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Subprime and Short Vol

February 6 - Wall Street Journal (Spencer Jakab): "Only very rarely has a trade gone from being so good to being so bad so quickly. Among the most profitable trades during the bull market has been to short volatility, essentially betting the market would get calmer and stay calm. An exchange-traded instrument, the VelocityShares Daily Inverse VIX Short-Term exchange-traded note, grew to $2 billion by harnessing futures on the Cboe Volatility Index. The note, with the symbol XIV, had a 46% compound annual return from its inception in 2010 to two weeks ago. Late on Monday, though, the combined value of the note fell 95% to less than $15 million as trading was halted early Tuesday... The product contained the seeds of its own destruction. By selling short futures on the Cboe Volatility Index, or VIX, it profited in two ways in the recent market calm. It took advantage of the typical 'contango' present in the market -- longer-dated futures tended to be higher-priced than VIX itself and fall in value. Constantly rolling over the position to sell more distant futures was a moneymaker. Another was simply profiting from volatility falling to near record lows."

The collapse of two Bear Stearns structured Credit funds in July 2007 marked a critical (mortgage finance) Bubble inflection point. These funds were highly leveraged in (mainly "AAA") collateralized debt obligations (CDOs), as well as being enterprising operators in Credit default swaps (CDS). It was essentially a leveraged play on the relatively stable spread between subprime mortgage yields and market funding costs. It all worked splendidly, so long as stability was maintained in the subprime mortgage marketplace. This strategy blew up spectacularly when confidence in subprime began to wane (rising delinquencies) and lenders to Bear Stearns (and others) turned skittish. Liquidity in subprime-related securities evaporated almost overnight.

About everyone downplayed the relevance of subprime. It was a "small" insignificant market. U.S. economic fundamentals were robust, while cracks had yet to become visible either in prime mortgages or U.S. housing more generally. Indeed, the decline in market yields heading into 2008 worked for a while to support home and asset prices, including an equities market rally and a new record high for the S&P500 in October 2007.

Missing in the analysis was the critical role structured finance had assumed throughout the mortgage marketplace, especially late in the cycle. CBBs during the mortgage financial Bubble period focused often on "The Moneyness of Credit" and "Wall Street Alchemy." Literally Trillions of risky mortgages were being transformed into perceived safe and liquid "AAA" securities. Sophisticated risk intermediation fundamentally altered demand dynamics for high-risk loans.

Perceived money-like subprime securities enjoyed virtually insatiable demand in the marketplace, providing prized high-yield fodder for a late-cycle manic episode of leveraged speculation. And so long as sophisticated risk intermediation was running hot, there remained readily available inexpensive mortgage Credit to sustain home price inflation and system liquidity more generally. It became of case of the greater the quantity of risky loans intermediated through Wall Street's sophisticated structures - the lower the cost and the greater the liquidity in the booming market for mortgage risk "insurance". With readily available cheap insurance, why not aggressively speculate and leverage?

Finance flooded into structured products, with 2006 seeing a staggering $1.0 TN of subprime-related CDO issuance. The insatiable demand for these higher-yielding instruments ensured even the weakest Credits (devoid of down-payments) would bid up home prices across the country. And years of housing inflation ensured risk model forecasts of minimal future loan losses - and "AAA" ratings galore. In a critical Bubble "Terminal Phase" dynamic, Credit Availability loosened dramatically as borrowing costs declined - ensuring a final precarious "blow-offs" in Credit, home inflation and asset price more generally. In the end, the parabolic expansion of systemic risk created untenable demands on the financial system and risk intermediation, in particular.

Underpinning mortgage finance Bubble Dynamics was the deeply held market view that Washington (the Fed, Treasury, GSEs and Congress) would never tolerate a housing bust. This perception ensured the GSEs would continue to insure mortgages and borrow at risk-free rates despite the reality that they were effectively insolvent. It was this deeply embedded perception and the booming prime mortgage marketplace that over time cultivated all the nonsense that unfolded in subprime structured finance. The Washington backstop ensured that unlimited cheap Credit remained readily available even after years of mounting excess. The resulting "Moneyness of Credit" nurtured major pricing distortions in Trillions of securities.

For nine long years now, CBB analysis has posited "the global government finance Bubble," "The Moneyness of Risk Assets" and the "Granddaddy of all Bubbles" theses. I believe the Bubble has likely been pierced. The spectacular blowup of all these "short vol" products is a replay of subprime in the summer of 2007 - just so much bigger and consequential. The "insurance" marketplace has badly dislocated, concluding for now the environment of readily available cheap market protection.

Structured finance was instrumental in ensuring the marginal subprime buyer could access the means to keep the Bubble inflating, even in the face of inflated home prices increasingly beyond affordability. These days, all these structured volatility products have been key to enormous pools of "money" chasing inflated securities prices increasingly detached from reality.

A Paradox of Dysfunctional Contemporary Finance: The higher home prices inflated (and the greater systemic risk) the cheaper it became to "insure" mortgage Credit risk. More recently, the higher stock prices have inflated (and the greater systemic risk), the cheaper it has been to "insure" equities market risk. These highly distorted "insurance" markets became instrumental in attracting the marginal source of finance fueling late-stage "Terminal Excess" throughout the risk markets.

Variations of these "short vol" strategies have essentially been writing flood insurance during a prolonged drought. Key to it all, global central bankers for the past nine years have been intently controlling the weather.

In the mortgage finance Bubble post-mortem, the Fed convinced itself that bad bankers and weak regulation of mortgage lending were the villains. In reality, the overarching issue was found within the financial markets: confidence that policymakers were backstopping the markets fomented price distortions, self-reinforcing speculative excess and untenable leverage. Failing to learn the critical lesson from the Bubble period, radical post-crisis monetary policymaking fostered the perception that equities and corporate Credit were safe and liquid money-like instruments ("Moneyness of Risk Assets"), in the process profoundly transforming market demand, price and speculative dynamics.

Importantly, activist reflationary policymaking ensures that speculative leveraging becomes a prevailing source of liquidity throughout the markets and in the overall economy. When de-risking/de-leveraging dynamics took hold in 2008, a deeply maladjusted system immediately became starved of liquidity. Dislocation (spike in pricing and illiquidity) in the "insurance" markets - subprime in 2007 and equities in early-2018 - marked a critical juncture in risk-taking, leveraging and overall system liquidity.

February 7 - Bloomberg (Dani Burger): "For a fledgling asset class whose idiosyncrasies are understood by few, there sure is a lot of money swirling around in volatility trades. Investment strategies and products married to market swings were thrust front and center by the worst market meltdown in seven years, in which the Cboe Volatility Index surged to its highest level since 2015. VIX-related securities were halted, volatility-targeting quants blamed, and options trading in benchmarks for turbulence ballooned. Too big to ignore, it's an asset class in its own right, with the might to push around the broader market. Getting a grip on it has confounded strategists and managers alike... There are two categories of securities linked to price turbulence, roughly speaking: ones tied to the VIX directly, and others that take their cue from the volatility of individual stocks. Altogether, estimates for the space are anywhere from $1.5 trillion to $2 trillion. Beyond that is the options market, which itself is an implicit bet on swings in shares."

Things turn crazy near the end of major Bubbles - and The Bigger the Crazier: One Trillion of subprime CDO issuance (2006) and today's "anywhere from $1.5 trillion to $2 trillion" of volatility trades is some real financial insanity. The Fed's strategy has been to aggressively reflate and entrust "macro-prudential" regulation for safeguarding financial stability. Why has there been zero effort to regulate the proliferation of highly leveraged "short vol" products?

It was an extraordinary week that offered overwhelming support for the Bubble thesis. In particular, the risk market "insurance" marketplace was in fact an accident waiting to happen. Moreover, today's Bubble is very much a global phenomenon.

The S&P500 sank 5.2% this week. Yet this pales in comparison to the Shanghai Composite's 9.6% drubbing. Hong Kong's Hang Seng Index fell 9.5%, with the Hang Seng Financials down 12.3%. Equities were bloodied throughout Asia. Japan's Nikkei 225 index sank 8.1%. Stocks were down 7.8% in Taiwan and 6.4% in South Korea. European equities were under pressure as well. Germany's DAX dropped 5.3%, France's CAC 40 5.3%, Spain's IBEX 5.6%, and Italy's MIB 4.5%. In Latin American equities, Brazil fell 3.7%, Mexico 5.2%, Argentina 7.6% and Chile 4.8%.

U.S. equities mounted a decent Friday afternoon rally, with the S&P500 (reversing an almost 2% inter-day decline) ending the session with a gain of 1.5%. Perhaps the U.S. market recovery will spark a Monday reversal in Asia and Europe. With option expiration next Friday, it would not be uncharacteristic for a market rally to pressure recent buyers of put protection into expiration. It also wouldn't be all too surprising to see some players ready to sell an elevated VIX with the first semblance of stability. It's worked so many times in the past.

It was an extraordinary week in several respects: the VIX traded as high as 50, intense selling of equities across the globe and a meaningful widening of high-yield corporate Credit spreads. Considering the spike in equities volatility, the corporate debt market held together reasonably well (certainly bolstered by ongoing large ETF inflows). Investment-grade CDS did jump to five-month highs. Junk bond funds suffered outflows of $2.743 billion, helping along with the VIX spike to spark the biggest jump in high-yield CDS in about a year. Global bank CDS moved higher this week (from compressed levels), led not surprisingly by Deutsche Bank and some of the other major European lenders. The GSCI Commodities index sank 6.1%, with crude down $6.25, silver falling 3.4% and copper sinking 4.8%.

Curiously, the Treasury market is struggling to live up to its safe haven billing. Notably, in all the market mayhem, 10-year Treasury yields actually added a basis point to 2.85% (up 45bps y-t-d). Long-bond yields rose seven bps to 3.16%. German bund yields gave up only two bps this week, with yields still up 32 bps y-t-d. So not only did the cost of market "insurance" hedges spike higher, Treasury holdings this week did not provide their traditional hedging function. This made it an especially rough week for "risk parity" and other leveraged strategies that have relied on a Treasury allocation to help mitigate portfolio risk.

The risk versus reward calculus has rather quickly deteriorated for risk-taking and leveraging. Markets have turned much more volatile and uncertain - equities, fixed-income, currencies and commodities. The cost of market "insurance" has spiked, the Treasury market safe haven attribute has been diminished and various market correlations have increased, certainly including global equities markets. "Risk Off" has made a rather dramatic reappearance. How much leverage is lurking out there in global securities and derivatives markets?

Next week is tricky. I would generally expect at least an attempt at a decent rally prior to options expiration. But at the same time, my sense is that market players are especially poorly positioned for the unfolding "Risk Off" backdrop. A break of this week's trading lows would likely see another leg down in the unfolding bear market. And with derivatives markets already stressed, major outflows from the ETF complex would be challenging for less than liquid markets to accommodate.

It took about 15 months from the collapse of the Bear Stearns structured Credit funds in 2007 to the market crisis in the fall of 2008. Many still believe that crisis was completely avoidable had the Fed intervened to save Lehman. Yet it was much more of an issue of Trillions of dollars of mispriced securities, dysfunctional risk intermediation, enormous accumulated financial and economic risks, and the inevitability of the financial system's inability to sustain the necessary quantities of new Credit to keep the Bubble inflating (following parabolic "terminal" excesses).

Similar issues overhang financial systems and economies today, but on an unprecedented global scale. The Treasury market is a glaring difference between 2018 and 2007. After trading as high as 5.30% in June 2007, 10-year Treasury yields sank to 3.84% by November. Fed funds were at 5.25% throughout the summer of 2007, with the Fed slashing rates 50 bps on September 18th and another 50 bps before year-end. I would posit that it stretched out five quarters from "inflection point" to crisis because the Fed back in 2007 still had significant room to push bond and MBS yields lower (prices higher). The Bernanke Fed enjoyed flexibility that the Powell Fed does not. The Treasury ran a $161 billion deficit in fiscal-year 2007.

Things Just Got Too Crazy - completely out of hand. The equities melt-up, the crypto currencies, the technology/biotech mania, M&A, leveraged loans, the return of booming structured finance and the collapse in risk premiums throughout global Credit markets. The Dow is going to a million - along with Bitcoin. Trillions of unending ETF flows. The VIX down to 8.56. Caution to the wind - epically. China Credit.

With another $2.7 TN of QE in 2017, central bankers pushed the envelope too far. And, importantly, Washington (and governments around the world) just went nuts with the view that spending is wonderful and deficits don't matter. Too many years of central bank-induced over-liquefied markets incentivized excess, from Wall Street to Silicon Valley to Washington to Beijing to Tokyo and Frankfurt. Markets at home and abroad completely failed as mechanisms to discipline, to self-adjust and to correct.

There will be a very steep price to pay.


For the Week:

The S&P500 dropped 5.2% (down 2.0% y-t-d), and the Dow fell 5.2% (down 2.1%). The Utilities declined 2.9% (down 8.2%). The Banks were hit 5.4% (up 1.4%), and the Broker/Dealers dipped 2.2% (up 1.9%). The Transports sank 5.2% (down 4.5%). The S&P 400 Midcaps fell 5.0% (down 4.2%), and the small cap Russell 2000 dropped 4.5% (down 3.8%). The Nasdaq100 lost 5.1% (up 0.3%). The Semiconductors fell 4.7% (up 0.2%). The Biotechs sank 6.2% (up 4.8%). With bullion declining $17, the HUI gold index sank 7.2% (down 9.2%).

Three-month Treasury bill rates ended the week at 1.53%. Two-year government yields fell seven bps to 2.08% (up 19bps y-t-d). Five-year T-note yields declined four bps to 2.54% (up 34bps). Ten-year Treasury yields added a basis point to 2.85% (up 45bps). Long bond yields gained seven bps to 3.16% (up 42bps).

Greek 10-year yields surged 43 bps to 4.08% (up 1bp y-t-d). Ten-year Portuguese yields rose eight bps to 2.10% (up 16bps). Italian 10-year yields were little changed at 2.05% (up 3bps). Spain's 10-year yields added one basis point to 1.48% (down 9bps). German bund yields slipped two bps to 0.75% (up 32bps). French yields declined three bps to 0.99% (up 20bps). The French to German 10-year bond spread narrowed one to 24 bps. U.K. 10-year gilt yields declined a basis point to 1.57% (up 38bps). U.K.'s FTSE equities index sank 4.7% (down 7.7%).

Japan's Nikkei 225 equities index was hammered 8.1% (down 6.1% y-t-d). Japanese 10-year "JGB" yields declined two bps to 0.07% (up 2bps). France's CAC40 lost 5.3% (down 4.4%). The German DAX equities index dropped 5.3% (down 6.3%). Spain's IBEX 35 equities index fell 5.6% (down 4.0%). Italy's FTSE MIB index declined 4.5% (up 1.4%). EM markets were under pressure. Brazil's Bovespa index declined 3.7% (up 5.9%), and Mexico's Bolsa fell 5.2% (down 3.2%). South Korea's Kospi index sank 6.4% (down 4.2%). India's Sensex equities index declined 3.0% (down 0.1%). China's Shanghai Exchange was hammered 9.6% (down 5.4%). Turkey's Borsa Istanbul National 100 index lost 3.8% (down 1.5%). Russia's MICEX equities index fell 3.7% (up 4.1%).

Junk bond mutual funds saw hefty outflows of $2.743 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates jumped 10 bps to a 14-month high 4.32% (up 15bps y-o-y). Fifteen-year rates gained nine bps to 3.77% (up 38bps). Five-year hybrid ARM rates rose four bps to 3.57% (up 36bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates jumping 24 bps to 4.59% (up 32bps).

Federal Reserve Credit last week declined $8.5bn to $4.379 TN. Over the past year, Fed Credit contracted $37.3bn, or 0.8%. Fed Credit inflated $1.569 TN, or 56%, over the past 275 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt jumped $21.2bn last week to $3.388 TN. "Custody holdings" were up $218bn y-o-y, or 6.9%.

M2 (narrow) "money" supply added $4.6bn last week to $13.850 TN. "Narrow money" expanded $577bn, or 4.3%, over the past year. For the week, Currency increased $2.2bn. Total Checkable Deposits fell $35.7bn, while savings Deposits rose $32.2bn. Small Time Deposits added $2.2bn. Retail Money Funds gained $3.8bn.

Total money market fund assets jumped $27.6bn to $2.837 TN. Money Funds gained $150bn y-o-y, or 5.6%.

Total Commercial Paper declined $8.8bn to $1.130 TN. CP gained $164bn y-o-y, or 17%.

Currency Watch:

The U.S. dollar index rallied 1.4% to 90.442 (down 1.8% y-o-y). For the week on the upside, the Japanese yen increased 1.3% and the South African rand gained 0.8%. For the week on the downside, the Norwegian krone declined 2.9%, the Brazilian real 2.5%, the Swedish krona 2.2%, the British pound 2.1%, the euro 1.7%, the Australian dollar 1.5%, the Canadian dollar 1.2%, the South Korean won 1.1%, the Swiss franc 0.8%, the New Zealand dollar 0.6%, the Singapore dollar 0.6% and the Mexican peso 0.6%. The Chinese renminbi was little changed versus the dollar this week (up 3.23% y-t-d).

Commodities Watch:

February 6 - Bloomberg (Ranjeetha Pakiam and Daniela Wei): "China's growing throng of affluent consumers is driving a rebound in demand for gold rings, bracelets and necklaces as a property boom and high stock market valuations boost wealth in the largest bullion market. 'Things are much more positive than they were this time last year,' and the jewelry market has bottomed out after three years of declines, said Nikos Kavalis, London-based director of research firm Metals Focus Ltd... The nation's demand for gold jewelry climbed 10% last year to almost 700 metric tons as the wealthy increased purchases and consumption improved in second and third-tier cities..."

The Goldman Sachs Commodities Index sank 6.1% (down 3.1% y-t-d). Spot Gold fell 1.3% to $1,316 (up 1.0%). Silver lost 3.4% to $16.139 (down 6%). Crude sank $6.25 to $59.20 (down 2%). Gasoline sank 9.2% (down 5%), and Natural Gas fell 9.2% (down 13%). Copper was hit 4.8% (down 8%). Wheat added 0.5% (up 5%). Corn was little changed (up 3%).

Market Dislocation Watch:

February 6 - CNBC (Tae Kim): "A key measure of market volatility is gyrating wildly Tuesday after a triple-digit percentage move the previous day. The CBOE Volatility Index, or VIX, is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. It's sometimes called the 'fear gauge.' Volatility refers to the amount of uncertainty in the size (and direction) of changes in a security's value and is typically measured by the deviation of returns. The VIX surged by 115.6% on Monday to 37.32. It rose briefly early Tuesday to over 50, the highest level since Aug 2015. The VIX then dropped to 22.42, rose to over 45, before fading to roughly 35."

February 5 - Bloomberg (Sarah Ponczek, Elena Popina, and Lu Wang): "Risk parity funds. Volatility-targeting programs. Statistical arbitrage. Sometimes the U.S. stock market seems like a giant science project, one that can quickly turn hazardous for its human inhabitants. You didn't need an engineering degree to tell something was amiss Monday. While it's impossible to say for sure what was at work when the Dow Jones Industrial Average fell as much as 1,597 points, the worst part of the downdraft felt to many like the machines run amok. For 15 harrowing minutes just after 3 p.m. in New York a deluge of sell orders came so fast that it seemed like nothing breathing could've been responsible."

February 6 - Bloomberg (Elena Popina and Sarah Ponczek): "Does the chaos embroiling equity markets have an obvious precedent that can guide investors on how it plays out? While the Crash of '87 and 2008 financial crisis have been name checked, a more relevant example may be 1998, the first test of the internet bubble. It was a period in the market that has some eerie parallels to today. Stocks were in the eighth year of a giant bull run that had relentlessly expanded valuations. The Federal Reserve had just begun a tightening cycle. And behind the scenes, sophisticated speculators were getting into trouble. While drama played out rapidly, its depth may be a lesson for investors wondering how bad things can get in such an environment. The S&P 500 Index violently plunged 19% in a matter of weeks, from a high on July 17, 1998, through the last day of August. Yet, the decline was all but forgotten two months later."

February 5 - Bloomberg (Lu Wang): "The plunge in U.S. stocks just after 3 p.m. went beyond a normal reaction to economic circumstances and had elements of a liquidity-driven selloff like the one that landed on markets in May 2010, an analyst said. 'We can officially call the last 20ish minutes a flash crash,' said Dennis Debusschere, head of portfolio strategy at Evercore ISI. Loosely defined, the term 'flash crash' denotes a phenomenon in electronic markets in which the withdrawal of stock orders rapidly exacerbates price declines."

February 5 - Market Watch (Mark DeCambre): "Tightly wound correlations between assets have prevailed in recent trade on Wall Street, and they are at their highest level since December 2012, according to Deutsche Bank's chief strategist, Binky Chadha. Chadha says closely bound correlations, meaning that a move in one directly influences a move in another, reflects market extremes as investors flock into certain assets. The Deutsche Bank analyst says cross-asset correlations are at 90%. A reading of 100% represents perfect correlation, where assets tend to move in the same direction at the same time."

Trump Administration Watch:

February 5 - Reuters (James Oliphant): "With stock markets declining again, the White House... said the fundamentals of the U.S. economy are strong. 'Markets fluctuate, but the fundamentals of this economy are very strong and they are headed in the right direction,' White House spokesman Raj Shah told reporters on Air Force One..."

February 7 - CNBC (Yian Mui): "Republicans are learning that the easiest way to solve a problem in Washington is with money. Lots of it. Back in full control of the levers of government, the party that long espoused fiscal prudence is paving the way for substantial new federal spending that -- combined with Republicans' sweeping tax cut -- is projected to send America's deficit to record highs. The Treasury Department says it will need to borrow more than $1 trillion in each of the next two fiscal years... That figure doesn't factor in the reported $300 billion in increased spending that Senate leadership is negotiating as part of a two-year deal to fund the government. Washington will also need to raise the national debt ceiling before the end of next month."

February 7 - Wall Street Journal (Nick Timiraos): "The spending deal reached by congressional leaders Wednesday marks an end to the budget austerity congressional Republicans sought to advance in Washington in 2011. Back then, Republicans negotiated a series of automatic curbs on defense and domestic discretionary spending with President Barack Obama that, along with a growing economy and ultralow interest rates, helped bring down deficits. Now, party leaders have made a U-turn. Last December, President Donald Trump signed into law tax cuts of $1.5 trillion over a decade, and congressional leaders Wednesday agreed with Democrats to boost federal spending by nearly $300 billion over two years from what was already in train."

February 6 - Financial Times (Shawn Donnan): "The US trade deficit grew 12.1% to its highest level since 2008 in Donald Trump's first year in office, suggesting that the president is making little headway in his promise to rewrite America's trading relationship with the world. Economists say the surge in the US goods and services deficit to $566bn last year was mostly caused by an improving domestic economy and rising demand from consumers and companies for imported goods. US exports grew 5.4% to $2.3tn, their second-highest level on record, while imports reached a record $2.9tn in 2017."

February 3 - Washington Post (Heather Long): "It was another crazy news week, so it's understandable if you missed a small but important announcement from the Treasury Department: The federal government is on track to borrow nearly $1 trillion this fiscal year... That's almost double what the government borrowed in fiscal year 2017. Here are the exact figures: The U.S. Treasury expects to borrow $955 billion this fiscal year... It's the highest amount of borrowing in six years, and a big jump from the $519 billion the federal government borrowed last year. Treasury mainly attributed the increase to the 'fiscal outlook.' The Congressional Budget Office was more blunt. In a report this week, the CBO said tax receipts are going to be lower because of the new tax law."

February 9 - Reuters (Richard Cowan and James Oliphant): "The budget deal passed by U.S lawmakers early on Friday will alleviate the spending fights that marked President Donald Trump's first year in office, but sets the stage for a battle over immigration and who is to blame for exploding deficits ahead of November's congressional elections. In the short term, reducing the risk of government shutdowns could help Trump and Republicans by conveying a greater sense of stability. But Democrats are gearing up to use rising budget deficits under Trump and what they see as draconian immigration policies to hammer Republicans in the midterm elections when they will seek to take back control of Congress."

February 6 - Wall Street Journal (Jacob M. Schlesinger): "China is showing a willingness to push back against mounting trade pressure from the Trump administration, filing challenges to new U.S. tariffs on solar panels and washing machines at the World Trade Organization. The petitions submitted to the global commerce arbiter... argue that the tariffs 'are not consistent' with international rules, and seek compensation from Washington. The petitions follow an announcement on Sunday by the Chinese Commerce Ministry that it was investigating American exporters of sorghum for allegedly 'dumping' the grain below cost, aided by improper U.S. government subsidies, into the Chinese market. The probe could result in duties being imposed to block the U.S. product. The Trump administration has been debating adopting a tougher trade policy against China, possibly including broad tariffs and investment restrictions. The measures are being considered as part of a probe into widespread complaints that the Chinese government forces U.S. companies to turn over valuable intellectual property as the price for entering their market..."

February 9 - Reuters (Ben Blanchard and Jess Macy Yu): "A U.S. bill that encourages reciprocal visits by U.S. and Taiwanese government officials threatens stability in the Taiwan Strait and the United States must withdraw it, China's Foreign Ministry said... The bill passed the U.S. Senate Committee on Foreign Relations this week and will now move to the Senate. Beijing considers democratic Taiwan to be a wayward province and integral part of 'one China', ineligible for state-to-state relations, and has never renounced the use of force to bring the island under its control."

U.S. Bubble Watch:

February 9 - CNBC (Natasha Turak): "U.S. stock funds saw a record $23.9 billion withdrawn by investors in the last week..., as the turmoil in global stock markets saw traders shun equities in favor of perceived safe havens. Exchange-traded fund (ETF) outflows alone constituted the bulk of withdrawals, at $21 billion, while mutual fund outflows made up $3 billion of withdrawals, according to data from Thomson Reuters' Lipper unit."

February 7 - Bloomberg (Sid Verma and Dani Burger): "The global market maelstrom spurred money managers to yank a record $17.4 billion from the mighty SPDR S&P 500 ETF over the past four trading sessions. The $8 billion removed on Tuesday alone was the third-largest daily withdrawal in the post-crisis era. The last time redemptions were close to matching this frenetic pace? In late 2007, when cracks in U.S. equities began to show before the global financial crisis unfolded."

February 6 - Bloomberg (Sho Chandra): "The U.S. trade deficit widened to the biggest monthly and annual levels since the last recession, underscoring the inherent friction in President Donald Trump's goal of narrowing the gap while enjoying faster economic growth. The deficit increased 5.3% in December to a larger-than- expected $53.1 billion, the widest since October 2008, as imports outpaced exports... For all of 2017, the goods-and-services gap grew 12% to $566 billion, the biggest since 2008."

February 9 - Wall Street Journal (Andrew Tangel, Harriet Torry and Heather Haddon): "U.S. manufacturers and food companies are grappling with rising material and ingredient costs on top of pressure from higher wages -- a potential double whammy that could force them to raise prices or accept lower profit margins. 'We just see the inflation trends creeping in on many parts of our value chain,' Whirlpool Corp. Chief Executive Marc Bitzer told analysts... The... appliance giant projected that additional raw-material costs, driven by rising prices of steel and resin, would shave as much as $250 million off its profit this year."

February 7 - Bloomberg (Elizabeth Campbell): "As Illinois prepares for Governor Bruce Rauner to unveil a proposed budget next week, the worst-rated state is already awash in billions of dollars of red ink, according to Comptroller Susana Mendoza. Lawmakers and Rauner will have to contend with deficit spending in the current fiscal year as they work to craft a spending plan for next year... $2.3 billion of deficit spending in the form of unappropriated liabilities held at state agencies as of Dec. 31. $8.4 billion of unpaid bills as of Feb. 7. $1.03 billion of late-payment interest fees incurred as of Dec. 31, 2017... $1.7 billion general fund deficit."

Federal Reserve Watch:

February 8 - CNBC (Jeff Cox): "New Federal Reserve Chairman Jerome Powell may have a few surprises in store for the market, judging by past statements he has made behind the central bank's closed doors and some whispers going around Wall Street. Powell took the helm of the Fed on Monday... While there seems little fear that Powell will be hostile to markets, assuming that he is going to be a carbon copy acolyte of Yellen could be a mistake. There are a few potential points of contrast. One is in comments Powell made during Federal Open Market Committee meetings in 2012... At several meetings then he expressed serious reservations about the direction of monetary policy, questioning the efficiency of the Fed's low-interest-rate money-printing philosophy at the time... 'I think we are actually at a point of encouraging risk-taking, and that should give us pause,' Powell said at the October 2012 FOMC meeting..."

February 5 - Bloomberg (Craig Torres and Christopher Condon): "Federal Reserve Chairman Jerome Powell was met with a surging bout of market volatility in his first day in office, as stocks fell and long-term interest rates plunged in response. The 4.1% rout in the S&P 500 index on Monday, the steepest decline since 2011, poses more questions than answers so far for Powell and his team."

February 7 - Wall Street Journal (Justin Lahart): "Investors think the Federal Reserve is waiting with a net below the stock market, and chances are they are right. The only problem is that the net is far below where stocks are now. The recent sharp drop in stocks began because investors were worried the Fed might raise rates faster than they had thought. When the selloff got worse, there was a view that the Fed might not raise very much because of the volatile market. Interest-rate futures now suggest investors are split over whether the central bank will raise rates three times this year, as Fed policymakers have projected, or just twice. Contrast that with early Friday, when the futures started pricing in the possibility of a fourth rate hike."

February 7 - Bloomberg (Jeanna Smialek): "Federal Reserve Bank of San Francisco President John Williams said he isn't altering his view on the U.S. economy or preference for a continued gradual rate hike path after several days of volatile markets. 'It's not about the market themselves, it's about -- basically, what are they telling us about the likely path of the economy?' Williams told reporters... 'At this point, I don't see any of the movements in asset prices of late to fundamentally change my view of the economy. I think the economy is on a very solid growth path. In fact, I think some of the market reaction is to the fact that the economy is doing well."

February 8 - Reuters (Balazs Koranyi): "The U.S. Federal Reserve is likely to continue removing policy accommodation gradually and could hike rates three times this year, Dallas Fed President Robert S. Kaplan told a business conference in Frankfurt... Kaplan said recent market volatility in itself was not enough to change his base scenario, although he was 'highly vigilant' about the turbulence and would study whether it has any effect on the real economy. 'At this point, I don't see this market adjustment spilling over into financial conditions - but I'll be watching carefully,' Kaplan... told reporters... 'My base case is the same.'"

February 2 - CNBC (Jeff Cox): "Janet Yellen leaves the Federal Reserve with the economy clicking, the stock market humming and the central bank on a clear path away from the emergency policies it put into place to help rescue the U.S. from the deep throes of the financial crisis. Yet her grade as head of the Fed is a decided 'incomplete.' Yes, by any typical standard of performance Yellen would be considered an unqualified success. She and her colleagues enacted programs and policies that have brought the economy and financial system back from the brink. She is almost universally respected on Wall Street, even if she remains a bit of an enigma on Main Street. But no one knows yet what the future ramifications will be of the extreme measures the Fed took under her watch and that of her immediate predecessor, Ben Bernanke."

February 5 - Bloomberg (Ros Krasny and Scott Lanman): "Outgoing Federal Reserve Chair Janet Yellen said U.S. stocks and commercial real estate prices are elevated but stopped short of saying those markets are in a bubble. 'Well, I don't want to say too high. But I do want to say high,' Yellen said on CBS's "Sunday Morning"... 'Price-earnings ratios are near the high end of their historical ranges.' Commercial real estate prices are now 'quite high relative to rents,' Yellen said. 'Now, is that a bubble or is it too high? And there it's very hard to tell. But it is a source of some concern that asset valuations are so high.'"

China Watch:

February 9 - Reuters (John Ruwitch and Samuel Shen): "Chinese stocks suffered their worst day in almost two years on Friday, with blue-chip led carnage dragging the markets into correction territory... The benchmark Shanghai Composite Index tumbled 4.0% and the blue-chip CSI300 ended the day down 4.3%. At one point, both were down more than 6%. It was the biggest single-day dive for the two since February 2016, when the fallout from a botched attempt to introduce a circuit-breaker mechanism after a market meltdown was still rattling investors. Hong Kong shares, meanwhile, slumped to their biggest weekly loss since the global financial crisis. 'It's bulls killing bulls', said hedge fund manager Gu Weiyong about the stampede out of stocks..."

February 7 - Bloomberg: "Chinese regulators appear to be winning their war against risk in one of the more dangerous corners of the country's shadow banking industry -- the so-called wealth management products that banks buy from each other in a search for easy profits. Interbank holdings of WMPs more than halved last year, to 3.25 trillion yuan ($520 million) in December from 6.65 trillion yuan a year earlier... That suggests higher interest rates and increased scrutiny by regulators are deterring Chinese banks from their previous practice of using cheap interbank borrowing to invest in each others' higher-yielding WMPs... The CBRC and other regulators are working closely in an unprecedented campaign to curb the $16 trillion shadow banking industry, of which WMPs issued by banks are the largest component. Another risky area that is contracting rapidly is some $3.8 trillion of so-called trust products, which have been a popular way for debt-ridden property developers and local governments to raise funds."

February 8 - Bloomberg (Sofia Horta E Costa): "Investors got a stark reminder of how fast their bets can turn in China, where the most bullish trades are falling apart. The country's currency was their latest favorite to succumb to a rout that has roiled financial markets around the world this week, losing as much as 1.2% on Thursday for the biggest decline since the aftermath of its 2015 shock devaluation. That follows a selloff in large caps and banks that has wiped out about $660 billion from the value of Chinese equities. Traders are running out of places to hide in a nation where market declines have a habit of snowballing. Government bonds are offering little in the way of comfort, and even commodities are feeling the squeeze. Making matters worse is the prospect of seasonally tighter liquidity ahead of the Lunar New Year holiday..."

February 7 - Bloomberg: "China's overseas shipments held up despite trade tensions with the U.S., while import growth surged reflecting calendar effects and higher commodity prices. Exports rose 11.1% in January in dollar terms from a year earlier while imports increased 36.9%, leaving a $20.34 billion trade surplus."

February 5 - Reuters (Stella Qiu and Ryan Woo): "China's services sector got off to a flying start in 2018, expanding at its fastest pace in almost six years as new orders surged and companies rushed to hire more staff... Economists also attributed the robust strength in services in January to better access to bank loans at the start of the year and solid demand before the long Lunar New Year celebrations, which fall in mid-February."

February 9 - Bloomberg (Sungwoo Park): "China, the world's biggest oil buyer, is opening a domestic market to trade futures contracts. It's been planning one for years, only to encounter delays. The Shanghai International Energy Exchange, a unit of Shanghai Futures Exchange, will be known by the acronym INE and will allow Chinese buyers to lock in oil prices and pay in local currency. Also, foreign traders will be allowed to invest -- a first for China's commodities markets -- because the exchange is registered in Shanghai's free trade zone. There are implications for the U.S. dollar's well-established role as the global currency of the oil market."

Central Bank Watch:

February 8 - Bloomberg (Jill Ward and David Goodman): "Mark Carney said U.K. interest rates may need to rise at a steeper pace than previously thought to prevent the Brexit-weakened economy from overheating. The Bank of England lifted its forecasts for economic growth... and said that inflation is projected to remain above the 2% target under the current yield curve, which prices in about three quarter-point hikes over the next three years. The governor noted that a key challenge is limited capacity. 'It will be likely to be necessary to raise interest rates to a limited degree in a gradual process but somewhat earlier and to a somewhat greater extent than what we had thought in November,' Carney said... 'Demand growth is expected to exceed the diminished supply growth.'"

February 8 - Wall Street Journal (Tom Fairless): "German Bundesbank President Jens Weidmann called on the European Central Bank... to wind down its giant bond-buying program after September, urging officials not to be distracted by a stronger euro currency or volatility in global financial markets. But the ECB's chief economist struck a more cautious note, underlining a debate within the world's number two central bank over how quickly to phase out its aggressive stimulus policies as the eurozone economy heats up. ...Mr. Weidmann said 'substantial net [asset] purchases beyond the announced amount do not seem to be required' if economic growth 'progresses as currently expected.'"

February 5 - Bloomberg (Alessandro Speciale and Jonathan Stearns): "Mario Draghi said that the European Central Bank still can't claim success in its struggle to restore inflation, and defended its policies from complaints that they widen inequalities. 'While our confidence that inflation will converge toward our aim of below, but close to, 2% has strengthened, we cannot yet declare victory on this front,' the ECB president said at European Parliament... 'Monetary policy will evolve in a fully data-dependent and time-consistent manner.'"

February 8 - Wall Street Journal (Megumi Fujikawa): "Bank of Japan Gov. Haruhiko Kuroda, while declining to discuss future monetary-policy action, renewed his pledge to continue the central bank's easy policy. 'Japan hasn't reached a stage where it can talk about timing or details of ways to exit from monetary easing,' Mr. Kuroda said in a parliamentary session... The comment was made in response to an opposition lawmaker's request that Mr. Kuroda share his exit strategy before his term expires in April."

Global Bubble Watch:

February 6 - Bloomberg (Kana Nishizawa): "The tumble in cryptocurrencies that erased nearly $500 billion of market value over the past month could get a lot worse, according to Goldman Sachs... global head of investment research. Most digital currencies are unlikely to survive in their current form, and investors should prepare for coins to lose all their value as they're replaced by a small set of future competitors, Goldman's Steve Strongin said... While he didn't posit a timeframe for losses in existing coins, he said recent price swings indicated a bubble and that the tendency for different tokens to move in lockstep wasn't rational for a 'few-winners-take-most' market. 'The high correlation between the different cryptocurrencies worries me,' Strongin said. 'Because of the lack of intrinsic value, the currencies that don't survive will most likely trade to zero.'"

February 7 - Bloomberg (Shelly Hagan): "The head of the World Bank compared cryptocurrencies to 'Ponzi schemes,' the latest financial voice to raise questions about the legitimacy of digital currencies such as Bitcoin. 'In terms of using Bitcoin or some of the cryptocurrencies, we are also looking at it, but I'm told the vast majority of cryptocurrencies are basically Ponzi schemes,' World Bank Group President Jim Yong Kim said... 'It's still not really clear how it's going to work.'"

Fixed-Income Bubble Watch:

February 8 - Bloomberg (Molly Smith and Austin Weinstein): "After weathering the stock-market turmoil all week, junk bonds are finally starting to show some cracks. The biggest exchange-traded fund that buys the debt clocked its worst day in more than a year on Thursday. Investors pulled money from high-yield bond funds for the seventh week in nine. That's driving up yields for some of the market's biggest borrowers... The cost to protect against losses on junk bonds rose Friday to its highest level since December 2016. In Asia, speculative-grade corporate notes registered a third week of losses."

February 6 - Financial Times (Robert Smith, Kate Allen and Eric Platt): "The surge in financial market volatility spurred banks underwriting a large junk-bond sale to raise its yield on Tuesday while other high-risk debt sales were postponed. Algeco's €1.4bn-equivalent bond sale was originally intended to close last week, but the modular building company had to push back the timing after investors demanded changes to the deal's... Algeco announced... that it was still proceeding with the debt sale, despite a sharp sell-off across global markets, but at substantially higher yields than earlier indicated. The riskiest slice of the deal -- a triple-C rated $305m unsecured bond -- is set to price at an 11.5% yield, having been earlier guided at 10%"

February 5 - Bloomberg (Narae Kim and Lianting Tu): "When it comes to calling the end of the decades-long bull run in bonds, Switzerland's Pictet Wealth Management is putting its money where its mouth is, and cutting its allocation to U.S. Treasuries. 'Huge regime change' is how Christophe Donay, head of asset allocation and macro research at Pictet, describes what's going on in the bond market, with yields surging. The old simple strategy of putting 60% in equities and 40% in Treasuries, which scored handsome returns for decades, won't work any more, he said. 'This story is over.'"

Europe Watch:

February 5 - Bloomberg (Carolynn Look): "Economic momentum in the euro area surged to the fastest pace in almost 12 years, pushing firms to pile on the most additional workers since the start of the millennium. A composite Purchasing Managers' Index rose to 58.8 in January from 58.1 in December, IHS Markit said."

February 7 - Reuters (Silvia Ognibene): "The leader of Italy's right-wing Northern League said... his party was preparing the ground to leave the euro zone and called the euro a 'German currency' which had damaged Italy's economy. 'It's clear to everyone that the euro is a mistake for our economy,' Matteo Salvini told reporters on the sidelines of a rally in Florence ahead of the March 4 parliamentary election."

Japan Watch:

February 5 - Reuters: "Japanese Prime Minister Shinzo Abe said... he hoped the central bank would continue to promote 'bold' monetary easing to achieve its 2% inflation target. He also said it was premature to declare an end to deflation despite growing signs of strength in the economy."

February 7 - Reuters (Leika Kihara and Stanley White): "Bank of Japan board member Hitoshi Suzuki said... the central bank could raise interest rates or slow the purchase of risky assets if the costs of prolonged monetary easing began to outweigh the benefits. The remarks from Suzuki, a former commercial banker who joined the board in July, underscored the BOJ's dilemma as anemic price and wage growth forces it to delay normalizing policy, despite the rising cost of its radical stimulus program."

EM Bubble Watch:

February 5 - Bloomberg (Enda Curran): "Here's a warning sign for Asia's central banks. Investors have started pulling out of emerging markets with the biggest slump in portfolio flows since the 2016 U.S. presidential election, according to analysts at the Institute of International Finance. Asia has taken the brunt of the reversal with South Korea, Indonesia and Thailand seeing the biggest outflows of the countries in the study. Those withdrawals have been concentrated in equities, while bonds have been hit less hard. India is bucking the trend with continued demand for both stocks and bonds."

Leveraged Speculation Watch:

February 8 - Bloomberg (Heejin Kim): "Jim Rogers, 75, says the next bear market in stocks will be more catastrophic than any other market downturn that he's lived through. The veteran investor says that's because even more debt has accumulated in the global economy since the financial crisis, especially in the U.S. While Rogers isn't saying that stocks are poised to enter bear territory now... he says he's not surprised that U.S. equities resumed their selloff Thursday and he expects the rout to continue. 'When we have a bear market again, and we are going to have a bear market again, it will be the worst in our lifetime,' Rogers... said... 'Debt is everywhere, and it's much, much higher now.'"

February 5 - Bloomberg (Saijel Kishan): "Paul Tudor Jones said inflation is about to appear 'with a vengeance' and may force the new Federal Reserve chair to accelerate interest-rate hikes. The hedge fund manager said policy has focused on a 'low inflation problem' and years of near-zero rates amid economic expansion will have 'painful' consequences. Policy makers should have been more aggressive in tightening policy and 'rejecting the fiscal impropriety associated with this most recent tax cut,' he said. 'We are replaying an age-old storyline of financial bubbles that has been played many times before,' Jones, founder of Tudor Investment Corp., wrote... 'This market's current temperament feels so much like either Japan in 1989 or the U.S. in 1999. And the events that have transpired so far this January make me feel more convinced than ever of this repeating history.'"

February 4 - Financial Times (Eric Platt): "The most aggressive start to a year for dealmaking since Bill Clinton was in the White House had been lacking razzmatazz. Then last week private equity firm Blackstone assembled a $17bn deal for the data and terminal business of media and information group Thomson Reuters... While the deal is the biggest since the financial crisis by Blackstone -- an ever more powerful force in finance over the past decade -- its success will depend on a less glamorous constituency: loan and bond investors."

Geopolitical Watch:

February 2 - Reuters (Idrees Ali): "Concerned about Russia's growing tactical nuclear weapons, the United States will expand its nuclear capabilities..., a move some critics say could increase the risk of miscalculation between the two countries. It represents the latest sign of hardening resolve by President Donald Trump's administration to address challenges from Russia, at the same time he is pushing for improved ties with Moscow to rein in a nuclear North Korea. The focus on Russia is in line with the Pentagon shifting priorities from the fight against Islamist militants to 'great power competition' with Moscow and Beijing."

February 4 - Reuters: "China urged the United States to drop its 'Cold War mentality' and not misread its military build-up, after Washington published a document on Friday outlining plans to expand its nuclear capabilities to deter others. 'Peace and development are irreversible global trends. The United States, the country that owns the world's largest nuclear arsenal, should take the initiative to follow the trend instead of going against it,' said China's Ministry of Defence..."


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