Credit Allocation

By: Doug Noland | Fri, Jun 6, 2014
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Signs of an upside dislocation...

Total (financial and non-financial) Credit jumped $484bn during Q1 to a record $59.399 TN, or 347% of GDP. Although economic growth faltered during the quarter, Q1 2014 Total Non-Financial Debt (NFD) expanded at a 5.0% rate. Corporate borrowings grew at a robust 9.3% pace, up from Q4's 7.7% and Q1 2013's 7.2%. Federal government debt mounted at a 7.1% rate, down from Q4's 11.6% and Q1 2013's 10.1%. Consumer Credit accelerated from Q4's 5.3% rate to 6.6% - the strongest increase in borrowings since Q2 2012. Consumer Credit expanded 4.1% in 2011, 6.2% in 2012 and 5.9% in 2013. If Q1 consumer borrowing is sustained, 2014 will post the strongest consumer (non-mortgage) debt growth since 2001 (8.6%).

The historic increase in federal debt runs unabated. Recall that federal government debt expanded 24.2% in 2008, 22.7% in 2009, 20.2% in 2010, 11.4% in 2011, 10.9% in 2012 and 6.5% in 2013. Federal debt has increased $9.718 TN, or 145%, in 23 quarters. The ongoing expansion of corporate debt is also noteworthy. Corporate debt expanded 8.3% in 2012 and another 8.9% in 2013 - significantly exceeding the growth in the real economy. We're in the midst of the strongest corporate debt expansion since the 9.2% in 2006 followed by 13.5% in 2007.

The Household (& Non-profits) Balance Sheet remains key to current Credit Bubble analysis. Household Assets increased $1.506 TN during the quarter to a record $95.549 TN. And with Household Liabilities up only $16.7bn, Household Net Worth jumped another $1.490 TN during the quarter. Over four quarters, Household Assets surged $8.189 TN, or 9.4%, with Liabilities increasing $209bn (1.5%). Household Net Worth surged $7.98 TN, or 10.8%, over the past year.

During the past four years, Household Net Worth has inflated an unprecedented $26.797 TN, or 49%. Over this period, Household holdings of Financial Assets have surged $22.0 TN, or 49%, to a record $67.2 TN. On the back of the QE3 liquidity onslaught, Household Net Worth jumped from 417% of GDP at mid-year 2012 to the recent 478% (and counting!). For comparison, Household Net Worth as a percentage of GDP peaked at 447% during the manic height of the "tech" Bubble (Q1 2000).

Analyzing the most-recent Z.1 "flow of funds" report recalls 2007 market exuberance. Looking back at the data, Non-financial Debt (NFD) growth increased to a blistering $2.344 TN in '07. Total Mortgage Debt growth, while slowing somewhat from the record 2004-2006 period, was still almost $1.1 TN (vs. 90's average $268bn). Total Business borrowing rose to a record $1.045 TN. It was easy to ignore some subprime tumult with the economy seemingly firing on all cylinders.

Importantly, near-record 2007 NFD growth was matched by record Financial sector debt expansion. Financial sector borrowings increased an unprecedented $1.944 TN (up from '06's $1.30 TN and '05's $1.08 TN) to $17.103 TN. This pushed six-year growth of Financial sector borrowings to $7.077 TN, or 78%. At the time, I saw the "parabolic" financial sector ballooning as a major problem. For one, it was indicative of ever heavier financial sector intermediation - the "Wall Street Alchemy" necessary to transform progressively risky loans into perceived safe/"money"-like instruments. This unrecognized spike in systemic risk was occurring even in the face of initial cracks in mortgage finance. Actually, subprime stench had the markets salivating over imminent monetary accommodation. The Fed cut the discount rate in an unscheduled meeting on August 17th and pushed rates 100bps lower by year-end. The S&P 500 traded to its then all-time high in October 2007, less than a year away from the abyss.

For the year 2007, GSE issues (debt & MBS) increased $887.6bn, up from 2006's $331bn growth. Outstanding ABS increased $350bn. Net Corporate bond issuance was a strong $709bn. A highly unbalanced financial and economic system was becoming only more vulnerable to what I believed was an imminent market tightening of Credit and resulting mortgage downturn. I saw fragility from a highly leveraged system and a heavily imbalanced real economy addicted to enormous amounts of cheap Credit and liquidity. There was acute fragility associated with gigantic speculative leverage in securities and instruments with market prices detached from unfolding fundamental developments. Despite record stock prices and a resilient real economy, the risk of a problematic period of speculative de-leveraging was extreme and growing.

I'll try to explain what I see as current parallels. Federal Reserve Credit has been this cycles' prevailing source of liquidity, "money" distorting the pricing and flow of finance through both the markets and real economy. Importantly, this key source of financial Credit is supposedly ending in a few short months. And like 2007, highly speculative financial Bubble markets choose to disregard fundamental prospects and instead go into destabilizing blow-off mode. Indeed, deteriorating prospects - along with accompanying shorting and hedging - provide market melt-up fuel.

In the 23 quarters Q3 2008 through Q1 2014, Federal Reserve Credit expanded $3.338 TN, or 351%. Over the final "parabolic" expansion, Fed Credit/liquidity has surged $1.474 TN, or 52%, in the past 82 weeks. The S&P 500 has increased 50% from June 2012 lows - and is now up 122% from March 2009 lows. Over this period, the small caps have gained 140% and the Morgan Stanley High Tech index has surged 215%.

Similar to 2006/07, a huge expansion in Financial sector Credit stokes an ongoing boom in corporate Credit. A replay of Chuck Prince's "still dancing" lending euphoria ensures a problematic Credit cycle downside. It is these days worth noting that net issuance of Corporate and Foreign Bonds increased $873bn in 2005, $1.242 TN in 2006 and a record $1.251 TN during (an oblivious) 2007. The 2008 Credit dislocation saw Corporate debt contract $215bn - a harsh reminder of how abruptly the Credit cycle can reverse course and bury folks.

It is worth recalling that non-financial debt (NFD) growth averaged $720bn annually during the nineties. It jumped to $1.046 during bubbling 1999. After a brief slowdown in 2000, aggressive Fed stimulus (and a resulting surge in mortgage borrowings) had NFD growth back in record territory in 2001 at $1.147 TN. NFD growth then jumped to $1.420 TN in 2002 and $1.716 TN by 2003. Fast-forward to 2007 and NFD expansion had jumped to $2.59 TN - more than triple the average from the nineties.

It's central to my Macro Credit Analytical Framework that prolonged Credit inflations/Bubbles inflate myriad price levels throughout the markets and real economy. After years of Bubble distortions, even the $942bn growth in NFD growth during 2009 was woefully insufficient to sustain real estate, stock and asset prices; as well as incomes, spending and corporate profits in the real economy. Market dislocation abruptly closed the Credit/liquidity spigot for key sectors.

Since the collapse of the mortgage finance Bubble, I have posited that it would require in the neighborhood of $2.0 TN of annual NFD growth to fuel a self-reinforcing recovery in asset prices and economic activity. While I expected the federal government to run big deficits, it was not obvious at the time that a rapid doubling of Federal debt would be accommodated at historically low borrowing costs. The key has been a previously unimaginable inflation in Federal Reserve Credit - liquidity that has inundated the securities market and inflated asset prices almost across the board.

The Fed did succeed in rejuvenating strong Credit growth. Q1 2014 NFD was reported at a Seasonally-adjusted and annualized rate (SAAR) of $2.113 TN - with NFD growth now above my $2.0 TN bogey for two straight quarters. Considering the degree of Credit expansion, the performance of the economy has been most unimpressive (Q1 GDP up SAAR $11.7bn). I'm further troubled by the composition of the recent Credit expansion. Over the past six months, the $2.0 TN bogey has been met with federal debt growth of SAAR $1.1 TN and total Business borrowing at about SAAR $940bn. I would argue that large federal borrowings coupled with corporate debt funding M&A and stock buybacks ("financial engineering") provide the real economy little bang for the Credit buck. Indeed, the massive inflation of Fed Credit has chiefly fueled dangerous speculation and runaway Bubbles in securities and asset prices. The divergence between inflated asset prices and deflating fundamental prospects now widens by the week.

I have repeatedly drawn parallels between the current extraordinarily protracted Credit cycle and that from the WWI to 1929 period. Both share similar characteristics of profound technological advancement, "globalization," financial innovation, experimental activism in monetary policy management and resulting prolonged Credit, speculative and economic cycles.

Late during the "roaring twenties" Bubble period, prices, finance and economic performance all began functioning abnormally. There was confusion. In hindsight, there were ample obvious warnings. But at the time they were so easily drowned out by a boisterous financial mania. There was the camp that accurately recognized and feared the consequences of historic Credit excess. They argued unsuccessfully for policy-makers to rein in the Bubble to save the financial system and economy from catastrophe (Bernanke's "Bubble poppers"). The Federal Reserve repeatedly acted to reinforce the boom - in the end believing downward pressure on prices and associated economic vulnerability dictated ongoing monetary accommodation.

Our central bank at the time was certainly not unaware of the stock market Bubble. The Fed's focus turned to trying to ensure Credit was allocated to productive endeavors in the real economy - rather than to the market exchanges. There were two sides to this debate. The "Bubble poppers" were again correct in stating that it was fallacy to expect that Fed measures could ensure Credit was used productively, not when the pricing and profit backdrop in the real economy was so weak compared to the enormous gains being achieved in the booming securities markets.

The ECB this week introduced "targeted long-term refinancing operations" (TLTRO). Despite a historic collapse in sovereign yields and booming stock markets, the Eurozone economy is expected to grow only 1% this year. Many fear that downward pricing pressures are intensifying. In Europe, as around the globe, central bank liquidity has stoked heated financial speculation as economies and prices have continued to cool. The European Central Bank's plan is to lend to banks specifically to finance loans to business and the real economy. Good luck with that, with feeble return prospects in the real economy paling in comparison to outsized speculative returns so easily achieved in manic securities markets.

The markets foresee only more central bank liquidity making its way to enticing market Bubbles. Italian 10-year sovereign yields sank 20 bps points this week to a record low 2.76%. Imagine a country with complete economic stagnation and debt-to-GDP approaching 130% - and borrowing at yields below 3%. This week saw Spain's yields sink another 22 bps to a record low 2.63%. Portuguese yields sank 11 bps to a near-record low 3.52%. With mounting debt and deep economic problems, French yields ended the week at 1.70%. A strong case can be made that the European debt Bubble has inflated into one of history's greatest mispricings of debt securities. European bonds - and global risk markets more generally - are showing signs of upside dislocation - likely spurred by derivatives and speculative trades gone haywire. The "global government finance Bubble" thesis finds added confirmation on a weekly basis.

June 6 - Bloomberg: "China's banking regulator vowed to expand loans and cap borrowing costs, seeking to boost the supply of funds to the real economy as growth slows amid a clampdown on shadow financing. Lending to small businesses, major infrastructure projects and first-home buyers will be a priority, the China Banking Regulatory Commission said... To give banks more capacity to lend, the regulator may ease the ratio of loans to deposits by including some stable sources of deposits in the calculation, CBRC Vice Chairman Wang Zhaoxing said... The CBRC will also take measures to rein in bubbles in the nation's real estate market because reliance of the economy on property and too much credit exposure to the sector could damage the financial system, he said.'"

Predictably, China is also focused on boosting the "supply of Credit to the real economy." After allowing their Credit and economic Bubbles to run completely out of control, Chinese officials now confront a monumental task. They must attempt to rein in speculative Credit excess and financial fraud, while ensuring that the "real" economy receives sufficient Credit to stave off collapse. Acute addiction to copious cheap finance is a fundamental dilemma associated with drawn-out Credit Bubbles. An inevitable tightening of financial conditions (less Credit Availability and associated higher borrowing costs) exposes previous fraud, malfeasance and mal-investment - in the process spurring the self-reinforcing downside to the Credit cycle.

China still retains an unusual capacity to sustain lending and Credit growth. Yet, at this point, only a more damaging "Terminal Phase" of excess is ensured. From my perspective, it will take an enormous amount of ongoing Credit to hold a nasty Chinese financial and economic downside at bay. This portends serious trouble for the Creditworthiness of the now behemoth Chinese banks as well as the sovereign.

Here in the U.S., with our booming markets dragging the listless economy along, there's not much talk of Credit allocation. With Bubble excess - stocks, bonds, corporate Credit, "tech," etc. - increasingly hard to ignore, there appears to finally be some concern building at the Fed. The headline from Jon Hilsenrath's Tuesday WSJ article read "Fed Officials Growing Wary of Market Complacency." This was toned down from the original Dow Jones Newswire headline: "Fed Worried Calm Markets Forecast A Storm to Come." Federal Reserve Bank President Esther George was out again this week with her rational raise rates "sooner and faster" than the dovish consensus. "My concern is that keeping rates very low into late 2016 will continue to incentivize financial markets and investors to reach for yield in an economy operating at full capacity, posing risks to achieving sustainable growth over the longer run."

Back in 2007, with cracks forming in mortgage finance, I spent a lot of time pondering how the system could possibly generate sufficient Credit to fuel such an unbalanced and maladjusted economic structure. I have similar concerns today. If Fed Credit growth disappears, I just don't see how we can sustain the necessary $2.0 TN of non-financial sector debt growth. There is little indication that mortgage Credit expansion will provide much help. Federal deficits are supposed to continue to decline, while state & local government borrowings remain minimal. Corporate Credit growth could continue to boom, although the marketplace appears more late-cycle euphoric to me.

Yet there remains a critical unknown. We are, after all, in the midst of the "Granddaddy of all Bubbles" - and when and how this all concludes nobody knows. It's an important aspect of Bubble Theory that leverage associated with speculative Bubbles creates its own self-reinforcing liquidity. So I will posit that so long as this Bubble continues to inflate at such a fervent pace, the tapering of Fed Credit has little impact. However, the bigger these Bubbles inflate the greater the risk of a destabilizing "risk off" bout of de-risking/de-leveraging. What is a leading catalyst for puncturing a speculative market Bubble? The unsustainability of parabolic "blow off" speculative excess.

It will be in the next "risk off" period that will find participants contemplating a marketplace without constant Federal Reserve liquidity injections. The markets will fret about life without an open-ended Fed QE backstop. Will the Fed be there with its typical timely reinsurance - or might a divided Fed struggle to live up to Dr. Bernanke's promises? For now, it's exuberance - emboldened by the notion that persistent "deflation" risks will keep global central bankers in an accommodative and experimental mood.

 


For the Week:

The S&P500 gained 1.3% to another record high (up 5.5% y-t-d), and the Dow rose 1.2% to a new high (up 2.1%). The Utilities gained 0.9% (up 11.7%). The Banks surged 2.7% (up 2.3%), and the Broker/Dealers jumped 3.0% (down 1.8%). The Morgan Stanley Cyclicals were up 2.4% to a record high (up 7.3%), and the Transports gained 1.3% to a new high (up 10.9%). The S&P 400 Midcaps jumped 2.4% to a record high (up 5.1%), and the small cap Russell 2000 surged 2.7% (up 0.1%). The Nasdaq100 rose 1.6% (up 5.6%), and the Morgan Stanley High Tech index increased 1.1% (up 4.9%). The Semiconductors surged 2.9% (up 15.4%). The Biotechs jumped 2.9% (up 14.3%). With bullion up $3.5, the HUI gold index recovered 1.2% (up 5.5%).

One-month Treasury bill rates ended the week at two bps and three-month rates closed at three bps. Two-year government yields increased three bps to 0.40% (up one bp y-t-d). Five-year T-note yields jumped 10 bps to 1.64% (down 10bps). Ten-year Treasury yields rose 11 bps to 2.59% (down 44bps). Long bond yields gained 11 bps to 3.43% (down 54bps). Benchmark Fannie MBS yields were up nine bps to 3.25% (down 36bps). The spread between benchmark MBS and 10-year Treasury yields narrowed two to 66 bps. The implied yield on December 2015 eurodollar futures jumped seven bps to 0.945%. The two-year dollar swap spread was little changed at 14 bps, while the 10-year swap spread increased one to 12 bps. Corporate bond spreads narrowed to multi-year lows. An index of investment grade bond risk dropped 5 to 57 bps. An index of junk bond risk sank 15 to 297 bps. An index of emerging market (EM) debt risk dropped 18 to 255 bps.

Debt issuance was strong. Investment-grade issuers included JPMorgan Chase $2.5bn, Express Scripts $2.5bn, American Express $2.4bn, Wells Fargo $2.0bn, AT&T $2.0bn, International Paper $1.6bn, Ford Motor Credit $1.5bn, Capital One $1.25bn, Caterpillar $1.0bn, TJX $750 million, NetApp $500 million, PACCAR $500 million, Delmarva Power & Light $500 million, Everest Reinsurance $400 million, Nextera Energy Capital $350 million, Fifth Third Bank $300 million, PPL Electric Utilities $300 million, Metropolitan Edison $250 million, Pennsylvania Electric $200 million and Southwestern Public Service $150 million.

Junk funds saw inflows slow to $302 million (from Lipper). Junk issuers included DC Finance $900 million, Cascades $550 million, Michaels Stores $510 million, Advanced Micro Devices $500 million, Southern Star Central $450 million, Cadence Financial $245 million and JCH $150 million.

Convertible debt issuers this week included Illumina $1.0bn, SunEdison $500 million, Sunpower $400 million, Insulet $175 million, Trina Solar $150 million and TPG Specialty Lending $100 million.

International dollar debt issuers included Kommunalbanken $1.75bn, Bank Nederlandse Gemeenten $1.5bn, International Finance Corp $1.0bn, South Korea $1.0bn, Credit Agricole $900 million, Ardagh $710 million, Asian Development Bank $700 million, Korea Exchange Bank $500 million and Suncorp-Metway $150 million.

Ten-year Portuguese yields dropped 11 bps to a near-record low 3.52% (down 262bps y-t-d). Italian 10-yr yields fell 20 bps to a record low 2.76% (down 137bps). Spain's 10-year yields fell 22 bps to a record low 2.63% (down 152bps). German bund yields slipped less than a basis point to 1.35% (down 58bps). French yields dropped six bps to a record low 1.70% (down 85bps). The French to German 10-year bond spread narrowed five to a three-year low 35 bps. Greek 10-year yields collapsed 49 bps to (a lowest since January 2010) 5.77% (down 265bps). U.K. 10-year gilt yields rose 9 bps to 2.66% (down 36bps).

Japan's Nikkei equities index jumped 3.0% (down 7.5% y-t-d). Japanese 10-year "JGB" yields gained two bps to 0.60% (down 14bps). The German DAX equities index added 0.4% to an all-time high (up 4.6%). Spain's IBEX 35 equities index was up 2.5% (up 11.6%). Italy's FTSE MIB index jumped 3.1% (up 17.5%). Emerging equities were mostly higher. Brazil's Bovespa index jumped 3.7% (up 3.1%). Mexico's Bolsa rose 3.4% (up 0.1%). South Korea's Kospi index was little changed (down 0.8%). India's Sensex equities index surged 5.0% to an all-time high (up 20%). China's Shanghai Exchange slipped 0.5% (down 4.1%). Turkey's Borsa Istanbul National 100 index gained 1.4% (up 18.6%). Russia's MICEX equities index rose 1.40% (down 1.3%).

Freddie Mac 30-year fixed mortgage rates increased two bps to 4.14% (up 3bps y-o-y). Fifteen-year fixed rates added two bps to 3.23% (up 20bps). One-year ARM rates declined a basis point to 2.40% (down 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates jumping nine bps to 4.60% (up 29bps).

Federal Reserve Credit last week increased $0.3bn to a record $4.285 TN. During the past year, Fed Credit expanded $935bn, or 27.9%. Fed Credit inflated $1.474 TN, or 52%, over the past 82 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt increased $16.7bn to $3.296 TN. "Custody holdings" were down $58bn year-to-date, with a one-year decline of $16.8bn, or 0.5%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $792bn y-o-y, or 7.1%, to $11.937 TN. Over two years, reserves were $1.528 TN higher for 15% growth.

M2 (narrow) "money" supply surged $36.1bn to a record $11.311 TN. "Narrow money" expanded $753bn, or 7.1%, over the past year. For the week, Currency increased $2.4bn. Total Checkable Deposits fell $4.2bn, while Savings Deposits jumped $39.0bn. Small Time Deposits were little changed. Retail Money Funds slipped $1.3bn.

Money market fund assets declined $7.3bn to $2.580 TN. Money Fund assets were down $139bn y-t-d and dropped $31bn from a year ago, or 1.2%.

Total Commercial Paper rose $10.8bn to $1.039 TN. CP was down $6.9bn year-to-date, while increasing $8.0bn over the past year, or 0.8%.

Currency Watch:

The U.S. dollar index was about unchanged at 80.41 (up 0.5% y-t-d). For the week on the upside, the Swedish krona increased 0.9%, the Norwegian krone 0.5%, the British pound 0.3%, the Australian dollar 0.3%, the Singapore dollar 0.2%, the Swiss franc 0.2%, the Danish krone 0.1% and the euro 0.1%. For the week on the downside, the Canadian dollar declined 0.8%, the Japanese yen 0.7%, the Mexican peso 0.6%, the Brazilian real 0.3%, the South African rand 0.1%, and the Taiwanese dollar 0.1%.

Commodities Watch:

June 5 - Bloomberg (Lisa Pham): "Crop plantations, food manufacturers, metals mining are among industries that may be affected if El Nino weather pattern returns this year, according to analysts. If severe El Nino weather event happened, agricultural commodity prices may be pushed up quite significantly, leading to inflation, Jeremy Lawson, chief economist at Standard Life Investments, said... El Nino has at least 70% chance of developing in 2014, with most climate models suggesting it will become established by August: Australia's Bureau of Meteorology..."

June 6 - Bloomberg (Megan Durisin): "This summer, U.S. consumers can look forward to opening a cold beer, firing up the grill and throwing on the most expensive pork chop they have ever purchased. A deadly disease has spread to more than 4,700 U.S. hog operations and that number is growing by as much as 200 every week... The porcine epidemic diarrhea virus, or PED, has killed about 8 million pigs since the outbreak began in May 2013, according to Paragon Economics. The spreading virus sent retail pork-chops to an all-time high of $4.044 a pound in April..."

June 5 - Bloomberg (Jasmine Ng and Chanyaporn Chanjaroen): "Surging supplies of seaborne iron ore will trigger the closure of high-cost output in China, according to Michael Zhu, former global sales director at Vale SA, the world's largest producer of the steel-making raw material. 'The first players to be out of the market will be the domestic producers who have higher costs,' said Zhu, president of Hong Kong-based trader Millennia Resources Ltd. Mainland mines will have to reduce output or shut if prices remain below $100 for another month or two, he said..., forecasting prices may drop as low as $80 a ton this year."

The CRB index slipped 0.1% this week (up 2.3% y-t-d). The Goldman Sachs Commodities Index declined 0.5% (up 2.3%). Spot Gold recovered 0.3% to $1,253 (up 3.9%). July Silver rallied 1.7% to $18.99 (down 2.0%). July Crude was little changed at $102.66 (up 4%). July Gasoline declined 1.1% (up 6%), while July Natural Gas jumped 3.7% (up 11.3%). July Copper dropped 2.3% (down 10%). July Wheat declined 1.4% (up 2%). July Corn fell 1.4% (up 9%).

U.S. Fixed Income Bubble Watch:

June 2 - Bloomberg (Susanne Walker and Liz Capo McCormick): "If the insatiable demand for bonds has upended the models you use to value them, you're not alone. Just last month, researchers at the Federal Reserve Bank of New York retooled a gauge of relative yields on Treasuries, casting aside three decades of data that incorporated estimates for market rates from professional forecasters. Priya Misra, the head of U.S. rates strategy at Bank of America Corp., says a risk metric she's relied on hasn't worked since March. After unprecedented stimulus by the Fed and other central banks made many traditional models useless, investors and analysts alike are having to reshape their understanding of cheap and expensive as the global market for bonds balloons to $100 trillion. With the world's biggest economies struggling to grow and inflation nowhere in sight, catchphrases such as 'new neutral' and 'no normal' are gaining currency to describe a reality where bonds are rallying the most in a decade. 'The world's gotten more complicated and it's a little different,' James Evans... money manager at Brown Brothers Harriman & Co., which oversees $30 billion, said... 'As far as predicting direction up and down, I don't think they have much value,' referring to bond-market models used by forecasters."

June 3 - Financial Times (Vivianne Rodrigues and Tracy Alloway): "The sale of complex debt products popular in the pre-crisis boom years has soared in 2014 as investors have embraced riskier assets in exchange for higher returns. Issuance of US-marketed payment-in-kind notes - which give a company the option to pay lenders with more debt rather than cash in times of crisis - has almost doubled so far this year to reach $4.2bn, according to Dealogic. That is the highest amount since the same period of 2007... The esoteric debt structures were a popular way for companies to finance big leverage buyouts during the boom era that defined the 2006-2007 credit bubble... 'We call it the yield-hunger games,' said Matt Toms, head of US public fixed income for Voya Investment Management. 'In this environment of very low yields and very low volatility, any extra yield that products such as these may offer already helps.'"

June 4 - Bloomberg (Kristen Haunss): "The business of bundling junk-rated corporate loans into top-rated securities is booming like never before after the implementation of regulation aimed at making the financial system safer. More than $46 billion of collateralized loan obligations have been raised this year in the U.S. through the end of May, after $82 billion were sold in all of 2013, according to Royal Bank of Scotland... JPMorgan... boosted its annual forecast to as much as $100 billion, which means 2014 may end up as the biggest year on record... Issuance of CLOs, which helped finance some of the biggest leveraged buyouts in history during the last credit boom, has picked up following an early 2014 slump brought on by the publication of the Volcker Rule designed to limit risk-taking by banks... 'It has been an extraordinary run; the market has been on a tear,' said Oliver Wriedt, co-president of CIFC Corp. in New York, which oversees about $12.3 billion. There is a lot of interest in investing in the most senior portions of CLOs, he said..."

Federal Reserve Watch:

June 3 - Bloomberg (Steve Matthews and Vincent Del Giudice): "Federal Reserve Bank of Kansas City President Esther George said the Fed should allow its balance sheet to shrink before raising the main interest rate, differing from an approach backed by New York Fed President William C. Dudley. 'Allowing the balance sheet to decline due to 'passive runoff,' which stops reinvesting the maturing securities, prior to the first rate hike is appropriate,' George said... The Federal Open Market Committee will need to decide in the 'relatively near future' on how to withdraw accommodation that has pumped up the Fed's balance sheet to $4.32 trillion, George said. Her preference for allowing 'passive runoff' in the balance sheet aligns with the FOMC's exit plan formulated in 2011, she said... Ending reinvestment of maturing securities prior to an increase in the benchmark lending rate 'may not be the best strategy,' Dudley said. 'As the outlook improves, this modest step would begin the normalization process and is in line with the 2011 principles,' George said... 'Unless there is a major change in the outlook I see abiding by principles that the FOMC reaffirmed last year as important. Central banks should make efforts to follow through on their plans, otherwise they risk losing credibility.'"

U.S. Bubble Watch:

June 6 - Bloomberg (Lu Wang and Callie Bost): "Calm is pervading the U.S. stock market like no time in seven years as stimulus from the European Central Bank and improving employment lifted equities for a third week, sending benchmark indexes to all-time highs. The Chicago Board Options Exchange Volatility Index, also known as VIX, slipped 5.9% for the week to 10.73, the lowest level since February 2007."

June 6 - Bloomberg (Caroline Chen): "A gauge of U.S. corporate credit risk fell to a seven-year low... The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, decreased 2 bps to 57.9 bps... That's the lowest intraday level since October 2007."

June 6 - Bloomberg (Michelle Jamrisko): "Consumer borrowing in the U.S. rose more than projected in April as Americans boosted credit-card use by the most since November 2007. The $26.8 billion surge in total credit exceeded the highest estimate...

June 4 - Bloomberg (Michelle Jamrisko): "The trade deficit ballooned in April to the widest in two years as Americans bought record amounts of consumer goods, business equipment and automobiles from abroad. The gap grew by 6.9% to $47.2 billion from the prior month's $44.2 billion... The April reading exceeded all estimates... was the biggest since April 2012. Exports were little changed."

June 3 - Bloomberg (Max Abelson): "What's ambitious about Jay Dweck's bathroom isn't the television by his whirlpool tub or the screen that will face his toilet and bidet. It isn't the wide nook in his shower for a third TV and one more across from the sink, or his plan to have each turn on automatically when he's nearby. It's that Dweck, a former Goldman Sachs Group Inc. and Morgan Stanley executive, wants to sell fellow bankers on renovations like the one at his $4.8 million house an hour's drive north of New York... 'I always have visions and dreams of things you can do, and this is a realization of something,' Dweck, 58, said near his violin-shaped pool, where about 5,600 fiber-optic cables light up like multicolored strings. 'The idea is to improve quality of life using technology.'"

Central Bank Watch:

June 6 - Financial Times (Claire Jones): "The European Central Bank's decision to cut rates below zero was the headline-grabber of the package of exceptional measures un-veiled on Thursday to rid the eurozone of the threat of deflation. But ECB-watchers view the central bank's offer of up to €400bn in cheap, fixed-rate loans - known officially as a targeted longer-term refinancing operation (TLTRO) - as the package's centrepiece. While the TLTRO might lack the appeal of a bold venture into negative territory, Gilles Moec, Deutsche Bank economist, dubbed it the 'star of the show'. The offer, which unlike earlier LTROs is linked to banks' lending more to credit-starved smaller businesses, is vital as there is a limited amount that ultra-low interest rates - or negative ones - can do to revive the eurozone's economy. This is because what is known in central bank parlance as the 'monetary transmission mechanism' is broken. Even if the ECB lowers the rate it charges to banks for its loans, lenders will not necessarily pass on those changes to businesses and households."

June 6 - Bloomberg (David Goodman and Lucy Meakin): "Mario Draghi has once again proved himself to be the bond market's best friend. A jump in government securities across the euro area sent yields to record lows today, inspired by a fresh package of stimulus measures from the European Central Bank. Spain's 10- year rate fell the most since June 2013 as sovereign bonds from the euro area's most-indebted nations extended a surge during ECB President Draghi's 2 1/2-year tenure that has hauled down borrowing costs from the highest in the currency bloc's history. 'We are happy because in our view the ECB delivered,' said Nicola Marinelli... at Sturgeon Capital Ltd. in London. 'This year a lot of the performance has come from peripheral investments, corporate and government bonds,' he said, describing Draghi as a 'rock-star central banker.'"

June 6 - Bloomberg (Stefan Riecher): "ECB Governing Council member Jens Weidmann says it's 'absurd to immediately herald the next round' of easing measures, Bild reports... Says 'now we'll have to wait and see the effects' of yesterday's ECB decisions. Says the ECB must not become the bad bank of the euro area. The Governing Council 'wrestled hard' before deciding on the latest package of measures. Banks are holding back with lending and companies' - credit demand is also very weak in some countries."

June 6 - Bloomberg (Simon Kennedy and Angeline Benoit): "Mario Draghi is betting the banking system rather than the bond market is his best ally for now in the fight against deflation. Acting in a more sweeping fashion than most investors anticipated, the European Central Bank... cut interest rates to unprecedented lows and its president unveiled measures to beef up lending for banks in a bid to revive inflation languishing at close to a quarter of his target. With the policy toolbox now virtually exhausted and much hinging on whether banks boost credit themselves, failure to spur consumer prices will leave Draghi with little option but to enter the uncharted terrain of U.S.-style bond buying. Some executives have more hope than confidence that Draghi's current plan will work... Battling a deteriorating economic outlook and prolonged period of slow inflation, the ECB became the first major central bank to charge rather than pay banks for parking cash in its coffers. The deposit rate is now minus 0.10 percent and it also knocked its benchmark to a record 0.15%. It created a targeted 400-billion-euro ($542bn) loan program to incentivize banks to lend themselves and extended the practice of granting them as much cheap cash as they want until the end of 2016. It also suspended the sterilization of crisis-era bond purchases to raise liquidity in money markets."

June 6 - Bloomberg (Alastair Marsh): "Mario Draghi is on a collision course with regulators as he seeks to revive Europe's asset-backed debt market to boost lending to businesses. The European Central Bank president said yesterday regulators are holding back the market he wants to use to spur economic growth. Policy makers are frustrated by the Basel Committee on Banking Supervision's demands that investors increase the capital they hold to absorb losses on the debt. 'We are working on the ABS, but you know that there are also other actors,' Draghi said... 'There has to be a revisitation of the regulation that had been introduced in the past few years about ABS to eliminate some of the undue discriminations.'"

Geopolitical Watch:

May 31 - Wall Street Journal (Trefor Moss and Julian Barnes): "Chinese defense officials reacted furiously to U.S. Defense Secretary Chuck Hagel's assertion that China has undertaken destabilizing actions as it pursues its territorial ambitions in the South China Sea. Rebutting Mr. Hagel's remarks, offered in a speech... at the Shangri-La Dialogue, a regional security summit in Singapore, Maj. Gen. Zhu Chenghu told The Wall Street Journal that the charges are 'groundless' and that 'the Americans are making very, very important strategic mistakes right now' in their approach to China. Gen. Zhu... accused Mr. Hagel of hypocrisy in his assessment of the region's security landscape, suggesting that in his view 'whatever the Chinese do is illegal, and whatever the Americans do is right.' Rather than lecture and accuse China, Gen. Zhu said that the U.S. 'should treat China as an equal partner, instead of as an enemy.' 'If you take China as an enemy, China will absolutely become the enemy of the U.S.,' he warned. 'If the Americans take China as an enemy, we Chinese have to take steps to make ourselves a qualified enemy of the U.S. But if the Americans take China as a friend, China will be a very loyal friend; and if they take China as a partner, China will be a very cooperative partner.'"

June 2 - Financial Times (Demetri Sevastopulo): "A top Chinese general has lashed out at the US and Japan, accusing the two countries of teaming up against China and making "provocative" comments amid escalating Asian maritime tensions. Speaking at a defence forum in Singapore on Sunday, Wang Guanzhong, deputy chief of the Chinese general staff, lambasted the US and Japanese defence ministers for telling Asian counterparts that China was using intimidation to assert its territorial claims... In the face of mounting efforts by the US and Japan to shore up new security relationships in Asia, Gen Wang said China opposed both the practice of building military alliances and 'attempts by any country to dominate regional affairs'. Japanese prime minister Shinzo Abe said... that Japan would give more support to southeast Asian nations facing Chinese pressure. Gen Wang said: 'The speeches by Mr Abe and Mr Hagel gave me the impression that they co-ordinated with each other, they supported each other, they encouraged each other and they took the advantage of speaking first... and staged provocative actions and challenges against China.'"

June 5 - Reuters (Michael Martina and Ben Blanchard): "China has lodged a diplomatic protest over U.S. remarks on the 25th anniversary of the brutal Tiananmen Square crackdown, issuing a sterner rejection of Washington's call for it to account for those killed in pro-democracy protests... The White House had honoured those who gave their lives in the action to crush the protests and said in a statement it would always speak out in support of the fundamental rights that the protesters sought. Foreign Ministry spokesman Hong Lei said China was 'strongly dissatisfied' and 'firmly opposed' to the U.S. statement..., adding that it had 'lodged solemn representations' with Washington. 'The U.S. statement on that incident shows a total disregard of fact,' Hong said. 'It blames the Chinese government for no reason, gravely interferes in China's internal affairs and violates the basic norms guiding international relations.'"

June 4 - Bloomberg: "China refused to defend its territorial claims in the South China Sea to a United Nations tribunal because it doesn't recognize international arbitration of its dispute with the Philippines. 'China's position that it will not accept or participate in the tribunal case involving the Philippines hasn't changed,' Foreign Ministry Spokesman Hong Lei said... So far China has refused any international efforts to resolve the dispute, insisting any discussions on the issue must be held directly between China and the Philippines. Under President Xi Jinping, China has been tapping its economic and military muscle to assert its claims to surrounding waters that may be rich in mineral and energy deposits. China claims much of the South China Sea under its 'nine dash-line' map, first published in 1947, which extends hundreds of miles south from China's Hainan Island to equatorial waters off the coast of Borneo, taking in some of the world's busiest shipping lanes."

June 5 - Bloomberg: "China should refrain from rolling out more stimulus to boost economic growth and continue to implement changes to curb dangers from shadow banking and local government debt, the International Monetary Fund said. 'We are not counseling stimulus at this point, we don't think that there are any sufficient signs to warrant that,' First Deputy Managing Director David Lipton said... China's government is trying to sustain growth without implementing a stimulus on the scale of the $586 billion policy boost begun in 2008 that caused a record buildup of debt and inflated asset bubbles. The State Council, which last week said there was 'relatively large' downward pressure on the economy, has so far resisted broader monetary-policy easing to curb debt that JPMorgan... estimates surged to 210% of gross domestic product last year."

June 3 - Bloomberg (Fabio Benedetti-Valentini and Vidya Root): "A potential $10 billion fine for BNP Paribas SA for breaking U.S. trade sanctions would be unreasonable, said French Foreign Minister Laurent Fabius. 'The fine has to be proportionate and reasonable,' Fabius said... 'These figures are not reasonable.' The remarks by Fabius, the most senior government official to publicly defend the largest French bank, signal growing indignation in France"

June 5 - Financial Times (Martin Arnold, Michael Stothard Tom Braithwaite): "The transatlantic tussle between France's biggest bank and US regulators over alleged sanctions breaches escalated on Wednesday after BNP Paribas's credit rating came under threat and François Hollande said he would raise the issue with Barack Obama. Amid alarm among French politicians about the prospect of BNP Paribas being fined as much as $10bn - more than its annual profits - Standard & Poor's said it had put the bank's A+ rating on 'credit watch with negative implications'.

June 3 - Financial Times (Vivianne Rodrigues and Tracy Alloway): "Russia and China have agreed to set up a joint rating agency as Moscow's stand-off with the west over Ukraine has made it more eager to establish institutions that would reduce its dependence on the US and Europe. 'In the beginning, the agency will assess Russian-Chinese investment projects with a view to attracting of [investors from] a number of Asian countries,' Anton Siluanov, Russia's finance minister, said... 'Gradually, based on the progress and authority of such an agency, we believe it will rise to a level where its opinions will attract other countries."

Ukraine & Russia Watch:

June 6 - Wall Street Jounral (Lukas I. Alpert): "Ukraine lost even more control over its porous border with Russia Friday when it abandoned eight border posts that had become the target of sustained attacks from separatist fighters. Ukraine has repeatedly accused Russia of allowing fighters and arms to filter across the border to join the rebellion in the east, an allegation Russia has denied. Ukrainian authorities had moved to reinforce its border crossings in the east, but fighting further from the frontier had left the posts increasingly cut off from the rest of Ukraine's forces... Seven of the posts are located in the southern Luhansk region where pro-Russian rebels appear to have gained firmer control in recent days despite a stepped-up military operation by the Kiev government to end the insurgency. The eighth crossing at Marynivka, in Ukraine's Donetsk region, was the scene of heavy fighting on Thursday. The border service said the battle raged for hours after an armored personnel carrier, seven vehicles loaded with fighters and four flatbed trucks equipped with machine-gun turrets approached the border posts from both sides of the frontier."

China Bubble Watch:

June 5 - Financial Times (Lucy Hornby and Xan Rice): "One of China's busiest ports is investigating whether aluminium and copper stocks have been used multiple times as collateral against loans, reigniting concerns about financing activity in the world's biggest commodity consumer. The case, which could have implications for western banks and trading houses, comes amid a crackdown on shadow financing and corruption in China. A private Chinese metals company is alleged to have pledged the aluminium and copper stocks stored at warehouses in Qingdao as collateral for loans more than once... About 3,000 tonnes of copper and 100,000 tonnes of aluminium have been pledged multiple times in Qingdao, traders and Chinese media said on Thursday. However, Macquarie Bank put the pledged amount much higher, at 20,000 tonnes of copper."

June 2 - Reuters (Melanie Burton): "China's northeastern port of Qingdao has halted shipments of aluminum and copper due to an investigation by authorities, causing concern among bankers and trade houses financing the metals, trading and warehousing sources said... 'We were told we can't ship any material out while they do this investigation,' a source at a trading house said. The port of Qingdao is China's third-largest foreign trade port and the world's seventh-largest port, trading with 700 ports in more than 180 countries... 'Banks are worried about their exposure,' one warehousing source in Singapore said. 'There is a scramble for people to head down there at the minute and make sure that their metal that they think is covered by a warehouse receipt actually exists,' he said."

June 5 - Bloomberg: "Economic growth in the northern Chinese city of Taiyuan, Shanxi province, has crashed to zero from 12% in one year. Yan Xiaofeng's coal-equipment business has gone down with it. Yan, 38, said last week that he's recorded 1 million yuan ($160,000) in sales so far this year from supplying gear and parts to coal mines, down from more than 10 million yuan a year in the boom times of 2009. 'The economy in Shanxi is very simple: It's all about coal,' said Yan, who's been in business in the region for 15 years... Taiyuan's hard landing shows how China's transition to slower growth from decades averaging 10% expansion will be messy in some places... 'It's always very hard to find a way to truly transform a local economy,' said Gao Shanwen, chief economist at Essence Securities Co. in Beijing, who previously worked at the People's Bank of China. 'If the ills in places like Taiyuan could be quickly cured, then hopes should be high for the Chinese economy. Unfortunately, the facts on the ground are harsh, and that's an obvious reason why people are cautious about the economic outlook.'"

June 3 - Bloomberg (Michelle Jamrisko): "China's economy is moving in tandem with credit expansion and the government needs to increase social financing if it wants to revive growth, according to China International Capital Corp. ...corporate and social borrowing rose at the slowest pace in more than eight years in April while the January-March 7.4% increase in gross domestic product was the least in six quarters. That compares with 35.3% credit growth in November 2009..., followed by a GDP increase of 11.9% in the first quarter of 2010. 'The slowdown in social financing is the main reason for economic growth losing momentum,' said Chen Jianheng, a... analyst at CICC. 'The government must consider policies such as easing lending limits on commercial banks and selling more bonds to help fund infrastructure projects.'"

June 4 - Financial Times (Charles Clover): "Chinese state media have launched a publicity offensive against Google and other US technology companies in recent days as a spat with the US over cyber espionage deepens. Google has been blocked in China since Monday, while a number of other US tech groups face sanctions and boycotts because of perceived security risks following revelations last year by Edward Snowden, the US National Security Agency contractor.' 'Foreign tech firms pose threat on internet: companies asked by Washington to use online services to spy on customers," read the banner headline and subheading of the English-language China Daily... 'To resist the naked internet hegemony, we will draw up international regulations, and strengthen technology safeguards, but we will also severely punish the pawns of the villain. The priority is strengthening penalties and punishments, and for anyone who steals our information, even though they are far away, we shall punish them!' the blog post read."

June 4 - Bloomberg: "China said it's dissatisfied with a U.S. decision to apply preliminary duties on Chinese solar equipment imports, imposed after the U.S. government determined they'd benefited unfairly from government subsidies. The ruling by the U.S. Department of Commerce 'won't solve the problems of the U.S. solar industry,' an unidentified official said... It urged the U.S. to stop the investigation as soon as possible."

June 6 - Bloomberg: "Chinese property developers face a record surge in maturing debt next year, as the country's banking regulator says it's monitoring risks from the cooling real-estate market. The amount of dollar-denominated bonds that must be repaid in 2015 will jump to $2.83 billion... Most Chinese builders listed on the mainland or in Hong Kong are behind fiscal-year sales targets and achieved less than 33% of their target in the first four months, analysis based on Bloomberg data show."

Global Bubble Watch:

June 5 - Bloomberg (Chris Bourke and Foster Wong): "The last time Asian syndicated loans were this big, Bill Clinton was U.S. President and the iPod hadn't been invented. The average deal size in the Asia-Pacific region outside Japan was $372 million in the first five months of this year... That's the highest for the period since 2000, as the top four borrowers, including Macau casino operator Sands China Ltd.... signed more than $20 billion of loans between them. Maturing Asian companies are taking advantage of the narrowest bank-loan interest margins in four years to grow by acquisition and refinance large slices of existing debt. Merger and acquisition activity in the Asia-Pacific region jumped 60% to $326.5 billion this year..., helping syndicated lending volumes swell to $161 billion, the most for a first five-month period since 2011."

EM Bubble Watch:

June 6 - Bloomberg (Filipe Pacheco): "Banco do Brasil SA's lending binge is poised to cost the state-controlled bank in the bond market. Latin America's biggest lender by assets wants to sell subordinated notes that can be converted to equity and are subject to partial payment and principal loss, Moody's... said... The premium that investors demand to own similar bonds from the bank instead of Treasuries has swelled 1.96 percentage points since they were issued in January 2013... Banco do Brasil plans to boost lending by as much as 18% this year as part of a government effort to revive an economy heading for its weakest expansion since 2008."

Japan Watch:

June 2 - Bloomberg (Kevin Buckland and Shigeki Nozawa): "Prime Minister Shinzo Abe's inflation drive may get a boost as Nomura Holdings Inc. forecasts as much as $200 billion in foreign asset purchases by Japan's pension funds will weaken the yen. Nomura predicts a selloff of local bonds by the $1.3 trillion Government Pension Investment Fund will depreciate the nation's currency by about 10 yen against the dollar over the next 12-18 months... GPIF and other public pension funds will shift an additional 12.4 trillion yen ($122bn) into foreign bonds and 7.5 trillion yen into overseas stocks, according to Nomura's 'upside scenario.'"

India Watch:

June 6 - Bloomberg (Santanu Chakraborty and Rajhkumar K Shaaw): "India's benchmark stock-index climbed to an all-time high for a second day as energy shares leaped on optimism Prime Minister Narendra Modi will agree to raise natural gas prices by the end of this month."

Europe Watch:

June 1 - Reuters (Michelle Martin): "Marine Le Pen, leader of France's far-right National Front, said she admired Vladimir Putin as much as German Chancellor Angela Merkel because the Russian president did not allow other countries to impose decisions on him. Le Pen's anti-immigrant, Eurosceptic party scored its first nationwide poll victory in European elections last week and has since said it is close to forming a political group in the European Parliament. In an interview... Le Pen said she had respect for leaders who defended their country's interests and added that Merkel's policies were good for Germany, though they would hurt others. 'I think (Putin) puts the interests of Russia and the Russian people first so in this regard I have the same amount of respect for him as for Ms Merkel,' she said... 'A lot of things are said about Russia because for years it has been demonised on U.S. orders. It should be one of the great characteristics of a European country to form its own opinion and not to see everything from the perspective of the U.S.'"

June 2 - Bloomberg (Fabio Benedetti-Valentini and Mark Deen): "The French are crying foul. A potential $10 billion U.S. penalty against France's largest bank BNP Paribas SA for its alleged dealings with Iran and other sanctioned nations, is stirring outrage in the country. It is putting pressure on President Francois Hollande, who hosts Barack Obama this week to mark the 70th anniversary of D-Day, to protect the bank from the American onslaught. Le Monde in its May 31 edition called the possible fine a 'masterful slap.' Le Figaro newspaper said the U.S. was making an example of BNP to deflect criticism it had been 'lenient with the American banks responsible for the financial crisis.'"

June 4 - Dow Jones (Stacy Meichtry): "France is preparing to train hundreds of Russian seamen to operate a powerful French-made warship this month, defying calls from the U.S. and other Western allies to keep the vessel out of the Kremlin's hands, say people familiar with the matter. A group of 400 Russian sailors are scheduled to arrive on June 22 in the French Atlantic port of Saint-Nazaire to undergo months of instruction before some of them pilot the first of two Mistral-class carriers back to Russia in the fall, said one of these people... The U.S. and other allies have called on the government of President François Hollande to cancel the contract, arguing the ships will significantly enhance Russian naval power at a time when the Ukraine crisis has raised tensions with the Kremlin to their highest levels since the Cold War."

June 2 - Bloomberg (Marcus Bensasson and Eleni Chrepa): "Alexis Tsipras is presenting a friendlier face to investors as he tries to cultivate an image as the leader of Greece's next government. Tsipras, 39, last week spoke of attracting capital to regenerate the economy, pledged to maintain a stable tax regime for companies and offered to cooperate with Europe's traditional left-wing parties in his first interview since claiming the biggest share of the vote in European elections. It's a far cry from the rhetoric of July 2012 when he announced his arrival on the international stage by telling prospective bidders for the crippled Greek state's assets that he'd make sure they lost their money. Fast-forward two years and with the economy set to expand for the first time since 2008, Tsipras is appealing to a broader audience. 'There is a gradual move to the center,' Aristides Hatzis, a professor of law and economics at the University of Athens, said... 'Tsipras and the leadership of Syriza have realized this is the only way to achieve a majority at the polls. After the European elections, this strategy is clearly dominant.' Tsipras's Syriza, a disparate collection of groups that only formally became a political party two years ago, won 26.6% of the vote in the Greek elections for the European parliament on May 25, topping a national poll for the first time. Prime Minister Antonis Samaras's New Democracy party gained 22.7% while Pasok, the party that dominated Greek politics for three decades, finished in fourth place with 8%..."

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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