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Yellen in Jackson Hole

By: Doug Noland | Saturday, August 26, 2017

"A resilient financial system is critical to a dynamic global economy -- the subject of this conference. A well-functioning financial system facilitates productive investment and new business formation and helps new and existing businesses weather the ups and downs of the business cycle." Janet Yellen, "Financial Stability a Decade after the Onset of the Crisis," August 25, 2017

I would add that a well-functioning financial system is critical to long-term social, political and geopolitical stability. Importantly, well-functioning finance would have mechanisms that promote adjustment and self-correction. This is fundamental to market-based systems. I would argue that this is also a basic premise of sound money and finance. Sound finance would neither suppress market volatility nor work to repeal business cycles - but would instead have inherent characteristics that counteract protracted market and economic excess.

For starters, I question whether a so-called "resilient financial system" is necessarily a sound one. As we have witnessed, obtrusive government measures can dictate "resilience" - in terms of extended sanguine backdrops free from volatility, risk aversion and crisis. Yet this type of resilience fosters excesses that can inevitably end with a financial and economic crash.

Ten years ago most would have argued forcefully that the system at the time was resilient. Chair Yellen argues in her Jackson Hole paper that myriad regulatory changes have created a much more resilient financial system and economy. Her long speech highlights a laundry list of measures put in place since the crisis. Much to my liking, 22 footnotes include references to even Minsky, Kindleberger and Charles Mackay.

There was also footnote #2: "A contemporaneous perspective on subprime mortgage market developments at this time is provided in Ben S. Bernanke (2007), "The Subprime Mortgage Market," speech delivered... May 17 (2007)."

Looking back, chairman Bernanke presented a knowledgeable understanding of the subprime industry in 2007. His deeply flawed understanding of the macro backdrop was captured in a single sentence: "In general, mortgage credit quality has been very solid in recent years."

Total mortgage Credit had doubled in less than seven years. Indicators of excess were everywhere. Inflation psychology had taken deep root throughout the nation's housing markets, with California housing prices spiraling ever higher. The inflationary backdrop ensured a proliferation of new mortgage products that kept the game going with low monthly payments for prime and subprime borrower alike.

As someone who chronicled the mortgage finance Bubble in its entirety on a weekly basis, it was all too conspicuous. This was the most important market for finance (mortgages) and the real economy (housing and home-related) - that was dominated by the thinly capitalized GSE with their implied federal backing. It was a sophisticated financial scheme. Measures going back to the Greenspan era (bolstered by "helicopter Ben" musings) convinced the markets that the Fed would respond aggressively to avert market crisis. Surely, Washington would never allow a housing bust. It would simply be too devastating. In an irony of recent Bubbles, the greater they inflate the more convinced markets become that officials will not permit a bust.

What might explain Bernanke's indifference to unprecedented mortgage and housing risks? Well, his policy doctrine was at the heart of the problem: Dr. Bernanke had been a leading proponent for using mortgage finance to reflate the system after the bursting of the "tech" Bubble.

Yellen: "Repeating a familiar pattern, the 'madness of crowds' had contributed to a bubble, in which investors and households expected rapid appreciation in house prices. The long period of economic stability beginning in the 1980s had led to complacency about potential risks, and the buildup of risk was not widely recognized. ...A self-reinforcing loop developed, ...as investors sought ways to gain exposure to the rising prices of assets linked to housing and the financial sector. As a result, securitization and the development of complex derivatives products distributed risk across institutions in ways that were opaque and ultimately destabilizing. In response, policymakers around the world have put in place measures to limit a future buildup of similar vulnerabilities."

As I've written in the past, I understand why officials did what they did back in the autumn of 2008. Clearly, they were not about to sit back and watch the system collapse. They would also not settle for mere stabilization. Their epic mistake was to push forward with aggressive reflationary policies - a global monetary inflation regime to which they remain entrapped nine years later. While post-"tech" Bubble reflation focused on mortgage Credit and housing, post-mortgage finance Bubble reflationary measures went much farther: reflate risk assets (equities, corporate debt and housing), collapse market yields and force savers out of the safety of deposits and money funds. It was the same flawed doctrine that had nurtured the "worst crisis since the Great Depression" - but on a much grander scale.

If there was the "madness of crowds" then, how about these days with Trillions flowing into passive ETFs, record corporate debt issuance, record securities and home prices, a proliferation of cryptocurrencies and a bubbling derivatives marketplace. So long as the Fed targets higher asset prices while repeatedly providing liquidity backstops, a culture of speculation becomes only more deeply entrenched.

Yellen's speech makes repeated mention of "too big to fail" - and how policy measures have dealt with this leading element of the previous crisis. In reality, central bankers have ensured that "too big to fail" moral hazard has mushroomed from an issue with respect to large financial institutions to a critical facet afflicting global securities and derivatives market pricing.

Yellen's speech, "Financial Stability a Decade after the Onset of the Crisis," somehow doesn't address the historic experiment with quantitative easing (QE). There's no mention of the Fed (and global central banks) repeatedly responding to incipient market instability (with QE, an extension of monetary stimulus, or a postponement of "normalization"). The powerful doctrine of the Fed "pushing back against a tightening of financial conditions" is omitted from the discussion. The Fed chair largely avoids monetary policy altogether.

Bernanke had his "mortgage credit quality has been very solid..." For Yellen, it's "evidence shows that reforms since the crisis have made the financial system substantially safer." If the Yellen Fed believed as much, I doubt rates would be at 1.25% and their balance sheet would remain ballooned at $4.4 TN.

Yellen: "Investors have recognized the progress achieved toward ending too-big-to-fail... Credit default swaps for the large banks also suggest that market participants assign a low probability to the distress of a large U.S. banking firm."

I would caution against calling out low bank CDS prices as evidence of progress toward ending too-big-to-fail. CDS is atypically low across the spectrum of corporate borrowers. Indeed, sovereign CDS pricing is unusually inexpensive around the globe despite a huge run up in debt loads (Italy 148bps!). And then there's the historically low VIX that astute analysts argue has been disregarding risk. Low risk premiums across various asset classes - at home and abroad - are consistent with market perceptions that central bankers are committed to liquidity backstopping necessary to safeguard against another crisis. "Too big to fail" has never had such momentous market impacts.

Yellen: "Our more resilient financial system is better prepared to absorb, rather than amplify, adverse shocks, as has been illustrated during periods of market turbulence in recent years. Enhanced resilience supports the ability of banks and other financial institutions to lend, thereby supporting economic growth through good times and bad."

Resilience over recent years has clearly been associated with concerted open-ended QE from all the world's leading central banks. It would also appear that chair Yellen overly emphasizes traditional banking when referencing the "financial system." "Banks are safer. The risk of runs owing to maturity transformation is reduced."

It's worth recalling that traditional bank runs were not much of an issue during the previous crisis. Traditional old Market Panic was. As they will do, long periods of market greed erupted into fear and panic. The acute issue was "repo" financing of large institutions financing MBS holdings - along with what a Wall Street liquidity crisis meant for the pricing of mortgage-related finance and the functioning of derivatives more generally. Investor panic was sparked by the loss of faith in the safety and liquidity of repo "money." Yet the overriding issue remained the mispricing of Trillions of MBS and mortgage-related securities and derivatives. I've always argued that a repricing of mortgage debt - and risk more generally - was inevitable, and that major financial and economic repercussions were unavoidable. Bubbles are not forever.

There is no doubt in my mind that today's issue of securities mispricing dwarfs the mortgage finance Bubble period. I also believe latent derivatives market-related instability (i.e. market "insurance") also likely exceeds pre-2008 crisis levels. Less clear is where an acute liquidity episode could initially manifest. Lehman and the cadre of leveraged speculators borrowing in the short-term repo market to finance long duration mortgage securities was rather egregious.

Financial crisis typically erupts in the "money" markets. This is where risk is perceived to be minimal, yet it is at the same time the domain of aggressive risk intermediation that works to distort overall market dynamics. Throughout the mortgage finance Bubble period, "Wall Street Alchemy" transformed progressively riskier mortgages into endless perceived safe and liquid "money"-like instruments - "The Moneyness of Credit," with the "repo" market at the epicenter of perilous risk distortions.

I have argued that unparalleled Fed and global central bank inflationary measures molded the "Moneyness of Risk Assets". In particular, central bank backing ensured that inflating markets in equities and corporate Credit came to be perceived as low-risk stores of value. And with the proliferation of (perceived liquid) fund choices available in the marketplace (ETFs in particular), central banks coupled with Wall Street Alchemy achieved the incredible: the transformation of high-risk securities - with ever-rising prices - into perceived "money"-like instruments.

Returning to the above opening paragraph extracted from Yellen's speech, I believe it is important to contemplate whether market resilience has been due to sound financial system structure or instead because of central bank-induced market distortions and liquidity backstops. If the latter, it is critical to appreciate that this extended period of "resiliency" has ensured cumulative financial distortions and Bubble Economy Maladjustment - on an unparalleled global scale. With tens of Trillions of mispriced securities globally, a painful bout of repricing is unavoidable.

We'll see how resilient "the financial system" proves to be come the unmasking of risk market liquidity and safety misperceptions. It's a curious discussion of "Financial Stability a Decade after the Onset of the Crisis," that glosses over near zero rates, unending QE, Trillions of global debt securities trading with negative yields and the extraordinary expansion of the ETF complex. It recalls Alan Greenspan's speeches - the reasoned analysis along with the intrigue of what went unsaid. For me, it's disingenuous and lacks credibility.

 


For the Week:

The S&P500 increased 0.7% (up 9.1% y-t-d), and the Dow rose 0.6% (up 10.4%). The Utilities gained 1.1% (up 12%). The Banks advanced 1.0% (up 2.3%), and the Broker/Dealers rallied 1.1% (up 10.5%). The Transports increased 0.4% (up 1.0%). The S&P 400 Midcaps gained 1.0% (up 2.9%), and the small cap Russell 2000 recovered 1.4% (up 1.4%). The Nasdaq100 added 0.5% (up 19.7%), and the Morgan Stanley High Tech index rose 1.2% (up 25.5%). The Semiconductors gained 0.8% (up 19.2%). The Biotechs surged 2.6% (up 26.3%). With bullion up $7, the HUI gold index jumped 2.4% (up 10.3%).

Three-month Treasury bill rates ended the week at 99 bps. Two-year government yields gained three bps to 1.33% (up 14bps y-t-d). Five-year T-note yields were unchanged at 1.76% (down 17bps). Ten-year Treasury yields declined three bps to 2.17% (down 28bps). Long bond yields fell three bps to 2.75% (down 32bps).

Greek 10-year yields fell nine bps to 5.49% (down 153bps y-t-d). Ten-year Portuguese yields jumped 10 bps to 2.87% (down 88bps). Italian 10-year yields rose seven bps to 2.10% (up 29bps). Spain's 10-year yields increased five bps to 1.61% (up 23bps). German bund yields slipped three bps to 0.38% (up 18bps). French yields declined two bps to 0.70% (up 1bp). The French to German 10-year bond spread widened one to 32 bps. U.K. 10-year gilt yields fell four bps to 1.05% (down 18bps). U.K.'s FTSE equities index rose 1.1% (up 3.6%).

Japan's Nikkei 225 equities index was little changed (up 1.8% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.02% (down 2bps). France's CAC40 slipped 0.2% (up 5.0%). The German DAX equities index was unchanged (up 6.0%). Spain's IBEX 35 equities index declined 0.4% (up 10.6%). Italy's FTSE MIB index dipped 0.3% (up 13.1%). EM equities were higher. Brazil's Bovespa index surged 3.4% (up 18%), and Mexico's Bolsa added 0.6% (up 12.6%). South Korea's Kospi gained 0.9% (up 17.4%). India's Sensex equities index added 0.2% (up 18.7%). China's Shanghai Exchange jumped 1.9% (up 7.3%). Turkey's Borsa Istanbul National 100 index rose 2.4% (up 40.5%). Russia's MICEX equities index rose 2.5% (down 11.4%).

Junk bond mutual funds saw outflows of $1.01 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates slipped three bps to 3.86% (up 43bps y-o-y). Fifteen-year rates were unchanged at 3.16% (up 42bps). The five-year hybrid ARM rate added a basis point to 3.17% (up 42bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 4.03% (up 46bps).

Federal Reserve Credit last week declined $5.4bn to $4.426 TN. Over the past year, Fed Credit declined $13.0bn. Fed Credit inflated $1.614 TN, or 58%, over the past 250 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $9.0bn last week to $3.342 TN. "Custody holdings" were up $135bn y-o-y, or 4.2%.

M2 (narrow) "money" supply last week expanded $11.5bn to a record $13.629 TN. "Narrow money" expanded $691bn, or 5.3%, over the past year. For the week, Currency increased $2.4bn. Total Checkable Deposits jumped $62bn, while Savings Deposits fell $59.2bn. Small Time Deposits gained $3.7bn. Retail Money Funds added $2.7bn.

Total money market fund assets jumped $29.65bn to a 2017 high $2.736 TN. Money Funds added $1.1bn y-o-y.

Total Commercial Paper rose $9.0bn to $996.5bn. CP declined $7.4bn y-o-y, or 0.7%.

Currency Watch:

The U.S. dollar index declined 0.7% to 92.74 (down 9.4% y-t-d). For the week on the upside, the Norwegian krone increased 2.0%, the Swedish krona 1.9%, the euro 1.4%, the South Korean won 1.2%, the Canadian dollar 0.8%, the Swiss franc 0.8%, the Mexican peso 0.5%, the Singapore dollar 0.5% and the British pound 0.1%. On the downside, the New Zealand dollar declined 1.0%, the Brazilian real 0.4% and the Japanese yen 0.2%. The Chinese renminbi gained 0.36% versus the dollar this week (up 4.49% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index slipped 0.4% (down 4.9% y-t-d). Spot Gold added 0.6% to $1,291 (up 12.1%). Silver rose 0.8% to $17.132 (up 7.2%). Crude fell 64 cents to $47.87 (down 11.1%). Gasoline jumped 2.6% (unchanged), while Natural Gas was little changed (down 23%). Copper surged 3.2% (up 22%). Wheat dropped 1.6% (up 7%). Corn sank 3.3% (unchanged).

Trump Administration Watch:

August 25 - Financial Times (Demetri Sevastopulo, Shawn Donnan and Gillian Tett): "Donald Trump will launch a major push on tax reform next week with a speech in Missouri, as the president shifts focus to fiscal policy in an effort to secure a badly needed first big legislative victory by the end of the year. Gary Cohn, head of the White House national economic council, told the Financial Times that the speech... would be the first in a series of addresses designed to convince the US public about the need to revamp a tax system that has remained largely unchanged for three decades. 'Starting next week, the president's agenda and calendar is going to revolve around tax reform,' Mr Cohn said... 'He will start being on the road making major addresses justifying the reasoning for tax reform and why we need it in the US.'"

August 23 - Reuters (Steve Holland and Dave Graham): "President Donald Trump delivered an angry and forceful defense of his response to the violence in Charlottesville, Virginia, declaring at a campaign-style rally of supporters in Phoenix that the news media had distorted his position. Addressing thousands of supporters... at the Phoenix Convention Center, Trump accused major media organizations of being 'dishonest" and of failing 'to report that I spoke out forcefully against hatred, bigotry.' Trump spent more than 20 minutes of a 75-minute speech delivering a selective account of his handling of the violence in Charlottesville, where he overlooked his initial statement blaming 'many sides,' as well his subsequent remarks that there were good people marching alongside the white supremacists."

August 23 - Wall Street Journal (Kristina Peterson and Siobhan Hughes): "President Donald Trump's threat to shut down the government if Congress doesn't approve funding for a wall along the Mexico border raised alarm among some GOP lawmakers, injecting new volatility into an already uncertain political climate this fall. Lawmakers returning to Washington in early September have a dozen days with both the House and Senate in session before the government's current funding expires on Oct. 1. Lawmakers from both parties had expected Congress to pass a stopgap two- or three-month spending bill, but Mr. Trump's remarks raised fresh questions about the path forward. The GOP president said... that he was prepared to dig in over his request for $1.6 billion toward the border wall, one of his signature campaign promises."

August 23 - Reuters: "Credit ratings agency Fitch Ratings... said a failure by U.S. officials to raise the federal debt ceiling in a timely manner would prompt it to review the U.S. sovereign rating, 'with potentially negative implications.' Fitch, which currently assigns the United States its highest rating — 'AAA' — said in a statement that the prioritization of debt service payments over other government obligations, should the debt ceiling not be raised, 'may not be compatible with 'AAA' status.' Without the ability to sell more debt, the government is expected to run out of cash, possibly in early October, and faces the risk of not paying the interest and principal on its debt on time."

August 20 - Financial Times (Shawn Donnan): "The Trump administration has decided to push hard for tax reform and dial down a controversial national security investigation into steel imports in a bid to swing Republican support behind the president after the turmoil of recent weeks, according to senior officials. They said that former marine general John Kelly, the new chief of staff, was leading efforts to restore order to the White House and reassure Republican leaders alarmed by Donald Trump's equivocal reaction to white nationalist-fueled violence in Virginia last week and the subsequent open criticism from business leaders."

August 23 - Reuters (Steve Holland and Dave Graham): "U.S. President Donald Trump warned... he might terminate the NAFTA trade treaty with Mexico and Canada after three-way talks failed to bridge deep differences. The United States, Canada and Mexico wrapped up their first round of talks on Sunday to revamp the trade pact with little sign of a breakthrough coming. Trump reopened negotiations of the 1994 treaty out of concern U.S. economic interests were suffering. 'Personally, I don't think we can make a deal. I think we'll probably end up terminating NAFTA at some point,' Trump said... Suggesting a termination might help jumpstart the negotiations, Trump said: 'I personally don't think you can make a deal without a termination.'"

August 22 - Bloomberg (Sahil Kapur): "A growing number of key congressional Republicans are considering a controversial maneuver that would allow for about $450 billion of tax cuts without offsets, according to four congressional aides... Under the proposal, the GOP would not account for things like expiring tax breaks when gauging the budgetary impact of tax legislation -- giving tax writers more room for cuts. Senate budget and tax panels are discussing the move to a 'current policy' baseline -- instead of the standard 'current law' baseline... The chief House tax writer, Kevin Brady, also signaled openness to the approach last month, saying it would lead to deeper tax cuts. The switch would risk a backlash from Democrats and deficit hawks."

August 22 - CNBC (Christine Wang): "President Donald Trump and Senate Majority Leader Mitch McConnell haven't spoken to each other in weeks, The New York Times reported... The newspaper said that one phone call between the president and the Kentucky Republican devolved into a 'profane shouting match.' Relations between the two men have been conspicuously tense. Trump has repeatedly slammed McConnell on Twitter, blaming him for the failure of the GOP's attempts to repeal and replace the Affordable Care Act."

August 19 - Wall Street Journal (Michael C. Bender and Peter Nicholas): "President Donald Trump ousted chief strategist Steve Bannon on Friday, as newly minted Chief of Staff John Kelly sought to bring order to an administration riven by infighting and power struggles, and increasingly at odds with congressional leaders. Mr. Bannon's departure marked the fourth senior official in five weeks—and sixth in seven months—to leave the Trump administration... A former investment banker and media executive, Mr. Bannon was most closely aligned with the president's 'America First' agenda, which he described as economic nationalism."

China Bubble Watch:

August 23 - Bloomberg: "China keeps tightening the screws in its campaign to reduce the mountain of debt. The latest curbs landed late Wednesday, with the banking watchdog targeting wealth-management products that have more than tripled in the past four years amid low deposit rates and curbs on financing to overheated industries. Lenders will need to record all WMP sales starting Oct. 20, after some 'misled' consumers or sold them without regulators' permission. While the consensus is that China still has a long way to go when it comes to actual deleveraging, it seems to have at least reined in the credit-growth beast, with WMPs plateauing since the crackdown was intensified in April."

August 19 - Reuters (Ma Rong and John Ruwitch): "China will strengthen oversight of arbitrage that takes advantage of uncoordinated regulations and increase penalties to try to prevent structural risks from getting out of control, a senior central banker said. Yin Yong, deputy governor of the People's Bank of China, told a conference... six forms of arbitrage were problematic. He said they involved differing maturities, credit conditions, investment liquidity, exchange rates, capital and information. 'These six forms of malicious regulatory arbitrage, which circumvent the regulatory system and its arrangements, and take advantage of the incompleteness of regulation, could result in risks to the entire financial system getting out of control,' he said. Chinese financial regulators have adopted a slew of 'de-risking' measures this year in the face of ballooning debt and have ramped up efforts to unearth hidden problems that could become systemic threats."

August 23 - Reuters (Yawen Chen and Elias Glenn): "China will use all necessary means to defend the interests of the country and its companies against a U.S. trade investigation, a spokesman for the Ministry of Commerce said... The ministry... expressed 'strong dissatisfaction' with the U.S. launch of the probe into China's alleged theft of U.S. intellectual property, calling it 'irresponsible'. The probe is the Trump administration's first direct measure against Chinese trade practices, which the White House and U.S. business groups say are bruising American industry."

August 22 - Wall Street Journal (Yifan Xie and Biman Mukherji): "China metal prices tumbled Wednesday as sentiment was battered by fresh warnings that the recent steel rally was unsustainable, the latest move by regulators to tame volatility in the futures market. The main steel-rebar futures contract in Shanghai snapped a four-day rally to trade down 4.9% by midday Wednesday at 3,744 yuan ($562) a metric ton..., while hot-rolled coil futures tumbled 5.3% to 3,828 yuan a ton. On the Dalian Commodity Exchange, iron-ore futures fell 4.5% to 574.5 yuan a ton, after soaring more than 20% over the past four sessions."

Central Bank Watch:

August 22 - BBC: "European Central Bank President Mario Draghi has said unconventional policies like quantitative easing (QE) have been a success both sides of the Atlantic. QE was introduced as an emergency measure during the financial crisis to pump money directly into the financial system and keep banks lending. A decade later, the stimulus policies are still in place, but he said they have 'made the world more resilient'... Central bankers, including Mr Draghi, are meeting in Jackson Hole, Wyoming, later this week, where they are expected to discuss how to wind back QE without hurting the economy. On Monday, a former UK Treasury official likened the stimulus to 'heroin' because it has been so difficult to wean the UK, US and eurozone economies off it."

Global Bubble Watch:

August 22 - Financial Times (Laurence Mutkin): "Since the financial crisis erupted in 2008, a significant source of demand in the world's largest bond markets has been central banks. The quantitative easing policies that institutions, including the US Federal Reserve, European Central Bank and Bank of Japan, have adopted to resist deflationary pressures unleashed by the crisis have consisted mostly of buying government bonds. A decade on, the threat of deflation has faded (at least for now) and so the pace of bond buying by central banks, which has already moderated, is set to fall sharply next year if the ECB and the Fed announce the changes to their QE policies in coming months. Given the very low levels of yields, this poses a significant threat to the pricing of bonds — and possibly of other financial assets too. The ECB and the BoJ are continuing their QE programmes, printing money to buy more bonds every month, and the Fed and the Bank of England — although no longer increasing their balance sheets — are still reinvesting the proceeds of maturing bonds previously bought under their programmes."

August 21 - Bloomberg (Jean-Michel Paul): "Quantitative easing, which saw major central banks buying government bonds outright and quadrupling their balance sheets since 2008 to $15 trillion, has boosted asset prices across the board. That was the aim: to counter a severe economic downturn and to save a financial system close to the brink. Little thought, however, was put into the longer-term consequences of these actions. From 2008 to 2015, the nominal value of the global stock of investable assets has increased by about 40%, to over $500 trillion from over $350 trillion. Yet the real assets behind these numbers changed little, reflecting, in effect, the asset-inflationary nature of quantitative easing. The effects of asset inflation are as profound as those of the better-known consumer inflation."

August 20 - Financial Times (John Authers and Claire Manibog): "The Great Financial Crisis did not turn into a second Great Depression, merely a Great Recession. Asset prices quickly recovered. But did the desperate measures taken then create new bubbles? Quantitative easing... left investors with cash that they had little choice but to put into risky assets. Critics complained that this was 'printing money,' and would lead to currency debasement. The havens were traditional stores of value that took on the acronym SWAG: silver, wine, art and gold. By 2012, SWAG assets had formed a bubble. But it deflated as inflation fears receded and confidence in governments returned. Bricks and mortar offered another haven — particularly for those nervous that their countries might not always tolerate their wealth."

August 22 - Bloomberg (Sid Verma and Cecile Gutscher): "HSBC Holdings Plc, Citigroup Inc. and Morgan Stanley see mounting evidence that global markets are in the last stage of their rallies before a downturn in the business cycle. Analysts at the Wall Street behemoths cite signals including the breakdown of long-standing relationships between stocks, bonds and commodities as well as investors ignoring valuation fundamentals and data. It all means stock and credit markets are at risk of a painful drop. 'Equities have become less correlated with FX, FX has become less correlated with rates, and everything has become less sensitive to oil,' Andrew Sheets, Morgan Stanley's chief cross-asset strategist, wrote... His bank's model shows assets across the world are the least correlated in almost a decade..."

August 24 - Bloomberg (Robert Brand and Cormac Mullen): "Political instability, money problems and economic growth still top the list of threats to global markets. It's just that the main players have swapped roles, according to Eurasia Group. 'For much of the post-crisis period, U.S. money, Chinese growth, and European politics have mattered most' to investors, ...director of global strategy at Eurasia, Karthik Sankaran, wrote... 'But developments over the past year suggest that markets should be paying attention to U.S. politics, European growth, and Chinese money.'"

Federal Reserve Watch:

August 24 - Bloomberg (Jeanna Smialek and Alessandro Speciale): "Federal Reserve Bank of Kansas City President Esther George said if U.S. economic data hold up, there will probably be an opportunity to raise interest rates again in 2017. 'I'll be looking at the data in the next few weeks as we get ready for the September meeting, and see whether that still makes sense,' George said... 'Based on what I see today, I think there's still opportunity to do that,' she told Bloomberg Television's Mike McKee..."

U.S. Bubble Watch:

August 23 - Bloomberg (Suzanne Woolley): "In a perfect world, the largest expenses in retirement would be for fun things like travel and entertainment. In the real world, retiree health-care costs can take an unconscionably big bite out of savings. A 65-year-old couple retiring this year will need $275,000 to cover health-care costs throughout retirement, Fidelity Investments said in its annual cost estimate... That stunning number is about 6% higher than it was last year... You might think that number looks high. At 65, you're eligible for Medicare, after all. But monthly Medicare premiums for Part B (which covers doctor's visits, surgeries, and more) and Part D (drug coverage) make up 35% of Fidelity's estimate. The other 65% is the cost-sharing, in and out of Medicare, in co-payments and deductibles, as well as out-of-pocket payments for prescription drugs."

August 22 - Reuters (Herbert Lash): "The sale price of high-end condominiums in Manhattan's most expensive neighborhood averaged $14.1 million in the 12 months through June, with one unit going for $65.7 million... The unit, at 432 Park Avenue, billed as the tallest residential tower in the Americas, was one of three at the Midtown East building that were in the top-five most expensive condominium sales in Manhattan, an analysis by CityRealty said. The analysis examined sale prices and what was paid per square foot in an index the realty company has created to gauge investment performance for what it considers the top 100 condominium buildings in Manhattan. The average price per square foot rose 9% to $2,788 in the 12-month period ended June 30..."

Europe Watch:

August 23 - Reuters (Shrutee Sarkar): "Euro zone business growth maintained a solid clip in August, driven by the best manufacturing performance in 6-1/2 years despite a strong euro, easily offsetting a mild slowdown in services growth... Taken together with a mild pickup in price pressures, the data is likely to support expectations that the European Central Bank will proceed later this year with making plans to scale back its multi-billion euro monthly asset purchases."

August 20 - Financial Times (Kate Allen and Claire Jones): "The European Central Bank may have little choice but to wind down its €2tn bond-buying programme next year — whether eurozone inflation picks up, or not. An improving eurozone economy already led the ECB to scale back its purchases by €20bn a month to €60bn in April, sharpening expectations that policymakers will set out a timeline for further tapering in the next couple of months... While traders will try to glean any indication of the ECB's intentions, Mr Draghi faces a dilemma of his own: the central bank is running out of bonds to buy. Its own rules restrict it to only purchasing a third of each country's debt in circulation, and the supply of German Bunds and Portuguese debt in particular is starting to run thin. 'The 33% issuer limit in Bunds presets a course of [purchase programme] exit, no matter the inflation outlook,' says Harvinder Sian, a Citigroup analyst."

August 21 - Financial Times (Izabella Kaminska): "Talk of a domestic parallel currency being introduced in Italy is not new. But it has been reinvigorated this week because of an interview with Silvio Berlusconi (a longstanding proponent of the idea) in Italian publication Libero Quotidiano, where he argues the introduction of a national parallel currency will help Italy regain monetary sovereignty in a way that later supports domestic demand."

Japan Watch:

August 20 - Reuters (Tetsushi Kajimoto and Izumi Kakagawa): "Confidence at Japanese manufacturers rose in August to its highest level in a decade led by producers of industrial materials, a Reuters poll showed, in a further sign of broadening economic recovery."

EM Bubble Watch:

August 20 - Bloomberg Businessweek (Anurag Joshi and Anto Antony): "Defaults on bonds and syndicated loans of Indian companies are at a record of almost $2 billion so far this year, compared with $494 million for all of 2016... State Bank of India, the nation's largest lender by assets, surprised investors this month when it reported bad loans had risen to 10% after the acquisition of smaller lenders. The government's injection of funds in August into a state-owned bank at risk of missing a coupon payment is beneficial for bondholders but creates a moral hazard by taking pressure of lenders to manage their capital pro-actively, according to Fitch..."

Leveraged Speculation Watch:

August 23 - Financial Times (Joe Rennison): "Hedge funds are embracing an esoteric credit product widely blamed for exacerbating the financial crisis a decade ago, as low volatility and near record prices for corporate debt tempt them into riskier areas to seek higher returns. The market for 'bespoke tranches' — bundles of credit default swaps that are tied to the risk of corporate defaults — has more than doubled in the first seven months of 2017. Traders in this opaque, over-the-counter market estimate there has been issuance of $20bn to $30bn this year, compared to $15bn in the whole of 2016 and $10bn in 2015... The surge in activity reflects the effort by investors to generate a higher rate of return during a period of historically low volatility in credit markets, compounded by low fixed rate yields."

Geopolitical Watch:

August 22 - Reuters (Christine Kim): "North Korean leader Kim Jong Un has ordered more solid-fuel rocket engines..., as he pursues nuclear and missile programs amid a standoff with Washington, but there were signs of tension easing. The report carried by the KCNA news agency lacked the traditionally robust threats against the United States after weeks of unbridled acrimony, and U.S. President Donald Trump expressed optimism about a possible improvement in relations. 'I respect the fact that he is starting to respect us,' Trump said of Kim at a raucous campaign rally in Phoenix, Arizona. 'And maybe - probably not, but maybe - something positive can come about,' he said."

August 22 - Reuters (David Brunnstrom and Doina Chiacu): "The United States... imposed new North Korea-related sanctions, targeting Chinese and Russian firms and individuals for supporting Pyongyang's weapons programs, but stopped short of an anticipated focus on Chinese banks. The U.S. Treasury designated six Chinese-owned entities, one Russian, one North Korean and two based in Singapore. They included a Namibia-based subsidiary of a Chinese company and a North Korean entity operating in Namibia. The sanctions also targeted six individuals - four Russians, one Chinese and one North Korean."

August 21 - Reuters (Ben Blanchard and Doug Busvine): "China laid the blame at India's door... for an altercation along their border in the western Himalayas involving soldiers from both of the Asian giants. Both countries' troops have been embroiled in an eight-week-long standoff on the Doklam plateau in another part of the remote Himalayan region near their disputed frontier. Last week, a source in New Delhi, who had been briefed on the military situation on the border, said soldiers foiled a bid by a group of Chinese troops to enter Indian territory in Ladakh, near Pangong lake."

August 23 - Reuters (Andrew Osborn): "Russian nuclear-capable strategic bombers have flown a rare mission around the Korean Peninsula at the same time as the United States and South Korea conduct joint military exercises that have infuriated Pyongyang. Russia, which has said it is strongly against any unilateral U.S. military action on the peninsula, said Tupolev-95MS bombers, code named 'Bears' by NATO, had flown over the Pacific Ocean, the Sea of Japan, the Yellow Sea and the East China Sea, prompting Japan and Seoul to scramble jets to escort them."

August 22 - Reuters (Yeganeh Torbati): "The United States suggested... it could cut U.S. aid to Pakistan or downgrade Islamabad's status as a major non-NATO ally to pressure the South Asian nation to do more to help it with the war in Afghanistan. A day after President Donald Trump committed to an open-ended conflict in Afghanistan and singled out Pakistan for harboring Afghan Taliban insurgents and other militants, U.S. Secretary of State Rex Tillerson said Washington's relationship with Pakistan would depend on its help against terrorism... U.S. officials are frustrated by what they see as Pakistan's reluctance to act against groups such as the Afghan Taliban and the Haqqani network that they believe exploit safe haven on Pakistani soil to launch attacks on neighboring Afghanistan."

 

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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