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Weak Links and Transmission Mechanisms

Global markets are turning more unsettled, and I suspect it has more to do with EM and the hedge funds than it does Syria.

It was another week of acutely unsettled emerging markets (EM). India's rupee (down 3.6% for the week) and Turkey's lira (down 2.5%) traded to record lows on Wednesday. Indonesia's rupiah traded to the lowest level since April 2009 (down 1.1%). The Mexican peso fell 3.2% and Brazilian real declined 1.5%, while many Eastern European currencies played downside catch-up. The Polish zloty declined 2.2%, the Hungarian forint 2.2%, the Czech koruna 1.5% and the Romanian leu 1.3%.

Especially early in the week, EM equities and bond markets were suffering the apparent effects of increasingly destabilizing outflows. Market tumult provoked a flurry of policy measures. Brazil raised rates. Indonesia boosted rates and extended a currency swap arrangement with the Bank of Japan (BOJ). India's central bank implemented a currency swap arrangement with the country's major energy companies, in a plan that would provide dollar liquidity to finance the rapidly escalating cost of energy imports. Policy effects seemed fleeting at best.

An unstable market backdrop compounded by desperate policy measures definitely made for some wild currency market volatility, notably for the Indian rupee and Indonesian rupiah. Meanwhile, the week provided added confirmation that the emerging market complex has commenced the self-reinforcing downside of an historic Credit cycle. Sinking currencies coupled with surging crude prices ensures that already rising inflationary pressures will intensify. This is especially an issue for India, Indonesia, Brazil, Turkey and Russia. And rising inflation and resulting bond market losses will only work to exacerbate "hot money" and investment outflows.

Weak markets, robust "hot money" outflows, rising inflation and higher policy rates all point to a consequential tightening of EM financial conditions. I have posited that major "Bubble" economies and financial systems are acutely vulnerable to any tightening of financial conditions. And while the marketplace is coming to better appreciate EM fragilities, the consensus view remains that the situation is quite manageable. Few expect EM to have much impact on U.S. markets or the American economic recovery.

EM instability has increased the relative appeal of U.S. securities markets, especially from the perspective of the hedge fund community and the greater "global pool of speculative finance" more generally. U.S. equities have benefitted from the rotation away from both EM and Treasuries. There is certainly no doubt that highly speculative, over-liquefied markets will chase outperforming asset classes. And a resilient equities market has both captured the imagination and worked to embolden the bullish mindset.

I would tend to view the popular consensus view as superficial and complacent. While U.S. stocks have been "resilient," I would warn against disregarding prospects for a tightening of financial conditions. From the vantage point of my analytical framework, I have seen sufficient confirmation of the bursting EM Bubble thesis. It's now time to begin thinking forward to potential consequences. What are potential Transmission Mechanisms that could link the unfolding EM crisis to U.S. markets and our economy? Where are possible Weak Links?

Generally, I view the global economy and financial "system" as anything but robust. Global economic maladjustment and imbalances are unprecedented. A multi-decade Credit boom - culminated by post-'08 crisis "terminal phase" excess in China and EM - has left a legacy of acute fragility. Europe remains susceptible. Analysts have been slow to recognize the direct impact the EM crisis will have upon global growth and corporate profits.

Unprecedented fiscal and monetary stimulus - years of ultra-loose "money" - have stoked renewed U.S. asset price inflation/Bubbles. Still, the structurally-challenged real economy refuses to gather a head of steam. Inflated global securities markets have become addicted to government guarantees and liquidity backstops, not to mention the Fed and BOJ's $160bn monthly QE/"money printing." From the "global government finance Bubble" perspective, there have been a multitude of excesses with associated fragilities to less accommodative market environments. I see systemic fragilities.

There would appear to be myriad Weak Links. I would argue that the global economy has never been as dependent upon the financial markets - although distorted markets have become hopelessly speculative and unstable. Fragile economic and financial systems have never been as vulnerable to a meaningful tightening of financial conditions. The bullish retort would be that central bankers remain on the case and have things well under control. That said, I believe the global leveraged speculating community is today a primary Weak Link and potential Transmission Mechanism for contagious EM disorder to afflict the developed world, including the U.S.

The hedge fund community has struggled for performance in recent years. Globally, there is way too much speculative finance chasing way too few attractive opportunities. So it's degenerated into a rather barbarous high-stakes speculative enterprise. Years of global imbalances coupled with Trillions of QE and central bank purchases have been instrumental in the ballooning pool of speculative finance and the dysfunctional "crowded trade" market phenomenon. The collapse of interest rates has been instrumental in driving "money" to the hedge funds, especially from the pension fund complex requiring 8-9% annual returns. So, despite weak performance, the hedge fund industry has continued to enjoy inflows and record assets.

This year commenced with great hope that the hedge fund industry would finally turn the corner and put up some big numbers. Massive QE seemed to guarantee inflating global risk asset markets. The Draghi Plan appeared to ensure Europe would finally emerge from crisis. And surging stocks and home prices were seen finally pushing the U.S. economic recovery to launch speed. Global markets got off to a strong start - but it wasn't too long before the global market instability wrecking ball started chipping away at hedge fund performance.

Gold and commodities weakness hurt performance, especially in the second quarter, as many funds were caught on the wrong side of a faltering "global reflation trade." EM currencies and equities also became minefields. Then (in spite of massive QE) global bond yields began to shoot higher, catching even the most adroit market operators flatfooted. June was a particularly painful month, as EM and bond selling fueled huge outflows from international and fixed-income funds. Latent liquidity issues surfaced in various ETF products, which induced a surprising tightening of market conditions in U.S. mortgage and municipal finance. At the same time, resilient U.S. equities ensured the performance-chasing speculators crowded further into our stock market.

A curious, perhaps quite important, dynamic developed. As the hedge funds and others increased exposure to outperforming U.S. stocks, the resulting resilience in our stock market bolstered the bullish view of the resiliency of the U.S. economy more generally. I would argue, however, that this dynamic makes certain that market participants will overlook significant mounting risks of a tightening of finance both globally and, believe it or not, even here in the U.S.

The overwhelming consensus view holds that the Fed (along with global central banks) controls financial conditions. Global markets have been keenly sensitive to taper talk, although most believe the Fed will continue to ensure ample liquidity - that the Fed, as Bernanke stated, would "push back" against a tightening of market liquidity.

And while central banks clearly play an instrumental role, I view the leveraged speculating community as customarily the marginal player in determining financial conditions. When risk is being embraced and leveraged positions are being expanded, this is constructive for marketplace liquidity and a loosening of financial conditions more broadly. When, instead, risk aversion and de-leveraging are in play, market liquidity suffers and financial conditions tighten. This dynamic has only been somewhat mitigated by ongoing huge QE.

The markets' fixation with tapering has distracted attention away from potentially far-reaching market developments. Has a multi-decade bond Bubble about run its course? Are global central banks finally losing control of market yields? After unprecedented inflows, does the abrupt reversal of flows away from EM (and resulting selling of international reserves by EM central banks) mark a major inflection point for Treasuries and global bonds more generally?

I think I can make a decent case that over recent years the U.S. (and global) bond market succumbed to "terminal phase" excess. Fed policies ensure Trillions of Treasury, municipals, MBS and corporate debt were issued at artificially low yields (inflated prices). This great mispricing is now coming back to trouble the system. Investors are being hit with losses and a self-reinforcing re-pricing dynamic is seeing flows begin to exit the sector. This reversal of flows coupled with EM central bank selling has significantly altered the risk profile of maintaining leveraged speculative positions in long-term fixed income instruments.

Fed QE notwithstanding, I believe the market backdrop today implies an important tightening of financial conditions going forward. Policy measures - including boosting QE - do have the potential to delay this tightening, although with the cost of only exacerbating the wide gulf that has developed between inflated global securities prices and deteriorating economic prospects.

If financial conditions are indeed tightening globally, I would expect the typical "periphery to core" dynamic to begin to jump from EM to the more fragile peripheral developed markets. Europe and the euro initially benefited from the flight out of EM, although this week's market performance was noteworthy. The euro dropped 1.2% (1.75% vs. the yen), its worst performance in weeks. Germany's DAX index was hit for 3.7%, France fell 3.3%, Spain sank 4.6% and Italian stocks dropped 3.8%. Perhaps indicating hedge fund de-risking/de-leveraging, European sovereign bond yield spreads (to bunds) widened this week. German bunds widened 8 bps verses French yields to a one-month high 61 bps. Bund to Italian and Spanish bond spreads widened a notable 15 and 16 bps. And at the troubled Eurozone periphery, Portugal saw its 10-yr yields jump 16 bps to 6.59% and Greece yields rose 24 bps to 10.02%. I suspect Draghi's dramatic year ago move to backstop European bonds enticed the leveraged speculators back into higher-yielding Eurozone bonds.

Here at home, stocks were under some pressure while Treasuries generally held their own. Risk spreads widened somewhat. Interestingly, the VIX index jumped to the highest level since late-June. Benchmark MBS spreads were little changed. It is worth noting that, at 4.51%, benchmark 30-year borrowing rates have jumped 116 bps points from May lows. The mortgage Bankers Association weekly refi application index this week dropped to the lowest level since February (and near the weakest level since 2009). Higher borrowing costs will now throw some cold water on real estate markets. And there will be further economic ramifications for the end to a several year period of homeowners improving their monthly cashflows by refinancing into low-cost mortgages.

Corporate debt issuance has slowed markedly, although issuance is expected to pick up in September. This week saw investment-grade and junk spreads widen 5 bps and 14 bps. Similar to equities, high-yield corporate debt has benefited at the expense of EM and Treasuries. I would expect junk bonds and leveraged finance more generally to be susceptible to equity market weakness and de-risking more generally.

According to Friday's Bond Buyer, "The plunge in long-term municipal bond volume for 2013 continued as issuers in August floated 37.7% less than they did over the same period in 2012... municipalities issued $20.9bn last month in 746 deals, against $33.5bn in 1,066 issues in August 2012." An index of long-term bond yields ended the week at 4.07%, up about 150 bps from early May to the highest level since May 2011.

I am increasingly focused on municipal debt market developments. Muni funds suffered another week of significant redemptions (14 straight weeks of outflows). Fed policies helped spur enormous inflows into municipal finance. I suspect, as well, that high-yielding tax-exempt muni bonds provided a too enticing venue for hedge fund, "structured products" and other derivative-related leveraging. It's also a big market where most underlying issues trade with little liquidity. And unlike Treasuries and MBS, muni debt doesn't enjoy the benefits of the Fed's QE backstop. So it has all the characteristics of a marketplace susceptible to risk aversion and a deteriorating general fixed income liquidity backdrop.

Benchmark Puerto Rico bond yields jumped 8 bps this week to 6.24%, having increased 60 bps in three weeks. Andrew Bary's "Troubling Winds" analysis of "Puerto Rico's huge debt load" was the cover story for last week's Barron's magazine. Reading Bary's informative piece, I immediately recalled the Greek debt fiasco. Over-liquefied and complacent markets were content to continue lending to Greece, despite increasingly obvious issues. In November 2009, Greece could tap the markets for two-year paper at just over 2% - and the marketplace could presume a Eurozone backstop and ignore fundamentals. Six months later, with market yields at 16%, Greece was hopelessly insolvent.

I don't know enough to compare Puerto Rican fundamentals to those of Greece. But from a marketplace standpoint, I would expect Puerto Rico to play a similar role as the marginal borrower, first to lose access to cheap finance in a faltering Bubble environment. With muni yields shooting higher, with an abrupt reversal of finance out of the municipal debt complex, and with Detroit and other municipalities in trouble, the tightening of muni finance could evolve into an important Transmission Mechanism of the unfolding global crisis to the U.S. economy.


For the Week:

The S&P500 fell 1.8% (up 14.5% y-t-d), and the Dow declined 1.3% (up 13.0%). The Morgan Stanley Consumer index dropped 2.0% (up 18.5%), and the Utilities declined 1.1% (up 4.7%). The Banks were hit for 4.2% (up 21.3%), and the Broker/Dealers fell 2.7% (up 38.9%). The Morgan Stanley Cyclicals were down 2.1% (up 17.5%), and the Transports sank 3.6% (up 17.8%). The S&P 400 MidCaps dropped 2.8% (up 16.0%), and the small cap Russell 2000 fell 2.6% (up 19.0%). The Nasdaq100 declined 1.6% (up 15.5%), and the Morgan Stanley High Tech index lost 1.8% (up 12.6%). The Semiconductors declined 1.3% (up 19.2%). The InteractiveWeek Internet index fell 2.4% (up 20.0%). The Biotechs slipped 0.9% (up 33.0%). Although bullion was down only $3, the HUI gold index was hit for 6.9% (down 42.9%).

One-month Treasury bill rates ended the week at two bps and three-month bill rates closed at two bps. Two-year government yields rose two bps to 0.40%. Five-year T-note yields ended the week up two bps to 1.64%. Ten-year yields slipped 3 bps to 2.79%. Long bond yields fell 9 bps to 3.70%. Benchmark Fannie MBS yields declined 3 bps to 3.57%. The spread between benchmark MBS and 10-year Treasury yields was little changed at 78 bps. The implied yield on December 2014 eurodollar futures declined 1.5 bps to 0.695%. The two-year dollar swap spread declined 2 to 16 bps, while the 10-year swap spread was little changed at 20 bps. Corporate bond spreads widened. An index of investment grade bond risk rose 5 to 84 bps. An index of junk bond risk jumped 14 to 406 bps. An index of emerging market (EM) debt risk gained 12 to 358 bps.

Debt issuance slowed to a crawl. Investment grade issuers included Overseas Private Investment Corp $250 million.

I saw no junk issues this week.

Convertible debt issuers included Qihoo 360 $550 million.

International dollar debt issuers included International Finance Corp $3.5bn, European Investment Bank $3.0bn, Export-Import Bank of Korea $1.0bn and Kommuninvest $600 million.

Ten-year Portuguese yields jumped 16 bps to 6.59% (down 16bps y-t-d). Italian 10-yr yields rose 7 bps to 4.40% (down 11bps). Spain's 10-year yields gained 8 bps to 4.52% (down 75bps). Pressuring eurozone bond spreads, German bund yields fell 8 bps to 1.86% (up 6bps). French yields were little changed at 2.47% (up 47bps). The French to German 10-year bond spread widened 8 to 61 bps. Greek 10-year note yields jumped 24 bps to 10.02% (down 45bps). U.K. 10-year gilt yields increased 6 bps to 2.77% (up 95bps).

Japan's Nikkei equities index ended the week down 1.99% (up 28.8% y-t-d). Japanese 10-year "JGB" yields dropped 5 bps to 0.71% (down 7bps). The German DAX equities index sank 3.7% for the week (up 6.5%). Spain's IBEX 35 equities index was hit for 4.6% (up 1.5%). Italy's FTSE MIB dropped 3.8% (up 2.5%). Emerging markets were wildly mixed. Brazil's Bovespa index sank 4.2% (down 18.0%), and Mexico's Bolsa fell 3.5% (down 9.6%). South Korea's Kospi index rallied 3.0% (down 3.5%). India's Sensex equities index gained 0.5% (down 4.2%). China's Shanghai Exchange jumped 2.0% (down 7.5%).

Freddie Mac 30-year fixed mortgage rates declined 7 bps to 4.51% (up 92bps y-o-y). Fifteen-year fixed rates fell 6 bps to 3.54% (up 68bps). One-year ARM rates were down 3 bps to 2.64% (up one bp). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates 6 bps lower at 4.69% (up 46bps).

Federal Reserve Credit jumped $12.0bn to a record $3.602 TN. Over the past year, Fed Credit was up $798bn, or 29%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $635bn y-o-y, or 6.0%, to a record $11.168 TN. Over two years, reserves were $1.015 TN higher, for 10% growth.

M2 (narrow) "money" supply dropped $18.3bn to $10.742 TN. "Narrow money" expanded 7.1% ($714bn) over the past year. For the week, Currency increased $1.4bn. Total Checkable deposits slipped $2.7bn, and Savings Deposits dropped $13.0bn. Small Time Deposits declined $1.8bn. Retail Money Funds fell $2.2bn.

Money market fund assets gained $6.5bn to $2.644 TN. Money Fund assets were up $73bn from a year ago, or 2.8%.

Total Commercial Paper outstanding was little changed at $1.020 TN. CP has declined $46bn y-t-d and $12bn, or 1.1%, over the past year.

Currency and 'Currency War' Watch:

The U.S. dollar index gained 0.9% to 82.087 (up 2.9% y-t-d). For the week on the upside, the South Korean won increased 0.6%, the Japanese yen 0.6%, the Singapore dollar 0.3% and the Taiwanese dollar 0.2%. For the week on the downside, the Mexican peso declined 3.2%, the Swedish krona 2.1%, the Norwegian krone 1.6%, the Brazilian real 1.5%, the Australian dollar 1.4%, the Danish krone 1.2%, the euro 1.2%, the New Zealand dollar 1.0%, the Swiss franc 0.8%, the British pound 0.4%, the Canadian dollar 0.4% and the South African rand 0.4%.

Commodities Watch:

The CRB index added 0.1% this week (down 1.3% y-t-d). The Goldman Sachs Commodities Index rose 1.2% (up 1.6%). Spot Gold slipped 0.2% to $1,395 (down 16.7%). Silver declined 1.1% to $23.51 (down 22%). October Crude gained $1.23 to $107.65 (up 17%). October Gasoline added 0.7% (up 5%), and October Natural Gas jumped 1.7% (up 7%). December Copper sank 3.7% (down 12%). September Wheat gained 1.4% (down 17%), while September Corn slipped 0.1% (down 29%).

U.S. Fixed Income Bubble Watch:

August 30 - Bloomberg (Michelle Kaske): "Municipal debt from Puerto Rico is poised for its worst year since at least 2000 as demand for state and local securities wanes with yields at two-year highs. Bonds of Puerto Rico and its localities have lost 14.9% this year through Aug. 28, about three times more than the rest of the $3.7 trillion municipal market, according to Standard & Poor's data. The commonwealth's borrowings haven't had an annual loss this steep since at least 2000. Investors demand 2.76 percentage points of additional yield to buy 30-year Puerto Rico general-obligation bonds rather than top-rated munis, the most since January... The island's general-obligation debt is rated one level above junk amid recurring budget deficits and a pension system that has a lower funding level than any U.S. state."

August 26 - Bloomberg (Charles Mead and Sridhar Natarajan): "It took three decades for the amount of speculative-grade debt to reach $1 trillion. It took about seven years to reach $2 trillion as investors sought relief from the financial repression brought on by near-zero interest rates. The market for dollar-denominated junk-rated debt has expanded more than eightfold since the end of 1997 from $243 billion, according to Morgan Stanley. That compares with a quadrupling of the investment-grade market to $4.2 trillion... While Federal Reserve policies have pushed investors toward riskier investments to generate high yields, allowing even the neediest companies that might otherwise default to access capital markets, concern is rising that missed payments may soar when benchmark rates begin to increase."

August 28 - Bloomberg (Charles Stein): "U.S. bond mutual funds last week suffered their biggest redemptions since June as yields reached a two-year high amid speculation that the Federal Reserve will begin cutting back asset purchases. Bond funds had withdrawals of $11.1 billion in the week ended Aug. 21... It was the largest move out of bond funds since the week ended June 26, when $28.2 billion was withdrawn."

August 30 - Bloomberg (Jody Shenn): "U.S. government-backed mortgage bonds are heading toward their longest monthly slump since 1999 as concern mounts that the Federal Reserve will begin paring its debt purchases even as the steepest rise in home-loan rates in at least 40 years slows the housing rebound. Securities guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae lost 0.53% through Aug. 28, heading for their fourth month of declines and bringing losses since April to 2.97%... For almost a year, the Fed has been adding $40 billion of bonds to its balance sheet each month from the more than $5 trillion market. It expanded the purchases in January to include $45 billion of Treasuries."

U.S. Bubble Economy Watch:

August 26 - Bloomberg (Michelle Jamrisko and Ilan Kolet): "The cost of higher education has surged more than 500% since 1985, illustrating why there have been renewed calls for change from both political parties. ...Tuition expenses have increased 538% in the 28-year period, compared with a 286% jump in medical costs and a 121% gain in the consumer price index. The ballooning charges have generated swelling demand for educational loans while threatening to make college unaffordable for domestic and international students. The 'skyrocketing' increases exacerbate income inequality by depriving those of less means of the schooling they need to advance and may also derail the 'prestige and status' of U.S. higher education, said Michelle Cooper, president of the... Institute for Higher Education Policy."

August 30 - Bloomberg (Prashant Gopal and Heather Perlberg): "Amy and Ted Wilder lost out in the bidding for several Seattle-area homes during the past six months, even with offers well above the asking price. After May's sudden spike in mortgage rates, the Microsoft Corp. consultants put their search on hold. 'We fell in love with a house for about $400,000 and thought we could afford it, and then we discovered it was $300 more a month than what we would have paid in February when we started looking,' Amy Wilder, 42, said. 'The mortgage rates just pushed it too far.' A surge in borrowing costs to a two-year high is starting to cool demand from homebuyers as higher rates combine with surging prices to reduce affordability... The biggest pinch is being felt in expensive markets such as Seattle and New York, where budgets already were stretched, leading to a more uneven national recovery."

August 28 - Bloomberg (Charles Mead): "Company debt loads in the U.S. are approaching the highest level since the aftermath of the financial crisis as borrowing to finance mergers and shareholder payouts exceeds earnings growth. Debt levels have increased faster than cash flow for six straight quarters, boosting the obligations of investment-grade companies in the second quarter to 2.09 times earnings before interest, taxes, depreciation and amortization, according to JPMorgan... That's up from 2.07 times in the first three months of 2013 and compares with 2.13 in the third quarter of 2009, when it peaked after the deepest recession since the Great Depression."

August 28 - Bloomberg (Donal Griffin and Dakin Campbell): "The six biggest U.S. banks, led by JPMorgan Chase & Co. and Bank of America Corp., have piled up $103 billion in legal costs since the financial crisis, more than all dividends paid to shareholders in the past five years. That's the amount allotted to lawyers and litigation, as well as for settling claims about shoddy mortgages and foreclosures, according to data compiled by Bloomberg. The sum tops the banks' combined profit last year. The mounting bills have vexed bankers who are counting on expense cuts to make up for slow revenue growth and make room for higher payouts. About 40% of the legal and litigation outlays arose since January 2012, and banks are warning the tally may surge as regulators, prosecutors and investors press new claims."

August 26 - Bloomberg (Inyoung Hwang and Alexis Xydias): "Price gains of stocks in the Standard & Poor's 500 Index are outpacing profits by the fastest rate in 14 years as the bull market extends beyond the average length of rallies since Harry S. Truman was president. The benchmark gauge for U.S. equities has risen 14% relative to income over the past 12 months to 16 times earnings... Valuations last climbed this fast in the final year of the 1990s technology bubble, just before the index began a 49% tumble. The rally that started in March 2009 has now outlasted the average gain since 1946, the data show."

August 26 - Bloomberg (Michael B. Marois): "California, which relies on private deals with banks for almost 80% of its bond offerings, plans its biggest competitive debt sale in six years as the state's relative borrowing costs sink to the lowest level since 2008. Governor Jerry Brown, 75, forecasts an $817 million surplus this year, the first in almost a decade, after the world's ninth-biggest economy ran up more than $100 billion of deficits since 2007."

Federal Reserve Watch:

August 26 - Bloomberg (Simon Kennedy, Joshua Zumbrun and Jeff Kearns): "Federal Reserve officials rebuffed international calls to take the threat of fallout in emerging markets into account when tapering U.S. monetary stimulus. The risk that the Fed's trimming of bond buying will hurt economies from India to Turkey by sparking an exodus of cash and higher borrowing costs was a dominant theme at the annual meeting of central bankers and economists in Jackson Hole, Wyoming... Such selloffs aren't an issue for Fed officials who said their sole focus is the U.S. economy as they consider when to start reining in $85 billion of monthly asset purchases that have swelled the central bank's balance sheet to $3.65 trillion... 'You have to remember that we are a legal creature of Congress and that we only have a mandate to concern ourselves with the interest of the United States,' Dennis Lockhart, president of the Atlanta Fed, told Bloomberg... 'Other countries simply have to take that as a reality and adjust to us if that's something important for their economies.'"

Global Bubble Watch:

August 25 - Financial Times (Ralph Atkins): "Global corporate bond issuance has this month fallen to the lowest level in five years as market turmoil triggered by rising US Treasury yields persuades companies worldwide to shelve funding plans. Just $61bn in investment grade corporate debt has been raised so far in August, putting it on course to be the weakest month since 2008, according to...Dealogic. In August last year, more than $121bn in new corporate debt was issued... 'What has been worrying people has been the speed and abruptness of moves. It has made people more nervous,' said Bryan Pascoe, global head of debt capital markets at HSBC. In the first months of this year, corporate bond issuance was running at a rapid pace as companies took advantage of historically low interest rates. A high water mark was reached in April when Apple, the US maker of the iPhone, sold bonds worth $17bn. But since May, weekly data show global corporate debt issuance tumbling. The steepest decline has been in emerging markets, where bond and equity markets have seen sharp price falls in recent weeks as investors have withdrawn capital."

August 28 - Bloomberg (Liam Vaughan and Gavin Finch): "In the space of 20 minutes on the last Friday in June, the value of the U.S. dollar jumped 0.57% against its Canadian counterpart, the biggest move in a month. Within an hour, two-thirds of that gain had melted away. The same pattern -- a sudden surge minutes before 4 p.m. in London on the last trading day of the month, followed by a quick reversal -- occurred 31% of the time across 14 currency pairs over two years... For the most frequently traded pairs, such as euro-dollar, it happened about half the time, the data show. The recurring spikes take place at the same time financial benchmarks known as the WM/Reuters rates are set based on those trades. Now fund managers and scholars say the patterns look like an attempt by currency dealers to manipulate the rates, distorting the value of trillions of dollars of investments in funds that track global indexes."

Global Economy Watch:

August 28 - Bloomberg (Theophilos Argitis): "Canadian manufacturers, dogged by the effects of a strong currency, are counting on a pickup in U.S. demand to end the sector's deepest contraction since 2009. Canadian factory production has shrunk 2.7% since the end of 2011 and is 7.6% weaker than it was in July 2008, right before the country slipped into its last recession. Aside from agriculture, manufacturing is the only part of the economy that has failed to return to pre-slump levels. Montreal-based Saputo Inc., the nation's largest dairy processor, and... Caterpillar Inc. are among companies shutting plants in Canada amid rising wage costs and tepid demand from the U.S., which buys about 75% of Canadian exports. Weakness in manufacturing, which accounts for 11% of gross domestic product, is holding back the world's 11th largest economy."

Bursting EM Bubble Watch:

August 26 - Bloomberg (Candice Zachariahs and Lilian Karunungan): "Asian nations are depleting foreign reserves as they seek to bolster their currencies while investors pull billions of dollars from the region. Of the 10 Asian central banks with the largest reserves, six have cut their holdings this year, led by a record 18% reduction by Indonesia... Overall their reserves are rising at the slowest pace in data going back to 2000... Asian nations are getting hit particularly hard from the rout in emerging markets, with the Bloomberg-JPMorgan Asia Dollar Index poised for the biggest annual drop since 2008. Standard & Poor's warned last week that the flight of capital from Asia may trigger higher financing costs, especially for those nations with large deficits in their current accounts."

August 28 - Bloomberg (Matthew Malinowski): "Brazil's central bank raised the key rate by half a percentage point for a third straight meeting, as a plunge in the currency undermines efforts to slow inflation in the world's second-largest emerging market. The bank's board... voted to raise the benchmark Selic rate to 9%... While last week's announcement of a $60 billion intervention plan has helped to buoy the currency, policy makers have maintained the pace of rate increases to fight pass-through to consumer prices..."

August 29 - Bloomberg (Novrida Manurung): "Bank Indonesia raised its benchmark interest rate by half a percentage point in an unscheduled move, joining the biggest emerging markets in implementing measures to shore up slumping currencies... The central bank increased the reference rate to 7% from 6.5%... and extended a bilateral swap deal with the Bank of Japan valued at $12 billion that will allow the two to borrow from each other's foreign-exchange reserves. Indonesia joins Brazil, Turkey and India in taking steps to support their currencies this month as the prospect of reduced U.S. monetary stimulus prompts investors to sell emerging-market assets."

August 29 - Bloomberg (Weiyi Lim, Anuchit Nguyen and Ian Sayson): "Stocks in Southeast Asia are tumbling at the fastest pace in 12 years relative to global equities, sending the regional benchmark index into a bear market as foreign investors cut holdings for a third month. The MSCI Southeast Asia Index has dropped 11% this month and is down 21% from this year's peak on May 8."

August 27 - Financial Times (By Victor Mallet in New Delhi and Avantika Chilkoti in Mumbai): "India's foreign exchange reserves have dropped by nearly $14bn since the end of March and are set to dwindle further as international investors shun the rupee and other emerging market assets in favour of the US dollar, according to economists and market analysts. India entered the latest emerging market sell-off, which was prompted by fears that the US Federal Reserve would soon 'taper' its quantitative easing, in relatively good shape in terms of financial safety."

August 29 - Bloomberg (Onur Ant): "Turkey's trade deficit grew more than expected in July as exports to the Middle East sank and imports of consumer goods surged. The $9.81 billion trade deficit exceeded the average estimate of $8.77 billion... Imports grew 10% from a year earlier to $22.9 billion, compared with a 2% increase in exports... Exports to the Middle East dropped 30% to $3.1 billion from a year ago."

August 29 - Bloomberg (Selcuk Gokoluk): "A U.S.-led strike against Syria risks widening Turkey's current-account deficit and boosting capital outflows already being spurred by speculation that the Federal Reserve will cut asset buying. The lira fell to a record against dollar yesterday and benchmark two-year bond yields climbed above 10% for the first time since January 2012 this week following the biggest surge among emerging markets in the last three months... 'Syrian turmoil is coming at a very bad time for Turkey,' Mohammed Kazmi, an emerging-markets strategist at Royal Bank of Scotland Group Plc in London, wrote..."

China Bubble Watch:

August 28 - Bloomberg: "China's benchmark money-market rate climbed the most in a week after the central bank rolled over some maturing three-year bills... 'The central bank's policy intention now looks pretty clear, it wants to ensure short-term liquidity but lock up on the long end,' said Cheng Qingsheng, an analyst at Evergrowing Bank Co. in Shanghai. 'The rates should be able to remain at the current level until the month-end, and the real challenge will be in late September.'"

August 28 - New York Times (Keith Bradsher): "China is slowing down, but the buildings keep going up -- until now. China is home to 60 of the world's 100 tallest buildings now under construction. But the skyward aspirations of Changsha, the capital of Hunan province, have inspired incredulity tinged with hostility. Broad Group, a manufacturer based here in Changsha, has been planning to erect the world's tallest building here this winter, and in record time. The 202-story 'Sky City' is supposed to be assembled in only four months from factory-built modules of steel and concrete early next year on the city's outskirts. The digging of foundations began on July 20. But the project's scale and speed have set off a burst of national introspection in recent days about whether Chinese municipal leaders and developers have gone too far in their increasingly manic reach for the skies. 'The vanity of some local government officials has determined the skylines of cities,' an editorial in the People's Daily newspaper, the Communist Party's mouthpiece, said... On Tuesday, the tycoon behind the project said in a telephone interview that he had ordered a pause in work at the site while waiting for further approvals from regulators in Beijing."

Japan Watch:

August 30 - Bloomberg (Toru Fujioka and Andy Sharp): "Japan's consumer prices increased at the fastest pace since 2008 in July, as energy costs rise and Prime Minister Shinzo Abe makes progress in pulling the economy out of 15 years of deflation. Consumer prices excluding fresh food climbed 0.7% from a year earlier..."

India Watch:

August 29 - Bloomberg (Jeanna Smialek): "India's economy faces bigger vulnerabilities as global liquidity tightens, presenting the government with both a challenge and an opportunity, an International Monetary Fund spokesman said. 'The combination of large fiscal and current-account deficits, high and persistent inflation, sizable unhedged corporate foreign borrowing, and reliance on portfolio inflows are longstanding vulnerabilities that have now been elevated as global liquidity conditions tighten,' IMF spokesman Gerry Rice said..."

August 28 - Bloomberg (Richard Frost and Santanu Chakraborty): "Oil and gold prices have never been so high for Indian buyers as they are now, hampering government efforts to contain inflation and reduce the nation's record current-account deficit... Oil has jumped 31% this quarter to the highest since at least 1988 in local currency terms, while the precious metal surged 3%... India imports almost 80% of its energy needs and is the world's biggest buyer of gold... The rupee has tumbled 20% versus the dollar this year, heading for the worst annual loss since a balance of payments crisis in 1991 forced the nation to seek loans from the International Monetary Fund. Consumer prices in Asia's third- largest economy rose 9.64% in July. 'The last thing India needs is higher oil prices,' Kelvin Tay, the chief investment officer for the southern Asia-Pacific region at UBS AG's wealth management..."

August 29 - Bloomberg (Jeanette Rodrigues and Shikhar Balwani): "India's incoming central bank Governor Raghuram Rajan has little room to use borrowing costs to spur Asia's third-largest economy as the rupee plummets, interest-rate swaps show. The cost to lock in rates for a year using the contracts has surged 267 bps this quarter to 10.16% as investors bet the Reserve Bank of India will prolong a cash crunch it created to shore up the currency. A similar rate in China is at 4.09%. The rupee plunged 3.9% yesterday to a record low of 68.8450 per dollar. Rajan, who takes office on Sept. 5, will inherit an economy with a record current-account deficit... 'The liquidity steps taken by the RBI have led to a gut- wrenching credit squeeze, going in the direction of worsening growth,' Mirza Baig, head of foreign-exchange and interest-rate strategy in Singapore at BNP, said... What Indian policy makers 'are doing is having no effect, they're losing their credibility and raising the risk of a rating downgrade,' he said."

Asia Crisis Watch:

August 30 - Bloomberg (Kyoungwha Kim and Whanwoong Choi): "Corporate bond sales in South Korea are falling to a six-year low just as companies face a record debt bill and credit-rating downgrades raise borrowing costs. Companies... have almost $100 billion of won-denominated bonds and loans due before March 31... Hanwha Investment Securities Co. says the 'maturity wall' is hitting records in both 2013 and 2014. Local-currency note sales plunged 44% this year to 20.6 trillion won ($18.6bn). South Korean industries are paying for a 57% jump in borrowing after the 2008 financial crisis when the government ensured easy credit to help create jobs."

Latin America Watch:

August 27 - Bloomberg (Peter Millard): "Petroleo Brasileiro SA is being treated like junk by derivatives traders as the most-leveraged major oil producer goes deeper into debt to finance its record $237 billion spending spree. The cost to protect debt from the Rio de Janiero-based company known as Petrobras for five years using credit-default swaps has almost doubled this year to 280.11 basis points, the most among 20 integrated oil companies worldwide... Petrobras, which has boasted investment-grade credit ratings for more than a decade, is borrowing more as it pursues $47 billion of spending a year to expand output and refining."

Europe Crisis Watch:

August 28 - Bloomberg (Jeff Black): "Lending to companies and households in the euro area fell for a 15th month in July, extending the longest credit contraction on record, even as signs of economic recovery in the region increase. Loans to the private sector dropped 1.9% from a year earlier... That's the steepest decline on record... The rate of growth in M3 money supply... slowed to 2.2% in July from 2.4% in June..."

August 28 - Bloomberg (Peter Levring): "Denmark's Economy Minister Margrethe Vestager said the reaction to the Federal Reserve's talk of scaling back stimulus as early as next month has made clear just how addicted people have become to record-low rates. The volatility that followed the Fed's June signal it may be preparing to taper support measures was a reminder that low borrowing costs are still underpinning demand across much of the globe, Vestager said. 'It's pretty obvious how we benefit from the low rates when we consider what happened all over the world when the U.S. Fed scared people saying that monetary policy perhaps should be slightly less relaxed,' Vestager said... 'We're currently benefiting from very loose monetary policy.'"

Portugal Watch:

August 30 - Financial Times (Peter Wise): "Portugal's constitutional court has ruled that legislation enabling the government to fire public sector workers who cannot be retrained is illegal, blocking a reform that Lisbon sees as critical to meeting the terms of the country's €78bn bailout. The ruling announced... came only five months after the court rejected public spending cuts of up to €1.3bn, forcing the government to rewrite this year's budget to meet deficit reduction targets agreed with international lenders. The decision to reject the bill on 'public sector requalification', which would have allowed the state to lay off workers permanently after they spent a year in reserve, means the government will have to rewrite a reform package aimed at cuts totalling €4.7bn. It is the third time in just over a year that the court has rejected important government reforms that it judged to contravene the constitution."

France Watch:

August 28 - UK Telegraph: "France is facing one of its poorest wine grape harvests in four decades due to a cold and rainy spring and severe hailstorms. The 2013 harvest is expected to reach just 43.5m hectoliters - well below the 10-year average of 45.4m... That would make the 2013 harvest one of the worst in 40 years and only a slight improvement on last year's record low harvest of 41.4m, according to Jerome Despey, head of FranceAgriMer's viticulture section. He said cool temperatures and excessive rains contributed to a particularly poor harvest, while some vineyard owners in famed wine regions such as Bordeaux and Burgundy saw their harvests nearly wiped out by severe hailstorms."


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