zaterdag 16 december 2017

BofA; "The Top 17 Themes To Remember From 2017"

Last week, as part of its must read 2018 Outlook piece, Bank of America's derivatives team pointed out two particularly notable things: the first was BofA's version of the (central-bank mediated) "feedback loop" diagram that keeps volatility record low and grinding even lower, as selling of vol has become a self-reinforcing dynamic, in which lower VIX begets more vol-selling by "yield-starved investors", leading to even lower VIX as the shock that can reset the feedback loop is no longer possible, and thus the strike price on the Fed's put can not be put to a market test, which also results in even greater market fragility and assured central bank interventions...



 And a chart suggesting that the market generally broke some time in 2014, when the "behavior of volatility entirely changed, with volatility shocks retracing at record speed. Investors no longer fear shocks, but love them, as it is an opportunity to predictably generate alpha"...



Now in keeping with the prevailing theme of the year, which for better or worse is the "paradoxical inversion" of everything, in its last report of the year, the BofA derivatives team looks not forward, but back, at the year that is almost over, and in an attempt to summarize the bank's volatility insights from 2017, has written: "17 facts from ‘17 to remember for 2018" First, here are the key takeaways from BofA's derivatives gurus:
- Extremes are everywhere when looking at markets through the lens of volatility.
- Despite low volatility, trading volatility as an asset class just keeps getting more popular.
- Use 2017 dislocations to your advantage in 2018 for cheap hedges, alpha and harvesting risk premia.
# With that in mind, here's what BofA thinks you need to remember about 2017 for 2018 (highlights our): And here are details on BofA's top themes:
1. Global assets' record dependency on US rates make rising rates vol a key risk. The correlation of rate-sensitive assets to US rates is at record highs as investors fail to care about outside risks, leaving markets increasingly dependent on US policy. Coupled with rates vol near lifetime-lows - on few expectations for policy disruption - this has helped suppress global cross-asset vol. However, with the Fed appearing to soldier-on towards policy normalization, persistently low rates vol may be at risk. This in turn creates risks for a market slaved to rates. To monetize this, buy calls on dispersion on a basket of highly rate-sensitive stocks, which could benefit from a pick-up in rates volatility and/or a decline in component correlation if assets become less slaved to a common factor...


2. Sharpe Ratios near 80yr highs suggests using cheap options for equity upside. In our 2018 year ahead, we focused on the question of whether 2018 is the year when we finally escape from this record vol depression or if this is a new normal? Our view is that this is not a new-normal, but a bubble. While one can debate whether risk assets like equities and credit are in a bubble, volatility is clearly there. As one piece of evidence, US equites generated near 80yr record Sharpe Ratios this year (4.3 for the Dow and 3.1 for the S&P500 and the Nasdaq100), not because returns were record high but because vol was record low. Given today's equity Sharpes are in "rare air", we continue to advocate using historically cheap options to capture upside without the need to time to top. Simply replacing upside equities with call structures for example makes sense. Or finding cheap puts on momentum stocks can create a synthetic long call position and provide more confidence to chase momentum...


3. Risk parity vol at its lowest in decades makes bond tantrum hedges cheap. In 2017, multi-asset portfolios continued to benefit from equity/bond diversification. Low equity/bond correlation alongside record low cross-asset volatility is driving the vol of equity/bond risk parity portfolios to its lowest levels since the 1960s. Other multi-asset portfolios holding a mixture of equities and bonds have likely also seen extremely low volatility recently. However, a disorderly rise in yields that accompanies an equity market pullback (2013 Taper Tantrum) could be a surprise for many investors who have become conditioned to the recent environment in which bonds and equities diversify one another. Hedges for a bond tantrum are still cheaply priced as derivatives imply this risk is remote, consider buying SPX puts contingent on higher 10yr CMS rates or HYG (HY Corporate Bond) put spreads...


4. US equity trading ranges hit 110yr lows; look for vol bubble deflation in '18. A less traditional depiction of the extreme low equity market vol we realized in the last year, both the S&P 500 (SPX) and Dow (INDU) traded in record tight trading ranges in 2017. Specifically, the S&P 12 day close-to-close trading range dropped to 0.32% in Aug-2017 (Chart 11) and the Dow 12 day close-to-close trading range fell to 0.47% in Mar-2017 (Chart 12), shattering 90 year and 117 year records respectively. While stock valuations are not at life-extremes, century-long records suggest volatility has reached levels that are unsustainable over the long term...


5. Buy-the-dip is alive and well as evidenced from record intra-day (vs daily) vol. As highlighted in our 2018 outlook Risk is not fake news, investors no longer fear shocks but love them. Since 2013, central banks have stepped in (or communicated that they may step in) to protect markets, leaving investors confident enough to "buy-the-dip". In fact, the market rebounded so quickly after Brexit (3 days) that the Fed did not even need to step in, with dips progressively becoming shallower from then. This intra-day mean-reversion (in part driven by buy-the-dip behaviour) has translated into record high intra-day realised vol relative to open-to-close realised vol. While this effect was particularly stark for US equities (Chart 13), it is also true for Europe and Japan...


6. Equity instability at 90yr highs despite low vol, but can be hedged with VIX. looking at the long-term history of the S&P500, 2017 stands out for generating an unprecedented number of 5? 1-day SPX drawdowns, suggesting US equities are unusually fragile today by historical standards. Our favorite "fragility" hedge entails going long VIX 1M 50-delta calls vs. short VIX 2M futures on a 1:0.85 ratio as a way to hedge a VIX singularity with low carry. Why? Funding VIX calls via rich term structure risk premium can (i) carry flat in quiet markets and (ii) unlike many other flat-carry hedges, provide attractive convexity benefits in shocks that come with little forewarning. The trade leverages both curve flattening/inversion and a spike in vol of vol - common features of the "fragility" events witnessed in recent years...


7. Extreme post-US election rotation crushed correlation creating opportunities. Record sector rotation since the US election has driven inter-sector correlation to multi-year lows, as markets continue to differentiate between perceived winners and losers under the Trump administration. Indeed, the average pairwise 6m realized correlation between the 10 GICS sectors in the S&P500 is at levels last seen during the dotcom bubble (albeit amid significantly lower realized vol). Going forward, this creates opportunities like buying hedges that harvest depressed correlation/volatility (best-of-puts) or monetizing the implied-realized correlation risk premium via vega flat dispersion...


8. Markets where we like owning vol are showing most signs of life in '17. With global equity volatility near multi-year lows in 2017, we note that volatility is still off 37-year lows in US small caps (RTY) and the NKY, while other markets including SPX are at life-lows. As highlighted in our 2018 year ahead, Risk is not fake news, we continue to like vol "decompression" trades through owning longer-dated realized vol spreads between NKY, RTY, and SX5E vs. SPX, as they carry flat to positively but should benefit from rising risk. US small cap realized volatility in 2017 is supported by the expectation of a tax reform and the NKY realized volatility is supported by the unexpected break-out of the index in 3Q 2017.
9. BOJ ETF purchases may peak in 2017, reducing impact on NKY vol in 2018. While, not the dominant driver of NKY vol this year, the BoJ has enlarged its ETF purchase program to ¥6trillion in 2017 and we estimate that the program depressed the current equity 6-month realized volatility by 0.8 volatility points (or 9% of its current realized volatility). With the trend of policy tightening globally, the BoJ may change the wording of its ETF purchase program in 2018 to enable stealth tapering...


10. Korean retail vol selling may have peaked in '17, lowering headwinds in '18. With a strong market rally and global rates remaining at relatively low levels, Korean structured product issuance is expected to hit a new all-time high of US$55bn in 2017. The substantial amount of volatility supply (>US$200mn vega) was one of the key drivers in pushing volatility lower this year. However, we expect to see headwinds in issuance amount from higher interest rates in 2018...


11. Diversification benefit of owning vol as an asset is near record highs. On a 6m basis, the beta between VIX/SPX, V2X/SX5E, and VNKY/NKY each reached new records in 2017 as spot indices rallied and vol remained restrained. Hence the diversification benefits of owning volatility as an asset have been near record highs. However, the beta between VHSI and HSI bucked the trend as its beta failed to reach a new record. During 2017, there were multiple instances where both HSI spot and HSI vol increased simultaneously, curtailing the beta ratio...


12. Record year for VIX volumes despite low VIX cements vol as an asset class. Volume in VIX-linked products reached multiple highs throughout the year despite historically low VIX levels, trading over $1bn vega daily 12 times in 2017 vs. 7 times in total from 2004-2016. The all-time high of $1.9bn vega was set on 10-Aug-17. On the day, volume in VIX call and put options reached $250M vega and VIX futures traded a record $850M vega (with the vast majority of this volume in the front and second month futures). Similarly, volume in long unlevered, long levered, and inverse VIX ETPs reached an all-time high of $830M vega traded...  While we do not see the VIX market as large enough or levered enough to destabilize the broader US equity market, VIX derivatives are clearly the dominant market for trading global equity volatility today. Hence the nuances of VIX positioning are more important than ever to understand, as discussed in our 2018 Outlook...


13. 50% VSTOXX futs. Growth shows it's a market of choice for trading EU risk. VSTOXX futures and options open interest and volumes reached record highs in 2017. Demand for VSTOXX derivatives, futures in particular, soared around the Apr/May-17 French elections, as it had done in the past around well-flagged political events like the Brexit vote in Jun-16 and US elections in Nov-16. Notably, while VSTOXX liquidity has significantly improved, it is still dwarfed by that of the VIX: average daily VSTOXX futures volume was EUR 5.2 mio vega in 2017, which is approx. 2% of the VIX (USD 256 mio vega, disregarding FX)...


14. VSTOXX futures may gain significantly as they wake up to Italian election risk. If history is anything to go by, the VSTOXX futures curve can reprice significantly going into well-flagged high-stakes events, as it did ahead of the UK's EU referendum (Jun16) and French elections (Apr/May 2017). While a reflection of Italian election risk (currently expected by mid-March 2018) was starting to emerge as early as mid Oct-17 in VSTOXX futures flies, the short 1xJan / long 2xFeb / short 1xMar fly has lost some steam recently. Arguably, uncertainty around the exact date of the vote may mean that the Mar future is also pricing some event risk...


15. 2017 vol crush left ESTX50 short-dated roll-down most attractive in history. Equities have been remarkably quiescent in 2017 and set multi-year records in terms of how tight trading ranges have been. European equities set an all-time record (30yr history) in their 1yr max versus min price range (Chart 25). As a result, short dated ESTX50 volatility collapsed, leading to extreme steepening in the vol term structure. Chart 26 highlights how low volatility has been in 2017 versus 2016 (on average). It is interesting to note the contrast in term structure in 2017 (much steeper) vs 2005, which was the last time European equities were stuck in a range close to the same extent as now...


16. Rising popularity of S&P weekly options shows lack of long-term conviction. Nearly 30% of all listed S&P 500 (SPX) options volume now takes place in options that are (i) short-dated, with expiries less than 2 weeks away, and (ii) close to at-the-money, with strikes between 98% and 102% of SPX spot. In our view, this reflects the proliferation of S&P weekly option listings, which allow investors to express increasingly precise views, particularly around macro catalysts - but also a market that has become increasingly short-term in its focus, lacking longer-term conviction and wary of carrying longer-term positions. Additionally, historically low volatility has likely forced both premium sellers and buyers alike into options that are closer to at-the-money...


17. Dispersion trumped geo-politics as the most popular research theme of 2017. Aside usual suspects like volatility, risk, etc, dispersion and hedging have been the most frequently referred themes based on our derivatives publication (GEVI) titles from 2017. This is in contrast to 2016 where key events like the Brexit vote and US elections dominated...

Lance Roberts; The "Exit" Problem

Market bubbles have NOTHING to do with valuations or fundamentals.” Let me explain. Stock market bubbles are driven by speculation, greed, and emotional biases, therefore valuations and fundamentals are simply a reflection of those emotions. In other words, bubbles can exist even at times when valuations and fundamentals might argue otherwise. Let me show you a very basic example of what I mean. The chart below is the long-term valuation of the S&P 500 going back to 1871”...


“First, it is important to notice that with the exception of only 1929, 2000 and 2007, every other major market crash occurred with valuations at levels LOWER than they are currently. Secondly, all of these crashes have been the result of things unrelated to valuation levels such as liquidity issues, government actions, monetary policy mistakes, recessions or inflationary spikes. However, those events were only a catalyst, or trigger, that started the ‘panic for the exits’ by investors.” Market crashes are an “emotionally” driven imbalance in supply and demand. You will commonly hear that “for every buyer, there must be a seller.” This is absolutely true. The issue becomes at “what price.” What moves prices up and down, in a normal market environment, is the price level at which a buyer and seller complete a transaction. The problem becomes when the “buyer at a higher price” fails to appear. The markets function much the same way as yelling “fire” in a theater filled to capacity with only one exit. Those closest to the exit will likely get out safely, but once the “bottleneck” forms, there is an inability to exit before the damage is done. The “exit” problem is exacerbated when “everyone is in the same theater.”
Dana Lyons observed this last week. “The percentage households’ financial assets currently invested in stocks has jumped to levels exceeded only by the 2000 bubble. Updating one of our favorite data series from the Federal Reserve’s latest Z.1 Release, we see that in the 3rd quarter, household and nonprofit’s stock holdings jumped to 36.3% of their total financial assets. This is the highest percentage since 2000. And, in fact, the only time in the history of the data (since 1945) that saw higher household stock investment than now was during the 1999 to 2000 blow-off phase of the dotcom bubble. Perhaps not everyone is in the pool, but it certainly is extremely crowded”...


“Note how stock investment peaked with major tops in 1966, 1968, 1972, 2000 and 2007. Of course, investment will rise merely with the appreciation of the market; however, we also observe disproportionate jumps in investment levels near tops as well. Note the spikes at the 1968 and 1972 tops and, most egregiously, at the 2000 top. Yes, there is still room to go (less than 6 percentage points now) to reach the bubble highs of 2000. However, one flawed behavioral practice we see time and time again is gauging context and probability based on outlier readings. The fact that we are below the highest reading of all-time in stock investment should not lead one’s primary conclusion to be that there is still plenty of room to go to reach those levels.”
# Sitting Closer To The Exit. Howard Marks once stated that being a “contrarian” is tough, lonely and generally right. To wit: “Resisting, and thereby achieving success as a contrarian, isn’t easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, particularly when momentum invariably makes pro-cyclical actions look correct for a while. (That’s why it’s essential to remember that‘being too far ahead of your time is indistinguishable from being wrong.’) Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one, especially as price moves against you – it’s challenging to be a lonely contrarian.”
The problem with being a contrarian is the determination of where in a market cycle the “herd mentality” is operating. The collective wisdom of market participants is generally “right” during the middle of a market advance but “wrong” at market peaks and troughs. This is why technical analysis, which is nothing more than the study of “herd psychology,” can be useful at determining the point in the market cycle where betting against the “crowd” can be effective. Being too early, or late, as Howard Marks stated, is the same as being wrong. The chart below is a historical chart of the S&P 500 index based on QUARTERLY data. Such long-term data is NOT useful for short-term market timing BUT is critically important in not only determining the current price trends of the market but potentially the turning points as well.
- The 12-period (3-year) Relative Strength Index (RSI),
- Bollinger Bands (2 and 3 standard deviations of the 3-year average),
- CAPE Ratio,
- The percentage deviation above and below the 3-year moving average,
- The vertical RED lines denote points where all measures have aligned...


While valuation risk is certainly concerning, it is the extreme deviations of other measures to which attention should be paid. When long-term indicators have previously been this overbought, further gains in the market have been hard to achieve. However, the problem comes, as identified by the vertical lines, is understanding when these indicators reverse course. The subsequent “reversions” have not been forgiving. The chart below brings this idea of reversion into a bit clearer focus. I have overlaid the real, inflation-adjusted, S&P 500 index over the cyclically-adjusted P/E ratio...


Historically, we find that when both valuations and prices have extended well beyond their intrinsic long-term trendlines, subsequent reversions beyond those trend lines have ensued. Importantly, these reversions have wiped out a decade, or more, in investor gains. As noted, if the next correction began in 2018, and ONLY reverts back to the long-term trendline, which historically has never been the case, investors would reset portfolios back to levels not seen since 1997. Two decades of gains lost. With everyone crowded into the “ETF Theater,” the “exit” problem should be of serious concern. 
# “Over the next several weeks, or even months, the markets can certainly extend the current deviations from long-term mean even further. But that is the nature of every bull market peak, and bubble, throughout history as the seeming impervious advance lures the last of the stock market ‘holdouts’ back into the markets.” 
Unfortunately, for most investors, they are likely stuck at the very back of the theater. With sentiment currently at very high levels, combined with low volatility and excess margin debt, all the ingredients necessary for a sharp market reversion are currently present. Am I sounding an “alarm bell” and calling for the end of the known world? Should you be buying ammo and food? Of course, not. However, I am suggesting that remaining fully invested in the financial markets without a thorough understanding of your “risk exposure” will likely not have the desired end result you have been promised. Since it is considered “bearish” to point out the potential “risks” that could lead to rapid capital destruction; then I guess you can call me a “bear.” Just make sure you understand I am still in “theater,” I am just moving much closer to the “exit”....

Raul Illargy; Crypto-Cornucopia Part 5, "We'll Be Lucky To Survive On Our Own"

Part 1 "Bitcoin Is A Trust Machine" here. 
Part 2 "This System Is Garbage, How Do We Fix It?" here.
Part 3 "A System With No Justice, No Order, No Rules, & No Predictability" here.
Part 4 "Without It, You're Talking Mad Max" here.
Bitcoin can be stolen. Although “Bitcoin” can’t be hacked, it’s only software and has many vulnerabilities. If held on an exchange, you have legal and financial risk. If held at home, you could have a hard drive fail and lose your passwords. If it’s on a hardware fob like a Trezor, the circuits could fail. For a robust system, computers themselves are pretty fragile. You could write down your passwords on paper, and have a house fire. You could print out several copies, but if any of the copies are found, they have full access to your account and stolen without you knowing. You could have your passwords stolen by your family, or have a trojan take a screen or keystroke capture. Hackers could find a vulnerability not in Bitcoin, but in Android or AppleOS, slowly load the virus on 10,000 devices, then steal 10,000 passwords and clear 10,000 accounts in an hour. There are so many things that can go wrong, not because of the software, but at the point where you interface with the software. Every vault has a door. The door is what makes a vault useful, but is also the vault’s weakness. This is no different than leaving blank checks around, losing your debit card, or leaving cash on your dashboard, but it’s not true that there are no drawbacks. However the risks are less obvious and more unfamiliar.
Bitcoin isn’t truly anonymous. If someone, the NSA, wanted to track your drug purchases on SilkRoad, they could follow the router traffic, they could steal or work out your keys, they could eventually identify your wallet, and from there have a perfect legal record of all your transactions. Defenders will say that wallets are anonymous, that like Swiss accounts, we have a number, but not a name, and you can create new numbers, new wallets endlessly at will. Fair enough, but if I can see the transfers from the old to the new, it can be tracked. If I can get your account number by any means, I can see the flows. To some extent it’s speculation because we don’t know what technology they have available to crack codes, to see into routers, Internet traffic and servers. Could there be a hidden exploit not in “Bitcoin” but in AES256 or the Internet itself? Maybe. Are there secret code-breaking mainframes? Possibly. But given enough interest, we can be sure that they could always get a warrant and enter your house, hack your computer, and watch your keyboard. However, this is no different than cash. If necessary, they can already track every serial number of every bill as it leaves an ATM or a drug sting. Then you follow those serial numbers as they are deposited and reappear. I expect Bitcoin is not very different, and like cash, is only casually anonymous. But is this a problem with cash? Or with Bitcoin?
Your intent as a citizen is to follow the law, pay your taxes, and not hurt others. If government or other power centers are willing to expend that much effort to track you, perhaps the problem should be addressed with proper oversight on warrants and privacy. Bitcoin is slow and expensive. Very true. Bitcoin Core has gotten so outsized from its origins that it may soon cost $5 to buy a $1 coffee and 48 hours to confirm the purchase. That’s clearly not cheaper, faster, OR better. It’s worse: far, far worse. Nor can it improve. Since Blockchain writes the ledger, the longer the ledger, the bigger it is. Technically, it can only clear a few transactions per second. This problem may not doom it, but it would relegate it to only huge, slow transactions like moving container ships. That is, a form of digital gold note. We don’t actually ship gold or whatever to pay for transactions; it just sits in the background, an asset. Per Satoshi, Bitcoin is a “Digital Asset.” And the core team seems to like this more secure, higher value direction, where these obstacles are acceptable. But without a larger, deeper market, it’s the plaything of billionaires and then who sets the price? It becomes another experiment, an antique. Luckily, the story doesn’t stop there. Because it’s only software, you can always change it if you can convince the participants to use the new version.
Bitcoin Cash is a fork that it larger, faster, and cheaper, reducing the limitations for now. And it can become Segwit2 or Cash2 later if the community agrees. But by design Bitcoin is not meant to be instant nor free, and probably never will be. Like gold, it is meant to be expensive, vaulted, and rarely moved. If you want fast and cheap, LiteCoin, Dash, and many others are vying to be the digital silver or digital payment card. That’s not very different from the gold standard, or even payments today. Bitcoin is a huge electric and Internet drain. This is true. However, it’s also misrepresented. What is the electric overhead of every bank, every terminal, every mainframe on the NYSE, every point-of-sale card machine, every cash register and router in retail? Don’t we use an awful lot of electric to keep those running? What about their cost, the repairmen, the creation of new systems every year from mine to market, from idea to update release, to replace them? We also personally have our computers and routers, the whole Internet on and idling. What’s the base cost? Is it fair to compare as if it were a pasture before Bitcoin arrived? We built the existing system this way because it gained efficiency. Time in the clearing, price in not running typewriters and mail worldwide, and of course taxes. We’re talking about creating a parallel financial system here. If the old one is replaced, is the new one better, or worse? Mining takes a lot of power, but the math in Bitcoin is meant to get increasingly harder to compensate for increasing computer speed. The computers are supposed to be on to confirm transactions. That means that the more people use it, the more power consumed, but that’s true of everything.
The more people that drive cars, the more gas is used. So is the car doing something useful and being used well? Is it replacing a less efficient horse, or just wasting energy better used elsewhere? These are complex questions. At the least, Bitcoin uses far, far too much energy in the design, and because of the speculation, far too many people are mining it without using it. However, all of the subsequent coins were concerned about this, and their power consumption is far, far less. As Bitcoin is near its hardest stage and stops at 22 Million, power consumption is near peak, but should stabilize, or even fork to a low-energy proof-of-stake model. As Bitcoin is not well-suited to worldwide transactions, it should be replaced with less-power intensive alternatives, and because of this, may get smaller. And if it replaces some of the existing system, it can generate an offset. But yes, if it uses too much power, is too inefficient by design, it will be too expensive, abandoned, and fail.
# Are Cryptos a scam? Probably not: we pointed out some legitimate uses above for both coins and tokens. But there’s one coin that arguably is a Ponzi, a dozen coins that are scams, scores that are terrible ideas like Pets.com and will fail, and another dozen good, well-meaning tokens that are honest but ultimately won’t succeed. Yet, like the .Com 90’s, there are probably some like Apple that rise far more than it seems they should, and by surviving, effectively give 16% compounded returns for 40 years, front-loaded. That’s the nature of business. But are many coins and tokens open scams that run off with your money? Yes. Are others worthless? Yes. It’s also true of the stock and bond market and can’t be helped. Buyer beware.
# Is Bitcoin a Ponzi? It’s not a Ponzi by definition because there is no central thief, nor are new investors paying off old investors. So is it a fraud, misrepresenting a few hours of electricity as worth $10,000? Well, that depends on what you think its value is. Is it providing value, a service? If so, what is that service worth to you? We already said it has the operational elements of money, with the addition of being extremely transmissible and transportable. If that has value to you, fine, if not, perhaps gold or bonds are more appropriate. But that’s the problem of what gives Bitcoin value. A stock or bond you can look at the underlying asset, the profit or income flows, the book value. But Canadian or New Zealand dollars? What gives them value? They’re also backed by nothing. What gives gold value? It has no income, just popularity. Likewise Bitcoin: what gives it value is that other people want it. If they stop wanting it, it has no value, but that’s psychological and can’t be directly measured. With that in mind, is its fair value $1K or $1B? No one knows. Can its value fall from $10k to $5k? Yes, and it has many times. Only the market, that is, we can decide what it’s worth to us, and the market is small and immature, with no price history and prone to wild swings. Shouldn’t the exchanges set the price? Yes, and they do, but how is that accomplished? We already said the Exchanges do internal trading off-ledger, outside Bitcoin. So aren’t they setting the price on the exchange instead of the people setting the price peer-to-peer? It would seem so. So aren’t they subject to market manipulation? Although at the moment they have a fairer design, and smaller pipelines to the larger market of money, yes.
So if they launch a Bitcoin future, a tracker, a triple-short ETF, internally inflate their holdings, wouldn’t that make it subject to corruption and thus back into the existing system? No one knows: it’s never been done before. I suspect not, but only because the people want Bitcoin specifically because it is Outside-system, Anti-fraud and watch these things carefully. But it’s run by humans and reflect human nature: that means over time some new form of exchange and corruption can grow up around it as before. While the ability to rig Bitcoin is limited because the quantity of Bitcoin is limited and riggers must first buy Bitcoin fairly, the Exchanges and the price-setting are an issue, and especially into the future. Central Banks and existing powers can outlaw or replace it. Bitcoin is still small, almost irrelevant, yet it has been driven down or outlawed in several places, for example North Korea, Venezuela, and New York. That’s right New York, you’re in proud company. North Korea outlaws everything and there is little internet access, so that’s no example. New York is simply regulating Bitcoin which creates business obstacles, but is still available via the few companies willing to do extensive paperwork. Venezuela, however, is actively suppressing Bitcoin which competes with the Bolivar, and is in fact seeking out and shutting down miners. They do this on the premise that Bitcoin is consuming valuable (and free) national electric that could be better used powering a small town.
Point taken. However, Bitcoin users are able to defend themselves against a terrible, lingering hyperinflation that is starving the nation to death, cutting off food, medicine, and services. Mining Bitcoin with national electric, or even having any, can be the difference between life or death. With Bitcoin, you can order food and medicine on Amazon. Without it, you can’t. So a ferocious national government has attempted to halt Bitcoin at gunpoint from both the users and the vendors. Like other currency oppressions, the USD in Zimbabwe for example, it hasn’t worked. Bitcoin is suppressed, but when the need for commerce is high enough, people make a way. So maybe they will replace it with their own coin. Go ahead: this is a free market, freely competing. Banks already made a coin called Ripple, which trades in volume on exchanges, but is not open and public. If people choose it, I can’t stop them. Suppressing Bitcoin may make the incentives to choose the legal option far higher. But ultimately the point of Bitcoin is to be open, fair, and uncontrolled. A coin that is closed, controlled, and operated by some untrustworthy men has no incentive. But it can happen: people have chosen against their better interest before. And that’s my real reservation. Suppose Bitcoin works. Suppose it replaces currency. Suppose it is adequately private. Suppose can be made fast enough, cheap enough, and slim enough. Suppose the old system fades and we all get used to having our lives entirely on the Blockchain.
Your every post is perfectly recorded and provably yours on Steemit. Your every photograph is saved and stamped to you. Every medical experience is indelibly written. Every purchase, every trade, it’s all on a blockchain somewhere. And even suppose it’s private. What then? I mean, isn’t this the system we had in 1900, under the former society and former gold standard? So what happened? Being comfortable and familiar with Blockchain ledgers, taking them as for granted as Millennials do Facebook, and someone says, “Hey, rather than waste power on this inefficient, creaking system of writing everywhere for a fraction of the power the Federal Reserve Block can keep it for you. Think of the whales.” Sound silly? That’s exactly what they did in 1913, and again in 1933 – replace a direct, messy, competitive system with a more efficient one run by smarter men. The people didn’t protest then any more than they do now, so why would we expect them to in 2050 or 2070? No one cares about corruption and murder: we’re only moving to this system now because it’s better and cheaper. If the Fed Reserve Block is cheaper, won’t we move then? I can’t solve the next generation’s problems. We’ll be lucky to survive our own. But I can warn you that even now this generation will never accept a digital mark without which you cannot buy or sell, not voluntarily and not by force. It’s too far to reach and social trust is too compromised.
But could they get us halfway there and just make it official later, when everything’s fixed again? I think absolutely. Once that’s in, you can finish all the plans written in the bank and government white papers: perfect, inescapable taxation. Perfect, indelible records of everyone you talked to, everything you said, everything you bought, everywhere you were, everyone you know. Not today, but in the future. And that is the purgatory or paradise they seek today. The price of Liberty is eternal vigilance. The system we have wasn’t always bad: a small cadre of bad men worked tirelessly while complacent citizens shirked their duty. So when we move to a new system softly, without real purge, real morality, real reform, what makes you think the same thing won’t happen to your new system? Only far, far more dangerous. But I can’t prevent that. Think, and plan accordingly....

Bitter Divisions Emerge At EU Summit Over Migration Issues

With the vast majority of migrants to Europe reaching Greece or Italy first, these two countries have been overwhelmed. Both countries have begged for help from the European Commission (EC), but there's been little help beyond rhetoric. In 2015, the EU adopted a migrant quota system last year that was supposed to relocate 160,000 refugees from Greece and Italy to other EU countries. The plan fell apart because few countries were willing to accept their quotas, and Hungary, Slovakia, the Czech Republic, Poland and Romania refused to resettle any refugees at all. In the end, only about 30,000 refugees were ever resettled under this plan. At an EU summit on Thursday that was supposed to be a show of EU solidarity and unity, especially with the Brexit talks going on. But bitter political divisions erupted after EU President Donald Tusk described the refugee quota program as "divisive and ineffective," and called for it to be replaced.
# According to a letter issued by Tusk, the migrant program will once again reach crisis levels by June of next year: "After the unprecedented migratory pressure on its external border in 2015, the European Union and its Member States are gradually restoring control. However, the migration challenge is here to stay for decades, especially due to the demographic trends in Africa. Despite our efforts, the smugglers are working energetically to exploit further vulnerabilities at our borders. A crisis situation can reoccur and so in order to prepare ourselves, we need to categorically strengthen our migration policy. To achieve this, we should first look at what has and has not worked in the past two years. On this basis, we should establish an effective and sustainable migration policy based on secure external borders and the prevention of mass arrivals. It also requires finding a consensus by June 2018 on the internal dimension of our migration policy, based on the concepts of responsibility and solidarity."
# Tusk says the existing quota system has to be scrapped and replaced by a new system before June 2018. He concludes by saying: "On the basis of the discussion, Leaders will return to these issues with a view to seeking a consensus in June 2018. If there is no solution by then, including on the issue of mandatory quotas, the President of the European Council will present a way forward." The quota system has essentially been a fiction, but a fiction that allowed the EU member countries to pretend to their domestic audience that the problems had been solved. Germany, Italy and the Netherlands have led criticism of Tusk's proposal. Greece's prime minister Alexis Tsipras said that Tusk's comments were "aimless, ill-timed and pointless." Italy's prime minister, Paolo Gentiloni, said, “We will continue to insist that a commitment on the relocation of refugees is needed.” Three countries, Hungary, Poland and the Czech Republic, came out in favor of Tusk's proposal because they have no intention of implementing a quota system anyway. In explaining why Poland would not accept any refugees, Poland's prime minister Mateusz Morawiecki said, "It is worth investing considerable amounts of money in helping refugees in (regions) they are fleeing from. The help on the ground there is much more effective."
# The Czech Republic's prime minister Andrej Babis, said that "It won't happen," and any attempt to impose "nonsensical" quotas in a majority vote would only widen the divisions in the EU. In response to Hungary's refusal to accept refugees, Dutch prime minister Mark Rutte has described Hungary's prime minister Viktor Orbán as ‘shameless’ for refusing to accept any refugees and attempting to buy off his obligations with money.... Guardian (London) and Reuters

European Union Continues To Face Crises Regarding Migration

After receiving millions of migrants in 2015 from the Mideast and northern Africa, the European Union implemented some stopgap measures to control the situation.
# To control the flow of migrants from Turkey to Greece, across the Aegean Sea, the EU reached a refugee deal with Turkey in 2016. Under the agreement, Turkey would patrol its Aegean Sea beaches and prevent migrants from leaving shore.
# To control the flow of migrants from Libya to Italy, crossing the Mediterranean Sea, Italy and the EU reached a deal with Libya's government and numerous local warlords to hold refugees in detention centers within Libya, rather than allow them to leave shore. Al-Jazeera
Each of these methods has been extremely successful in significantly reducing the flow of migrants from Turkey and Libya, respectively. However, in a sense they haven't solved the problem at all, but instead stretched it out. Furthermore, with winter approaching, the season of heaviest migration is ending for now, but there will be a new surge of migration within just a few months. Current and approaching problems include the following:
 # The EU-Turkey refugee deal hasn't been 100% effective. Greece's Lesbos Island alone has seen a massive influx in the last few months, as many as 100 new arrivals every day. A large proportion are women and children who require a high level of care. This has stretched resources to breaking point. The Moria refugee camp on Lesbos has a capacity of 2,000 people, but is currently holding 6,000 people in extremely squalid, disgusting conditions. PRI
# The EU-Libya deal has produced an enormous backlash. Refugees are being held in vastly overcrowded detention centers, in extremely squalid circumstances. The detention centers are so overcrowded that there has been a revival of a thriving slave trade that had been thought to have ended in the 1800s. Men, women and children are being sold at slave auctions for $400-800 apiece, for labor and sex. The EU is being blamed for this revival of the slave trade. Amnesty International
# The "migrant-smuggling trade" has become big business within the EU, greater than the arms smuggling trade, drug smuggling trade and even the human trafficking trade, Europol is actively investigating some 5,000 organized crime groups operating internationally. The problem is particularly severe in the Balkan countries, especially Romania... EurActiv (20-Oct) and Reuters

China Continues Aggressive Military Buildup In The South China Sea

China's aggressive military buildup in the South China Sea has been out of the news for a while, but not because it hasn't been occurring. New imagery released by the Asia Maritime Transparency Initiative (AMTI) show that China has been aggressively implementing illegal offensive and defensive weapons systems on their artificial islands. According to AMTI:
# "AMTI has identified all the permanent facilities on which China completed or began work since the start of the year. These include buildings ranging from underground storage areas and administrative buildings to large radar and sensor arrays. These facilities account for about 72 acres, or 290,000 square meters, of new real estate at Fiery Cross, Subi, and Mischief Reefs in the Spratlys, and North, Tree, and Triton Islands in the Paracels. This does not include temporary structures like storage containers or cement plants, or work other than construction, such as the spreading of soil and planting of grass at the new outposts." 
According to AMTI, "China is poised to substantially boost its radar and signals intelligence capabilities." There's an irony here that this is the same kind of capability that comes with America's Terminal High Altitude Area Defense (THAAD) anti-missile defense systems. China has been infuriated that there are THAAD systems deployed in South Korea, but at least those are legal. China's radar systems in the South China Sea are a violation of international law.... Asia Maritime Transparency Initiative (CSIS/AMTI) and Reuters

China-Australia Relations Plummet Over China's Illegal Militarization Of South China Sea

China's relations with Australia have taken a sharp downturn following the November publication of Australia's "2017 Foreign Policy White Paper," which harshly criticizes China's illegal militarization of the South China Sea. The White Paper says the following:
"The South China Sea is a major fault line in the regional order. Australia is not a claimant state and does not take sides in the competing claims. Like other non-claimant states, however, we have a substantial interest in the stability of this crucial international waterway, and in the norms and laws that govern it. We have urged all claimants to refrain from actions that could increase tension and have called for a halt to land reclamation and construction activities. Australia is particularly concerned by the unprecedented pace and scale of China’s activities. Australia opposes the use of disputed features and artificial structures in the South China Sea for military purposes. We support the resolution of differences through negotiation based on international law. All claimants should clarify the full nature and extent of their claims according to the United Nations Convention on the Law of the Sea (UNCLOS). The Government reaffirms its position that the Permanent Court of Arbitration’s ruling on the Philippines South China Sea Arbitration is final and binding on both parties."
According to Australian analyst Nick Bisley, Australia in the past year has become increasingly outspoken in its criticism of Beijing’s behavior, particularly in the South China Sea, but also because of China's interference in Australian domestic affairs. According to Bisley: "But after I recently spent a week in China talking to scholars, analysts and commentators, it is also clear that the sourness in Canberra is being reciprocated. The mood among Chinese elites ranges from head scratching puzzlement to outright hostility. The people involved in these discussions are Australia specialists, many have studied here, sent their children to study here and have a generally positive disposition toward to the country. Ordinarily, scholars from China tend to be cautious and often voice their opinions obliquely. Not this time. Australia's very public backing for the arbitration tribunal decision and its repeated figuring in public pronouncements appears to be a major concern. 'Australia is not a claimant, so why does it make it such an issue?' the Chinese wonder. Indeed, Australia has no disputes or conflicting security interests with China yet it repeatedly emphasizes that China is making the region less secure. This seems to get under the skin of many scholars and commentators."
The issue, of course, is that China is an international criminal according to a harsh July 2016 ruling by a Tribunal at the United Nations Permanent Court of Arbitration in the Hague. The ruling eviscerated all of China's claims to the South China Sea, and declared its construction of artificial islands and military bases in international waters in the South China Sea to be illegal...
# China's continuing military buildup on Fiery Cross island. This year alone, there was construction on buildings covering 27 acres, or about 110,000 square meters...

China's continuing military buildup on Fiery Cross island.  This year alone, there was construction on buildings covering 27 acres, or about 110,000 square meters (AMTI/CSIS)

# China reacts contemptuously to Australia's foreign policy white paper. Pretty much any criticism of China infuriates them, but probably nothing infuriates them more than any mention of the July 2016 Tribunal ruling, which essentially made China an international criminal. So if Australia is increasingly concerned about China's military threat to the region and the world, then it's not surprising that Australia has frequently made reference to the Tribunal ruling. And if Australia is making frequent reference to the Tribunal ruling, then it's not surprising China is directing more and more of bottomless supply of fury at Australia. The Foreign Policy White Paper has drawn a particularly large tsunami of contemptuous criticism from China's media. These criticisms have called the white paper "irresponsible." It labeled Australia a "distant propaganda outpost" agitating against China. It called Australia "ungrateful" for not appreciating all of the economic benefits they've had because of China, and threatened that China "could relegate ties with Australia to the back of the line, and ignore its immature outburst."
What I found very interesting about Bisley's remarks is that the Chinese are supposedly bewildered and puzzled by the criticism, since Australia isn't directly involved in the South China Sea. It's similar to when a man beats up his wife and then is bewildered and puzzled why anyone else should care, since they aren't involved. The Australians are of course concerned that China's illegal militarization of the South China Sea could result in a regional war in which Australia will be forced to participate. In fact, Australia is directly involved in the South China Sea as $3 trillion of commercial traffic passes through it each year. China's military belligerence in the South China Sea is of concern to Australia, the whole region, and the whole world. For Chinese scholars, analysts and commentators to be bewildered and puzzled by Australia's concern is just a sign of how delusional the Chinese people are, something that I've written about many types as typical in a generational Crisis era. In the case of the Tribunal ruling, some of China's evidence to support it claims turns out to be delusional or a complete hoax. China Daily
Many Chinese people believe that their dictatorship is inherently stronger than the "weak" Western democracies, and that they'll win any war easily. Xi Jinping's 'Socialism with Chinese characteristics' is identical to Hitler's National Socialism. China is becoming a military dictatorship, is annexing other countries' territories as Nazi Germany did in Czechoslovakia and Poland, and is adopting strong nationalist, xenophobic and racist views targeting the Tibetans, Uighurs, Japanese, South Koreans, Philippine people, and Vietnamese. As I've written in the past, China is behaving in a highly emotional, irrational, panicky, nationalistic manner, issuing delusional and fabricated evidence to support claims that everybody knows are false claims. China is preparing for a war that it believes it will win, but instead will cause the worst catastrophe in history, to itself and the entire world.... Lowy Institute (Australia) and Australian Broadcasting

Don Quijones; Stressful Year Ahead For Spanish Banks

The “spillover effects.” Just how much more stress Europe’s banking system can bear will be one of the big questions of 2018. This year was already a pretty stressful year, what with two major Italian banks being put out of their misery while, another, Monte dei Paschi di Siena, was brought back from the dead. In Spain, 300,000 shareholders and subordinate bondholders mourned the passing of the country’s sixth biggest bank, Banco Popular, which was acquired by Santander for the measly price of one euro. Now, a whole new problem awaits. A report published by Spain’s second largest lender, BBVA, has warned about the potential impact on the sector’s profitability of new rules on provisions due to come into effect in early 2018. Until now, banks only had to report losses when loans began deteriorating, when the defaults began. But the introduction in January of a new accounting rule, known as IFRS 9, will force banks in Europe to provision for souring loans much sooner than at present.
One direct result will be that banks will have to hold more capital on their books, and that will have a detrimental impact on their profits. If next year’s stress test by the ECB sets the same macroeconomic conditions and parameters as those used in 2014, banks holding just over one-fifth of the market share in Spain, measured in risk-weighted assets, would have to undertake provisions exceeding 200 basis points, the BBVA report predicts. That would leave some entities with a solvency rating lower than 9%, on the brink or even below the minimal level required by European regulation. BBVA calculates that in January banks will have to increase their provisions by 21%, around €5.2 billion, to comply with the new requirements. This amount should be manageable for the industry as a whole, though some lenders, in particular the smaller banks, will suffer more stress than others. In 2017 it was Banco Popular that suffered the most stress, before being forced into a shotgun takeover by Spain’s biggest bank, Santander, in June. The decline and fall of Popular was important for a number of reasons:
# It served as a reminder that Spain’s banking system is far from fixed, despite the tens of billions of euros (hundreds of billions if you include government guarantees) thrown at it. Just today, the government sold a further 7% of Bankia’s shares at a €70 million loss. The bank’s shares slid 2.4% on the news.
# It put to rest the widely disseminated myth that Spain’s banking crisis was exclusively the result of the chronic mismanagement of the state-owned savings banks, the “cajas”. As the former Director of the Bank of Spain, Aristóbulo de Juan de Frutos, recently told a commission into the banking crisis, Popular’s collapse was proof that some retail banks had operated in exactly the same reckless way as the cajas.
# Popular’s collapse also proved that, when push comes to shove, Europe’s Single Supervisory Mechanism is more than willing to allow certain banks to hit the wall, though its very different treatment of Italy’s Monte dei Pacshi shows that a consistent application of the rules is as yet far from guaranteed.
But it’s not just small or medium-size banks that pose risks for Spain’s banking system in 2018. As the IMF warned in its latest assessment of Spain’s financial sector, the significant international presence of the country’s biggest banks, while providing welcome diversification effects, may also have significant implications for inward and outward spillovers:
# The share of financial assets abroad has grown continuously for the Spanish banking sector, with the largest international exposures by financial assets concentrated in the United Kingdom, the United States, Brazil, Mexico, Turkey and Chile. 
At least four of those six markets, Brazil, Mexico, Turkey and the UK, are likely to face headwinds in 2018, while in the U.S. Santander’s subsidiary, Santander Consumer USA, is dangerously exposed to the subprime auto-loan sector. The subsidiaries of Santander and BBVA are also “systemically important” for a number of banking systems in Latin America, accounting for about 38% and 25% of Mexico and Chile’s banking sector assets, respectively. In the case of BBVA, its Mexico operations accounted for almost half of the group’s global profits in the first half of 2017. As the IMF cautions, “the high reliance on foreign subsidiaries in profit generation could imply significant vulnerabilities if the economic and financial conditions in host countries were to deteriorate.” Like Brazil, which provided a quarter of Santander’s global profits in the first half of 2017, Mexico faces a tough year ahead, with inflation still high, growth stagnating, political uncertainty rising, and serious doubts clouding the future of NAFTA. If conditions deteriorate in either or both of these key emerging markets, it won’t take much for the spillover effects to be felt in Spain’s banking system. Given that the systemic risks posed by Santander and BBVA are of an order of magnitude far larger than those posed by the now-defunct Popular, such a turn of events could make for a very stressful 2018. Uncertainty, threats, and counter-threats are piling up....

Wolf Richter; The Flattening US “Yield Curve”? NIRP Refugees

US Treasury securities are doing something that is worrying a lot of folks, including Fed Chair Janet Yellen: While short-term yields are rising in line with the Fed’s hikes of its target range for the federal funds rate, longer-term yield have done the opposite: they’ve been declining. This has flattened the “yield curve” to a level not seen since before the Financial Crisis. This chart shows the yield curve of today’s yields (red line) across the maturity spectrum against the yields of exactly a year ago, after the rate hike at the time. Note how short-term yields on the left have risen in line with the rate hikes, while toward the right of the chart, long-term yields have fallen...


When long term yields fall below shorter term yields, the curve becomes “inverted.” This has been a reliable predictor of a recession or worse. And we’re getting closer. Today, the 10-year yield closed at just 0.53 percentage points above the two-year yield. This is the narrowest spread since August 2007. However, in her post-FOMC-meeting press conference yesterday, where this conundrum came up hard and heavy, Yellen cautioned that “correlation does not imply causation.” An inverted yield curve these days doesn’t necessarily cause a recession, she said. An inverted yield curve is itself a product of various factors. And one of those factors is heavy buying of long-dated US Treasuries by investors in countries on which central banks have inflicted their negative-interest-rate policies, the ravaged NIRP refugees hailing from Europe and Japan. There are a lot of them, and they’re having an increasingly large problem that is only going to get worse next year – regardless of what the ECB will or will not do.
Fitch Ratings estimates that the total amount of global negative-yielding government debt is $9.7 trillion, with Japanese government debt accounting for $5.8 trillion and European government debt for $3.9 trillion. While the ECB has tapered its QE program from €80 billion a month to €60 billion a month in April and has announced further tapering to €30 billion a month starting in January, it has acquired a volume of government bonds equivalent to 3.5 times the net issuance on average in 2016 and 2017, according to Fitch. This massive buying pressure has inflated the prices of those bonds to ludicrous levels. As bond yields by definition fall when bond prices rise, it has pushed many yields into the negative. For example, even Spain’s two-year debt has a yield of negative -0.23%. Fitch:
# This is forcing holders of Eurozone debt to purchase other assets, such as US treasury securities. While long-term yields in the US remain low, they remain well above core Eurozone yields that are near their 2017 lows. 
With the US Treasury 10-year yield at 2.34% today and the German “Bund” 10-year yield at 0.32%, the spread between them is a juicy 202 basis points. And this is going to be a problem for institutional investors with large positions in medium and longer-term European sovereign debt, such as pension funds and insurers that hold bonds to maturity.
# Maturing securities will continue to be reinvested in securities with little to no coupon income in Europe and Japan, hurting investment income and increasing duration risk, all else equal. In Germany, a bond originally with 10 years to maturity will come due in January 2018 with a coupon of 4%. If reissued, with a coupon at current market rates, the German bond will have a coupon of around 30bps as 0.3%. 
A large pile of bonds is maturing, all with significantly higher coupon payments than are available today. They will be replaced with near-zero or below-zero yielding bonds to produce a significant loss of income for those investors, unless they seek refuge in the relatively attractive longer-term yields available in the US market. Thus, these NIRP refugees in Europe and Japan are piling into the US market, gobbling up longer-term Treasury securities, driving up their prices, and thereby pushing down yields, which “has likely contributed to a rapidly flattening yield curve in the US,” Fitch said. The Fed continues with its gradual rate hikes, which impacts short-term rates. It has also gingerly commenced its QE unwind, which should push up longer-term yields, but Fitch says, “demand from yield-hungry investors overseas” has so far overwhelmed the Fed’s QE unwind. With short-term yields rising and longer-term yields stuck at low levels, the yield curve has flattened, and the spread between the two-year and the 10-year yield has narrowed to levels not seen since before the Financial Crisis.
This phenomenon is occurring “despite the fact that US GDP growth has exhibited strong momentum and outperformance in 2017, similar to the Eurozone,” Fitch says. So neither Fitch nor Yellen see the flattening yield curve as an ominous sign of anything other than exasperated NIRP refugees looking for a somewhat less gruesome alternative. And folks hoping the Fed will use the flattening yield curve as an excuse to back off from further rate hikes will likely be disappointed. And at the same press conference, Yellen was repeatedly badgered about bitcoin....

Russian Banking Crisis: 3rd Major Bank Topples in 4 months

“It turned into a lender which financed its owners”: Central Bank. It’s Friday, and another Russian bank gets taken over and most of its creditors get bailed out by the Central Bank, this time the 10th largest bank in Russia, Promsvyazbank, with the top six being state-owned banks; with number seven, Bank Otkritie, having toppled in August; with number 12, B&N Bank, having toppled in September; and with Jugra Bank having gotten its banking licence revoked in July for having falsified its accounts. The bailout of Promsvyazbank (PSB) will require between 100 billion rubles and 200 billion rubles (between $1.7 billion and $3.4 billion), based on a preliminary estimate, said Central Bank deputy governor Vasily Pozdyshev on Friday, according to Reuters. “Preliminary estimates” of bank-bailout costs have a way of morphing into bigger ones. The Central Bank, which is also the banking regulator, has already increased its estimate for the combined cost of the bailouts of Otkritie and B&N Bank to 820 billion rubles ($14 billion), but it now deems both too financially weak to continue. The combined assets of PSB, Otkritie, and B&N would amount to 4 trillion rubles, equivalent to Russia’s fourth biggest bank, according to Reuters calculations.
By comparison, Russia’s largest bank, state-controlled Sberbank, accounts for one-third of the Russian banking system, as it says, and has 22 trillion rubles ($374 billion) in assets. PSB’s subordinated debt will likely be written off, Pozdyshev said. Shareholders will also take a big hit or be wiped out. They include as of the end of November: The European Bank for Reconstruction and Development, Russian financial group Budushchee, the Credit Bank of Moscow, and non-state pension fund Safmar. But the Central Bank plans to honor the PSB’s other obligations to creditors and bondholders, which include other Russian banks. It always does this to avoid contagion. The Central Bank will provide funds to support the bank’s liquidity and will send temporary administrators to take control of the bank, which would be operating as normal, Pozdyshev said. The bailout came after late-night talks between PSB’s co-owner and chairman, Dmitry Ananyev, and Central Bank governor Elvira Nabiullina, agreed on the bailout, “people with direct knowledge of the matter” told Reuters. Dmitry Ananyev and his brother, Alexei, together control over 50% of the bank. Reuters:
# Pozdyshev said PSB had a healthy business model before the global financial crisis of 2008 drove up non-performing loans. The bank’s owners shifted assets that were collateral for those loans to other parts of their empire. Those assets created a drag on the other parts of the owners’ holding, so Promsvyazbank had to pour more money into them, Pozdyshev said. “So from a market-focused bank it turned into a lender which financed its owners,” Pozdyshev said. “The amount of loans issued to the owners exceeds the bank’s capital.”
PSB has loaned its owners over 150 billion rubles, he said. The owners aren’t going to pay back those loans, it seems, and the bank needs to set up 150 billion rubles in bad loan provisions, which would knock its capital down by that much. The bank’s capital had already been knocked down to 52 billion rubles earlier this week when the bank increased its bad loan provisions by 104 billion rubles to recognize reality on other loans. What’s left is a big gaping capital hole. The Ananyevs brothers control another bank, Vozrozhdenie Bank, Russia’s 36th largest. As punishment for having strip-mined PSB, the brothers must now reduce their holdings of Vozrozhdenie to 10%, per central bank rules. August 18, shortly before Otkritie was taken over, Fitch had warned about the “liquidity squeeze” at non-state-owned Russian banks, singling out four, Otkritie, B&N Bank, PSB, and Credit Bank of Moscow, three of which have now toppled. The Central Bank is currently tightening the rules about lending to related parties and is demanding stronger capital buffers. These new rules will take effect on January 1.
As Reuters put it: The stricter rules make the business of so-called “pocket banks”, creatures of the early capitalist years of Russia, less profitable. PSB, Otkritie, and B&N Bank weren’t the last banks to get taken down, but they were among the biggest. Since 2013, the Central Bank has shut down over 300 banks. There are still over 500 banks in Russia. And the cleanup of that reeking industry and the bailout of its bondholders are not yet finished.

Canada Home Values Hit “First Quarterly Decline since Q1 2009” as Household Debt Binge Hits New High

How exposed are over-indebted household to rising interest rates? Household debt in Canada rose to a new record of C$2.11 trillion in the third quarter 2017, up 5.2% from a year ago and up 10.7% from two years ago, Statistics Canada said on Thursday in its quarterly report on national balance sheets. Mortgages accounted for 65.6% of the total. Canada’s infamous household-debt-to-disposable income ratio, one of the highest in the world, rose to a breath-taking record of 173.3%. The ratio means that households, on average, owed C$1.73 for every dollar of after-tax income earned. This chart shows how the indebtedness in relationship to after-tax income has soared since 2001, when Canada’s housing boom took off in earnest...


While US households “deleveraged” somewhat during the Great Recession, mostly by defaulting on their debts when housing crashed and jobs vanished, Canadian households barely took a breather as there was no housing bust in Canada. Hence the consistently rising and record-breaking debt-to-disposable income ratio above. Disposable income in 2016 got hit by “a significant downward revision,” based on new data received from Canada’s tax collection agency, Statistics Canada said. This resulted “in an upwards shift to this ratio.” The debt-to-disposable-income ratio of 173%, scary as it is, is just a national average. But it’s not normally the top of the income categories that get in trouble. It’s the lower categories. In a separate report also released on Thursday on the distribution of income and assets, Statistics Canada added to this debate:
# Economy-wide debt-to-asset and debt-to-disposable-income ratios can mask the financial risk associated with increasing debt for a given group of Canadian households. In 2016, the national average debt-to-disposable-income ratio was 172.1%. Decomposing this by household disposable income quintile reveals that the debt-to-disposable-income ratio for the bottom income earning households was 333.4%, while the debt-to-disposable-income ratio for the top was 128.3%. 
This chart shows the debt-to-disposable-income ratio by income quintile. Households in the bottom 20% income category (red column) are far more at risk than top-earning households. Also note that in the second and third quintiles, where many mortgages are taken out, the debt-to-disposable income is approaching 200%...


In terms of a housing bust, the average homeowner gets through it just fine. It’s the most vulnerable homeowners that get in trouble. If only 10% of all homeowners default, it translates into a national mortgage crisis of the kind the US saw during the housing bust. This comes as the value of residential real estate owned by households declined by $3.0 billion “due to weakening housing resale prices,” Statistics Canada said, adding. “This was the first quarterly decline since the first quarter of 2009.” With home prices no longer guaranteed to soar, and with debt at record levels and growing, households are immensely exposed to higher rates. Variable-rate mortgages dominate in Canada. Many mortgages adjust nearly instantly to higher rates. Others might have fixed rates for up to five years, and then they adjust. Every quarter-point increase in interest rates puts more strain on homeowners. When home prices soar reliably, the additional interest costs have little impact overall as troubled homeowners can always sell the home, and since its price has increased, pay off the mortgage. But when prices decline, as they did in Q3 for the first time since 2009, the entire equation changes.
The Bank of Canada has raised rates twice this year by a quarter point each time – tiny baby steps. And it might raise rates more next year. But even these tiny baby steps push up mortgage costs for Canadian households. And the Bank of Canada is already getting very cold feet, in face of the mountain of interest-rate-sensitive household debt. Now the Bank of Canada and government authorities are trying to walk a fine line to contain the housing bubble without accidentally causing it to implode, with fallout hitting the rest of the housing-dependent Canadian economy. But the risk appetite in housing continues as the housing & debt bubble ascends to the next level of risk....

vrijdag 15 december 2017

US Yield Curve Crashes Most In 6 Years As Stocks, Bitcoin Hit Record Highs

What could go wrong?


Small Caps exploded higher today, driven by financials, presumably on tax reform hype, but after Bob Corker said "yes" there was some notable "sell the news"...


Notably, as soon as the cash market closed, futures ripped to the highs of the day...


On the week, Nasdaq (green) and Dow (red) outperformed as Trannies (blue lagged)...


Tech outperformed on the week but financials lagged...


Oddly, high-tax companies notably undeperformed low-tac companies on the week....


High yield bonds lagged notably on the week...


Yields were mixed on the week with the short-end higher and long-end outperforming...


30Y Treasury yields are at their lowest since September's Draghi taper tantrum...


The 5s30s yield curve crashed 10bps this week to 52bps (the last two days post-Fed have seen the biggest curve flattening since June 2009)...


The weekly plunge is the biggest percentage flattening of the Treasury curve since the US downgrade in the fall of 2011...


The yield curve is down 5 straight weeks. The Dollar ended the week modestly lower, after chopping around on The Fed and tax headlines (and CPI)...


Huuge week for copper but crude ended the week lower...


Bitcoin rose 13.5% this week, the 5th weekly gain in a row to a new record high. And gold managed to hold gains...


Futures compressed their premium to spot...


And finally, there is a very serious dollar shortage around the world, signalling ominous signs of growing funding stress in the financial “plumbing”...

Bond Markets Really Are Signalling A Slowdown

Analysts shouldn’t dismiss the yield curve’s message just because inflation expectations have been declining in recent years. When it comes to the economic outlook, the bond market is smarter than the stock market. That Wall Street adage appears to be on the money from a cyclical vantage point, with key indicators in the fixed-income markets independently corroborating slowdown signals from the Economic Cycle Research Institute’s leading indexes. The yield curve is widely considered to be among the most prescient indicators. That’s why its flattening this year has been troublesome for an otherwise optimistic consensus to explain away. This hasn’t stopped optimistic analysts from dismissing the yield curve’s message on the grounds that inflation expectations have been declining in recent years, or that foreign central banks like the European Central Bank and the Bank of Japan continue to artificially suppress their bond yields, pulling down U.S. yields. We’re reminded of Sir John Templeton’s warning that “this time it’s different” are the "four most costly words in the annals of investing", but that’s effectively what it means to simply ignore the slowdown signals emanating from the fixed-income markets. Of course, there’s no Holy Grail in the world of forecasting, which is why we look at a wide array of leading indexes that each includes many inputs. From that vantage point, the yield curve flattening actually makes a lot of sense. Growth in ECRI’s U.S. Short Leading Index, which doesn’t include the yield curve, has been falling since early this year (top line in chart), pointing to a U.S. growth rate cycle downturn that should become evident in coming months...


Next, please note the separate slowdown signal coming from the difference between the yields on junk bonds and investment-grade corporate bonds, also known as the quality spread (middle line, shown inverted). It has widened in recent months because the rising default risk for junk bonds during economic slowdowns makes their yields climb faster than those of investment grade bonds, which are less likely to default. That the quality spread has little to do with the term spread is telling. Please note how closely the (inverted) quality spread has followed the Short Leading Index growth rate, not only this year, but also in past cycles. Finally, we turn to the term spread between 10-year and two-year Treasury yields, which has been falling all year (bottom line), flattening the yield curve. Again, this is being dismissed by some analysts who attribute the phenomenon to foreign central banks' suppression of their bond yields, even though this is nothing new. And while declining longer-term inflation expectations and trend growth expectations help explain the long-term downtrend in the term spread, they don't explain its cyclical fluctuations.
Of course, the quality spread doesn’t exhibit a similar long-term downtrend. That’s because it’s unaffected by both foreign monetary policy and the years-long downgrading of long-term growth and inflation expectations. Nevertheless, the chart shows that the cyclical ups and downs of both the quality spread and the term spread have followed those of the Short Leading Index's growth rate. In other words, our leading indexes, as well as two very different bond market spreads, are telegraphing an economic slowdown that nobody sees coming. It certainly threatens to blindside the Fed, which, fixated on the Phillips curve, keeps projecting multiple rate hikes over the next year. There’s a choice. Perhaps it is different this time, with the Fed, the stock market and Wall Street analysts all outsmarting the bond market and ECRI’s leading indexes. Or you can heed these slowdown signals, and begin thinking through the implications....

Global Dollar Liquidity Shortage Explodes, Worse Than European Crisis

Very quietly, in the last few days, cross currency basis swaps (CCBS) related to the dollar have reversed their rise and started collapsing deeper into negative territory… again. This might not be of much interest to buyers of global equity markets at this point, but it is signalling ominous signs of growing funding stress in the financial “plumbing”...


As Bloomberg notes “cross-currency basis swaps, which money managers and corporate treasurers outside the U.S. can use to borrow in dollars, remain close to the widest levels since January even after quarter-end, when such financing strains typically dissipate. The market was a key indicator of stress during the financial crisis, and while it’s nowhere near the alarming levels of that era, it’s still garnering the attention of analysts.” The shortage is across all the majors...


The shortage in Europe is the worst since the EU Crisis and the shortage in UK is the worst since Lehman as Japanese dollar shortage is extreme too. In simple terms, the CCBS is the cost in basis points (typically for three months) of swapping these currencies into dollars over and above prevailing interest rate differentials. In a benign environment the CCBS should trade at zero, not in negative territory. The latter implies a shortage of US dollar balance sheet (credit) offered by the global banking system. As the chart above shows, dollar liquidity became extremely tight in December 2016, especially for Yen borrowers, although it not nearly as bad as what happened in May of 2015 when we first brought attention to this little followed corner of the financial system. Despite the weakness in the dollar during much of the current year, the dollar liquidity issue never completely disappeared.
There are several reasons why, like in recent years, financing in dollars is becoming more expensive, but this very sudden spike in dollar funding costs, a sudden dollar shortage, likely combines the effects of the perception of credit risk for the European region’s banks (Italy), the prospect that a U.S. tax overhaul could trigger dollar repatriation, and the outlook for monetary-policy divergence with the Federal Reserve starting to unwind its balance sheet, and analysts see the trend only worsening (even as Draghi promises to taper). As is clear above, there are always year-end liquidity strains but this collapse is drastically beyond just that. “My first take on this a week or two ago was that a lot of the stress was just people preparing for the end of the year earlier,” Lyn Graham-Taylor, senior rates strategist at Rabobank. “But now it does look pretty bad.”
# As WSJ reports, the scarcity is having other effects, boosting some markets. The widening of the basis swap makes it more lucrative for any U.S. investors who can expand their balance sheets to buy euro-denominated assets, given banks are so keen to get their hands on their dollars. As a result, the eurozone’s safest short-dated bonds have rallied in recent weeks. “The combination of a decline in excess reserves, higher short-term rates, and dollars coming back to the US from overseas earnings should result in a structural shift in the money markets and dollar-funding availability,” said Nomura in a research note this week. Emerging markets are even more exposed to the U.S. dollar than advanced economies like the eurozone. “The reliance on US dollar funding has become increasingly marked for emerging markets since the global financial crisis in international debt markets,” the research noted. And it appears the cracks are starting to show as The Fed increases its normalization liquidty suck out....