Janet Yellen’s Wednesday news conference was her final as Fed chair. Dr. Yellen has a long and distinguished career as an economist and public servant. Her four-year term at the helm of the Federal Reserve is almost universally acclaimed. History, however, will surely treat her less kindly. Yellen has been a central figure in inflationist dogma and a fateful global experiment in radical monetary stimulus. In her four years at the helm, the Yellen Fed failed to tighten financial conditions despite asset inflation and speculative excess beckoning for policy normalization.
Ben Bernanke has referred to the understanding of the forces behind the Great Depression as “the holy grail of economics.” When today’s historic global Bubble bursts, the “grail” quest will shift to recent decades. Yellen’s comments are worthy of chronicling for posterity.
CNBC’s Steve Liesman: “Every day it seems we look at the stock market, it goes up triple digits in the Dow Jones. To what extent are there concerns at the Federal Reserve about current market valuations? And do they now or should they, do you think, if we keep going on the trajectory, should that animate monetary policy?”
Chair Yellen: “OK, so let me start, Steve, with the stock market generally. I mean, of course, the stock market has gone up a great deal this year. And we have in recent months characterized the general level of asset valuations as elevated. What that reflects is simply the assessment that looking at price-earnings ratios and comparable metrics for other assets other than equities, we see ratios that are in the high end of historical ranges. And so that’s worth pointing out.
But economists are not great at knowing what appropriate valuations are; we don’t have a terrific record. And the fact that those valuations are high doesn’t mean that they’re necessarily overvalued. We are in a — I mentioned this in my opening statement and we’ve talked about this repeatedly – likely a low interest rate environment, lower than we’ve had in past decades. And if that turns out to be the case, that’s a factor that supports higher valuations, where enjoying solid economic growth with low inflation and the risks in the global economy look more balanced than they have in many years.
So, I think what we need to and are trying to think through is if there were an adjustment in asset valuations, the stock market, what impact would that have on the economy? And would it provoke financial stability concerns? And I think when we look at other indicators of financial stability risks, there’s nothing flashing red there or possibly even orange. We have a much more resilient, stronger banking system. And we’re not seeing some worrisome buildup in leverage or credit growth at excessive levels. So, this is something that the FOMC pays attention to. But if you ask me is this a significant factor shaping monetary policy now, well it’s on the list of risks. It’s not a major factor.”
Reuter’s Howard Schneider: “So you mentioned in response to Steve’s question that asset valuations, you didn’t think, were on the high-priority risk list right now. So I’m wondering what do you think is on that risk list? And more broadly, what have you left undone? You’ve gotten high marks for bringing the economy back towards its goals, but are there things that are going to nag you when you walk out of here in February, and say, ‘Really, I wish I’d seen this to completion’? I mean, we’re not doing negative interest rates. We’re not doing inflation framework. What’s at the top of the to-do list that you are not getting to see to bring to ground here?”
Yellen: “So you asked about the risk list. There are always risks that affect the outlook. We tend to focus, in our own evaluation, on economic risks. And we’ve characterized them as balanced, and I think they are balanced. I can always give you a list of, you know, potential troubles, international developments that could result in downside economic risk.
But look, at the moment the U.S. economy is performing well. The growth that we’re seeing it’s not based on, for example, an unsustainable buildup of debt, as we had in the run-up to the financial crisis. The global economy is doing well. We’re in a synchronized expansion. This is the first time in many years that we’ve seen this. Inflation around the world is generally low. So I think the risks are balanced, and there’s less to lose sleep about now than has been true for quite some time. So I feel good about the economic outlook…
As I mentioned, I think the financial system is on much sounder footing, and that we have done a great deal to put in place greater capital, liquidity, and so forth that make it less crisis-prone, and that has been an important objective. What’s on my undone list, you ask? We have a 2% symmetric inflation objective, and for a number of years now, inflation has been running under 2%, and I consider it an important priority to make sure that inflation doesn’t chronically undershoot our 2% objective. And I want to see it move up to 2%. So most of my colleagues and I do believe that it’s being held down by transitory factors, but there’s work undone there in the sense we need to see it move up in line with our objective.”
Bloomberg’s Mike McKee: “…Do you think that there is any Fed blame or complicity in the flattening of the yield curve, and are you worried that there might be some sort of policy mistake built into that that could slow the economy?”
Yellen: “The yield curve has flattened some as we’ve raised short rates. The flattening curve mainly reflects higher short-term rates. The yield curve is not currently inverted, and I would say that the current slope is well within its historical range. Now there is a strong correlation historically between yield curve inversions and recessions. But let me emphasize that correlation is not causation. And I think that there are good reasons to think that the relationship between the slope of the yield curve and the business cycle may have changed. One reason for that is that long-term interest rates generally embody two factors: One is the expected average value of short rates over, say, ten years. And the second piece of it is a so-called term premium that often reflects things like inflation and inflation risk. Typically, the term premium historically has been positive. So when the yield curve has inverted historically, it meant that short-term rates were well above average expected short rates over the longer run – so with a positive term premium that’s what it means. And typically that means that monetary policy is restrictive – sometimes quite restrictive. And some of those recessions were situations in which the Fed was consciously tightening monetary policy because inflation was high and trying to slow the economy. Well, right now the term premium is estimated to be quite low – close to zero. And that means that structurally – and this could be true going forward – that the yield curve is likely to be flatter than it’s been in the past. And so it could more easily invert if the Fed were to even move to a slightly restrictive policy stance – could see an inversion with a zero term premium. So, I think the fact the term premium is so low and the yield curve is generally flatter is an important factor to consider.”
The yield curve has become, once again, a critical Bubble issue. Recall Alan Greenspan’s “conundrum.” The Greenspan Fed raised short-term rates 350 bps (June ’04 to January ’06) yet 10-year Treasury yields barely budged (around 4.5%). After trading as high as 273 bps in 2003, the spread between two-year and 10-year Treasuries ended 2004 at 115 bps and 2005 at about flat. The yield curve inverted as much as 18 bps in November 2006.
Keep in mind that system Credit was expanding by record amounts, fueled by years of compounding double-digit annual mortgage Credit growth. Annual Total Non-Financial Debt (NFD) growth averaged $760 billion during the decade of the nineties. By 2002, NFD was up to $1.346 TN and accelerating rapidly. NFD expanded $1.654 TN in 2003, $2.115 TN in 2004, $2.291 TN in 2005, $2.416 TN in 2006 and $2.509 TN in 2007. Clearly, a flat or inverting yield curve was not explained by restrictive monetary policies.
The fundamental issue was not so much that market yields were not rising in response to Fed “tightening” measures. Rather, why were borrowing rates not increasing in the face of unprecedented demand for Credit? How had the price of finance become completely disconnected from underlying demand? And, critically, why was the Credit system not self-adjusting and correcting, but instead fueling a runaway mortgage finance Bubble?
Arguing asset price valuations back in the 2004 to 2007 Bubble period was as futile as it is today. It was the yield curve that signaled something was seriously amiss. The so-called “conundrum” needed serious contemplation, not clever self-serving rationalization and justification (i.e. “global savings glut”). Moreover, the anomalous yield curve was providing important corroboration of anomalous Credit growth data.
Finance had been fundamentally altered. Contemporary Credit systems, increasingly dominated by market-based finance, were essentially operating with unlimited supply. Somehow, a rapid doubling of mortgage Credit in just over six years neither stressed the supply of Credit nor evoked higher risk premiums. Instead of self-correction, this new financial apparatus was a self-reinforcing Bubble machine. The system had badly malfunctioned, though the ugly reality remained camouflaged until later in 2008. In the meantime, it flaunted a pretense of being both phenomenal and sustainable.
The yield curve has again flattened significantly in 2017. The two-year to 10-year Treasury spread ended Friday’s session at 51 bps, down from the 125 bps to start the year, to the narrowest spread since the heydays of Bubble excess back in 2007. Short-rates have risen, the economy has gathered momentum and prospects for an uptick in inflation have increased. What’s behind the replay of the “conundrum”?
On one point, I concur with chair Yellen: “I think there are good reasons to think that the relationship between the slope of the yield curve and the business cycle may have changed.” But I would posit that this change evolved over recent cycles, as central bankers took an increasingly activist role in the economy and, most importantly, throughout the financial markets.
I would argue that the yield curve flattened in’06 and ’07 specifically because of Bubble Dynamics in mortgage Credit coupled with Bernanke’s previous professing on “helicopter money” and the government printing press. Dr. Bernanke, a radical inflationist, had become a powerful force in Federal Reserve policymaking. Bond markets back then discerned mortgage finance Bubble unsustainability, while deftly anticipating the Federal Reserve’s crisis response. The bursting Bubble saw the formal unveiling of the new central bank modus operandi: slash short rates to at least zero; aggressively inject liquidity into the markets through long-term debt purchases; manipulate long-term market yields much lower while telegraphing unwavering liquidity support.
The Fed and conventional thinking are comfortable with the view that today’s flat yield curves (low long-term yields) signal ongoing disinflationary pressures. The talk is of an extraordinarily low “neutral rate” that, conveniently, necessitates ongoing aggressive monetary accommodation. Apparently, financial stability concerns remain undeserving of the Fed’s “risk list”, so long as core consumer prices remain (slightly) below the 2% target.
December 13 – Reuters (John Ruwitch and Winni Zhou): “Financiers keep pouring cash into the shale oil sector, providing producers with a path to keep U.S. output rising through the middle of the next decade. The United States is on track to deliver up to 80% of the world’s oil production gains through 2025, the International Energy Agency estimates, increases fueled in part by easy access to capital. Rising U.S. production is undermining OPEC’s attempts to curb global supply and boost prices, forcing the oil cartel to continue restraining output through the end of 2018. Hedge funds and private equity firms have given producers a range of new and traditional financial levers they can pull as needed to keep shale rigs drilling…”
In so many ways, years of loose finance have spurred over-investment and attendant downward pricing pressures. Shale finance is only one of the more visible examples. Importantly, excess cheap finance and investment have evolved into powerful global phenomena. One has only to point to the runaway Credit boom – and resulting manufacturing overcapacity in China (and Asia more generally) – to come to the rather obvious conclusion that activist monetary management/accommodation can foment downward pricing pressures.
These days, central bankers from around the globe sing from the same hymn sheet. The inflation backdrop demands ongoing stimulus. The yield curve is “within its historical range”. “The financial system is on much sounder footing.” There’s “less to lose sleep about.” “When we look at other indicators of financial stability risks, there’s nothing flashing red there or possibly even orange. We have a much more resilient, stronger banking system. And we’re not seeing some worrisome buildup in leverage or credit growth at excessive levels.” When it comes to mounting risk throughout global securities and derivative markets, it’s hear no evil, see and speak none either. It’s worth highlighting an exchange from Mario Draghi’s Thursday press conference”
Question: “What kind of discussions have been going on within the governing council about possible bubbles in sectors of the market or economy – and how exiting the asset purchase plan could impact those bubbles?”
Mario Draghi: “We always discuss financial stability issues, and we certainly closely monitor the financial stability risks that may emerge from a situation where we had very, very low interest rates for a long period of time; abundant liquidity for a long period of time. So, the ground is fertile for these risks. At the same time, we are not seeing systemically important financial stability risks. We see the local spots where valuations tend to be over-stretched. But also, as soon as you ask this question, one should also ask the question ‘How’s leverage?’ Because a bubble is also the outcome of two components. So how’s leverage behaving? And there, differently from other parts of the world, we don’t see leverage – for the private sector going up, as for the whole of the Eurozone. As a matter of fact, debt to GDP or debt to value of assets – depending on the yardstick – continues to decrease…”
My response: Proclaiming a lack of “private sector” leveraging is disingenuous when the greatest sources of systemic leverage throughout this long cycle have been ballooning central bank and government balance sheets. It recalls how pristine government finance was an important facet of the last cycle’s bull story. Meanwhile, massive leveraging by the private and financial sectors was behind the mirage of responsible fiscal management.
As for Draghi’s “local spots” of “over-stretched” valuations, could he be referring to Italian 10-year yields at 1.80% or Spain at 1.49%? Or perhaps Greece at 3.89%, or Portugal at 1.76%. Or could it be German 10-year yields at 0.29%, or perhaps German two-year yields at negative seven bps. And then there’s French 10-year yields at 0.62%, Switzerland at negative 0.24%, Finland at 0.45%, Ireland at 0.48%, Belgium at 0.49%, Netherlands at 0.40%, Austria at 0.45% or Slovenia at 0.69%.
It’s reminiscent of chairman Greenspan’s declaration that you won’t have a national real estate Bubble because all real estate markets are local. The flaw in the maestro’s thinking was his apparent disregard for the Bubble throughout mortgage finance – very much on a systemic, national basis. Today’s Bubble is in finance on a systemic, global basis – most prominent in government, central bank and securities finance – developed, EM and, importantly, all things China. Leveraging galore – with the associated Bubble finance utterly “fungible.”
December 13 – Bloomberg (Chris Anstey): “European investors have been plowing so much capital abroad they’ve taken up about half the boom in U.S. corporate debt in recent years, but now that liquidity tap is poised to be shut off, according to Oxford Economics. ‘The global debt issuance boom is likely to lose steam, given the extent to which it has relied on the support of European investors,’ Guillermo Tolosa, an economic adviser to Oxford Economics in London who has worked at the International Monetary Fund, wrote… ‘Issuers better seize the opportunities while they last.’ European Central Bank asset purchases took up so great a supply of bonds that it pushed euro area investors into markets abroad, to the tune of 400 billion euros ($473bn) a year over the past three years, Oxford Economics estimates.”
It’s simply difficult to believe that these central bankers fail to recognize what have evolved into deeply systemic risks. They know they’re trapped, but in denial – right? Then again, complacent central bankers have a history of being blindsided. Clearly, they’re determined to cling to flawed doctrine. I’ve always believed conventional thinking has it wrong: The great risk is not deflation but runaway Credit Bubbles. And very serious problems unfold when the risk of a bursting Bubble ensures that policymakers rationalize, justify – and sit back and do nothing.
December 12 – CNBC (Tae Kim): “Stanley Druckenmiller believes the overly easy monetary policies by global central banks will have disastrous consequences. ‘The way you create deflation is you create an asset bubble. If I was ‘Darth Vader’ of the financial world and decided I’m going to do this nasty thing and create deflation, I would do exactly what the central banks are doing now,’ he told CNBC’s Kelly Evans… ‘Misallocate resources [with low interest rates], create an asset bubble and then deal with the consequences down the road,’ he said. The investor noted how this boom-and-bust cycle has happened time and time again. ‘Deflation just doesn’t appear out of nowhere and it doesn’t happen because you are near the zero bound. Every serious deflation I’ve looked at is preceded by an asset bubble and then it bursts,’ he said. ‘Think about the ’20s, a big asset bubble that burst, you have the Depression. Think about Japan. Asset bubble in the ’80s. It burst. You have the consequences follow. Think about 2008, 2009.’”
For the Week:
The S&P500 gained 0.9% (up 19.5% y-t-d), and the Dow rose 1.3% (up 24.7%). The Utilities slipped 0.5% (up 13.7%). The Banks dipped 0.4% (up 15.8%), while the Broker/Dealers were little changed (up 28.4%). The Transports were about unchanged (up 14.9%). The S&P 400 Midcaps slipped 0.2% (up 13.6%), while the small cap Russell 2000 recovered 0.6% (up 12.8%). The Nasdaq100 jumped 1.9% (up 33.0%). The Semiconductors rose 1.0% (up 38.0%). The Biotechs declined 1.4% (up 35.7%). With bullion regaining $6, the HUI gold index rallied 1.6% (down 1.2%).
Three-month Treasury bill rates ended the week at 129 bps. Two-year government yields rose four bps to 1.84% (up 65bps y-t-d). Five-year T-note yields added a basis point to 2.15% (up 23bps). Ten-year Treasury yields slipped two bps to 2.35% (down 9bps). Long bond yields fell eight bps to 2.68% (down 38bps).
Greek 10-year yields dropped 54 bps to 3.93% (down 309bps y-t-d). Ten-year Portuguese yields added three bps to 1.84% (down 191bps). Italian 10-year yields jumped 16 bps to 1.81% (unchanged). Spain’s 10-year yields rose nine bps to 1.49% (up 11bps). German bund yields declined a basis point to 0.30% (up 10bps). French yields were unchanged at 0.63% (down 5bps). The French to German 10-year bond spread widened one to 33 bps. U.K. 10-year gilt yields sank 13 bps to 1.15% (down 9bps). U.K.’s FTSE equities gained 1.3% (up 4.9%).
Japan’s Nikkei 225 equities index fell 1.1% (up 18.0% y-t-d). Japanese 10-year “JGB” yields slipped a basis point to 0.046% (up 1bp). France’s CAC40 declined 0.9% (up 10.0%). The German DAX equities index slipped 0.4% (up 14.1%). Spain’s IBEX 35 equities index dropped 1.7% (up 8.5%). Italy’s FTSE MIB index sank 3.0% (up 14.9%). EM markets were mixed. Brazil’s Bovespa index dipped 0.2% (up 20.6%), while Mexico’s Bolsa gained 1.1% (up 5.3%). South Korea’s Kospi index added 0.7% (up 22.5%). India’s Sensex equities index increased 0.6% (up 25.7%). China’s Shanghai Exchange declined 0.7% (up 5.2%). Turkey’s Borsa Istanbul National 100 index rose 1.3% (up 39.9%). Russia’s MICEX equities index declined 0.2% (down 4.0%).
Junk bond mutual funds saw outflows of $922 million (from Lipper).
Freddie Mac 30-year fixed mortgage rates slipped a basis point to 3.93% (down 23bps y-o-y). Fifteen-year rates were unchanged at 3.36% (down 1bp). Five-year hybrid ARM rates added a basis point to 3.36% (up 17bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates unchanged at 4.15% (down 4bps).
Federal Reserve Credit last week expanded $4.2bn to $4.401 TN. Over the past year, Fed Credit fell $16.6bn. Fed Credit inflated $1.581 TN, or 56%, over the past 266 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $5.5bn last week to $3.385 TN. “Custody holdings” were up $232bn y-o-y, or 7.4%.
M2 (narrow) “money” supply dipped $4.0bn last week to $13.806 TN. “Narrow money” expanded $638bn, or 4.8%, over the past year. For the week, Currency slipped $0.4bn. Total Checkable Deposits rose $20.7bn, while Savings Deposits dropped $23.2bn. Small Time Deposits were little changed. Retail Money Funds declined $0.9bn.
Total money market fund assets jumped $33.76bn to a seven-year high $2.841 TN. Money Funds rose $108bn y-o-y, or 4.0%.
Total Commercial Paper declined $2.9bn to $1.050 TN. CP gained $100bn y-o-y, or 10.5%.
Currency Watch:
The U.S. dollar index was little changed at 93.932 (down 8.3% y-t-d). For the week on the upside, the South African rand increased 4.33%, the New Zealand dollar 2.1%, the Australian dollar 1.8%, the Japanese yen 0.8%, the South Korean won 0.4%, and the Singapore dollar 0.3%. For the week on the downside, the Norwegian krone declined 1.1%, the Mexican peso 1.0%, the Swedish krona 0.7%, the British pound 0.5%, the Brazilian real 0.3%, the euro 0.2% and the Canadian dollar 0.1%. The Chinese renminbi increased 0.17% versus the dollar this week (up 5.08% y-t-d).
Commodities Watch:
The Goldman Sachs Commodities Index was little changed (up 5.3% y-t-d). Spot Gold recovered 0.6% to $1,255 (up 9.0%). Silver rallied 1.5% to $16.063 (up 1%). Crude slipped six cents to $57.30 (up 6%). Gasoline dropped 3.6% (down 1%), and Natural Gas sank 5.8% (down 30%). Copper surged 5.2% (up 25%). Wheat slipped 0.2% (up 3%). Corn fell 1.5% (down 1%).
Trump Administration Watch:
December 14 – Wall Street Journal (Richard Rubin): “The tax bill moving through Congress is about 500 pages long, containing enough paper to wrap lots of Christmas presents for boys and girls across the land. The gifts in the text are tax cuts—more than $1.4 trillion of them over the next decade—scattered throughout a bill that Republican lawmakers are striving to make into law next week. The centerpiece of the plan is a lower corporate tax rate that will help domestic retailers, who are chief among businesses that pay close to the 35% corporate tax rate in effect now. Not everyone will benefit. The GOP plan also takes away some longstanding tax breaks, including the ability for individuals to fully deduct their state and local taxes. That’s going to be a problem for upper-middle-class wage-earners in high-tax states such as New York and California. The plan would add nearly $1.5 trillion to the nation’s budget deficits over the next decade, according to the Joint Committee on Taxation…”
December 11 – Bloomberg (Sahil Kapur): “A funny thing happened when Congress approved a tax cut for the middle class eight years ago: Most Americans didn’t notice. The 2009 economic-stimulus bill contained a one-year tax break worth $800 for married couples in 95% of working households — a little over $15 a week. A February 2010 poll found that just 12% said their taxes had been reduced. More than half, 53%, said they saw no change. A remarkable 24% thought their taxes had increased. ‘Virtually nobody believed they got a tax cut,’ said Jared Bernstein, an economist who worked in former President Barack Obama’s White House.”
December 10 – Financial Times (Bryan Harris): “North Korea has criticised a proposed US naval blockade, saying such a move would constitute another ‘declaration of war’. The fiery comments in the state-run Rodong Sinmun newspaper came a day before the US, South Korea and Japan launched rocket tracking drills on Monday aimed at improving detection and monitoring of the reclusive regime’s ballistic missile tests.”
December 13 – Wall Street Journal (Dante Chinni): “Democrat Doug Jones’s improbable victory in one of the nation’s reddest states is sure to fuel Republican anxieties about next year’s midterm elections, as it offers more evidence that Democrats in the era of President Donald Trump are eager to vote, while GOP voter turnout is muted. Mr. Jones eked out a narrow win in his U.S. Senate race due to high turnout among African-Americans, who overwhelmingly backed the Democrat, and low turnout in the largely white, rural counties that Republicans have counted on as a large part of their base.”
December 13 – Reuters (Eliana Raszewski and Luc Cohen): “The United States, European Union and Japan vowed… to work together to fight market-distorting trade practices and policies that have fueled excess production capacity, naming several key features of China’s economic system. In a joint statement that did not single out China or any other country, the three economic powers said they would work within the World Trade Organization and other multilateral groups to eliminate unfair competitive conditions caused by subsidies, state-owned enterprises, ‘forced’ technology transfer and local content requirements. The move was a rare show of solidarity with the United States at a World Trade Organization meeting…”
China Watch:
December 11 – Bloomberg: “China’s broadest gauge of new credit and an index of loan growth both exceeded projections, signaling that a government push against leverage hasn’t crimped lending. Aggregate financing stood at 1.6 trillion yuan ($242bn) in November…, compared with an estimated 1.25 trillion yuan in a Bloomberg survey and 1.04 trillion yuan the prior month… The broad M2 money supply increased 9.1%, exceeding projections and rising from the 8.8% record low in October.”
December 11 – Reuters (Kevin Yao): “Bank lending in China hit a fresh record after a much stronger-than-expected surge in credit in November, even as authorities step up efforts to reduce risks in the financial system from a rapid build-up in debt. Chinese banks extended 1.12 trillion yuan ($169.27bn) in net new yuan loans in November…, well above analysts’ expectations… The November credit splurge brought China’s total new lending so far this year to 12.94 trillion yuan, more than Italy’s GDP and exceeding 2016’s record 12.65 trillion yuan with one month left to go.”
December 13 – Reuters (John Ruwitch and Winni Zhou): “China’s central bank nudged money market interest rates upward on Thursday just hours after the Federal Reserve raised the U.S. benchmark, as Beijing seeks to prevent destabilizing capital outflows without hurting economic growth… The People’s Bank of China called it a ‘normal market reaction’ to the Fed that would keep interest rate expectations reasonable and help with the deleveraging campaign.”
December 13 – Bloomberg: “China’s new home sales rebounded in November, climbing the most in five months. Sales by value, excluding affordable housing, increased 12.4% from a year earlier to 1.02 trillion yuan ($151bn)…”
December 11 – Wall Street Journal (Nathaniel Taplin): “In the West, bad children get coal in their Christmas stockings. In China, everyone gets coal, as consumption peaks during the winter-heating season. Its leaders want to change this. In line with President Xi Jinping’s recent call for a ‘better life’ for Chinese citizens, coal power curbs this winter are rolling across northern China. China’s green push has a problem, however. Electric power is the country’s most indebted sector, with total debt of 7.8 trillion yuan ($1.2 trillion) at the end of 2016… A good chunk of that is sunk into coal power plants with the capacity to produce more than one billion kilowatts of electricity, roughly three times the coal power capacity of the U.S.”
December 13 – Bloomberg (Denise Wee and Carrie Hong): “Debt-laden Chinese conglomerate HNA Group Co. met with Chinese lenders for talks on financing next year, after borrowing costs surged in recent weeks and prompted some units to scrap bond offerings. Representatives from eight Chinese banks’ branches in the southeastern province of Hainan, where HNA is based, met with the group Wednesday on providing credit support in 2018, the company said…”
December 14 – Wall Street Journal (Shen Hong): “Chinese companies are turning away from capital markets and heading back to state-owned banks to raise cash, in a reversal of Beijing’s previous efforts to modernize the way the corporate sector in the world’s No. 2 economy is funded. China’s bond and stock markets have provided about a quarter of all financing for companies in the past two years. This year, that proportion is down to just 6.6%…”
December 10 – Bloomberg: “China’s securities regulator is cracking down on the fast-growing hedge-fund industry, investigating 10 cases of alleged wrongdoing. Officials are probing private fund practices including market manipulation, misappropriation of client funds, insider trading and trading by managers using their personal accounts, the China Securities Regulatory Commission said… Some funds used the Hong Kong-Shanghai stock connect to manipulate prices and some employees sought personal gain by exploiting the hedging mechanism for stock index futures, it said.”
Federal Reserve Watch:
December 13 – Financial Times (Sam Fleming): “The Federal Reserve lifted short-term interest rates for a third time this year and predicted more increases to follow in the new year as Janet Yellen prepares to hand over the chair amid robust hiring and surging financial markets. The US central bank’s Federal Open Market Committee increased the target range for the federal funds rate by a quarter point to 1.25-1.5%. Policymakers’ median forecast was for another three quarter-point increases in 2018 and two in 2019, even as they acknowledged inflation is continuing to undershoot their target. Two policymakers – Charles Evans of Chicago and Neel Kashkari of Minneapolis — dissented…”
December 12 – Wall Street Journal (Ben Eisen, Daniel Kruger and Chelsey Dulaney): “Investors have greeted the Federal Reserve’s recent string of interest rate increases with some of the most docile market conditions in years, a sign that they could be in for a shock if the central bank decides to ramp up the pace of rate rises next year. The Goldman Sachs Financial Conditions Index, a widely-watched measure of how easily money and credit flow through the economy via financial markets, was this month at its lowest level since 2014. Financial conditions are now looser than they were before the Fed began lifting rates in 2015.”
U.S. Bubble Watch:
December 12 – Reuters (Lucia Mutikani): “U.S. producer prices rose in November as gasoline prices surged and the cost of other goods increased, leading to the largest annual gain in nearly six years. The fairly strong report… suggested a broad acceleration in wholesale price pressures, which could assuage concerns among some Federal Reserve officials over persistently low inflation. ‘This demand-led price push from higher commodity prices is a classic early warning signal that consumer goods will also see increasing inflationary pressures,’ said Chris Rupkey, chief economist at MUFG… The Labor Department said its producer price index for final demand increased 0.4% last month, advancing by the same margin for three straight months. In the 12 months through November, the PPI shot up 3.1%.”
December 14 – Reuters: “U.S. import prices surged in November amid an increase in the cost of imported petroleum products, leading to the largest year-on-year increase in seven months. The Labor Department said… that import prices jumped 0.7% last month after a downwardly revised 0.1% gain in October… In the 12 months through November, import prices advanced 3.1%…”
December 12 – Bloomberg (Vince Golle): “Optimism among small companies in the U.S. advanced last month to the highest level in more than 34 years as owners became more upbeat about future economic conditions and sales prospects, according to a National Federation of Independent Business survey… The small-business optimism index showed all but two of the 10 components increased from a month earlier, including a record net 24% share of small-business owners who said they plan to add jobs.”
December 11 – Wall Street Journal (Paul J. Davies): “Would you invest in a company that couldn’t tell you what its business was going to be? Some would, in fact they are doing so in record amounts. Blank-check companies, otherwise known as special purpose acquisition companies, or SPACs, are listed companies that raise money from investors to go and buy a company as yet unidentified… Investing blind looks to be as high-risk as it sounds. This year, there have been almost $14 billion worth of new listed shares in blank-check companies, a record, outstripping 2007’s $12.3 billion global issuance, and giving it all a peak-of-the-markets feel. Between 2007 and 2017, listings were fewer and issuance averaged less than $3 billion a year.”
December 13 – Wall Street Journal (Josh Mitchell): “The number of Americans severely behind on payments on federal student loans reached roughly 4.6 million in the third quarter, a doubling from four years ago, despite a historically long stretch of U.S. job creation and steady economic growth. In the third quarter alone, the count of such defaulted borrowers—defined by the government as those who haven’t made a payment in at least a year—grew by nearly 274,000…”
December 12 – Wall Street Journal (Nicole Friedman): “Raging wildfires in Southern California could push the amount of insured losses this year from natural disasters to a record. Insurers and reinsurers are already on track for one of the largest ever industrywide losses from natural catastrophes. Hurricanes Harvey, Irma and Maria, along with two Mexican earthquakes, caused between $66 billion and $111 billion in damage, according to estimates from catastrophe-modeling firms. Wildfires in California in October caused $9.4 billion in insurance claims, the state insurance commissioner said last week. Insurers haven’t yet estimated the scope of damage from the fires in Southern California.”
December 12 – Reuters (Lindsay Dunsmuir): “The U.S. government reported a $139 billion deficit in November… That compared with a budget deficit of $137 billion in the same month last year… The deficit for the fiscal year to date was $202 billion, compared to a deficit of $183 billion in the comparable period for fiscal 2017.”
December 11 – Wall Street Journal (Katherine Clarke): “A roughly 20,000-square-foot mansion with its own red velvet movie theater and panic room is in contract for about $80 million… If it closes for that price, the property would become the most expensive townhouse ever sold in New York City, according to appraiser Jonathan Miller. The current record was set in 2006, when financier J. Christopher Flowers paid $53 million for the Harkness mansion on East 75th Street, Mr. Miller said.”
Central Banker Watch:
December 15 – NewEurope: “On Thursday the European Central Bank (ECB) raised growth and inflation projections, but Mario Draghi remains committed to cheap liquidity. Employment is surging in the Eurozone and growth remains on track for a fifth successive year. Growth in the Eurozone is projected to be 2.4% for 2017 and 2.3% for 2018. However, Eurozone inflation in 2017 is expected to be a meagre 1.4% and will remain below the 2% target beyond 2020. The forecast for 2020 is 1.7%. …ECB’s President Mario Draghi noted that with current projections there was still need for ‘ample stimulus,’ or at least until September 2018.”
Global Bubble Watch:
December 13 – New York Times (Desmond Lachman): “In late 2008, at a meeting with academics at the London School of Economics, Queen Elizabeth II asked why no one seemed to have anticipated the world’s worst financial crisis in the postwar period. The so-called Great Recession, which had begun in late 2008 and would run until mid-2009, was set off by the sudden collapse of sky-high prices for housing and other assets — something that is obvious in retrospect but that, nevertheless, no one seemed to see coming. Are we about to make the same mistake? All too likely, yes. Certainly, the American economy is doing well, and emerging economies are picking up steam. But global asset prices are once again rising rapidly above their underlying value — in other words, they are in a bubble. Considering the virtual silence among economists about the danger they pose, one has to wonder whether in a year or two, when those bubbles eventually burst, the queen will not be asking the same sort of question. This silence is all the more surprising considering how much more pervasive bubbles are today than they were 10 years ago. While in 2008 bubbles were largely confined to the American housing and credit markets, they are now to be found in almost every corner of the world economy.”
December 12 – Bloomberg: “2017 is set to go down as the year when easy monetary policy and budding global growth came together to deliver blockbuster returns for the world’s emerging markets. Currencies and stocks in developing economies are on track for their biggest rallies in eight years as even the riskiest markets shrugged off various crises and threats to deliver gains for investors. Bonds, too, have had a good run, with local-currency emerging-market debt returning the most since 2012 amid the loose policy environment.”
December 11 – Bloomberg: “Years of cheap money across Asia have left a legacy of surging debt that will force the region’s central bankers to be cautious when they eventually follow in the footsteps of South Korea by raising interest rates. In South Korea… household debt has ballooned to about 150% of disposable income. It’s an even larger 194% in Australia. In China, it’s companies feeling the strain with corporate debt equating to about 160% of gross domestic product. Years of unprecedented stimulus have swollen the Bank of Japan’s balance sheet to almost the size of the economy. Given the 2% inflation target is still in the distance, a tightening of monetary policy remains a long way off, so that debt pile is set to keep on swelling.”
December 12 – Bloomberg (Luke Kawa): “‘Buy the dip’ has never been so popular. The practice of treating any and all pullbacks in risk assets as opportunities to accumulate more has become entrenched in global equity markets, especially in the U.S., according to analysts at Bank of America Merrill Lynch. ‘Investors no longer fear shocks but love them,’ a team led by global equity derivatives researcher Nitin Saksena wrote… ‘Since 2013, central banks have stepped in (or communicated that they may step in) to protect markets, leaving investors confident enough to ‘buy-the-dip.’’”
December 10 – Bloomberg (David Goodman): “Wall Street economists are telling investors to brace for the biggest tightening of monetary policy in more than a decade. With the world economy heading into its strongest period since 2011, Citigroup Inc. and JPMorgan… predict average interest rates across advanced economies will climb to at least 1% next year in what would be the largest increase since 2006. As for the quantitative easing that marks its 10th anniversary in the U.S. next year, Bloomberg Economics predicts net asset purchases by the main central banks will fall to a monthly $18 billion at the end of 2018, from $126 billion in September, and turn negative during the first half of 2019.”
December 10 – Bloomberg (Rob Urban, Camila Russo, and Yuji Nakamura): “Bitcoin has landed on Wall Street. Futures on the world’s most popular cryptocurrency surged as much as 26% in their debut session on Cboe Global Markets Inc.’s exchange, triggering two temporary trading halts designed to calm the market. Initial volume exceeded dealers’ expectations, while traffic on Cboe’s website was so heavy that it caused delays and temporary outages… ‘It is rare that you see something more volatile than bitcoin, but we found it: bitcoin futures,’ said Zennon Kapron, managing director of Shanghai-based consulting firm Kapronasia.”
December 11 – CNBC (Michelle Fox): “Bitcoin is in the ‘mania’ phase, with some people even borrowing money to get in on the action, securities regulator Joseph Borg told CNBC… ‘We’ve seen mortgages being taken out to buy bitcoin. … People do credit cards, equity lines,’ said Borg, president of the North American Securities Administrators Association… ‘This is not something a guy who’s making $100,000 a year, who’s got a mortgage and two kids in college ought to be invested in.’”
Europe Watch:
December 14 – Bloomberg (Piotr Skolimowski): “Economic momentum in the euro area unexpectedly accelerated to the fastest pace in almost seven years as manufacturing posted record growth at the end of 2017. A composite Purchasing Managers’ Index rose to 58 in December from 57.5 in November, IHS Markit said… An index for Germany, the region’s biggest economy, jumped to the highest since 2011.”
December 13 – Reuters (Fanny Potkin): “Italy’s 10-year bond yield rose and Milan-listed bank shares fell on Wednesday following on prospects the country will hold a national election in March, raising concerns about political stability in the euro zone’s third biggest economy. Italy’s parliament will be dissolved between Christmas and the New Year with national elections probably set for March 4, a parliamentary source in contact with the president’s office said…”
December 13 – Bloomberg (Kelly Gilblom and Chiara Albanese): “Italy’s power industry is in the throes of the biggest shakeup since it opened to competition almost two decades ago after rising prices and a regulatory crackdown unmasked risky practices and spurred losses. Two of the country’s energy providers are liquidating, forcing thousands of customers… to find new suppliers, often at higher rates. The disruption is unlikely to stop there. ‘In the next few months we will see three things: bankruptcies, mergers and CEOs losing their jobs,’ said Gianfranco Sorasio, chief executive officer of power supplier eVISO Srl. ‘The Italian energy market is shaking.’”
Japan Watch:
December 12 – Financial Times (Roger Blitz): “Most forecasters thought they could dismiss the Bank of Japan from their 2018 lists of central banks to watch. Amid talk of a retreat from quantitative easing, the BoJ looked nailed on to maintain its ‘yield curve control’ policy, putting off the idea of tightening until long into the future. That was until a few weeks ago when Haruhiko Kuroda, the bank governor, started to muse about the impact of its ultra-low rates policy on the economy, comments that sparked market interest and drove the yen higher. All too predictably, the governor has rowed back from those remarks. The policy has not changed, he said in a speech last Thursday, arguing that yield curve control was designed to be ‘highly sustainable’. So, is that it? Was it a miscommunication, kite-flying beloved of policymakers, or something more meaningful?”
December 11 – Reuters (Leika Kihara): “Regardless of a return to solid economic growth, the risk of sharp appreciation in the yen means Japan’s central bank would be in no rush to exit its ultra-loose monetary policy, say sources familiar with the bank’s thinking. Stubbornly low inflation would also make the Bank of Japan hesitant to taper its huge crisis-mode stimulus programme and shift away from rock-bottom interest rates too quickly.”
Leveraged Speculation Watch:
December 15 – Bloomberg (Katherine Burton): “John Griffin told investors he’s closing his $6 billion Blue Ridge Capital, ending a three-decade career in hedge funds as the eight-year bull market weighs on his industry. ‘This can be a humbling business, and many times we were tested, especially on the short side, but we have remained committed to the long-short portfolio strategy that has been our founding philosophy since we launched over 21 years ago,’ Griffin wrote…”
