Federal Reserve is indeed moving to cap its balance sheet, the risk vs. reward calculus has been altered for leveraging in global fixed income. And if an inflating stock market Bubble pressures the Fed into action, this as well has major ramifications for leveraged speculation throughout global "bond" markets.

December 20 - Financial Times (Simon Rabinovitch): "An emergency cash injection by the Chinese central bank failed to calm the country's lenders as money market rates climbed to dangerously high levels. Analysts cited a variety of technical factors for the tightness in the Chinese financial system, but the sudden run-up in rates was an uncomfortable echo of a cash crunch that rattled global markets earlier this year. Investors were alarmed at the potential for a repeat of that squeeze. The Shanghai Composite, the country's main equities index, fell 2%. The nine-day decline for Chinese stocks is their worst losing streak in nearly two decades. Concerns focused on the rates at which Chinese banks lend to each other. The seven-day bond repurchase rate, a key gauge of short-term liquidity, was emblematic of their reluctance to part with cash. It averaged 7.6% in morning trading on Friday, its highest since the crunch that hit China in late June. That was up 100 bps from Thursday and far above the 4.3% level at which it traded just a week ago. The sharp increase occurred despite the central bank's highly unusual decision to conduct a 'short-term liquidity operation' on Thursday... The China Business News... reported that the short-term injection was worth Rmb200bn ($33bn), a large amount... Lu Ting, an economist with Bank of America Merrill Lynch, said China's financial system was entering a new era and policy makers were struggling to adapt. 'The PBoC is faced with some serious challenges and is confused,' he said. 'The PBoC finds it much more likely than before to make [operational] mistakes.'"

Global markets convulsed back in May/June as the Fed moved to prepare the world for less QE and Chinese officials finally decided to more forcefully clampdown on China's runaway Credit and asset Bubbles. Respective domestic fragilities coupled with global fragilities saw both the Fed and Chinese in quick "tightening" retreat. And in both cases Bubble excesses bounced right back stronger and more unwieldy than ever. Global markets must now again face the prospect of major uncertainties, as the Fed and Chinese make a second attempt at confronting Bubble issues. The bullish consensus view holds that the markets have moved beyond taper fears. In response, I'll say "follow the 'money'" and fear what is unfolding in China.

 


For the Week:

The S&P500 jumped 2.4% (up 27.5% y-t-d), and the Dow surged 3.0% (up 23.8%). The Utilities gained 1.7% (up 6.3%). The Banks rose 2.6% (up 33.3%), and the Broker/Dealers advanced 2.9% (up 67.3%). The Morgan Stanley Cyclicals were up 2.9% (up 37.7%), and the Transports rose 2.8% (up 37.2%). The S&P 400 Midcaps gained 2.3% (up 29.2%), and the small cap Russell 2000 jumped 3.6% (up 34.5%). The Nasdaq100 rose 2.2% (up 32.7%), and the Morgan Stanley High Tech index surged 3.55% (up 29.4%). The Semiconductors jumped 3.3% (up 35.9%). The Biotechs advanced 3.0% (up 47.9%). With bullion sinking $36, the HUI gold index was down 2.8% (down 57.2%).

One-month Treasury bill rates ended the week at zero, and three-month rates closed at 6 bps. Two-year government yields were up 5 bps to 0.38%. Five-year T-note yields ended the week 15 bps higher to 1.68%. Ten-year yields increased 3 bps to 2.89%. Long bond yields declined 5 bps to 3.82%. Benchmark Fannie MBS yields were unchanged at 3.52%. The spread between benchmark MBS and 10-year Treasury yields narrowed 3 bps to 63 bps. The implied yield on December 2014 eurodollar futures rose 2.5 bps to 0.41%. The two-year dollar swap spread declined 2 to 8 bps, while the 10-year swap spread was little changed at 6 bps. Corporate bond spreads collapsed to the lowest levels since 2007. An index of investment grade bond risk was down 5 to 65 bps (low since October '07). An index of junk bond risk sank 23 bps to 319 bps (low since June '07). An index of emerging market (EM) debt risk fell 8 bps to 314 bps.

Debt issuance slowed for the holidays. Investment grade issuers included Kroger $2.0bn.

Junk bond funds saw outflows jump to $876 million (from Lipper). Junk issuers included First Data $725 million, MGM Resorts International $500 million, Darling $500 million, Micron Semiconductor $462 million, Halcon Resources $400 million, Michael Stores $260 million and Sierra Hamilton LLC $110 million.

This week's convertible debt issuers included TTM Technologies $220 million and Spectrum Pharmaceuticals $100 million.

International dollar debt issuers included Ukraine $3.0bn, Royal Bank of Scotland $2.0bn, Banco Santander $1.3bn, YPF Sociedad Anonima $500 million and Venterra RE $250 million.

Ten-year Portuguese yields slipped 2 bps to 5.96% (down 79bps y-t-d). Italian 10-yr yields rose 3 bps to 4.12% (down 38bps). Spain's 10-year yields gained 4 bps to 4.13% (down 114bps). German bund yields added 4 bps to 1.87% (up 55bps). French yields gained 4 bps to 2.47% (up 46bps). The French to German 10-year bond spread was little changed at 60 bps. Greek 10-year note yields were down another 23 bps to 8.35% (down 212bps). U.K. 10-year gilt yields were up 5 bps to 2.94% (up 112bps).

Japan's Nikkei equities index surged 3.0% to a 2013 high (up 52.7% y-t-d). Japanese 10-year "JGB" yields declined 2 bps to 0.6% (down 11bps). The German DAX equities index surged 4.4% (up 23.5%). Spain's IBEX 35 equities index jumped 4.5% (up 18.6%). Italy's FTSE MIB index rose 4.3% (up 14.1%). Emerging markets were notably mixed. Brazil's Bovespa index gained 2.3% (down 16%), and Mexico's Bolsa increased 0.7% (down 3.5%). South Korea's Kospi index gained 1.0% (down 0.7%). India's Sensex equities index advanced 1.8% (up 8.8%). China's Shanghai Exchange sank 5.1% (down 8.1%).

Freddie Mac 30-year fixed mortgage rates gained 5 bps to a three-month high 4.47% (up 110bps y-o-y). Fifteen-year fixed rates jumped 7 bps to 3.51% (up 86bps). One-year ARM rates rose 6 bps to 2.57% (up 5bps ). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates unchanged at 4.57% (up 60bps).

Federal Reserve Credit jumped $53.0bn to a record $3.958 TN. Over the past year, Fed Credit was up $1.059 TN, or 36.5%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $692bn y-o-y, or 6.4%, to $11.538 TN. Over two years, reserves were $1.255 TN higher for 12% growth.

M2 (narrow) "money" supply expanded $17.5bn to a record $10.972 TN. "Narrow money" expanded 6.0% ($626bn) over the past year. For the week, Currency decreased $1.2bn. Total Checkable Deposits grew $5.0bn, and Savings Deposits jumped $15.8bn. Small Time Deposits were unchanged. Retail Money Funds declined $2.2bn.

Money market fund assets dropped $34.4bn to $2.675 TN. Money Fund assets were up $39bn from a year ago, or 1.5%.

Total Commercial Paper increased $3.9bn to $1.085 TN. CP was up $27bn over the past year, or 2.6%.

Currency Watch:

The U.S. dollar index was up 0.5% to 80.575 (up 1.0% y-t-d). For the week on the upside, the Norwegian krone increased 0.3% and the British pound gained 0.2%. For the week on the downside, the Brazilian real declined 2.4%, the Taiwanese dollar 1.1%, the Singapore dollar 0.9%, the Japanese yen 0.9%, the South Korean won 0.8%, the New Zealand dollar 0.8%, the Swiss franc 0.8%, the Mexican peso 0.7%, the South African rand 0.6%, the Danish krone 0.5%, the euro 0.5%, the Canadian dollar 0.5%, the Australian dollar 0.5% and the Swedish krona 0.2%.

Commodities Watch:

The CRB index rallied 1.2% this week (down 4.0% y-t-d). The Goldman Sachs Commodities Index jumped 2.2% (down 1.5%). Spot Gold dropped 2.9% to $1,203 (down 28%). March Silver slipped 0.8% to $19.45 (down 36%). January Crude jumped $2.39 to $99.32 (up 8%). January Gasoline surged 5.8% (up 1%), and January Natural Gas gained 1.5% (up 32%). March Copper was little changed (down 9%). March Wheat dropped 2.4% (down 21%), while March Corn recovered 1.8% (down 38%).

U.S. Fixed Income Bubble Watch:

December 15 - Dow Jones (Mike Cherney): "Bond investors are showing the most confidence in corporate America since the financial crisis, underscoring expectations that the U.S. economy will keep rolling as the Federal Reserve prepares to trim monetary stimulus. Purchasers of corporate debt are demanding the smallest interest-rate premium to comparable government bonds since 2007. Demand has also put sales of new junk-rated corporate bonds in the U.S. on pace to surpass last year's record. Sales of investment-grade bonds in the U.S. this year are already at the highest ever, according to... Dealogic... High-grade corporate debt now yields 1.21 percentage points more than comparable U.S. Treasurys, while the gap, or spread, between junk-rated debt and Treasurys is 3.96 percentage points... Last year at this time, high-grade debt was yielding 1.45 percentage points more than Treasurys and junk debt was yielding 5.09 percentage points more."

December 18 - Bloomberg (Jesse Hamilton): "The Federal Reserve has decided to delay imposing limits on leverage at eight of the biggest U.S. financial institutions until a global agreement is completed, according to two people briefed on the discussions. Fed officials want to wait for a finished rule from the Basel Committee on Banking Supervision before completing their own requirement for how much capital U.S. banks must hold as a percentage of all assets on their books... The Fed's wait-and-see position is aligned with groups representing the banking industry, who have argued for a delay on grounds that the regulations should be consistent."

December 17 - Bloomberg (William Selway and Brian Chappatta): "Wall Street banks are trying to prevent the Volcker Rule from forcing them to wind down funds that use borrowed money to bet on the $3.7 trillion municipal-bond market. The rule..., approved by regulators last week, limits banks' ability to run investments known as tender-option bond funds. The investments form a $70 billion segment of the local-debt market, according to the Securities Industry and Financial Markets Association. The funds issue short-term securities and use the proceeds to buy longer-maturity local-government obligations, profiting from the difference in interest rates."

December 16 - Bloomberg (Brian Chappatta): "The largest wave of withdrawals from municipal-bond mutual funds since August is extending the $3.7 trillion market's worst losses in five years. As speculation mounts that the Federal Reserve is preparing to reduce its bond purchases, individuals yanked $1.9 billion from muni funds last week, Lipper US Fund Flows data show. Outflows have tallied a record $57.5 billion this year, driving munis to their first annual loss since 2008..."

December 17 - Bloomberg (Daniel Kruger): "China, the largest foreign creditor to the U.S., increased its ownership of Treasuries in October to almost the record level reached in July 2011... Holdings rose $10.7 billion... to $1.304 trillion... Total foreign holdings of Treasuries rose $600 million, or 0.01%, in October to $5.65 trillion."

December 17 - Bloomberg (Kristen Haunss): "The number of U.S. companies with the lowest credit ratings has jumped to the highest level in six months after speculative-grade borrowers obtained a record amount of bonds and loans in 2013. Some 156 borrowers are rated B3 with a 'negative' outlook, up from 148 three months ago and the most since reaching a high for the year of 160 in June, according to Moody's..."

December 17 - Financial Times (Stephen Foley): "The flow of money into a new class of bond fund that gives managers unprecedented discretion over its trading strategy has surged this year, amid retail investors' concern over the prospect of rising interest rates. New figures from Morningstar... show that the assets in so-called 'non-traditional' bond funds have jumped 76% in the US, as investors put in more money in 2013 than in the previous three years combined. While regulators have warned investors to be sure they know what they are buying and to pay close attention to changing fund strategies, fund management firms are marketing the products heavily as a safe haven should the Federal Reserve start to taper quantitative easing... Morningstar calculates that $51.5bn has flowed into US non-traditional bond funds since the start of January, pushing assets in this class of fund to $119.4bn. These funds make substantial use of credit default swaps and other derivatives to take both positive and negative bets on fixed income instruments."

Federal Reserve Watch:

December 20 - Bloomberg (Jeff Kearns and Catarina Saraiva): "The Federal Reserve will probably reduce its bond purchases in $10 billion increments over the next seven meetings before ending the program in December 2014, economists said. The median forecast in a Bloomberg survey of 41 economists matches the $10 billion reduction announced two days ago as the Fed began to unwind the unprecedented stimulus that has defined Ben S. Bernanke's chairmanship. The Federal Open Market Committee said in a statement it will slow buying 'in further measured steps at future meetings' if the economy improves as forecast. The Fed may taper its buying by about $10 billion per gathering, Bernanke said... 'We're going to take further modest steps subsequently, so that would be the general range... We could stop purchases if the economy disappoints, we could pick them up somewhat if the economy is stronger."

December 17 - Bloomberg (Jeff Kearns): "The Federal Reserve's balance sheet is poised to exceed $4 trillion, prompting warnings its record easing is inflating asset-price bubbles and drawing renewed lawmaker scrutiny just as Janet Yellen prepares to take charge. The Fed's assets rose to a record $3.99 trillion on Dec. 11, up from $2.82 trillion in September 2012, when it embarked on a third round of bond buying... Among Fed officials, 'there's discomfort in the sense that the portfolio could grow almost without limit,' former Fed Vice Chairman Donald Kohn said last week during a panel discussion in Washington. Kohn said there was 'discomfort in the potential financial stability effects' and added: 'There's some legitimacy in those discomforts.'"

U.S. Bubble Economy Watch:

December 19 - Bloomberg (Prashant Gopal): "U.S. homes gained $1.9 trillion in total value this year, the biggest jump since 2005... Zillow Inc. said. At the end of 2013, the housing stock will be worth about $25.7 trillion, Zillow said... U.S. homes as a whole lost $6.3 trillion in value from 2007 through 2011 and have recovered 44% of that... Home prices are rising across the U.S. as investors drain markets of inventory and improving employment brings in more buyers. Almost 90% of the 485 metropolitan areas analyzed by Zillow had price gains this year. The total value of the nation's housing stock jumped about 7.9% from 2012, the second straight annual increase..."

December 16 - Bloomberg (Whitney Kisling and Callie Bost): "Companies buying their own stock make up more of the U.S. equity market than ever before, underpinning share values even as the Federal Reserve prepares to reduce stimulus. Stock acquired under company repurchase programs represented 6.4% of daily trading in the Russell 3000 Index by value through Sept. 30, exceeding 2007's level of 4.1%...The proportion of trading is higher even as chief executive officers spend $343 billion less on buybacks so far this year, reflecting a seven-year decline in equity volume."

December 19 - Bloomberg (Darrell Preston and Aaron Kuriloff): "When voters approved a sales-tax increase to pay $540 million toward stadiums for Cincinnati's professional baseball and football teams almost two decades ago, city leaders promised lower property levies and a business district along the Ohio River. The tax relief hasn't materialized as pledged... Instead, the county government is grappling with annual stadium expenses totaling at least $43 million this year, including debt service... Residents have seen a public hospital sold, mass-transit investments postponed and little private development near the stadiums that didn't involve additional public subsidies..."

December 16 - Bloomberg (Clea Benson): "The U.S. regulator of Fannie Mae and Freddie Mac is seeking comment on a proposal for cutting the maximum size of loans the mortgage-finance firms can buy as part of an effort to shrink their footprint in the market. Loan limits would shrink to $400,000 from $417,000 in most areas under the Federal Housing Finance Agency plan released for public input... The maximum would drop to $600,000 from $625,000 in high-cost areas such as New York City and Washington, D.C., under the FHFA plan. Reducing the limits 'would modestly reduce Fannie Mae's and Freddie Mac's business at the high end of the market, invite private capital to re-enter the market and limit taxpayer exposure to losses,' the agency said..."

Global Bubble Watch:

December 17 - Financial Times (Andrew Bolger): "Global corporate bond issuance cruised past $3tn last month and this year is set to exceed the level reached by the end of 2012, according to Standard & Poor's... 'We are mindful that corporate leverage is growing, although it is still manageable, and this could give investors pause... 'With relatively few alternatives to improve yield, investors were eager to lend even to entities with lower credit quality,' said Diane Vazza, head of S&P's global fixed income research. By the end of 2013, the agency predicted global corporate speculative-grade bond issuance was likely to exceed $500bn for the first time, and comprise more than 15% of the total year's issuance. To put this in perspective, speculative-grade bond issuance was $208bn in 2006 and $213bn in 2007, before the global recession, and fell to just $56bn in 2008."

December 20 - Financial Times (Andrew Bolger): "Investors' hunger for yield in a low interest rate environment has led to the best year for global high-yield corporate debt on record, according to Thomson Reuters. It has reached $473bn this year, already up 18% over last year's total. For the fourth quarter of 2013, global corporate debt totalled $111bn, a 1% decrease from the third quarter."

December 20 Reuters (Kylie MacLellan, Olivia Oran and Elzio Barreto): "This year has been the biggest for equity fundraising globally since 2010, thanks to improving confidence among companies on the back of the strong investor demand for stocks, according to Thomson Reuters data... A total of $774 billion has been raised worldwide from equity capital market offerings as of December 18, including flotations, issues of bonds which are convertible into stock, and secondary share offers by already-listed companies, a rise of 24% on 2012. Companies globally raised $159.7 billion from initial public offerings (IPOs), a 37% increase on 2012 and bankers expect 2014 to carry on where 2013 left off..."

December 16 - Bloomberg (Katie Linsell): "Spanish corporate bonds are set to hand investors the biggest returns this year among investment- grade company debt sold in Europe. Gas Natural SDG SA, Spain's largest gas supplier, and Telefonica SA, the nation's biggest phone company, led gains with returns of 18.6% and 18.3%..."

December 17 - Bloomberg (William Selway and Brian Chappatta): "Chinese central bank officials told third-party payment service providers to stop offering clearing services to online Bitcoin exchanges, according to China Business News... Companies currently offering services must end services by the Chinese New Year, a weeklong holiday that begins on Jan. 31..."

EM Bubble Watch:

December 19 - Bloomberg (David Biller and Raymond Colitt): "Brazil's central bank will prolong its currency intervention program through at least the first half of next year after the real weakened yesterday on news of reduced monetary stimulus in the U.S. The central bank will extend through the end of June and possibly longer a program of foreign exchange currency swaps that originally was set to end Dec. 31... Starting Jan. 2, the bank will auction $200 million a day in swaps and offer additional transactions to sell dollars if needed, it said. The announcement came just hours after the U.S. Federal Reserve said it would trim monthly bond purchases that have supported demand for emerging-market assets such as the real."

December 18 - Financial Times: "The summer of market discontent in the wake of expectations that the US Federal Reserve would start to scale back its massive monetary stimulus, only made too clear the need for the governments of emerging economies to start getting serious about domestic reforms. As expectations rise again that the Fed could 'taper' as soon as this month, the 'fragile five', economies identified by Morgan Stanley as particularly vulnerable due in part to large current account deficits, are once more in focus. The central banks of Brazil, India, Indonesia, South Africa and Turkey have been busy hiking rates to counter plunging currencies. But governments have yet to tackle the difficult domestic reforms, including tax and labour, to free up their economies and attract the long-term investment they need - not least as all five face elections in 2014."

December 18 - Bloomberg (Blake Schmidt):"President Dilma Rousseff's plan to ramp up spending before elections in October is pushing Brazil closer to its first debt-rating downgrade in a decade, according to HSBC Holdings Plc and Banco Bilbao Vizcaya Argentaria SA. Brazil's dollar-denominated bonds have lost 11.4% this year, almost twice the average drop for emerging markets... HSBC says the chance of a pre-election downgrade is 'very high,' as Rousseff cuts taxes to boost Brazil's economy and maintains fuel subsidies to damp inflation that has exceeded the central bank's target for more than three years. A bill that cleared Senate committees this month makes it easier for states bailed out by the government in 1997 to borrow, showing Rousseff won't do what it takes to avoid a downgrade, according to BBVA."

December 20 - Bloomberg (Boris Korby): "Junk-bond investors are abandoning Brazil as the nation's biggest corporate default, the threat of a sovereign downgrade and plunging sugar prices leave holders with the deepest losses since the credit crisis. Speculative-grade notes from Brazil have lost an average 6.4% this year, versus gains of 5.7% for the securities globally... The slump is the biggest since 2008 and the third worst in the world, trailing only Chile and Mongolia. The rout in Brazil's $36 billion junk-bond market... deepened as creditors of former billionaire Eike Batista's OGX Petroleo & Gas Participacoes SA and Lupatech SA lost almost 90% this year as the companies sought bankruptcy protection."

December 19 - Bloomberg (Jonathan Browning and Lulu Yilun Chen): "Chinese Internet giants Alibaba Group Holding Ltd., Baidu Inc. and Tencent Holdings Ltd. have spent a record $7.4 billion on acquisitions this year. Now their smaller listed peers are raising capital faster than ever to join the technology deal rush. The financing weapons of choice for the nation's mid-sized Internet companies are convertible bonds. Companies from travel agent Ctrip.com International Ltd. to web portal Sina Corp. sold $3 billion of the securities this year, more than in all previous years combined, data compiled by Bloomberg show."

Turkey Watch:

December 20 - Bloomberg (Taylan Bilgic): "Turkey's lira tumbled to a record against the dollar and euro while bonds fell as Prime Minister Recep Tayyip Erdogan's government purged police leadership in a fight back against a probe into official corruption. The lira dropped as much as 1.2% to 2.0982 per dollar, the weakest since at least 1981... Yields on two-year benchmark notes increased 25 bps to 9.61%, the highest since Sept. 3. 'Political risk has increased considerably,' Melih Onder, chairman of Logos Portfoy Yonetimi AS... said... 'It took a few days for foreign investors to digest what has happened. This selloff could continue for as long as 10 days.'"

December 19 - Bloomberg (Selcan Hacaoglu and Onur Ant): "Turkish Prime Minister Recep Tayyip Erdogan turned the tables on a corruption investigation targeting his party, vowing to reveal a 'state within a state' and purging about 50 police chiefs. Istanbul chief Huseyin Capkin was among those dismissed today, ending his term after 4 1/2 years... Deputy Prime Minister Bekir Bozdag told a meeting of parliament's justice committee that he was filing a criminal complaint against prosecutors for 'violating the secrecy of the probe,' referring to publication of details of an investigation that's ensnared the chief executive of a state bank, four cabinet ministers and at least one billionaire. 'This isn't a struggle against corruption, it's another version of political engineering,' Erdogan said... 'There are those who are trying to create a state within a state. We will definitely bring this organization into the open.'"

December 19 - Dow Jones (Ayla Albayrak and Joe Parkinson): "The corruption probe that is rocking Turkish politics has snared a string of high-profile allies of Prime Minister Recep Tayyip Erdogan, including ministers' relatives and bank executives. But the most recognizable face so far caught in the dragnet is construction tycoon and self-styled 'king of real estate' Ali Agaoglu. The flamboyant founding chairman of Agaoglu Group, one of Turkey's largest construction companies, was one of more than 50 people detained in a series of dawn raids in Istanbul... on allegations of graft, corruption and money laundering, according to the chief prosecutor's office."

China Bubble Watch:

December 20 - Financial Times (Simon Rabinovitch): "An emergency cash injection by the Chinese central bank failed to calm the country's lenders as money market rates climbed to dangerously high levels. Analysts cited a variety of technical factors for the tightness in the Chinese financial system, but the sudden run-up in rates was an uncomfortable echo of a cash crunch that rattled global markets earlier this year. Investors were alarmed at the potential for a repeat of that squeeze. The Shanghai Composite, the country's main equities index, fell 2%. The nine-day decline for Chinese stocks is their worst losing streak in nearly two decades. Concerns focused on the rates at which Chinese banks lend to each other. The seven-day bond repurchase rate, a key gauge of short-term liquidity, was emblematic of their reluctance to part with cash. It averaged 7.6% in morning trading on Friday, its highest since the crunch that hit China in late June. That was up 100 bps from Thursday and far above the 4.3% level at which it traded just a week ago. The sharp increase occurred despite the central bank's highly unusual decision to conduct a 'short-term liquidity operation' on Thursday... The China Business News... reported that the short-term injection was worth Rmb200bn ($33bn), a large amount... Lu Ting, an economist with Bank of America Merrill Lynch, said China's financial system was entering a new era and policy makers were struggling to adapt. 'The PBoC is faced with some serious challenges and is confused,' he said. 'The PBoC finds it much more likely than before to make [operational] mistakes.'"

December 19 - Financial Times (Simon Rabinovitch): "The Chinese central bank has made an emergency money injection after a surge in interbank rates, trying to prevent a repeat of the cash crunch that rattled global markets earlier this year. In a highly unusual move, the People's Bank of China said it had conducted a 'short-term liquidity operation' to provide credit to banks in need of money. According to the central bank's own rules, it is only meant to announce SLOs one month after their implementation, but on this occasion it was unwilling to brook such a delay. On Thursday afternoon, it used its account on Weibo, China's Twitter-like platform, to tell a jittery market that it had provided banks with the emergency cash. Earlier in the day Chinese money market rates had soared to levels last seen in late June when the country was hit by a liquidity squeeze that alarmed investors around the world about the potential for a financial crisis in China. The seven-day bond repurchase rate, an important gauge of short-term liquidity, spiked to nearly 10% as banks hoarded cash."

December 18 - Bloomberg: "New home prices in the four Chinese cities defined as first-tier by the government rose, with Shenzhen posting the biggest gain in almost three years, as property measures by local governments failed to deter buyers. Shenzhen and Guangzhou posted increases of 21% from a year earlier, while prices climbed 18% in Shanghai and 16% in Beijing... Prices rose from a year earlier in 69 of 70 cities tracked by the government last month, it showed. China has held off from introducing more nationwide policies to rein in the property market, opting for measures implemented by local authorities instead that have included higher down-payment requirements for second-home purchases in three of the first-tier cities... 'Home prices in major cities have already become unaffordable; the impact of the local-level property measures is not very strong, we've seen similar policies before,' Yao Wei, China economist at Societe Generale... 'The central government is treating cities differently, but they will still take nationwide actions if home prices are rising too quickly.'"

December 18 - Bloomberg: "President Xi Jinping's efforts to rein in local debt face an unprecedented challenge next year as $49 billion in borrowing must be repaid to avoid defaults that could strain the financial system. Local-government financing vehicles, which cities and towns use to raise funds, must repay 299.5 billion yuan ($49bn) of bonds in 2014, according to Everbright Securities Co., the most since it started compiling the data in 2000 and up 56% from this year. The yield on five-year notes rated AA, the most common grade for the securities, has climbed 139 bps this year to a record 7.41%."

December 16 - Bloomberg (William Selway and Brian Chappatta): "A Chinese manufacturing index unexpectedly fell to a three-month low as output gains eased and employment weakened, suggesting the world's second-largest economy is vulnerable to a slowdown. The preliminary reading of 50.5 for a Purchasing Managers' Index released today by HSBC Holdings Plc and Markit Economics compares with a final figure of 50.8 in November and the 50.9 median estimate..."

December 17 - Bloomberg: "When completed in 2015, the Shanghai Tower will be China's tallest building. The 632-meter (2,074-feet) skyscraper will also deepen a glut of offices in the city, putting pressure on rents. The project, in the Lujiazui financial district, will add 220,000 square meters (2.4 million square feet) of office space, or more than 10% of the new supply forecast for the city in 2015... About 2 million square meters of grade-A offices will be added between 2014 and 2015, more than double the supply in the previous two years, according to broker Savills Plc."

December 17 - Bloomberg: "Ma Huateng, chairman of Asia's largest Internet company Tencent Holdings Ltd., overtook property tycoon Wang Jianlin to become China's second-richest man, according to the Bloomberg Billionaires Index. Ma has a net worth of $12.1 billion, surpassing Wang by $100 million... Tencent shares have soared 90% this year in Hong Kong trading, compared with a 2.5% increase in the benchmark Hang Seng Index. Ma, 42, is benefiting from Tencent's development of mobile Internet games and services, especially WeChat, an instant messaging and social networking app known as Weixin in China."

Japan Bubble Watch:

December 20 - Bloomberg (Toru Fujioka and Masahiro Hidaka): "The Bank of Japan maintained its record easing, after a U.S. Federal Reserve decision to taper policy helped weaken the yen to a five-year low against the dollar. Governor Haruhiko Kuroda's board kept its pledge to expand the monetary base by an annual 60 trillion to 70 trillion yen ($670bn) today after a two-day meeting... Kuroda's push for 2% inflation underscores the difference in policy direction between the BOJ and the Fed, which could end its bond-purchase program next year."

December 18 - Bloomberg (Toru Fujioka and Masahiro Hidaka): "Bank of Japan officials see significant scope to boost government bond purchases if needed to achieve their inflation target, according to people familiar with the discussions, signaling little concern with perceptions of underwriting fiscal deficits. While no decision will be made until the central bank has more time to assess price trends, the current pace of asset purchases -- equivalent to 70% of new government-debt issuance -- isn't a limit for many officials, according to the people, who asked not to be named...The BOJ in September reported that it held 15.4% of the 969 trillion yen ($9.4 trillion) of government bonds outstanding."

December 20 - Bloomberg (Masaki Kondo and Shigeki Nozawa): "The Bank of Japan is poised to top domestic insurers as the biggest holder of the nation's bonds, rekindling debate over whether the central banks should be financing government deficits. The BOJ held 184.2 trillion yen ($1.76 trillion) of Japan's government bonds as of Dec. 10. Local life and casualty insurance companies owned 193 trillion yen at the end of September, making up 20% of the total... The Federal Reserve, which this week decided to slow bond purchases, accounted for 17% of the total U.S. debt ownership as of Sept. 30. BOJ Governor Haruhiko Kuroda said a week after doubling monthly bond purchases on April 4 that yields would jump should the central bank be seen as monetizing debt."

December 20 - Bloomberg (Toru Fujioka): "Japanese companies' cash holdings rose to a record last quarter, highlighting Prime Minister Shinzo Abe's struggle to spur the investment and wage increases needed to end a 15-year deflationary malaise. Corporate holdings of cash and deposits rose to 224 trillion yen ($2.15 trillion), up 5.9% from a year earlier..."

December 16 - Bloomberg (Toru Fujioka and Chikako Mogi): "Large Japanese businesses pared their projections for capital spending this fiscal year, signaling challenges for Abenomics as a sales-tax increase looms in April. Big companies plan to boost spending by 4.6% in the year ending March 2014... That compared with a 5.1% projection three months earlier... Prime Minister Shinzo Abe is trying to convince businesses to raise wages and investment as part of efforts to catapult the nation out of a 15-year deflationary malaise. While the yen's slide to a five year-low against the dollar last week highlighted the boost to exporters from Abenomics, companies aren't convinced the nation's recovery will be sustained."

India Watch:

December 16 - Bloomberg (Kartik Goyal): "India's wholesale inflation was faster than economists estimated in November, reaching a 14-month high and adding pressure for a further increase in the benchmark interest rate this week to quell price pressures. The wholesale-price index rose 7.52% from a year earlier, compared with 7% in October..."

December 20 - Bloomberg (Shikhar Balwani): "Reserve Bank of India Governor Raghuram Rajan's decision this week to skip an interest-rate increase predicted by most economists is helping cap the biggest decline in government bonds since 2009. The 10-year yield dropped 15 bps from a three-week high to 8.76% after the RBI held its repurchase rate at 7.75% at a Dec. 18 review... The Indian yield is still up 71 bps since the end of 2012..."

December 17 - Bloomberg (Anurag Joshi): "Overseas bond sales in India are set for a record in 2013, after the biggest quarterly drop in dollar borrowing costs in a year encouraged issuers to rush offerings before the Federal Reserve starts paring stimulus. Indian companies have sold $14.4 billion of international notes since Dec. 31, 47% more than all of 2012 and the most since Bloomberg began compiling the data in 1999."

Europe Watch:

December 18 - Financial Times (Christopher Thompson): "Europe's banks are preparing for the possibility their creditors could face losses in the event of bank failure by issuing bumper amounts of subordinated bonds designed to absorb losses. Banks have taken advantage of yield-chasing investors to issue $90.7bn of subordinated debt for the year to date, a 41% increase compared to the same period in 2012. It is the highest such volume since the $122.4bn seen in 2008 according to Dealogic..."

December 20 - Reuters: "Spanish police searched the headquarters of the ruling People's Party (PP) for 14 hours as part of a corruption investigation that earlier this year threatened to destabilize the government of Prime Minister Mariano Rajoy. Police entered late on Thursday on the order of examining Magistrate Pablo Ruz, searching for documents and invoices that might provide evidence of off-the-book payments linked to renovation work on the building carried out from 2005 to 2011, a PP spokesman said. They left the central Madrid building on Friday morning."

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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