EM Contagion and a New Z.1

By: Doug Noland | Fri, Mar 13, 2015
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With the (king) U.S. dollar index trading Friday above 100 for the first time since 2003, the unfolding EM - ongoing "global reflation trade" - unwinds broadened and turned more disorderly. Brazil is now lurching toward crisis. Friday trading saw the Brazilian real slammed for 2.6% to the low since April 2003, boosting y-t-d losses to 18.2% (down 27.2% y-o-y). Brazil sovereign CDS surged 13 bps Friday to 302, the high since early-2009. Notably, Brazil's dollar yields surged 23 bps Friday to a multi-year high 5.08%. For the week, Brazilian (real) yields jumped 43 bps to 13.40% (traded as high as 13.79% intraday Friday).

May 13 - Bloomberg (Filipe Pacheco and Paula Sambo): "Bonds and stocks of Petroleo Brasileiro SA fell after a newspaper reported that the company is in talks with creditors to extend a deadline for publishing audited results and avoid a possible acceleration of payments. Petrobras's $2.5 billion in bonds due 2024 declined 2.7 cents to 90.55 cents per dollar, the biggest daily drop since Jan. 30. Yields on the notes jumped 0.45 percentage point to 7.74%. The preferred shares of the company at the center of the nation's biggest corruption probe slid 2.5%... extending this week's slump to 10%. The Rio de Janeiro-based oil driller has held negotiations with about 15 banks and investment firms in the past few weeks to extend the deadline, Folha de S. Paulo reported..."

The Bloomberg Commodity Index dropped 3.1% this week to the lowest level since August 2002. This index is now down 44% from 2011 highs. Weakness was notably broad-based. The week saw heating oil hit for 7.3%, coffee 6.7%, lean hogs 6.0%, sugar 5.9%, cocoa 3.8%, cotton 3.4%, natural gas 3.9%, lead 2.3%, nickel 1.7%, silver 2.0%, orange juice 1.5%, corn 1.4% and soybeans 1.2%. With crude (WTI) crushed 9.6% to the lowest level since early-2009, there was notable pressure on EM energy and commodities-related bonds. Troubled Petroleo Brasileiro (Petrobras) CDS surged 70 bps Friday and were up 120 bps for the week to a record 711 bps. Vale CDS jumped 55 bps this week to the high since early-2009 (331bps). The markets are increasingly nervous of the major Brazilian lenders, including the state-directed banks. Banco do Brasil CDS jumped 62 bps this week to 442 bps. Brazilian development bank BNDES CDS jumped 48 bps. It's also worth mentioning that Petroleos Mexicanos CDS jumped 24 bps to 207 bps.

Venezuela dollar yields jumped 66 bps Friday and were up 220 bps for the week to 28.65%. Pricing imminent default, Venezuela CDS surged 1,294 bps this week to 5,506 bps. Colombia CDS jumped 21 bps to 175 bps, Peru 22 bps to 145 bps, and Panama 20 bps to 149 bps. Jumping 20 bps, Mexican CDS this week traded to the highest level since July 2013 (136 bps)

EM currency weakness was broad-based. In Latin America this week, the the Brazilian real fell 5.7%, Colombian peso 3.2% and the Chilean peso 1.8%. Eastern European currencies were under heavy pressure. The Polish zloty was hit for 3.6%, the Bulgarian lev 3.2%, the Hungarian forint 3.2%, the Romanian leu 3.2%, the Czech koruna 3.1% and the Iceland krona declined 2.4%. The Russian ruble reversed course and declined 2.9% this week.

EM bonds were also under pressure. The lira's 1.9% Friday decline wiped out the Turkey currency's earlier rally, as Turkish lira yields jumped 14 bps this week to a three-month high 8.36%. Turkey CDS traded to an almost one-year high earlier in the week. In Asia, Indonesia CDS rose 12 bps to a two-month high 160 bps. Interestingly, China CDS gained 5 bps to 89 bps.

EM stocks were not spared. Russian stocks were hit for 5.8% and Turkish equities were slammed for 4.6%. India's Sensex index fell 3.2%. Eastern European equities were under pressure almost across the board. Things were not much better in Latin America and Asia.

The euro was slammed for 3.2% this week, trading to the lowest level versus the dollar since 2002. Greek five-year yields surged 329 bps to 15.15%. Greek CDS jumped 350 bps to 1,708 - not far from the highest levels since 2012.

The Federal Reserve released its Q4 Z.1 "flow of funds" report Thursday. Total Non-Financial Debt (NFD) expanded at a seasonally-adjusted and annualized (SAAR) rate of $1.938 TN, the strongest growth since Q4 2012. Total Business borrowings expanded SAAR $845bn, up from Q3's SAAR $581bn to the highest level since Q1 2008. Federal government borrowed at SAAR $700bn, down from Q3's SAAR $913bn. Total Household borrowings increased SAAR $361bn, little changed from Q3.

For all of 2014, NFD expanded $1.701 TN, up from 2013's $1.463 TN. With 2014 federal borrowings ($667bn) about half the 2012 level, 2014 NFD somewhat lagged 2012's $1.828 TN expansion. Yet 2014 Household borrowings of $376bn were up significantly from 2013's $197bn to the highest level since 2007 ($913bn). Total Business borrowings of $672bn were up from 2013's $546bn to the strongest growth since 2007 ($1.116 TN).

On a percentage basis, NFD expanded 4.3% in 2014, up from 2013's 3.8%. Business debt growth accelerated to 7.2% from 2013's 5.0%. Although mortgage debt growth remained below 1%, total Household borrowings increased 2.9%. Outstanding State & Local borrowings contracted 0.5% in 2014.

Bank growth slowed during Q4, with Banking Assets expanding $954bn during 2014, or 6.0%. Bank loans, however, posted another strong quarter, with notable 2014 growth of 12.3% ($308bn). For the year, Credit Union assets expanded 5.9%, REIT liabilities 8.3%, and Security Credit 7.7%. A significant Q4 decline pushed Securities Broker/Dealer Assets to a 4.5% 2014 contraction.

Despite only modest growth from most traditional sources of Credit, inflationary forces continue to buttress securities markets. My proxy for "Total Debt Securities" - Treasuries, Agency Securities, Corporate Bonds and Muni debt - increased $1.25 TN during 2014 to a record $36.15 TN. Total Debt Securities have increased $8.075 TN, or 29%, since the end of 2008. Total Equities have jumped $20.816 TN, or 133%, since 2008. As such, my proxy of "Total Securities" jumped $4.08 TN in 2014 to a record $72.608 TN. Total Securities have increased $28.9 TN since the end of 2008, or 66%.

"Total Securities" as a percentage of GDP is helpful for Bubble Analysis. After beginning the nineties at 173% of GDP, "Total Securities" ended the Bubble year 1999 at an unprecedented 341%. The bursting "tech" Bubble saw this ratio decline to 267% to end 2002. Mortgage finance Bubble reflation then pumped this ratio to a record 360% by the end of 2007. The Bubble burst and "Total Securities" ended 2008 at 297%. Six years of incredible monetary inflation had Total Securities ending 2014 at a record 417% of GDP.

I have on a quarterly basis chronicled the inflation of Household sector Net Worth as a key facet of Federal Reserve reflationary policies. Household Assets inflated another $1.61 TN during Q4, with a 2014 gain of $4.431 TN. For the year, Household Real Estate Assets increased $1.223 TN and Financial Assets rose $3.045 TN. And with Household Liabilities growing $363bn, Household Net Worth (assets minus liabilities) jumped another $4.068 TN in 2014 to a record $82.912 TN. Since the end of 2008, Household Net Worth has inflated $26.403 TN, or 47%. This "wealth creation" goes a long way in explaining the economic recovery - as well as its vulnerability to asset market weakness.

As a percentage of GDP, Household Net Worth began the nineties at 379% ($21.5 TN). Net Worth rose to 446% ($43.1 TN) of GDP to end 1999, only to fall back down to 398% ($43.7 TN) to close 2002. Net Worth inflated to a record 461% ($66.7 TN) to end 2007. Net Worth closed 2014 at a record 476% of GDP ($82.9 TN).

Federal Reserve Asset growth slowed to $48bn during the quarter, with 2014 growth of $482bn, or 11.8%. Amazingly, the Fed's balance sheet inflated $1.601 TN, or 54%, during the past two years. And since the end of 2007, Fed liabilities have inflated $3.604 TN, or 379%.

Curiously, GSE borrowings (debt as opposed to MBS) expanded SAAR $316bn during Q4, the most rapid GSE growth in years. Is the GSE ramp up coincident with the wind down of Fed QE? The GSEs posted three straight quarters of strong growth. As hard as it is to believe, GSE activities should be monitored closely in 2015.

Overall, 2015 is destined to be a fascinating and challenging year for macro Credit and flow analysis. After six years of extraordinary monetary stimulus, the U.S. asset markets and Credit system have attained a degree of momentum. Thus far, the conclusion of Fed QE has had little apparent liquidity impact. I believe ongoing liquidity abundance owes much to global "hot money" flowing into (hot) king dollar securities markets. Faltering Bubbles at the Periphery have incited self-reinforcing robust flows to the "Core." But as bursting EM Bubble contagion now gathers momentum, there's potential for a more globalized Risk Off dynamic to surprise U.S. markets with a bout of destabilizing de-risking and de-leveraging. This week did see a modest widening of Credit spreads. I continue to believe a reversal and strengthening yen would likely incite more aggressive speculative de-leveraging.

 


For the Week:

The S&P500 declined 0.9% (down 0.3% y-t-d), and the Dow slipped 0.6% (down 0.4%). The Utilities recovered 0.3% (down 8.8%). The Banks increased 0.6% (down 1.1%), and the Broker/Dealers jumped 2.5% (up 2.6%). The Transports gained 0.4% (down 2.1%). The S&P 400 Midcaps increased 0.3% (up 2.7%), and the small cap Russell 2000 gained 1.2% (up 2.3%). The Nasdaq100 fell 1.9% (up 1.9%), and the Morgan Stanley High Tech index dropped 2.4% (down 0.3%). The Semiconductors lost 0.7% (up 3.1%). The Biotechs rose another 1.8% (up 18.4%). With bullion down $9, the HUI gold index was slammed for 3.6% (down 2.1%).

One- and three-month Treasury bill rates ended the week at two bps. Two-year government yields fell seven bps to 0.66% (down one bp y-t-d). Five-year T-note yields dropped 11 bps to 1.59% (down 7bps). Ten-year Treasury yields sank 13 bps to 2.12% (down 6bps). Long bond yields dropped 15 bps to 2.69% (down 6bps). Benchmark Fannie MBS yields fell 10 bps to 2.83% (unchanged). The spread between benchmark MBS and 10-year Treasury yields widened three bps to 71 bps. The implied yield on December 2015 eurodollar futures dropped 7.5 bps to 0.79%. Corporate bond spreads widened. An index of investment grade bond risk rose four to a one-month high 66 bps. An index of junk bond risk jumped 18 bps to 328 bps. An index of EM debt risk surged a notable 27 bps to one-month high 373 bps.

Greek 10-year yields jumped 136 bps to 10.61% (up 86bps y-t-d). Ten-year Portuguese yields sank 21 bps to a record low 1.55% (down 108bps). Italian 10-yr yields fell 17 bps to a record low 1.15% (down 74bps). Spain's 10-year yields dropped 15 bps to 1.15% (down 47bps). German bund yields declined 14 bps to a record low 0.27% (down 29bps). French yields dropped 20 bps to 0.50% (down 33bps). The French to German 10-year bond spread narrowed six to 23 bps. U.K. 10-year gilt yields sank 24 bps to 1.71% (down 4bps).

Japan's Nikkei equities index gained 1.5% to a new 15-year high (up 10.3% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.40% (up 8bps y-t-d). The German DAX equities index jumped 3.0% to a new record high (up 21.4%). Spain's IBEX 35 equities index slipped 0.5% (up 7.3%). Italy's FTSE MIB index gained 1.2% to an almost five-year high (up 19.5%). Emerging equities were mostly under pressure. Brazil's Bovespa index dropped 2.8% (down 2.9%). Mexico's Bolsa gained 1.7% (up 2.0%). South Korea's Kospi index declined 1.4% (up 3.7%). India's Sensex equities index sank 3.2% (up 3.7%). China's Shanghai Exchange surged 4.1% (up 4.3%). Turkey's Borsa Istanbul National 100 index sank 4.6% (down 10.6%). Russia's MICEX equities index fell 5.8% (up 16.6%).

Debt issuance remained brisk. Investment-grade issuers included Zimmer $4.0bn, JM Smucker $3.65bn, Bank of America $1.9bn, Toyota Motor Credit $1.75bn, Citigroup $1.5bn, Morgan Stanley $1.5bn, KKR Group $1.0bn, Cigna $900 million, Valero Energy $1.25bn, American Honda $1.25bn, Aflac $1.0bn, Borg-Warner $1.0bn, EOG Resources $1.0bn, ACE Holdings $800 million, Essex Portfolio LP $500 million, Priceline $500 million, Spectra Energy Partners LP $1.0bn, Potomac Electric Power $500 million, Peachtree Corners $500 million, Duke Energy $500 million, Sempra Energy $500 million, Federal Realty Investment Trust $450 million, TC Pipelines LP $350 million, American University $123 million and Froedtert and Community Health $100 million.

I saw no convertible debt issues this week.

Junk funds saw a big flow reversal, with outflows of $1.956bn (from Lipper). Junk issuers included United Rentals $1.0bn, Shea Homes $750 million, Crestwood Midstream Partners LP $700 million, Boardwalk Pipelines $600 million, Evolution $600 million, KCG Holdings $500 million, Helmerich & Payne International Drilling $500 million, Masonite International $475 million, Reliance Intermediate Holdings LP $375 million, HealthSouth $300 million, EPR Properties $400 million, San Diego Gas & Electric $250 million and Surgical Care Affiliates $250 million.

International debt issuers included Valeant Pharmaceuticals $8.5bn, Canada $3.5bn, Barclays $3.0bn, BP Capital $3.0bn, International Bank of Reconstruction & Development $2.75bn, ING Bank $2.35bn, Bank of England $2.0bn, Sweden $1.5bn, Credit Agricole $1.5bn, Lloyds Bank $1.5bn, Panama $1.25bn, Nordic Investment Bank $1.25bn, Toronto Dominion Bank $1.0bn, Petronas $5.0bn, Abbey National Treasury Services $1.0bn, Noble Holding Intl $1.1bn, Air Canada $850 million, International Finance Corporation $750 million, Asian Development Bank $500 million, Millicom International Cellular $500 million, Kommunalbanken $500 million, Cimpress $275 million and GFL Environmental $250 million.

Freddie Mac 30-year fixed mortgage rates jumped 11 bps to a 10-week high 3.86% (down one bp y-t-d). Fifteen-year rates rose seven bps to 3.10% (down 5bps). One-year ARM rates increased two to an almost one-year high 2.46% (up 6bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down nine bps to 4.22% (down 6bps).

Federal Reserve Credit last week expanded $1.7bn to $4.450 TN. During the past year, Fed Credit inflated $316bn, or 7.6%. Fed Credit inflated $1.640 TN, or 58%, over the past 122 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week declined $7.6bn to an almost one-year low $3.248 TN. "Custody holdings" were down $26bn over the past year, or 0.8%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were down $70bn y-o-y, or 0.6%, to $11.652 TN. Reserve Assets are now down $364bn from the August 2014 peak. Over two years, reserves were $709bn higher, for 6% growth.

M2 (narrow) "money" supply declined $7.1bn to $11.846 TN. "Narrow money" expanded $717bn, or 6.4%, over the past year. For the week, Currency increased $2.9bn. Total Checkable Deposits gained $6.2bn, while Savings Deposits fell $12.7bn. Small Time Deposits declined $1.1bn. Retail Money Funds dipped $2.3bn.

Money market fund assets jumped $18.2bn to $2.690 TN. Money Funds were down $42.3bn year-to-date.

Total Commercial Paper rose $24.4bn to $1.023 TN. CP increased $2.0bn over the past year, or 0.2%.

Currency Watch:

The U.S. dollar index jumped 2.6% to 100.18 (up 11% y-t-d). For the week on the upside, the Mexican peso increased 0.1%. For the week on the downside, the Brazilian real declined 5.7%, the Norwegian krone 3.7%, the South African rand 3.5%, the Danish krone 3.4%, the euro 3.2%, the Swedish krona 2.9%, the South Korean won 2.7%, the Swiss franc 2.0%, the British pound 2.0%, the Canadian dollar 1.2%, the Singapore dollar 1.1%, the Australian dollar 1.0%, the Taiwanese dollar 0.6%, the Japanese yen 0.5% and the New Zealand dollar 0.4%.

Commodities Watch:

The Goldman Sachs Commodities Index sank 4.5% (down 5.9% y-t-d). Spot Gold lost 0.7% to $1,159 (down 1%). May Silver fell 2.0% to $15.49 (down 1%). April Crude sank $4.77 to $44.84 (down 16%). April Gasoline slid 6.4% (up 20%), and March Natural Gas dropped 3.9% (down 6%). May Copper rallied 2.1% (down 6%). March Wheat recovered 4.7% (down 14%). March Corn declined 1.4% (down 6%).

U.S. Bubble Watch:

May 12 - Bloomberg (Oshrat Carmiel): "Manhattan's smallest apartments are fueling big gains in rents. The median rent in the borough jumped 8.9% last month to $3,375, according to... appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate. Costs for studio apartments climbed 10% to a median $2,351, while rents for one-bedrooms rose 9.4% to $3,400, both the highest in more than seven years of record-keeping."

Central Bank Watch:

May 12 - Bloomberg (Jiyeun Lee and Cynthia Kim): "South Korea's central bank unexpectedly lowered its key interest rate to an all-time low to prevent the nation from falling into deflation and support economic growth. The Bank of Korea lowered the seven-day repurchase rate to 1.75%... With South Korea's inflation at slowest pace since 1999 and exports falling, the BOK joins more than 20 other central banks in loosening policy this year, including its Thai counterpart, which unexpectedly cut rates Wednesday."

Global Bubble Watch:

May 9 - Bloomberg (Masaki Kondo and Chikako Mogi): "Japanese investors were net buyers of major overseas sovereign debt in January, except that of the U.K., underscoring their appetite for higher returns as the Bank of Japan's unprecedented easing suppresses bond yields. Net purchases of Canada's sovereign bonds maturing in more than a year rose to 99.5 billion yen ($822 million), the most since May 2010... They also bought a net 469.7 billion yen of French government bonds, the biggest amount in seven months. Investors in Japan are increasingly diversifying their assets as they seek those with higher yields."

ECB Watch:

May 11 - Reuters (Emelia Sithole-Matarise and Marius Zaharia): "Germany's central bank may soon find there are not enough Bunds in the market for it to meet its share of European Central Bank sovereign bond purchases as vanishing yields squeeze the pool of eligible debt. The Bundesbank, the euro zone's most influential central bank, is set to buy the lion's share under the ECB's 1 trillion euro quantitative easing programme that kicked off on Monday. It has not said how much it plans to buy over the 19 months of the programme but analysts estimate it will buy about 214 billion euros worth... This looks increasingly hard to attain set against ECB rules barring purchases of bonds yielding less than its deposit rate of -20 bps and owning more than a quarter of any one bond. 'The universe of buyable bonds is melting like snow in the spring sun,' Societe Generale strategist Ciaran O'Hagan said. 'Our reckoning is the Buba won't fill its quota.'"

May 12 - Bloomberg (Jeff Black and Stefan Riecher): "An improving euro-area economy shows the European Central Bank's government bond-purchase program isn't needed, Governing Council member Jens Weidmann said. 'I remain unconvinced that the macroeconomic situation really warrants' quantitative easing, Weidmann... said... 'One especially problematic aspect is that the massive government-bond purchases will make the Eurosystem central banks the biggest creditors of the euro-area member countries. Fiscal policy and monetary policy will become even more closely entwined.' The Bundesbank, as part of the 19-nation system of European central banks, started buying its quota of bonds this week in the ECB's 1.1 trillion-euro ($1.2 trillion) asset-purchase plan. While Weidmann has argued against the need for extra stimulus, his institution is responsible for carrying out the largest national portion of the purchases."

May 12 - Reuters (Paul Carrel and Maria Sheahan): "European Central Bank policymaker Jens Weidmann put the onus squarely on governments... to decide whether they wanted to cover Greece's funding needs, saying this was 'less than ever' a task for the euro zone's central banks. Reporting a fall in the German Bundesbank's 2014 profit due to reduced interest income, Weidmann also said a rosy outlook for Germany's economy was no reason to turn a blind eye to risks such as geopolitical tensions and a demographic shift. 'Complacency in economic policy matters has no place in Germany,' Weidmann... 'The unfavourable demographic outlook will weigh heavily on the German economy in the medium term,' Weidmann said."

Europe Watch:

May 12 - BBC (Giorgos Christides): "Deepening ties between Greece's new government and Russia have set off alarm bells across Europe, as the leaders in Athens wrangle with international creditors over reforms needed to avoid bankruptcy. While Greece may be eyeing Moscow as a bargaining chip, some fear it is inexorably moving away from the West, towards a more benevolent ally, a potential investor and a creditor. Europe is not pleased. Should it also be worried? A drove of Greek cabinet members will be heading to Moscow. Prime Minister Alexis Tsipras will be hosted by Russian President Vladimir Putin in May, accompanied by coalition partner Panos Kammenos, defence minister and leader of the populist right-wing Independent Greeks party."

May 9 - Reuters (Noah Barkin): "A leading lawmaker from Chancellor Angela Merkel's conservative bloc has described a Greek exit from the euro zone as a 'great opportunity' for the country to bolster its economy, in the latest sign that German sentiment towards a so-called 'Grexit' is shifting. Peter Ramsauer, a former transport minister under Merkel and chairman of the economic affairs committee in the German parliament, wrote... that more muddling through with Greece made little sense. Although no longer a member of the government, Ramsauer is arguably the most prominent politician in Merkel's camp to come out in favour of Greece leaving the euro zone. 'By leaving the euro zone, as Finance Minister (Wolfgang) Schaeuble has suggested, the country could make itself competitive again from a currency perspective with a new drachma,' Ramsauer... wrote in Bild."

China Bubble Watch:

May 12 - Reuters (Kevin Yao and Judy Hua): "Chinese banks extended 1.02 trillion yuan ($162.87bn) worth of new loans in February, well above market expectations, while growth in broad money supply quickened... Economists polled by Reuters had expected new local-currency loans to fall to 750 billion yuan in February from 1.47 trillion yuan in January... Broad M2 money supply (M2) in February rose 12.5% from a year ago, beating expectations of 11% and quickening from January's 10.8%, which was the weakest since records started in 1998. Outstanding loan growth was 14.3% in February... The central bank also said that total social financing, a broader measure of overall liquidity in the economy, was 1.35 trillion yuan in February, versus 2.05 trillion yuan in January."

May 11 - Bloomberg: "China's economy is already behind target as monetary easing shows few signs of traction. Industrial output, investment and retail sales growth missed analysts' estimates in January and February, suggesting more stimulus is needed to boost the world's second-largest economy. Bloomberg's gross domestic product tracker, which draws on that data as well as measures such as electricity production, shows economic growth slowing to 6.28% in the period, the weakest pace since the start of 2009... 'The mix of the real activity indicators suggests the effects of monetary policy easing effort so far has remained limited,' Liu Li-Gang, chief economist for greater China at Australia & New Zealand Banking Group... wrote... 'Further easing effort or even targeted 'fiscal stimulus' is needed in order to arrest the downside risk."

May 11 - Reuters (Clare Jim): "China's property sales in the first two months of 2015 dropped by the most in three years amid a glut of housing supply, and real estate investment growth eased. Sales revenue dropped 15.8% in the two-month period versus January-February last year, the worst drop since the 2012 fall of 20.9%. The January-February figures are combined to smooth out the effect of Lunar New Year holidays. The property sector accounts for some 15% of China's economic output, with weak property sales highlighting the risks faced even to achieve the government's reduced 7% growth target."

May 9 - Reuters (Koh Gui Qing, Matthew Miller and Nate Taplin): "China's plan to run its biggest fiscal deficit since the global financial crisis may help develop its bond market, but the extra competition for funding could sink some of the major providers of local government financing. Local government financing vehicles (LGFVs), which were invented to skirt restrictions on local government fundraising, are already under pressure from Beijing's drive to reduce local debt and migrate provincial financing to a more transparent municipal bond model. With over $3 trillion in outstanding debt that funded essential infrastructure, along with some vanity projects and speculative adventures, LGFVs are finding it hard to service their existing debts, let alone raise new money when loans fall due. Some fear they could go under. 'There is no way we can survive, and the pressure on the company is huge,' said an executive at an LGFV in Yanghou city... who spoke on condition of anonymity. His company has several billion yuan in debt raised to build roads and lay pipes. 'Our loans are due, and we can't repay them. If financing remains this tight, some companies will die.'"

May 9 - Bloomberg: "China will allow regional authorities to convert some high-yielding debt into municipal bonds in a bid to cut financing costs on liabilities brokerages say have topped $3 trillion, sparking speculation investors may shoulder losses. The government will permit as much as 1 trillion yuan ($160bn) of the obligations to be swapped into local-government notes that have lower yields... China is seeking to rein in local-government borrowing while accelerating fiscal spending to defend a 7% economic growth target. The debt swelled to 17.9 trillion yuan as of June 2013... The liabilities may have already reached 25 trillion yuan, bigger than the size of the German economy, according to estimates from Mizuho Securities Asia Ltd."

May 8 - Bloomberg (Lianting Tu): "A forklift maker, a leather producer and a textiles company have missed payments on privately sold bonds in China this year, as the central bank's failure to cut borrowing costs in line with slowing inflation wrecks profits. HSBC Holdings Plc says more defaults may occur after consumer price increases in the world's second-biggest economy cooled to 0.8% in January, the slowest since 2009. Rates on the benchmark one-year lending rate after accounting for living costs rose to a five-year high at 4.59%. Prices received by manufacturers dropped 4.3% last month, matching January's decline that was the biggest since 2009... Borrowing costs have also jumped for lower-rated companies in the public bond market, as the slowest economic growth in more than two decades dents sentiment. The yield on five-year corporate debentures with ratings of AA- has surged 45 bps to 5.93% since November..."

May 8 - Bloomberg: "China's money-market funds' total assets surged six-fold in the 18 months through December, rising to 2.2 trillion yuan ($351.3bn), according to Fitch... The expansion was driven mainly by retail investments in e-commerce related funds, Fitch analysts Li Huang, Charlotte Quiniou and Alastair Sewel wrote... Retail investors accounted for more than 70% at the end of the second half of last year, the note said, adding that the five largest asset managers held 51% of total assets. Yu'E Bao, managed by Tianhong Asset Management Co. and sold online by Alibaba Group Holding Ltd., was the largest with 26%. 'Demand for Chinese money-market funds will continue to grow, albeit at a slower pace,' the analysts wrote. 'It will be more driven by institutional investors and multinational companies operating in China that are more conservative and less yield-hungry than retail investors.'"

May 13 - Bloomberg: "Senior Chinese government advisers are calling for tighter supervision of peer-to-peer online lending after a ratings company warned 1,250 platforms or more may go bankrupt or run into difficulty. Authorities should clarify the industry's role and make clear whether it can offer borrower guarantees, Yang Kaisheng, an adviser to the banking regulator and the former president of Industrial & Commercial Bank of China Ltd., said... 'A storm of credit risks is brewing in the peer-to-peer lending industry,' said Xu Zhipeng, the Beijing-based president of the data unit at Dagong Global Credit Rating Co., which issued the warning list on March 10. Most investors are individuals and any collapse would 'have a huge social impact and affect tens of millions of families,' he said."

May 11 - Wall Street Journal (Lingling Wei): "China's leadership is preparing to radically consolidate the country's bloated state-owned sector, telling thousands of enterprises they need to rely less on state life support and get ready to list on public markets. The economic slowdown has heightened the imperative to eke better returns out of the state firms that tower over China's economy, from the giants that dominate oil, banking and other strategic sectors, to smaller ones that run hotels and make toothpaste... In an analysis for The Wall Street Journal, economist Zhu Chaoping at UOB Kay Hian Holdings Ltd., a Singapore-based brokerage, found that assets at state-owned enterprises, defined as those majority-controlled by the government, jumped 90% to 25.1 trillion yuan ($4 trillion) in 2012 from 2008. Return on equity among state-controlled manufacturers, however, averaged 11.6% in 2013, compared with nearly 25.7% for their private brethren, according to Mr. Zhu's analysis."

May 11 - New York Times (Neil Gough): "China's exports of steel are soaring. But that is not a good sign for the economy. China has far more steel mills than it needs, a problem made worse by the country's shrinking housing market, the most voracious consumer of the metal. Domestic steel prices have collapsed. Thousands of workers have been laid off as mills have scaled back or closed. With scant demand at home, those mills still in business have turned to foreigners as buyers of last resort. China shipped a record 100 million metric tons of steel overseas in the 12 months to the end of February, a 55% increase from the previous 12 months... The country's traditional drivers of growth -- manufacturing, real estate, local government infrastructure spending -- are now among the biggest threats to China's economy."

Geopolitical Watch:

May 9 - Reuters (Koh Gui Qing, Matthew Miller and Nate Taplin): "China's long-awaited international payment system to process cross-border yuan transactions is ready and may be launched as early as September or October, three sources with direct knowledge of the matter told Reuters. The launch of the China International Payment System (CIPS) will remove one of the biggest hurdles to internationalizing the yuan and should increase global usage of the Chinese currency by cutting transaction costs and processing times. The system, which would be a worldwide payments superhighway for the yuan, will replace a patchwork of networks and allow hassle-free renminbi transactions. The CIPS is ready now and China has selected 20 banks to do the testing, among which 13 banks are Chinese banks and the rest are subsidiaries of foreign banks,' said a senior banking source... 'The official launch will be in September or October, depending on the results of the testings and preparation,' the source said."

May 11 - New York Times (David D. Kirkpatrick): "The Islamic State has established more than a foothold in this Mediterranean port. Its fighters dominate the city center so thoroughly that a Libyan brigade sent to dislodge the group remains camped on the outskirts, visibly afraid to enter and allowing the extremists to come and go as they please. 'We are going to allow them to slip out, because the less people we have to fight, the better,' said Mohamed Omar el-Hassan, a 28-year-old former crane operator who leads the brigade from a prefabricated shed on a highway ringing the city. 'Why make the city suffer?' he said, trying to explain his delay more than 16 days after the brigade arrived in Surt. Nearly four years after the ouster of Col. Muammar el-Qaddafi, Libya's warring cities and towns have become so entangled in internal conflicts over money and power that they have opened a door for the Islamic State to expand into the country's oil-rich deserts and sprawling coastline. Libya has become a new frontier for the radical group as it comes under increasing pressure from American-led airstrikes on its original strongholds in Iraq and Syria."

Brazil Watch:

May 11 - Bloomberg (Paula Sambo): "Aldemir Bendine never worked in the oil industry, but he already knew plenty about Petroleo Brasileiro SA before becoming its chief executive officer last month. That's because he occupied the same post for years at Banco do Brasil SA. The firm is one of the state-controlled banks that Moody's... estimates lent a combined $30 billion to Petrobras, which is at the center of what may be Brazil's widest-ranging corruption investigation. The banks are coming under scrutiny as Petrobras assesses the extent of writedowns in the wake of allegations that its executives took bribes from builders in exchange for contracts. The lenders are also at risk of higher loan-loss provisions because they will probably have to provide financing to the oil company as funding options dwindle, Moody's said. 'It's putting banks -- particularly the state-owned lenders -- under huge strain,' Nicholas Spiro, a managing director at Spiro Sovereign Strategy... said... Banco do Brasil SA's $1.5 billion of notes due 2022 lost 7.7% since November, when Petrobras first delayed its earnings report... Caixa Economica Federal's $500 million of notes with similar maturity slumped 7% while BNDES's $1.75 billion of bonds due 2023 dropped 6.4%... Since Rousseff took office in 2011, BNDES has disbursed about $234 billion, more than the World Bank. Banco do Brasil has increased lending at an annual average pace of 19% over that period... Caixa has expanded its loan book more than twice as fast as Brazilian peers in the span..."

May 11 - Bloomberg (Gerson Freitas Jr): "Braskem SA, Latin America's largest petrochemicals producer, sank the most in more than 20 years after a newspaper cited court testimony that linked the company to a graft scandal at Petroleo Brasileiro SA. The shares tumbled as much as 21%... Bonds due in 2024 declined 5.3 cents to 95.84 cents on the dollar... 'All the payments and contracts between Braskem and Petrobras followed the legal requirements and were approved in a transparent manner in accordance with the governance rules of both companies,' Braskem said..."

EM Bubble Watch:

May 12 - Bloomberg (Sebastian Boyd and Christine Jenkins): "Venezuela has already blown through almost of all the $5.9 billion in new financing it managed to scrounge up this year. And while it will probably use $1.3 billion of the money to pay bonds coming due on Monday, the cash-strapped country's spending underscores why derivatives traders say there's a better than 50% chance it will default within a year. After using up the money it squeezed out of its U.S. oil-refining unit and spending the payment it received from Dominican Republic for crude sales last month, Venezuela's foreign reserves now stand at $22.1 billion... That's far short of the $33 billion in financing that Barclays Plc estimates the country needs this year with oil prices around $50 a barrel."

May 11 - Bloomberg (Brendan Case, Benjamin Bain and Isabella Cota): "Mexican policy makers stepped up support for the peso, with plans for at least $3 billion of dollar sales through June, after the currency sank to a record low. The central bank will sell $52 million a day over the next 60 business days with no minimum price, the nation's currency commission said... The new intervention is in addition to a program started in December of $200 million of dollar sales that happen whenever the peso weakens by 1.5% or more from the previous day. The central bank also will scale back the pace at which it has been accumulating foreign reserves."

May 9 - Bloomberg (Isobel Finkel): "The Turkish central bank is becoming a spectator to the lira's retreat, as reserves dwindle and political pressure neutralizes its most effective tools for intervention. The currency plunged to its fourth record-low this month on Friday, capping the longest run of declines since January last year. That's when Governor Erdem Basci was forced to more than double interest rates to halt a lira rout after $18 billion of interventions failed to stem the slide. The central bank's options are now limited by its lowest net reserves in more than six months and political clamoring for lower borrowing costs, according to Ozgur Altug at BGC Partners... Credit Agricole SA cut its lira forecast last week along with Societe Generale SA whose strategist Bernd Berg said Turkey faces 'a home-made currency crisis.'"

Russia and Ukraine Watch:

May 11 - Bloomberg (Marton Eder): "A key element to President Vladimir Putin's vision of growing Russian influence in the world is his plan to lead the former Soviet republics into an economic union. Right now, though, what he's mostly doing is wiping out their currencies. Just as Russia's financial crisis is finally showing signs of easing amid a tenuous cease-fire in Ukraine, the aftershocks are spreading from Moscow to former Kremlin satellites including Belarus, Azerbaijan and Moldova. Those three countries -- along with Ukraine itself -- dominate the very bottom of the world's worst-performing currency list this year. And just one spot beyond them, right after the Brazilian real, is another regional currency, Georgia's lari. All of these currencies have plunged more than 13% against the dollar, and three of them, led by the Belarus ruble, are down more than 25%."

 


 

Doug Noland

Author: Doug Noland

Doug Noland
Credit Bubble Bulletin

Doug Noland

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

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

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

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

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

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