Saturday, October 29, 2016

Weekly Commentary: Peak Monetary Stimulus

October 28 – Bloomberg (Eliza Ronalds-Hannon and Claire Boston): “After all central bankers have done since the financial crisis to prop up bond prices, it didn’t take much for them to send the global debt market reeling. Bonds worldwide have lost 2.9% in October, according to the Bloomberg Barclays Global Aggregate Index, which tracks everything from sovereign obligations to mortgage-backed debt to corporate borrowings. The last time the bond world was dealt such a blow was May 2013, when then-Federal Reserve Chairman Ben S. Bernanke signaled the central bank might slow its unprecedented bond buying.”

German bund yields surged 16 bps this week to 0.16% (high since May), with Bloomberg calling performance the “worst month since 2013.” French yields jumped 18 bps this week (to 0.46%), and UK gilt yields rose 17 bps (to 1.26%). Italian yields surged a notable 21 bps to a multi-month high 1.58%.

A cruel October has seen German 10-year yields surging 31bps, with yields up 58 bps in the UK, 31 bps in France, 40 bps in Italy, 33 bps in Spain and 30 bps in the Netherlands. Ten-year yields have surged 43 bps in Australia, 40 bps in New Zealand and 25 bps in South Korea.

Countering global bond markets, Chinese 10-year yields traded Monday at a record low 2.60%. There seems to be a robust safe haven dynamic at work. It’s worth noting that China’s one-year swap rate ended the week at an 18-month high 2.73%, with China’s version of the “TED” spread (interest-rate swaps versus government yields) also widening to 18-month highs.

Here at home, 10-year Treasury yields this week jumped 12 bps to 1.85%, the high since May. Long-bond yields rose 15 bps to 2.62%, with yields up 30 bps in four weeks.

And while sovereign bond investors are seeing a chunk of their great year disappear into thin air, the jump in yields at this point hasn’t caused significant general angst. During the October sell-off, corporate debt has outperformed sovereign, and there are even U.S. high yield indices that have generated small positive returns for the month. Corporate spreads generally remain narrow – not indicating worries of recession or market illiquidity.

October 27 – Wall Street Journal (Ben Eisen): “By some measures, October is already a record month for mergers and acquisitions. Qualcomm $39 billion deal to buy NXP Semiconductors helped push U.S. announced deal volume this month to $248.9 billion, according to… Dealogic. That tops the previous record of $240.2 billion from last July… It was assisted by last week’s record weekly U.S. volume of $177.4 billion.”

And while bond sales have slowed somewhat in October, global corporate bond issuance has already surpassed $2.0 TN. The Financial Times is calling it “the best year in a decade,” with issuance running 9% ahead of a very strong 2015. According to Bloomberg, this was the third-strongest week of corporate debt issuance this year.

At this point, there’s not a strong consensus view as to the factors behind the global backup in yields. Some see rising sovereign yields as an indication of central bank success: with inflation finally having turned the corner, there will be less pressure on central bankers to push aggressive stimulus. Others argue that central bankers are coming to accept that the rising risks of QE infinity and negative rates have overtaken diminishing stimulus benefits.

Importantly, there’s no imminent reduction in the approximately $2.0 TN annual QE that has been underpinning global securities and asset prices. It’s hard to believe it’s been almost three and one-half years since the Bernanke “taper tantrum.” With only one little baby-step rate increase to its Credit, rate normalization couldn’t possibly move at a more glacial pace.

There’s deep complacency in the U.S. regarding vulnerability to reduced monetary stimulus. The Fed wound down QE and implemented a rate increase without major market instability. I believe this was only possible because of the extraordinary monetary stimulus measures in play globally. “Whatever it takes” central banking, in particular from the ECB and BOJ, unleashed Trillions of liquidity (and currency devaluation) that certainly underpinned U.S. securities and asset markets. Prices of sovereign debt, including Treasuries, have traded at levels that assume global central banker support will last indefinitely. Markets have begun reassessing this assumption.

October 28 – Reuters (Leika Kihara): “As his term winds down, Bank of Japan Governor Haruhiko Kuroda has retreated from both the radical policies and rhetoric of his early tenure, suggesting there will be no further monetary easing except in response to a big external shock. In a clear departure from his initial ‘shock and awe’ tactics to jolt the nation from its deflationary mindset, he has even taken to flagging what little change lies ahead, trying predictability where surprise has failed. This new approach will be on show next week, when the BOJ is set to keep policy unchanged despite an expected downgrade in forecasts that could show Kuroda won't hit his perpetually postponed 2% inflation target before his five-year term ends in April 2018. ‘The days of trying to radically heighten inflation expectations with shock action are over,’ said a source familiar with the BOJ's thinking. ‘No more regime change.’”

My view that “QE has failed” has seemed extreme – even outrageous to conventional analysts. Yet Japan is the epicenter of the Bernanke doctrine of radical experimental inflationism. Unshakable central banker “shock and awe” and “whatever it takes” were supposed to alter inflationary expectations throughout the economy, in the process boosting asset prices, investment, incomes, spending and – importantly – the general price level. Deflation, it was argued, was self-imposed.

It may have worked brilliantly in theory – it’s just not looking so bright in practice. An impervious Japanese CPI has continued to decline, while the central bank has pushed bond prices to ridiculous extremes by purchasing a third of outstanding government debt. Major risks associated with an out-of-control central bank balance sheet and asset Bubbles are not inconspicuous in Japan. There is today heightened pressure in Japanese policy circles to wind down this experiment before it’s too late. It will not go smoothly.

In the category “truth is stranger than fiction”, November 8th can’t arrive soon enough. Suddenly, it appears the markets may have some election risk to contemplate. And there will be no rest for the weary. The ECB meets one month later, on December 8th.

October 27 – Bloomberg (Jeff Black and Jill Ward): “European Central Bank officials signaled that they support extending asset buying beyond the earliest end-date of March, arguing that returning to a healthy level of inflation demands maintaining the pace as the economy heals. Speaking in London…, Irish central bank Governor Philip Lane said that the ‘broad narrative’ in the market about the ECB’s strategy on bond purchases is that it will continue until inflation is heading reliably toward the target of just under 2%. His comments echoed remarks by Executive Board member Benoit Coeure… and Spain’s Governor Luis Maria Linde… ‘March was always an intermediate staging post,’ said Lane. ‘The narrative of the euro area is that there’s been this moderate but sustained recovery, by and large driven by domestic factors, especially consumption. But inflation remains low compared to target and essentially that’s the assessment.’”

I’m not so sure Germany and fellow ECB hawks saw March as “always an intermediate staging post.” Draghi purposely avoided commencing the discussion of extending QE past March. What will likely be a heated debate will take place in December.

October 25 – Reuters (Gernot Heller): “There is a growing international consensus that monetary policy has reached the limits of its possibilities, German Finance Wolfgang Schaeuble told a group of government officials in Berlin… Schaeuble also said that he believed that there was an excess of liquidity and excess of indebtedness internationally.”

Over recent months, German public opinion has turned even more against QE. Bundesbank President Jens Weidmann has been opposed to QE from day one, and his skepticism has been shared by fellow German (ECB executive board member) Sabine Lautenschläger. A majority of Germans believe QE is hurting Deutsche Bank and the German banking system more generally. And there is growing frustration that the ECB is a mechanism for redistributing German wealth. The stakes for dismissing German concerns are growing.

Draghi has grown accustomed to playing dangerously. Front-running committee deliberations, he has signaled to the markets that QE will run past March. Comments and leaks from within the ECB have encouraged the markets to assume that aggressive stimulus will run uninterrupted for months to come. All this places great pressure on ECB hawks. And this is a group that has seen its concerns repeatedly rejected; a group that has surely become only more troubled by the course of Eurozone and global monetary policymaking. If they have much say in policy come December, markets will tantrum. I can imagine that Draghi’s pressure tactics must by this point be wearing really thin.

Fledgling “risk off” turned more apparent this week. Notably, the broader U.S. equities market came under pressure. Having outperformed over recent months, the now Crowded Trades in the mid- and small-caps saw price drops of 1.8% and 2.5%. In general, the beloved high dividend and low volatility stocks – colossal Crowded Trades – also badly lagged the market. The REITS (VNQ) dropped another 3.6% this week, having declined 13% from August highs to trade to the lowest level since April. The homebuilders (XHB) declined to the low since March. It’s worth noting that Ford this week also traded to lows going back to March.

Abnormal has been around so long now we’ve grown accustomed. Fifteen-year mortgage rates at 2.78%. ARMs available at 2.75%. And I’m hearing automobile advertisements even more outrageous than 2007. “Lease Kia two for $222 a month.” How much future demand has been pulled forward by history’s lowest interest rates – and accompanying loose Credit.

QE is not disappearing any day soon. Yet there’s a decent argument that we’re at Peak Monetary Stimulus. The Fed is preparing for a hike in December. The Kuroda BOJ has lost its appetite for surprising markets with added stimulus. And I suspect the ECB is just over a month away from a contentious discussion of how to taper QE starting after March 2017. Market liquidity may not be a pressing concern today, but it will be in the not too distant future.


For the Week:

The S&P500 declined 0.7% (up 4.0% y-t-d), while the Dow was little changed (up 4.2%). The Utilities gained 1.0% (up 12.7%). The Banks rose 1.2% (up 2.0%), while the Broker/Dealers declined 1.6% (down 4.0%). The Transports were about unchanged (up 6.8%). The broader market was under pressure. The S&P 400 Midcaps fell 1.8% (up 7.2%), and the small cap Russell 2000 sank 2.5% (up 4.6%). The Nasdaq100 declined 1.0% (up 4.6%), while the Morgan Stanley High Tech index gained 0.8% (up 10.9%). The Semiconductors increased 0.5% (up 23.4%). The Biotechs sank 3.1% (down 22.3%). Though bullion gained $9, the HUI gold index dropped 4.1% (up 86%).

Three-month Treasury bill rates ended the week at 28 bps. Two-year government yields added three bps to 0.85% (down 20bps y-t-d). Five-year T-note yields rose eight bps to 1.32% (down 43bps). Ten-year Treasury yields jumped 12 bps to 1.85% (down 40bps). Long bond yields surged 14 bps to 2.62% (down 40bps).

Greek 10-year yields declined seven bps to 8.21% (up 89bps y-t-d). Ten-year Portuguese yields jumped 15 bps to 3.31% (up 79bps). Italian 10-year yields surged 21 bps to 1.58% (down one bp). Spain's 10-year yields rose 12 bps to 1.23% (down 54bps). German bund yields jumped 16 bps to 0.16% (down 46bps). French yields gained 18 bps to 0.46% (down 53bps). The French to German 10-year bond spread widened two to 30 bps. U.K. 10-year gilt yields rose 17bps to 1.26% (down 70bps). U.K.'s FTSE equities index slipped 0.3% (up 12.1%).

Japan's Nikkei 225 equities index rallied 1.6% (down 8.2% y-t-d). Japanese 10-year "JGB" yields inched up a basis point to negative 0.06% (down 32bps y-t-d). The German DAX equities index was little changed (down 0.4%). Spain's IBEX 35 equities index rose 1.1% (down 3.6%). Italy's FTSE MIB index gained 0.9% (down 19.1%). EM equities were mixed. Brazil's Bovespa index added 0.3% (up 48%). Mexico's Bolsa fell 0.8% (up 11.7%). South Korea's Kospi declined 0.7% (up 3.0%). India’s Sensex equities slipped 0.5% (up 7.0%). China’s Shanghai Exchange added 0.4% (down 12.3%). Turkey's Borsa Istanbul National 100 index dipped 0.6% (up 9.2%). Russia's MICEX equities index gained 1.2% (up 12.5%).

Junk bond mutual funds saw outflows of $48 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell five bps last week to 3.47% (down 29bps y-o-y). Fifteen-year rates slipped a basis point to 2.78% (down 20bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up four bps to 3.67% (down 17bps).

Federal Reserve Credit last week declined $4.6bn to $4.430 TN. Over the past year, Fed Credit contracted $28.3bn (0.6%). Fed Credit inflated $1.619 TN, or 58%, over the past 207 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $2.8bn last week to $3.125 TN. "Custody holdings" were down $167bn y-o-y, or 5.1%.

M2 (narrow) "money" supply last week fell $9.3bn to $13.115 TN. "Narrow money" expanded $956bn, or 7.9%, over the past year. For the week, Currency increased $2.7bn. Total Checkable Deposits dropped $76.2bn, while Savings Deposits jumped $68.5bn. Small Time Deposits were little changed. Retail Money Funds declined $3.9bn.

Total money market fund assets expanded $16.1bn to $2.651 TN. Money Funds declined $66bn y-o-y (2.4%).

Total Commercial Paper declined $2.2bn to $903bn. CP declined $153bn y-o-y, or 14.5%.

Currency Watch:

The U.S. dollar index slipped 0.3% to 98.34 (down 0.4% y-t-d). For the week on the upside, the South African rand increased 1.1%, the euro 0.9% and the Swiss franc 0.6%. For the week on the downside, the Mexican peso declined 2.1%, the Brazilian real 1.4%, the Swedish krona 1.1%, the Japanese yen 0.9%, the British pound 0.4%, the Canadian dollar 0.5%, the Norwegian krone 0.2% and the Australian dollar 0.1%. The Chinese yuan declined 0.2% versus the dollar (down 4.4% y-t-d).

Commodities Watch:

October 24 – Bloomberg (Ranjeetha Pakiam): “Further weakness in China’s currency and investors’ concerns over the outlook for the nation’s property market may spur gold demand in Asia’s top economy, according to Goldman Sachs… ‘The potential drivers of increased Chinese physical buying include purchasing gold as a way to hedge for potential currency depreciation in the face of capital controls,’ analysts including Jeffrey Currie and Max Layton, wrote… Bullion consumption in China may also rise ‘as a way of diversifying away from the property market,’ they said.”

The Goldman Sachs Commodities Index declined 1.5% (up 18.7% y-t-d). Spot Gold added 0.7% to $1,275 (up 20%). Silver gained 1.3% to $17.76 (up 29%). Crude dropped $2.19 to $48.66 (up 31%). Gasoline fell 4.1% (up 16%), and Natural Gas sank 7.0% (up 19%). Copper surged 5.2% (up 3%). Wheat declined 1.4% (down 13%). Corn gained 0.7% (down 1%).

China Bubble Watch:

October 24 – Bloomberg (David Biller): “Earlier this year, Mr. and Mrs. Cai, a couple from Shanghai, decided to end their marriage. The rationale wasn’t irreconcilable differences; rather, it was a property market bubble. The pair, who operate a clothing shop, wanted to buy an apartment for 3.6 million yuan ($532,583), adding to three places they already own. But the local government had begun, among other bubble-fighting measures, to limit purchases by existing property holders. So in February, the couple divorced. ‘Why would we worry about divorce? We’ve been married for so long,’ said Cai, the husband… ‘If we don’t buy this apartment, we’ll miss the chance to get rich.’ China’s rising property prices this year have been inspiring such desperate measures, as frenzied buyers are seeking to act before further regulatory curbs are imposed.”

October 25 – Financial Times (Yuan Yang): “China is introducing a slew of new restrictions on property-related lending, as the central government takes the lead in efforts to head off a housing bubble. Property developers are facing curbs on their ability to raise financing by issuing debt or equity, after two government regulators were instructed to step in, it has emerged. The China Securities Regulatory Commission and the National Development and Reform Commission — China’s economic planner — have been instructed by high-level officials to restrict developers’ issuances in the Hong Kong stock market, in the Hong Kong bond market and in the Chinese interbank bond market… The news comes less than a week after the Shanghai Stock Exchange froze all bond issuances by property developers.”

October 26 – Wall Street Journal (Anjani Trivedi): “Attempts to cut down China’s debt problems aren’t working, so Beijing is casting a wider net. Whether it works or not, the move adds to the sense that monetary tightening is in the air. In a document sent out this month and widely published Wednesday, China’s central bank tightened the noose once again on banks use of wealth-management products—investment vehicles sold to customers that are typically stashed off-balance sheet to avoid banks’ breaching regulatory capital limits. The latest rules appear to be a more all-encompassing attempt to follow up on previous, ineffectual directives to curb such shadow lending. The latest iteration forces banks to include these WMPs in calculations of banks ‘broad credit,’ which will force them to set aside more capital against these assets.”

October 26 – Reuters (Chen Yang): “China's central bank will take into account off-balance sheet financing at commercial banks to assess their overall financial health, three sources with direct knowledge of the matter said… The People's Bank of China will make the change to its so-called Macro Prudential Assessment (MPA) risk-tool to broaden its regulatory oversight to include wealth management products often sold by banks and not counted on their balance sheets… The move marks another step in the PBOC's efforts to control rising leverage in the nation's financial system and underscored worries among analysts that unsustainable credit could hit an already slowing economy hard.”

October 25 – Bloomberg (Jeff Black and Carolynn Look): “China’s overnight money rate climbed to the highest level in 18 months, fueled by capital outflows as the yuan weakened to a six-year low. The one-day repurchase rate, a gauge of interbank funding availability, jumped 17 bps, the most since February, to 2.41%... ‘Yuan depreciation-fueled outflows are causing a shortfall in base money supply and tightening liquidity,’ said Liu Dongliang, a senior analyst at China Merchants Bank… ‘This will add pressure to institutions which are highly leveraged in bond investments, if the tightness continues.’ …Liquidity in China’s interbank market has been hard hit by the currency’s accelerated decline. A net $44.7 billion worth of yuan payments left the nation last month… That’s the most since the government started publishing the figures in 2010, and compares with August’s outflow of $27.7 billion. Goldman Sachs… warned Friday that China’s currency outflows have risen to $500 billion this year.”

Europe Watch:

October 26 – Reuters (Francesco Canepa and Frank Siebelt): “The European Central Bank is nearly certain to continue buying bonds beyond its March target and to relax its constraints on the purchases to ensure it finds enough paper to buy, central bank sources have told Reuters. The moves will come in an attempt to bolster what is being heralded as the start of an economic recovery in the euro zone. ECB policymakers are due to decide in December on the future shape and duration of their 80 billion euros (£71.58 billion) monthly quantitative easing (QE) scheme, based on new growth and inflation forecasts.”

October 27 – Reuters (Balazs Koranyi): “The effectiveness of the European Central Bank's ultra-loose monetary policy may decline over time while side effects could increase, a key policymaker argued… ‘The longer the measures are in place, the less effective they may become,’ ECB board member Yves Mersch said… ‘The fact that additional lending in the euro area is losing momentum and that German banks are saying that the negative deposit facility rate is constraining lending volumes warrants attention… We must be vigilant that this development does not spread to other euro area countries.’”

October 27 – Bloomberg (George Georgiopoulos): “The ECB will decide in December on the mechanism of prolonging its quantitative easing asset purchase program, European Central Bank policymaker Ewald Nowotny said… ‘There will be two decisions. It's not as dramatic as they sound. One of course is to prolong, to what extent, for what duration,’ Nowotny, a member of the Governing Council of the European Central Bank, said… The second, he said, was what assets to purchase. ‘... Do we have enough assets to buy, and this is a point of discussion that we are just now underway,’ Nowotny said.”

October 24 – Reuters (Jonathan Cable): “Business activity in the euro zone has expanded at the fastest pace this year so far in October, as a buoyant Germany offset the impact from firms raising prices at the sharpest rate in more than five years, a survey showed… IHS Markit's euro zone flash composite Purchasing Managers' Index… jumped to 53.7 from September's 52.6.”

October 26 – Bloomberg (Jeff Black and Carolynn Look): “Mario Draghi used his second appearance in Berlin in a month to drive home his message that a three-decade slide in long-term interest rates can only be properly arrested with the help of governments. The ‘type of actions we need, if we want interest rates at higher levels, are those that can raise the natural rate,’ the European Central Bank president said… ‘And this requires a focus on policies that can address the root causes of excess saving over investment -- in other words, fiscal and structural policies.”

October 24 – Bloomberg (Alessandro Speciale and Carolynn Look): “Anti-establishment parties are gaining ground in the heart of the European Union, and they may pose a bigger challenge to the region’s economy than any of those that have drawn support in the periphery over the past years. While populists in Spain or Italy are revolting against restrictive fiscal policies and a weakening of social safety nets, the backlash in France and Germany focuses on monetary union itself. Parties openly advocating a break from the euro are building momentum ahead of a year of election across the region and politicians skeptical about EU integration are already twisting policy decisions.”

Fixed-Income Bubble Watch:

October 24 – Bloomberg (Brian Chappatta and Anchalee Worrachate): “The hottest craze in fixed income is at risk of overheating. A headlong rush into higher-yielding, long-term bonds in recent years has created one of the most crowded trades in financial markets. Investors seeking relief from central banks’ zero-interest-rate policies have poured into government debt due in a decade or more, swelling the amount worldwide by a record $733 billion this year. It’s more than doubled since 2009 to about $6 trillion… Now money managers overseeing more than $1 trillion say the case for owning longer maturities -- stellar performers for most of 2016 -- is crumbling. There’s mounting evidence that inflation is starting to stir, just as some central banks hint that higher long-term interest rates may be the key to boosting growth. That’s troubling because a key bond-market metric known as duration has reached historic levels, and the higher that gauge goes, the steeper the losses will be when rates rise.”

October 26 – Bloomberg (John Gittelsohn): “Bad times lie ahead for bondholders as rising inflation and resurging deficits conspire to drive up interest rates, according to Jeffrey Gundlach. ‘We’re in the eye of a hurricane for the next three to four years,’ Gundlach, chief executive officer of DoubleLine Capital, said… ‘Come 2018, 2019 and 2020, look out!’”

Global Bubble Watch:

October 24 – Wall Street Journal (Julie Steinberg and Kane Wu): “As the West sank into recession in 2008, Chinese tycoon Chen Feng decided it was time to stretch his wings. Mr. Chen’s conglomerate, HNA Group, already had a collection of domestic assets that spanned hotel chains, supermarkets, shipping firms and Hainan Airlines, the country’s biggest privately held airline. The next place to go, Mr. Chen told a local business magazine… Mr. Chen is part of an aggressive new generation of Chinese deal makers. Not only are they buying up foreign assets at the fastest pace in history—Chinese companies’ announced overseas acquisitions have hit a record $199 billion so far this year—they are also snagging bigger deals in increasingly high-profile areas like movies, airplanes and hotels.”

October 26 – Bloomberg (Matt Scully): “Deutsche Bank AG is reviewing whether it misstated the value of derivatives in its interest-rate trading business, and is sharing its findings with U.S. authorities, according to people with knowledge of the situation. The bank is looking at valuations on a type of derivative known as zero-coupon inflation swaps… After finding valuations that diverged from internal models, it began questioning traders, the people said.”

October 26 – Financial Times (Caroline Binham and Martin Arnold): “The Bank of England has asked large British lenders to detail their current exposure to Deutsche Bank and some of the biggest Italian banks, including Monte dei Paschi, amid mounting market jitters over the health of Europe’s financial sector. The request was made in recent weeks by the BoE’s Prudential Regulation Authority as investors sold off Deutsche and Monte dei Paschi…”

October 23 – CNBC (Javier E. David): “Despite the chill winds of a softening luxury real estate market and political uncertainty across the globe, it's still a buyer's market for the ultra-wealthy, a recent survey suggests. In partnership with the YouGov Affluent Perspective, Luxury Portfolio International surveyed the top echelon of consumers across 12 countries, finding that the majority of those consumers were ‘cautious but optimistic’ in the face of an uncertain and often turbulent world economy… Research from Credit Suisse showed that there are more than 123,000 individuals in this category, a whopping 53% jump in just five years.”

U.S. Bubble Watch:

October 24 – Reuters (Caroline Humer and Toni Clarke): “The average premium for benchmark 2017 Obamacare insurance plans sold on Healthcare.gov rose 25% compared with 2016…, the biggest increase since the insurance first went on sale in 2013 for the following year. The average monthly premium for the benchmark plan is rising to $302 from $242 in 2016…”

October 24 – New York Times (Landon Thomas Jr.): “European and Asian investors have been rushing into the United States bond market, spurred by a global glut of savings that has reached record levels. Running from near-zero interest rates at home, foreign buyers are piling into the booming market for corporate bonds, including high-grade debt securities… and riskier fare churned out by energy and telecommunications companies. A growing number of economists are concerned that this flood of money may inflate the value of these securities well beyond what they are worth, potentially leading to a market bubble that eventually bursts.”

October 26 – Wall Street Journal (Annamaria Andriotis): “For auto lenders, there is trouble on the used-car lot. Several large companies have warned that prices of used vehicles are likely to weaken, potentially leading to higher losses on loans on which cars are the collateral. That, combined with looser terms for loans and the growth of loans going to subprime borrowers, is sounding a warning for the long credit boom that has spurred auto sales. Auto-loan balances topped $1 trillion for the first time ever this year.”

October 27 – Bloomberg (Oshrat Carmiel): “Home prices in New York’s Hamptons fell the most in almost three years as buyers in the beachfront towns sought out less-expensive properties and shunned the middle of the market, priced from $1 million to $5 million. Homes in the area, a second-home mecca favored by Wall Street executives, sold for a median of $825,000 in the third quarter, down 13% from a year earlier…”

Federal Reserve Watch:

October 24 – Wall Street Journal (Kate Davidson and Jon Hilsenrath): “Federal Reserve officials, wary of raising short-term interest rates amid the uncertainty surrounding the U.S. presidential election, are likely to stand pat at their November policy meeting and remain focused on lifting them in December. Their challenge will be deciding how strongly to signal their expectation of a move at their last scheduled meeting of the year, Dec. 13-14. Market expectations suggest officials may not need to fire strong new warning shots: Traders in futures markets already place a 74% probability on a Fed rate increase by then.”

Japan Watch:

October 24 – Bloomberg (Keiko Ujikane): “Japan’s consumer prices fell for a seventh straight month and household spending slumped again in September, underscoring the challenges Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda face in trying to revive the world’s third-largest economy… Consumer prices excluding fresh food, the BOJ’s primary gauge of inflation, dropped 0.5% in September from a year earlier. Household spending fell 2.1% from a year earlier…”

October 26 – Reuters (Leika Kihara and Yoshifumi Takemoto): “Years of heavy money printing by the Bank of Japan has made the bond market dysfunctional and fiscal policy heavily dependent on cheap money offered by the bank, a former BOJ deputy governor said, warning against expanding monetary stimulus further. Toshiro Mutoh, who retains strong influence among policymakers, also said it would be hard for Japan to intervene in the currency market to stem yen gains… Having gobbled up a third of the Japanese government bond (JGB) market, the BOJ is also nearing the limit of its massive asset-buying program.”

October 27 – Reuters (Leika Kihara): “Bank of Japan Governor Haruhiko Kuroda said… the central bank would not try to push down super-long government bond yields - even if they rise further - because it is focused on controlling the yield curve for out to 10 years. Kuroda told parliament he saw no immediate need to change the minus 0.1% short-term interest rate target and the 10-year government bond yield target of around zero percent, suggesting that the BOJ will hold off on easing policy at next week's rate review. Kuroda also rejected the idea of buying foreign-currency denominated bonds…”

October 23 – Bloomberg (Connor Cislo): “Japanese exports fell for a 12th consecutive month in September, rounding out a rough year for manufacturers struggling with a stronger yen and soft global demand… Overseas shipments dropped 6.9% in September from a year earlier…”

EM Watch:

October 26 – Bloomberg (Matthew Hill, Elena Popina and Natasha Doff): “Mozambique’s Eurobonds slumped to a record for a second day after the government hired advisers to negotiate a restructuring that at least one adviser said could involve write downs for investors… The $727 million security has fallen 22 cents on the dollar to 59 cents…”

October 24 – Bloomberg (David Biller): “Economists reduced their growth forecast for Brazil next year to its lowest level in two months, underscoring how Latin America’s largest nation is struggling to emerge from recession. Gross domestic product will expand 1.23% in 2017, according to a central bank survey of economists…”

Leveraged Speculator Watch:

October 27 – Bloomberg (Dakin Campbell): “A team of Citigroup Inc. derivatives traders generated about $300 million of revenue this year, thriving from serving companies and investors trying to anticipate central bank decisions, according to people with direct knowledge of the matter. The windfall was produced by the bank’s U.S. dollar interest-rate swaps desk…”

Geopolitical Watch:

October 21 – New York Times (Nicole Perlroth): “Major websites were inaccessible to people across wide swaths of the United States on Friday after a company that manages crucial parts of the internet’s infrastructure said it was under attack. Users reported sporadic problems reaching several websites, including Twitter, Netflix, Spotify, Airbnb, Reddit, Etsy, SoundCloud and The New York Times. The company, Dyn, whose servers monitor and reroute internet traffic, said it began experiencing what security experts called a distributed denial-of-service attack just after 7 a.m… And in a troubling development, the attack appears to have relied on hundreds of thousands of internet-connected devices like cameras, baby monitors and home routers that have been infected… with software that allows hackers to command them to flood a target with overwhelming traffic.”

October 26 – Reuters (Robin Emmott and Phil Stewart): “Britain said… it will send fighter jets to Romania next year and the United States promised troops, tanks and artillery to Poland in NATO's biggest military build-up on Russia's borders since the Cold War. Germany, Canada and other NATO allies also pledged forces at a defense ministers meeting in Brussels on the same day two Russian warships armed with cruise missiles entered the Baltic Sea between Sweden and Denmark, underscoring East-West tensions… NATO Secretary-General Jens Stoltenberg said the troop contributions to a new 4,000-strong force in the Baltics and eastern Europe were a measured response to what the alliance believes are some 330,000 Russian troops stationed on Russia's western flank near Moscow.”

October 25 – Wall Street Journal (Thomas Grove): “Russian authorities have stepped up nuclear-war survival measures amid a showdown with Washington, dusting off Soviet-era civil-defense plans and upgrading bomb shelters in the biggest cities. At the Kremlin’s Ministry of Emergency Situations, the Cold War is back. The country recently held its biggest civil defense drills since the collapse of the U.S.S.R., with what officials said were 40 million people rehearsing a response to chemical and nuclear threats. Videos of emergency workers deployed in hazmat suits or checking the ventilation in bomb shelters were prominently aired on television when the four days of drills were held across the country. Students tried on gas masks and placed dummies on stretchers in school auditoriums.”

October 27 – Reuters (Michael Martina and Benjamin Kang Lim): “China's Communist Party gave President Xi Jinping the title of ‘core’ leader on Thursday, putting him on par with past strongmen like Mao Zedong and Deng Xiaoping, but it signaled his power would not be absolute. A lengthy communique released by the party following a four-day, closed-door meeting of senior officials in Beijing stressed maintaining the importance of collective leadership. The collective leadership system ‘must always be followed and should not be violated by any organization or individual under any circumstance or for any reason’, it said.”

October 26 – Reuters (Ben Blanchard): “China will carry out military drills in the South China Sea all day on Thursday, the country's maritime safety administration said…, ordering all other shipping to stay away. China routinely holds drills in the disputed waterway, and the latest exercises come less than a week after a U.S. navy destroyer sailed near the Paracel Islands, prompting a warning from Chinese warships to leave the area.”

Thursday, October 27, 2016

Friday's News Links

[Bloomberg] Bonds Selloff Deepens as Japanese Stocks Buoyed by Weaker Yen

[Bloomberg] Japan Consumer Prices Keep Falling, Household Spending Slips

[WSJ] Merger Deals Set Monthly Record, Even as Election Looms

Thursday Evening Links

[Reuters] Stocks dip as earnings pour in, consumer discretionary lags

[FT] Rising defaults cast cloud over US junk bond surge

[WSJ] Inflation Fear Fuels Bond Rout

[WSJ] October Has Already Set a Record for U.S. M&A Deals

[FT] Global bond yields climb to multi-month highs

[FT] China signals return to strongman rule

Thursday's News Links

[Bloomberg] Bonds Sink on Policy Outlook Amid Debt-Sale Deluge; Stocks Fall

[Reuters] Asia shares slip after Apple results hit Wall Street, dollar off highs

[Bloomberg] China Steps Up Yuan Rhetoric as Currency Falls to Six-Year Low

[Bloomberg] Orders for U.S. Capital Goods Decline by Most Since February

[Reuters] ECB's Nowotny says December meet will decide on QE, what assets to buy if prolonged

[Reuters] China September industrial profit growth slows, signals fragile recovery

[Reuters] BOJ won't try to push down super-long yields: Kuroda

[Reuters] Deutsche Bank warns of tough times ahead as braces for U.S. fine

[Bloomberg] These Are the Charts That Scare Wall Street

[Bloomberg] Hamptons Home Prices Fall the Most Since 2013

[WSJ] Auto Lenders Have New Reason to Worry

[Reuters] China's Xi anointed 'core' leader, on par with Mao, Deng

Wednesday, October 26, 2016

Wednesday's News Links

[Bloomberg] Stocks Decline With Oil as Apple Tumbles on Forecast; Bonds Fall

[Bloomberg] Recession Risk Is Rising, Deutsche’s Chief U.S. Economist Warns

[FT] BoE seeks details of UK exposure to Deutsche and Italian banks

[FT] Bitcoin as a Chinese capital outflow proxy

Wednesday's News Links

[Bloomberg] U.S. Stocks Fluctuate as Bank Rally Offsets Apple; Bonds Decline

[Bloomberg] Italy’s Bond Yields Touch Four-Month High as Debt Supply Weighs

[Reuters] Asia stocks slide on Wall Street losses, oil drops on inventory rise

[Bloomberg] Mozambique Bonds Tumble as Restructuring Plan Stuns Investors

[Reuters] ECB all but certain to keep buying bonds beyond March, ease QE rules - central bank sources

[Bloomberg] Deutsche Bank Said to Review Valuations of Inflation Swaps

[Bloomberg] Sales of New U.S. Homes Remain Close to an Almost Nine-Year High

[Bloomberg] Gundlach Says ‘Look Out’ for Exploding Deficits in 2018-2020

[Reuters] China to count off-balance sheet financing in assessing banks' risk - sources

[Reuters] Ex-BOJ deputy governor warns of demerits of easy policy

[WSJ] China’s Latest Debt Crackdown Just Delays More Serious Action

[WSJ] China Central Bank Seeks More Control Over Wealth-Management Products

[Reuters] NATO seeks troops to deter Russia on eastern flank

[Reuters] China to carry out more military drills in South China Sea

Sunday, October 23, 2016

Monday's News Links

[Bloomberg] Stocks Rise With Bonds as Europe Lifts Market With Triple Boost

[Bloomberg] Offshore Yuan Nears Record Low as PBOC Seen Tolerating Declines

[Bloomberg] Most Asian Emerging Currencies Decline as China's Yuan Weakens

[Reuters] Fed's Bullard says one rate increase is all that's needed for now

[Bloomberg] Most Crowded Trade in Bonds Is a Powder Keg Ready to Blow

[Bloomberg] China Rate Swaps Rise to Six-Month High as PBOC Curbs Leverage

[Bloomberg] China Tackles Bad Debt by Allowing More Asset Firms, News Says

[Bloomberg] Japan’s Exports Drop for 12th Month in Dismal Year for Trade

[Reuters] Euro zone October business growth buoyant, prices rise: PMIs

[Bloomberg] Brazil Economists Trim Economic Growth Outlook for 2016 and 2017

[CNBC] Santoli: Overcrowded ETF market headed for a shakeout

[WSJ] Subprime Credit Card Surge Pushing Up Missed Payments

[WSJ] Sputtering Startups Weigh on U.S. Economic Growth

[Reuters] As China plenum opens, party paper says 'core' leadership needed

[WSJ] Investors’ New Message to Global Governments: Spend More

[WSJ] Russians Conduct Nuclear-Bomb Survival Drills as Cold War Heats Up

Sunday Evening Links

[Bloomberg] Asia Stocks Signal Mixed Open Ahead of Earnings; Euro Holds Lows

[Dow Jones] Bankruptcy Bust: How Zombie Companies Are Killing the Oil Rally

[Bloomberg] Fake Divorce Is Path to Riches in China’s Hot Real Estate Market

[Bloomberg] German Momentum Grows for Curbs on Chinese Overseas Investment

[Bloomberg] How China's Dealmakers Pulled off a $207 Billion Global Spree

[CNBC] Ultra-wealthy still interested in buying real estate despite slowdown, uncertainty

Sunday's News Links

[Reuters] Banks preparing to leave UK over Brexit, says banking body chief executive

[Reuters] Italy's front line in fight to save banks: a storage room

[WSJ] China’s Xi Jinping Seeks Safety in Numbers—Or Else

[WSJ] China Banking Regulator Seeks Fresh Limits on Property Lending

Saturday, October 22, 2016

Saturday's News Links

[Verge]  How an army of vulnerable gadgets took down the web today

[NYT] Hackers Used New Weapons to Disrupt Major Websites Across U.S.

[Spiegel] A Precarious Alliance Takes on Islamic State

Weekly Commentary: The Latest on China's Mortgage Finance Bubble

It’s been a full seven days since a CBB focused on China… Important – confirmation of the thesis - data again this week.

October 21 – Reuters (Yawen Chen and Nicholas Heath): “China's new home prices rose in September at the fastest rate on record as buyers rushed to close contracts before new restrictive measures took effect in October. The boom in sales and prices was evident in mortgage lending, with new housing loans to individuals totaling 475.9 billion yuan in September alone, some 76% higher than the same month last year… Prices in China's 70 major cities rose 11.2% in September from a year earlier, accelerating from a 9.2% increase in August, as 64 of them saw year-on-year price gains…”

Year-on-year prices were up 34.1% in Shenzhen, 32.7% in Shanghai, and 27.8% in Beijing.

Also from Reuters: “The house-prices-to-household-disposable-income ratio in first-tier cities has risen to be around 18 to 20 times in this year's housing fever, putting housing affordability close to Hong Kong's and making it less affordable than London, UBS wrote…”

October 19 – Wall Street Journal (Lingling Wei): “Xiong Meifang was about $30,000 short two months ago for a 30% down payment on an $895,000 apartment in the southern part of China’s capital. To make up the difference, the 31-year-old graphic designer took out a line of credit from a national bank. She said the bank told her she could use the loan however she wanted. China bans borrowing for down payments. A surge in such financing offered by nonbank lenders earlier this year led to a regulatory clampdown. But as banks increasingly turn to mortgage lending, there are new signs of risky practices. In some instances, banks offer credit lines to borrowers buying apartments with few questions asked. In others, banks work with independent loan brokers or property agents to funnel money into down-payment financing… Data released Tuesday showed medium- and long-term household loans, almost all of which are mortgages, made up 60% of all new loans created in the third quarter, up from 47% in the second quarter and 23% in the first.”

The above noted WSJ article, "China’s Property Frenzy Spurs Risky Business" (Lingling Wei), included some insightful data and a particularly interesting chart. While briefly dipping below 10% in 2012, new mortgage loans as a share of the value of total new loans averaged around 20% for much of the period 2010 through 2015 – before spiking over recent quarters. “…medium- and long-term household loans, almost all of which are mortgages, made up 60% of all new loans created in the third quarter, up from 47% in the second quarter and 23% in the first.”

The article also included a graphic, “Number of years of median household income needed to buy a property of median value.” Here, Chinese cities are compared to some of the more notoriously expensive markets in the world: London 29 years, Tokyo 23, New York 15 and Sydney 12. With China’s Credit Bubble now spurring rampant housing inflation, Shenzhen has shot to the top of the list at 41 years, followed by Beijing (34) and Shanghai (32). Guangzhou made the list at 25 years, followed by Nanjing (22) and Hangzhou (17).

Not a big surprise, China’s September loan growth was reported at a level double forecasts.

October 18 – AFP: “New loans by Chinese banks in September surged nearly 30% from the previous month…, deepening concern about risky credit expansion in the world’s second largest economy. New loans extended by banks jumped to 1.22 trillion yuan ($181.3bn) last month from 948.7 billion yuan in August… Beijing has relied on stimulus measures such as loose credit to boost the economy, which faces a tough structural transition and sluggish global demand. But the rapid rise in borrowing has sparked alarm.”

Fueled by a surge in housing-related finance, September Total Social Finance (total Credit excluding govt bonds) surged to almost $250 billion, about a third larger than forecast. This was the strongest Credit expansion since (“off the charts”) March ($360bn).

October 18 – Bloomberg: “The value of China’s new home sales rose 61% in September from a year earlier, defying policymakers’ moves earlier this year to cool the property market. The value of homes sold rose to 1.2 trillion yuan ($178bn) last month from a year earlier… The increase compares with a 33% gain the previous month.”

“CTV.” During the U.S. mortgage finance Bubble heyday period, I regularly highlighted a “Calculated Transaction Value” that I pulled from my spreadsheet of National Association of Realtors data (sales volumes by average prices). A Bubble’s manic phase sees a powerful surge in the number of transactions - at rapidly inflating prices. This explains how the value of China’s September home sales inflated 61% from September 2015, with “new housing loans to individuals” up 76% y-o-y.

I viewed CTV as the leading indicator of systemic risk associated with mortgage Bubble excess. For one, it provided a timely barometer of the general tenor of Credit growth. It was clearly the best gauge of the “inflationary bias” at work throughout housing. Parabolic growth in CTV also accurately reflected the commencement of “Terminal Phase” excess.  Moreover, the historic surge of (borrowed) “money” into housing was indicative of destabilizing speculative excess, loose Credit conditions and, more generally, the degree to which financial stimulus was fueling economic imbalances.

It’s my view that the world is at the critical late-stage of a historic multi-decade Credit Bubble. China has become integral to the global Bubble – the marginal source of Credit and global finance. And in the face of a faltering Bubble Economy and increasingly vulnerable Chinese financial system, China’s mortgage finance Bubble has evolved into the predominant source of stimulus. Record Chinese Credit growth is the biggest global financial and economic story of 2016.

There’s a fundamental problem with speculative melt-ups and Credit Bubble “Terminal Phases:” They are invariably unsustainable. A torrent of Credit-driven liquidity inflates prices to unsustainable levels. Mortgage finance Bubbles are especially dangerous. They tend to be powerfully self-reinforcing, with Credit expanding exponentially during the precarious “Terminal Phase.” Fear and panic, as we’ve witnessed, can rather quickly see massive Credit expansion transformed into collapse.

It’s now been years of Chinese officials tinkering with an increasingly impervious Credit Bubble. They remain too timid, and I’d be surprised if current measures to slow housing markets have a dramatic impact. More likely, Chinese Credit continues to grow rapidly over the coming months. The much higher interest rates needed to slow rampant mortgage Credit excess are viewed as completely incompatible with a struggling general economy. Instead, it appears China will tolerate booming mortgage Credit as it systematically devalues its currency.

According to Zerohedge, a Goldman analyst (MK Tang) estimated that flows out of China surged to $78 billion during September, up from August’s estimated $32 billion. This would be the highest outflows since January. The Chinese currency weakened another 60 bps versus the dollar this week, putting the year-to-date devaluation to a not insignificant 4.2%.

Perhaps booming Chinese Credit and strong financial outflows are behind a growing inflationary bias taking hold in global markets. Crude traded near 15-month highs this week. This week in the currencies, the South African rand jumped 2.3%, the Mexican peso 2.2%, the Brazilian real 1.6% and the Russian ruble 0.9%. Brazilian stocks surged 3.8%, and Mexican stocks jumped 1.5%.

Along with EM, markets are looking at bank stocks through more rose-colored glasses. European banks jumped 5.1% this week, with Italian bank surging 7.3%. U.S. bank stocks rose 3.5%. The European periphery also rallied strongly this week, with Spanish and Italian stocks up 3.8% and 3.5%.

And while global yields have risen over the past month, bonds don’t seem all that fearful of an inflation resurgence. Recall 2007, and how the bond market had smelled out the loaming mortgage bust. Yields dropped, basically ignoring stocks (and crude) as equities went to all-time highs. What I remember most from that period was how monetary disorder created heightened instability across the markets right up until the crisis.

For the Week:

The S&P500 added 0.4% (up 4.8% y-t-d), while the Dow was about unchanged (up 4.1%). The Utilities gained 0.5% (up 11.7%). The Banks surged 3.5% (up 0.8%), and the Broker/Dealers increased 0.2% (down 2.4%). The Transports slipped 0.2% (up 6.9%). The S&P 400 Midcaps gained 0.5% (up 9.2%), and the small cap Russell 2000 rose 0.5% (up 7.2%). The Nasdaq100 gained 0.9% (up 5.6%), and the Morgan Stanley High Tech index advanced 1.1% (up 10%). The Semiconductors recovered 0.6% (up 22.8%). The Biotechs rallied 0.8% (down 19.8%). With bullion up $15, the HUI gold index surged 8.2% (up 94%).

Three-month Treasury bill rates ended the week at 32 bps. Two-year government yields slipped a basis point to 0.82% (down 23bps y-t-d). Five-year T-note yields fell five bps to 1.24% (down 51bps). Ten-year Treasury yields dropped seven bps to 1.73% (down 52bps). Long bond yields fell eight bps to 2.48% (down 54bps).

Greek 10-year yields rose six bps to 8.28% (up 96bps y-t-d). Ten-year Portuguese yields dropped 11 bps to 3.16% (up 64bps). Italian 10-year yields slipped a basis point to 1.37% (down 22bps). Spain's 10-year yields declined one basis point to 1.11% (down 66bps). German bund yields dropped five bps to 0.00% (down 62bps). French yields fell five bps to 0.28% (down 71bps). The French to German 10-year bond spread was unchanged at 28 bps. U.K. 10-year gilt yields were unchanged at 1.09% (down 87bps). U.K.'s FTSE equities index was little changed (up 12.5%).

Japan's Nikkei 225 equities index rallied 1.9% (down 9.7% y-t-d). Japanese 10-year "JGB" yields dipped a basis point to negative 0.07% (down 33bps y-t-d). The German DAX equities index rose 1.2% (down 0.3%). Spain's IBEX 35 equities index surged 3.8% (down 4.6%). Italy's FTSE MIB index jumped 3.5% (down 19.9%). EM equities were mostly higher. Brazil's Bovespa index surged 3.8% (up 48%). Mexico's Bolsa gained 1.5% (up 12.7%). South Korea's Kospi increased 0.5% (up 3.7%). India’s Sensex equities jumped 1.5% (up 7.5%). China’s Shanghai Exchange rose 0.9% (down 12.7%). Turkey's Borsa Istanbul National 100 index jumped 1.7% (up 9.9%). Russia's MICEX equities index slipped 0.4% (up 11.1%).

Junk bond mutual funds saw outflows of $160 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose five bps last week to a four-month high 3.52% (down 27bps y-o-y). Fifteen-year rates added three bps to 2.79% (down 19bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down a basis point to 3.63% (down 24bps).

Federal Reserve Credit last week jumped $17.3bn to $4.435 TN. Over the past year, Fed Credit contracted $22.7bn (0.5%). Fed Credit inflated $1.624 TN, or 58%, over the past 206 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt sank $23.7bn last week to a new six-year low $3.122 TN. "Custody holdings" were down $179bn y-o-y, or 5.4%.

M2 (narrow) "money" supply last week surged $43.4bn to a record $13.123 TN. "Narrow money" expanded $955bn, or 7.9%, over the past year. For the week, Currency increased $0.9bn. Total Checkable Deposits fell $5.5bn, while Savings Deposits surged $37.5bn. Small Time Deposits slipped $0.8bn. Retail Money Funds gained $11.6bn.

Total money market fund assets dropped $14.1bn to a 16-month low $2.635 TN. Money Funds declined $64bn y-o-y (2.4%).

Total Commercial Paper increased $2.4bn to $905bn. CP declined $158bn y-o-y, or 14.8%.

Currency Watch:

The U.S. dollar index added 0.6% to 98.63 (down 0.1% y-t-d). For the week on the upside, the South African rand increased 2.3%, the Mexican peso 2.2%, the Brazilian real 1.6%, the New Zealand dollar 1.0%, the British pound 0.4% and the Japanese yen 0.4%. For the week on the downside, the Canadian dollar declined 1.5%, the euro 0.8%, the Swedish krona 0.8%, the Swiss franc 0.3%, the Norwegian krone 0.3%, and the Australian dollar 0.1%. The Chinese yuan fell another 0.6% versus the dollar (down 4.2% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index was unchanged (up 20.6% y-t-d). Spot Gold rallied 1.2% to $1,266 (up 19.4%). Silver increased 0.5% to $17.53 (up 27%). Crude gained 50 cents to $50.85 (up 37.3%). Gasoline rose 2.6% (up 21%), while Natural Gas sank 9.1% (up 28%). Copper fell 1.0% (down 2%). Wheat dropped 1.5% (down 12%). Corn declined 0.5% (down 2%).

China Bubble Watch:

October 18 – Bloomberg: “China’s economic growth remained stable in the third quarter, all but ensuring the government’s full-year growth target is met and opening a window for policy makers to deliver on vows to rein in excessive credit and surging property prices. Gross domestic product rose 6.7% in the third quarter from a year earlier, matching the median projection by economists…”

October 16 – Bloomberg (Narae Kim): “China has been issued another yellow card. In a report released last week, S&P Global Ratings warned that China is at risk of losing its AA-status if it doesn't rein in its debt-fueled economic growth. ‘Credit growth in China continues to outpace income growth, and much new lending appears to be financing public investment,’ S&P analysts Kim Eng Tan and Xin Liu wrote. ‘Consequently, we see support for the Chinese sovereign ratings gradually diminishing.’ A downgrade would be the latest blow to the world's second-largest economy, whose outlook was slashed to negative from stable by the ratings agency in March.”

October 20 – Reuters (Samuel Shen and Adam Jourdan): “China has uncovered over 1 trillion yuan (120.35 billion pounds) worth of illegal transactions by underground banks this year, the official Financial News reported… The State Administration of Foreign Exchange (SAFE) will step up investigations into capital outflows and intensify a crackdown on underground banks to foster healthy development of the country's foreign exchange market, Zhang Shenghui, a senior director at SAFE told the newspaper.”

October 18 – Bloomberg: “China’s financial hub Shanghai is stepping up a crackdown on property developers and the flow of funds into land transactions, part of broader government efforts to prevent a housing bubble. Shanghai’s commission of housing and urban-rural development said… it was investigating whether eight developers raised selling prices for residential projects without permission. The agency has already suspended transaction licenses for some properties…”

Europe Watch:

October 20 – Bloomberg (Jeff Black and Jana Randow): “In Germany, fretting about inflation is a political currency that never seems to lose its value. In the past week, for example, at least three national newspapers have run prominent articles telling the populace that their savings -- denied the magic of compound interest by the European Central Bank’s low-rate policies -- are in for a renewed onslaught from accelerating consumer prices. The Bundesbank forecasts average inflation of 1.5% next year, whereas rates will likely be around zero.”

October 16 – Bloomberg (Mark Whitehouse): “Will Italy follow the U.K.'s example and leave the European Union? Far-fetched as it may seem, capital flows suggest that some people aren’t waiting to find out. To keep the euro area's accounts in balance, Europe's central banks track flows of money among the members of the currency union. If, for example, a depositor moves 100 euros from Italy to Germany, the Bank of Italy records a liability to the Eurosystem and the Bundesbank records a credit. If a central bank starts building up liabilities rapidly, that tends to be a sign of capital flight. Lately, Italy's central bank has been building up a lot of liabilities to the Eurosystem. As of the end of September, they stood at about 354 billion euros, up 118 billion from a year earlier -- and up 78 billion since the end of May… The outflow isn't quite as large as during the sovereign-debt crisis of 2012, but it's still significant. The main beneficiary seems to be Germany, which has seen its credits to the Eurosystem increase by 160 billion over the past year.”

October 20 – Bloomberg (Carolynn Look): “Portugal’s debt would no longer be eligible for purchase under the European Central Bank’s quantitative-easing program if the country’s credit rating is downgraded on Friday, President Mario Draghi said. A decision by Canadian rating company DBRS Ltd. to take away the country’s only investment-grade rating would disqualify Portuguese sovereign bonds from asset purchases and use as collateral in refinancing operations, Draghi said…”

Brexit Watch:

October 21 – Bloomberg (Lukanyo Mnyanda and Stephen Spratt): “Money markets are zeroing in on Article 50 as the catalyst for increased risk in banks’ pound borrowing. A gauge of where bank borrowing costs will be in coming months, known as the FRA/OIS spread, shows a marked increase in traders’ perception of risk beyond March 2017. That’s the point by which U.K. Prime Minister Theresa May has pledged to formally invoke the article of the Lisbon Treaty that will formally put the nation on a path out of the European Union.”

Fixed-Income Bubble Watch:

October 18 – Bloomberg (Scott Lanman): “China’s holdings of U.S. Treasuries fell to the lowest level since November 2012, as the world’s second-largest economy draws down its foreign reserves to prop up the yuan. The biggest foreign holder of U.S. government debt had $1.19 trillion in bonds, notes and bills in August, down $33.7 billion from the prior month, the biggest drop since 2013… The portfolio of Japan, the largest holder after China, fell for the first time in three months, down $10.6 billion to $1.14 trillion. Saudi Arabia’s holdings of Treasuries declined for a seventh straight month, to $93 billion.”

October 20 – Reuters (Herbert Lash and Joy Wiltermuth): “The dramatic shift to online shopping that has crushed U.S. department stores in recent years now threatens the investors who a decade ago funded the vast expanse of brick and mortar emporiums that many Americans no longer visit. Weak September core retail sales… provide a window into the pain the holders of mall debt face in coming months as retailers with a physical presence keep discounting to stave off lagging sales. Some $128 billion of commercial real estate loans - more than one-quarter of which went to finance malls a decade ago - are due to refinance between now and the end of 2017…”

Global Bubble Watch:

October 16 – Bloomberg (Phil Kuntz): “The world’s biggest central banks are bulking up their balance sheets this year at the fastest pace since 2011’s European debt crisis… The 10 largest lenders now own assets totaling $21.4 trillion, a 10% increase from the end of last year… Their combined holdings grew by 3% or less in both 2015 and 2014. The accelerating expansion of central banks’ balance sheets comes as debate rages over whether their asset purchases and continued low interest rates are creating bubbles, especially in the bond market… Almost 75% of the world’s central-bank assets are controlled by policy makers in four places: China, the U.S., Japan and the euro zone. The next six -- …Brazil, Switzerland, Saudi Arabia, the U.K., India and Russia -- each account for an average of 2.5%.”

October 19: “ETFGI… today reported assets invested in ETFs/ETPs listed globally reached a new record high US$3.408 trillion at the end of Q3 2016. Net flows gathered by ETFs/ETPs in September were strong with US$25.19 bn… marking the 32nd consecutive month of net inflows… Record levels of assets were also reached at the end of Q3 for ETFs/ETPs listed in the United States at US$2.415 trillion, in Europe at US$566.74 bn, and in Asia Pacific ex-Japan at US$131.88 bn. At the end of Q3 2016, the Global ETF/ETP industry had 6,526 ETFs/ETPs, with 12,386 listings, assets of US$3.408 trillion, from 284 providers listed on 65 exchanges in 53 countries.”

October 17 – Financial Times (Elaine Moore and Thomas Hale): “The European Central Bank’s mass bond-buying programme is escalating stress in a crucial short-term funding market that underpins the eurozone financial system, raising the risk of shocks in wider markets. Large-scale purchases of government bonds by the ECB has resulted in a squeeze on the availability of assets favoured for trillions of euros of repurchase agreements, or ‘repos’ — effectively short-term loans between institutions. Bankers and asset managers say the market’s dysfunction should be high on the list of topics discussed by the ECB’s governing council when it meets in Frankfurt this week to decide on the future of its €80bn a month quantitative easing programme.”

October 18 – Bloomberg (Luke Kawa and Andrea Wong): “It’s not hard to see the potential flash points on the horizon -- the U.S. presidential election; Deutsche Bank AG’s mounting legal charges; the day central banks stop buying bonds. Yet when it comes to gauging risks in the world’s financial markets, these days investors are flying more or less blind. That’s because the once-dependable indicators traders relied on for decades to send out warnings are no longer up to the task. The so-called yield curve isn’t the recession predictor it once was. Swap spreads are so distorted they can’t be trusted. Even the vaunted VIX -- sometimes referred to as the ‘fear gauge,’ is leading its followers astray, strategists say.”

October 18 – Bloomberg (Sid Verma and Luke Kawa): “Fears of a bond-market crash, a breakdown in globalization, a new crisis in the euro area? There were a bevy of reasons for fund managers to push their cash balances to 5.8% of their portfolios in October, up from 5.5% last month, matching levels not seen since the aftermath of the Brexit vote. The share of cash hasn't been higher than that since November 2001, shortly after the terrorist attacks in the U.S…”

U.S. Bubble Watch:

October 21 – Bloomberg (Oliver Renick and Rebecca Spalding): “U.S. companies are on pace to spend a record $1 trillion on buybacks and dividends in 2016. It’ll be a tough record to top. A total $600 billion in share repurchases and $400 billion in dividends will be doled out by S&P 500 Index members by the end of the year, the biggest combined payout in history, according to… Barclays Plc. Gravy like that is getting tougher to sustain as corporate profits suffer a six-quarter slump and cash levels begin to dwindle. As a result, fewer companies in the third quarter upped their dividend -- and more are tapping the debt market to sustain their buyback programs, data from S&P Global Inc. and JPMorgan… show. For U.S. stock investors, it means a key pillar of the 7 1/2-year-old bull market may be tipping over.”

October 20 – Bloomberg (Michelle Jamrisko): “Sales of previously owned U.S. homes increased more than projected in September, showing residential real estate continues to contribute modestly to growth… Contract closings rose 3.2% to a 5.47 million annual rate… Sales climbed 2.8% from September 2015… Median sales price increased 5.6% from September 2015 to $234,200. Inventory of available properties dropped 6.8% from a year earlier to 2.04 million…”

October 17 – Wall Street Journal (Dennis K. Berman and Jamie Heller): “Investors are giving up on stock picking. Pension funds, endowments, 401(k) retirement plans and retail investors are flooding into passive investment funds, which run on autopilot by tracking an index. Stock pickers, archetypes of 20th century Wall Street, are being pushed to the margins. Over the three years ended Aug. 31, investors added nearly $1.3 trillion to passive mutual funds and their brethren—passive exchange-traded funds—while draining more than a quarter trillion from active funds, according to Morningstar Inc.”

October 20 – Financial Times (Robin Wigglesworth, Nicole Bullock and Joe Rennison): “The US Securities and Exchange Commission is gearing up for a root-and-branch review of the rapidly growing exchange traded fund industry amid concerns massive flows into ETFs may be exacerbating volatility in financial markets. In the US alone, ETF assets stand at $2.4tn, and globally they hold $3.3tn, according to ETFGI… They account for about 30% of the value of all US shares traded… ETFs were at the centre of wild equity trading in August 2015. In one session, more than 1,000 securities were suspended from trading for sharp moves and some ETFs veered sharply from their net asset values. The chaotic trading highlighted how interconnected ETFs are with the underlying stocks as well as the futures market.”

October 17 – Wall Street Journal (Dennis K. Berman and Jamie Heller): “Picking stocks is at heart an arrogant act. It requires in the stock picker a confidence that most others are dunces, and that riches await those with better information and sharper instincts. Entire cities—notably New York and London—have been erected in service of this belief. And the image of the clever, dauntless stock maestro is embedded in the American ideal. Yet there is a simple, destructive idea taking over Wall Street: that stock pickers can’t pick stocks well—or at least well enough for the fees they charge. And even those who do can’t sustain it year after year. In short, the idea of the ‘active manager’ is rapidly losing its intellectual legitimacy to the primacy of the ‘passive investor’ who merely buys an index of shares.”

October 18 – Bloomberg (Michelle Jamrisko): “The cost of living in the U.S. rose at the fastest pace in five months on energy and shelter prices, a sign inflation is getting closer to the Federal Reserve’s goal. The consumer-price index increased 0.3% in September from the previous month… The year-on-year rise was 1.5%, the most since October 2014.”

October 16 – Wall Street Journal (Julie Jargon and Lillian Rizzo): “The U.S. is having one of its biggest restaurant shakeouts in years, as an oversupply of eateries and new rivals offering prepared meals to go claim what is expected to be a growing number of casualties. In one recent week alone, three restaurant companies filed for chapter 11 bankruptcy protection, including Così Inc.; Rita Restaurant Corp., parent of the Don Pablo chain, and Garden Fresh Corp... At least five other restaurant operators have filed for court protection this year, with restructuring plans that call for restaurant closures.”

Federal Reserve Watch:

October 20 – Bloomberg (Jeanna Smialek): “The U.S. economy maintained a steady growth pace between late August and early October, as a tight labor market with nascent wage pressures contributed to a ‘mostly positive’ outlook, a report from the 12 Federal Reserve districts showed. ‘Most districts indicated a modest or moderate pace of expansion,’ according to the Fed’s latest Beige Book, an economic survey by reserve banks. ‘Outlooks were mostly positive, with growth expected to continue at a slight to moderate pace in several districts.’”

October 18 – Bloomberg (Jeanna Smialek): “The boards of directors at nine of the 12 regional Federal Reserve banks last month sought an increase in the rate on direct loans from the Fed to 1.25% from 1%… The Atlanta Fed joined the calls for an increase in the discount rate, pushing the number of regional banks asking for a hike to its highest since December 2015.”

Japan Watch:

October 18 – Reuters (Malcolm Foster and Tetsushi Kajimoto): “Japan Inc has little faith in the central bank's latest shift in monetary policy, with companies saying it won't generate long-desired inflation, spur further business investment or have an impact on the economy. The findings of the Reuters Corporate Survey… suggest a long road ahead for Prime Minister Shinzo Abe… More than 80% of firms said last month's overhaul in policy - one that targets the bond market's yield curve instead of the amount of money pumped into the financial system - will not have an impact on prices or change their capital spending plans.”

Leveraged Speculator Watch:

October 20 – Bloomberg (Saijel Kishan): “Howard Fischer, wearing a white shirt and khakis, leans back into a window seat at a juice bar in Greenwich, Connecticut, sips a cold-brewed Mexican mocha and shares his angst. ‘It’s miserable, miserable,’ the 57-year-old manager of $1.1 billion Basso Capital Management says of hedge fund returns over the past few years. ‘If that’s the normal expectation, I don’t have a business.’ Fischer’s lament and ones like it are echoing through the industry. It’s an existential crisis for former masters of the universe who once prided themselves on their trading prowess. Now they’re questioning their wisdom and their ability to generate profits that made them among the richest in finance. The $2.9 trillion industry has posted average annual returns of 2% over the past three years, well below those of most index funds…”

October 20 – Bloomberg (Saijel Kishan and Simone Foxman): “Hedge fund investors pulled $28.2 billion from the industry in the third quarter, the most since the aftermath of the global financial crisis, according to Hedge Fund Research Inc. The net outflows, which amount to 0.9% of the industry, are the largest since the second quarter of 2009… Investors redeemed $51.5 billion in the first nine months of the year, even as industry assets rose to a record $2.97 trillion… The third quarter was the fourth consecutive quarter of redemptions for the industry, the longest since 2008 and 2009, HFR said. Redemptions were concentrated in the biggest funds…”

October 20 – Bloomberg (Sonali Basak): “Portfolio managers at hedge funds, facing an exodus of investors frustrated with high fees, are about to feel the pain from an estimated 34% reduction in their compensation. While fund managers may take the biggest pay cut in the industry, professionals with seven or more years of experience see their total compensation declining by 14% on average for 2016, recruiter Odyssey Search Partners said in a report…”

October 19 – Wall Street Journal (Justin Baer): “One junk-bond trader at Goldman Sachs Group Inc. earned more than $100 million in trading profits for the firm earlier this year, an unusual gain at a time when new regulations have pushed Wall Street to take fewer risks.”

October 18 – Bloomberg (Suzy Waite): “Asia hedge funds are opening at the slowest pace since the turn of the century. Just 27 new funds started trading in Asia in the first nine months of this year, the fewest since 2000 when 56 funds opened, according to Eurekahedge. It’s the third straight year of declines, and down from 83 new funds last year.”

Geopolitical Watch:

October 19 – Reuters (David Brunnstrom and Arshad Mohammed): “The United States and South Korea agreed… to step up military and diplomatic efforts to counter North Korea's nuclear and missile programs, saying they posed a ‘grave’ security threat following repeated tests this year. After talks in Washington between their foreign and defense ministers, the countries said they had agreed to set up a high-level Extended Deterrence Strategy and Consultation Group to leverage ‘the full breadth of national power – including diplomacy, information, military coordination, and economic elements’ in the face of the North Korean threat.”

October 20 – Bloomberg (Ian Wishart, John Follain and Patrick Donahue): “The European Union said it was too soon to consider imposing sanctions on Russia for the bombing of rebel-held areas of Syria, while maintaining the threat of action if Vladimir Putin doesn’t back down… While the U.K., France and Germany wanted to take a harsher tone with Russia, Italy’s Matteo Renzi led those countries who opposed the move.”

October 20 – Bloomberg (Andreo Calonzo and Cecilia Yap): “Philippine President Rodrigo Duterte will bring home $24 billion worth of funding and investment pledges from his four-day visit to China as both nations agreed to resume talks and explore areas of cooperation in the South China Sea. China will provide $9 billion in soft loans, including a $3 billion credit line with the Bank of China, while economic deals including investments would yield $15 billion… Preliminary agreements in railways, ports, energy and mining worth $11.2 billion were signed… ‘China is not only a friend. China is only a relative, but China is a big brother,’ Communications Secretary Martin Andanar said in Beijing…”

October 20 – Reuters (Ben Blanchard): “Philippine President Rodrigo Duterte announced his ‘separation’ from the United States on Thursday, declaring he had realigned with China as the two agreed to resolve their South China Sea dispute through talks. Duterte made his comments in Beijing, where he is visiting with at least 200 business people to pave the way for what he calls a new commercial alliance as relations with longtime ally Washington deteriorate. ‘In this venue, your honors, in this venue, I announce my separation from the United States,’ Duterte told Chinese and Philippine business people, to applause, at a forum in the Great Hall of the People attended by Chinese Vice Premier Zhang Gaoli.”

October 19 – Reuters (Orhan Coskun and Nick Tattersall): “Smarting over exclusion from an Iraqi-led offensive against Islamic State in Mosul and Kurdish militia gains in Syria, President Tayyip Erdogan warned… Turkey ‘will not wait until the blade is against our bone’ but could act alone in rooting out enemies. In a speech at his palace, Erdogan conjured up an image of Turkey constrained by foreign powers who ‘aim to make us forget our Ottoman and Selcuk history’, when Turkey's forefathers held territory stretching across central Asia and the Middle East. ‘From now on we will not wait for problems to come knocking on our door, we will not wait until the blade is against our bone and skin, we will not wait for terrorist organizations to come and attack us…’”

Weekly Commentary: The Latest on China's Mortgage Finance Bubble

It’s been a full seven days since a CBB focused on China… Important – confirmation of the thesis - data again this week.

October 21 – Reuters (Yawen Chen and Nicholas Heath): “China's new home prices rose in September at the fastest rate on record as buyers rushed to close contracts before new restrictive measures took effect in October. The boom in sales and prices was evident in mortgage lending, with new housing loans to individuals totaling 475.9 billion yuan in September alone, some 76% higher than the same month last year… Prices in China's 70 major cities rose 11.2% in September from a year earlier, accelerating from a 9.2% increase in August, as 64 of them saw year-on-year price gains…”

Year-on-year prices were up 34.1% in Shenzhen, 32.7% in Shanghai, and 27.8% in Beijing.

Also from Reuters: “The house-prices-to-household-disposable-income ratio in first-tier cities has risen to be around 18 to 20 times in this year's housing fever, putting housing affordability close to Hong Kong's and making it less affordable than London, UBS wrote…”

October 19 – Wall Street Journal (Lingling Wei): “Xiong Meifang was about $30,000 short two months ago for a 30% down payment on an $895,000 apartment in the southern part of China’s capital. To make up the difference, the 31-year-old graphic designer took out a line of credit from a national bank. She said the bank told her she could use the loan however she wanted. China bans borrowing for down payments. A surge in such financing offered by nonbank lenders earlier this year led to a regulatory clampdown. But as banks increasingly turn to mortgage lending, there are new signs of risky practices. In some instances, banks offer credit lines to borrowers buying apartments with few questions asked. In others, banks work with independent loan brokers or property agents to funnel money into down-payment financing… Data released Tuesday showed medium- and long-term household loans, almost all of which are mortgages, made up 60% of all new loans created in the third quarter, up from 47% in the second quarter and 23% in the first.”

The above noted WSJ article, "China’s Property Frenzy Spurs Risky Business" (Lingling Wei), included some insightful data and a particularly interesting chart. While briefly dipping below 10% in 2012, new mortgage loans as a share of the value of total new loans averaged around 20% for much of the period 2010 through 2015 – before spiking over recent quarters. “…medium- and long-term household loans, almost all of which are mortgages, made up 60% of all new loans created in the third quarter, up from 47% in the second quarter and 23% in the first.”

The article also included a graphic, “Number of years of median household income needed to buy a property of median value.” Here, Chinese cities are compared to some of the more notoriously expensive markets in the world: London 29 years, Tokyo 23, New York 15 and Sydney 12. With China’s Credit Bubble now spurring rampant housing inflation, Shenzhen has shot to the top of the list at 41 years, followed by Beijing (34) and Shanghai (32). Guangzhou made the list at 25 years, followed by Nanjing (22) and Hangzhou (17).

Not a big surprise, China’s September loan growth was reported at a level double forecasts.

October 18 – AFP: “New loans by Chinese banks in September surged nearly 30% from the previous month…, deepening concern about risky credit expansion in the world’s second largest economy. New loans extended by banks jumped to 1.22 trillion yuan ($181.3bn) last month from 948.7 billion yuan in August… Beijing has relied on stimulus measures such as loose credit to boost the economy, which faces a tough structural transition and sluggish global demand. But the rapid rise in borrowing has sparked alarm.”

Fueled by a surge in housing-related finance, September Total Social Finance (total Credit excluding govt bonds) surged to almost $250 billion, about a third larger than forecast. This was the strongest Credit expansion since (“off the charts”) March ($360bn).

October 18 – Bloomberg: “The value of China’s new home sales rose 61% in September from a year earlier, defying policymakers’ moves earlier this year to cool the property market. The value of homes sold rose to 1.2 trillion yuan ($178bn) last month from a year earlier… The increase compares with a 33% gain the previous month.”

“CTV.” During the U.S. mortgage finance Bubble heyday period, I regularly highlighted a “Calculated Transaction Value” that I pulled from my spreadsheet of National Association of Realtors data (sales volumes by average prices). A Bubble’s manic phase sees a powerful surge in the number of transactions - at rapidly inflating prices. This explains how the value of China’s September home sales inflated 61% from September 2015, with “new housing loans to individuals” up 76% y-o-y.

I viewed CTV as the leading indicator of systemic risk associated with mortgage Bubble excess. For one, it provided a timely barometer of the general tenor of Credit growth. It was clearly the best gauge of the “inflationary bias” at work throughout housing. Parabolic growth in CTV also accurately reflected the commencement of “Terminal Phase” excess.  Moreover, the historic surge of (borrowed) “money” into housing was indicative of destabilizing speculative excess, loose Credit conditions and, more generally, the degree to which financial stimulus was fueling economic imbalances.

It’s my view that the world is at the critical late-stage of a historic multi-decade Credit Bubble. China has become integral to the global Bubble – the marginal source of Credit and global finance. And in the face of a faltering Bubble Economy and increasingly vulnerable Chinese financial system, China’s mortgage finance Bubble has evolved into the predominant source of stimulus. Record Chinese Credit growth is the biggest global financial and economic story of 2016.

There’s a fundamental problem with speculative melt-ups and Credit Bubble “Terminal Phases:” They are invariably unsustainable. A torrent of Credit-driven liquidity inflates prices to unsustainable levels. Mortgage finance Bubbles are especially dangerous. They tend to be powerfully self-reinforcing, with Credit expanding exponentially during the precarious “Terminal Phase.” Fear and panic, as we’ve witnessed, can rather quickly see massive Credit expansion transformed into collapse.

It’s now been years of Chinese officials tinkering with an increasingly impervious Credit Bubble. They remain too timid, and I’d be surprised if current measures to slow housing markets have a dramatic impact. More likely, Chinese Credit continues to grow rapidly over the coming months. The much higher interest rates needed to slow rampant mortgage Credit excess are viewed as completely incompatible with a struggling general economy. Instead, it appears China will tolerate booming mortgage Credit as it systematically devalues its currency.

According to Zerohedge, a Goldman analyst (MK Tang) estimated that flows out of China surged to $78 billion during September, up from August’s estimated $32 billion. This would be the highest outflows since January. The Chinese currency weakened another 60 bps versus the dollar this week, putting the year-to-date devaluation to a not insignificant 4.2%.

Perhaps booming Chinese Credit and strong financial outflows are behind a growing inflationary bias taking hold in global markets. Crude traded near 15-month highs this week. This week in the currencies, the South African rand jumped 2.3%, the Mexican peso 2.2%, the Brazilian real 1.6% and the Russian ruble 0.9%. Brazilian stocks surged 3.8%, and Mexican stocks jumped 1.5%.

Along with EM, markets are looking at bank stocks through more rose-colored glasses. European banks jumped 5.1% this week, with Italian bank surging 7.3%. U.S. bank stocks rose 3.5%. The European periphery also rallied strongly this week, with Spanish and Italian stocks up 3.8% and 3.5%.

And while global yields have risen over the past month, bonds don’t seem all that fearful of an inflation resurgence. Recall 2007, and how the bond market had smelled out the loaming mortgage bust. Yields dropped, basically ignoring stocks (and crude) as equities went to all-time highs. What I remember most from that period was how monetary disorder created heightened instability across the markets right up until the crisis.

For the Week:

The S&P500 added 0.4% (up 4.8% y-t-d), while the Dow was about unchanged (up 4.1%). The Utilities gained 0.5% (up 11.7%). The Banks surged 3.5% (up 0.8%), and the Broker/Dealers increased 0.2% (down 2.4%). The Transports slipped 0.2% (up 6.9%). The S&P 400 Midcaps gained 0.5% (up 9.2%), and the small cap Russell 2000 rose 0.5% (up 7.2%). The Nasdaq100 gained 0.9% (up 5.6%), and the Morgan Stanley High Tech index advanced 1.1% (up 10%). The Semiconductors recovered 0.6% (up 22.8%). The Biotechs rallied 0.8% (down 19.8%). With bullion up $15, the HUI gold index surged 8.2% (up 94%).

Three-month Treasury bill rates ended the week at 32 bps. Two-year government yields slipped a basis point to 0.82% (down 23bps y-t-d). Five-year T-note yields fell five bps to 1.24% (down 51bps). Ten-year Treasury yields dropped seven bps to 1.73% (down 52bps). Long bond yields fell eight bps to 2.48% (down 54bps).

Greek 10-year yields rose six bps to 8.28% (up 96bps y-t-d). Ten-year Portuguese yields dropped 11 bps to 3.16% (up 64bps). Italian 10-year yields slipped a basis point to 1.37% (down 22bps). Spain's 10-year yields declined one basis point to 1.11% (down 66bps). German bund yields dropped five bps to 0.00% (down 62bps). French yields fell five bps to 0.28% (down 71bps). The French to German 10-year bond spread was unchanged at 28 bps. U.K. 10-year gilt yields were unchanged at 1.09% (down 87bps). U.K.'s FTSE equities index was little changed (up 12.5%).

Japan's Nikkei 225 equities index rallied 1.9% (down 9.7% y-t-d). Japanese 10-year "JGB" yields dipped a basis point to negative 0.07% (down 33bps y-t-d). The German DAX equities index rose 1.2% (down 0.3%). Spain's IBEX 35 equities index surged 3.8% (down 4.6%). Italy's FTSE MIB index jumped 3.5% (down 19.9%). EM equities were mostly higher. Brazil's Bovespa index surged 3.8% (up 48%). Mexico's Bolsa gained 1.5% (up 12.7%). South Korea's Kospi increased 0.5% (up 3.7%). India’s Sensex equities jumped 1.5% (up 7.5%). China’s Shanghai Exchange rose 0.9% (down 12.7%). Turkey's Borsa Istanbul National 100 index jumped 1.7% (up 9.9%). Russia's MICEX equities index slipped 0.4% (up 11.1%).

Junk bond mutual funds saw outflows of $160 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose five bps last week to a four-month high 3.52% (down 27bps y-o-y). Fifteen-year rates added three bps to 2.79% (down 19bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down a basis point to 3.63% (down 24bps).

Federal Reserve Credit last week jumped $17.3bn to $4.435 TN. Over the past year, Fed Credit contracted $22.7bn (0.5%). Fed Credit inflated $1.624 TN, or 58%, over the past 206 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt sank $23.7bn last week to a new six-year low $3.122 TN. "Custody holdings" were down $179bn y-o-y, or 5.4%.

M2 (narrow) "money" supply last week surged $43.4bn to a record $13.123 TN. "Narrow money" expanded $955bn, or 7.9%, over the past year. For the week, Currency increased $0.9bn. Total Checkable Deposits fell $5.5bn, while Savings Deposits surged $37.5bn. Small Time Deposits slipped $0.8bn. Retail Money Funds gained $11.6bn.

Total money market fund assets dropped $14.1bn to a 16-month low $2.635 TN. Money Funds declined $64bn y-o-y (2.4%).

Total Commercial Paper increased $2.4bn to $905bn. CP declined $158bn y-o-y, or 14.8%.

Currency Watch:

The U.S. dollar index added 0.6% to 98.63 (down 0.1% y-t-d). For the week on the upside, the South African rand increased 2.3%, the Mexican peso 2.2%, the Brazilian real 1.6%, the New Zealand dollar 1.0%, the British pound 0.4% and the Japanese yen 0.4%. For the week on the downside, the Canadian dollar declined 1.5%, the euro 0.8%, the Swedish krona 0.8%, the Swiss franc 0.3%, the Norwegian krone 0.3%, and the Australian dollar 0.1%. The Chinese yuan fell another 0.6% versus the dollar (down 4.2% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index was unchanged (up 20.6% y-t-d). Spot Gold rallied 1.2% to $1,266 (up 19.4%). Silver increased 0.5% to $17.53 (up 27%). Crude gained 50 cents to $50.85 (up 37.3%). Gasoline rose 2.6% (up 21%), while Natural Gas sank 9.1% (up 28%). Copper fell 1.0% (down 2%). Wheat dropped 1.5% (down 12%). Corn declined 0.5% (down 2%).

China Bubble Watch:

October 18 – Bloomberg: “China’s economic growth remained stable in the third quarter, all but ensuring the government’s full-year growth target is met and opening a window for policy makers to deliver on vows to rein in excessive credit and surging property prices. Gross domestic product rose 6.7% in the third quarter from a year earlier, matching the median projection by economists…”

October 16 – Bloomberg (Narae Kim): “China has been issued another yellow card. In a report released last week, S&P Global Ratings warned that China is at risk of losing its AA-status if it doesn't rein in its debt-fueled economic growth. ‘Credit growth in China continues to outpace income growth, and much new lending appears to be financing public investment,’ S&P analysts Kim Eng Tan and Xin Liu wrote. ‘Consequently, we see support for the Chinese sovereign ratings gradually diminishing.’ A downgrade would be the latest blow to the world's second-largest economy, whose outlook was slashed to negative from stable by the ratings agency in March.”

October 20 – Reuters (Samuel Shen and Adam Jourdan): “China has uncovered over 1 trillion yuan (120.35 billion pounds) worth of illegal transactions by underground banks this year, the official Financial News reported… The State Administration of Foreign Exchange (SAFE) will step up investigations into capital outflows and intensify a crackdown on underground banks to foster healthy development of the country's foreign exchange market, Zhang Shenghui, a senior director at SAFE told the newspaper.”

October 18 – Bloomberg: “China’s financial hub Shanghai is stepping up a crackdown on property developers and the flow of funds into land transactions, part of broader government efforts to prevent a housing bubble. Shanghai’s commission of housing and urban-rural development said… it was investigating whether eight developers raised selling prices for residential projects without permission. The agency has already suspended transaction licenses for some properties…”

Europe Watch:

October 20 – Bloomberg (Jeff Black and Jana Randow): “In Germany, fretting about inflation is a political currency that never seems to lose its value. In the past week, for example, at least three national newspapers have run prominent articles telling the populace that their savings -- denied the magic of compound interest by the European Central Bank’s low-rate policies -- are in for a renewed onslaught from accelerating consumer prices. The Bundesbank forecasts average inflation of 1.5% next year, whereas rates will likely be around zero.”

October 16 – Bloomberg (Mark Whitehouse): “Will Italy follow the U.K.'s example and leave the European Union? Far-fetched as it may seem, capital flows suggest that some people aren’t waiting to find out. To keep the euro area's accounts in balance, Europe's central banks track flows of money among the members of the currency union. If, for example, a depositor moves 100 euros from Italy to Germany, the Bank of Italy records a liability to the Eurosystem and the Bundesbank records a credit. If a central bank starts building up liabilities rapidly, that tends to be a sign of capital flight. Lately, Italy's central bank has been building up a lot of liabilities to the Eurosystem. As of the end of September, they stood at about 354 billion euros, up 118 billion from a year earlier -- and up 78 billion since the end of May… The outflow isn't quite as large as during the sovereign-debt crisis of 2012, but it's still significant. The main beneficiary seems to be Germany, which has seen its credits to the Eurosystem increase by 160 billion over the past year.”

October 20 – Bloomberg (Carolynn Look): “Portugal’s debt would no longer be eligible for purchase under the European Central Bank’s quantitative-easing program if the country’s credit rating is downgraded on Friday, President Mario Draghi said. A decision by Canadian rating company DBRS Ltd. to take away the country’s only investment-grade rating would disqualify Portuguese sovereign bonds from asset purchases and use as collateral in refinancing operations, Draghi said…”

Brexit Watch:

October 21 – Bloomberg (Lukanyo Mnyanda and Stephen Spratt): “Money markets are zeroing in on Article 50 as the catalyst for increased risk in banks’ pound borrowing. A gauge of where bank borrowing costs will be in coming months, known as the FRA/OIS spread, shows a marked increase in traders’ perception of risk beyond March 2017. That’s the point by which U.K. Prime Minister Theresa May has pledged to formally invoke the article of the Lisbon Treaty that will formally put the nation on a path out of the European Union.”

Fixed-Income Bubble Watch:

October 18 – Bloomberg (Scott Lanman): “China’s holdings of U.S. Treasuries fell to the lowest level since November 2012, as the world’s second-largest economy draws down its foreign reserves to prop up the yuan. The biggest foreign holder of U.S. government debt had $1.19 trillion in bonds, notes and bills in August, down $33.7 billion from the prior month, the biggest drop since 2013… The portfolio of Japan, the largest holder after China, fell for the first time in three months, down $10.6 billion to $1.14 trillion. Saudi Arabia’s holdings of Treasuries declined for a seventh straight month, to $93 billion.”

October 20 – Reuters (Herbert Lash and Joy Wiltermuth): “The dramatic shift to online shopping that has crushed U.S. department stores in recent years now threatens the investors who a decade ago funded the vast expanse of brick and mortar emporiums that many Americans no longer visit. Weak September core retail sales… provide a window into the pain the holders of mall debt face in coming months as retailers with a physical presence keep discounting to stave off lagging sales. Some $128 billion of commercial real estate loans - more than one-quarter of which went to finance malls a decade ago - are due to refinance between now and the end of 2017…”

Global Bubble Watch:

October 16 – Bloomberg (Phil Kuntz): “The world’s biggest central banks are bulking up their balance sheets this year at the fastest pace since 2011’s European debt crisis… The 10 largest lenders now own assets totaling $21.4 trillion, a 10% increase from the end of last year… Their combined holdings grew by 3% or less in both 2015 and 2014. The accelerating expansion of central banks’ balance sheets comes as debate rages over whether their asset purchases and continued low interest rates are creating bubbles, especially in the bond market… Almost 75% of the world’s central-bank assets are controlled by policy makers in four places: China, the U.S., Japan and the euro zone. The next six -- …Brazil, Switzerland, Saudi Arabia, the U.K., India and Russia -- each account for an average of 2.5%.”

October 19: “ETFGI… today reported assets invested in ETFs/ETPs listed globally reached a new record high US$3.408 trillion at the end of Q3 2016. Net flows gathered by ETFs/ETPs in September were strong with US$25.19 bn… marking the 32nd consecutive month of net inflows… Record levels of assets were also reached at the end of Q3 for ETFs/ETPs listed in the United States at US$2.415 trillion, in Europe at US$566.74 bn, and in Asia Pacific ex-Japan at US$131.88 bn. At the end of Q3 2016, the Global ETF/ETP industry had 6,526 ETFs/ETPs, with 12,386 listings, assets of US$3.408 trillion, from 284 providers listed on 65 exchanges in 53 countries.”

October 17 – Financial Times (Elaine Moore and Thomas Hale): “The European Central Bank’s mass bond-buying programme is escalating stress in a crucial short-term funding market that underpins the eurozone financial system, raising the risk of shocks in wider markets. Large-scale purchases of government bonds by the ECB has resulted in a squeeze on the availability of assets favoured for trillions of euros of repurchase agreements, or ‘repos’ — effectively short-term loans between institutions. Bankers and asset managers say the market’s dysfunction should be high on the list of topics discussed by the ECB’s governing council when it meets in Frankfurt this week to decide on the future of its €80bn a month quantitative easing programme.”

October 18 – Bloomberg (Luke Kawa and Andrea Wong): “It’s not hard to see the potential flash points on the horizon -- the U.S. presidential election; Deutsche Bank AG’s mounting legal charges; the day central banks stop buying bonds. Yet when it comes to gauging risks in the world’s financial markets, these days investors are flying more or less blind. That’s because the once-dependable indicators traders relied on for decades to send out warnings are no longer up to the task. The so-called yield curve isn’t the recession predictor it once was. Swap spreads are so distorted they can’t be trusted. Even the vaunted VIX -- sometimes referred to as the ‘fear gauge,’ is leading its followers astray, strategists say.”

October 18 – Bloomberg (Sid Verma and Luke Kawa): “Fears of a bond-market crash, a breakdown in globalization, a new crisis in the euro area? There were a bevy of reasons for fund managers to push their cash balances to 5.8% of their portfolios in October, up from 5.5% last month, matching levels not seen since the aftermath of the Brexit vote. The share of cash hasn't been higher than that since November 2001, shortly after the terrorist attacks in the U.S…”

U.S. Bubble Watch:

October 21 – Bloomberg (Oliver Renick and Rebecca Spalding): “U.S. companies are on pace to spend a record $1 trillion on buybacks and dividends in 2016. It’ll be a tough record to top. A total $600 billion in share repurchases and $400 billion in dividends will be doled out by S&P 500 Index members by the end of the year, the biggest combined payout in history, according to… Barclays Plc. Gravy like that is getting tougher to sustain as corporate profits suffer a six-quarter slump and cash levels begin to dwindle. As a result, fewer companies in the third quarter upped their dividend -- and more are tapping the debt market to sustain their buyback programs, data from S&P Global Inc. and JPMorgan… show. For U.S. stock investors, it means a key pillar of the 7 1/2-year-old bull market may be tipping over.”

October 20 – Bloomberg (Michelle Jamrisko): “Sales of previously owned U.S. homes increased more than projected in September, showing residential real estate continues to contribute modestly to growth… Contract closings rose 3.2% to a 5.47 million annual rate… Sales climbed 2.8% from September 2015… Median sales price increased 5.6% from September 2015 to $234,200. Inventory of available properties dropped 6.8% from a year earlier to 2.04 million…”

October 17 – Wall Street Journal (Dennis K. Berman and Jamie Heller): “Investors are giving up on stock picking. Pension funds, endowments, 401(k) retirement plans and retail investors are flooding into passive investment funds, which run on autopilot by tracking an index. Stock pickers, archetypes of 20th century Wall Street, are being pushed to the margins. Over the three years ended Aug. 31, investors added nearly $1.3 trillion to passive mutual funds and their brethren—passive exchange-traded funds—while draining more than a quarter trillion from active funds, according to Morningstar Inc.”

October 20 – Financial Times (Robin Wigglesworth, Nicole Bullock and Joe Rennison): “The US Securities and Exchange Commission is gearing up for a root-and-branch review of the rapidly growing exchange traded fund industry amid concerns massive flows into ETFs may be exacerbating volatility in financial markets. In the US alone, ETF assets stand at $2.4tn, and globally they hold $3.3tn, according to ETFGI… They account for about 30% of the value of all US shares traded… ETFs were at the centre of wild equity trading in August 2015. In one session, more than 1,000 securities were suspended from trading for sharp moves and some ETFs veered sharply from their net asset values. The chaotic trading highlighted how interconnected ETFs are with the underlying stocks as well as the futures market.”

October 17 – Wall Street Journal (Dennis K. Berman and Jamie Heller): “Picking stocks is at heart an arrogant act. It requires in the stock picker a confidence that most others are dunces, and that riches await those with better information and sharper instincts. Entire cities—notably New York and London—have been erected in service of this belief. And the image of the clever, dauntless stock maestro is embedded in the American ideal. Yet there is a simple, destructive idea taking over Wall Street: that stock pickers can’t pick stocks well—or at least well enough for the fees they charge. And even those who do can’t sustain it year after year. In short, the idea of the ‘active manager’ is rapidly losing its intellectual legitimacy to the primacy of the ‘passive investor’ who merely buys an index of shares.”

October 18 – Bloomberg (Michelle Jamrisko): “The cost of living in the U.S. rose at the fastest pace in five months on energy and shelter prices, a sign inflation is getting closer to the Federal Reserve’s goal. The consumer-price index increased 0.3% in September from the previous month… The year-on-year rise was 1.5%, the most since October 2014.”

October 16 – Wall Street Journal (Julie Jargon and Lillian Rizzo): “The U.S. is having one of its biggest restaurant shakeouts in years, as an oversupply of eateries and new rivals offering prepared meals to go claim what is expected to be a growing number of casualties. In one recent week alone, three restaurant companies filed for chapter 11 bankruptcy protection, including Così Inc.; Rita Restaurant Corp., parent of the Don Pablo chain, and Garden Fresh Corp... At least five other restaurant operators have filed for court protection this year, with restructuring plans that call for restaurant closures.”

Federal Reserve Watch:

October 20 – Bloomberg (Jeanna Smialek): “The U.S. economy maintained a steady growth pace between late August and early October, as a tight labor market with nascent wage pressures contributed to a ‘mostly positive’ outlook, a report from the 12 Federal Reserve districts showed. ‘Most districts indicated a modest or moderate pace of expansion,’ according to the Fed’s latest Beige Book, an economic survey by reserve banks. ‘Outlooks were mostly positive, with growth expected to continue at a slight to moderate pace in several districts.’”

October 18 – Bloomberg (Jeanna Smialek): “The boards of directors at nine of the 12 regional Federal Reserve banks last month sought an increase in the rate on direct loans from the Fed to 1.25% from 1%… The Atlanta Fed joined the calls for an increase in the discount rate, pushing the number of regional banks asking for a hike to its highest since December 2015.”

Japan Watch:

October 18 – Reuters (Malcolm Foster and Tetsushi Kajimoto): “Japan Inc has little faith in the central bank's latest shift in monetary policy, with companies saying it won't generate long-desired inflation, spur further business investment or have an impact on the economy. The findings of the Reuters Corporate Survey… suggest a long road ahead for Prime Minister Shinzo Abe… More than 80% of firms said last month's overhaul in policy - one that targets the bond market's yield curve instead of the amount of money pumped into the financial system - will not have an impact on prices or change their capital spending plans.”

Leveraged Speculator Watch:

October 20 – Bloomberg (Saijel Kishan): “Howard Fischer, wearing a white shirt and khakis, leans back into a window seat at a juice bar in Greenwich, Connecticut, sips a cold-brewed Mexican mocha and shares his angst. ‘It’s miserable, miserable,’ the 57-year-old manager of $1.1 billion Basso Capital Management says of hedge fund returns over the past few years. ‘If that’s the normal expectation, I don’t have a business.’ Fischer’s lament and ones like it are echoing through the industry. It’s an existential crisis for former masters of the universe who once prided themselves on their trading prowess. Now they’re questioning their wisdom and their ability to generate profits that made them among the richest in finance. The $2.9 trillion industry has posted average annual returns of 2% over the past three years, well below those of most index funds…”

October 20 – Bloomberg (Saijel Kishan and Simone Foxman): “Hedge fund investors pulled $28.2 billion from the industry in the third quarter, the most since the aftermath of the global financial crisis, according to Hedge Fund Research Inc. The net outflows, which amount to 0.9% of the industry, are the largest since the second quarter of 2009… Investors redeemed $51.5 billion in the first nine months of the year, even as industry assets rose to a record $2.97 trillion… The third quarter was the fourth consecutive quarter of redemptions for the industry, the longest since 2008 and 2009, HFR said. Redemptions were concentrated in the biggest funds…”

October 20 – Bloomberg (Sonali Basak): “Portfolio managers at hedge funds, facing an exodus of investors frustrated with high fees, are about to feel the pain from an estimated 34% reduction in their compensation. While fund managers may take the biggest pay cut in the industry, professionals with seven or more years of experience see their total compensation declining by 14% on average for 2016, recruiter Odyssey Search Partners said in a report…”

October 19 – Wall Street Journal (Justin Baer): “One junk-bond trader at Goldman Sachs Group Inc. earned more than $100 million in trading profits for the firm earlier this year, an unusual gain at a time when new regulations have pushed Wall Street to take fewer risks.”

October 18 – Bloomberg (Suzy Waite): “Asia hedge funds are opening at the slowest pace since the turn of the century. Just 27 new funds started trading in Asia in the first nine months of this year, the fewest since 2000 when 56 funds opened, according to Eurekahedge. It’s the third straight year of declines, and down from 83 new funds last year.”

Geopolitical Watch:

October 19 – Reuters (David Brunnstrom and Arshad Mohammed): “The United States and South Korea agreed… to step up military and diplomatic efforts to counter North Korea's nuclear and missile programs, saying they posed a ‘grave’ security threat following repeated tests this year. After talks in Washington between their foreign and defense ministers, the countries said they had agreed to set up a high-level Extended Deterrence Strategy and Consultation Group to leverage ‘the full breadth of national power – including diplomacy, information, military coordination, and economic elements’ in the face of the North Korean threat.”

October 20 – Bloomberg (Ian Wishart, John Follain and Patrick Donahue): “The European Union said it was too soon to consider imposing sanctions on Russia for the bombing of rebel-held areas of Syria, while maintaining the threat of action if Vladimir Putin doesn’t back down… While the U.K., France and Germany wanted to take a harsher tone with Russia, Italy’s Matteo Renzi led those countries who opposed the move.”

October 20 – Bloomberg (Andreo Calonzo and Cecilia Yap): “Philippine President Rodrigo Duterte will bring home $24 billion worth of funding and investment pledges from his four-day visit to China as both nations agreed to resume talks and explore areas of cooperation in the South China Sea. China will provide $9 billion in soft loans, including a $3 billion credit line with the Bank of China, while economic deals including investments would yield $15 billion… Preliminary agreements in railways, ports, energy and mining worth $11.2 billion were signed… ‘China is not only a friend. China is only a relative, but China is a big brother,’ Communications Secretary Martin Andanar said in Beijing…”

October 20 – Reuters (Ben Blanchard): “Philippine President Rodrigo Duterte announced his ‘separation’ from the United States on Thursday, declaring he had realigned with China as the two agreed to resolve their South China Sea dispute through talks. Duterte made his comments in Beijing, where he is visiting with at least 200 business people to pave the way for what he calls a new commercial alliance as relations with longtime ally Washington deteriorate. ‘In this venue, your honors, in this venue, I announce my separation from the United States,’ Duterte told Chinese and Philippine business people, to applause, at a forum in the Great Hall of the People attended by Chinese Vice Premier Zhang Gaoli.”

October 19 – Reuters (Orhan Coskun and Nick Tattersall): “Smarting over exclusion from an Iraqi-led offensive against Islamic State in Mosul and Kurdish militia gains in Syria, President Tayyip Erdogan warned… Turkey ‘will not wait until the blade is against our bone’ but could act alone in rooting out enemies. In a speech at his palace, Erdogan conjured up an image of Turkey constrained by foreign powers who ‘aim to make us forget our Ottoman and Selcuk history’, when Turkey's forefathers held territory stretching across central Asia and the Middle East. ‘From now on we will not wait for problems to come knocking on our door, we will not wait until the blade is against our bone and skin, we will not wait for terrorist organizations to come and attack us…’”