Tuesday, August 23, 2016

Saturday, August 20, 2016

Saturday's News Links

[Bloomberg] Rajan’s Deputy Patel Named as India’s Central Bank Governor

[Reuters] Turkey asks Germany for help with Gulen crackdown: report

Weekly Commentary: The "Neutral Rate"

The neutral (or natural) rate of interest is the rate at which real GDP is growing at its trend rate, and inflation is stable. It is attributed to Swedish economist Knut Wicksell, and forms an important part of the Austrian theory of the business cycle. The neutral rate provides an important benchmark for policymakers to compare with the market rate. When interest rates are neutral the economy is on a sustainable path, and it is deviations from neutrality that cause booms and busts.” (Financial Times/lexicon)

Wicksell based his theory on a comparison of the marginal product of capital with the cost of borrowing money. If the money rate of interest was below the natural rate of return on capital, entrepreneurs would borrow at the money rate to purchase capital (equipment and buildings), thereby increasing demand for all types of resources and their prices; the converse would be true if the money rate was greater than the natural rate of return on capital. So long as the money rate of interest persisted below the natural rate of return on capital, upward price pressures would continue… Price stability would result only when the money rate of interest and the natural rate of return on capital—the marginal product of capital—were equal.” “Wicksell’s Natural Rate”, Federal Reserve Bank of St. Louis Monetary Trends, March 2005

Wicksell’s “natural rate” is a powerful analytical concept. In a more traditional backdrop, I would view the so-called “natural rate” as the price of Credit where supply and demand intersect at a point of relative stability for returns on capital. When economic returns are high, heightened demand for Credit (to fund investment) pushes up its cost. Over time, increased investment will result in an expanded supply of output and lower returns. Weak economic returns then engender less demand for borrowings and a resulting lower cost of Credit.

The hypothetical “natural rate” embodies a self-regulating system. During Wicksell’s time, money and Credit entered into the economic system primarily through lending for capital investment. And, importantly, there were constraints on the supply of “money” available to be lent. Banks were the dominant source of lending, and they were subject to specific restraints on Credit expansion (i.e. bank reserve and capital requirements, the gold standard).

Wicksell’s “natural rate” is incompatible with contemporary finance. These days, finance is introduced into systems (economic and financial) with little association to economic returns. Indeed, the primary mechanisms for the creation of new finance are government (fiscal and monetary) spending and asset-based lending. Furthermore, there are no restrains on the available supply of Credit, so its price is outside the purview of supply and demand. For the most part, the government dictates the price of finance. This system is neither self-adjusting nor self-correcting.

Enter the current monetary debate: Things have not progressed as expected. Years of unthinkable monetary stimulus have failed to achieve either general prosperity or consistent inflation in the general price level. Fragilities are as acute as ever. So policymaker reassessment is long overdue. Not surprisingly, however, there’s no second guessing “activist” (inflationist) monetary doctrine. Central bankers are not about to admit that a policy of zero rates and Trillions of monetization is fundamentally flawed. Apparently, we are to believe that forces outside their control have pushed down the “neutral rate.” The solution, predictably, is lower for longer – along with more government spending and programs. So focus on the “neutral rate” becomes the latest elaborate form of policymaking rationalization/justification.

From Ben Bernanke’s August 8, 2016 blog, “The Fed’s Shifting Perspective on the Economy and its Implications for Monetary Policy”: “Projections of r* can be interpreted as estimates of the ‘terminal’ or ‘neutral’ federal funds rate, the level of the funds rate consistent with stable, noninflationary growth in the longer term… As mentioned, a lower value of r* implies that current policy is not as expansionary as thought… In particular, relative to earlier estimates, they see current policy as less accommodative, the labor market as less tight, and inflationary pressures as more limited. Moreover, there may be a greater possibility that running the economy a bit ‘hot’ will lead to better productivity performance over time. The implications of these changes for policy are generally dovish, helping to explain the downward shifts in recent years in the Fed’s anticipated trajectory of rates.”

Today’s monetary “debate” is reminiscent of Alan Greenspan’s fateful foray into New Paradigm worship. In particular, he viewed (going back to 1996) that technological advancement and attendant productivity gains had fundamentally raised the economy’s “speed limit”. Monetary policy could be run looser than in the past – and run it did. Such fallacious thinking was only temporarily discredited with the the bursting of the “tech” Bubble, as captured in a 2001 WSJ article:

December 28, 2001 – Wall Street Journal (Greg Ip and Jacob M. Schlesinger): “Five years ago, Alan Greenspan began pushing a reluctant Federal Reserve to embrace his New Economy vision of rapid productivity growth and rising living standards. Today, Fed policy makers are debating whether they went too far. The answer could help determine whether the current recession marks a temporary aberration in an era of swift growth, or whether the rapid growth of the late 1990s itself was the aberration. Mr. Greenspan hasn't lost the faith. ‘New capital investment, especially the high-tech type, will continue where it left off,’ he declared in a speech… He ignored the collapse of so many symbols of the 1990s boom, including Enron Corp., the sponsor of the ‘distinguished public service’ award he received that evening. ‘The long-term outlook for productivity growth, as far as I'm concerned, remains substantially undiminished,’ the Fed chairman asserted.”

New technologies are seductive. Rapid technological advancement coupled with momentous financial innovation proved absolutely engrossing. It was easy to ignore Enron, WorldCom and the like, just as it was to disregard 1994’s bond market tumult, the Mexican meltdown, the SE Asia debacle, the Russian collapse and LTCM. By 2001 it was rather obvious that New Age finance was highly unstable. Yet the 2002 corporate debt crisis along with the arrival of Dr. Bernanke to the the Marriner S. Eccles Building ensured that the FOMC pursued even more egregious policy blunders.

The Federal Reserve has been rationalizing loose monetary policies for 20 years now. Instead of Alan Greenspan’s electrifying productivity miracle, it’s a future of dreadful “secular stagnation.” Enron was little small potatoes compared to the frauds that followed. And the key issue from two decades ago somehow remains unaddressed: over-liquefied and speculative securities markets are incapable of effectively allocating financial and real resources. Moreover, central bank command over both the cost of finance and the performance of securities markets ensures dysfunction both financially and economically.

Contemporary notions of a “neutral rate” are deeply flawed – to the point of being ludicrous. From Bloomberg: “The Fed aims to set short-term interest rates in relation to the ‘natural rate’—the one that would produce full employment without excess inflation.” Yet it’s not the Fed funds rate spawning “full employment,” and central bankers certainly do not control a general price level. It is instead the ongoing historic Bubble in market-based finance that dictates the flow of “money” and Credit throughout the economy. One would have to be a diehard optimist to believe either markets or global economies are on a “sustainable path”. Market participants have been incentivized to take excessive risks and to speculate, with central bankers clearly responsible for inflationary Bubbles that have engulfed global securities and asset markets.

There’s no mystery surrounding the sinking employment rate. Ultra-loose monetary policies (rates and QE) have stoked excess securities market inflation, boosting perceived wealth while fostering extremely loose corporate Credit conditions. Such a backdrop spurs business borrowing, spending and hiring. Still, ongoing pathetic growth and productivity dynamics, along with weakening profits, corroborate the view that resources continue to be poorly allocated.

A low unemployment rate concurrent with mild CPI inflation is no conundrum either. On a global basis, unfettered finance has spurred unprecedented over- and malinvestment, ensuring downward price pressures. To be sure, the proliferation of new technologies and digitized output has fundamentally broadened the available supply of goods. Moreover, at home and abroad, unsound global finance has fomented wealth inequality that plays prominently in the disinflationary backdrop more generally.

A low “neutral rate” might be consistent with an economic boom, or it could just as well be compatible with financial and economic collapse. Causation – the driving force behind either boom or bust - is found with intertwined and closely correlated global securities markets. Two decades of persistently loose monetary policies have created deep economic maladjustment and historic asset price Bubbles. And these days central bankers see resulting stagnation (growth, productivity, pricing power, profits, etc.) as evidence of a historically low “neutral rate” - that is then used to justify their runaway experiment in ultra-loose monetary management.

Back in 2013, in the midst of a bout of market tumult, chairman Bernanke reassured the markets that the Fed was prepared to “push back against a tightening of financial conditions.” In the eyes of the market, this significantly augmented/clarified “whatever it takes.” The Federal Reserve – and global central bankers more generally – could simply not tolerate fledgling risk aversion (“risk off”) in the securities markets that would impinge financial conditions more generally. The Fed would use its rate and QE policy specifically to backstop the securities markets, in the process sustaining Bubble Dynamics.

“Whatever it takes” and “pushing back” unleashed a precarious Terminal Bubble Phase. With economic and market risks now so elevated, even the thought of recession or bear market has become unacceptable to central bankers.

There was a research piece this week from Federal Reserve Bank of San Francisco President John Williams, “Monetary Policy in a Low R-star World:” “The time has come to critically reassess prevailing policy frameworks and consider adjustments to handle new challenges, specifically those related to a low natural real rate of interest. While price level or nominal GDP targeting by monetary authorities are options, fiscal and other policies must also take on some of the burden to help sustain economic growth and stability.” And there was Thursday’s Washington Post op-ed from Larry Summers: “What We Need to do to Get Out of This Economic Malaise.” “I cannot see how policy could go wrong by setting a level target of 4 to 5% growth in nominal gross domestic product and think that there could be substantial benefits.”

Let me suggest what is going wrong.  Even after several years of typical recovery, there would be the issue of mounting imbalances and excesses. With almost eight years of history’s most extreme monetary stimulus – including zero rates, massive monetization and the direct targeting of securities and asset inflation – there is surely an extraordinary degree of underlying economic maladjustment. One should expect an inordinate number of uneconomic enterprises, along with the now typical amounts of fraud and nonsense (that prosper on loose finance).

Historic excess and distortions have for years accumulated throughout the securities markets. The underlying amount of speculative leverage likely exceeds 2008. Eight years of Federal Reserve zero rates and liquidity backstops have severely perverted market risk perceptions. Literally Trillions have flowed into perceived liquid and low-risk securities – fixed-income and equities. Trillions have chased yields and returns, assuming liquidity while being indifferent to risk. The unwieldy global pool of speculative finance has inflated by Trillions. Meanwhile, the Fed’s serial interventions to smother “Risk Off” has undoubtedly cultivated major latent fragilities within the derivatives trading complex.

The current policy objective should be for Fed to begin extricating itself from market dominance. It’s absolutely crucial for the economy and markets to commence the process of learning to stand on their own. At this point, such a transition would not go smoothly. The alternative is only deeper structural impairment and more extreme financial and economic fragility.

The system has been put in a quite precarious position, but it’s time to let Capitalism sorts its way through. The very opposite seems ensured. We’re in the early stage of even more egregious government (fiscal and monetary) intervention in the economy and markets. The election will usher in a surge of deficit spending. Meanwhile, the Federal Reserve appears poised to use a low “neutral rate” as an excuse to cling to ultra-loose monetary policies.

I am often reminded of misguided late-nineties dollar optimism. New Paradigm thinking had the markets content to overlook underlying U.S. financial and economic fragilities, not to mention massive intractable Current Account Deficits. King dollar had become a Crowded Trade, although nothing in comparison to this cycle’s dollar exuberance. Curiously, the dollar index declined 1.2% this week. In the face of Japan’s deep problems and policy shortcomings, the $/yen traded below 100 this week (yen up 16.9% y-t-d). Despite the eurozone’s serious deficiencies, the euro ended the week above 113 (up 4.3% y-t-d). In general, emerging markets are a mess, yet many EM currencies have rallied strongly against the dollar.

Integral to the dollar bull case have been expectations that an outperforming U.S. economy would ensure rising U.S. rates and attractive interest-rate differentials. Yet king dollar excesses (foreign and speculative flows) exacerbated Bubble Dynamics, with market and economic vulnerabilities now having trapped the Yellen Fed in ultra-loose monetary measures. Global markets appear to have begun anticipating a weaker dollar. This would certainly help to explain the big turnarounds in commodities and EM.

If the Fed is hellbent on spurring inflation (at home and abroad), a weaker dollar could go a long way. But policy savants be careful what you wish for. After all, global markets are awash in Crowded Trades betting on dollar strength, disinflationary forces, low bond yields and market stability - as far as the eye can see. There is today no “neutral rate” that could possibly neutralize such a perilous global Bubble.


For the Week:

The S&P500 was unchanged (up 6.8% y-t-d), while the Dow slipped 0.1% (up 6.5%). The Utilities dropped 1.3% (up 16.2%). The Banks jumped 1.7% (down 3.9%), and the Broker/Dealers rose 1.1% (down 6.3%). The Transports advanced 1.6% (up 5.6%). The S&P 400 Midcaps added 0.3% (up 11.7%), and the small cap Russell 2000 increased 0.6% (up 8.9%). The Nasdaq100 was unchanged (up 4.6%), and the Morgan Stanley High Tech index gained 1.2% (up 9.1%). The Semiconductors jumped 2.2% (up 20.1%). The Biotechs declined 0.7% (down 13.0%). Though bullion added $6, the HUI gold index fell 3.6% (up 142%).

Three-month Treasury bill rates ended the week at 30 bps. Two-year government yields rose five bps to 0.75% (down 30bps y-t-d). Five-year T-note yields rose seven bps to 1.16% (down 59bps). Ten-year Treasury yields gained seven bps to 1.58% (down 67bps). Long bond yields increased six bps to 2.29% (down 73bps).

Greek 10-year yields fell 13 bps to 7.86% (up 54bps y-t-d). Ten-year Portuguese yields surged 31 bps to 2.98% (up 46bps). Italian 10-year yields jumped nine bps to 1.13% (down 46bps). Spain's 10-year yield increased three bps to 0.95% (down 82bps). German bund yields rose seven bps to negative 0.04% (down 66bps). French yields gained seven bps to 0.18% (down 81bps). The French to German 10-year bond spread was unchanged at 22 bps. U.K. 10-year gilt yields rose 10 bps to 0.62% (down 134bps). U.K.'s FTSE equities index declined 0.8% (up 9.9%).

Japan's Nikkei 225 equities index dropped 2.2% (down 13.1% y-t-d). Japanese 10-year "JGB" yields increased three bps to negative 0.09% (down 26bps y-t-d). The German DAX equities index fell 1.6% (down 1.8%). Spain's IBEX 35 equities index sank 3.0% (down 11.5%). Italy's FTSE MIB index was hit 4.0% (down 23.9%). EM equities were mixed. Brazil's Bovespa index gained another 1.5% (up 36.5%). Mexico's Bolsa was little changed (up 12.4%). South Korea's Kospi index added 0.3% (up 4.8%). India’s Sensex equities slipped 0.3% (up 7.5%). China’s Shanghai Exchange jumped 1.9% (down 12.2%). Turkey's Borsa Istanbul National 100 index was about unchanged (up 8.9%). Russia's MICEX equities index slipped 0.4% (up 11.3%).

Junk bond mutual funds saw inflows of $889 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined two bps to 3.43% (down 54bps y-o-y). Fifteen-year rates slipped two bps to 2.74% (down 52bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up three bps to 3.61% (down 47bps).

Federal Reserve Credit last week expanded $10.4bn to $4.438 TN. Over the past year, Fed Credit declined $22.3bn. Fed Credit inflated $1.627 TN, or 58%, over the past 197 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $2.9bn last week to $3.203 TN. "Custody holdings" were down $153bn y-o-y, or 4.6%.

M2 (narrow) "money" supply last week increased $5.6bn to a record $12.971 TN. "Narrow money" expanded $884bn, or 7.3%, over the past year. For the week, Currency increased $0.8bn. Total Checkable Deposits surged $69.8bn, while Savings Deposits dropped $65.3bn. Small Time Deposits added $1.0bn. Retail Money Funds slipped $0.7bn.

Total money market fund assets dropped $34.9bn to a six-week low $2.710 TN. Money Funds rose $24bn y-o-y (0.9%).

Total Commercial Paper dropped $11.0bn to $1.012 TN. CP declined $45bn y-o-y, or 4.2%.

Currency Watch:

The U.S. dollar index dropped 1.2% to 94.5 (down 4.2% y-t-d). For the week on the upside, the euro increased 1.5%, the Swiss franc 1.4%, the British pound 1.2%, the Japanese yen 1.1%, the New Zealand dollar 1.0%, the Swedish krona 0.8%, the Canadian dollar 0.6%, and the Mexican peso 0.2%. For the week on the downside, the Brazilian real declined 0.4%, the Australian dollar 0.3%, the South African rand 0.3%, and the Norwegian krone 0.1%. The Chinese yuan declined 0.3% versus the dollar (down 2.5% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index surged 4.9% (up 18.9% y-t-d). Spot Gold added 0.4% to $1,341 (up 26%). Silver declined 2.1% to $19.31 (up 40%). WTI Crude surged $4.08 to $48.57 (up 31%). Gasoline jumped 10.8% (up 20%), while Natural Gas slipped 0.4% (up 10%). Copper gained 1.8% (up 2%). Wheat surged 5.3% (down 5%). Corn advanced 3.2% (down 4%).

Turkey Watch:

August 14 – Reuters (Humeyra Pamuk): “Turkey will not compromise with Washington over the extradition of the Islamic cleric it accuses of orchestrating a failed coup, Prime Minister Binali Yildirim said…, warning of rising anti-Americanism if the United States fails to extradite.”

August 18 – Reuters (Ayla Jean Yackley): “Turkish authorities ordered the detention of nearly 200 people, including leading businessmen, and seized their assets as an investigation into suspects in last month's failed military rebellion shifted to the private sector. President Tayyip Erdogan has vowed to choke off businesses linked to U.S.-based Muslim cleric Fethullah Gulen, whom he blames for the July 15 coup attempt, describing his schools, firms and charities as ‘nests of terrorism.’ Tens of thousands of troops, civil servants, judges and officials have been detained or dismissed in a massive purge…”

August 14 – Reuters (Michelle Martin and Humeyra Pamuk): “Turkey could walk away from its promise to stem the flow of illegal migrants to Europe if the European Union fails to grant Turks visa-free travel to the bloc in October, Foreign Minister Mevlut Cavusoglu told a German newspaper. His comments… coincide with rising tensions between Ankara and the West that have been exacerbated by the failed coup attempt… Turkey is incensed by what it sees as an insensitive response from Western allies to the failed putsch, in which 240 people were killed.”

Brexit Watch:

August 13 – Bloomberg (Scott Hamilton and Colin Keatinge): “Monetary policy is only a ‘short-term balm’ that can’t fully insulate the U.K. from the long-term impacts of the vote to leave the European Union, Bank of England Chief Economist Andrew Haldane wrote… The bank’s package of monetary policy measures unleashed earlier this month, including the first interest-rate cut in seven years, are designed to be a shot in the arm for business and consumer confidence after the vote to leave the European Union ‘has thrown up a dust cloud of economic uncertainty, making it harder for companies to plan, with potentially adverse implications for future investment and jobs,’ Haldane said…”

August 15 – Reuters (Ana Nicolaci da Costa): “The price of homes for sale in England and Wales fell in August, posting the biggest drop since November… Asking prices fell by a monthly 1.2%..., after shedding 0.9% in July. The biggest drop was in London and the South East, with asking prices falling by 2.6% and 2.0% respectively.”

August 16 – Bloomberg (Janet Lorin): “Larger investment banks with their European headquarters in London are already making plans for their own withdrawal. Many plan to start the process of moving jobs from the U.K. within weeks of the government triggering Brexit, people briefed on the plans of four of the biggest firms told Bloomberg's Gavin Finch. That suggests the banks may move faster than their public messages of patience would imply, and reflects dismay with the U.K.'s lack of a clear plan to protect its status as a global financial hub. There are concerns British-based banks will lose the right to sell services freely around the European Union.”

Europe Watch:

August 18 – New York Times (Landon Thomas Jr.): “In Italy, where two decades of economic stagnation have created a long line of barely breathing companies, Feltrinelli, one of the country’s largest booksellers, stands out. Since 2012, the company has chalked up three consecutive years of losses totaling nearly 11 million euros ($12.4 million). Even so, late last year, Feltrinelli was able to secure a fresh €50 million line of credit from a syndicate that included two of Italy’s largest banks, UniCredit and Intesa Sanpaolo, at an interest rate below what top-rated companies in Europe were paying. As Italy and Europe more broadly struggle to come to grips with an escalating problem with bad loans, a new paper by economists connected to the Center for Economic Policy Research… highlights the extent to which Italy’s main banks — known to be the weakest in the eurozone in terms of cash reserves — have stepped up their lending to the country’s most troubled companies.”

Fixed-Income Bubble Watch:

August 14 – Wall Street Journal (Carolyn Cui and Mike Bird): “Bond investment funds that usually have little appetite for riskier debt are boosting their exposure to the developing world, a move that is helping drive this year’s emerging-markets rally. International bond funds run by BlackRock Inc., Legg Mason Inc. and OppenheimerFunds are among the big money managers that have been increasing their positions in emerging-market debt in recent months. That shift reflects how global bond funds are feeling the pinch from low U.S. interest rates and negative rates in Japan and much of Europe.”

Global Bubble Watch:

August 18 – New York Times (Robin Wigglesworth): “Paul Singer, head of $28bn hedge fund Elliott Management, has warned that the global bond market is ‘broken’, and predicted that the end of the current environment is ‘likely to be surprising, sudden, intense, and large’… In his second quarter letter to investors… Mr Singer sounded an ominous warning on the state of the global debt market, with more than $13tn of bonds trading with negative yields. The hedge fund manager said it was ‘the biggest bond bubble in world history,’ and cautioned that investors should shy away from sub-zero yielding debt. ‘Hold such instruments at your own risk; danger of serious injury or death to your capital!’, he wrote… He added that ‘the ultimate breakdown (or series of breakdowns) from this environment is likely to be surprising, sudden, intense, and large’.”

August 16 – Reuters (Claire Milhench): “Global investors have cut their cash holdings sharply and added to emerging market and U.S. stocks in August as global growth expectations have rebounded, a Bank of America Merrill Lynch (BAML) survey indicated… Cash levels dropped to 5.4% from a 15-year high of 5.8% in July… A net 23% of investors now expect the global economy to improve over the next 12 months, an optimism reflected in the overall equity allocation recovering to a net overweight of 9%. This was up from a net 1% underweight last month - the first underweight in four years. Among the biggest beneficiaries of this switch were emerging market stocks, where the allocation rose to a net 13% overweight - the highest level since September 2014. This was up from 10% last month.”

August 16 – Bloomberg (Vincent Cignarella): “This wasn't supposed to happen. The central banks of Australia and New Zealand lowered benchmark interest rates and their respective currencies promptly strengthened. Traders puzzled by the way foreign-exchange markets are behaving should consider that potential for capital appreciation, in addition to yield, may be a significant driver of recent moves. Investors are engaging in a type of 'reverse carry trade,' buying low-yield currencies for high-yield pairs and accepting small interest rate differential losses for potential large capital gains where central banks are cutting rates or buying more domestic bonds. Those moves should push up the price of underlying assets and, in theory, outweigh small losses on interest rate carry.”

U.S. Bubble Watch:

August 18 – The Economist: “WHAT are the most dysfunctional parts of the global financial system? China’s banking industry, you might say, with its great wall of bad debts and state-sponsored cronyism. Or the euro zone’s taped-together single currency, which stretches across 19 different countries, each with its own debts and frail financial firms. Both are worrying. But if sheer size is your yardstick, nothing beats America’s housing market. It is the world’s largest asset class, worth $26 trillion, more than America’s stockmarket. The slab of mortgage debt lurking beneath it is the planet’s biggest concentration of financial risk. When house prices started tumbling in the summer of 2006, a chain reaction led to a global crisis in 2008-09. A decade on, the presumption is that the mortgage-debt monster has been tamed. In fact, vast, nationalised, unprofitable and undercapitalised, it remains a menace to the world’s biggest economy.”

August 18 – Bloomberg (Joe Light): “The hole at the corner of 15th and L streets, in downtown Washington, is deep -- and getting deeper. Earth-movers there are laying the foundations of a shiny new headquarters for Fannie Mae, the bailed-out giant of American mortgages. But the sleek design, replete with glass sky bridges, belies a sober reality: Fannie Mae and its cousin, Freddie Mac, are once again headed for trouble. In fact, there’s almost no way around it. On Jan. 1, 2018, the two government-sponsored enterprises will officially run out of capital under the current terms of their bailout. After that, any losses would be shouldered by taxpayers. Granted, few people are predicting a disaster like the one in 2008, when the GSEs had to be thrown a $187.5 billion federal lifeline. But eight years later, people still don’t agree on what to do with these wards of the state… ‘Everyone agreed that this was a broken business model that made no sense,’’ said Douglas Holtz-Eakin, president of the American Action Forum… ‘Now, inertia is driving the way.’”

August 16 – Bloomberg (Sid Verma and Luke Kawa): “Stock buybacks appear to be slowing down, suggesting either corporate America's outlook has dimmed, stock valuations have become prohibitively high or, most optimistically, that companies are starting to listen to investors and put funds toward other uses. Buybacks announced for the second quarter's earnings season between July 8 and August 15 totaled an average of $1.8 billion a day, the lowest volume in an earnings season since the summer of 2012, according to TrimTabs Investment Research… In the first seven months of 2016, buybacks totaled $376.5 billion, according to TrimTabs. That's down 21% from $478.4 billion in the first seven months of last year.”

August 19 – Wall Street Journal (Mike Bird, Vipal Monga and Aaron Kuriloff): “Big companies are handing more of their profits to shareholders than at any time since the financial crisis, as record-low bond yields put a premium on dividends. Payouts at S&P 500 companies for the past 12 months amounted to almost 38% of net income over the period, according to FactSet, the most since February 2009. In the second quarter, 44 S&P 500 companies paid an annual dividend that exceeded their latest 12 months of net income… That is the most in a decade and a practice some analysts deem unsustainable.”

August 12 – Wall Street Journal (Maria Armental): “As U.S. stocks rally, private-equity firms are taking the other side of the trade. The S&P 500, Dow Jones Industrial Average and Nasdaq Composite Index all notched record highs Thursday, a triple-threat that hadn’t occurred since the dot-com boom. Meanwhile, 15 block trades, bulk sales of big chunks of stock, raised a total of $5 billion in the biggest week for such deals since March 2015. Private-equity firms, which use block trades to sell out of companies they previously took public, accounted for nine of the 15 deals.”

August 17 – Bloomberg (Rachel Evans): “Store closures by Macy’s Inc. could hurt more than the mall rats, according to Morningstar Credit Ratings. Almost $30 billion of bonds backed by commercial mortgages are exposed to the retailer, which last week announced plans to shutter 100 outlets, the rating company wrote… More than $3.6 billion in loans would be affected by the closing of 28 stores that Morningstar identifies as most at risk, several of which support multiple asset-backed securities…”

Federal Reserve Watch:

August 17 – Financial Times (Sam Fleming): “A divided Federal Reserve left open the prospect of a further interest rate rise this year even as policymakers insisted they needed more evidence on the durability of the rebound before feeling confident enough to pull the trigger. Minutes to their latest July meeting revealed a hard-fought debate over when to move rates, with a couple of participants urging an immediate move, while others were urging caution amid questions over how rapidly inflation will return to target.”

August 16 – Bloomberg (Matthew Boesler): “The Federal Reserve could potentially raise interest rates as soon as next month, New York Fed President William Dudley said, warning investors that they are underestimating the likelihood of increases in borrowing costs. ‘We’re edging closer towards the point in time where it will be appropriate, I think, to raise interest rates further,’ Dudley… said… Asked whether the FOMC could vote to raise the benchmark rate at its next meeting Sept. 20-21, Dudley said, ‘I think it’s possible.’”

Central Bank Watch:

August 16 – Bloomberg (Jeanna Smialek): “The world made it through the Great Recession. Now it's entered what you might call the Great Reassessment. High-profile researchers are publicly questioning the most basic tenets of monetary policy in the run-up to the Federal Reserve Bank of Kansas City’s economic symposium in Jackson Hole, Wyoming, which starts Aug. 25. San Francisco Fed President John Williams has issued a call for a major rethink among central bankers and fiscal policy makers, with an eye on scrapping low-inflation targeting. Former Fed Chairman Ben Bernanke analyzes why the Fed has been revising its economic projections. Meanwhile, a new IMF paper assesses both the effectiveness of, and the outlook for, Europe’s negative interest-rate policies.”

August 18 – Bloomberg (Jana Randow and Carolynn Look): “European Central Bank officials ‘widely’ agreed that their immediate reaction to the outcome of the U.K.’s referendum shouldn’t fuel excessive speculation about more stimulus. ‘The view was widely shared that the Governing Council needed to reiterate its capacity and readiness to act, if warranted, to achieve its objective, using all the instruments available within its mandate, while not fostering undue expectations about the future course of monetary policy,’…”

China Bubble Watch:

August 12 – Bloomberg (Paul Panckhurst): “International Monetary Fund staff said that 19 trillion yuan ($2.9 trillion) of Chinese ‘shadow’ credit products are high-risk compared with corporate loans and highlighted the danger that defaults could lead to liquidity shocks. The investment products are structured by the likes of trust and securities companies and based on equities or on debt -- typically loans -- that isn’t traded… The commentary highlighted the potential for risks bigger to the nation’s financial stability than from companies’ loan defaults. While loan losses can be realized gradually, defaults on the shadow products could trigger risk aversion that’s harder to manage… The ‘high-risk’ products offer yields of 11% to 14%, compared with 6 percent on loans and 3% to 4% on bonds, the commentary said. The lowest-quality of these products are based on ‘nonstandard credit assets,’ typically loans, it said.”

August 15 – Bloomberg: “China’s central bank urged investors not to focus too much on short-term concerns and said the diverging pace of credit expansion doesn’t mean monetary policy is losing steam. July credit growth slowing to a two-year low was a distortion and the reports for August and September will show it rebounding… Markets should avoid over-interpretation of short-term data for a specific month, the PBOC said. The commentary also said the growing gap between two money-supply gauges, M1 and M2, isn’t an indicator of a ‘liquidity trap,’ an economics term for when central bank cash injections into the economy fail to spur growth as monetary policy loses potency.”

August 17 – Reuters (Yawen Chen and Sue-Lin Wong): “China home prices rose 0.8% in July nationwide, but stalled or fell in more cities than in June, adding to concerns that one of the economy's key growth drivers is losing steam but offering some relief for policymakers worried about property bubbles. A robust recovery in home prices and sales gave a stronger-than-expected boost to the world's second-largest economy in the first half of the year, helping to offset stubbornly weak exports.”

Japan Watch:

August 14 – Bloomberg (Anna Kitanaka, Yuji Nakamura and Toshiro Hasegawa): “The Bank of Japan’s controversial march to the top of shareholder rankings in the world’s third-largest equity market is picking up pace. Already a top-five owner of 81 companies in Japan’s Nikkei 225 Stock Average, the BOJ is on course to become the No. 1 shareholder in 55 of those firms by the end of next year… BOJ Governor Haruhiko Kuroda almost doubled his annual ETF buying target last month, adding to an unprecedented campaign to revitalize Japan’s stagnant economy.”

August 15 – Reuters (Leika Kihara): “The Bank of Japan's policy review could put up for debate its target for expanding base money through massive asset purchases, sources say, but the challenge would be to avoid spooking bond markets… The BOJ's announcement last month of a thorough review of its policy and its effects triggered a sharp bond sell-off as investors feared the central bank, wary of its dwindling policy tools, might lean toward reducing its government bond purchases. It is currently buying roughly 110-120 trillion yen in bonds each year to meet its pledge to expand base money… by an annual 80 trillion yen ($790bn). But after initial successes in the asset-buying program, which is aimed at ending two decades of deflationary pressure, prices are falling again.”

August 16 – Nikkei AR: “Tuesday marked six months since the Bank of Japan introduced negative interest rates, and the effects and drawbacks of the unusual step have come to the fore. The policy has yet to produce falls in the yen's value, arousing concern about adverse effects on earnings at financial institutions… It thus remains halfway to its target of stimulating the real economy to push up prices. Negative interest rates ‘will help the [Japanese] economy expand by stimulating investment and consumption,’ BOJ Gov. Haruhiko Kuroda said… ‘Together with an increase in inflation expectations, the rate of price growth will move toward 2%,’ he said.”

August 15 – Reuters (Leika Kihara and Tetsushi Kajimoto): “Japan's economic growth ground to a halt in April-June as weak exports and shaky domestic demand prompted companies to cut spending… The weak reading underscores the challenges policymakers face in ending two decades of crippling deflation, as an initial boost from Abe's stimulus programs, dubbed ‘Abenomics’, appears to be quickly fading. The world's third-largest economy expanded by an annualized 0.2% in the second quarter, less than the 0.7% increase markets had expected and a sharp slowdown from a revised 2.0% increase in January-March…”

August 17 – Bloomberg (Connor Cislo): “Japan’s exports declined the most since 2009, with shipments down for a 10th consecutive month. The continued drop highlights the difficulty of kick-starting growth and pulling Japan’s economy out of the doldrums. Overseas shipments fell 14% in July from a year earlier… Imports dropped 24.7%, leaving a trade surplus of 513.5 billion yen ($5.2bn).”

EM Watch:

August 18 – Bloomberg (Marton Eder): “The rout in Ukrainian assets worsened, with the nation’s restructured bonds heading for their worst week since May, on concern a flare-up in fighting between government troops and separatists in the country’s east may be a precursor to a full-blown conflict. The yield on the government’s $1.7 billion Eurobond due 2019 rose 15 bps to 8.51%..., bringing the increase this week to 44 bps. The hryvnia currency slumped toward to the weakest level in three months…”

August 18 – Bloomberg (Ye Xie): “A 40% increase in the amount of corporate debt coming due in developing nations over the next three years is creating a potential default risk if investors start pulling money out of emerging markets, according to the Bank for International Settlements. About $340 billion of debt is maturing between this year and 2018… The total payments due each year during the period is equivalent to the net bond sales by non-financial companies in developing nations in 2015, it said. ‘Given the steep repayment schedule that lies ahead, the refinancing capacity of highly leveraged EME companies is likely to be tested soon, especially if the rise of the U.S. dollar continues,’ economists led by Nikola Tarashev wrote… Debt sold by non-financial companies in developing nations increased to 110% of their gross domestic product by 2015, up from less than 60% in 2006, BIS said…”

August 16 – Bloomberg (Ye Xie and Natasha Doff): “Central banks in developing economies are taking advantage of the biggest rally in their currencies since 2010. Led by Turkey and Thailand, they’re using stronger exchange rates to build up foreign reserves for the first time in two years, replenishing shortfalls created as they attempted to prop up their currencies during recent routs… International reserves have grown by $154 billion, or 1.4%, since the end of March to $11 trillion… Turkey’s cash coffer expanded the most during the period, increasing more than 6%. Thailand’s currency pile rose 5.5%, while Indonesia’s climbed 3.6%”

Leveraged Speculator Watch:

August 16 – Wall Street Journal (Laurence Fletcher and Gregory Zuckerman): “A growing exodus from hedge funds extended to two of the biggest names in the industry Tuesday, Tudor Investment Corp. and Brevan Howard, as disenchanted investors increasingly shun what was once the hottest place to put money. The funds’ problem is clear: They just aren’t performing. Hedge funds and actively managed mutual funds have been underperforming since financial markets began their rebound in early 2009. The average hedge fund is up 3% this year through the end of July, according to… HFR Inc., less than half the S&P 500’s rise… Funds in the $2.9 trillion hedge-fund sector have now experienced three consecutive quarters of withdrawals for the first time since 2009, according to HFR.”

August 16 – Bloomberg (Lu Wang): “The steady drumbeat of gains that has lifted the S&P 500 Index in six of the last seven weeks is making life difficult for bears. Hedge funds that aim to profit from long and short bets have raised net equity holdings in the past three months, with bullish positions now exceeding bearish ones by 22.7 percentage points. That’s higher than 97% of the time since Credit Suisse Group AG began tracking the data in 2009. Perhaps not coincidentally, marketwide readings of short interest just posted the biggest decline in four years, while shares of the most-hated companies led in the rally that just lifted the S&P 500 to another record Monday, its 10th since early July.”

August 15 – Wall Street Journal (Maria Armental): “Billionaire investor George Soros, who rose to fame and fortune by betting against the sterling in 1992, on Monday showed his latest hand: nearly doubling down on his bearish bet against the market. The 86-year-old’s fund disclosed in a regulatory filing it had increased its bet against the S&P 500…, reporting ‘put’ options on roughly 4 million shares as of June 30 in an exchange-traded fund that tracks the index. That’s up from ‘puts’ on 2.1 million shares as of March 31.”

August 16 – Bloomberg (Janet Lorin): “Following the lead of pensions, some U.S. endowments and foundations are souring on hedge funds. Hedge fund fees and lagging performance are cause for concern for nonprofit investors, who are reducing their allocation, according to a survey published Monday by NEPC, a Boston-based consulting firm with 118 endowment and foundation clients with assets of $57 billion… ‘The last several years have been difficult for the industry and investors are starting to look very closely at how hedge funds can work for them,’ Cathy Konicki, who oversees the company’s endowment and foundation business, said…”

Geopolitical Watch:

August 18 – Bloomberg (Daryna Krasnolutska Aliaksandr Kudrytski): “Ukraine isn’t ruling out a full-scale Russian invasion and may institute a military draft if the situation with its neighbor worsens, President Petro Poroshenko said… The confrontation between Ukrainian forces and the rebels in Ukraine’s eastern Donbas region has worsened, Poroshenko said… Putin vowed to respond with ‘serious measures.’ ‘The probability of escalation and conflict remains very significant,’ Poroshenko said… ‘We don’t rule out full-scale Russian invasion.’”

August 19 – Wall Street Journal (James Marson and Thomas Grove): “Russia is bolstering its military presence on its western border, sending tens of thousands of soldiers to newly built installations within easy striking distance of Ukraine. The moves, which come as Moscow ratchets up confrontation over the Black Sea peninsula of Crimea, are a centerpiece of a new military strategy the Kremlin says is meant to counter perceived threats from the North Atlantic Treaty Organization.”

August 13 – Bloomberg (Monami Yui): “The Japanese government has decided on a plan to develop land-to-sea missiles with a range of 300 kilometers (186 miles) to protect the nation’s isolated islands, including the Senkaku, the Yomiuri newspaper reported… China has been stepping up pressure on Japan over the disputed Senkaku Islands, which are called Diaoyu in Chinese. Hundreds of fishing boats and more than a dozen coastguard vessels have been spotted recently in the area, encroaching at times on what Japan sees as its territorial waters.”

August 17 – Bloomberg (Iain Marlow): “From the sandstone walls of the 17th-century Red Fort in India’s capital, Prime Minister Narendra Modi sent a warning shot this week to his counterparts in Islamabad and Beijing. Modi’s reference to disputed territories on Monday during his annual Independence Day speech -- his most high-profile appearance of the year -- signaled that India would become more aggressive in asserting its claims to Pakistan-controlled areas of Kashmir. The region is a key transit point in the $45 billion China-Pakistan Economic Corridor known as CPEC that will give Beijing access to the Arabian Sea through the port of Gwadar.”

Tuesday, August 16, 2016

Tuesday Afternoon Links

[Reuters] Wall St. slips after NY Fed head talks up rate hike

[Reuters] Investors cut cash, load up on EM and U.S. stocks: BAML

[Reuters] Hedge fund Tudor Investment lays off 15 percent of staff: source

[Reuters] Putin hints at war in Ukraine but may be seeking diplomatic edge

[FT] Easy money is a dangerous cure for a debt hangover


Tuesday Morning Links

[Bloomberg] Yen Strengthens Past 100 Per Dollar for First Time Since June 24

[Bloomberg] U.S. Stocks Decline With Treasuries After Dudley’s Rate Comments

[Bloomberg] Asian Stocks Decline as Japanese Shares Fall on Stronger Yen

[Bloomberg] Dollar’s Decline Reverberates as Emerging Markets Rise With Gold

[Bloomberg] Japanese Shares Slump, Yen Gains as Investors Keep Eye on BOJ

[Bloomberg] Hedge Funds Relinquishing Shorts as S&P 500 Hovers Around Record

[Bloomberg] U.S. Buyback Announcements Tumble to a 2012 Low

[Bloomberg] Housing Starts in U.S. Climbed to a Five-Month High in July

[Bloomberg] Dudley Says September Hike Is Possible, Markets Too Complacent

[Bloomberg] Gas Glut Upends Global Trade Flows as Buyers Find Leverage

[Bloomberg] Monetary Policy Makers Rethink the Rules, and Other Economic Must-Reads

[Nikkei AR] BOJ's negative rate policy still only halfway to intended results

[Bloomberg] After Losing $1 Trillion, Central Banks Build Reserves Again

[Bloomberg] Hedge Funds Are Losing Endowments After Exodus of Pensions

[Bloomberg]  Brexit Bulletin: Banks Already Plotting City Exodus

[WSJ] Central Banks Could Be This Market’s Pets.com

[WSJ] Soros Doubles Down on Bet Against the S&P 500

[WSJ] The Specter of an Accidental China-U. S. War

Saturday, August 13, 2016

Saturday's News Links

[Bloomberg] High-Risk ‘Shadow’ Credit in China Put at $2.9 Trillion by IMF

[Reuters] Turkish PM says Ankara sees no compromise with the U.S. over Gulen extradition

Weekly Commentary: Inflation

(Email from reader T.B.) “These various stages of capitalism, or finance, are interesting and descriptive. But I think the progression is rather simply explained as an ongoing perversion of capitalism caused by inflation: credit expansion or any kind of money-supply inflation.

Have you seen Henry Hazlitt's colorful statement about the consequences of inflation? If not, just consider this: “It [Inflation] discourages all prudence and thrift. It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.” Henry Hazlitt, Economics in One Lesson, page 176

Isn’t this a nearly perfect short description of what is happening to us?”



Yes, it is. Henry Hazlitt (1894-1993) was a brilliant thinker and prolific writer. He was a noted journalist throughout the “Roaring Twenties” and Great Depression periods. Hazlitt learned his economics from some of the masters. He was friends with Benjamin Anderson (“Chase Economic Bulletin” and “Economics and the Public Welfare”). From Wikipedia: “According to Hazlitt, the greatest influence on his writing in economics was the work of Ludwig von Mises, and he is credited with introducing the ideas of the Austrian School of economics to the English-speaking layman.”

As an admirer of Hyman Minsky, I view “Minskian” analysis as the authority on critical aspects of financial evolution and institutional and Capitalistic development. At the same time, when it comes to economic analysis more generally, I'm an “Austrian” at heart. Minsky seemed to hesitate when it came to discussing the profound impact finance and financial evolution had on the underlying economic structure. From the standpoint of my analytical framework, this void is filled superbly by Austrian thinking. When it comes to understanding the nature and destructive capacities of inflation, the “Austrians” put the “Keynesians” to shame.

A couple conventional definitions: “Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.” “Inflation is a process of continuously rising prices, or equivalently, of a continuously falling value of money.”

Yet a rise in consumer prices is just one of myriad possible inflationary manifestations. Mises viewed inflation as a general increase in the money supply. Simple enough, except for the layers of complexity inherent to both money and inflation. What comprises this so-called supply of “money”? We’re surely addressing more than just currency, but how much more? Bank reserves? Deposits? How about “repos,” money market funds or perhaps even liquid short-term debt instruments more generally? Then what about highly liquid funds invested in equity and bond instruments? Derivatives?

Mises, viewing monetary inflation in broad terms, wrote of “fiduciary media,” or instruments with the economic functionality of “narrow money”. In our age of globalized digitized/electronic finance, I’ve always taken the view that “money is as money does.” Generally, the broader the definition the better. And we must accept that contemporary “money” is certainly not what it should be; it’s not what we wish it were.

I was introduced to “Austrian” economic thinking back in 1990, when I began my monthly ritual of studying “The Richebacher Letter.” It was love at first reading. Then I had the good fortune to work with the great German economist, Dr. Kurt Richebacher, assisting with his publication from 1996 through 2001 or so. It was an especially rich period for financial and economic analysis – S.E. Asia, Russia, LTCM, “The Committee to Save the World,” “The New Paradigm,” the “tech Bubble,” etc. Contemporary finance – with it’s unfettered “money” and Credit – was wreaking increasing havoc. Central bankers and others seemed to go out of their way to misdiagnose the problem.

From Dr. Richebacher and my own analysis, it became clear that contemporary inflation was really a Credit phenomenon. Expand (inflate) Credit and monitor for consequences. These might include a rise in aggregates of consumer and producer prices - traditional “inflation.” But the creation of new purchasing power also inflated asset prices. “Austrian” analysis becomes even more powerful with the understanding of how Credit inflation feeds through to the real economy. Inflation begets distortions in spending and business investment - and over time exerts increasingly deleterious effects upon the underlying economic structure. Inflation and Bubbles redistribute and destroy wealth. Inflation alters decisions, perceptions and behavior, including the nurturing of subtle mayhem throughout saving and investment, the bedrock of Capitalism. You’d think by now the entire world would have adopted “Austrian” thinking.

Dr. Richebacher argued that of all the various consequences of Credit inflation, the rise in consumer prices was one of the least pernicious. With sufficient determination, policymakers could (Chairman Volcker did) tighten financial conditions and break inflationary processes and psychology. Expect an attentive constituency when it comes to reining in destabilizing CPI.

But how about asset price inflation and Bubbles? Well, there is a powerful proclivity for letting asset prices run. An inflationary bias in asset markets certainly “makes it more profitable to speculate than to produce.” And the larger the speculative Bubble the more powerful the constituencies that arise to demand government involvement, intervention and manipulation to sustain Bubble Dynamics. Misguided policymakers will endorse destabilizing asset inflation as confirmation of sound policies (Greenspan, Bernanke, Draghi, Kuroda…). In one of financial history’s most misconceived policy blunders, central bankers specifically targeted asset price inflation as the primary mechanism for post-crisis system reflation.

Let there be no doubt, Credit Bubbles are an inflationary phenomenon. Having badly mismanaged domestic Credit, the U.S. proceeded to export asset inflation and Credit Bubbles to the entire world. And as the global Credit inflation aged, broadened and became deeply entrenched, the consequences evolved. Limitless cheap finance on a global basis ensured a historic investment boom and resulting overcapacity in just about everything. Meanwhile, the myth persisted that central bankers were in control of a general price level. Accordingly, monetary stimulus had to be ratcheted up to counteract downward price pressures and insufficient aggregate demand. And then with the protracted inflationary boom having reached the point of acute financial and economic fragility, desperate global central bankers embarked on unprecedented “money” printing (only exacerbating asset Bubbles and speculative excess).

It was the evolution to securitization and market-based finance that fundamentally – and fatefully - transformed inflationary dynamics. For one, the tantalizing New Age Credit apparatus was inherently unstable. This ensured progressive government meddling. Government guarantees and backstops further incentivized speculation, in the process exacerbating speculative leveraging and Bubble Dynamics. Faltering Bubble mayhem then fostered QE, where central bankers intervened directly in the marketplace with massive buy programs. Central bankers then became hostage to unwieldy global Bubbles dependent upon ongoing massive monetary stimulus.

Inflation Dynamics have created a world of record high securities prices, including $13.4 TN (per FT) of negative-yielding government bonds. The most hopelessly indebted governments in the world now borrow at a cost of about nothing. Negative yields in Japan. Italian 10-year yields ended the week at a record low 1.04%. In blow-off dynamics that rival Internet stocks and subprime CDOs, “money” is flooding into bond ETFs. Meanwhile, U.S. stock prices are at all-time highs, with real estate prices essentially back to highs.

August 12 – Financial times (Robin Wigglesworth and Eric Platt): “The value of negative-yielding bonds swelled to $13.4tn this week, as negative interest rates and central bank bond buying ripple through the debt market. The universe of sub-zero yielding debt — primarily government bonds in Europe and Japan but also a mounting number of highly-rated corporate bonds — has grown from $13.1tn last week… ‘It’s surreal,’ said Gregory Peters, senior investment officer at Prudential Fixed Income. ‘It’s clear that central banks are dominating markets. There’s a race to the bottom. Central banks are the main drivers of this, it’s not fundamental.’”

August 12 – Financial Times (Joe Rennison and Eric Platt): “Investors have poured more money into US fixed income exchange traded funds so far this year than for the whole of 2015, as the hunt for returns intensifies with nearly $13tn of global bond yields trades below zero. US fixed income ETFs have attracted more than $60bn of money this year — outstripping 2015, when the funds lured just under this year’s current total, according to… Deutsche Bank. International investors seeking fixed rates of return via bonds are targeting the higher yields on US government and corporate debt via fixed income ETFs, which track bonds and trade like a stock price on an exchange… Large bond ETFs like the iShares Core US aggregate bond fund, which gives exposure to US investment grade debt, have outstripped inflows to larger equity ETFs.”

This week’s tiny move in the S&P500 masked ongoing global market instability. It appears short squeeze dynamics remain in force, although they now shift around the globe and between markets. Global financial stocks rallied sharply this week. Hong Kong’s Hang Seng Financials surged 5.3%. Japan’s TOPIX Banks Stock Index jumped 3.9% (Nikkei 225 up 4.1%). The STOXX Europe 600 Bank Index rose 3.2%. Italian Banks surged 4.0%. Overall, European equities were strong. Germany’s DAX surged 3.3%, with major indices up about 2% in France, Spain and Italy. EM markets were on a tear. Mexican equities jumped 2.5%, with Turkish stocks up 2.8% and the Shanghai Composite 2.5% higher. The Mexican peso surged 2.6%.

It’s ironic. As market participants and global central bankers over recent decades fretted the prospect of deflation, global debt and asset markets experienced history’s greatest inflationary Bubble. It’s my view that global markets are these days dominated by a historic dislocation in debt trading. There are hundreds of Trillions of interest-rate derivatives outstanding. And global bond yields have done this year what no one thought possible. As was the case with previous derivative-related melt-ups (i.e. mortgages 1993, SE Asia 1996, Nasdaq 1999, subprime 2006/7), these types of dislocations foment extraordinary underlying leverage (i.e. levered bond holdings as hedges against derivative exposures).

This leveraging creates marketplace liquidity, while spurring self-reinforcing short-covering and speculation. These kinds of speculative blow-offs also tend to take on lives of their own. The squeeze that propelled U.S. stock indices to record highs has now fully engulfed corporate Credit and EM more generally. A couple of Friday evening FT headlines make the point: “Record-Breaking US Stocks are a Sideshow Next to Bond Bonanza” and “Emerging Market Monetary Conditions Ease Dramatically”.

It is not hyperbole to posit that global securities markets are in the midst of a historic short squeeze and the greatest ever market dislocation. And it’s not unreasonable to suggest that this is a sadly fitting climax to the world’s most spectacular inflationary Bubble.

Yet through the fa├žade of unprecedented perceived global wealth, one can begin to more clearly identify the the Scourge of Inflationism: “It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls.”

It’s been akin to a wreaking ball. We’ve seen the general population unknowingly surrender wealth to Inflationism. In the face of so-called disinflation, millions have suffered at the hand of inflating costs for housing, health care, tuition and insurance, to name a few. We’ve seen these serial booms and busts take a terrible toll on many workers, families and communities. We witnessed many lose much of their retirements – and faith in the markets - in two major stock market busts. Millions lost much of their life’s savings during the collapse of the mortgage finance Bubble. Millions of students have taken on tremendous loads of debt to finance higher education and vocational training. Millions have been lured by (years of) low monthly payments into purchasing homes, automobiles, vacation properties, recreation vehicles, etc. that they cannot afford.

Inflationism has seen real wages for much of the workforce stagnate or worse over the past decade. Inflationism and his accomplice malinvestment are the culprits behind pathetic productivity trends and declining living standards. Worse yet, Inflationism and his many cohorts are fomenting disturbing social, political and geopolitical turmoil. And reminiscent of the Weimar hyperinflation, central bankers somehow remain oblivious that their operations are of primary responsibility. If people don’t these days trust central bankers, politicians, Wall Street, and governments and institutions more generally, just wait until the Bubble bursts.


For the Week:

The S&P500 was little changed (up 6.9% y-t-d), while the Dow added 0.2% (up 6.6%). The Utilities were unchanged (up 17.7%). The Banks declined 1.3% (down 5.5%), and the Broker/Dealers fell 0.9% (down 7.3%). The Transports lost 0.8% (up 4.0%). The S&P 400 Midcaps slipped 0.3% (up 11.4%), while the small cap Russell 2000 was little changed (up 8.3%). The Nasdaq100 added 0.3% (up 4.7%), and the Morgan Stanley High Tech index increased 0.7% (up 7.7%). The Semiconductors gained 0.8% (up 17.5%). The Biotechs sank 3.4% (down 12.4%). Though bullion ended unchanged, the HUI gold index added another 1.5% (up 151%).

Three-month Treasury bill rates ended the week at 27 bps. Two-year government yields declined two bps to 0.70% (down 35bps y-t-d). Five-year T-note yields fell five bps to 1.09% (down 66bps). Ten-year Treasury yields dropped eight bps to1.51% (down 74bps). Long bond yields sank nine bps to 2.23% (down 79bps).

Greek 10-year yields dropped 13 bps to 7.99% (up 67bps y-t-d). Ten-year Portuguese yields dropped 17 bps to a seven-month low 2.67% (up 15bps). Italian 10-year yields fell nine bps to a record low 1.04% (down 88bps). Spain's 10-year yield dropped nine bps to a record low 0.92% (down 85bps). German bund yields declined four bps to negative 0.11% (down 73bps). French yields fell four bps to 0.11% (down 88bps). The French to German 10-year bond spread was unchanged at 22 bps. U.K. 10-year gilt yields sank 15 bps to a record low 0.52% (down 144bps). U.K.'s FTSE equities index jumped 1.8% (up 10.8%).

Japan's Nikkei equities index rallied 4.1% (down 11.1% y-t-d). Japanese 10-year "JGB" yields declined two bps to negative 0.12% (down 38bps y-t-d). The German DAX equities index surged 3.3% (down 0.3%). Spain's IBEX 35 equities index gained 2.1% (down 8.7%). Italy's FTSE MIB index jumped 2.2% (down 20.6%). EM equities were strong. Brazil's Bovespa index gained 1.1% (up 34.5%). Mexico's Bolsa jumped 2.5% (up 12.5%). South Korea's Kospi index gained 1.2% (up 4.5%). India’s Sensex equities added 0.3% (up 7.8%). China’s Shanghai Exchange jumped 2.5% (down 13.8%). Turkey's Borsa Istanbul National 100 index rose 2.8% (up 9.1%). Russia's MICEX equities index advanced 1.2% (up 11.7%).

Junk bond mutual funds saw inflows of $1.655 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates added two bps to 3.44% (down 49bps y-o-y). Fifteen-year rates increased two bps to 2.76% (down 41bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 3.58% (down 46bps).

Federal Reserve Credit last week expanded $1.8bn to $4.428 TN. Over the past year, Fed Credit declined $22.3bn. Fed Credit inflated $1.617 TN, or 58%, over the past 196 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt sank $18.7bn last week to a six-year low $3.200 TN. "Custody holdings" were down $161bn y-o-y, or 4.8%.

M2 (narrow) "money" supply last week jumped another $32bn to a record $12.965 TN. "Narrow money" expanded $911bn, or 7.6%, over the past year. For the week, Currency increased $1.2bn. Total Checkable Deposits dropped $38.1bn, while Savings Deposits surged $68.1bn. Small Time Deposits and Retail Money Funds were each little changed.

Total money market fund assets gained $6.0bn to $2.745 TN. Money Funds rose $70.1bn y-o-y (2.6%).

Total Commercial Paper added $0.9bn to $1.023 TN. CP declined $36bn y-o-y, or 3.4%.

Currency Watch:

The U.S. dollar index declined 0.6% to 95.68 (down 3.0% y-t-d). For the week on the upside, the Norwegian krone increased 3.5%, the Mexican peso 2.6%, the South African rand 1.8%, the Canadian dollar 1.7%, the Swedish krona 1.3%, the euro 0.7%, the New Zealand dollar 0.7%, the Swiss franc 0.6%, the Japanese yen 0.5% and the Australian dollar 0.4%. For the week on the downside, the British pound declined 1.2% and the Brazilian real fell 0.8%. The Chinese yuan increased 0.4% versus the dollar (down 2.2% y-d-t).

Commodities Watch:

The Goldman Sachs Commodities Index jumped 3.2% (up 13.3% y-t-d). Spot Gold was unchanged at $1,336 (up 26%). Silver was little changed at $19.72 (up 43%). WTI Crude surged $2.51 to $44.49 (up 20%). Gasoline slipped 0.3% (up 8%), while Natural Gas sank 6.2% (up 11%). Copper declined 0.9% (unchanged). Wheat rallied 1.6% (down 10%). Corn declined 0.4% (down 7%).

Turkey Watch:

August 10 – Reuters (Ebru Tuncay and Asli Kandemir): “Turkish President Tayyip Erdogan took aim at banks on Wednesday, saying they shouldn't be charging high interest rates in the aftermath of a failed coup and promising to take action against lenders who ‘go the wrong way’ on interest rates. High borrowing costs are a familiar target for Erdogan, who favours consumption-driven growth and says that interest rates cause inflation… But the comments… were some of his sharpest yet directed at lenders. In a speech to members of Turkey's exporters assembly, Erdogan said he would consider it ‘treason’ if banks do not ‘pave the way for investors’. ‘We will not shy away from noting down and questioning banks where we see banks go the wrong way on interest rates and credit policies,’ he said… ‘If the banking sector tries to turn this into an opportunity they will deal with us.’”

Brexit Watch:

August 9 – Bloomberg (Anooja Debnath and Marianna Duarte De Aragao): “The Bank of England’s expanded quantitative-easing program ran into a stumbling block on just its second day as investors proved unwilling to part with their holdings of longer-dated bonds. The central bank failed to buy enough gilts to reach its stated goal at an operation on Tuesday -- the first such failure since it initially started quantitative easing in 2009. The yield on 10- and 30-year bonds fell to records after the operation.”

August 10 – Bloomberg (Neil Callanan): “The value of land for luxury homes in central London fell 6.9% in the second quarter, broker Knight Frank LLP said… Shares of developers with large residential projects in the U.K. capital’s best districts have lagged behind commercial-property landlords since the Brexit referendum vote after the companies began to write down the value of their holdings on slowing sales and falling prices.”

August 10 – Bloomberg (Thomas Seal): “Brexit is undermining the near-term outlook for the U.K. housing market, with both demand and sales dropping in July, according to the Royal Institution of Chartered Surveyors. The… group said new buyer inquiries fell for a fourth month, while its index of sales is pointing to the fastest decline in transactions since the global financial crisis in 2008. Prices continued to rise, but at the slowest pace in three years.”

Europe Watch:

August 12 – Bloomberg (Lorenzo Totaro): “Italy’s economy unexpectedly stalled in the second quarter, which will further weigh on Prime Minister Matteo Renzi as he prepares for a referendum on which he has staked his political future. Gross domestic product was unchanged in the three months through June… The economy grew 0.7% from a year earlier.”

Fixed-Income Bubble Watch:

August 8 – Financial Times (Eric Platt): “Record-low interest rates are no barrier for US companies finding buyers for their debt thanks to a relentless global quest for fixed returns that shows little sign of easing. The pace of US corporate debt sales… is expected to continue unabated driven by foreign buyers in a world where roughly $13tn of sovereign and corporate debt trades in negative territory… More than $2.3tn of dollar-denominated debt has been issued by companies and banks since the year began, including three of the ten largest corporate bond sales on record, Dealogic data show.”

August 9 – Bloomberg (Joe Mayes and Julie Edde): “There’s no sign of a summer holiday in the corporate-bond market. Companies worldwide are poised to raise more than $100 billion so far this month, the most for the period in Bloomberg data going back to 1999.”

August 9 – Bloomberg (Emma Orr): “The worst may be yet to come for some strained oil services companies as $110 billion in debt, most of it junk rated, creeps closer to maturity. More than $21 billion of debt from oilfield services and drilling companies is estimated to be maturing in 2018, almost three times the total burden in 2017, according to… Moody’s… More than 70% of those high-yield bonds and term loans are rated Caa1 or lower, and more than 90% are rated below B1. Speculative-grade debt is becoming increasingly risky, as the default rate is expected to reach 5.1% in November… The 12-month global default rate rose to 4.7% in July, up from its long-term average of 4.2%, Moody’s wrote. Of the 102 defaults this year, 49 have come from the oil and gas sector, Moody’s noted.”

August 11 – Bloomberg (Angelina Rascouet): “While shale drilling in the U.S. is on the rise again, prices need to climb nearer to $60 a barrel for U.S. producers to have a ‘substantial’ boost in activity, the International Energy Agency said. Producers remain ‘cautious on outlook,’ and further drilling increases this year may be ‘limited,’ the IEA said in its monthly report.”

Global Bubble Watch:

August 11 – Bloomberg (Natasha Doff): “Investors who piled into some of the world’s riskiest bonds to escape near-zero interest rates got a reality check this week as signs of an economic crisis in Mongolia and a flare up in the conflict in Ukraine sent their bonds tumbling. Mongolia’s $1 billion of notes due in six years fell the most on record on Wednesday after the finance minister went on television to say his critical goal was to avoid default as growth slows and the debt burden soars... A slump in Ukrainian Eurobonds sent yields toward their biggest one-day increase since February on Thursday after officials in Kiev warned Russia is seeking to escalate a military conflict over the disputed Crimean peninsula.”

August 10 – Financial Times (Attracta Mooney): “Fund managers that attempt to beat the market are losing significant ground to cheaper rivals as investors shun stockpickers amid concerns over bad performance and high fees. Assets managed in passive mutual funds, which provide lower-cost exposure to markets by tracking an index, have grown four times faster than traditional active products since 2007, according to… Morningstar… According to Morningstar, assets under management in passive mutual funds have grown 230% globally, to $6tn, since 2007. In contrast, assets held in active funds, where stock pickers try to beat the market, have grown 54%, to $24tn.”

August 10 – Financial Times (Attracta Mooney): “The amount of new money raised by exchange traded funds exposed to global stock markets has dropped 85% in the first half of 2016… Equity ETFs that track an index attracted a net $15bn from investors in the first half of this year, a significant decline on the $102bn invested over the same period in 2015, according to ETFGI… Just $1.2bn was invested in ETFs focused on Asia-Pacific stocks, down 96% on the $33.4bn invested in the first six months of 2015. However, emerging market-focused ETFs and those investing in North American stocks experienced greater inflows this year than during the same period last year. Total assets invested in ETFs and exchange traded products rose to $3.2tn at the end of June 2016, due to strong flows into fixed income products.”

August 10 – Bloomberg (Joseph Ciolli and Lu Wang): “A year that’s brought little but pain for bearish traders is getting worse. Not only is the rising market punishing shorts, it’s lifting their favorite targets at a rate that is by some measures three times as great as everything else. As a result, the 50 most-shorted stocks -- that is, the ones bears had bet would fall -- have instead rallied as much as 16% since the end of June, on track for the biggest quarterly gain in more than five years… Unlucky stock selection is making a tough year worse for the group, who’ve watched the value of U.S. stocks swell by more than $2 trillion since late June.”

August 8 – Wall Street Journal (Veronica Dagher): “Whatever the world’s economic and market turbulence last year, one group has held up well: billionaires. The combined wealth of the world’s billionaires, defined as individuals with a net worth of $1 billion or above, increased by 5.4% to a record $7.7 trillion, according to Wealth-X’s 2015-2016 billionaire census… The world’s billionaire population grew by 6.4% to 2,473 in 2015.”

August 10 – Bloomberg (Robert Frank): “The world's billionaires are holding more than $1.7 trillion in cash — the highest amount since one firm began recording the measure in 2010. Because of what they perceive to be growing risks in the economy and world, the world's 2,473 billionaires are keeping 22.2% of their total net worth in cash, according to the Wealth-X Billionaire Census… Altogether, their cash hoard is now roughly the size of the Brazil's GDP. ‘Billionaires are taking money off the table where available, while uncertainties in the economy and the historical highs found in deals have resulted in cash-flush portfolios,’ the report said.”

August 8 – Bloomberg (Shahien Nasiripour): “Hong Kong-based Bitfinex said all users will lose 36% of their deposits after the bitcoin exchange concluded its review of a $71 million hacking attack. To compensate its customers, Bitfinex said users will receive tokens that may later be redeemed or exchanged for shares in its parent company… ‘After much thought, analysis, and consultation, we have arrived at the conclusion that losses must be generalized across all accounts and assets,’ the exchange wrote…”

U.S. Bubble Watch:

August 9 – Bloomberg (Michelle Jamrisko): “The productivity of American workers unexpectedly declined for a third straight quarter, deepening efficiency woes that have characterized the economic expansion. The measure of employee output per hour decreased at a 0.5% annualized rate in the three months through June after dropping 0.6% in the prior quarter… Expenses per worker climbed at a 2% pace after being revised to a decline in the previous period. Productivity compared with a year earlier fell for the first time since 2013…”

August 9 – Bloomberg (Christopher Olsen): “U.S. companies have taken on so much debt that they’re at least as vulnerable to defaults and downgrades as they were leading up to the 2008 financial crisis, according to… S&P Global Ratings… Corporate leverage in the U.S., excluding financial firms, is at the highest level in 10 years, driven by a combination of low interest rates and slowing profits, S&P analysts Jacob Crooks and David Tesher wrote. This has resulted in record leverage ratios across a universe of 2,200 companies, they wrote… ‘With the level of leverage that we’re seeing, some of these more-peripheral stressed sectors are going to experience some challenges to obtain new financing as well as refinancing,’ Tesher said… ‘It’s not a question of if, it’s a question of when.’ Meanwhile, bondholders who are searching for yield are increasingly willing to accept less compensation and weaker protections than than in the past…’”

August 9 – Bloomberg (Prashant Gopal): “Fewer U.S. housing markets are seeing double-digit gains in prices as affordability becomes more of a challenge in some areas. In the second quarter, prices rose 10% or more from a year earlier in 25 metropolitan areas, down from 28 markets in the first quarter and 34 in the second quarter of 2015, the National Association of Realtors said… Home prices have been outpacing income gains, making it harder for some buyers to compete in many of the strongest markets across the U.S. The median price of an existing single-family home rose from a year earlier in 83% of the 178 markets measured…”

August 11 – Wall Street Journal (Annamaria Andriotis): “The bill is coming due for many homeowners on a type of loan that was widely popular in the run-up to the housing bust, causing a rise in delinquencies at banks. More homeowners are missing payments on their home-equity lines of credit, or Helocs, a type of loan that allows borrowers to withdraw cash from their house to pay for renovations, college tuition or almost any other expense. These loans typically require interest-only payments for the first 10 years, but then principal payments kick in for the next 15 or 20 years… Roughly 840,000 Helocs taken out in 2006 are resetting this year, with principal payments on an additional nearly one million loans expected to hit in 2017… Resets can lead to payments jumping by hundreds, or in some cases thousands, of dollars a month.”

August 8 – Bloomberg (Shahien Nasiripour): “When it comes to collecting on student loans, the U.S. Department of Education treats college dropouts the same as Ivy League graduates: They just want the money back. New data show the perils of that approach. Dropouts who took out loans to finance the degrees they ultimately didn't obtain often end up worse off for attending college... The typical college dropout experienced a steep fall in wealth from 2010 to 2013…, and an 11% drop in income—the sharpest decline among any group in America. It should therefore come as no surprise that half of federal student loan borrowers who dropped out of school within the past three years are late on their payments…”

August 10 – Wall Street Journal (Laura Kusisto): “The housing recovery that began in 2012 has lifted the overall market but left behind a broad swath of the middle class, threatening to create a generation of permanent renters and sowing economic anxiety and frustration for millions of Americans. Home prices rose in 83% of the nation’s 178 major real-estate markets in the second quarter…. Overall prices are now just 2% below the peak reached in July 2006, according to S&P CoreLogic Case-Shiller Indices… The lopsided recovery has shut out millions of aspiring homeowners who have been forced to rent because of damaged credit, swelling student loans, tough credit standards and a dearth of affordable homes, economists said. In all, some 200,000 to 300,000 fewer U.S. households are purchasing a new home each year than would during normal market conditions, estimates Ken Rosen, chairman of the Fisher Center of Real Estate and Urban Economics at the University of California at Berkeley.”

August 11 – Wall Street Journal (Josh Barbanel): “Vacancy rates for Manhattan rental apartments reached their highest level for any July in at least 14 years, the latest evidence that the market is softening, according to… Citi Habitats. The report also said deals that include landlord concessions more than doubled from July 2015. July is usually a strong month for New York City landlords, as college graduates move in and families scramble to find apartments in time for the fall semester.”

August 9 – Bloomberg (Joe Light): “Fannie Mae and Freddie Mac could need as much as $125.8 billion in bailout money from taxpayers in a severe economic downturn, according to stress test results released Monday by their regulator. The Federal Housing Finance Agency said that the government-controlled companies, which back nearly half of new mortgages, would need at least $49.2 billion.”

August 10 – Bloomberg (Melissa Mittelman): “As venture capitalists exercise more caution and place fewer bets, they’re leaving media startups behind. Venture funding to media-tech companies slid for the third consecutive quarter to $91.7 million, the lowest amount since mid-2013, according to… industry researcher CB Insights. Investment activity followed a similar trend, declining to the fewest number of deals since the second quarter of 2012. While U.S. venture deals were down overall in the first half of the year, the drop in funding to media companies has outpaced declines in other sectors, said Garrett Black, an analyst at researcher PitchBook.”

August 11 – Bloomberg (Lu Wang): “Investors who scored big gains by swooping in at the bottom of the last two U.S. equity selloffs now are backing away from the market. The number of officers and directors of companies purchasing their own stock tumbled 44% from a year ago to 316 in July, the lowest monthly total ever… With 1,399 executives unloading stock, sellers outnumbered buyers at a rate that was exceeded only two other times. While companies themselves keep buying back shares, demand from their highest-ranking employees has dried up as the S&P 500 Index climbed to fresh highs after going for more than a year without surpassing its previous peak.”

August 9 – Bloomberg (David Wilson): “Day-to-day drama has been largely absent from this quarter’s record-setting advance in the S&P 500 Index. The gap between daily highs and lows averaged 0.64 percentage point as of Monday… This would be the narrowest spread for a full quarter since U.S. stocks started the current bull market, as shown in the chart, or at any other time since 1993.”

August 11 – Reuters (Tim McLaughlin and Heather Somerville): “Some U.S. mutual funds are boosting their performance with relatively big bets on private companies such as Uber and Pinterest, which they have been marking up at a rate far greater than the broad stock market. Relied upon by millions of Americans to save for their retirement, mutual funds emphasize that their investments in young tech companies ahead of their initial public offerings are relatively small. A Reuters analysis of fund filings and other data shows, though, that some have taken a more aggressive approach, boosting the share of these companies to more than 5% of assets and awarding them rich valuations that in some cases have helped them beat their benchmarks and peers by a wider margin.”

China Bubble Watch:

August 12 – Bloomberg: “China’s broadest measure of new credit and another key gauge of lending increased at the slowest pace in two years, suggesting monetary authorities are more concerned about swelling financial risks than giving more of a boost to old growth engines. Aggregate financing was 487.9 billion yuan ($73.4bn) in July, compared with a median estimate of 1 trillion yuan… New yuan loans stood at 463.6 billion yuan, versus a projected 850 billion yuan…. Both increased by the least since July 2014. The broad M2 money supply increased 10.2%, the slowest pace since April 2015.”

August 12 – New York Times (Keith Bradsher): “The deal could be hard to resist. A Shanghai investment firm is offering a fat return of up to 10% a year, handily beating both the local stock market and the paltry payouts from bank accounts. It requires a minimum deposit of about $15… Investors can pull out in as little as seven days. Best of all, the money is guaranteed. There is just one catch: Investors know surprisingly little about what they are buying. The firm, State Gold Treasure, said the money would be plowed into a real estate company building a luxury serviced-apartment complex here in Shanghai. But it will not release details, including the complex’s address… Over the last five years, Chinese investors have plowed at least $2.8 trillion into buying such funds from banks alone. After quintupling since 2011, these investments, known as wealth management products, now total an amount roughly equal to more than one-third of… annual economic output. Their growth has increased as China’s economy has slowed.”

August 9 – Reuters (Elias Glenn and Yawen Chen): “China's exports and imports fell more than expected in July in a rocky start to the third quarter, pointing to further weakness in global demand in the aftermath of Britain's decision to leave the European Union. Imports fell 12.5% from a year earlier, the biggest decline since February and suggesting China's domestic demand may be faltering despite a flurry of measures to stimulate economic growth… Exports fell 4.4% on-year…”

August 9 – Reuters (Elias Glenn and Yawen Chen): “China's factory price deflation moderated further in July, with prices falling at their slowest pace in two years… A government-led building spree has increased demand for construction materials, but higher prices are also due in part to speculation in China's commodities futures market, which has pushed up Shanghai rebar futures up by 50% this year. The producer price index (PPI) fell 1.7% in July from a year ago…”

August 11 – Bloomberg (Tracy Alloway): “The good news is that the capital raises have begun. The bad news is that they need to continue. An analysis of 765 banks in China by UBS Group AG shows that efforts to clean up the country's debt-ridden financial system are well underway, with as much as 1.8 trillion yuan ($271bn) of impaired loans shed between 2013 and 2015, and 620 billion yuan of capital raised in the same period. But the work is far from over, as to reach a more sustainable debt ratio the Chinese banking sector will still require up to 2 trillion yuan of additional capital as well as the disposal of 4.5 trillion yuan worth of bad loans… ‘Contrary to market perception, bank recapitalisation and bailouts have begun,’ said UBS's Jason Bedford. ‘Most interestingly, for the first time in a decade we note formal implementations of asset restructuring plans and recapitalisations and bailouts of individual — and large — institutions.’”

August 11 – Bloomberg: “China’s infrastructure investors have had a tough two weeks, with plugs being pulled on at least $15 billion of potential deals in nuclear power and electricity distribution. Britain and Australia refused to sign off on investments where state-owned Chinese companies were ready to provide much-needed funding. In both cases, the long-term utility programs were halted in the later stages, stunning participants. Those in the U.K. were all set to join a signing ceremony when the announcement came. ‘As China’s diplomatic policies become more and more assertive, there’s a trend that these countries are gradually enhancing their vetting on Chinese investment,’ said Tao Jingzhou, a managing partner at Dechert LLP in Beijing. ‘This is an attitude change.’”

Japan Watch:

August 11 – Reuters (Leika Kihara): “The Bank of Japan has already prepared a preliminary outline of a ‘comprehensive’ review of its policies due next month that will maintain a pledge to hit its 2% inflation target as soon as possible, sources familiar with its thinking said. In the draft, the BOJ identifies sharp falls in oil prices, a prolonged hit to growth from a sales tax hike in 2014 and Japan's inability to shake off its deflationary mindset as hampering achievement of its inflation target, the sources said. By blaming external factors for keeping inflation subdued, the BOJ could use the review to defend its policy framework from rising criticism that three years of heavy money printing had failed to achieve its price target, they added.”

EM Watch:

August 12 – Bloomberg (Jeanette Rodrigues): “India’s inflation accelerated more than estimated, narrowing room for monetary easing as investors wait to see who will replace hawkish central bank Governor Raghuram Rajan next month. Consumer prices rose 6.07% in July from a year earlier… The consumer food price index rose 8.35% in July…”

Geopolitical Watch:

August 10 – Reuters (Andrew Osborn and Gleb Stolyarov): “Vladimir Putin accused Ukraine… of using terrorist tactics to try to provoke a new conflict and destabilize annexed Crimea after Russia said it had thwarted two armed Ukrainian attempts to get saboteurs into the contested peninsula. Russia's FSB security service said two people were killed in clashes and its forces had dismantled a Ukrainian spy network inside Crimea. Kiev denied the assertions, calling them an attempt by Moscow to create an excuse to escalate towards a war.”

August 11 – Bloomberg (Kateryna Choursina and Stepan Kravchenko): “Russia said the deaths of servicemen in Crimea would carry ‘consequences’ and Ukraine put its troops on ‘high alert,’ warning that Vladimir Putin is seeking to reignite the conflict in the disputed territories. The Foreign Ministry in Moscow raised the threat of retaliation a day after the Russian president vowed to respond with ‘very serious’ measures and said Ukrainian agents had engaged in ‘terror’ tactics on the Black Sea peninsula… Poroshenko dismissed the accusations as ‘fiction’ that could be an ‘excuse for further military threats’ by Russia.”

August 6 – Reuters (Michael Martina): “China's air force sent bombers and fighter jets on ‘combat patrols’ near contested islands in the South China Sea, in a move a senior colonel said was part of an effort to normalize such drills and respond to security threats. The exercises come at a time of heightened tension in the disputed waters after an arbitration court in The Hague ruled last month that China did not have historic rights to the South China Sea.”

August 9 – Reuters (Kiyoshi Takenaka and Eric Beech): “Japan warned China… that ties were deteriorating over disputed East China Sea islets, and China's envoy in Tokyo reiterated Beijing's stance that the specks of land were its territory and called for talks to resolve the dispute. The diplomatic tussle comes amid simmering tension as China builds on outposts in the contested South China Sea, including what appear to be reinforced aircraft hangars, according to new satellite images. Ties between Asia's two largest economies have been strained in recent days since Japan saw a growing number of Chinese coastguard and other government ships sailing near the East China Sea islets, called the Senkaku in Japan and Diaoyu in China.”

August 11 – Washington Times (Carlo Munoz): “U.S. military officials are trying to pacify a furious China in the wake of Washington’s plan to deploy a battery of advanced missile defense systems in South Korea, insisting to angry military leaders in Beijing that the weapons would be solely targeting ballistic missile threats from North Korea and not undercut China’s own military deterrent. Beijing has denounced the planned deployment of the Terminal High Altitude Area Defense weapon in South Korea and has already retaliated in ways large and small, including blocking a U.N. Security Council resolution condemning a recent North Korean missile test…”

August 11 – Reuters (Adam Jourdan): “A newly launched satellite will help China protect its maritime interests, the official China Daily newspaper reported… amid growing tensions over disputed territory in the South China Sea. The ‘Gaofen 3’ satellite that was launched on Wednesday has a radar system that captures images from space with a resolution down to 1 meter (3 feet) and can operate in all weathers… The satellite will play an important role in monitoring the marine environment, islands and reefs, and ships and oil rigs,’ the China Daily said, citing project leader Xu Fuxiang…. ‘Satellites like the Gaofen 3 will be very useful in safeguarding the country's maritime rights and interest…”

August 10 – Reuters (Greg Torode): “Vietnam has discreetly fortified several of its islands in the disputed South China Sea with new mobile rocket launchers capable of striking China's runways and military installations across the vital trade route, according to Western officials. Diplomats and military officers told Reuters that intelligence shows Hanoi has shipped the launchers from the Vietnamese mainland into position on five bases in the Spratly islands in recent months, a move likely to raise tensions with Beijing.”