Pondering the Summers of 2012 and 2014

By: Doug Noland | Fri, Aug 29, 2014
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The gulf between inflating global securities prices and deteriorating fundamental prospects widens by the week.

Another captivating week capped off a dramatic summer. War erupts in Europe. In the Middle East, a terrorist organization with unprecedented military might blows through Iraqi defenses to take control of a large swath of Iraq to go along with its considerable territory in Syria (establishing an "Islamic caliphate").

Meanwhile, global securities markets enjoyed rallies that were equally dramatic. Enjoying a summer surge, U.S. equities disregarded geopolitics to post all-time highs (S&P 2000!). Curiously, Treasury yields were in no way excluded from the frenzy. In the face of rallying stocks and generally positive U.S. economic data, Treasury yields surprised with a determined move to the downside. This latest "conundrum" saw 10-year yields sink to 2.34%, a 15-month low. While notably volatile, corporate Credit spreads ended August about where they began June.

Interestingly, European debt markets once again became a focal point - somewhat a mirror image of the drama-filled Summer of 2012. German 10-year bund yields sank this week to a record-low 0.89%, with French yields at an all-time low 1.25%. Incredibly, German sovereign yields turned negative all the way out to four year maturities. More amazing yet, yields across the spectrum of Europe's basket-case periphery collapsed to at or near historic lows.

Spain's 10-year yields traded to record low yields, ending August at 2.23%, down 62 bps in three months and a stunning 524 bps below July 2012 highs. Despite national public debt surpassing 130% of GDP (and rising!), Italian 10-year yields (briefly) traded below Treasuries before ending the month at 2.44%. Italian yields were down about 50bps in three months (down 470bps from 2012 highs). Portuguese yields dropped another 30bps this summer to 3.22%, increasing 2014's y-t-d yield decline to almost 300 bps. Simply astounding.

The global backdrop is absolutely fascinating, if not comforting. From an analytical perspective, the divergence between the troubling global fundamental backdrop and surging securities prices comes chock full of intrigue. An exuberant marketplace, especially in the U.S., perceives a virtually best-case scenario: an economic recovery having attained important momentum, with market yields pushed lower by global factors. The Jackson Hole central bank powwow, with a dovish Janet Yellen and hints of impending QE from the Draghi ECB, placed a bold exclamation point on the already emboldened bullish view.

This week I found myself reflecting back to that fateful summer of 2012 - a critical juncture for global policymaking and markets that forever changed the world. Back then Europe was the weakest link in a fragile post-crisis global financial and economic recovery. I remain convinced the world was at the brink of what would have been a crisis more problematic than 2008/09.

Europe was facing a systemic crisis of confidence. With the periphery countries succumbing one-by-one to financial crisis, the euro currency was facing an existential threat. In particular, the marketplace was rapidly losing confidence in a heavily indebted Italy. It was simply too big to bail out. Italy along with the periphery began to suffer destabilizing financial outflows. And a crisis engulfing the Italian banks was poised to spark a crisis of confidence throughout the entire vulnerable European banking system. A crisis of confidence in Europe would have spread globally through various channels, certainly via the leveraged speculating community and emerging markets (EM) that were both heavily dependent upon European bank finance.

Why would the Summer of 2012 occupy my mind? Well, in last week's CBB I focused on how the Fed's open-ended QE program fundamentally altered market perceptions, certainly including market faith that the Fed and global central bankers will ensure ongoing liquid securities markets. And this perception - the "Moneyness of Risk Assets" - has been fundamental to what I believe has evolved into speculative "blow-offs" in historic multi-decade Credit and securities Bubbles.

If not for a potentially dire European crisis, I don't believe Bernanke would have so aggressively moved forward with "QE infinity." It was never really about jobs; that was merely a feint. The whole focus on the unemployment rate, employment dynamics and such has been a ruse. As far as I'm concerned, the current employment-fixation underpinning chair Yellen's policy doctrine is a ploy. Jackson Hole 2014 - "Re-Evaluating Labor Market Dynamics" - was little more than policymaking subterfuge.

Importantly, the Summer of 2012 saw international monetary policy come under the seemingly complete control of a quite small group of central bankers (see Hilsenrath's "Inside the Risky Bets of Central Banks," WSJ, December 11, 2012). Recall that shortly after Draghi declared "The ECB is ready to do whatever it takes... And believe me, it will be enough," both the Bernanke Fed and Kuroda Bank of Japan (BOJ) commenced discussions to implement "open-ended" QE. The nucleus of the global central bank community all quickly fell in line. This has profoundly impacted market perceptions, hence global securities markets dynamics and prices. The notion of a small cadre of central bankers dictating global monetary policy - irrespective of the views of various central bank committees - plays prominently in current market exuberance that only the views of uber-doves Yellen, Draghi and Kuroda really matter. Geopolitical strife, even war, along with global financial and economic fragility, even deflation, would undoubtedly be met with more open-ended monetary stimulus (and higher securities prices!).

It would be dangerous if global market Bubbles were inflating in the face of deteriorating fundamentals. If a deteriorating backdrop was specifically intensifying Bubble excesses, then I would argue strongly that such dynamics were fomenting catastrophe. Indeed, I see the recent rapidly widening gulf between inflating Bubbles and fundamental deterioration as creating the most precarious global backdrop in decades (going back to the late-twenties). And the situation now turns more alarming by the week.

Global markets were pleased with Yellen's Jackson Hole dovishness. Market participants were tickled to hear BOJ's Kuroda talk of extending aggressive monetary stimulus for "some time" to ensure the defeat deflation. Yet the markets were downright giddy when the ECB's Draghi noted heightened deflation risks while hinting at QE measures. Why such keen interest? Because Europe is once again the weak link in an increasingly fragile global system. And clearly, as bullish thinking goes, heightened European risks ensure that global central bankers will keep the monetary spigots running wide open. Buy stocks, bonds and risk assets.

So, from the standpoint of my analytical framework, I am confident in the global securities markets Bubble thesis. According to Bloomberg, the value of global equities this week rose to a record $66 TN. The S&P500 has now rallied 57% off of June 2012 lows. Over this period, the Nasdaq 100 (NDX) has gained 67%, the MidCaps 63%, the Semiconductors (SOX) 87% and the Biotechs (BTK) 131%. In Europe, European equities (Euro Stoxx index) have rallied 55% from 2012 lows, led by gains of 81% in Spain and 67% in Italy.

No doubt whatsoever that two years of unprecedented monetary stimulus have had a profound effect on global securities prices (and asset prices more generally). How about on global fundamentals? While the bulls would disagree, I believe the global economy is only more vulnerable these days. The Chinese economy is clearly weaker - arguably acutely vulnerable - than two years ago. Growth generally throughout EM is weaker (i.e. Brazil Q2 '14 growth negative 0.6% vs. positive growth throughout 2012).

How about Europe, the catalyst for two years of reckless global monetary stimulus? Well, the prognosis is not good. A temporary stimulus-induced uptick in growth has of late given way to stagnation. At about 12.5%, Eurozone unemployment is essentially unchanged from 2012. And in the face of global liquidity abundance (and resulting booming securities markets), consumer price inflation has weakened. European "CPI" has declined from about 2.5% in 2012 to the recent annual rate of 0.3%. With "core" French and German economies slowing - and geopolitical risks rapidly escalating - European economic prospects are nothing short of abysmal.

I believed in 2012 that the euro currency regime was unsustainable - and I have seen little to alter this view. If anything, the past two years have provided additional confirmation that the experiment in European economic, financial and currency integration was a historic mistake. Today's forces of disenchantment, acrimony and disintegration are too powerful. Public angst has become more engrained. Anti-euro/EU sentiment has only gained momentum, with troubling social and political ramifications. And I believe this unsettled and divisive backdrop has contributed greatly to Putin's Ukraine gambit.

Yet all of this is viewed as "bullish". Clearly, the economic, financial, social and military risks are so high on the European continent that Mr. Draghi will have no alternative than to pursue Federal Reserve style QE. This, apparently, will ensure another shot of monetary fuel to further inflate global securities Bubbles. And a weak euro will provide another reliably weak currency for speculative "carry trade" riches. Moreover, Draghi's compatriots at the Fed, BOJ, Bank of England, Swiss National Bank and elsewhere will surely lend support both to help Europe and to fight the "scourge of deflation."

Bloomberg's Caroline Connan: "The ECB president Mario Draghi is calling for more help from governments in terms of fiscal policy. What could Germany do to help France?"

Germany Finance Minister Wolfgang Schaeuble: "What Mario Draghi is saying again and again is that what is needed are structural reforms. That is not to the ECB to implement, because monetary policy can't. It's up to national governments and parliaments. In this regard we agree, 100%: monetary policy has to take its responsibility. But monetary policy can only buy time. To solve the underlying problems is a matter of fiscal policy and especially of economic policies - structural reforms. It's a globalized economy. We have to work for - ongoing, again and again - to enhance competitiveness. Because markets are changing very fast. And if you look at what's going on with the global economy, it's very important that we all know in Europe - every member state - that we have to stick on structural reforms again and again to enhance competitiveness. If we will be complacent, even in Germany, we are fine actually but if we would not continue to enhance our competitiveness in coming years, we would lose our position."

Connan: "...One more comment on the Eurozone. We are going to get the latest inflation numbers..., it's going to be much below the 2% target. Should the ECB do more to fight deflation?"

Schaeuble: "I don't think that the ECB's monetary policy has the instruments to fight deflation, to be very frank. Interest-rates are on a historical level low. You can't solve the problem in lowering interest rates. The liquidity in markets is not too low; it's even too high. Therefore we have the problems. I think monetary policy has come to the end of its instruments. Therefore, what we urgently need is investment, regaining confidence - by investors, by markets, by consumers. In Germany, of course our economy faces geopolitical risks in the given situation... But our growth is driven by internal demand, because we have high confidence of consumers - investors as well. And the main reason we have such high confidence, I think, is our public finance is sustainable, we will stick to what we have promised; and we will continue to stick on investments... And of course we have to raise our expenditure for research and development. That is what the French government is also deciding to do. I think this is the right direction."

I'd been awaiting a German response to all the Draghi QE jubilation. It is notable that it came from Finance Minister Schaeuble and not Bundesbank President Weidmann. Expectations for aggressive ECB monetary inflation do come at the same time as the anti-German "austerity" movement becomes increasingly clamorous. At the end of the day, I still don't see how the French, Italians and Germans (among others) share a common currency. The cultures - the views on so many things, including how wealth is created (and shared), how economies should function, and how monetary and fiscal affairs must be managed - are inconsistent and often conflicting. At some point, somebody - the "periphery" countries, the French and Italians, or perhaps the German people - will say "enough is enough - this is not sustainable."

In this age of monetary inflationism, the Germans provide a veritable oasis of sanity. At its best, "monetary policy can only buy time." At its worst - the current reality - over time it buys problematic out-of-control Bubbles. Why would European banks partake in higher risk lending for business investment when they can make seemingly risk-free profits buying sovereign bonds? For that matter, why would American CEOs invest in plant and equipment at home when so much "wealth" is created buying back their stock? Meanwhile, two years of massive global monetary stimulus has prolonged historic investment booms in China and throughout much of Asia. This has exacerbated Bubbles, while only worsening the global pricing backdrop and capital investment environments elsewhere. Global imbalances have worsened.

Monetary policy promised way too much back in 2012. As I've written repeatedly, at this stage of a most spectacular and protracted Credit cycle, monetary inflation can only make things worse. Where does it end? And not for a minute do I believe the alarming rise in geopolitical risk and instability is unrelated to years of prolonged global monetary disorder. Mismanagement of the world's reserve currency is replete with huge consequences. Mismanagement of all the world's major currencies is a complete fiasco.

 


For the Week:

The S&P500 gained 0.8% (up 8.4% y-t-d), and the Dow added 0.6% (up 3.2%). The Utilities jumped 1.7% (up 12.3%). The Banks increased 0.6% (up 3.2%), and the Broker/Dealers added 0.2% (up 4.0%). The Transports slipped 0.3% (up 13.6%). The S&P 400 Midcaps advanced 0.9% (up 7.1%), and the small cap Russell 2000 jumped 1.3% (up 1.0%). The Nasdaq100 gained 0.7% (up 13.7%), and the Morgan Stanley High Tech index increased 0.1% (up 10.2%). The Semiconductors jumped 0.9% (up 20.6%). The Biotechs surged 6.1% (up 34.4%). With bullion regaining $8, the HUI gold index rallied 3.1% (up 24.2%).

One-month Treasury bill rates closed the week at one basis point and three-month bills ended at two bps. Two-year government yields were little changed at 0.49% (up 11bps y-t-d). Five-year T-note yields were down four bps to 1.63% (down 12bps). Ten-year Treasury yields dropped six bps to 2.34% (down 69bps). Long bond yields fell eight bps to 3.08% (down 89bps). Benchmark Fannie MBS yields declined seven bps to 3.08% (down 53bps). The spread between benchmark MBS and 10-year Treasury yields narrowed one to 74 bps. The implied yield on December 2015 eurodollar futures declined 1.5 bps to 0.995%. The two-year dollar swap spread was little changed at 22 bps, and the 10-year swap spread was about unchanged at 15 bps. Corporate bond spreads narrowed somewhat. An index of investment grade bond risk declined one to 57 bps. An index of junk bond risk fell three to 311 bps. An index of emerging market (EM) debt risk dipped one to 280 bps.

Ten-year Portuguese yields slipped a basis point to 3.22% (down 291bps y-t-d). Italian 10-yr yields dropped 14 bps to 2.44% (down 169bps). Spain's 10-year yields sank 15 bps to a record low 2.23% (down 192bps). German bund yields fell nine bps to a record low 0.89% (down 104bps). French yields sank 12 bps to a record low 1.25% (down 130bps). The French to German 10-year bond spread narrowed three to 36 bps. Greek 10-year yields declined three bps to 5.82% (down 260bps). U.K. 10-year gilt yields were down four bps to 2.37% (down 65bps).

Japan's Nikkei equities index slipped 0.7% (down 5.3% y-t-d). Japanese 10-year "JGB" yields were little changed at 0.496% (down 25bps). The German DAX equities index jumped 1.4% (down 0.9%). Spain's IBEX 35 equities index rallied 2.2% (up 8.2%). Italy's FTSE MIB index jumped 2.7% (up 7.8%). Emerging equities were mostly higher. Brazil's Bovespa index advanced 4.9% (up 19.0%). Mexico's Bolsa added 0.6% (up 6.8%). South Korea's Kospi index increased 0.6% (up 2.8%). India's bubbly Sensex equities index added 0.8% to another all-time high (up 25.8%). China's Shanghai Exchange fell 1.1% (up 4.8%). Turkey's Borsa Istanbul National 100 index gained 1.8% (up 18.5%). Russia's MICEX equities index sank 3.7% (down 6.9%).

Debt issuance slowed to a late-summer crawl. I saw no investment-grade, junk or convert issues. Junk funds saw inflows slow to $672 million (from Lipper).

International dollar debt issuers included European Investment Bank $3.0bn, FMS Wertmanagement $1.5bn, Nederlandse Waterschapsbank $1.5bn and Kommunalbanken $300 million.

Freddie Mac 30-year fixed mortgage rates were unchanged at 4.10% (down 41bps y-o-y). Fifteen-year rates increased two bps to 3.25% (down 29bps). One-year ARM rates added a basis point to 2.39% (down 17bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up seven bps to a one-month high 4.62% (down 9bps).

Federal Reserve Credit last week expanded $2.5bn to $4.376 TN. During the past year, Fed Credit inflated $774bn, or 21.5%. Fed Credit inflated $1.565 TN, or 56%, over the past 94 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt surged $19.0bn last week to $3.341 TN. "Custody holdings" were down $12.7 year-to-date, while posting a one-year increase of $20bn.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $848bn y-o-y, or 7.6%, to $12.017 TN. Over two years, reserves were $1.484 TN higher for 14% growth.

M2 (narrow) "money" supply jumped $32.0bn to a record $11.458 TN. "Narrow money" expanded $719bn, or 6.7%, over the past year. For the week, Currency increased $1.3bn. Total Checkable Deposits fell $32.3bn, while Savings Deposits surged $61.9bn. Small Time Deposits were little changed. Retail Money Funds added $1.6bn.

Money market fund assets gained $10.8bn to $2.595 TN. Money Fund assets were down $124bn y-t-d and dropped $49bn from a year ago, or 1.9%.

Total Commercial Paper jumped $17bn to $1.040 TN. CP was down $6bn year-to-date, while expanding $20bn from a year ago.

Currency Watch:

The U.S. dollar index added 0.5% to 82.748 (up 3.4% y-t-d). For the week on the upside, the Brazilian real increased 1.9%, the Canadian dollar 0.6%, the Mexican peso 0.4%, the South Korean won 0.4%, the Australian dollar 0.2%, the South African rand 0.2%, the Taiwanese dollar 0.2% and the British pound 0.2%. For the week on the downside, the Swedish krona declined 1.1%, the euro 0.8%, the Danish krone 0.8%, the New Zealand dollar 0.6%, the Norwegian krone 0.5%, the Swiss franc 0.5% and the Japanese yen 0.1%.

Commodities Watch:

The CRB index rallied 1.4% this week (up 4.5% y-t-d). The Goldman Sachs Commodities Index gained 1.3% (down 3.4%). Spot Gold rose 0.6% to $1,288 (up 6.8%). September Silver increased 0.2% to $19.49 (up 0.6%). October Crude rose $2.31 to $95.96 (down 2.5%). October Gasoline recovered 1.3% (down 6%), and October Natural Gas bounced 4.7% (down 4%). September Copper fell 1.9% (down 7%). September Wheat slipped 0.3% (down 9%). September Corn was down 1.8% (down 15%).

U.S. Fixed Income Bubble Watch:

August 28 - Bloomberg (Nabila Ahmed and Katie Linsell): "The bond market is about to roar back to life after the slowest August in six years. From grocer Safeway Inc. to Australian mall owner Westfield Corp., companies are poised to fuel debt sales in the U.S. next month that Bank of America Corp. said may exceed $100 billion, keeping the market on pace for a third straight record year. 'People are preparing to walk in on Sept. 2 with a pretty robust tone,' said Huw Richards, the... co-head of investment grade finance at JPMorgan..., the biggest underwriter of corporate bonds. Behind the anticipated rush to raise debt is the biggest acquisition boom since the credit crisis, as well as the opportunity to lock in near-record low yields while the rally that began in 2009 endures."

August 28 - Bloomberg (Saleha Mohsin): "The head of debt investment at Norway's $880 billion sovereign wealth fund, the world's largest, said a rally in U.S. corporate bonds may be coming to an end. Looking at 'American corporate investment grade bonds, we see that the spread lies around 100 bps, that is nearly just as low as they were before the financial crisis,' Ole Christian Froeseth, head of fixed-income at the oil fund, said... 'One can argue that there isn't much juice left in this spread, especially not in relation to where we were during the financial crisis.'"

U.S. Bubble Watch:

August 25 - Bloomberg (Lu Wang): "The Standard & Poor's 500 Index jumped above 2,000 for the first time ever, building on a rally with a velocity approaching the strongest stretch of the 1990s dot-com bubble. Investors who owned the index when the advance began on March 9, 2009, are sitting on price appreciation of 195.5%, or 24.5% a year on average... That compares with a gain of 236%, or 27.1% annually, over an equal amount of days ending on March 24, 2000. Similarities to the technology-fueled gains of two decades ago are multiplying with the bull market approaching three years without a decline of 10% or more."

August 26 - Wall Street Journal (James R. Hagerty, John W. Miller and Bob Tita): "America's shale boom has raised hopes of a revival in U.S. manufacturing, in part fueled by cheaper energy. But U.S. factories still are losing ground to rivals in Asia and Europe. Much of the problem stems from steel, trucks, car parts, industrial machinery and furniture. The U.S. deficit on trade in goods swelled in the first half to $371.59 billion from $354.64 a year earlier. Imports rose 3.3%, while exports increased 2.6%. Manufactured exports, excluding petroleum and coal, rose just 0.8%... Without a strong, sustainable increase in exports, U.S. factories are unlikely to have the kind of resurgence forecast by some pundits. But achieving that growth is difficult as China and other countries have pursued aggressive export strategies and the U.S. has lost manufacturing skills and suppliers after shifting production overseas. China isn't the only country winning the battle. U.S. trade gaps with the three largest members of the euro zone -- Germany, France and Italy -- all increased in the first half."

August 27 - Financial Times (Camilla Hall): "The chief executive of Wells Fargo has warned that the biggest US mortgage provider will avoid providing home loans to people with lower credit scores unless federal authorities reduce the threat that the banks will bear the costs for soured loans. John Stumpf said government-backed agencies that buy mortgages, such as Fannie Mae, Freddie Mac and the Federal Housing Administration, were too quick to accuse banks of faulty underwriting on mortgages that default and force them to repurchase the soured loans, known as 'put-back' risk. 'If you guys want to stick with this programme of 'putting back' any time, any way, whatever, that's fine, we're just not going to make those loans and there's going to be a whole bunch of Americans that are underserved in the mortgage market,' Mr Stumpf told the Financial Times."

August 27 - Bloomberg (Kasia Klimasinska): "The U.S. budget deficit will narrow less than forecast this year even as it falls to the lowest level since 2007 as a share of the economy... The projected shortfall will be $506 billion in the 12 months ending Sept. 30, compared with an April prediction for $492 billion and a $680 billion gap posted last year, the nonpartisan CBO said... In 2015 it's projected to shrink for a sixth straight year, to $469 billion, capping the longest stretch of fiscal improvement since 2000, near the end of an era of surpluses."

August 28 - Bloomberg (Prashant Gopal): "Julian and Danielle Katz budgeted $1.5 million to buy a home in their popular Brooklyn, New York, neighborhood of Fort Greene. The only places they could afford were smaller than where they already lived. The couple, who have three young daughters, instead bought a brick townhouse in nearby Crown Heights. They paid almost $1.2 million and are spending another $300,000 to renovate the previously vacant three-story home that's a short walk to hipster hangouts cropping up on Franklin Avenue and a newly opened beer hall partly funded by Goldman Sachs Group Inc. 'We were priced out of a lot of Brooklyn neighborhoods,' said Julian Katz, a 41-year-old advertising producer... 'We loved Fort Greene but we could only afford a modest apartment there. We could get a whole house in Crown Heights.' A surge in Brooklyn home values is fueling rapid gentrification in Crown Heights, where apartment prices are up more than 50% from a year ago..."

August 29 - Bloomberg (Oshrat Carmiel): "Prices for previously owned Manhattan condominiums rose to a record last month even as an increase in the supply of units eased competition among buyers. An index of resale prices climbed 1.1% from June to reach the highest level in data going back to 1995, StreetEasy.com... said..."

Europe Watch:

August 29 - Bloomberg (Jeff Black and Ian Wishart): "Mario Draghi has made European political leaders an offer: You scratch my back and I'll scratch yours. In turning up the rhetoric on his readiness to start quantitative easing, the European Central Bank president is also asking governments to open their own wallets. His message to European leaders preparing to gather in Brussels for a summit tomorrow is that it's high time they boost domestic demand by using the 'flexibility' built into their budget pact."

August 29 - Bloomberg (Ian Wishart): "Euro-area inflation slowed in August and the region's unemployment rate remained close to a record, increasing pressure on the European Central Bank to take action to kindle the bloc's faltering recovery. Consumer prices rose 0.3% in August from a year earlier after a 0.4% increase in July... That's the weakest rate since October 2009... Unemployment remained at 11.5% in July..."

August 26 - Financial Times (Jeevan Vasagar): "German industry is predicting a drop in exports to Russia of 20-25% over the course of this year, compounding gloom over the health of Europe's biggest economy. A business lobby group representing German companies trading in eastern Europe complained that 'significant uncertainties' over embargo provisions were resulting in delays to deliveries of German machine parts. German exports to Russia fell by 15.5% year on year in the first half, while exports to Ukraine dropped by 32%."

August 26 - Reuters: "The time has come for France to resist Germany's 'obsession' with austerity and promote alternative policies across the euro zone that support household consumption, firebrand French Economy Minister Arnaud Montebourg said... Deficit-reduction measures carried out since the 2008 financial crisis have crippled Europe's economies and governments need to change course swiftly or they will lose their voters to populist and extremist parties, Montebourg told a socialists' meeting in eastern France. 'France is the euro zone's second-biggest economy, the world's fifth-greatest power, and it does not intend to align itself, ladies and gentlemen, with the excessive obsessions of Germany's conservatives,' Montebourg said. 'That is why the time has come for France and its government, in the name of the European Union's survival, to put up a just and sane resistance [to these policies].' Montebourg said consensus was growing among economists and politicians worldwide on the need for growth-oriented policies and mentioned his German socialist counterpart Sigmar Gabriel and Italy's premier Matteo Renzi as potential allies. He cited former president Charles de Gaulle and former British prime minister Margaret Thatcher as having effectively spoken up to change the course of EU policies they opposed."

August 25 - Bloomberg (Mark Deen and Helene Fouquet): "French President Francois Hollande's firing of malcontent minister Arnaud Montebourg risks unleashing the ruling Socialist Party's chief critic of budget cuts, adding to an austerity backlash stirring across Europe. Montebourg, 51, industry minister for the past two years, will not be part of the new team Hollande names tomorrow after he publicly criticized the president for 'slavish' and 'dogmatic' deficit reduction that he said stokes unemployment. The dismissal of a top minister underlines the growing political crisis confronting Hollande as he seeks to balance European Union pressure to reduce the deficit with domestic demands to revive a stalled economy. It also exposes a wider rift in Europe as Italy uses its six-month presidency of the 28-nation EU to make a stand against a German-led drive to clamp down on spending. 'The backlash against austerity has taken some time to arrive, but this is it,' Antonio Barroso, an analyst at Teneo Intelligence in London, said... 'Of course Montebourg has done this for his personal ambition, but his timing is good: The mood on this is shifting at the European level.' With an approval rating of just 17 percent and faced with record-high French unemployment levels, Hollande's room for maneuver is shrinking as he slips into the second half of his five-year mandate."

August 27 - Bloomberg (Jillian Ward): "French factory confidence fell to the lowest in 13 months in August, adding to signs that the economy may struggle to grow after a stagnant first half... A separate business-confidence index also declined. The latest evidence of weakness in the French economy comes as President Francois Hollande deals with a mutiny within his government over austerity. The economy failed to expand in the past two quarters and a survey last week showed manufacturing contracted for a fourth month in August. 'Political turmoil in France bodes ill for the struggling economy in the near term,' Jennifer McKeown, an economist at Capital Economics..., said... 'Moreover, the rift within the government will diminish the public's already limited faith in its ability to get the economy back on track.'"

August 29 - Bloomberg (Alessandro Speciale and Lorenzo Totaro): "Italy's consumer prices this month dropped the most since records began after the euro-area's third-largest economy slipped into recession, adding to concerns that the region might be headed toward deflation. The inflation rate... fell 0.2% in August from a year earlier... Prices also fell 0.2% from July. Italy's economy contracted for a second quarter in the three months through June sliding into its third recession since 2008, Istat said... Data also showed unemployment at a record high in the second quarter."

August 29 - Bloomberg (Giovanni Salzano): "Istat publishes... [Italian] seasonally adjusted unemployment rate rose to 12.6% in July from 12.3% in June. Jobless rate for 15-to 24-y/o fell to 42.9% in July from 43.7% in June..."

August 27 - Bloomberg (Jeff Black): "The European Central Bank's efforts to restart the region's ailing securitization industry may fall short unless governments step in and guarantee at least some of the debt, Executive Board member Benoit Coeure said. 'Europe is facing a very fundamental choice if it wants to move to an ABS market that is as deep and liquid as the U.S. market,' Coeure said... 'To reach this goal, the securitization market will require a significantly different amount of public sponsoring than is currently the case.' ECB President Mario Draghi said in June that the central bank was intensifying preparations to purchase asset-backed securities in an effort to revitalize the $1.9 trillion market that has contracted 34% since 2009. While the ECB has said it's ready to use its own balance sheet, the European Union and national governments so far have shown no willingness to help coax investors back to the asset class."

Global Bubble Watch:

August 27 - Bloomberg (Inyoung Hwang): "Rallies from Brazil to Japan and the Standard & Poor's 500 Index's first trip above 2,000 sent the value of global equities to a record $66 trillion. Shares worldwide added more than $2.2 trillion in value since Aug. 7... Optimism that central banks will support economic growth sent the MSCI All-Country World Index up 3.8% from its low this month... Global markets are surmounting crises in Ukraine, the Gaza Strip and Iraq as investors renew bets that stimulus will revive growth... 'Geopolitical events are significant and major new attacks are tragic, but they're not enough to unsettle the global economic forces in play, especially in America,' said Patrick Spencer, head of U.S. equity sales at Robert W. Baird & Co... 'Draghi gave clear indication that he's standing ready with further measures to stimulate growth and that's helping overall sentiment.'"

August 27 - Bloomberg (Katherine Burton): "Neil Chriss is hitting his stride. The math doctorate turned hedge-fund manager founded Hutchin Hill Capital LP more than six years ago and built it to cater to large investors. After posting annualized returns of 12%, about six times the average of his peers, he finds himself in the sweet spot for fundraising... Chriss, 47, is one of the prime beneficiaries as investors are on track to hand over the most cash to hedge funds since 2007, driven by a search for steady returns and protection from market declines... 'There are huge sums of money being put to work,' said Adam Blitz, chief executive officer at Evanston Capital Management LLC... 'You are getting some big checks coming into a fairly small universe of brand-name managers who want to grow and are on the approved list of hedge-fund consultants.' Hedge funds attracted a net $57 billion in the first half of this year, compared with $63.7 billion for all of 2013, according to Hedge Fund Research Inc. Nine firms, including Hutchin Hill, gathered almost a third of that amount... Industry assets have swelled to a record $2.8 trillion even though funds, on average, have posted 7% annualized returns since the financial crisis... Multistrategy firms, which use a range of tactics to invest across asset classes, are the most popular this year after collecting a net $29.5 billion, according to Hedge Fund Research... 'Pension funds see multistrategy hedge funds as a one- size-fits-all investment,' said Brad Balter, head of... Balter Capital Management LLC. 'It's very difficult right now to identify attractive opportunities, so they are letting the manager make the tactical decisions rather than wait for their own investment committees to re-allocate capital.'"

August 26 - Bloomberg (Lyubov Pronina and Natasha Doff): "China's debt dynamics 'are very dangerous, the way it is going now is not sustainable,' Maarten-Jan Bakkum, an emerging-market strategist at ING Groep NV, says... 'It is possible that China has a big financial problem in the coming 12 months...' As long as authorities keep focusing on other things and don't start deleveraging process, 'risks are increasing for the system.' Bakkum sees risk of more defaults: 'it could start with some big real estate development companies or with steel companies with overcapacity, local government finances... There are all these weak spots, and they're all connected..."

EM Bubble Watch:

August 29 - Bloomberg (Matthew Malinowski and Peter Millard): "Brazil's economy slipped into recession in the first half of the year, after contracting more than expected in the second quarter. Gross domestic product shrank by 0.6% in the April-June period from the previous three months, after contracting a revised 0.2% in the first quarter... President Dilma Rousseff's efforts to spark growth through tax cuts, billions of dollars in credit and higher social spending have failed to gain traction, as estimates of expansion this year continue to tumble. Less than two months before elections, the economy has been stalled by falling consumer confidence and shrinking industrial output."

Geopolitical Watch:

August 29 - Financial Times: "Western governments have long wondered whether President Vladimir Putin would order a Russian assault on eastern Ukraine. That such an attack is under way is no longer in doubt. Mr Putin may be conducting a creeping 'stealth' offensive against his neighbour rather than a conventional invasion. But the Nato alliance estimates that there are at least 1,000 Russians operating in Ukraine, using tanks, artillery and armoured personnel carriers. This is a dangerous escalation of the crisis - and one that demands a response from the west. Mr Putin's actions demonstrate that he has no intention whatsoever of abandoning his ambition to dismember Ukraine. He wants to thwart any chance of Kiev's new pro-western leadership taking the country into the Nato alliance. To frustrate Ukraine's hopes of greater integration with the west, Russia's leader is determined to foment a 'frozen conflict' in the east of country."

August 29 - Bloomberg (Robert Hutton and Ian Wishart): "The U.K. will press European Union leaders to consider blocking Russian access to the SWIFT banking transaction system under an expansion of sanctions over the conflict in Ukraine, a British government official said. The Society for Worldwide Interbank Financial Telecommunication, known as SWIFT, is one of Russia's main connections to the international financial system. Prime Minister David Cameron's government plans to put the topic on the agenda for a meeting of EU leaders in Brussels tomorrow... 'Blocking Russia from the SWIFT system would be a very serious escalation in sanctions against Russia and would most certainly result in equally tough retaliatory actions by Russia,' said Chris Weafer, a senior partner at Moscow-based consulting firm Macro Advisory."

August 29 - Bloomberg (Robert Hutton): "Prime Minister David Cameron said the threat to the U.K. from Islamic State militants is greater than anything previously faced, as the government raised the terror threat level to 'Severe,' the second-highest level, based on new intelligence... Speaking today in London, Cameron said the battle against Islamic extremism is a 'generational struggle' which will probably last decades. He said Islamic State, the Sunni militant group also known as ISIL and ISIS that has captured ground in both Syria and Iraq, had taken it to a new level. 'What we are facing in Iraq now with ISIL is a greater threat to our security than we have seen before... We could be facing a terrorist state on the shores of the Mediterranean and bordering a NATO member."

August 25 - Xinhua: "Secretary General of the Organization for Security and Co-operation in Europe (OSCE) Lamberto Zannier has warned of an 'aggressive nationalism' in Europe brought about by confrontations and conflicts, local media reported... In an interview with the Austria Press Agency Monday, Zannier put particular emphasis on the current crisis between Russia and Ukraine, though said an increase in nationalism is also visible in Western Europe, particularly in the form of intolerance in multi-ethnic societies."

August 28 - Bloomberg (Hugh Son): "JPMorgan Chase & Co., the biggest U.S. bank, said it increased defenses against computer hackers after an attack against the industry this month. The lender is working with U.S. authorities to determine the scope of the assault and is taking additional steps to safeguard confidential information... JPMorgan will contact any customers that might have been affected, Wexler said, adding that the firm hasn't seen unusual fraud levels. JPMorgan was among at least five banks targeted in the coordinated attack on financial institutions in recent weeks, a U.S. official said... The assault led to the theft of customer data that could be used to drain accounts, according to another person briefed by U.S. law enforcement."

August 25 - Bloomberg (Indira A.R. Lakshmanan): "With its reign of terror over a large population and ability to self-finance on a staggering scale, the extremist group that beheaded American journalist James Foley resembles the Taliban with oil wells. The Islamic State, which now controls an area of Iraq and Syria larger than the U.K., may be raising more than $2 million dollars a day in revenue from oil sales, extortion, taxes and smuggling, according to U.S. intelligence officials... Unlike other extremist groups' reliance on foreign donations that can be squeezed by sanctions, diplomacy and law enforcement, the Islamic State's predominantly local revenue stream poses a unique challenge to governments seeking to halt its advance and undermine its ability to launch terrorist attacks that in time might be aimed at the U.S. and Europe. 'The Islamic State is probably the wealthiest terrorist group we've ever known,' said Matthew Levitt, a former U.S. Treasury terrorism and financial intelligence official... 'They're not as integrated with the international financial system, and therefore not as vulnerable' to sanctions, anti-money laundering laws and banking regulations."

August 28 - Bloomberg (Tarek El-Tablawy and Mariam Fam): "Egypt has won the United Arab Emirates' support for a crackdown on Islamists and there are signs the collaboration is extending beyond its borders. U.S. officials say the U.A.E. and Egypt were behind air strikes in the Libyan capital in the past week. Egypt has denied its forces were involved, while the U.A.E. said claims of its intervention were an attempt to divert attention from political reversals suffered by Libya's Islamists. The Arab revolts that broke out three years ago have morphed into armed conflicts that mostly pit Islamists against more secular-minded forces. The involvement by a Gulf Cooperation Council member in the Libya strikes, if confirmed, would signal a transition from financier to active participant."

August 26 - Bloomberg (Jason Scott): "Australian lawmaker Clive Palmer issued a written apology to China's ambassador for insulting the nation after calling his Chinese business partners 'mongrels' who want to take over the country's resources. The mining magnate-turned politician, who Prime Minister Tony Abbott must negotiate with to pass legislation, told Chinese Ambassador Ma Zhaoxu he regretted 'any hurt or anguish' his comments may have caused... The millionaire is embroiled in a long-running legal dispute with Citic Pacific Ltd., which has alleged he used funds from a joint account to help finance his political campaign. Palmer also said on the program that the Chinese 'are communists, they shoot their own people, they haven't got a justice system and they want to take over this country.'"

China Bubble Watch:

August 28 - Bloomberg: "Rising stress in China's $6 trillion shadow banking industry is testing central bank Governor Zhou Xiaochuan's resolve to limit monetary easing as risks to the government's growth target climb. In the past three months at least 10 trusts backed by assets spanning coal mines in Shanxi to forests in Fujian have struggled to meet payments, sparking protests by investors outside banks that distributed their products. A slump in new credit in July underscored strains on the industry that funded as much as half of China's recent growth, presenting Zhou with a choice: ease policy to avert a slowdown, or hold the line. 'The central bank faces a dilemma,' said Ding Shuang, senior China economist with Citigroup... 'On one hand, it's part of the government and has to do what it can to aid growth; on the other, it knows better than any other government agency the danger of rising debt. It's a tricky balancing act.'"

August 26 - Financial Times: "China's tottering property market presents one of the greatest threats to the global economy. Not only do the construction and real estate industries account for a full 13% of Chinese gross domestic product, they also form the backbone of the country's fixed asset investment, the lodestar for commodity-exporting economies the world over. News of sagging real estate market activity is, therefore, a concern in its own right. More troubling, though, is that faith in Beijing's ability to prevent a slump from descending into a crash is starting to unravel. The newsflow is bleak. Official statistics for July showed 64 of 70 cities surveyed experiencing falling home prices, the biggest monthly proportion of declines since records began in 2005. Developers are pulling back from new investments, and floor space sold in July tumbled 16.3% year on year, down sharply from June."

August 26 - Financial Times (Jamil Anderlini): "On desolate salt flats on the far outskirts of China's sixth-largest city, dozens of enormous half-built skyscrapers stand as a monument to the excess and optimism of the Chinese real estate market. As physical manifestations of China's property bubble go, few examples can beat this effort to replicate Wall Street in a wasteland 40km outside Tianjin and 150km from the capital Beijing. Blueprints for the Yujiapu Financial District are intentionally modelled on Manhattan's skyline, complete with an ersatz Rockefeller Center and twin office towers that look uncannily similar to the ones destroyed on September 11 2001. Officials in charge of the project boast that when Yujiapu is eventually finished in 2019 it will be one-third larger than the City of London and more than three times the size of New York's financial district, at least in terms of surface area. But after years of soaring prices and frantic construction across the entire country, China's real estate bubble is showing serious signs of strain and this project's fate is now in question. The country's property market is barely 15 years old and nobody has ever experienced a real crash because, before the late 1990s, most urban residents in post-Communist China were still provided housing by their' 'work unit'."

August 27 - Financial Times (Gabriel Wildau): "In the latest sign of Chinese developers' desperation to unload inventory into a weak property market, China Vanke Co is offering discounts of up to $325,000 to homebuyers who shop on Alibaba's Taobao, an e-commerce platform. The country's biggest developer will give discounts that match shoppers' spending of up to Rmb2m ($325,000) on the eBay-like service. Homes in real estate developments in Beijing, Shanghai, Guangzhou and Chongqing, among other cities, will qualify... Developers began cutting prices this year but have so far failed to revive flagging volumes. More than 30 cities have also removed purchase restrictions introduced in 2010 to restrain price growth amid public anger over high prices."

August 29 - Bloomberg (Fion Li): "A probe into China's bond market and concern over debt risks will combine to slow corporate issuance, according to a Moody's... joint venture in the world's second-largest economy. The China Securities Regulatory Commission and National Audit Office are reviewing whether consulting fees paid by bond underwriters played a role in winning mandates, Caixin magazine reported this month. Credit concerns are escalating as property prices fall, state banks increase bad-loan provisions and at least 10 trusts struggle to meet payments. 'This investigation focuses on the approval process, which could become lengthier and likely reduce corporate issuance in the first quarter of 2015,' Yu Lu... analyst at China Chengxin International Credit Rating Co., part-owned by Moody's, said... 'The authorities have raised the alarm on rising corporate bond risks, given the negative headlines.'"

August 25 - Bloomberg (Ting Shi): "China may cut salaries of executives at state-owned enterprises and financial institutions by as much as 70%, the most drastic proposal yet in a planned overhaul of SOE management, according to Caijing magazine. The upper limit for the annual salary of bosses at central SOEs and banks would be set at 600,000 yuan ($97,532) under the change, Caijing magazine reports, citing unidentified people with knowledge of a draft plan by the Ministry of Human Resources and Social Security, the Ministry of Finance and other related agencies. The South China Morning Post cited unidentified officials last week as saying SOE executives would face pay cuts of as much as 50% under the draft plan."

Japan Watch:

August 23 - Reuters: "The Bank of Japan may have to pursue its aggressive monetary policy easing for 'some time' to fully vanquish deflation, BoJ Governor Haruhiko Kuroda said... Speaking at a global central banking conference here, Kuroda said the central bank's efforts to overcome deflation by stimulating Japan's economy with large-scale asset purchases was proving effective. He added, however, that the public was not yet convinced Japan's central bank would hit its 2% inflation target. Creating that expectation was necessary to get firms to raise wages - a key step in Japan's long war with deflation, he said. 'We have committed ourselves to continuing the increasingly accommodative stance until the 2% inflation target is met and maintained in a sustainable manner,' Kuroda said. 'That means inflation expectations are anchored to 2% ... (and) that may take some more time.'"

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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