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Crisis of Confidence

By: Doug Noland | Saturday, August 19, 2017

Global markets are indicating heightened vulnerability. Thursday trading saw the S&P500 decline 1.54%, the second biggest decline of 2017. The session also saw the junk bond market under pressure. A notable $2.18bn of junk fund outflows this week spurred the headline, "Risk Exodus Gets Real With Biggest Fund Redemptions in 6 Months." Currency markets are increasingly unstable. The euro traded to 1.1838 on Monday and fell to a trading low of 1.1662 on Thursday. The dollar/yen rose to 110.95 on Wednesday before reversing course to a near nine-month low of 108.60 during Friday trading. Gold traded to $1,300 in early Friday trading, the high going back to the election. Early-week market relief over the North Korean situation quickly shifted to unease over festering domestic issues.

August 16 – Wall Street Journal (Gabriel Wildau): "One of the most influential analysts of China's financial system believes that bad debt is $6.8tn above official figures and warns that the government's ability to enforce stability has allowed underlying problems to go unchecked. Charlene Chu built her reputation as China banking analyst at credit rating agency Fitch, where she was among the earliest to warn of risks from rising debt, especially in the country's shadow banking system... In her latest report, Ms Chu estimates that bad debt in China's financial system will reach as much as Rmb51tn ($7.6tn) by the end of this year, more than five times the value of bank loans officially classified as either non-performing or one notch above. That estimate implies a bad-debt ratio of 34%, well above the official 5.3% ratio for those two categories at the end of June... 'What I've gotten a greater appreciation for is how everything is so orchestrated by the authorities,' she said. 'The upside is that it creates stability. The downside is that it can create a problem of proportions that people would think is never possible. We're moving into that territory.'"

As is typical, China's Credit expansion slowed during the month of July. Growth in Total Aggregate Social Finance declined to about $180bn. New loans increased $124bn, the slowest rise since last November - but still stronger-than-expected and much stronger than July 2016. In a data point to follow closely, loans to households (mostly mortgages) slowed from June's strong pace. Shadow banking contracted during June (first since October), although y-o-y growth remained a robust 16.5%. At 9.2%, y-o-y money supply growth was the slowest in decades.

It's worth mentioning that Chinese data generally disappointed this week. Retail sales (up 10.4%) were down marginally from June and were below estimates (10.8%). Growth in Fixed Investment (8.3%) and Industrial Production (6.4%) were similarly down m-o-m and below forecasts.

August 13 – Bloomberg: "China's home sales grew last month at the slowest pace in more than two years amid regulators' moves to rein in soaring prices. The value of new homes sold rose 4.3% to 779 billion yuan ($117bn) in July from a year earlier... The increase is the smallest since March 2015, when the home market started to take off on policies to encourage demand from buyers."

There is significant uncertainty associated with Chinese Credit and economic prospects. Through July, the growth in Total Aggregate Finance is tracking 20% above 2016's record level. The first-half boom in Chinese Credit growth – especially household mortgage borrowings – goes a long way in explaining economic resiliency. There are certainly indications that Chinese officials are increasingly concerned with overall system Credit growth, but there is also the view that no tough measures will be adopted that would risk instability heading into this fall's communist party gathering.

August 15 – Financial Times (Tom Mitchell): "China's economy will grow faster than expected over the next three years because of the government's reluctance to rein in 'dangerous' levels of debt, the International Monetary Fund warned... In an annual review of the world's second-largest economy, IMF staff said China's annual economic growth would average 6.4% in 2018-20, compared with a previous estimate of 6%. The IMF is also predicting that the Chinese economy will expand 6.7% this year, up from its earlier forecast of 6.2% growth. The Chinese government, which pledged to double the size of the economy between 2010 and 2020, has tolerated a rapid run-up in debt in order to meet its target. 'The [Chinese] authorities will do what it takes to attain the 2020 GDP target,' the IMF said. As a result, the IMF now expects China's non-financial sector debt to exceed 290% of GDP by 2022, compared with 235% last year. The fund had previously estimated that debt levels would stabilise at 270% of GDP over the next five years."

Looking out past the next few months, there's significant uncertainty associated with Chinese policymaking, finance and economic performance. And before we segue to the mess in Washington, there are as well major near-term uncertainties with respect to global monetary management. There were indications this week that both the ECB and Federal Reserve lack the confidence and consensus necessary to communicate a plan for unwinding what have been years of unprecedented monetary stimulus. It's not confidence inspiring.

August 17 – Wall Street Journal (Todd Buell): "The European Central Bank is wary of pulling the plug too soon on its large bond-buying program, and worried that any move in that direction will push the euro higher, the accounts of its latest meeting showed... The comments suggest that ECB President Mario Draghi will move with immense caution as he approaches two major public appearances in the coming weeks..."

August 17 – Bloomberg (Craig Torres): "Federal Reserve officials are looking under the hood of their most basic inflation models and starting to ask if something is wrong. Minutes from the July 25-26 Federal Open Market Committee meeting showed a revealing debate over why the economy isn't producing more inflation in a time of easy financial conditions, tight labor markets and solid economic growth. The central bank has missed its 2% price goal for most of the past five years. Still, a majority of FOMC participants favor further rate increases. The July minutes showed an intensifying debate over whether that is the right policy response. 'These minutes to me were troubling,' said Ward McCarthy, chief financial economist at Jefferies... 'They don't have their confidence in their policy decisions; and they don't have confidence that they can provide the right kind of guidance.'"

August 16 – Wall Street Journal (David Harrison): "New doubts over sagging inflation in the past few months are driving a split at the Federal Reserve about the timing of the next increase in interest rates. The internal debate raises the possibility that the Fed could deviate from its plans for a third rate increase this year. Soft inflation has bedeviled Fed officials, forcing them to pull back on plans to raise rates multiple times in 2015 and 2016. Minutes from the July 25-26 meeting released Wednesday reveal growing concern among some officials that recent soft inflation numbers could be a sign that something has fundamentally changed in the economy, leading them to suggest holding off on raising rates again for the time being."

China is in an historic Bubble, and this has created extraordinary uncertainty for the future. Global central banks have been engaged in an unprecedented and prolonged monetary inflation, and this has created extraordinary uncertainty for the future. An important facet of the problem is that years of extreme monetary stimulus have ensured that way too much "money" has gravitated to highly speculative global securities and derivatives markets. This has profoundly distorted inflationary dynamics in the securities markets as well as in the global economy overall.

Central bankers are increasingly perplexed as to how to proceed with normalization. While markets remain convinced that monetary policies globally will stay loose indefinitely, I believe indecision at the major central banks creates uncertainties that will increasingly weigh on risk-taking (especially with leverage). Watch the currencies. With the backdrop set, let's move on to Washington.

The Trump Administration now confronts a full-fledged Crisis of Confidence. Even Republican supporters are calling for radical change. And it would at this point appear that some degree of radical departure will be required for the President to muster enough support to move forward with his agenda. I assume the administration will adopt a razor-sharp focus on tax cuts and reform in an attempt to stabilize a sinking ship.

As for the stock market, this week saw the "Trump Rally" conveniently morph to the "Cohn Rally." Rumors of a Gary Cohn departure were said to be behind market selling pressure. It would be shocking to see Cohn abandoned Washington. He may now be the second most powerful individual in the country, with the most powerful enveloped in mayhem.

Importantly, "Risk Off" is gathering some momentum. Over recent years we've witnessed the markets repeatedly disregard – or at least downplay – major political developments. For the most part, markets were this week generally resilient in the face of a distressing and rapidly deteriorating political landscape. So far, the monetary and economic backdrops have remained constructive.

This week saw a stronger-than-expected reading in the Empire Manufacturing Index. Monthly Retail Sales were stronger-than-expected, as was the National Home Builders Housing Market Index (although Starts and Permits lagged). The weekly Bloomberg Consumer Comfort index rose to the highest level since 2001. The Bloomberg National Economy Expectations index surged back to near multi-year highs.

It's worth noting that 10-year Treasury yields declined less than four basis points during Thursday's stock market swoon. For a week that saw U.S. risk markets under some pressure and the VIX spike for the second straight week, it was notable that Treasury yields rose slightly. This should raise concerns that Treasuries may not provide much of a hedge during the next bout of "Risk Off." And if Treasury gains are limited in the event of "Risk Off," what are the ramifications for an overheated corporate debt marketplace?

Unprecedented risk has accumulated across the markets over the past nine years. "Money" has flooded into passive strategies that are essentially a speculation that the bull market – in equities and corporate Credit – will run unabated. Myriad derivatives strategies have flourished, with the proliferation of many products that are essentially writing market insurance ("flood insurance during a drought").

Markets have experience "flash crashes" in the recent past, so I assume there will be more. For good reason, market participants these days presume that central banks will use their balance sheets to ensure that markets remain abundantly liquid. At the same time, the reality is that global central bankers have limited policy tools available in the event of market instability. The downside of delaying policy normalization (for years) is that we're in the late innings of a global Bubble yet rates remain at or near zero around the globe. Central banks have little room to cut interest-rates, while pressure builds to wind down extraordinary balance sheet operations.

I am somewhat reminded of when accounting fraud issues precluded Fannie and Freddie from providing the MBS marketplace a liquidity backstop. It was a pivotal development, though market players were content to ignore ramifications for several years. With booming markets anticipating liquidity abundance indefinitely, it wasn't until the 2008 de-leveraging episode that the absence of the GSE backstop bid mattered.

I don't want to get too far ahead of myself here, but it's worth noting that bank CDS has begun to price in rising risk. For the most part, CDS price reversals are modest and come from multi-year lows. But bank CDS risk has been increasing now for going on a month. And on a global basis, it's kind of the same old potential problem children that have experienced the biggest gains – Dexia, Deutsche Bank, Societe Generale, UBS, BNP Paribas and Credit Suisse. Some of the big European banks saw CDS rise to two month highs this week. U.S. banks are now also seeing a modest rise in CDS prices, in many cases ending the week at one-month highs. It's worth noting as well that the broker/dealer equities index (XBD) declined more than 2% Thursday and was hit 1.4% for the week. Japan's TOPIX Bank Index dropped 2.4% this week.

August 15 – Financial Times (Eric Platt): "Amazon sealed the year's fourth-largest corporate bond sale on Tuesday as the technology and online retail group locked in $16bn to fund its takeover of premium grocer Whole Foods... The company, founded by Jeff Bezos, borrowed the $16bn across seven tranches, ranging from three- to 40-year maturities. Orders for the multibillion-dollar deal climbed to nearly $49bn as banks closed their books..."

I'll also be closely monitoring indicators of corporate Credit risk. According to Dealogic, August's $110 billion of U.S. corporate debt sales pushed y-t-d issuance to $1.2 TN. And while corporate debt prices for the most part held their own this week, spreads have widened meaningfully from July. Even the investment-grade market is indicating a changing backdrop.

I feel compelled to offer brief comments on the sad state of our great nation. Sure, the stock market is close all-time highs and unemployment is at multi-year lows. Business and consumer confidence are strong, which is understandable considering the prolonged Bubble period. That there are such widespread feelings of acrimony and animosity - and that our country can be so bitterly divided - in the midst of today's economic/market backdrop must be alarming to anyone paying attention. I hate to think of the environment after the Bubble bursts – the type of hostility and insecurity that would seem to ensure an epic bear market.

It's almost unbelievable that the November election offered a choice between about the two most divisive figures in American politics. It's as if there are two completely divergent and irreconcilable views of how the world works, how the economy should operate and the role of the federal government. Somehow we've gotten to the point where there cannot even be a civil discussion – let along a meeting of the minds - on the most basic issues.

As has become a popular (Daniel Moynihan) quote to recite, "Everyone is entitled to their own opinions, but they are not entitled to their own facts." These days, facts are in dispute and they're often disputed hatefully. Okay, let's assume the Administration does see some legislative success. What happens after the mid-terms?

It's too easy to blame the political class. Yet politicians do what politicians do. There should be little doubt that the boom and bust dynamics experienced over recent decades have taken a toll on our nation's social and economic fabric. And while many want to blame "globalization," I believe much that we label "globalization" would be more accurately understood as fallout from years of unfettered global finance. Could NAFTA have been as destabilizing to U.S. manufacturing without endless cheap finance flooding into Mexico (and EM more generally). How dominant would China be today without essentially limitless amounts of virtually free "money" to finance over-investment the likes of which the world has never experienced?

I strongly believe that unfettered finance has been instrumental in the long period of U.S. deindustrialization – the transformation from a manufacturing powerhouse into an experiment in a consumption and services-based economic structure. Bubbling securities markets and booming Wall Street finance were integral to this fateful structural shift.

Millions of skilled jobs have been lost, replaced by millions of service sector positions where workers can toil for years and still possess skills of only marginal value. It's now been decades of malinvestment and structural impairment. There has been profound overinvest in almost all things consumption related, which impinges both economic productivity and wage growth. Unimaginable monetary stimulus has spurred asset inflation and spending, but we're now left with a historic Bubble and only deeper structural maladjustment.

Understandably, much of the population feels they've been shortchanged or even cheated. The ongoing inequitable redistribution of wealth becomes only more conspicuous as those fortunate enough to participate in the Bubble accumulate incredible wealth. There's a general sense that the system is unfair and untrustworthy. Too many citizens no longer trust Washington and Wall Street, and they're as well losing trust in our institutions more generally. There's tremendous deep-seated anger for large groups of citizens that feel cheated and marginalized. Two-decades of spectacular boom and bust dynamics have left a tremendous amount of damage.

It's all been so frustratingly predictable. Certainly not for the first time in history, the scourge of unsound money and inflationism has been so subtle that it goes virtually undetected. Instead of being appreciated as the root cause of economic, social, political and geopolitical trouble, monetary inflation is viewed as integral to the solution. Just a little more – just one more round of monetary inflation will do the trick and we'll get back to normal. Right... It ensures hopeless addiction – with tremendous collateral damage. It was a troubling week where the absurdity of it all seemed on full display.

 


For the Week:

The S&P500 slipped 0.6% (up 8.3% y-t-d), and the Dow declined 0.8% (up 9.7%). The Utilities gained 1.2% (up 10.9%). The Banks dipped 0.6% (up 1.6%), and the Broker/Dealers fell 1.4% (up 9.3%). The Transports lost 1.1% (up 0.6%). The S&P 400 Midcaps dropped 1.1% (up 1.9%), and the small cap Russell 2000 fell 1.2% (unchanged). The Nasdaq100 declined 0.7% (up 19.1%), while the Morgan Stanley High Tech index added 0.6% (up 24%). The Semiconductors increased 0.5% (up 18.2%). The Biotechs dropped 1.2% (up 23.2%). With bullion down $5, the HUI gold index declined 0.7% (up 7.8%).

Three-month Treasury bill rates ended the week at 99 bps. Two-year government yields added a basis point to 1.31% (up 12bps y-t-d). Five-year T-note yields gained two bps to 1.76% (down 17bps). Ten-year Treasury yields increased one basis point to 2.19% (down 25bps). Long bond yields slipped a basis point to 2.78% (down 29bps).

Greek 10-year yields rose seven bps to 5.76% (down 145bps y-t-d). Ten-year Portuguese yields fell eight bps to 2.77% (down 97bps). Italian 10-year yields were unchanged at 2.03% (up 22bps). Spain's 10-year yields jumped 10 bps to 1.56% (up 18bps). German bund yields gained three bps to 0.41% (up 21bps). French yields rose three bps to 0.71% (up 3bps). The French to German 10-year bond spread was little changed at 30 bps. U.K. 10-year gilt yields increased three bps to 1.09% (down 15bps). U.K.'s FTSE equities index added 0.2% (up 2.5%).

Japan's Nikkei 225 equities index fell 1.3% (up 1.9% y-t-d). Japanese 10-year "JGB" yields declined three bps to 0.03% (down 1bp). France's CAC40 advanced 1.1% (up 5.2%). The German DAX equities index gained 1.3% (up 6.0%). Spain's IBEX 35 equities index increased 1.0% (up 11.1%). Italy's FTSE MIB index jumped 2.2% (up 13.4%). EM equities were mostly higher. Brazil's Bovespa index jumped 2.2% (up 14.1%), and Mexico's Bolsa increased 0.8% (up 11.9%). South Korea's Kospi rallied 1.7% (up 16.4%). India's Sensex equities index rose 1.1% (up 18.4%). China's Shanghai Exchange jumped 1.9% (up 5.3%). Turkey's Borsa Istanbul National 100 index added 0.2% (up 37.2%). Russia's MICEX equities index declined 0.7% (down 13.5%).

Junk bond mutual funds saw outflows of $2.188 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates slipped a basis point to 3.89% (up 46bps y-o-y). Fifteen-year rates dipped two bps to 3.16% (up 42bps). The five-year hybrid ARM rate rose two bps to 3.16% (up 42bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up four bps to 4.07% (up 46bps).

Federal Reserve Credit last week added $1.4bn to $4.430 TN. Over the past year, Fed Credit declined $8.4bn. Fed Credit inflated $1.619 TN, or 58%, over the past 249 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $3.5bn last week to $3.333 TN. "Custody holdings" were up $129bn y-o-y, or 4.0%.

M2 (narrow) "money" supply last week expanded $7.3bn to $13.619 TN. "Narrow money" expanded $694bn, or 5.4%, over the past year. For the week, Currency increased $1.4bn. Total Checkable Deposits dropped $46.6bn, while Savings Deposits jumped $49.6bn. Small Time Deposits added $1.2bn. Retail Money Funds rose $1.3bn.

Total money market fund assets gained $12.6bn to $2.706 TN. Money Funds fell $23bn y-o-y (0.1%).

Total Commercial Paper rose $7.3bn to $988bn. CP declined $25bn y-o-y, or 2.4%.

Currency Watch:

The U.S. dollar index gained 0.4% to 93.43 (down 8.8% y-t-d). For the week on the upside, the South African rand increased 2.4%, the Brazilian real 1.5%, the Canadian dollar 0.7%, the Mexican peso 0.7%, the Australian dollar 0.4%, the Norwegian krone 0.3%, and the South Korean won 0.3%. On the downside, the British pound declined 1.1%, the euro 0.5%, the Swiss franc 0.3% and the Singapore dollar 0.1%. The Chinese renminbi declined 0.1% versus the dollar this week (up 4.12% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index declined 0.6% (down 4.5% y-t-d). Spot Gold dipped 0.4% to $1,284 (up 11.4%). Silver slipped 0.4% to $17.00 (up 6.4%). Crude declined 31 cents to $48.51 (down 10%). Gasoline recovered 0.7% (down 3%), while Natural Gas dropped 3.0% (down 23%). Copper rose 1.7% (up 18%). Wheat sank 5.2% (up 9%). Corn dropped 2.4% (up 4%).

Trump Administration Watch:

August 16 – Wall Street Journal (Peter Nicholas, Siobhan Hughes and Michael C. Bender): "President Donald Trump's comments faulting both sides in Saturday's deadly white nationalist protest in Virginia rattled his staff and risk setting back his policy agenda in Congress, lawmakers and administration aides said. Mr. Trump's top economic adviser, Gary Cohn, was upset by the remarks and the trajectory of a news conference Tuesday that was supposed to showcase the White House's infrastructure plans, aides said. Instead, the event was dominated by Mr. Trump's fiery commentary about the violence in Charlottesville that left one person dead."

August 15 – Wall Street Journal (Andrew Browne): "By ordering his first trade action against Beijing, while amping up pressure on Chinese leaders to rein in Pyongyang's nuclear menace, U.S. President Donald Trump is bringing to a head two of the most intractable problems that bedevil U.S.-China relations. There are hints that Mr. Trump's hard-nosed strategy could be having an impact—at least in the near-term. After repeated North Korean threats to launch missiles toward the U.S. Pacific territory of Guam, Pyongyang suddenly backed away from that threat Tuesday. And China has signed on to U.N. sanctions that will slash North Korea's already meager foreign revenues by another $1 billion. But Mr. Trump's strategy comes with risks; each issue—trade and North Korea—is volatile enough to upend the relationship. Mismanaged, one could ignite a trade war, the other trigger scenarios that could lead to military conflict."

August 14 – CNBC (Jacob Pramuk): "President Donald Trump on Monday signed a memorandum that could lead to a trade investigation of alleged Chinese theft of intellectual property. The measure directs U.S. Trade Representative Robert Lighthizer to look into options to protect U.S. intellectual property. It does not take any specific action against China at this point. 'We will safeguard the copyrights, patents, trademarks, trade secrets and other intellectual property that is so vital to our security and to our prosperity,' Trump said. He added, 'This is just the beginning.'"

August 14 – Reuters (Michael Martina): "China will take action to defend its interests if the United States damages trade ties, the Ministry of Commerce said..., after U.S. President Donald Trump authorized an inquiry into China's alleged theft of intellectual property. Trump's move, the first direct trade measure by his administration against China, comes at a time of heightened tension over North Korea's nuclear ambitions, though it is unlikely to prompt near-term change in commercial ties. U.S. Trade Representative Robert Lighthizer will have a year to look into whether to launch a formal investigation of China's policies on intellectual property, which the White House and U.S. industry groups say are harming U.S. businesses and jobs."

August 15 – Reuters (Balazs Koranyi): "The United States... laid down a tough line for modernizing the North American Free Trade Agreement, demanding major changes to the pact that would reduce U.S. trade deficits with Mexico and Canada and increase U.S. content for autos. Speaking at the start of the talks in Washington, U.S. President Donald Trump's top trade adviser, Robert Lighthizer, said Trump was not interested in 'a mere tweaking' of the 23-year-old pact, which he blames for hundreds of thousands of job losses to Mexico. 'We feel that NAFTA has fundamentally failed many, many Americans and needs major improvement,' Lighthizer, the U.S. Trade Representative, said in an opening statement."

August 14 – Reuters: "Industry groups and other sectors of society are gearing up to fight proposed changes to the personal income tax. Proposed changes to the personal tax code have already stirred opposition from real estate agents, home builders, mortgage lenders and charities. U.S. Congress members are focused during their August recess on finding ways to lower the corporate tax rate."

China Bubble Watch:

August 14 – Wall Street Journal (Anjani Trivedi): "All roads in Beijing's deleveraging efforts lead to its banks. China's central bank—increasingly becoming the one all-powerful financial regulator—said it would begin reclassifying the fastest-growing source of banks' wholesale funding from the first quarter of next year. So-called negotiable certificates of deposits (NCDs), a type of money-market instrument that came into existence just three years ago, have grown almost 60% in the past year to 8.4 trillion yuan ($1.26 trillion) in July. The new rule is supposed curb Chinese banks' ability to expand their balance sheets rapidly using these short-term financing tools. Funding has become a difficult task for China's banks. The traditional deposit base has been fleeing to higher-yielding investment products while capital markets have made raising debt punitive. So NCDs have been all the rage. Of the 1.6 trillion yuan issued in July, small and midsize banks issued the bulk of the volume and half of all NCDs are issued by a dozen such banks."

August 15 – Bloomberg: "China's giant shadow banking industry shrank for the first time in nine months during July -- evidence Beijing's campaign to quash risks to the financial system may be starting to bear fruit. At the same time, however, traditional forms of lending are seeing a renaissance. Net corporate bond issuance has been jumping as non-financial corporations opt for cheaper sources of finance than borrowing in the shadow banking sector, where costs have surged amid the government crackdown. As China stares down a twice-a-decade leadership re-shuffle later this year, President Xi Jinping has made financial-sector stability a top priority."

August 14 – Bloomberg: "China's economy showed further signs of entering a second-half slowdown, as curbs on property, excess borrowing and industrial overcapacity began to bite. Industrial output rose 6.4% from a year earlier in July, versus a median projection of 7.1% and June's 7.6%. Retail sales expanded 10.4% from a year earlier, compared with a projection of 10.8% and 11% in June. Fixed-asset investment in urban areas rose 8.3% from a year earlier in the first seven months, versus a forecast 8.6% rise."

August 14 – Bloomberg: "Nearly two months after reports about Chinese regulators' scrutiny of the country's top dealmakers, the concerns have left a mark in the local bond market, where one of those companies is facing yields double the national average. Yields on onshore securities without put or call options of Dalian Wanda Commercial Properties Co., which has an AAA rating onshore, are above 9%... That compares with the average 4.55% yield on top-rated notes due in three years from all corporate borrowers in the country. It's also higher than the 5.8% average yield on three-year notes with AA- ratings, considered junk in China."

August 16 – Bloomberg: "Yu'E Bao, the world's biggest money-market fund, still has potential to grow more even after it expanded at the fastest half-year pace in three years in the first six months of 2017, according to Fitch... The Chinese fund is sold on the mobile-payment platform Alipay, offered by Alibaba Group Holding Ltd.'s financial affiliate, which is controlled by Jack Ma. The billionaire founder of Alibaba has promoted Alipay for everything from grocery shopping to settling restaurant bills. That's spurred growth of Yu'E Bao, which gives users a way to stash away savings with no minimum investment or time frame. Yu'E Bao has 1.4 trillion yuan ($210bn) of assets under management... It has beaten the average returns for money-market funds in the nation for much of this year, further boosting its allure, according to Fitch analyst Huang Li."

Central Bank Watch:

August 16 – Reuters (Balazs Koranyi): "European Central Bank President Mario Draghi will not deliver a new policy message at the U.S. Federal Reserve's Jackson Hole conference, two sources familiar with the situation said, tempering expectations for the bank to start charting the course out of stimulus. An ECB spokesman said that Draghi will focus on the theme of the symposium, fostering a dynamic global economy, in his Aug. 25 remarks, while the sources added that he was keen to hold off on the policy discussion until the autumn... Expectations for the speech had been building in recent weeks with investors pointing to next Friday's event as the likely kick off in the ECB's debate how to recalibrate monetary policy given solid growth, rapidly falling unemployment but persistently weak underlying inflation."

August 15 – Financial Times (Claire Jones): "The European Central Bank faces a legal challenge over its €2tn quantitative easing programme after Germany's highest court said the measures may violate EU law. The country's constitutional court said on Tuesday that it would refer a case launched against QE to the European Court of Justice. It said there were indications that decisions about the programme overstepped the ECB's mandate and contravened a ban on purchasing bonds directly from governments, known as monetary financing. 'In the view of the [court] significant reasons indicate that the ECB decisions governing the asset purchase programme violate the prohibition of monetary financing and exceed the monetary policy mandate of the European Central Bank,' the court said... 'It is doubtful whether the [purchase of government bonds under QE] is compatible with the prohibition of monetary financing.'"

Global Bubble Watch:

August 15 – Financial Times (Kate Allen and Keith Fray): "Leading central banks now own a fifth of their governments' total debt, a sign of the scale of the challenge they will face in unwinding unprecedented stimulus measures deployed over the past decade. Since the financial crisis emerged, the world's biggest central banks have carried out large-scale purchases of bonds and other securities in a bid to boost the global economy by driving down borrowing costs for households and businesses. In total, the six central banks that have embarked on quantitative easing over the past decade — the US Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England, along with the Swiss and Swedish central banks — now hold more than $15tn of assets, ...more than four times the pre-crisis level. Of this, more than $9tn is government bonds — one dollar in every five of the $46tn total outstanding debt owed by their governments."

August 14 – Financial Times (Leo Lewis): "There was a time when a US president threatening 'fire and fury' and footage of children practising nuclear drills might have hit the Nikkei 225 harder than a 2% dip. But that was before the Bank of Japan's addiction to exchange traded funds (ETFs). There is no enigma here. Last week, when Japanese investors might reasonably have taken fright, the BoJ unleashed a test launch of its own — a record-breaking grab of more than $2bn of Japanese equity ETFs in 52 hours. That adds to a BoJ share portfolio whose book value passed $127bn at the end of June..."

August 13 – Bloomberg: "China's surging commodity prices are sending a warning signal on inflation. That should be negative for bonds, but the debt market seems unruffled. As futures on steel reinforcement bars surged to their highest level since 2013 in Shanghai last week, joining copper and aluminum at multi-year highs, bonds barely registered. A Bank of America index of the Chinese debt market was little changed, continuing a trend that's left it steady in the quarter, even as commodity prices look to be stirring."

August 15 – Bloomberg (Greg Quinn and Erik Hertzberg): "Canada's benchmark home price fell by the most in nearly a decade last month as Toronto led a fourth straight decline in sales. The nationwide benchmark home price declined 1.5% to C$607,100 ($476,000) from June... In Toronto, the country's largest city, the price fell 4.7% on the month."

August 14 – Bloomberg (Michael Heath): "Australia's central bank renewed its focus on mounting household debt, even as the outlook for the nation's economy improved, according to the minutes of this month's policy decision... The main change is one of emphasis after the Reserve Bank of Australia removed the labor market and added household balance sheets -- where debt is currently at a record 190% of income -- to its key areas of concern alongside the residential property market."

Fixed Income Bubble Watch:

August 15 – Wall Street Journal (Sam Goldfarb): "Amazon.com Inc. sold $16 billion of bonds... to help fund its purchase of Whole Foods Market Inc., meeting strong demand from investors as it made a rare trip to the debt market. Amazon sold a $3.5 billion 10-year bond at a 0.9-percentage-point yield-premium to Treasurys, below the 1.1-percentage-point guidance set by underwriters earlier in the day... The e-commerce giant benefited from similarly favorable price adjustments across six other maturities, ranging from three-years to 40-years, the person said. In its entirety, the sale added up to the fourth-largest U.S. corporate bond deal of the year..."

August 17 – Bloomberg (Natasha Doff): "Investors overseeing about $1.1 trillion have been cutting exposure to the world's riskiest corporate debt as rates grind too low to compensate for potential risks. Even after a selloff last week amid rising tensions between the U.S. and North Korea, a Bloomberg Barclays index of global junk bonds still yields 5.3%, 100 bps below the average for the past five years. High-yield corporate debt has been one of the biggest beneficiaries of central stimulus... The danger now is that higher Federal Reserve interest rates and the European Central Bank tapering will reverse the trend."

August 14 – Bloomberg (Nabila Ahmed, Sally Bakewell, Molly Smith, and Claire Boston): "Have we finally reached peak credit markets? It's a question that big names like BlackRock, DoubleLine and Pimco have been asking during this seemingly endless summer of debt. Signs of froth are everywhere. U.S. high-grade companies, which have already sold almost $1 trillion of bonds this year, are on track to break old issuance records. By some measures, corporate America is deeper in debt than ever before. Junk bonds, yielding on average just 5.8%, have fallen close to post-crisis lows. And on Friday, investors lined up in droves to provide $1.8 billion in financing to Elon Musk's unprofitable electric carmaker, Tesla Inc. -- and at interest rates that few could have envisioned a couple of years ago."

Federal Reserve Watch:

August 16 – Wall Street Journal (David Harrison): "New doubts over sagging inflation in the past few months are driving a split at the Federal Reserve about the timing of the next increase in interest rates. The internal debate raises the possibility that the Fed could deviate from its plans for a third rate increase this year. Soft inflation has bedeviled Fed officials, forcing them to pull back on plans to raise rates multiple times in 2015 and 2016. Minutes from the July 25-26 meeting released Wednesday reveal growing concern among some officials that recent soft inflation numbers could be a sign that something has fundamentally changed in the economy, leading them to suggest holding off on raising rates again for the time being."

August 14 – Bloomberg (Jeanna Smialek): "Federal Reserve Bank of New York President William Dudley said it isn't unreasonable to expect the central bank to announce plans in September to start trimming its balance sheet and said he supports another interest-rate increase this year if the economy evolves as he expects. 'I would expect -- I would be in favor of doing another rate hike later this year' if the economy holds up, Dudley said..."

August 14 – Wall Street Journal (Ben Eisen): "The market is once again second-guessing whether the Federal Reserve can lift rates again this year. The yield on the two-year Treasury note... fell to 1.29% from its early-July level of 1.41%, the highest since 2008. In the fed funds futures market, where traders wager on the path of the Fed's policy rate, there was a 36% chance of at least one more rate increase by the end of the year, down from 54% a month ago..."

August 16 – Financial Times (Sam Fleming): "One of the Federal Reserve's top policymakers has attacked attempts to reverse the post-crisis drive for tougher regulation, calling efforts to loosen constraints on banks 'dangerous and extremely short-sighted'. Stanley Fischer, the vice-chairman of the Fed's board of governors, said... there are troubling signs of a drive to return to the status quo that preceded it. While he endorsed efforts to ease up on small banks, he said political pressure in Washington to curtail regulatory burdens on large institutions was very hazardous. Republican politicians have been urging a loosening of some capital and liquidity requirements on financial institutions, arguing that they are hampering firms' ability to lend... 'I am worried that the US political system may be taking us in a direction that is very dangerous... It took almost 80 years after 1930 to have another financial crisis that could have been of that magnitude. And now after 10 years everybody wants to go back to a status quo before the great financial crisis. And I find that really, extremely dangerous and extremely short-sighted. One can understand the political dynamics of this thing, but one cannot understand why grown intelligent people reach the conclusion that [you should] get rid of all the things you have put in place in the last 10 years.'"

U.S. Bubble Watch:

August 13 – Financial Times (Chris Flood): "Record-breaking inflows into exchange traded funds this year are fuelling fears that the tide of money surging into passive investment is helping to inflate a bubble in the US stock market... Investors have ploughed $391bn into ETFs in the first seven months of 2017, already surpassing last year's record annual inflow of $390bn, according to ETFGI... The ETF industry has attracted almost $2.8tn in new business since the start of 2008, coinciding with one of the longest bull runs in US stock market history. The US benchmark S&P 500 index hit an all-time high on August 8, up 267% since its post financial-crisis low in March 2009... 'When the management of assets is on autopilot, as it is with ETFs, then investment trends can go to great excess,' said Howard Marks, co-founder of Oaktree Capital.'"

August 15 – Reuters (Jonathan Spicer): "Americans' debt level notched another record high in the second quarter, after having earlier in the year surpassed its pre-crisis peak, on the back of modest rises in mortgage, auto and credit card debt, where delinquencies jumped. Total U.S. household debt was $12.84 trillion in the three months to June, up $552 billion from a year ago... The proportion of overall debt that was delinquent, at 4.8%, was on par with the previous quarter. However a red flag was raised over the transitions of credit card balances into delinquency, which the New York Fed said 'ticked up notably.'"

August 15 – Bloomberg (Adam Tempkin): "Amid all the reflection on the 10-year anniversary of the start of the subprime loan crisis, here's a throwback that investors could probably do without. There's a section of the auto-loan market -- known in industry parlance as deep subprime -- where delinquency rates have ticked up to levels last seen in 2007, according to... Equifax. 'Performance of recent deep subprime vintages is awful,' Equifax said... 'We're seeing an increase in delinquencies across all credit scores, but in the highest credit quality, it's just a basis point or two,' Chief Economist Amy Crews Cutts said... 'In deep subprime, the rise is more substantial. What stood out to me was the issuers. Those that have been doing this for a decade or more were showing the 'better' performance, while those that were relative newcomers were in the 'worse' category.'"

August 16 – Bloomberg (Michelle Jamrisko): "U.S. housing starts stumbled in July on an abrupt slowdown in apartment construction and a modest decline in single-family homebuilding that shows the industry will do little to spur the economy... Residential starts decreased 4.8% to a 1.16 mln annualized rate (est. 1.22 mln). Multifamily home starts slumped 15.3%, one-family down 0.5%. Permits, a proxy for future construction, fell 4.1% to 1.22 mln rate."

August 15 – Bloomberg (Michelle Jamrisko): "Sentiment among American homebuilders unexpectedly increased to a three-month high as builders saw greater prospects for industry demand despite elevated material costs and shortages of labor and lots, according to... the National Association of Home Builders/Wells Fargo. Builders' Housing Market Index increased to 68 (est. 64) from 64 in July. Measure of six-month sales outlook rose to 78 from 73. Index of current sales climbed to 74 after 70."

August 15 – CNBC (Diana Olick): "The cost of housing is rising at a fast clip, and nowhere is it more apparent than in the market for newly built homes. Sales there are rising, but only on the higher end, and that is leaving the majority of entry-level buyers out of luck... While homebuilders claim they are trying to target the high demand from entry-level buyers, the numbers simply don't show that. More affordable homes, those priced under $200,000, made up 44% of the market in 2010. Today, they are just 16% of new, for-sale construction... During the same period, the share of newly built homes priced between $200,000 and $400,000 has grown to 55% from 43%. Going even further up the price scale, the share of new homes priced above $400,000 has more than doubled to 29% of the market from 13%."

August 14 – Bloomberg (Luke Kawa): "U.S. stocks have been able to hit fresh highs this year despite a dearth of demand from a key source of buying. Share repurchases by American companies this year are down 20% from this time a year ago, according to Societe Generale global head of quantitative strategy Andrew Lapthorne. Ultra-low borrowing costs had encouraged large firms to issue debt to buy back their own stock, thereby providing a tailwind to earnings-per-share growth. 'Perhaps over-leveraged U.S. companies have finally reached a limit on being able to borrow simply to support their own shares,' writes Lapthorne. Repurchase programs account for the lion's share of net inflows into U.S. equities during this bull market."

Europe Watch:

August 14 – Reuters (Gernot Heller): "German Finance Minister Wolfgang Schaeuble said... that the European Central Bank's ultra-loose monetary policy would come to an end in the foreseeable future, but interest rates would remain low. Regarding the end of the period of low interest rates, Schaeuble said: 'There are signs that it is gradually getting better.' Speaking at an campaign rally ahead of a Sept. 24 election, the veteran conservative said: 'No one seriously disputes that interest rates are rather too low for the strength of the German economy and the exchange rate of the euro, which is rising now.' Schaeuble said most people expected the ECB to take a further step at a September meeting towards gradually quitting its very expansive monetary policy."

Japan Watch:

August 13 – Bloomberg (Keiko Ujikane): "Japan's economy grew for a sixth straight quarter, extending the longest expansion in more than a decade, as a strong pick-up in demand at home compensated for softer exports. Gross domestic product increased by an annualized 4.0% in the three months ended June 30 (estimate +2.5%), compared with a revised 1.5% in the previous quarter."

August 16 – Wall Street Journal (Peter Landers): "Amid a welter of conflicting views over North Korea, there is one reliable standby. Japan's prime minister has agreed with President Donald Trump, every time. Shinzo Abe is the type of leader to repeat talking points in measured words, while Mr. Trump is known for issuing aggressive statements unpredictably. On substance, however, they are in the same place... 'I think highly of President Trump's commitment toward the security of allies,' Mr. Abe said Tuesday after a 30-minute phone call with the president, the ninth time the two leaders have spoken by telephone since Mr. Trump's inauguration. The two have also met three times this year in person..."

EM Bubble Watch:

August 16 – Financial Times (Adam Samson): "Investors in exchange-traded funds have garnered increasing sway over emerging-market stocks and bonds, Citigroup said..., underscoring the swelling importance to global markets of passive instruments. ETFs that track EM assets now have almost $250bn dollars under management, with $196bn in equities and $48bn in fixed income... That represents close to a fifth of total emerging-market mutual fund AUM. Just two years ago, the figure was just above 12%. The figures highlight how the boom in passive investing is not limited just to developed markets that have more liquid assets. In fact, the sixth-biggest ETF by assets tracks emerging markets stocks... 'ETF flows themselves increasingly representative of asset class sentiment as a whole,' notes Citi's Luis Costa."

Geopolitical Watch:

August 16 – CNBC (Justina Crabtree): "While the world has focused on North Korea, the globe's two biggest emerging economies are squaring off over their shared border. China and India's borderlands, though geographically desolate and inhospitable, have been a hot spot for increasing military tension in recent months. The two giants are wrestling more broadly for hegemony in Asia, and given that both are equipped with nuclear weapons, the situation could escalate. 'Both sides stand to lose tremendously, economically speaking, should this boil over into an actual war,' wrote Asia analysts Shailesh Kumar and Kelsey Broderick at consulting firm Eurasia Group."

August 15 – Reuters: "Indian and Chinese soldiers were involved in an altercation in the western Himalayas on Tuesday, Indian sources said, further raising tensions between the two countries, which are already locked in a two-month standoff in another part of the disputed border. A source in New Delhi, who had been briefed on the military situation on the border, said soldiers foiled a bid by a group of Chinese troops to enter Indian territory in Ladakh, near the Pangong lake."

August 15 – Reuters: "Iran could abandon its nuclear agreement with world powers 'within hours' if the United States imposes any more new sanctions, Iranian President Hassan Rouhani said... If America wants to go back to the experience (of imposing sanctions), Iran would certainly return in a short time - not a week or a month but within hours - to conditions more advanced than before the start of negotiations,' Rouhani told a session of parliament... Iran says new U.S. sanctions breach the agreement it reached in 2015 with the United States, Russia, China and three European powers in which it agreed to curb its nuclear work in return for the lifting of most sanctions."

 

Author: Doug Noland

Doug Noland
Credit Bubble Bulletin

Doug Noland

I just wrapped up 25 years (persevering) as a "professional bear." My lucky break came in late-1989, when I was hired by Gordon Ringoen to be the trader for his short-biased hedge fund in San Francisco. Working as a short-side trader, analyst and portfolio manager during the great nineties bull market - for one of the most brilliant individuals I've met - was an exciting, demanding and, in the end, a grueling and absolutely invaluable learning experience. Later in the nineties, I had stints at Fleckenstein Capital and East Shore Partners. In January 1999, I began my 16 year run with PrudentBear, working as strategist and portfolio manager with David Tice in Dallas until the bear funds were sold in December 2008.

In the early-nineties, I became an impassioned reader of The Richebacher Letter. The great Dr. Richebacher opened my eyes to Austrian economics and solidified my lifetime passion for economics and macro analysis. I had the good fortune to assist Dr. Richebacher with his publication from 1996 through 2001.

Prior to my work in investments, I worked as a treasury analyst at Toyota's U.S. headquarters. It was working at Toyota during the Japanese Bubble period and the 1987 stock market crash where I first recognized my love for macro analysis. Fresh out of college I worked as a Price Waterhouse CPA. I graduated summa cum laude from the University of Oregon (Accounting and Finance majors, 1984) and later received an MBA from Indiana University (1989).

By late in the nineties, I was convinced that momentous developments were unfolding in finance, the markets and policymaking that were going unrecognized by conventional analysis and the media. I was inspired to start my blog, which became the Credit Bubble Bulletin, by the desire to shed light on these developments. I believe there is great value in contemporaneous analysis, and I'll point to Benjamin Anderson's brilliant writings in the "Chase Economic Bulletin" during the Roaring Twenties and Great Depression era. Ben Bernanke has referred to understanding the forces leading up to the Great Depression as the "Holy Grail of Economics." I believe "The Grail" will instead be discovered through knowledge and understanding of the current extraordinary global Bubble period.

Disclaimer: Doug Noland is not a financial advisor nor is he providing investment services. This blog does not provide investment advice and Doug Noland's comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. The Credit Bubble Bulletins are copyrighted. Doug's writings can be reproduced and retransmitted so long as a link to his blog is provided.

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