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Bubbles, Money and the VIX

February 10 - Financial Times (John Authers): "The Importance of Bubbles That Did Not Burst:"

"Is there really such a thing as a market bubble? I feel almost heretical answering this question. I and most readers have lived through two decades that were dominated by two vast investment bubbles and the attempt to deal with their consequences when they burst. Getting into definitions is beside the point. As US Supreme Court Justice Potter Stewart once said to define pornography: 'I know it when I see it.' And there is no point in arguing that the dotcom bubble that came to a head in 2000, or the credit bubble that burst seven years later, were not bubbles. I know a bubble when I see one, and they were bubbles. For those of my generation, spotting bubbles before they get too big, and thwarting them, seems to be vital for regulators and investors alike."

"But in a great new compendium on financial history, several writers make the same points. The number of bubbles in history is very small. That makes it hard to draw any valid inferences from them. Further, definition is a real problem, and not just one for linguistic nitpickers. History's acknowledged bubbles all have one critical factor in common; they burst. But that gives us a one-sided view. We need to look at those bubbles that did not burst and the crises that did not happen."

We're at the stage where there's impassioned pushback against the Bubble Thesis. To most, it's long been totally discredited. Even those sympathetic to Bubble analysis now question why the current backdrop cannot be sustained. "The number of bubbles in history is very small." Most booms did not burst. So why then must the current boom end in crisis - when most don't? It has become fashionable for writers to try to convince us that such an extraordinary backdrop need not end extraordinarily.

There's great confusion that I wish could be clarified. I define Bubbles generally as "a self-reinforcing but inevitably unsustainable inflation." There are numerous types of Bubbles. Most definitions and research (as was the case with the analysis cited by the FT's Authers) focus specifically on asset prices ("an extreme acceleration in share prices. In one version, [Yale's Will Goetzmann] required them to double in a year -- which excluded the dotcom bubble and the Great Crash of 1929. To keep them in, he also tried a softer version where stocks doubled in three years").

Behind every consequential Bubble is an inflation in underlying Credit. My analysis focuses on the nature of the monetary expansion responsible for the asset inflation. I'm less concerned with P/E ratios and valuation than I am Credit expansions and the nature of risk intermediation. Earnings are important, but more critical to the analysis is the degree to which they (and "fundamentals" more generally) are being inflated by monetary factors - and whether such inflation is sustainable or susceptible.

Credit Dynamics are key. Mr. Authers refers to the "dot.com" and "Credit" Bubbles. Yet the nineties Bubble was fueled by extraordinary expansions in GSE Credit, securitizations and corporate debt. Internet stocks inflated spectacularly, but in the grand scheme of the Bubble were rather inconsequential. The Bubble faltered initially in 2000 with the sharp reversal in technology stocks. Less embedded in memory is the near breakdown in corporate Credit back in 2002. The resulting aggressive Fed-induced reflation then spurred a doubling of mortgage Credit in just over six years. The transformation of risky Credit into perceived safe money-like securities ("Wall Street Alchemy") was integral to both "tech" and "mortgage finance" Bubble periods. The fact that dot.com price inflation and overvaluation greatly exceeded that of home prices is meaningless.

When I initially titled my weekly writings the "Credit Bubble Bulletin" back in 1999, I anticipated that "Bubble" would remain in the title only on a short-term basis. And indeed, I thought the Bubble had burst in 2000/2001 and then again in 2008. But in both instances Credit Dynamics and resurgent monetary inflation made it clear to me that a more powerful Bubble had reemerged. Whether one prefers to date the beginning of the Great Credit Bubble 1992, 1987 or even 1971, it's been inflating now for quite a long time. Too be sure, the expansion of government Credit over the past eight years puts mortgage Credit and other excesses to shame. I would argue that price distortions and risk misperceptions similarly overshadow those from the mortgage finance Bubble period.

Of course, the vast majority have become convinced that the boom is sustainable. Indeed, analysis these days is eerily reminiscent of "permanent plateau" jubilation from 1929. The bullish perspective sees an improving global economy and a powerful pro-growth agenda unfolding in the U.S. Worries about debt, China and such matters have turned stale. A contrary argument focuses on Credit Dynamics and the unsustainability of today's unique monetary and market backdrops.

Over the years, I've made the point that a Bubble financed by junk bonds would not create a systemic issue. There are, after all, limits to the demand for high-risk debt. Long before such a boom could go to prolonged and dangerous extremes (imparting deep structural maladjustment), investors would shy away from increasingly unattractive Credit issued in clear excess. The boom would lose its monetary fuel.

I define contemporary "money" as a financial claim perceived as a safe and liquid store of (nominal) value. Money these days is Credit, but a special type of Credit. Unlike junk bonds, "money" enjoys essentially insatiable demand. As such, a boom fueled by "money" is a quite different animal than our above junk bond example. I would posit that a prolonged inflation of perceived safe "money" by its nature ensures far-reaching risk distortions. For one, Bubbles fueled by "money" appear especially sustainable, while a prolonged inflation of "money" virtually ensures a destabilizing crisis of confidence. Governments throughout history have abused money. Contemporary central bankers took it to a whole new level.

I referred to the "Moneyness of Credit" throughout the mortgage finance Bubble period, a boom financed largely by "AAA" money-like MBS, ABS and "repo" Credit. Back in 2009, with the arrival of enormous expansions of central bank Credit and fiscal deficits coupled with the Fed's reflationary policies targeting the securities markets, I proffered the "global government finance Bubble" and the "Moneyness of Risk Assets."

I understand the rationality of complacency. I appreciate that confidence runs high that this boom need not end badly. Those willing to bet on central banks have won, repeatedly. "Money" - to the tune of Trillions - has flowed with great abundance to managers and fund structures programmed to disregard risk. The consensus view holds that huge amounts of buying power await a market dip. Moreover, only "dips" at this point would side against the mighty bull.

There's no mystery why the VIX ended the week near ten-year lows. And I don't believe, as explained by an analyst on Bloomberg television, that improved global economic fundamentals explain unusually low implied equities market volatilities (VIX). The VIX clearly does not reflect global political and geopolitical uncertainties. Instead, it's more a reflection of robust global "money" and Credit growth and the perception that central bankers will ensure ongoing monetary inflation while backstopping global securities markets. With impatient dip buyers and central bankers not about to allow pullbacks to gain momentum, why not write put options and other derivative market "insurance"? Selling flood insurance during a drought. Central bankers have promised abundant liquidity and persistent loose financial conditions, while placing a floor under stock prices and a ceiling over market yields.

Returning to John Authers, when it comes to the current Bubble backdrop, I take exception to "I know it when I see it." It's the nature of Bubbles that the more conspicuous they appear the less systemic their impact. I point to the example of the conspicuous "tech" Bubble and much more systemic Bubble in "mortgage finance." Even in the craziness of 2006 and early-2007, the truth of the matter is that few at the time recognized the Bubble.

Today's Bubble is global, and it resides at the very heart of contemporary electronic "money." This means, as we've already witnessed, that it can inflate almost indefinitely, at the discretion of a small group of central bankers and so long as their Credit is readily accepted. It's unique in financial history, the consequence of the runaway global experiment in unfettered "money" and Credit. Even after tens of Trillions of issuance, the demand for central bank Credit ("money") and (money-like) government debt is today as insatiable as ever. The downside is that this prolonged Bubble has inflated most assets across the globe. It has evolved to be deeply systemic on a global basis, with unprecedented distortions in risk perceptions and asset prices more generally.

There's a reason why crises tend to erupt in the money markets. Panic quickly ensues when markets suddenly sense their perceived safe and liquid holdings are at risk. The VIX is low today because of the perception that global financial institutions remain flush with liquidity, buoyed by rising asset prices, and under the safekeeping of central bankers and government officials. The perception of moneyness pervades "repo" markets, and robust repo and securities financing markets convey easy access to liquidity for securities dealers and derivative players. The VIX is low because of extraordinary confidence in counterparties and the functioning of derivatives markets more generally. The VIX is low based on faith that Beijing will backstop China's entire over-heated Credit system.

It's worth recalling that a year ago bank stocks were under intense pressure around the world. For example, from 2015 highs to 2016 lows, Japanese stocks dropped almost 50%. Similar losses were shared by banks throughout Asia and Europe. Especially in early-2016, fears were mounting that a Credit crisis in China could unleash financial and economic stress around the globe. As a weak link in global finance, European banks were feeling the contagion. In short, there was heightened nervousness that risk was seeping back into the international daisy-chain of various bank liabilities. "Moneyness" - a now global phenomenon - was in jeopardy.

Well, "whatever it takes" - from strong-handed Chinese officials, from the inflationist BOJ and ECB, and from a dovish Fed - nipped potential crisis in the bud. Promises of a couple Trillion additional QE crushed global yields and kept the game going. Markets have inflated significantly over the past year. What will central banks do for an encore?

It is a principal thesis of Bubble Analysis that, once commenced, monetary inflations turn progressively difficult to control. Credit inflations raise myriad price levels throughout the economy and asset markets. Especially after years of inflating asset and securities markets, it will not be possible for global central bankers to walk away from QE without major consequences. The world is currently at peak QE, with major uncertainties surrounding future operations.

Europe, in particular, has begun to fret the effects of waning QE. I've highlighted the recent significant rise in sovereign yields in Portugal, Italy, Spain and Greece. I've noted the major widening of spreads between French and German bonds yields.

This week saw European bank stocks sink 2.4%. It's worth highlighting the performance of the major French banks, with BNP Paribas (down 8.9%), Societe Generale (down 7.6%) and Credit Agricole (down 7.1%) posting notable declines. Italian Banks were slammed 5.1%, increasing y-t-d losses to 6.6%. UniCredit led the list of widening bank CDS, followed by Banco Santander and Intesa Sanpaulo.

Similarly concerning, European sovereign spreads continued to widened. Safe haven German bund yields dropped nine bps to a five-week low 0.32%. The France to Germany 10-year yield spread widened seven to 74 bps, the widest going all the way back to tumultuous 2012. Italy's spread widened 10 to 195 bps, trading this week at the widest level since early-2014. Spain was 11 wider to 138 bps, the widest since last June.

U.S. bank stocks also lagged this week's market rally. But with Chinese and Asian banks enjoying strong gains, it might be too early to make much out of the return of European bank concerns. Yet it does have to start somewhere. ECB policies have encouraged Europe's banks to (again) load up on government bonds at incredibly inflated prices. Now what?

Here in the U.S., markets this week took comfort in a relatively well-contained President Trump. He greeted Japanese Prime Minister Abe with a big, warm hug. He sent a letter to Chinese President Xi, stating that his Administration would honor the "One China" policy. While perhaps somewhat mollified by his correspondence, Chinese leadership must be deeply suspicious of Trump's zeal for chumming around with Shinzo (Abe). But at least for now, our President was trying to get along with (most) folks. Markets got along well with the idea of "phenomenal" tax cuts.


For the Week:

The S&P500 added 0.8% (up 3.5% y-t-d), and the Dow gained 1.0% (up 2.6%). The Utilities rose 0.8% (up 1.0%). The Banks were unchanged (up 1.5%), while the Broker/Dealers added 0.6% (up 8.0%). The Transports jumped 1.6% (up 3.9%). The S&P 400 Midcaps (up 3.6%) and the small cap Russell 2000 (up 2.3%) both gained 0.8%. The Nasdaq100 advanced 1.3% (up 7.5%), and the Morgan Stanley High Tech index jumped 1.6% (up 8.9%). The Semiconductors were little changed (up 6.2%). The Biotechs gained 1.0% (up 8.5%). With bullion gaining $13, the HUI gold index rose 3.2% (up 20%).

Three-month Treasury bill rates ended the week at 53 bps. Two-year government yields slipped a basis point to 1.19% (unchanged y-t-d). Five-year T-note yields declined two bps to 1.89% (down 4bps). Ten-year Treasury yields fell five bps to 2.41% (down 4bps). Long bond yields gained three bps to 3.12% (up 5bps).

Greek 10-year yields fell 17 bps to 7.26% (up 24bps y-t-d). Ten-year Portuguese yields declined six bps to 4.12% (up 37bps). Italian 10-year yields added a basis point to 2.27% (up 46bps). Spain's 10-year yields gained two bps to 1.70% (up 32bps). German bund yields dropped nine bps to 0.32% (up 12bps). French yields declined two bps to 1.06% (up 38bps). The French to German 10-year bond spread widened seven to 74 bps. U.K. 10-year gilt yields fell 10 bps to 1.26% (up 2bps). U.K.'s FTSE equities index rose 1.0% (up 1.6%).

Japan's Nikkei 225 equities index jumped 2.4% (up 1.4% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.1% (up 5bps). The German DAX equities index was little changed (up 1.6%). Spain's IBEX 35 equities index declined 0.9% (up 0.3%). Italy's FTSE MIB index fell 1.3% (down 1.9%). EM equities were mixed. Brazil's Bovespa index gained 1.8% (up 9.8%). Mexico's Bolsa rose 1.2% (up 4.7%). South Korea's Kospi was about unchanged (up 2.4%). India's Sensex equities index added 0.3% (up 6.4%). China's Shanghai Exchange rose 1.8% (up 3.0%). Turkey's Borsa Istanbul National 100 index declined 1.0% (up 11.9%). Russia's MICEX equities index dropped 2.9% (down 3.2%).

Junk bond mutual funds saw inflows of $442 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates dipped two bps to 4.17% (up 52bps y-o-y). Fifteen-year rates also declined two bps to 3.39% (up 44bps). The five-year hybrid ARM rate fell two bps to 3.21% (up 38bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 4.27% (up 59bps).

Federal Reserve Credit last week added $1.6bn to $4.417 TN. Over the past year, Fed Credit contracted $29.8bn (down 0.7%). Fed Credit inflated $1.606 TN, or 57%, over the past 222 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $3.8bn last week to $3.169 TN. "Custody holdings" were down $98bn y-o-y, or 3.0%.

M2 (narrow) "money" supply last week fell $16.8 billion to $13.282 TN. "Narrow money" expanded $795bn, or 6.4%, over the past year. For the week, Currency increased $0.2bn. Total Checkable Deposits declined $10.4bn, and Savings Deposits dipped $3.8bn. Small Time Deposits were little changed. Retail Money Funds slipped $2.6bn.

Total money market fund assets declined $3.2bn to $2.677 TN. Money Funds declined $79bn y-o-y (2.9%).

Total Commercial Paper was about unchanged at $965bn. CP declined $112bn y-o-y, or 10.4%.

Currency Watch:

The U.S. dollar index rallied 0.9% to 100.8 (down 1.6% y-t-d). For the week on the upside, the Brazilian real increased 0.3%, the Mexican peso 0.1% and the British pound 0.1%. For the week on the downside, the Norwegian krone declined 1.9%, the Swedish krona 1.7%, the New Zealand dollar 1.7%, the euro 1.3%, the Danish krone 1.3%, the Swiss franc 0.9%, the Singapore dollar 0.8%, the Japanese yen 0.5%, the South African rand 0.5%, the Canadian dollar 0.5%, the South Korean won 0.3% and the Australian dollar 0.1%. The Chinese yuan declined 0.16% versus the dollar (up 1.0% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index gained 1.9% (up 2.3% y-t-d). Spot Gold rose 1.1% to $1,234 (up 7.1%). Silver surged 2.6% to $17.93 (up 12.2%). Crude added three cents to $53.86 (up 0.1%). Gasoline recovered 2.3% (down 4.9%), while Natural Gas slipped 0.9% (down 18.9%). Copper surged 5.8% (up 10.4%). Wheat jumped 4.4% (up 10%). Corn gained 2.5% (up 6.4%).

Trump Administration Watch:

February 10 - Fitch Rating: "The Trump Administration represents a risk to international economic conditions and global sovereign credit fundamentals, Fitch Ratings says. US policy predictability has diminished, with established international communication channels and relationship norms being set aside and raising the prospect of sudden, unanticipated changes in US policies with potential global implications. The primary risks to sovereign credits include the possibility of disruptive changes to trade relations, diminished international capital flows, limits on migration that affect remittances and confrontational exchanges between policymakers that contribute to heightened or prolonged currency and other financial market volatility."

February 5 - Wall Street Journal (Nick Timiraos): "For an economy that isn't in recession, the U.S. is facing one of the bleakest fiscal outlooks since World War II. One question that President Donald Trump will soon have to decide: How much is he willing to embrace even wider deficits? ...Before Mr. Trump does anything, growing budget deficits are already on a course to push federal debt to record levels as a share of gross domestic product. That will make it extremely difficult to make good on promises to cut taxes and boost spending without spilling more red ink. Unlike past periods, deficits are swelling not because of an economic downturn or a short-term boost in discretionary spending, but because of the costs of caring for an aging population... Ten years ago, some 6,700 Americans turned 65 every day. The number is now 9,800 Americans, and it will rise to 11,700 by 2026."

February 8 - Politico (Rachael Bade and Josh Dawsey): "President Donald Trump wants to rebuild the nation's roads and bridges, boost military spending, slash taxes and build a 'great wall.' But Republicans on Capitol Hill have one question for him: How the heck will we pay for all of this? GOP lawmakers are fretting that Trump's spending requests, due out in a month or so, will blow a gaping hole in the federal budget... Trump has signaled he's serious about a $1 trillion infrastructure plan, as he promised on the campaign trail. He also wants Republicans to approve extra spending this spring to build a wall along the U.S. southern border and beef up the military -- the combined price tag of which could reach $50 billion, insiders say. And that's to say nothing of tax cuts, which the president's team has suggested need not necessarily be paid for. Trump, meanwhile, has made clear he has little interest in tackling the biggest drivers of the national debt: entitlements."

February 7 - Bloomberg (Steven T. Dennis and Elizabeth Dexheimer): "President Donald Trump's pledge to dismantle the Dodd-Frank financial overhaul is colliding with the same reality as his pledge to gut Obamacare: The Republican majority in Congress can't decide how to make it happen and Democrats are vowing to fight. Trump, who last month said Obamacare would be replaced 'the same day or the same week' or perhaps 'the same hour,' acknowledged Sunday that the health-care law isn't going away anytime soon. 'We should have something within the year and the following year,' told Fox News's Bill O'Reilly. The Dodd-Frank directive he signed Friday is hitting the same road block on Capitol Hill and at federal agencies."

China Bubble Watch:

February 8 - Financial Times (Gabriel Wildau): "China's central bank has quietly raised interest rates and tightened liquidity in recent days, fuelling speculation that the government's policy focus has shifted from stimulating growth to addressing the risk from rising corporate debt. But economists say the recent rate rises are primarily aimed at deflating financial asset bubbles -- especially in the bond market. Analysts still expect lending to increase rapidly this year, as authorities seek to ensure a strong economy in the run-up to a crucial leadership transition in November. At the same time, President Xi Jinping wants to ensure that the bond bubble does not explode spectacularly in an echo of the 2015 stock market bust."

February 9 - Wall Street Journal (Rachel Rosenthal and Anjie Zheng): "Chinese companies are increasingly stepping in as lenders, as banks reduce their funding to struggling industries and the country's mammoth bond market comes under strain. Company-to-company loans in China jumped by 20% last year to 13.2 trillion yuan ($1.92 trillion), according to research firm CEIC... This entrusted lending, so named because banks serve as middlemen, is now the fastest-growing major component of the country's elaborate system of informal, or shadow, banking. The most recent surge came during the selloff in China's $9.3 trillion bond market late last year. Big, cash-rich companies--mostly state-owned enterprises and some private companies--stepped in: New entrusted loans rose to 405.7 billion yuan ($59.02 billion) in December, more than double the month prior, ...the highest monthly issuance in two years."

February 7 - Bloomberg (Justina Lee): "China's doors to foreign investors may be opening ever wider, but that's not enough for many worried about finding an exit. Fourteen months after qualifying for official reserve-currency status, and after a series of steps opening up domestic markets to overseas funds, the take-up remains below estimates. For all China's attraction as the second-largest economy with large and expanding domestic capital markets, regulators' efforts to tamp down on outflows of money have stoked concerns. 'There's no return lower than not getting your money back,' Brad Holzberger, chief money manager of QSuper... said... 'We're worried about understanding the transparency of decision making -- as well as property rights, rule of law, transmission of capital controls and those sorts of things.'"

February 9 - Reuters (Jake Spring): "China vehicle sales in January fell by the largest margin since 2015 for several global automakers, with General Motors Co and Ford Motor Co blaming the roll back of a tax cut on small-engined vehicles and the Lunar New Year holiday. Ford Motor said... its sales fell 32% year-on-year, while GM said sales dropped 24%... Toyota recorded a 18.7% drop in January sales, its largest decline since March 2015."

Global Bubble Watch:

February 8 - Bloomberg (Birgit Jennen, Alessandro Speciale and Rainer Buergin): "Germany has abandoned a renewed effort to push the Group of 20 to rein in monetary stimulus, according to people familiar with the matter. German officials failed to convince counterparts that the G-20 should support language backing tighter monetary policy to promote global financial resilience, the people said... Germany had drafted it in a document as part of its presidency of the group this year, and will host finance chiefs next month in the spa town of Baden-Baden."

February 9 - Reuters: "Germany's central bank is bringing home gold reserves stored in places like New York and Paris faster than planned... Stashed away at the height of the Cold War in safe havens well out of Moscow's reach, the 3,378-tonne, 120 billion-euro gold stockpile has become a symbol of Germany's economic ascent and a guardian of its stability. But with Europe stumbling from crisis to crisis, the German public has grown uneasy about keeping the gold abroad. Some even argue the world's second biggest bullion reserve may be needed to back a new deutschmark, should the euro zone break up."

February 6 - Wall Street Journal (Min Zeng): "Political uncertainty in Europe sent investors piling into the harbor of U.S. Treasury bonds, German bunds and the U.K. gilts as government debt in France, Italy, Spain and Greece sold off. The yield on the 10-year French government bond rose to the highest since September 2015, with its premium relative to the 10-year German bund, the benchmark for debt markets in the eurozone, widening to the highest level since November 2012."

February 8 - Financial Times (Thomas Hale): "The European Central Bank now holds more than €1.5tn of assets, which it has bought as part of purchases designed to kick-start the continent's economy. Late last year, it announced it would extend purchases at the end of March, albeit reducing the rate from €80bn to €60bn a month. The scale of these purchases has dominated prices in credit markets across Europe, from government debt to covered bonds. But how have European markets been changed by the ECB, and how will they react if and when its dominance begins to recede? 'There are not many debt markets that are not distorted in the euro area,' says Joost Beaumont, an analyst at ABN Amro... One of the most significant distortions created from bulk buying of government bonds and other high quality debt has shown up in Europe's repo market, a key part of the continent's financial plumbing. Government bonds are used as collateral for repurchase or 'repo' trades -- secured short-term loans between banks, investors and other market participants."

February 7 - Financial Times (Elaine Moore and Robin Wigglesworth): "The advance of anti-euro politicians is prompting some eurozone investors to do something they have not felt the need to do for several years: pay close attention to the fine print of bond documents. As politicians calling for an exit from the European Economic and Monetary Union garner support in Italy, France and the Netherlands, concern over which euro-denominated sovereign bonds may be most at risk from a potential switch back into former national currencies is gradually becoming a talking point. Although eurozone government debt sold since January 2013 cannot be redenominated without bondholder approval, more than half the current €7tn in outstanding debt does not carry this safeguard clause."

February 5 - Financial Times (Claire Jones, Javier Espinoza and Tom Hancock): "Chinese overseas deals worth almost $75bn were cancelled last year as a regulatory clampdown and restrictions on foreign exchange caused 30 acquisitions with European and US groups to fall through. The figures, which reveal a sevenfold rise in the value of cancelled deals from about $10bn in 2015, highlight a waning appetite for global dealmaking by the world's second-largest economy. But despite more deals being abandoned, ...Chinese direct investment into the US and Europe still more than doubled to a record $94.2bn in 2016."

Brexit Watch:

February 7 - Financial Times (Jim Brunsden, Alex Barker and Claire Jones): "Europe's leading central bankers are at loggerheads over one of the biggest economic judgments facing the continent: does a disorderly Brexit pose a financial stability risk? Mark Carney, Bank of England governor, fears a messy and severe Brexit could be a 'Jenga' moment that leads to the collapse of the legal architecture the underpins financial flows, hurting the City of London's European customers even more than the UK itself. Mario Draghi, meanwhile, is largely unfazed. The European Central Bank chief has told negotiators from the remaining 27 EU nations that he is unworried about a highly mobile financial services industry that is used to adapting to new circumstances... Mr Carney's argument centres on hedging. The fear is that without a post-Brexit market access deal, European banks and businesses would find it harder to tap Europe's dominant derivatives market located in the City and find essential products to manage their balance sheet risks."

Europe Watch:

February 8 - Wall Street Journal (Ian Talley): "The International Monetary Fund warned... that Greece once again risks a eurozone exit amid stalled bailout talks, sending the clearest signal yet the emergency lender isn't likely to soon rejoin Europe's failed efforts to fix the debt-weary nation. Fund officials said Athens and its European creditors must agree to much deeper economic overhauls and substantial debt relief before the fund considers contributing another cent. Two fund documents made public Tuesday reveal deep-seated skepticism that Europe's latest financing program can fix the broken economy. Both the IMF's annual review of Greece's economy and a scathing assessment of its own second bailout to the deeply ailing economy underscore a third fund package is unlikely soon."

February 8 - Financial Times (Jim Brunsden): "After months out of the spotlight, Greece's international bailout programme is working its way back up bond traders' list of worries. Yields on Greek sovereign debt are sharply up, reflecting concerns about splits between the eurozone and International Monetary Fund over the future of the programme and the sense that in an election-heavy year for Europe, the political window for an agreement is closing. Amid warnings from Athens that it will reject 'the IMF's absurd demands' and disagreements this week within the fund's executive board, eurozone finance ministers are under pressure to deliver a breakthrough at their next meeting on February 20. Greece's international creditors, namely eurozone governments and the IMF, have markedly different opinions about the country's economic situation and how to make its debt load manageable."

February 7 - Reuters (John Geddie): "Investors in cash-strapped Greece appear to be losing faith in a pledge from European officials five years ago that the country's default would be a one-off. It was partly the strength of that promise that allowed Greece to make one of the fastest returns to markets of any defaulted sovereign, taking money from private investors in 2014 just two years after it had imposed hefty writedowns. The rationale for those who bought the bonds was simple: public creditors, which have lent Athens hundreds of billions of euros, but were spared in the 2012 restructuring, would have to take the next hit. Yet just months before the first instalment of the new debt falls due on July 17, a three-way quarrel between Greece, the EU and the International Monetary Fund, has triggered a fall in prices that suggests that logic might be flawed."

February 7 - Reuters (Valentina Za): "The head of Italy's bank-bailout fund said... the country lacked a clear strategy for shifting 356 billion euros ($381bn) in problem loans. In an extraordinary outburst from a man picked by Rome to help tackle the problem, Alessandro Penati... said he felt 'bitter and disillusioned'. His comments exposed tensions within the banking sector over Italy's rescue efforts. 'There is no clear vision of the problem and no strategy,' Penati said..., suggesting that he was virtually working alone on rescues that had revealed 'horror stories' within some banks."

February 9 - Associated Press (Colleen Barry): "Italian bank UniCredit announced a heavy fourth-quarter loss Thursday of 13.6 billion euros ($14.5bn) as its new CEO moved to fortify the firm by cleaning up its portfolio of soured loans. Italy's largest bank by assets, UniCredit said that it incurred 13.2 billion euros in one-off expenses, which included a previously announced 8.1-billion-euro write-off on bad loans plus other charges such as contributions to an Italian fund to save weaker banks."

February 7 - Bloomberg (Eleni Chrepa and Ian Wishart): "Greece's two-year note yields neared 10% as a quarrel between the nation's creditors over its fiscal targets boosted concern the country is running out of time to complete yet another review of its bailout program before Europe gears up for a busy election season beginning in March."

February 7 - Bloomberg (David Goodman, Sid Verma, and Anooja Debnath): "'The consequences of a bad outcome may be severe.' Some would call that an understatement. Marco Valli, the chief euro-area economist at UniCredit SpA in Milan, was reflecting on the chances of an upset in one of this year's three major elections in Europe. The votes hold the real -- albeit unlikely -- prospect of installing at least one leader devoted to dragging her country out of both the single currency and the European Union. In the shadow of surprise victories for Donald Trump and the campaign for Britain to leave the EU, that's throwing up a raft of new challenges for investors."

February 7 - Financial Times (Claire Jones): "The president of the Bundesbank has decried US accusations that Germany is a currency manipulator, highlighting the risk of a clash between Washington and Berlin over Donald Trump's protectionist rhetoric. Jens Weidmann rejected as 'more than absurd' US claims that Germany was deliberately weakening the euro to boost exports, stepping up a war of words between Europe and the US over trade. His criticism echoes an attack by Mario Draghi in Brussels on Monday, where the European Central Bank president pushed back on a range of Washington's policies, from protectionism to plans to weaken financial regulation."

February 5 - Reuters (Ingrid Melander): "France's far-right party leader Marine Le Pen... told thousands of flag-waving supporters chanting 'This is our country!' that she alone could protect them against Islamic fundamentalism and globalization if elected president in May. Buoyed by the election of President Donald Trump in the United States and by Britons' vote to leave the European Union, Le Pen's anti-immigration, anti-EU National Front (FN) hopes for similar populist momentum in France. In 144 'commitments' published on Saturday, Le Pen says she would drastically curb migration, expel all illegal migrants and restrict certain rights now available to all residents, including free education, to French citizens. An FN government would also take France out of the euro zone, hold a referendum on EU membership, and slap taxes on imports and on the job contracts of foreigners."

ECB Watch:

February 5 - Financial Times (Patrick McGee): "German finance minister Wolfgang Schäuble has blamed the European Central Bank for an exchange rate that is 'too low' for Germany, following criticism last week from US president Donald Trump's top trade adviser. Mr Schäuble acknowledged... that the ECB had to set monetary policy for the eurozone as a whole, but said: 'It is too loose for Germany.' 'The euro exchange rate is, strictly speaking, too low for the German economy's competitive position... When ECB chief Mario Draghi embarked on the expansive monetary policy, I told him he would drive up Germany's export surplus...I promised then not to publicly criticise this [policy] course. But then I don't want to be criticised for the consequences of this policy.'"

February 6 - Bloomberg (Jeff Black and Jonathan Stearns): "Mario Draghi took the Trump administration to task, addressing recent assertions that Germany is a currency manipulator and warning against the rollback of post-crisis financial regulation. ...The European Central Bank president responded to the charge by U.S. National Trade Council Director Peter Navarro and others that Germany is using a 'grossly undervalued' euro to gain an unfair trade advantage. 'The ECB has not intervened in the foreign exchange markets since 2011,' Draghi told European Union lawmakers... 'Germany has a significant bilateral trade surplus with the U.S., a material current account surplus, but it has not engaged in persistent one-sided intervention in the foreign exchange market.'"

Fixed-Income Bubble Watch:

February 8 - Financial Times (Eric Platt): "Investors are piling into some of the riskiest bonds sold by US companies as they bet on President Donald Trump delivering on his promises of a stronger economy, lower taxes and less regulation. Demand for junk-rated bonds has driven yields on debt with the lowest quality credit rating down towards 10% as more than $10bn has flowed into funds that invest in the asset class since the start of December. Borrowings by triple-C rated groups, among the lowest tier of the high-yield universe, have risen nearly two-thirds from a year earlier when the average yield for this part of the junk market peaked at 21.7%... The current market rally has allowed the extension of credit to riskier borrowers at appealing terms, with high-yield groups raising a total of $41bn in the US so far this year... the greatest amount for a comparable period since 2013, according to Dealogic."

February 5 - Financial Times (Robin Wigglesworth): "The US bond market is succumbing to the advances of passive investing, with exchange traded funds and index-trackers now controlling more than a fifth of the fixed-income market -- and rising fast. ETFs have proven increasingly popular over the past decade, and absorbed more than $1bn a day globally last year... The shift towards passive investing is most advanced in equities, with now nearly 40% of US equity assets under management in the hands of ETFs and index-tracking funds. But there has been a similar but accelerating trend in the US bond market in recent years, pushing the share of passive vehicles to more than 20% of the total..."

U.S. Bubble Watch:

February 10 - Wall Street Journal (Sarah Krouse): "Indexing pioneer Vanguard Group has climbed to $4 trillion in assets for the first time, accentuating a loss of faith among investors in traditional money managers who handpick stocks. The record of $4.048 trillion, reached at the end of January, follows a year when Vanguard's funds pulled in more new money than all of its competitors combined, according to one industry total. Of the $533 billion of net flows into all mutual funds and exchange-traded funds last year, 54%, or $289 billion, went to funds managed by Vanguard, according to... Morningstar Inc. The fund company's own tally for the year was even higher, at $322.8 billion."

February 9 - Bloomberg (Prashant Gopal): "Home price gains accelerated in the fourth quarter, with increases reported in 89% of U.S. metropolitan areas, as competition heated up for a record-low supply of listings... The median price of an existing single-family home rose from a year earlier in 158 of the 178 areas measured... In the third quarter, 87% of metropolitan areas had price increases. Thirty-one regions had gains of 10% of more in the three months through December, up from 25 in the third quarter."

February 7 - CNBC (Diana Olick): "Rising mortgage rates, bigger jumps in home prices and still-moderate income growth are adding up to a triple threat for the housing market this spring. Home affordability fell to the lowest level in seven years at the end of 2016, and the ingredients for a reversal are not there anytime soon. It now takes 22.2% of median income to make the monthly principal and interest payment on the median priced home, according to... Black Knight Financial Services, which based the measure on borrowers using a 30-year fixed mortgage. That monthly payment on the median-priced home increased 10% in the fourth quarter alone..."

February 6 - Reuters (Megan Davies and Tenzin Pema): "A fiscal boost to the United States is more likely in 2018 than this year, according to Goldman Sachs economists, as 'the balance of risks is somewhat less positive' one month into the new year and as U.S. President Donald Trump's growth-boosting agenda could be offset by negative effects of restrictions on trade and immigration. Following the election, the positive shift in sentiment among investors suggested that the probability of tax cuts and easier regulation was higher than the probability of meaningful restrictions to trade and immigration... However, one month into the year, the balance of risk is 'somewhat less positive in our view.'"

February 8 - Wall Street Journal (Jesse Newman and Patrick McGroarty): "The Farm Belt is hurtling toward a milestone: Soon there will be fewer than two million farms in America for the first time since pioneers moved westward after the Louisiana Purchase. Across the heartland, a multiyear slump in prices for corn, wheat and other farm commodities brought on by a glut of grain world-wide is pushing many farmers further into debt. Some are shutting down, raising concerns that the next few years could bring the biggest wave of farm closures since the 1980s. The U.S. share of the global grain market is less than half what it was in the 1970s. American farmers' incomes will drop 9% in 2017... extending the steepest slide since the Great Depression into a fourth year. 'You keep pinching and pinching and pretty soon there's nothing left to pinch,' said Craig Scott, a fifth-generation farmer in this Western Kansas town."

February 7 - Bloomberg (Sho Chandra): "The U.S. trade deficit widened last year to the biggest since 2012 as exports fell more than imports, though a narrowing gap in December suggests demand is stabilizing overseas for American goods. For all of 2016, the deficit increased 0.4% to $502.3 billion..."

Federal Reserve Watch:

February 6 - Bloomberg (Jeanna Smialek): "Federal Reserve Bank of Philadelphia President Patrick Harker said the U.S. central bank's March meeting is a live option for an interest rate increase if job market momentum holds up, growth continues and wages rise. 'March is on the table. I would never take a meeting off the table, it depends on how the data evolve,' Harker... told reporters... John Williams, his colleague from San Francisco and a non-voter this year, told Bloomberg last week that he sees the next meeting as a possible rate-hike candidate."

February 9 - Bloomberg (Steve Matthews and Matthew Boesler): "Federal Reserve Bank of St. Louis President James Bullard said the central bank ought not rush to raising interest rates next month because uncertainty over the Trump administration's fiscal policies clouds the U.S. economic outlook. 'It is unlikely that fiscal uncertainty will be meaningfully resolved by the March meeting, which is only a few weeks away,' Bullard, who doesn't vote on policy this year, told reporters... 'Why not wait until that gets resolved?'"

February 6 - Bloomberg (Liz McCormick and Matt Scully): "Almost a decade after it all began, the Federal Reserve is finally talking about unwinding its grand experiment in monetary policy. And when it happens, the knock-on effects in the bond market could pose a threat to the U.S. housing recovery. Just how big is hard to quantify. But over the past month, a number of Fed officials have openly discussed the need for the central bank to reduce its bond holdings... The talk has prompted some on Wall Street to suggest the Fed will start its drawdown as soon as this year, which has refocused attention on its $1.75 trillion stash of mortgage-backed securities. While the Fed also owns Treasuries as part of its $4.45 trillion of assets, its MBS holdings have long been a contentious issue, with some lawmakers criticizing the investments as beyond what's needed to achieve the central bank's mandate. Yet because the Fed is now the biggest source of demand for U.S. government-backed mortgage debt and owns a third of the market, any move is likely to boost costs for home buyers."

February 6 - Reuters (Howard Schneider): "Loan officers at U.S. banks reported largely unchanged lending standards and slightly looser terms for business loans in the last three months of 2016, the Federal Reserve reported... in a quarterly survey. About a third of the 69 institutions surveyed, however, said they had 'tightened somewhat' the standards for commercial real estate construction and land development loans, and close to a fifth had tightened standards on loans secured by multifamily properties."

EM Watch:

February 9 - Bloomberg (Nacha Cattan and Michelle Davis): "Mexico's central bank raised borrowing costs for a fourth straight meeting as President Donald Trump's election undermined the peso and fuel prices soared, sending inflation spiraling above target. Banco de Mexico... increased the key rate by 50 bps to 6.25%, more than twice the level of December 2015."

Leveraged Speculation Watch:

February 7 - Wall Street Journal (Chris Dieterich): "The biggest short bets just keep going wrong. The 50 stocks in the S&P 500 that hedge funds are shorting most often rallied 6% last month, while the benchmark index itself rose just 1.8%, according to... Credit Suisse. It's the continuation of a brutal trend. Last year, the 50 stocks that show up the most frequently in hedge fund short books rose 37%, the biggest wrong-way move since Credit Suisse began tabulating the data in 2013. These strategies took it on the chin last year, as the average long/short hedge fund fell 3.4% in 2016. They managed a 1.3% gain in January, according to Credit Suisse."

Geopolitical Watch:

February 6 - Wall Street Journal (Gerald F. Seib): "In a recent conversation, former Defense Secretary Robert Gates ticked off four areas most likely to produce the first national-security crisis for the new Trump administration: a confrontation with Iran in the Persian Gulf, a showdown with North Korea over its nuclear program, a clash with China in the South China Sea or an encounter with Russia in the Baltic Sea. The risk with China and Russia, he said, is of an 'unintended incident that escalates.' The danger with Iran and North Korea, by contrast, is an intentional provocation or challenge. As Team Trump begins just its third full week in office, confrontation with Iran has clearly moved to the top of that list of early potential flashpoints."

February 8 - Reuters (Ben Blanchard): "The United States needs to brush up on its history about the South China Sea, as World War Two-related agreements mandated that all Chinese territories taken by Japan had to be returned to China, Chinese Foreign Minister Wang Yi said... China has been upset by previous comments from the new U.S. administration about the disputed waterway. In his Senate confirmation hearing, Secretary of State Rex Tillerson said China should not be allowed access to islands it has built there. The White House also vowed to defend 'international territories' in the strategic waterway."

February 5 - New York Times (Jane Perlez): "China reacted with strong displeasure on Saturday to a promise by Defense Secretary Jim Mattis that the United States would defend two uninhabited islands in the East China Sea that Japan controls but China also claims as its own. Mr. Mattis, the first member of President Trump's cabinet to visit East Asia, had told Japanese officials earlier Saturday that America's defense obligations to Japan extended to the disputed rocky outposts, known in China as the Diaoyu and in Japan as the Senkaku. The chief spokesman for China's Foreign Ministry, Lu Kang, accused Mr. Mattis of putting regional stability at risk and urged him to forgo what he called a Cold War mentality."


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