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Draghi Ready to Fight

A few Friday Bloomberg headlines: "Asian Stocks Jump by Most in Four Months on Stimulus Speculation;" "Japanese Stocks Surge by Most in Four Months as Bears Retreat;" "Hong Kong Dollar Jumps Most in 12 Years as Global Stocks Rally." It was quite a week.

Back in early December I posited that Mario Draghi had evolved into the world's most powerful central banker. I also stated my view that his inability to orchestrate a larger ECB QE program was likely an inflection point in the markets' confidence in Draghi and central banking more generally. Mario's not going down without a fight.

Global markets were too close to dislocating this week. Wednesday saw the S&P500 trade decisively below August lows. Japan's Nikkei 225 Index sank to test November 2014 lows. Emerging stocks fell to six-year lows, with European equities at 13-month lows. Wednesday also saw WTI crude trade below $27 (sinking almost 7%), boosting y-t-d losses to 25%. Credit spreads were blowing out, and currency markets were increasingly disorderly. Early Thursday trading saw the Russian ruble down 5.3% (at a record low vs. dollar), with Brazil's real also under intense pressure. The Hong Kong dollar peg was looking vulnerable. The VIX traded to the highest level since the August "flash crash," while the Japanese yen traded to one-year highs (vs. $). De-risking/de-leveraging dynamics were quickly overwhelming global markets.

The Italian banking sector sank 7% Wednesday, pushing y-t-d losses above 20% (down 32% from 2015 highs). Fears of mounting bad loans and undercapitalization have been weighing on Italian and European bank shares and bonds. This week also saw a notable widening of sovereign spreads to bunds. Despite a post-Draghi narrowing of risk premiums, Italian spreads to bunds widened another seven bps this week, with Portuguese spreads blowing out 35 bps. A fragile European financial sector was rapidly succumbing to a deepening global financial crisis.

January 21 - Financial Times (Claire Jones and Elaine Moore): "Mario Draghi signalled that the European Central Bank is prepared to launch a fresh round of monetary stimulus as soon as March, bolstering a recovery on US and European equities in the wake of heavy losses this year. The ECB president said it would 'review and possibly reconsider' its monetary policy stance at its next meeting in six weeks... 'We are not surrendering in front of these global factors,' he said, referring to the China slowdown and the falling oil price that have destabilised global markets in recent weeks. The ECB has 'the power, the willingness, the determination to act, and the fact that there are no limits to our action' to bring inflation up to its target of just below 2%, he added. Policymakers, he said, would 'absolutely reject' attempts to derail their efforts to raise inflation 'without undue delay'."

January 22 - Bloomberg (Roxana Zega and Alan Soughley): "European stocks posted their biggest two-day gain since October 2011 on increased investor confidence that central banks will act to support markets. The Stoxx Europe 600 Index rose 3% to 338.36 at the close of trading, taking its two-day climb to 5%."

Italian bank stocks rallied 7% Thursday on Draghi. Germany's DAX index surged 5.6% off Wednesday's lows. Stocks in Spain and Italy rallied 7% and 8%. Japan's Nikkei surged 5.88% on Friday. Overall, from Wednesday's lows the S&P500 recovered 5.5%. Crude oil enjoyed its "biggest rally in seven years" (up almost 17% from Wednesday lows).

Bloomberg adjusted its original Friday morning headline, "Global Stocks Charmed by Draghi Effect as Oil Rallies With Ruble," to "Global Stocks Charmed by Central Banks as Oil Jumps, Bonds Fall." Draghi did have some help. The People's Bank of China (PBOC) injected $61 billion of liquidity into the system, the "most in three years." China's Vice President assured the markets that Beijing will "look after" Chinese stock investors. There was also talk of added stimulus from the Bank of Japan (BOJ) and a much more dovish Fed. The markets interpreted a feistily dovish Draghi as evidence that global central bankers had assumed crisis-management mode.

The markets will now have six-weeks to ponder whether Draghi can deliver. Even assuming that he successful drags ECB hawks along, it's not easy to envisage how an additional $10 billion or so of QE will have much impact on (bursting) global Bubble Dynamics. An emphatic Draghi was, however, certainly capable of reversing global risk markets that were increasingly positioned/hedged for bearish outcomes. Over the years we've witnessed powerful short squeezes take on lives of their own, repeatedly giving the global Bubble an extended lease on life. And while bear market rallies tend to be the most spectacular, at this point I expect nothing beyond fleeting effects on the unfolding global Bubble unwind. Draghi is a seasoned pro at punishing speculators betting against Europe.

The media fixates on "corrections," "bottoms" and "bear markets." Of late, there's been some comparison of the current backdrop to previous periods, most notably 2008/09 and 2000. I have no desire to try to leapfrog other bearish commentary. My objective is always to present an analytical framework that assists in understanding the extraordinary world in which we live and operate.

Going back to 2009, I've referred to the "global government finance Bubble" as the "Granddaddy of All Bubbles." I am these days more fearful than ever that this period has indeed been the terminal phase of decades of serial Bubbles. Bubble excess made it to the heart of contemporary "money" and Credit - central bank Credit and government debt. This period also saw a historic Bubble engulf the emerging markets, including China. It encompassed stocks, bonds, derivatives and financial assets generally - virtually everywhere. Central bankers "printed" Trillions out of thin air.

Today's predicament is becoming increasingly apparent: as the current global Bubble deflates and risk aversion takes hold, there is both a lack of sources of reflationary Credit and insufficient economic growth potential necessary to inflate an even bigger reflationary global Bubble. With confidence in central banking waning and the monstrous Chinese Bubble faltering, there is confirmation in the thesis that a most prolonged period of inflationary financial Bubbles is drawing to a close.

The collapse of the Soviet Union coupled with the Greenspan Fed's push into activist central banking ushered in what was almost universally accepted as an epic victory for free-market capitalism. Too much of this was a quite powerful illusion. U.S. finance was becoming increasingly state-directed. The Fed manipulated interest-rates and the shape of the yield curve. The Washington-based GSEs moved to completely dominate mortgage Credit. The massive U.S. "too big to fail" financial conglomerates came to dictate securities and derivatives-based finance - and market-based finance monopolized the real economy. And each faltering Bubble ensured more aggressive central bank "activism" - lower rates, greater market intervention and increasingly outlandish talk of "helicopter money" and the government printing press.

With the bursting of the mortgage finance Bubble, the Fed and global central banks resorted to desperate measures - reckless "money" printing, manipulation and market liquidity backstops. Along the way, virtually the entire world adopted U.S.-style market-based finance and policymaking. The process culminated with communist China adopting U.S.-style finance. So long as inflating financial markets were supportive of central planner objectives, everyone could pretend it was a move toward free markets.

What began with Greenspan's early-nineties covert bank recapitalization evolved into Bernanke's foolish policy to openly inflate risk markets with new central bank Credit. Amazingly, U.S. inflationism took the world by storm.

The issue today goes much beyond a stock market correction, a bear market or even global financial crisis. Contemporary central banking has failed. Theories have failed. Doctrine has failed. The inability to spur self-sustaining economic recovery has been a major issue. Yet, from my perspective, the critical failure has been the incapacity to generate general price inflation. The delusion has been that central bankers would always enjoy the capacity to inflate away excessive debt levels. Bubbles needn't be feared, not with central banks "mopping" up with reflationary monetary stimulus. And for quite a while it seemed that "enlightened" contemporary inflationist doctrine had it all figured out.

Central bankers and market-based finance are a dangerous mix. Over the years, I have referred to market-based finance as the most powerful monetary policy transmission mechanism in the history of central banking. Greenspan could inflate the markets - and the entire system - with inklings of a 25 bps rate cut. Later it took Dr. Bernanke Trillions - the dawn of "whatever it takes," and markets rejoiced.

Central banks around the world abused their newfound power and the power of financial markets. And for seven years egregious monetary inflation has been used specifically to inflate global securities markets. And "shock and awe," "whatever it takes," and "push back against a tightening of financial conditions" all worked to ensure the markets that central bankers would no longer tolerate crises, recessions or even a bear market.

For seven long years, risk misperceptions and market price distortions turned progressively more severe. Inflating securities markets around the globe became, as they do, self-reinforcing. "Money" flooded into the markets - especially through ETFs and derivatives. Trillions flowed into perceived safe equities index and corporate debt instruments. With central bankers providing a competitive advantage for leveraging and professional speculation, the hedge fund industry swelled to $3.0 TN (matching the $3 TN ETF complex). Wealth effects and the loosest financial conditions imaginable boosted spending, corporate profits, incomes, investment, tax receipts and GDP - not to mention M&A, stock repurchases and financial engineering.

But this historic wealth illusion has been built on a foundation of false premises - that central bank monetization can inflate price levels and spur system inflation necessary to grow out of debt problems; that securities markets should trade at higher multiples based upon contemporary central banker capacities to spur self-reinforcing economic recovery and liquid securities markets; that 2008 was "the hundred year flood." In reality, central bankers inflated history's greatest divergence between global securities prices and economic prospects.

Global markets have commenced what will be an extremely arduous adjustment process. Markets must now confront the harsh reality that central bankers don't have things under control. Risk premiums must rise significantly - which means the destabilizing self-reinforcing dynamic of lower securities prices, faltering economic growth, uncertainty, fear and even higher risk premiums. This means major issues for global derivatives markets that have inflated to hundreds of Trillion on misperceptions and specious assumptions. I'll assume Draghi, Kuroda, Yellen, the PBOC and others resort to more QE - and perhaps they prolong the adjustment period while holding severe global crisis at bay. But the global Bubble has burst. And if QE has been largely ineffective in the past, we'll see how well it works as confidence in central banking withers. Perhaps this helps explain why global financial stocks now trade like death.


For the Week:

The S&P500 bounced 1.4% (down 6.7% y-t-d), and the Dow recovered 0.7% (down 7.6%). The Utilities increased 0.8% (up 1.3%). The Banks lost another 2.2% (down 14.8%), and the Broker/Dealers declined 1.1% (down 15.0%). The Transports rallied 1.3% (down 9.7%). The S&P 400 Midcaps gained 1.4% (down 7.9%), and the small cap Russell 2000 rose 1.3% (down 10.1%). The Nasdaq100 jumped 2.9% (down 7.3%), and the Morgan Stanley High Tech index gained 1.2% (down 8.8%). The Semiconductors surged 4.2% (down 9.8%). The Biotechs were unchanged (down 16.0%). Although bullion gained $9, the HUI gold index was little changed (down 3.9%).

Three-month Treasury bill rates ended the week at 30 bps. Two-year government yields gained three bps to 0.87% (down 18bps y-t-d). Five-year T-note yields rose two bps to 1.48% (down 27bps). Ten-year Treasury yields increased two bps to 2.05% (down 20bps). Long bond yields added a basis point to 2.82% (down 20bps).

Greek 10-year yields rose 17 bps to 8.79% (up 147bps y-t-d). Ten-year Portuguese yields surged 29 bps to a seven-month high 3.01% (up 49bps). Italian 10-year yields added a basis point to 1.57% (down 2bps). Spain's 10-year yields declined three bps to 1.72% (down 5bps). German bund yields fell six bps to 0.48% (down 14bps). French yields dropped seven bps 0.80% (down 19bps). The French to German 10-year bond spread narrowed one to 32 bps. U.K. 10-year gilt yields rose five bps to 1.71% (down 25bps).

Friday's spectacular 5.88% rally cut the weekly loss for Japan's Nikkei equities index to 1.1% (down 10.9% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.22% (down 4bps y-t-d). The German DAX equities index rallied 2.3% (down 9.1%). Spain's IBEX 35 equities index gained 2.1% (down 8.6%). Italy's FTSE MIB index declined 0.9% (down 11.2%). EM equities were mixed. Brazil's Bovespa index was down 1.4% (down 12.3%). Mexico's Bolsa rallied 1.9% (down 3.2%). South Korea's Kospi index was unchanged (down 4.2%). India's Sensex equities index was little changed (down 6.4%). China's Shanghai Exchange recovered 0.5% (down 17.6%). Turkey's Borsa Istanbul National 100 index fell 1.2% (down 2.1%). Russia's MICEX equities index surged 6.8% (down 2.5%).

Junk funds saw outflows of a sizable $2.0bn (from Lipper). Notably, investment-grade bond funds saw their ninth consecutive week of outflows ($412 million).

Freddie Mac 30-year fixed mortgage rates dropped 11 bps to 3.81% (up 18bps y-o-y). Fifteen-year rates fell nine bps to 3.10% (up 17bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down six bps to 3.87% (down 41bps).

Federal Reserve Credit last week expanded $5.3bn to $4.456 TN. Over the past year, Fed Credit declined $11.5bn, or 0.3%. Fed Credit inflated $1.645 TN, or 59%, over the past 167 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week dropped another $11.1bn to a nine-month low $3.266 TN. "Custody holdings" were down $18.5bn y-o-y, or 0.6%.

M2 (narrow) "money" supply surged $137bn to a record $12.469 TN. "Narrow money" expanded $769bn, or 6.6%, over the past year. For the week, Currency increased $3.5bn. Total Checkable Deposits dropped $134.8bn, while Savings Deposits jumped $198.7bn. Small Time Deposits were unchanged. Retail Money Funds rose $69.8bn.

Total money market fund assets were little changed at $2.743 TN. Money Funds rose $39bn y-o-y (1.4%).

Total Commercial Paper gained $6.3bn to $1.052 TN. CP expanded $42bn y-o-y, or 4.2%.

Currency Watch:

January 19 - Bloomberg (Saijel Kishan Dominic Lau): "Hong Kong dollar forwards sank to their weakest level this century, interbank loan rates jumped the most in seven years and the Hang Seng Index tumbled as China's market turmoil fueled speculation the city's 32-year-old currency peg will end."

January 20 - Bloomberg (Arif Sharif, Matthew Martin and Chiara Albanese): "Pressured by plunging oil prices and costly wars in the Middle East, Saudi Arabia moved to stamp out speculation that it might be forced to break the link between its currency and the dollar. Authorities this week ordered banks to limit traders' ability to bet against the riyal, whose peg to the dollar has been a bulwark of the kingdom's economic and financial stability since its introduction three decades ago. Officials aimed 'to kill this speculative activity over the sustainability of the riyal peg,' Apostolos Bantis, a credit analyst at Commerzbank AG, said... 'Over time, this measure will lead to an easing of the forwards because it will make it far more risky for investors to do this trade.'"

January 22 - Wall Street Journal (Carolyn Cui): "A number of emerging markets are taking a risky approach to dealing with growing pressure on their currencies: They're trying to ban it. Oil-dependent Azerbaijan said this week it would slap a 20% tax on any transaction that takes money out of the country. Saudi Arabia told banks with branches imposed spending limits on credit and debit cards denominated in foreign currency. The capital controls are aimed at deterring or slowing the outflow of money and reducing the downward pressure on currencies that traders are betting have farther to fall. But they also risk exacerbating the problem by driving away foreign investors who bristle at limitations on the flow of capital and hurting businesses that need to hedge. 'It's a sign of economic weakness and a dramatic shift in terms of trade, and it also increases the risk premium because of the policy uncertainty,' said George Hoguet, global investment strategist at State Street Global Advisors, which has about $2.4 trillion of assets under management."

January 17 - Bloomberg: "China is stepping up efforts to counter speculative bets against the nation's currency, through imposing reserve requirements on yuan deposits held on the mainland at offshore participant banks. The move follows pledges by Chinese officials to maintain a stable exchange rate, and a squeeze in interbank funds in Hong Kong that saw borrowing costs in yuan in the city soar to a record last week. Premier Li Keqiang... said that there was 'no basis for a continued depreciation of the yuan exchange rate.'"

The U.S. dollar index added 0.6% this week to 99.53 (up 0.9% y-t-d). For the week on the upside, the Canadian dollar increased 2.9%, the Australian dollar 2.0%, The South African rand 1.9% and the Norwegian krone 1.1%. For the week on the downside, the Japanese yen declined 1.5%, the Swiss franc 1.5%, the euro 1.1%, the Brazilian real 1.1% and the Mexican peso 1.0%. The Chinese yuan was little changed versus the dollar.

Commodities Watch:

The Goldman Sachs Commodities Index rallied 4.0% (down 6.9% y-t-d). Spot Gold gained 0.8% to $1,098 (up 3.5%). March Silver rose 0.8% to $14.02 (up 1.6%). March WTI Crude rallied $2.58 to $29.67 (down 13%). February Gasoline jumped 4.8% (down 15%), and February Natural Gas increased 0.6% (down 9%). March Copper recovered 3.0% (down 6%). March Wheat increased 0.4% (up 1%). March Corn gained 2.0% (up 3%).

Fixed-Income Bubble Watch:

January 18 - Bloomberg (Michelle Kaske): "Puerto Rico said the island's financial situation is worsening and increased estimates of how much the commonwealth will fall short of being able to make debt payments over the next decade to $23.9 billion. Revenue will fall short of covering principal and interest payments each year through 2025, according to an updated fiscal and economic growth plan... The payment deficit over the next five years has widened to an estimated $16.06 billion, up from a $14 billion forecast in September."

January 20 - Bloomberg (Fion Li): "The number of issuers that had credit ratings cut by Standard & Poor's in 2015 rose to the highest in six years... S&P last year downgraded 892 issuers, representing 69% of all ratings actions, according to a report... That's the most since 2009, when it downgraded 1,325 issuers, or 83% of total actions. Downgrade potential remains under historical averages, S&P said. 'While we expect further deterioration in global credit markets, we do not see a particularly disruptive or abrupt acceleration, despite a backdrop of financial and market volatility in recent weeks,' S&P analysts including Diane Vazza and Sudeep Kesh wrote... The impact of a slowdown in China has been 'more pronounced with respect to market volatility than a rapid, lower revision of our ratings on global corporate issuers,' they wrote."

January 22 - Bloomberg (Cordell Eddings, Michelle Davis and Fion Li): "When credit markets were booming, investors snatched up longer-term bonds from energy and mining companies, among others. They may have made a big mistake. Some $117 billion of the securities maturing in 10 years or more could be cut to junk by the end of 2017, strategists at UBS Group AG estimate, more than twice the amount currently outstanding in that market... Owning long-term bonds that get cut to junk could be especially painful for investors -- many of the current holders will have to sell them, and few junk bond portfolio managers want to take the risk of lending to speculative-grade borrowers for more than a decade... 'It's going to be a massive issue to contend with,' said Bank of America Corp. strategist Michael Contopoulos."

Global Bubble Watch:

January 21 - Wall Street Journal (Tom Fairless and Jon Hilsenrath): "Central banks in the U.S., Europe and Japan face renewed pressure to keep interest rates low or expand easy-money policies in response to gyrating stock markets, tumbling oil prices and slow growth in China and elsewhere. In a telling example, European Central Bank President Mario Draghi sent a strong signal Thursday he is prepared to launch additional monetary stimulus in March... 'We don't give up,' Mr. Draghi said... 'We are not surrendering in front of these global factors.' In Japan, calls are increasing for Bank of Japan Gov. Haruhiko Kuroda to launch new stimulus measures as early as next week, with Japan's economy sputtering and inflation near zero... The ECB's 25-member governing council was unanimous in underlining its 'power, willingness and determination to act" against persistently low inflation, Mr. Draghi said, and that 'there are no limits to our action, within our mandate of course.'"

January 22 - The Economist: "Along with bank runs and market crashes, oil shocks have rare power to set monsters loose. Starting with the Arab oil embargo of 1973, people have learnt that sudden surges in the price of oil cause economic havoc. Conversely, when the price slumps because of a glut, as in 1986, it has done the world a power of good. The rule of thumb is that a 10% fall in oil prices boosts growth by 0.1-0.5 percentage points. In the past 18 months the price has fallen by 75%, from $110 a barrel to below $27. Yet this time the benefits are less certain. Although consumers have gained, producers are suffering grievously. The effects are spilling into financial markets, and could yet depress consumer confidence. Perhaps the benefits of such ultra-cheap oil still outweigh the costs, but markets have fallen so far so fast that even this is no longer clear."

January 19 - Reuters: "Politicians and business leaders gathering in the Swiss Alps this week face an increasingly divided world, with the poor falling further behind the super-rich and political fissures in the United States, Europe and the Middle East running deeper than at any time in decades. Just 62 people, 53 of them men, own as much wealth as the poorest half of the entire world population - or 3.6 billion people - according to a report released by anti-poverty charity Oxfam."

January 20 - Bloomberg (Pavel Alpeyev): "SoftBank Group Corp. dropped for the fourth straight day after shares of Sprint Corp., the U.S. wireless carrier it controls, fell to multiyear lows on growing pessimism about the the company's ability to pay down debt. SoftBank dropped as much as 2.2%..., the lowest level since April 2013. Sprint closed 7.2% down in New York at the lowest in more than two years. Its bonds led declines among junk-rated debt Wednesday. Billionaire Masayoshi Son has struggled to turn around Sprint since the purchase of a controlling stake in 2013... SoftBank's market value had already dropped by 1.74 trillion yen ($14.8bn) before today's trading. Sprint's $1.5 billion of 7% bonds due 2020 plunged 8.25 cents on the dollar to 60.75 cents..."

U.S. Bubble Watch:

January 20 - Bloomberg (Fion Li and Aleksandra Gjorgievska): "A measure of investor fear of junk-bond defaults is set to turn in its biggest jump at the start of a year since 2009... The risk premium on the Markit CDX North American High Yield Index, a credit-default swaps benchmark tied to the debt of 100 speculative-grade companies, surged 94 bps between Dec. 31 and Wednesday, reaching 564 bps, the highest level since 2012. That jump was the biggest since the start of 2009, when it rose 227 bps. A similar index for investment-grade debt also rose to a three-year high... Exchange-traded funds that hold U.S. junk bonds slid to their lowest levels in almost seven years."

January 21 - Reuters (Trevor Hunnicutt): "Investors yanked $5.2 billion from stock mutual funds in the United States during the sharply volatile week that ended Jan. 20, Lipper data showed..., marking three consecutive weeks of outflows... High-yield junk bond funds were at the epicenter of the market anxiety, and they posted $2 billion in outflows, their third straight week not taking in net new money... Investors pulled $412 million from taxable-bond funds during the weekly period, Lipper said, a relatively small figure but one that nonetheless delivered the funds their ninth straight week of withdrawals. Altogether, taxable-bond funds have bled $42.3 billion over their nine-week streak of outflows... Investors have pulled $25.6 billion from U.S. stock funds over the last three weeks..."

China Bubble Watch:

January 18 - Financial Times (Gabriel Wildau and Tom Mitchell): "The flow of capital out of China and other emerging markets was significantly worse than previously thought in 2015, according to new estimates. In a report... the ... Institute of International Finance said outflows increased as overseas investors pulled out of emerging markets and Chinese companies scrambled to pay off overseas loans in the final three months of the year amid a weakening renminbi. Emerging markets saw an estimated $735bn in net capital outflows last year with all but $59bn of that coming from China. In October, the global finance industry group had predicted 2015 would see net outflows from emerging markets of $540bn, the first since 1988."

January 19 - Reuters (David Stanway): "China's output of electric power and steel fell for the first time in decades in 2015, while coal production dropped for a second year in row, illustrating how a slowing economy and shift to consumer-led growth is hurting industrial consumers. China's economy grew at its weakest pace in a quarter of a century in 2015 and efforts to restructure have not only slashed demand but also exposed massive overcapacity in industrial sectors such as coal, steel and power."

January 18 - Reuters (Nathaniel Taplin): "Chinese brokers are directing large amounts of capital fleeing China's tumbling stock market into high-yielding private debt, aiding embattled corporates but also raising risks for buyers including mutual funds, trusts and ultimately retail investors... Newly announced private placements - high-yielding bonds sold directly to institutional investors in one-to-one deals - were more than 60 billion yuan ($9.12bn) in November on the Shanghai exchange alone, more than the total new corporate debt issued in both Shanghai and Shenzhen as recently as April. Shanghai-listed placements were up 450% on the year in October and November, and accounted for a third of all bond listings... In such a yield-scarce environment, private placements typically yield a highly attractive 6 to 9%."

January 21 - Bloomberg: "China's central bank cranked up cash injections in its money-market operations for the third week in a row, heading off a squeeze as a seasonal jump in demand for funds coincides with surging capital outflows. The People's Bank of China added 400 billion yuan ($61bn) to the financial system using reverse-repurchase agreements, the most in three years, bringing net injections via its various lending tools for the month to more than 1 trillion yuan..."

January 21 - Bloomberg (Tracy Alloway): "Here is the Hong Kong Stock Exchange Hang Seng China Enterprises Index, recently falling below 8,000 -- a crucial trigger point for a type of structured product known as an autocallable. According to a Citigroup analysis, a 'substantial amount of autocallables will be knocked in if the HSCEI falls below 8,000. In particular, these knock-in strikes are concentrated below 7,600 and 8,000 and then a larger concentration around 7,300.' The knocking-in of autocallables has the undesirable effect of producing losses for retail investors who bought the products to bet on the direction of Asian stocks and who now face losing a chunk of their principal. It also triggers a potential wave of turmoil at the banks that sold the products. 'The problem really comes about with the hedging of the products, especially around the knock-in as the issuer becomes short vol[atility] at the worst time,' Citi says, meaning banks need to buy volatility just as markets are in turmoil, and doing so becomes more expensive."

January 19 - Bloomberg (Ye Xie): "By almost all measures, China's $3.3 trillion foreign reserves, the world's largest, look formidable. Except one. Compared with the amount of yuan sloshing around in the economy, a proxy for potential capital outflows, China's firepower seems limited. The dollar reserves account for 15.5% of M2, a broad measure of money in circulation. That's the lowest since 2004 and is less than levels in most Asian economies including Thailand, Singapore, Taiwan, Philippines and Malaysia... It is not to say all the money will leave China -- people need yuan to buy clothes, pay rent and fill up the gas tank."

Brazil Watch:

January 21 - Bloomberg (Filipe Pacheco): "Bailing-out state-controlled oil producer Petroleo Brasileiro SA could cost the government as much as $21 billion, according to research from Citigroup... That would be the amount necessary to plug the company's cash hole and fix the capital structure on a sustainable basis were oil to fall to $20 for 12 months, Citigroup credit analysts including Eric Ollom wrote... The company, with $127 billion of bonds and loans, could see its ratio of net debt to earnings before items rise to what Citi called an 'unsustainable level' of 6.5 times. Petrobras, as the company is known, slashed its 2015-2019 investment plan by 24% last week..."

EM Bubble Watch:

January 19 - Wall Street Journal (Ian Talley and Anjani Trivedi): "Underlying this month's market turmoil runs a deeper worry that mounting debt burdens in developing nations, particularly in Asia and Latin America, threaten to become a drag on global growth. Across the emerging world, concerns are rising about how well indebted companies will weather further turbulence. Ratings firms are accelerating corporate-debt downgrades and borrowing costs are climbing. Investors are pulling out of risky assets that looked appealing in better times. A net half-trillion dollars is estimated to have flowed out of developing countries last year... After years of powering the global economy, emerging markets are caught between fading growth and tighter lending conditions, squeezing their private sectors, which had borrowed heavily during an era of low rates. The fallout from any debt defaults can spread fast: Foreign banks have lent $3.6 trillion to companies in emerging markets, and foreign investors hold, on average, 25% of local debt in developing economies."

January 19 - Bloomberg (Kenneth Kohn): "Investors pulled more than $2.1 billion out of U.S. exchange traded funds that invest in emerging markets last week, the most since August. China and Hong Kong led the losses."

January 19 - Bloomberg (Javier Blas): "In the days of the commodity boom a few years ago, oil-rich nations and their petrodollar wealth were the darlings of the World Economic Forum. A panel that included Kuwaiti, Saudi and Russian sovereign-wealth fund officials was one of the hottest tickets at Davos in January 2008, just before oil prices surged to $150 a barrel. It was a time when crude producers were accumulating billions of dollars in debt and equities, plus real estate, sports teams and other trophy assets... Now, with oil below $30 a barrel, the situation has reversed. Instead of buying U.S. Treasuries, British department stores and French soccer teams, producing countries are selling, helping depress already-spooked markets. Only a handful of wealth-fund heads are scheduled to appear at the 2016 annual forum of the rich and powerful. And not one panel is devoted to the topic."

January 22 - Financial Times (Andres Schipani and Elaine Moore): "Farmers brought parts of Uruguay to a standstill this week demanding the government help them recover unpaid bills from Venezuela in the latest sign that the crisis-ravaged South American country may soon renege on it debts. In spite of Venezuela's socialist president Nicolás Maduro reassuring bond investors that he will make good on more than $10bn of payments this year, economists say default is 'practically inevitable' as prices for oil, the Caribbean country's lifeblood, plummet. Crude oil accounts for 96% of export revenues and falling prices, coupled with years of mismanagement, have crushed the country's economy. A sell-off in sovereign bonds has pushed the price on benchmark 2026 debt to 37 cents in the dollar, a level considered a precursor to default."

Leveraged Speculation Watch:

January 20 - Bloomberg (Will Wainewright): "Investors withdrew more money from hedge funds than they added between October and December in the industry's first quarterly net outflow in four years... Investors pulled a net $1.52 billion from the $2.9 trillion industry in the fourth quarter of last year, ...Hedge Fund Research said... The typical hedge fund lost 1% in 2015, even after rising 0.8% in the fourth quarter... Investors are 'looking for strategies that will help preserve capital' in a volatile market environment, Hedge Fund Research president Ken Heinz said..."

January 20 - Bloomberg (Simone Foxman and Katherine Burton): "As U.S. stocks extend their losses, some of the biggest decliners are companies popular with hedge funds. Of the year's 100 worst-performing companies larger than $1 billion as of Jan. 19, more than half are at least 10% owned by hedge funds, and 17 are at least 25% owned by such funds.

January 20 - Bloomberg (Katherine Chiglinsky): "Fannie Mae plunged below $1 a share, falling for a seventh straight trading day. The mortgage-finance company, which operates under U.S. conservatorship, declined 10% to 99 cents..., compared with a peak closing price last year of $3.31."

Europe Watch:

January 21 - UK Guardian (Stephanie Kirchgaessner): "Italy's beleaguered banking sector has been boosted after the European Central Bank and the Italian prime minister sent soothing messages to anxious investors. Shares in Italy's troubled banking sector recovered on Thursday following weeks of freefall, after the ECB president Mario Draghi said there were no plans to demand tougher provisions to cover the country's bad debt pile. Italy's banks have some €201bn in non-performing loans (NPLs) which are unlikely ever to be paid back and which are restraining the country's sluggish economic recovery by putting a brake on the release of new credits. However, the Italian leader, Matteo Renzi, underscored the ECB's positive comments to help buoy shares in the country's largest banks. 'The situation is much less serious than the market thinks,' Renzi told reporters..., adding that his economy minister was 'working miracles' trying to find a solution with Brussels to Italy's bad loan problem."

January 20 - Reuters (Giovanni Legorano): "The increased levels of bad loans confronting the Italian banking system is raising investors' concerns about the health of the sector, prompting another selloff in local banking stocks... According to data published Tuesday by Italy's banking lobby ABI, Italian banks' gross bad loans, measured at their face value, stood at EUR201 billion in November, 11% higher than the same period a year prior. Gross bad loans were 10.4% of total loans in November, the highest percentage figure since 1996."

January 20 - CNBC: "Billionaire financier George Soros has warned that the European Union is on the 'verge of collapse' over the migrant crisis and is in 'danger of kicking the ball further up the hill' in its management of the issue which has seen more than a million migrants and refugees arrive in the region in 2015. In an interview with the New York Review of Books, Soros added that the German Chancellor Angela Merkel is key to solving the crisis...'There is plenty to be nervous about,' the financier said. 'As she (Merkel) correctly predicted, the EU is on the verge of collapse. The Greek crisis taught the European authorities the art of muddling through one crisis after another. This practice is popularly known as kicking the can down the road, although it would be more accurate to describe it as kicking a ball uphill so that it keeps rolling back down.'"

Japan Watch:

January 21 - Reuters (Hideyuki Sano): "Renewed turmoil in global markets is beginning to erode investor confidence in Japanese Prime Minister Shinzo Abe's pledge to revitalize the economy through his massive 'Abenomics' stimulus program. Doubts over the efficacy of Abe's cocktail of monetary easing, fiscal stimulus and structural reforms have been growing for several months as the world's third-largest economy fails to motor on and inflation remains a long way off the Bank of Japan's 2% goal... 'The perception on Abenomics is changing,' said Tomoichiro Kubota, senior market analyst at Matsui Securities. 'It has been boosting share prices essentially by working on expectations. But after all expectations were just expectations.'"

Geopolitical Watch:

January 17 - Reuters (James Pomfret, Matthew Miller and Ben Blanchard): "Taiwan should abandon its 'hallucinations' about pushing for independence, as any moves towards it would be a 'poison', Chinese state-run media said after a landslide victory for the island's independence-leaning opposition. Tsai Ing-wen and her Democratic Progressive Party (DPP) won a convincing victory in both presidential and parliamentary elections on Saturday, in what could usher in a new round of instability with China, which claims self-ruled Taiwan as its own. Tsai pledged to maintain peace with its giant neighbour China, while China's Taiwan Affairs Office warned it would oppose any move towards independence and that Beijing was determined to defend the country's sovereignty... But the official Xinhua news agency also warned any moves towards independence were like a 'poison' that would cause Taiwan to perish. 'If there is no peace and stability in the Taiwan Strait, Taiwan's new authority will find the sufferings of the people it wishes to resolve on the economy, livelihood and its youth will be as useless as looking for fish in a tree,' it said."

January 21 - Washington Post (Simon Denyer): "It's hard not to see it as a response, of sorts, to Taiwan's elections. Days after Taiwanese voters elected the leader of a pro-independence party to the president's office, China's military announced that a unit based opposite Taiwan had carried out live firing drills and mock landing exercises. Separately, thousands of trolls from mainland China jumped over the Great Firewall to flood the Facebook page of Taiwan's next president, Tsai Ing-wen, with hostile comments. The Chinese government has responded warily to Tsai's election, saying it wants good relations with an island it considers part of its sovereign territory. But it also demands Tsai embrace the idea that there is only 'one China' and renounce any notion that Taiwan could one day declare formal independence."


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