A week of "Bo, Bo" - Bubble Off, Bubble On

It was an interesting week, including in the financial markets. We'll focus on these extraordinary market gyrations. I'll have nothing to say about the Federal Reserve, as I believe they actually had little to do with the markets.

The Russian ruble traded Tuesday as low as 79.17 to the dollar (after beginning the year at 33), before closing the week at 59.61. At Tuesday's record low, the ruble was down 20% for the day, before a late-session rally cut the loss to 5.4%. The ruble was under pressure again early-Wednesday, until major buying pushed the ruble to a 10.3% session gain. By the time of Putin's annual (three-hour) press conference on Thursday, the ruble and Russia bonds had miraculously stabilized. The world's risk markets rejoiced the thought of the deep-pocket Chinese resolving Russia's crisis: Bubble On.

If forced to venture a guess, I'd say the Chinese were actively supporting the ruble and Russian debt on Wednesday and Thursday. Early Thursday from Reuters: "China is closely monitoring the slide in the Russian rouble, the foreign exchange regulator said on Thursday, as the currency of one of its major energy importers struggles to avoid a free-fall... Chinese Foreign Ministry spokesman Qin Gang, speaking at a later news conference, added that he believed Russia would overcome its problems. 'Russia has rich resources, quite a good industrial base. We believe that Russia has the ability to overcome its temporary difficulties,' Qin said."

And early Thursday from the South China Morning Post: "Russia May Seek China Help to Deal with Crisis: Russia could fall back on its 150 billion yuam currency swap agreement with China if the rouble continues to plunge... The deal was signed by the two central banks in October, when Premier Li Keqiang visited Russia. 'Russia badly needs liquidity support and the swap line could be an ideal too,' said Ban of Communications chief economist Lian Ping."

The South China Morning Post came later with additional articles, including "Beijing May Spend Bigger in Russia," and "Russia's Currency Crisis Poses Risks to Other Emerging Markets."

December 19 - Bloomberg: "China offered enhanced economic ties with Russia at a regional summit this week as its northern neighbor struggled to contain a currency crisis. 'To help counteract an economic slowdown, China is ready to provide financial aid to develop cooperation,' Premier Li Keqiang said... While the remark applied to any of the five other nations represented at the meeting of the Shanghai Cooperation Organization group, it was directed at Russia... Any rescue package for Russia would give China the opportunity of exercising the kind of great-power leadership the U.S. has demonstrated for a century -- sustaining other economies with its superior financial resources. President Xi Jinping last month called for China to adopt 'big-country diplomacy' as he laid out goals for elevating his nation's status. 'If the Kremlin decides to seek assistance from Beijing, it's very unlikely for the Xi leadership to turn it down,' said Cheng Yijun, senior researcher with the Institute of Russian, Eastern European, Central Asian Studies at the Chinese Academy of Social Sciences in Beijing. 'This would be a perfect opportunity to demonstrate China is a friend indeed, and also its big power status.'"

I'll speculate that the Chinese were becoming increasingly nervous - nervous about Russia, nervous about EM and nervous about China. Global markets on Tuesday again found themselves at the precipice. The ruble collapse was inciting a more general flight out of EM currencies, bonds and stocks. Marketplace liquidity was evaporating - leading to brutal contagion at the Periphery and increasingly destabilizing de-risking/de-leveraging at the Core. In short, Bubble Off was taking over - in yet another market "critical juncture." The ruble (miraculously) reversed course, EM rallied, global markets for the most part reversed and the "Core" U.S. equities market took flight. From Wednesday lows to Friday's highs, the Dow surged 800 points, or 4.7%. Bubble On. "Risk on" no longer does justice.

Most would likely challenge my view of the markets being on the "precipice" during Tuesday trading. Let me back up my claim. Tuesday trading saw a major Emerging Market CDS (Credit default swap) index jump to the highest level since the tumultuous summer of 2012. On Tuesday, the Brazilian real traded to a new nine-year low (trading down as much as 2.8% intraday). Interestingly, Brazil CDS surged to 268 intraday Tuesday, up from Friday's close of 212 and 153 to start the month. Tuesday's high actually surpassed the 2013, 2012 and 2011 spikes - to the highest level since 2009.

It's worth noting that CDS traded to multi-year highs for the major Brazilian financial institutions. Banco do Brasil surged to over 420 on Tuesday before ending the week up 28 bps to 315 bps. BNDES (Brazil's national development bank) CDS spiked higher Tuesday, before ending the week up 52 bps to 234. Banco Bradesco CDX traded to 300, before ending the week up 21 to 266 bps.

My thesis has been that the "global government finance Bubble" has burst at the Periphery. EM sovereign, corporate and financial debt is the global "system's" weak link. Dollar-denominated EM debt in particular is unfolding crisis' "toxic" debt. Regrettably, Brazil is right in the thick of it.

Last week I wrote that the EM dollar-denominated debt dam had given way. This dynamic was clearly in play early in the week. Russia dollar bond yields traded as high at 7.88% Tuesday, up from the previous week's closing 6.76%. Ukrainian dollar yields surpassed 32.5% Tuesday, before ending the week at 26.52%. Venezuela dollar bond yields jumped to 27.85% on Tuesday, up from Friday's closing 24.28% - before ending the week at 22.29%. Brazilian 10-year dollar yields rose as high as 5.28%, up from the previous week's 4.82%. Turkey dollar yields traded as high as 4.88% on Tuesday, up from last Friday's 4.52%. Colombia yields jumped to 4.40%, up from the previous week's 4.16%.

Turkey (lira) bond yields this week traded at high as 8.60%, up from 7.62% to begin the month. The lira traded to a record low Tuesday. Indonesia yields rose to 8.48%, up from 7.70% to start December. The rupiah Tuesday traded to the lowest level versus the dollar since 1998. South African yields this week traded as high as 8.12%, up from 7.60%. Tuesday saw the rand trade to the lowest level since 2000. Eastern European currencies were under notable pressure. For the week, the Hungarian forint declined 4.3%, the Polish zloty 3.6%, the Czech koruna 2.5%, the Bulgarian lev 1.8% and the Romanian leu 1.7%. Iceland's krona fell 2.5% this week.

It wasn't just EM under pressure earlier in the week. Greek five-year yields traded to 9.80% Tuesday, up from the previous Friday's 9.65% close - to the highest level since the 2012 European crisis. Greek CDS traded as high at 1,178 - before closing the week at 1,025. Italian CDS traded to 165 bps Tuesday (10-month high), before ending the week about unchanged at 142. There's been an interesting divergence of late between declining sovereign yields and rising CDS prices in Italy, Spain and Portugal.

Part of my thesis back in 2012 was that a crisis of confidence in Italian debt was about to provoke a crisis of confidence in the European banking system and the euro. I believed a loss of confidence in European banks risked a major global crisis involving derivatives, counterparty issues and funding of leveraged speculation. A Bloomberg headline from Wednesday caught my attention: "SocGen [French bank Societe Generale] Default Swaps Jump to One-Year High on Russia Turmoil."

SocGen (subordinated debt) CDS traded to 225 bps on Wednesday (closed week at 200), after beginning the month at 171. An index of European (subordinated) bank CDS traded Tuesday almost back to the highs from October's market tumult. An index of European high-yield corporate debt also spiked Tuesday back to October Tumult levels. Basically, CDS has been rising just about everywhere. Japan CDS traded to 75 on Tuesday, having now more than doubled the level from September lows (to an 18-month high).

Here at home, 10-year Treasury yields traded to 2.01% Tuesday, the low going back to May 2013. The week saw more all-time record low yields in Germany (0.59%), France (0.87%), Spain (1.70%), Netherlands (0.74%) and Austria (0.75%), among others.

December 19 - Financial Times (Tracy Alloway): "Big investors have been buying hundreds of billions of dollars worth of exotic credit derivatives to protect themselves against the possibility that growing numbers of corporate bond issuers will default. Options that give investors the right to buy insurance against bond defaults have exploded in popularity this year as asset managers and hedge funds seek to affordably offset the risk of a big blow-up in credit. Trading volumes of the instruments -- known as credit index options or swaptions -- have jumped 148% in the past 12 months, with about $1.4tn of the instruments exchanging hands in 2014 compared with $573bn in 2013. 'You can buy a very leveraged bet that the market will collapse using credit index options,' said Andrew Jackson, chief investment officer at Cairn Capital. He added: 'That is definitely the hedge of choice for real money investors who don't really care that much about the level of volatility, but care about the amount of dollars they're paying to hedge against Armageddon risk.' Credit indices, such as Markit's iTraxx or CDX series, are credit default swaps (CDS) written on baskets of corporate credits that investors and traders may use to hedge, or offset, their exposure to corporate debt or to make bets on the way the underlying companies will perform. Credit index options act in a similar way to options on other assets, such as stocks, by giving the holder the right to enter into a CDS contract at a certain time in the future. According to Citigroup research, asset managers account for a quarter of the total credit index options volume, compared with 15% just a year ago."

Early-week instability evoked talk of the 1998 market crisis. A Bloomberg headline: "Memories of 1998 Rekindled in Routs From Russia to Venezuela." I was convinced in early-1998 that Russia was the likely next big domino to drop after the brutal 1997 collapse of the "Asian Tiger miracle economies." And I recall an FT article that highlighted the spectacular growth in derivatives to protect against a ruble decline. The knowledge that huge derivative "insurance" positions had accumulated convinced me that collapse was inevitable.

It's time to ponder the ramifications of accumulating hedges against "Armageddon risk" with potentially highly leveraged options and "swaptions" derivative instruments. This has become an important market issue. And it's troubling to see that the trading of these types of instruments has exploded right along with trading options on equity volatility indices (i.e. VIX, VXX, etc.). Coincidently, I was listening to a conversation this week that went something like this: "Everyone is hedged (against market risk). Who is on the other side of these trades?"

Long-time readers know I am no fan of Credit and market "insurance." Cheap insurance invariably fuels excess on the upside of the boom, only later to ensure dislocation when the Bubble burst. Basically, Credit and market risks are uninsurable - they are neither random nor independent events (such as auto accidents and house fires). I won't this week dive back into this fascinating theoretical topic.

I believe options and swaptions on corporate Credit are exceptionally dangerous. I also believe they likely help to explain some of this year's (and this week's!) unusual market trading dynamics. Again, think "Bubble On, Bubble Off." Who is on the other side of the explosion of Credit and market insurance? Computers and models. If a customer buys an option on a CDS contract - a computerized trading system will dictate how much of the underlying instrument that must be either bought or sold to "hedge" the contract written. And as market prices change, "dynamic trading" strategies will adjust trading positions accordingly. If prices move little, there will be little to do on the trading/hedging side. If prices move a lot, there will be a major trading effort involved. Big price changes ensure a trend-following bias.

The implied leveraged in "Armageddon" trading strategies generally causes little issue. Think for example if you go out and buy a put option on the equity market 25% out-of-the-money (crash protection). For the most part, the (derivative counter-) party that wrote this market insurance has little to do or worry about - so long as the market is quiescent. But if the market suddenly is on a downward spiral, the computerized trading model will dictate that a short position be established as a partial hedge against the "insurance" written. If the market continues to decline, more selling will be required to ensure a trading position that will generate sufficient cash-flow (trading gain) to pay on the insurance contract. And as this "out of the money" option gets closer to the "strike" price, the amount of ("delta") trading necessary to hedge rises exponentially. But if the market then abruptly recovers, to avoid losses will require that this short market hedge be unwound into a rising market.

The Fed and global central bankers have had a profound role on derivatives markets. I would argue that many of these key financial "insurance" markets viable only because of central bank assurances of "liquid and continuous" markets. Certainly, the proliferation of these types of products would not be possible if not for the view that central banks will protect against market crisis. Who would write market and Credit insurance if they thought central banks weren't underpinning the markets?

The proliferation of Credit "insurance" over recent years is an especially fascinating issue. With unlimited central bank "money" printing, why not book easy profits by ensuring against Credit losses? Why not write "flood insurance" when central bankers are ensuring drought? Why not write CDS (default protection) contracts for easy returns? And those on the other side of the derivative trade can simply buy corporate debt (on leverage, of course), to provide the cash-flows to pay on the contracts. And with CDS "insurance" so cheap and liquid, it's perfectly rational for others to position aggressively long corporate Credit while purchasing option protection just in case of "Armageddon." This has had a profound impact on Credit Availability and loose financial conditions more generally.

Actually, I think "do whatever it takes" central bank money printing coupled with zero rates has spurred risk-taking and a resulting historic Bubble throughout high-yield debt. CDS and derivatives more generally have played a profound role - creating significant unappreciated leverage on the upside of the boom. Now, with the global Bubble bursting, this "insurance" marketplace holds the potential to incite an abrupt tightening of Credit conditions (has it already started?) On the one hand, a widening of spreads and higher CDS prices will lead to some unwinding of derivative-related leveraged holdings. Worse yet, the proliferation of "out-of-the-money" option "Armageddon" protection will dictate that those that have written these derivatives short securities as the market and Credit backdrop deteriorates.

I believe that the Trillions of Credit "insurance" derivatives in the marketplace help to explain volatile and now generally unstable markets. It helps explain why high-yield CDS has gyrated over the past year - beginning the year just over 300 - jumping to 360 in February - sinking to about 290 in July, only to spike to 355 in August - to fall back to 310 in early September. Things turned only more interesting over recent months. CDS spiked to almost 370 in late-September and then drop back to 330 in early October. High-yield CDS then traded to 400 during the October Tumult, before again sinking back below 330 in late-November. CDS closed Tuesday at 406.

When the Russia currency and bond collapse unfolded in October 1998, derivative trading strategies played a significant role in overwhelming market selling pressure and resulting illiquidity. In the end, Russian banks that had written ruble insurance collapsed right along with the ruble and the Russian debt market. I have no doubt that derivatives and associated "dynamic" trading strategies will play a major destabilizing role in the unfolding global financial crisis.

And more from the FT: "The surge in trading of credit index options stands in stark contrast to the CDS market itself, which has been shrinking dramatically since the financial crisis. The derivatives were widely blamed for exacerbating the crisis and have since come under tighter regulatory scrutiny and control, including a requirement that they be 'cleared' through exchange-like central counterparties. Unlike CDS, options on CDS indices are not yet required to be centrally cleared. 'Every single month in 2014 experienced volume growth compared to the same period in 2013, which suggests the growth was not seasonal, or in response to one-off events in 2014,' the Citi analysts said. "Credit options are currently one of the fastest growing areas in credit derivatives."

There's a fascinating aspect of Periphery to Core dynamics that I believe today underpins "Bo, Bo." I've written extensively on how cracks (and even a bursting Bubble) at the Periphery work initially to funnel "hot money" flows to the bubbling Core. Importantly, this dynamic also promotes the accumulation of derivative risk "insurance" positions. First, trouble at the periphery provides impetus for the discerning to hedge mounting systemic risk. Second, an over-liquefied Core ensures readily available inexpensive insurance - cheap insurance that spurs late-cycle risk-taking and general complacency.

Indeed, this dynamic now plays a critical role in prolonged "blow off" excesses. Importantly, at the point where the Core begins to buckle this massive derivatives (hedging) trade will overhang system stability. The market cannot hedge market risk. There's no one with the wherewithal to "take the other side of the trade." The "other side" is instead a computer model, programmed to dump sell orders into faltering markets. Liquidity will inevitably become a critical problem.

A year ago this week I was invited to participate in a company event - a bull vs. bear debate. I presented my Bubble thesis, arguing against the bullish "house" view. I posed what I am convinced is a fundamental question: "Is the underlying money and Credit sound or unsound?" I also added the following: "I do not sit around worrying about my reputation or my career prospects. I am driven by two things: analytical integrity and the quality of my analysis." I would have it no other way.

For the Week:

The S&P500 rallied 3.4% (up 12.0% y-t-d), and the Dow gained 3.0% (up 7.4%). The Utilities jumped 2.8% (up 23.4%). The Banks rose 2.9% (up 6.7%), and the Broker/Dealers surged 3.9% (up 14.8%). Transports gained 1.7% (up 21.5%). The S&P 400 Midcaps advanced 3.4% (up 8.0%), and the small cap Russell 2000 jumped 3.8% (up 2.8%). The Nasdaq100 gained 2.0% (up 19.2%), and the Morgan Stanley High Tech index jumped 3.9% (up 13.0%). The Semiconductors rose 2.2% (up 28.2%). The Biotechs surged 3.7% (up 52.1%). Although bullion dropped $26.20, the HUI gold index was little changed (down 16.4%).

One-month Treasury bill rates closed the week at one basis point and three-month rates ended at three bps. Two-year government yields jumped 10 bps to 0.64% (up 26bps y-t-d). Five-year T-note yields rose 14 bps to 1.65% (down 10bps). Ten-year Treasury yields gained eight bps to 2.16% (down 87bps). Long bond yields added two bps to 2.76% (down 121bps). Benchmark Fannie MBS yields were up three bps to 2.83% (down 78bps). The spread between benchmark MBS and 10-year Treasury yields narrowed five to 67 bps. The implied yield on December 2015 eurodollar futures rose nine bps to 0.92%. The two-year dollar swap spread was little changed at 23 bps, and the 10-year swap spread was about unchanged at 13 bps. Corporate bond spreads reversed sharply narrower. An index of investment grade bond risk dropped seven to 65 bps. An index of junk bond risk sank 48 bps to 348 bps. An index of emerging market (EM) debt risk fell 28 bps to 355 bps.

Greek 10-year yields dropped 71 bps to 8.43% (up one basis point y-t-d). Ten-year Portuguese yields sank 25 bps to 2.73% (down 341bps). Italian 10-yr yields fell 11 bps to 1.95% (down 217bps). Spain's 10-year yields dropped 18 bps to 1.70% (down 245bps). German bund yields declined three bps to a record low 0.59% (down 134bps). French yields sank 11 bps to a record low 0.89% (down 167bps). The French to German 10-year bond spread narrowed eight to 30 bps. U.K. 10-year gilt yields rose five bps to 1.85% (down 117bps).

Japan's Nikkei equities index gained 1.4% (up 8.2% y-t-d). Japanese 10-year "JGB" yields dropped four bps to a record low 0.35% (down 39bps). The German DAX equities index rallied 2.0% (up 2.5%). Spain's IBEX 35 equities index gained 1.2% (up 4.5%). Italy's FTSE MIB index was up 2.1% (unchanged). Emerging equities were again wildly volatile. Brazil's Bovespa index recovered 3.4% (down 3.6%). Mexico's Bolsa gained 2.0% (down 0.5%). South Korea's Kospi index added 0.4% (down 4.1%). India's Sensex equities index was little changed (up 29.3%). China's Shanghai Exchange surged another 5.8% (up 46.9%). Turkey's Borsa Istanbul National 100 index increased 0.4% (up 23.3%). Russia's MICEX equities index slipped 0.7% (down 3.7%).

Debt issuance has slowed to a drip. I saw no investment-grade or convertible debt issues.

Junk funds saw outflows jump to $3.08bn (from Lipper), the largest outflows since August. Junk issuers this week included Global Cash Access $700 million.

International dollar debt issuers included Alliance Bank $237 million and Energia Eolica $204 million.

Freddie Mac 30-year fixed mortgage rates dropped 13 bps to 3.80% (down 67bps y-o-y). Fifteen-year rates fell 11 bps to 3.09% (down 42bps). One-year ARM rates declined two bps to 2.38% (down 19bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.19% (down 44bps).

Federal Reserve Credit last week expanded $16.1bn to a record $4.464 TN. During the past year, Fed Credit inflated $505bn, or 12.8%. Fed Credit inflated $1.653 TN, or 59%, over the past 110 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $3.9bn last week to $3.328 TN. "Custody holdings" were down $25.7bn year-to-date and fell $51.5bn from a year ago.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $237bn y-o-y, or 2.1%, to $11.774 TN. Over two years, reserves were $929bn higher for 9% growth.

M2 (narrow) "money" supply expanded $5.3bn to a record $11.608 TN. "Narrow money" expanded $635bn, or 5.79%, over the past year. For the week, Currency increased $2.5bn. Total Checkable Deposits jumped $33bn, while Savings Deposits fell $28.7bn. Small Time Deposits declined $1.7bn. Retail Money Funds were little changed.

Money market fund assets declined $13.4bn to $2.693 TN. Money Funds were down $25.7bn y-t-d, while increasing $17.7bn from a year ago, or 0.7%.

Total Commercial Paper dropped $12.5bn to $1.074 TN. CP expanded $28.5bn year-to-date, while declining $11.3bn over the past year, or 1.0%.

Currency Watch:

December 18 - Bloomberg (Justina Lee): "Yuan forwards fell to a two-year low after the central bank reduced the currency's fixing by the most in six weeks amid dollar demand on bets the U.S. will increase interest rates next year."

The U.S. dollar index gained 1.4% to 89.60 (up 11.9% y-t-d). For the week on the upside, the Mexican peso increased 1.1%, the South Korean won 0.1% and the South African rand 0.1%. For the week on the downside, Swedish krona declined 2.4%, the Swiss franc 2.1%, the euro 1.9%, the Danish krone 1.9%, the Australian dollar 1.4%, the Japanese yen 0.6%, the British pound 0.6%, the Taiwanese dollar 0.5%, the New Zealand dollar 0.2%, the Brazilian real 0.2%, the Norwegian krone 0.2%, the Canadian dollar 0.2% and the Singapore dollar 0.1%.

Commodities Watch:

The Goldman Sachs Commodities Index declined another 1.6% to a more than five-year low (down 30.3%). Spot Gold fell 2.1% to $1,196 (down 0.8%). March Silver sank 6.0% to $16.03 (down 17%). January Crude declined 95 cents to $57.13 (down 42%). January Gasoline fell 2.4% (down 44%), and January Natural Gas dropped 6.7% (down 18%). March Copper lost 1.7% (down 15%). March Wheat jumped 4.2% (up 5%). March Corn increased 0.7% (down 3%).

U.S. Fixed Income Bubble Watch:

December 17 - Bloomberg (Kristen Haunss and Luca Casiraghi): "Wall Street dealers are bracing for a steep drop in issuance of collateralized loan obligations after a record amount of the debt was raised this year, threatening to boost borrowing costs for the neediest companies. Rules designed to limit risk-taking may mean CLO sales will be at least 41% less than the unprecedented $119.2 billion issued so far in 2014, according to the most pessimistic forecast by JPMorgan... CLOs helped finance some of the biggest leveraged buyouts in history, and the outlook for a drop in issuance comes as prices in the more-than $800 billion market for high-yield, high-risk loans are already near a two-year low and the debt is on track to deliver annual losses for the first time since 2008."

U.S. Bubble Watch:

December 15 - Bloomberg (Bradley Olson and Tim Loh): "Autry Stephens knows the look and feel of an oil boom going bust, and he's starting to get ready. The West Texas wildcatter, 76, has weathered four such cycles in his 52 years draining crude from the Permian basin... Though the collapse in prices since June doesn't yet have him in a panic, Stephens recognizes the signs of another downturn on the horizon. And like many bust-hardened veterans in this region -- which has made and broken the fortunes of thousands -- he's talking about it like a gathering storm. The ups and downs of oil are a way of life in Midland and Odessa, Texas, dating all the way back to the Great Depression... 'We're going to hunker down and go into survival mode,' Stephens, founder of Endeavor Energy Resources LP, said... 'Stay alive is our mantra, until the price recovers.' Go about 1,300 miles due north and you get a very different take from the rookie oil barons in North Dakota, where crude output from the Bakken formation went from 200,000 barrels a day in 2008 to about 1.2 million today. They're not seeing any need to take shelter, and it shows in their swagger."

Federal Reserve Watch:

December 19 - Bloomberg (Craig Torres): Federal Reserve officials see the federal funds rate rising less by the end of 2015 than they projected three months ago, according to the median estimate of new forecasts released today. They also forecast the economy will be at full employment by the end of next year. The benchmark rate will be 1.125% at the end of next year, compared with a 1.375% median estimate in September... The rate will be 2.5% at the end of 2016, and 3.625% at the end of 2017, according to the median. Federal Open Market Committee participants said they don't expect to reach their 2% target for inflation until 2016..."

ECB Watch:

December 16 - Bloomberg (Jeff Black and Jana Randow): "Jens Weidmann said there's no need for the European Central Bank to expand monetary stimulus, and argued that sovereign-debt purchases are problematic even if slumping oil prices cause deflation. 'Such a development initially requires no monetary policy response, as long as no second round effects are to be seen,' the Bundesbank president said... 'There's a whole row of economic reasons that speak against government-bond purchases, even before you consider the legal question of whether they're compatible with the ban on monetary financing.' ...Weidmann, and up to five other Governing Council members, are against pre-announcing government-bond buying before the effects of existing programs can be judged. 'We have already acted, pre-emptively, in the expectation of a worsening of the economic situation,' Weidmann said. 'But this plays only a minor role in the discussion. Instead, it's only ever asked, 'what is coming next?' And then mostly the question, 'when will you finally buy government bonds?' That raises the expectations for this measure to such a level that they can only be disappointed.'"

Central Bank Watch:

December 18 - Bloomberg (Zoe Schneeweiss and Jan Schwalbe): "The Swiss National Bank imposed the country's first negative deposit rate since the 1970s as the Russian financial crisis and the threat of further euro-zone stimulus heaped pressure on the franc. A charge of 0.25% on sight deposits... will apply as of Jan. 22... The SNB move follows Russia's surprise interest-rate increase this week and hints at the investment pressures that resulted after that decision failed to stem a run on the ruble. Swiss officials acted as the turmoil, along with the imminent threat of quantitative easing from the ECB, kept the franc too close to its 1.20 per euro ceiling for comfort."

Russia/Ukraine Watch:

December 19 - Financial Times (Courtney Weaver and Jack Farchy): "A defiant Vladimir Putin said Russia should brace itself for two years of recession, as he blamed economic woes on a western plot to defang the Russian bear. The president was speaking at a three-hour press conference during which he addressed this week's market turmoil in public for the first time. He claimed that a period of economic hardship was the price Russia would have to pay to maintain its independence in the face of western aggression, repeatedly blaming the rouble's plunge and a looming recession on 'external factors'. In a metaphor that summed up his entire performance, he compared Russia to a bear which the west was trying to weaken by stripping it of its nuclear weapons and taking its natural resources. 'They will always try to put it on a chain,' he said. 'As soon as they succeed in doing so they will tear out its fangs and claws.' That, he said, would leave it nothing but a 'stuffed animal'."

December 17 - Wall Street Journal (Chiara Albanese and David Enrich): "Global banks are curtailing the flow of cash to Russian entities, a response to the ruble's sharpest selloff since the 1998 financial crisis. Such banks as Goldman Sachs... this week started rejecting requests from institutional clients to engage in certain ruble-denominated repurchase agreements and other transactions designed to raise cash... Bankers and traders say the moves to restrict some ruble transactions have become increasingly widespread among major Western financial institutions this week... The moves, which the banks are deploying to protect themselves against further swings in the currency, have the potential to add to the strain on Russia's financial system."

December 19 - Bloomberg (Vladimir Kuznetsov): "Trust between Russian lenders is breaking down after the biggest ruble rout since the country's 1998 default, sending interbank rates to the highest in eight years. The Mosprime overnight rate jumped to 27.3% yesterday, the highest since Bloomberg started compiling the data in 2006. It declined to 25% today compared with from 11.85% a week ago... 'Banks are either demanding additional collateral, or asking to close deals and then reducing limits on the counterparty,' Oleg Kouzmin, an analyst at Renaissance Capital in Moscow, said... 'Gradually, the situation is getting worse, the market is shrinking.'"

December 19 - Bloomberg (Daryna Krasnolutska): "Ukraine's credit rating was cut by Standard & Poor's, which said a default could become inevitable as central bank reserves are melting and a bailout is being held up as fighting in the country's easternmost regions continues. S&P lowered the long-term sovereign rating one level to CCC-... 'A default could become inevitable in the next few months if circumstances do not change, for instance if additional international financial support is not forthcoming,' S&P analysts led by Ana Jelenkovic said..."

Brazil Watch:

December 17 - Bloomberg (Julia Leite): "Petroleo Brasileiro SA, Brazil's state- controlled oil producer, would be a junk-rated company if it weren't for the government's support, Standard & Poor's said. Petrobras's so-called stand-alone credit rating was lowered two steps to BB, S&P said..., citing a corruption investigation... The company's benchmark bonds due 2021 have slumped to a record low of about 88 cents on the dollar after Petrobras delayed reporting its financial results amid Brazil's largest- ever money laundering probe."

December 16 - Bloomberg (Sabrina Valle and Leonardo Silva): "Petroleo Brasileiro SA, the biggest oil producer in ultra-deep waters, is curbing refining and exploration spending in response to the collapse in prices and difficulties tapping debt markets during a corruption probe, said two people with direct knowledge of the matter. The state-run oil company known as Petrobras plans to freeze investments in the Premium I and Premium II refineries in northeastern Brazil and sell assets to protect its cash position..."

EM Bubble Watch:

December 15 - Bloomberg (Boris Korby): "Emerging markets are ending the year much like how they began it -- in freefall. From Russia to Venezuela, Thailand to Brazil, stocks, bonds and currencies across the developing world are plunging. The Russian ruble tumbled past 60 for the first time on record today while Venezuelan bonds sank below 40 cents on the dollar and Thai stocks fell the most in 11 months. Brazil's corporate debt market is reeling as a graft probe of state oil producer Petroleo Brasileiro SA infects the market. All of this has something of a familiar feel to it, dating back to 1998, when, just like now, oil was tumbling and driving crude exporters Russia and Venezuela into financial crisis."

December 15 - Bloomberg (Ken Kohn and Minh Bui): "Investors withdrew more than $2.5 billion from U.S. exchange-traded funds that buy emerging-market stocks and bonds last week, the biggest outflow since January... The last time outflows were greater was in the week of Jan. 27, when they reached $4.46 billion, the most this year. All 24 of the emerging markets tracked by ETFs saw withdrawals..."

December 17 - Bloomberg (Benjamin Harvey): "President Recep Tayyip Erdogan is reviving a political battle that helped drive the Turkish lira to a record low in January, and again yesterday. The currency weakened to an all-time low and two-year note yields rose the most in emerging markets after Russia yesterday, as police detained at least 20 people at media groups linked to a U.S.-based cleric accused by Erdogan of plotting against the government... 'Political risk draws attention to Turkey's domestic and external weaknesses -- particularly at a time when sentiment towards risk assets is deteriorating markedly,' Nicholas Spiro, managing director of Spiro Sovereign Strategy...said... 'What's patently clear is that the lira remains one of the most vulnerable emerging market currencies.'"

Europe Watch:

December 18 - Financial Times (Kerin Hope): "Greek lawmakers failed to elect Stavros Dimas as the country's next president in Wednesday's first-round vote, but the result indicated he could still scrape a win in the final ballot on Dec 29 and avert a snap general election. Mr Dimas captured 155 votes from the governing coalition and another five from independent deputies. He needs 180 votes to secure victory in the third and final round... Mr Samaras's decision to bring forward the presidential election by two months has sparked turmoil on financial markets and prompted fears that prolonged political instability could even put at risk Greece's membership of the eurozone. Opinion polls suggest that the radical leftwing Syriza party, which wants to restructure Greece's sovereign debt while boosting public spending in defiance of the country's bailout agreement, would come first in a general election. Mr Samaras has warned that this would threaten a fragile economic recovery following an unprecedented six-year recession."

Global Bubble Watch:

December 17 - New York Times (Neil Irwin): "It has been a hairy 24 hours in global financial markets, particularly for anyone who works in the oil business or has a stake in the health of Russia's economy. But what is really going on, and what does it mean for the United States? With the Russian ruble in near free fall, the country's central bank announced an emergency interest rate increase at 1 a.m. Moscow time on Tuesday, raising its main interest rate 6.5 percentage points to a whopping 17%. The idea was to make the ruble more attractive with the very high interest rates it might earn, and thus avert the outflow of capital that has driven the currency down since summer. The initial results were promising, with a brief uptick in the value of the ruble. But it didn't last. After falling about 11% Monday, the ruble was down a further 10% against the dollar early Tuesday, before rebounding to be down 6%..."

December 18 - Reuters: "China is closely monitoring the slide in the Russian rouble, the foreign exchange regulator said on Thursday, as the currency of one of its major energy importers struggles to avoid a free-fall. Wang Yungui, head of policy and regulations for the State Administration of Foreign Exchange (SAFE), told a news conference that China was paying attention considering the close economic relationship between the two. 'We haven't seen a significant impact on our cross-border capital flows,' he said. Chinese Foreign Ministry spokesman Qin Gang... added that he believed Russia would overcome its problems. 'Russia has rich resources, quite a good industrial base. We believe that Russia has the ability to overcome its temporary difficulties,' Qin said. China's exports to Russia rose an on-year 10.5% and imports went up 2.9% in the first three quarters of the year, with total trade valued at $70.78 billion."

December 19 - Bloomberg (Luca Casiraghi and Cordell Eddings): Junk-bond investors worldwide are forfeiting all the gains they've accumulated this year as a selloff triggered by plunging oil prices thrusts the debt toward its first loss since the financial crisis. The worst monthly performance in more than three years has eroded returns on speculative-grade debt, shrinking the year's gain to 0.15% after ending November at 4.34%... That puts the debt on pace to hand investors their first annual loss since it gave up 27% in 2008... With energy-company bonds making up more than 10% of the global high-yield market, investors are shunning the debt on concern that oil prices below $60 a barrel will precipitate defaults. More than $80 billion has been wiped off the value of junk securities worldwide in the past month."

December 17 - Bloomberg (John Glover): "The cost of insuring against losses on Societe Generale SA's junior bonds jumped to the highest in more than a year amid concern it will be hurt by Russia's financial crisis. The second-biggest French lender owns Moscow-based Rosbank and has about 25 billion euros ($31bn) of exposure to the Russian economy, according to Citigroup Inc. That's equivalent to 62% of the bank's equity and the largest amount for European institutions. 'SocGen's one of the banks that's most exposed to Russia,' said Robert Montague, an analyst at ECM Asset Management... Credit-default swaps insuring SocGen's subordinated bonds rose 24 bps to 225.5 bps... That's the highest since October 2013, the data show."

December 16 - Financial Times (Christopher Adams): "Almost $1tn of spending on future oil projects is at risk after a brutal plunge in crude prices to nearly $60 a barrel, Goldman Sachs has warned. Any cancellation of these developments would deprive the world of 7.5m barrels a day of new output over the coming decade -- or 8% of current global oil demand. The findings suggest the supply glut that has sent prices tumbling could soon vanish as the oil majors delay big-ticket production projects -- the lifeblood of future petrol supplies, heating fuels and chemicals... The price plunge has shaken the energy industry, throwing some of the majors' most ambitious plans into doubt and pummelling oil company shares. Projects in challenging frontier regions like the deep waters of the Gulf of Mexico are predicated on high oil prices and may not be economic with oil at $60 a barrel..."

Geopolitical Watch:

December 19 - South China Morning Post (Teddy Ng): "China is preparing to flex its financial strength amid the economic crisis in Russia as it closely watches how the slump of the Russian rouble affects cooperation between the two countries, mainland analysts have said. They said Beijing was unlikely to send aid to Moscow, but it would boost infrastructure and investment projects to stop the collapse of the Russian economy, a result that would hurt the two nations' joint attempts to build influence in international affairs. China and Russia have both described their relationship as reaching a 'new stage' after the signing of massive cooperation deals in recent months... Companies have already started talks about building the necessary pipeline to deliver the gas. But a continued drop in the Russian economy could leave Moscow unable to complete the pipeline, and Chinese capital - possibly a concessionary loan - could be required, analysts said."

December 18 - Bloomberg: "China is aiming to purge most foreign technology from banks, the military, state-owned enterprises and key government agencies by 2020, stepping up efforts to shift to Chinese suppliers, according to people familiar with the effort. The push comes after a test of domestic alternatives in the northeastern city of Siping that was deemed a success, said the people, who asked not to be named because the details aren't public. Workers there replaced Microsoft Corp.'s Windows with a homegrown operating system called NeoKylin and swapped foreign servers for ones made by China's Inspur Group Ltd., they said. The plan for changes in four segments of the economy is driven by national security concerns and marks an increasingly determined move away from foreign suppliers under President Xi Jinping, the people said."

December 13 - Reuters (Jim Finkle): "The Federal Bureau of Investigation has warned U.S. businesses to be on the alert for a sophisticated Iranian hacking operation whose targets include defense contractors, energy firms and educational institutions, according to a confidential agency document. The operation is the same as one flagged last week by cyber security firm Cylance Inc as targeting critical infrastructure organizations worldwide, cyber security experts said. Cylance has said it uncovered more than 50 victims from what it dubbed Operation Cleaver, in 16 countries, including the United States... Cylance Chief Executive Stuart McClure said the FBI warning suggested that the Iranian hacking campaign may have been larger than its own research revealed. 'It underscores Iran's determination and fixation on large-scale compromise of critical infrastructure,' he said."

China Bubble Watch:

December 15 - Bloomberg: "What if a central bank cut interest rates and borrowing costs rose? Since the People's Bank of China surprised markets with the first benchmark rate reduction in two years on Nov. 21, the five-year sovereign bond yield climbed 15 bps, that for similar AAA corporate notes surged 35 and AA debt yields jumped 74. While finance companies did start charging less for mortgages, their funding costs rose as the one-week Shanghai interbank lending rate added 39 basis points. The PBOC move misfired as it triggered an 18% surge in the Shanghai Composite Index of shares... 'Financing costs moved in the opposite way than the central bank wished,' said Deng Haiqing, Beijing-based chief fixed-income analyst at Citic Securities Co., China's biggest brokerage. 'We don't think the call for aggressive interest rate or reserve-requirement ratio cuts are well-grounded under current circumstances, as it could fuel bubbles in stocks.'"

December 17 - Bloomberg: "Two local governments in China pulled support for bond sales by their financing vehicles in the space of a week, throwing the market into disarray. On Dec. 12, Changzhou Tianning Construction Development Co. in the eastern province of Jiangsu said it wouldn't go ahead with a 1.2 billion yuan ($194 million) planned offering after city authorities said they wouldn't support the debt... This week, officials in Urumqi in the northwestern province of Xinjiang withdrew backing for a planned 1 billion yuan sale, another U-turn. The shakeup was signaled in October when China's cabinet said that governments have no obligation to repay debt not raised for public works, raising the risk of mothballed construction and defaults in the world's second-largest economy. While a national audit showed regional liabilities swelled to 17.9 trillion yuan as of June 2013, the actual amount may be greater, China Business News reported... 'The two local governments' statements shocked investors,' said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shanghai."

December 18 - Bloomberg: "China's central bank offered short-term loans to commercial lenders as the benchmark money-market rate jumped the most in 11 months. The amount of money made available by the People's Bank of China wasn't clear... Policy makers are adding funds to the financial system to address a cash crunch as subscriptions for the biggest new share sales of the year lock up funds. Twelve initial public offerings from today through Dec. 25 will draw orders of as much as 3 trillion yuan ($483 billion), Shenyin & Wanguo Securities Co. estimated. The seven-day repurchase rate, a gauge of interbank funding availability in the banking system, surged 139 bps... to a 10-month high of 5.28%..."

December 16 - Financial Times (Gabriel Wildau): "China's once high-flying trust industry has seen its fortunes reverse this year as a slowing economy and competition for investor funds curb growth. Trust loans outstanding increased for 33 straight months through June this year, helping China's trust sector surpass the insurance industry as the largest category of financial institution by assets, behind commercial banks. But figures released on Friday showed trust loans falling for a fifth straight month, the longest run of declines since 2010. Overall trust assets, which include loans, publicly traded securities and private equity-style investments, rose at their slowest pace in over two years in the third quarter... Just a year ago, trust companies were riding a wave of growth. In 2010, as regulators tried to rein in the explosion in bank credit resulting from the country's Rmb4tn ($645bn) economic stimulus plan, banks turned to trusts to help them comply with lending controls. Trust companies bought loans from banks and packaged them into high-yielding wealth management products, which they marketed to bank clients as a higher yielding substitute for traditional savings deposits. Trust assets surged to Rmb10.3tn at the end of 2013, from just Rmb2.9tn in 2011."

December 18 - Bloomberg: "New-home prices fell in fewer Chinese cities last month after the government eased property curbs and cut interest rates for the first time since 2012, boosting demand. Prices dropped in 67 cities of the 70... Prices fell in 69 cities in October... New-home prices in the first-tier cities of Beijing, Shanghai, Shenzhen and Guangzhou all declined last month from the same period last year. 'New-home prices are dropping because the supply is much larger than the demand,' said Liu Yuan, a Shanghai-based research director for Centaline Group, China's biggest property agency. 'The market sentiment and fundamentals are not good enough to drive price up.' Property developers offering discounts to boost sales to meet year-end targets is also weighing on prices, Liu said."

December 17 - Bloomberg: "Chinese billionaire Li Shufu's Geely Automobile Holdings Ltd. said it expects full-year net income to fall about 50% from 2013 because of the slumping Russian currency and declining sales. Depreciation of the ruble resulted an unrealized foreign-exchange loss from operations in Russia, Geely said... Sales volume dropped 26% in the first 11 months of the year, led by a 49% decline in export markets..."