maandag 23 april 2018

An Orderly Unwind Of Stock Market Leverage?

That would be a first, but it might be happening. Everything in slow motion, even market declines? There is nothing like a good shot of leverage to fire up the stock market. How much leverage is out there is actually a mystery, given that there are various forms of stock-market leverage that are not tracked, including leverage at the institutional level and “securities backed loans” offered by brokers to their clients. But one type of stock-market leverage is measured: “margin debt”, the amount individual and institutional investors borrow from their brokers against their portfolios. Margin debt had surged by $22.9 billion in January to a new record of $665.7 billion, the last gasp of the phenomenal Trump rally that ended January 26. But in February, as the sell-off was rattling some nerves, margin debt dropped by $20.7 billion to $645.1 billion. By March, those worries have settled down, and margin debt ticked up a bit to $645.2 billion, but remained $20.5 billion below January, according to FINRA, which regulates member brokerage firms and exchange markets, and which has taken over margin-debt reporting from the NYSE. In January, days before the sell-off began, FINRA warned about the levels of margin debt. It was “concerned,” it said, “that many investors may underestimate the risks of trading on margin and misunderstand the operation of, and reason for, margin calls.”
Investors might not understand that their broker can liquidates much or all of their portfolio “under unfavorable market conditions,” when prices are crashing. “These liquidations can create substantial losses for investors,” FINRA warned. And when the bounce comes, these investors, with their portfolios cleaned out, cannot participate in it. This is why leverage such as margin debt is the great accelerator for stocks on the way up as it creates new liquidity that goes into buying stocks. And this is also why margin debt is the great accelerator on the way down, when forced selling kicks in and liquidity just disappears. But this is not the scenario the markets are in at the moment. Everything is so orderly, though it’s a lot more volatile than it was during the run-up last year. And margin debt too has declined in an orderly manner: For the 12-month period through March, margin debt rose $67.6 billion, down by nearly half from the 12-month period ended in January, when margin debt had soared $112.2 billion, the fifth-largest 12-month gain in the history of the data series, behind only the 12-month periods ending in:
- December 2013 ($123 billion)
- July 2007 ($160 billion)
- March 2000 ($133.7 billion)
- November 1997 ($132 billion).
Margin debt has soared since 2009, with only a few noticeable down-periods, including during the Oil Bust when the S&P 500 index dropped 19%, and the 2011 sell-off when the S&P 500 index dropped 18%. In March, it exceeded the prior peak of July 2007 ($416 billion) by 55%. But that’s down from 60% in January. This chart shows the longer view...

During margin debt’s peak-to-peak surge of 60%, nominal GDP (not adjusted for inflation) rose 32% and the Consumer Price Index 20%. Historically, this disconnect has had a tendency to correct via messy panicked crashes and deleveraging. The last three spikes in margin debt are indicated in the chart above. The first two were followed by market crashes. And now? Clearly, this will correct again. It always does. But the manner in which it corrects may well be very different, more orderly rather than panicky, taking its goodly time, given the glacial pace of the Fed’s tightening and the large amounts of liquidity still in the market looking for a place to go. And this type of gradual unwinding of stock-market leverage would be a first, but it might be happening before our very eyes....

What’s Going On In The Treasury Market?

The Fed’s new paradigm. The three-month Treasury yield closed at 1.81% on Friday. It has been at about this level since before the Fed’s March 21 meeting, when it hiked its target range for the federal funds rate to 1.50%-1.75%. In other words, the three-month yield had been trading above the upper limit of the Fed’s range even before it was announced. So the rate hike was fully priced in, plus some, in preparation for another rate hike in June. This is up from 0% in 2015 when lots of folks said that the Fed could never raise interest rates again. The two-year yield had no such moment of rest. It rose to 2.46% on Friday, the highest since August 11, 2008, and up from 2.31% on rate-hike day in March...

As bond yields rise, bond prices fall by definition. So a rising-yield environment can be tough on holders of bonds with longer maturities. The ten-year Treasury yield moved only sporadically, wavering, or even declining as short-term yields soared, but then shot higher, before taking another break. Now it’s shooting higher again. On Friday, the 10-year yield rose to 2.96%, the highest close since January 9, 2014. It’s tantalizingly close to 3% and appears to be setting up for a another try at breaking the 3% level. If the 10-year yield closes at 3.05%, just 9 basis points higher than Friday’s close, it will be the highest close since July 2011...

In mid-February, as the 10-year yield was soaring and threatened to take out the 3% level, I speculated that it would run into a wall over the near term, for two reasons: Enormous demand at the 3% level, and record short positions by hedge funds against the 10-year Treasury. This begged for a contrarian rally, or even a short squeeze. While the ensuing rally wasn’t exactly spectacular, it pushed the yield down to 2.73% by early April. But since then, the 10-year has sold off again. Now with the yield at 2.96%, it might try to make another run at breaking 3%. It might not succeed this time. But it will succeed sooner rather than later. Of note, the two-year yield has not yet run into this kind of wall of resistance. As in the prior three rate-hike cycles going back to the 1990s, the two-year yield has reacted faster to rate hikes than the 10-year yield. While the 10-year yield tends to surge later in the cycle, the two-year yield also surges and has a tendency to overshoot late in the cycle. The current spread between the two-year yield (2.46%) and the 10-year yield (2.96%) is 50 basis points, about the same as in December. That spread is narrow. But this is practically normal in rate-hike cycles. The chart below compares the two-year yield (black line) and the 10-year yield (red line) going back to 1992. We’re now in the fourth rate-hike cycle over the period. Note how much jumpier the two-year yield is than the 10-year yield...

The two-year yield was higher than the 10-year yield in 2000 and then again in 2006/2007. This was when the yield curve “inverted,” the unusual phenomenon when the 10-year yield is lower than shorter-term yields. But this rate-hike cycle is different from the prior ones. The last rate-hike cycle started in June 2004 and ended in June 2006. During those two years, the Fed took its policy rate from 1% to 5.25%. This time, the Fed is moving at a glacial pace. If it hikes rates by 25 basis points four times this year, it will be a lot. In this cycle, the Fed has engaged in policy action only at meetings that are followed by a press conference. There are four of them per year. The Fed started in December 2015 with a 25-basis-point hike, did another one in December 2016, did three in 2017, and might do four in 2018. For now, it is set to proceed at a similar pace in 2019 and possibly into 2020. At this pace, the rate-hike cycle might last up to five years, instead of two years. The Fed’s persistent word for this has been “gradual.”
Given that the pace is so much slower, and that the duration of the cycle is already longer than the 2004-2006 cycle, the results will likely be different too. The last two rate-hike cycles ended in inverted yield curves and were followed by recessions and worse. This pattern might not occur again, given the Fed’s new paradigm, the slow-motion approach. And we’re left guessing as to how this might turn out. If the economy adjusts to these higher rates without recession, the Fed might not cut rates again for a long time, even as asset prices, stocks, bonds, real estate, etc, “gradually” meander lower for years in response to higher rates and tighter credit. Think about the implications. The bond market is already talking about the next rate cuts, possibly as soon as 2019, much like it was talking about “QE Infinity” in 2012 or the permanent zero-interest-rate policy in early 2015. And given the new scenario of long slow-motion rate hikes, the bond market may be engaging in wishful thinking once again....

This Is How First-Time Buyers Get Squeezed By Rampant Home Price Inflation

Millennials can go to the Fed and complain. Home prices have been surging in many markets, mortgage rates have been rising, and incomes have plodded along with little growth, and the disconnect is getting bigger and bigger. This is not a problem for well-to-do Americans who’ve owned a lot of assets and benefited from the rampant asset price inflation over the past eight years, but it is a problem for those trying to buy a home based on their wages, especially first-time buyers, which now include more and more millennials. Freddie Mac reported on Thursday that its weekly average 30-year fixed mortgage rate rose to 4.47%, the highest since January 2014, which is still very low historically. On Friday, the average 30-year fixed mortgage rate for top tier borrowers rose to 4.58%, according to Mortgage News Daily, on a day when the Treasury 10-year yield surged to 2.96%, the highest since 2014. This comes to the drumbeat of ballooning home prices.
So, the monthly costs of an “entry-level home” on a nationwide basis surged 9% in March from a year ago, according to a note by John Burns Real Estate Consulting Senior Research Analyst Devyn Bachman. The report defined “entry-level home” as one that sells for 80% of the median price (resale and new) in that particular market. It assumed a 5% down-payment and a 30-year fixed-rate mortgage for the remainder. The monthly costs include principal, interest, taxes, insurance, and private mortgage insurance. But they do not include maintenance and other costs associated with owning a home. In the San Francisco Bay Area, a diverse area that includes San Francisco, Silicon Valley, much of the East Bay, and parts of the North Bay, the monthly costs of this entry-level home surged 14% in March compared to a year earlier, to $4,673! This is the highest monthly cost of any major Metropolitan Statistical Area in the US. But this is based on the median price of a large and diverse area. In some cities within the Bay Area, monthly costs of the “entry-level home” are lower, in others far higher. 
For example, in San Francisco, where the median home is $1.4 million, and the “entry-level home” $1.12 million, the monthly mortgage payment (interest and principal) would come to about $5,400 for an entry-level home. Property taxes would come to about $633 a month. So already over $6,000 a month. Plus insurance and private mortgage insurance. So pretty soon, this “entry-level home” costs about $75,000 a year, not including utilities, maintenance, and other expenses. If it’s a condo, and at this price, it certainly is a condo, the homeowner association fees will have to be added on top. This is why even the median Facebook employee (not to be confused with its contract workers), making over $240,000 a year in total compensation before income taxes, is feeling the squeeze. In the Seattle metro, the monthly costs of the entry-level home jumped 13% from a year ago to $2,790, the second highest in the country. The report finds that in the San Francisco Bay Area and in the Seattle metro, “home buyers have become overly exuberant.” To put it mildly. In the vast and divers New York City metro area, the costs of an entry-level home inched up 1% to $2,634, third highest in the country. However, the median price in Manhattan was $1.1 million in Q1 and the average price was nearly $2 million, according to the Elliman Report.
Within Manhattan, there are huge differences. In TriBeCa, the most expensive spot, the median sales price was $3.6 million, according to PropertyShark. In SoHo, it was $3.2 million, in the West Village it was $2.3 million. These are condos or coops. Talk about “overly exuberant” home buyers. There simply are no “entry-level homes” in these neighborhoods. This is the case in many areas of Manhattan. So just forget it. Of the largest 31 metro areas, 23 have an affordability problem that is “notably worse than the long-term norm,” the report finds. So here’s Burns’ list of the monthly housing costs of the top 31 metros, in order of their year-over-year percentage increases. The San Francisco Bay Area is at the top with a 14% jump in costs. The New York and Washington D.C. metros are at the bottom with increases of 1% (I added the red marks)...

“In conclusion, home buyers can afford less homes today than they could one year ago,” the report says. This is the effect of rampant asset price inflation. It hits real life in this way:
- The costs of housing will siphon off the new owner’s income that cannot be used for other things.
- Potential buyers are looking for housing further away, thus incurring the costs and hassles of longer commutes.
- Buyers end up with something even smaller (not as if homes in New York City or San Francisco are palatial in size to begin with).
- They’re looking for condos instead of single-family houses.
And starting in 2018, there will be additional costs due to the new tax law, on top of home-price increases and jumpy mortgage interest rates: the mortgage interest deductibility has been further reduced. So first-time buyers, having missed out on the home-price surge of the past eight or so years, this includes most millennials, bear the brunt of the costs of this asset price inflation in the housing market. That lunch was free for some. But others are paying for it. And those folks, including the millennials, can go to the Fed and complain about it since it was the Fed that set out to “heal” the housing market after the Financial Crisis by purposefully inflating home prices, or more precisely, devalue the fruits of labor for buying assets....

“Financial Stress” In The Credit Markets Versus The 2-Year Yield

The two-year yield, now surging, is a leading indicator. The Financial Stress Index, released weekly by the St. Louis Fed, is designed to track financial conditions that companies face in the markets. It reached record lows in November, meaning that there was extraordinarily little “financial stress” in the markets after years of ultra-easy monetary policies. The index then ticked up a little and did a mini-spike in February, but was still far below the historical “normal.” Then it zigzagged higher. Last week it had risen to the highest level since the Oil Bust two years ago, though it remained way below historical “normal.” In the current release, the index backed off again. The index is designed to show a level of zero for “normal” financial conditions (blue line). When financial conditions are tighter than normal, the index shows a positive value. When these conditions are easier than normal, the index is negative. Note the recent rise (circled)...

After years of ultra-loose monetary policies, financial conditions in the US economy have been dominated by risk-blind investors chasing any kind of yield, which resulted in minuscule risk premiums for investors, ultra-low borrowing costs even for junk-rated companies, and immensely inflated asset prices. Even the Oil Bust and the Taper Tantrum, while they increased financial stress somewhat, couldn’t push financial conditions back to “normal” levels, given the Fed’s stimulus at the time. The chart also shows just how long the easy-money conditions have endured since the Financial Crisis, with the Financial Stress Index below “normal” since late 2009. So now there’s also some response in the market to the removal of accommodation by the Fed, but it isn’t much. The response hasn’t even reached the level of the Taper Tantrum, when the Fed had suggested it might eventually “taper” away what had been called “QE Infinity.” Now at -0.97, the index remains solidly below “normal.”
The index, made up of 18 components, seven interest rate measures, six yield spreads, and five other indices, takes a broad measure of how markets perceive and price risk. And currently, the markets are still somnolent. By “normalizing” its monetary policies, the Fed effectively attempts to tighten financial conditions in the markets to bring them back to historical norms: raise yields, widen spreads, increase risk premiums, etc, in other words, make credit more expensive and harder to come by, and increase the price of risk. But the market is slow to react to a shift in monetary policies. And when it does begins to react, the adjustments can be eye-popping. The Financial Stress Index and the two-year Treasury yield move roughly in parallel, but with a large time lag. The two-year yield is very responsive to changes in monetary policy and tends to overshoot late in the rate-hike cycle. This makes it a leading indicator by years as to where many of the financial stress components will go: junk bond yields, spreads, risk premiums, and the like. They will follow, but way behind. The two year yield (black line, right scale) started rising ever so slowly in 2014, as QE was ending. But in late 2016, it surged and hasn’t looked back since. The Financial Stress Index (red line, left scale) began rising just four months ago. The chart below shows this relationship. Look at the years leading up to the Financial Crisis...

The two-year yield shot up in 2005 and 2006 as the Fed was raising rates and it overshot late in the cycle, when investors penciled in more rate hikes than were forthcoming. It peaked in June 2006 and then settled down some. By about that time, the Financial Stress Index started stirring. A year later, in July 2008, it reached “normal.” In September 2008, it began to spike with the Lehman bankruptcy. So what we’re seeing in the chart above in the current cycle is the lag between the two-year yield, which has been shooting higher, and the actual tightening of the financial conditions, a process that is just now gradually starting to take off.
The Financial Stress Index is not a leading indicator. It just shows what’s going on in the credit markets right now. But the two-year yield is a leading indicator of financial stress in the credit markets. The hope is that there won’t be a repeat of 2008. The huge spike in the Financial Stress Index was a sign that credit had solidly frozen over, and this had huge consequences in a credit-based economy. The Fed has been indicating that it wants to “normalize” financial conditions, thus bringing the Financial Stress Index into positive territory near the zero line. There have also been suggestions recently that it may want to tighten beyond “normal,” in which case it would want to see the Financial Stress Index in positive territory. At the current pace, it has quite a ways to go, and rates will have to rise quite a bit further before the rest of the markets gets it and catches up with the Fed’s intentions....

North Korea Promised To Denuclearize In 2008 And Proved Its Sincerity

In 2008, the North Koreans committed to denuclearization, and to prove it, they blew up a nuclear reactor cooling tower. The reaction from the West was euphoric. North Korea was taken off the international terror list, and many sanctions were immediately removed. Here's an AP news story from June 27, 2008:
* "North Korea destroyed the most visible symbol of its nuclear weapons program today, blasting apart the cooling tower at its main atomic reactor. The demolition of the 60-foot-tall cooling tower at the North's main reactor complex is a response to America's concessions after the North delivered a declaration yesterday of its nuclear programs to be dismantled. "This is a very important step in the disablement process and I think it puts us in a good position to move into the next phase," the U.S. State Department's top expert on the Koreas, Sung Kim, who attended the demolition, said. Kim shook hands with a North Korean official following the tower's tumble to the ground. In its first reaction to the developments this week, North Korea's Foreign Ministry welcomed Washington's decision to take the country off the U.S. trade and sanctions blacklists. "The U.S. measure should lead to a complete and all-out withdrawal of its hostile policy toward (the North) so that the denuclearization process can proceed smoothly," the ministry said in a statement carried by the official (North) Korean Central News Agency."
It was all very sweet and friendly, except that North Korea kept on secretly developing nuclear weapons, and a year later started testing again. The North Korean promises were completely meaningless, but they got major concessions that remained for years... AP (27-June-2008)
# North Korea suspends all nuclear, missile tests, shuts down nuclear test site; In what some analysts are calling a "dramatic about-face," North Korea promised on Saturday to end all nuclear and missile tests and shut down a nuclear test site. Instead, the country will pursue economic growth and a "strong Socialist economy." According to the (North) Korean Central News Agency (KCNA): "Under the proven condition of complete nuclear weapons, we no longer need any nuclear tests, mid-range and intercontinental ballistic rocket tests, and that the nuclear test site in northern area has also completed its mission. To secure transparency on the suspension of nuclear tests, we will close the republic's northern nuclear test site. Nuclear development has proceeded scientifically and in due order and the development of the delivery strike means also proceeded scientifically and verified the completion of nuclear weapons. We no longer need any nuclear test or test launches of intermediate and intercontinental range ballistic missiles and because of this, the northern nuclear test site has finished its mission. We will concentrate all efforts on building a powerful socialist economy and markedly improving the standard of people’s living through the mobilization of all human and material resources of the country." Korea Herald
I am totally incapable of figuring out why anyone would think that this is some sort of about-face or breakthrough. In fact, this is a statement of the West's worst nightmare. North Korea will stop nuclear weapon and ballistic missile testing, but will keep their existing weapons, and will continue development without open testing.. In the past, the North Koreans have said that they will manufacture an arsenal of nuclear weapons and ballistic missiles. Furthermore, North Korea has sold chemical weapons technology to Syria and other countries, and will do the same with nuclear technology. There is no mention of North Korean "denuclearization." Instead, the statement elsewhere says "(It's an) important process for global nuclear disarmament," meaning that North Korea will happily denuclearize if the rest of the world denuclearizes. In January, the North announced that there would be no testing during the Winter Olympics games being held in Seoul. So this new announcement is just an extension and repetition of the previous one. I've heard a couple of analysts claim that this announcement is extremely significant because the North didn't have to do it, and the fact that they did do it proves that they're sincere. However, three days ago, president Donald Trump said this, in reference to his planned meeting with North Korea's child dictator Kim Jong-un: "I hope to have a very successful meeting. If I think it's a meeting that is not going to be fruitful, we are not going to go. If the meeting, when I'm there, is not fruitful, I will respectfully leave the meeting." BBC
So it's possible that North Korean officials decided to make Saturday's announcement in response to Trump's remarks. From the North's point of view, Trump's meeting with Kim will send the following message to the world: North Korea is an advanced nuclear power, and is an equal to the United States. Trump and South Korea are demanding that North Korea "denuclearize," which means that the North give up all its weapons. This is never going to happen without a war. The North has been building nuclear weapons for decades, and they will not stop now just when they are finally building their arsenal. Really, the situation hasn't changed since the beginning of the year: Either North Korea will have an arsenal of nuclear weapons and ballistic missiles that can reach the United States, as well as Asian targets that include Japan, or else the US will have to launch a military strike to take out North Korea's nuclear capabilities, if such a strike is even possible.... CNN and Korea Times

zaterdag 21 april 2018

Now Even A Fed Dove Homes In On The “Everything Bubble”

Bonds, junk bonds, spreads, commercial real estate, leveraged loans, over-leveraged companies,  all get named as risks to the banks. This is why tightening will continue. “If we have learned anything from the past, it is that we must be especially vigilant about the health of our financial system in good times, when potential vulnerabilities may be building,” explained Federal Reserve Board Governor Lael Brainard in a speech in Washington, D.C, this morning. This was a reference to a time-honored banker adage, now mostly forgotten after nearly nine years of easy money: Bad deals are made in good times. Brainard fills one of the seven slots on the Board of Governors. Two slots are filled by Chairman Jerome Powell and by Randal Quarles. Four slots remain vacant, waiting for Trump appointees to wend their way. She is a strong “dove” in the world of central banks, and she just pointed at why the Fed is tightening, and will continue to tighten: the Everything Bubble. After rattling off a litany of indicators showing why and how the economy’s “cyclical conditions have been strengthening,” she added this gem, there being nothing like Fed-speak to make your day: “Currently, inflation appears to be well-anchored to the upside around our 2 percent target.” “Well-anchored to the upside” of the Fed’s target and then she moved on to the “signs of financial imbalances.” “Financial imbalances,” in Fed speak, are asset bubbles, a phenomenon when prices are out of whack with economic reality.
In a credit-based economy, assets are collateral for debt. And inflated asset prices put the financial system, meaning the lenders, at risk when those asset prices deflate. Since the Fed has to take care of the financial system, and since it blew up so wonderfully last time due to asset bubbles deflating, the Fed is right to be worried about it. At first the hawks, the rare ones; and now even the doves. And she goes on, sticking all the while to the central banker rule of never calling anything in front of them a “bubble.” They say, prices are “elevated”:
# Our scan of financial vulnerabilities suggests elevated risks in two areas: asset valuations and business leverage. First, asset valuations across a range of markets remain elevated relative to a variety of historical norms, even after taking into account recent market volatility. 
In other words, even after the mini-selloff since the end of January, prices are still too “elevated.” And then she goes into my favorite metrics, the bond market bubble where investment-grade yields are low and junk-bond yields are ludicrously low, with paper-thin spreads or risk premiums that don’t pay investors for the massive risks they’re taking, the bubble in “leveraged loans” and collateralized loan obligations (CLOs), and the bubble in commercial real estate, particularly in multifamily and industrial:
* Corporate bond yields remain low by historical comparison, and spreads of yields on junk bonds above those on comparable-maturity Treasury securities are near the lower end of their historical range. Spreads on leveraged loans and securitized products (CLOs) backed by those loans remain narrow. Prices of multifamily residential and industrial commercial real estate (CRE) have risen, while capitalization rates for these segments have reached historical lows. 
It is rare to hear a Fed governor, and a dove in particular, list some of the biggest elements in the Everything Bubble as a concern. And the concern is not how to maintain it and keep it inflated; but how to tamp down on it gradually. And then she gets into “business leverage,” in other words, companies with too much debt, which has turned into a record problem:
* Second, business leverage outside the financial sector has risen to levels that are high relative to historical trends. In the nonfinancial business sector, the debt-to-income ratio has increased to near the upper end of its historical distribution, and net leverage at speculative-grade junk-rated firms is especially elevated. 
I added the bold below:
* As we have seen in previous cycles, unexpected negative shocks to earnings though they’re actually not unexpected, as we’ve seen in the brick-and-mortar meltdown in combination with increased interest rates could lead to rising levels of delinquencies among business borrowers and related stresses to some banks’ balance sheets. 
OK, already happening. Chapter 11 bankruptcies spiked 63% in March from a year ago and have hit the highest level since April 2011. The credit cycle has already begun to turn. So Brainard has just outlined in her elegant and soft-spoken Fed-speak manner a big part of the Everything Bubble and the risks its deflation poses to the banking system. She then explains that the banks are in good shape now, very profitable, with plenty of liquidity, and with large capital buffers, and are much more tightly regulated than before the Financial Crisis, so that they can take a good wallop from their borrowers without collapsing. This leads her to her next topic, with stark references to the Financial Crisis: Now, the good times, is not the time to back off from regulation and it’s not the time to lower capital requirements and reduce liquidity rules. But it is the time to tamp down on these “elevated” asset prices that are putting banks at risk. There appears to be now a near-consensus at the Fed about this.
The keyword is “gradual.” Nearly every time the Fed says anything big, it has “gradual” in it. And this is why the tightening will continue though it may become slightly less “gradual.” But because it’s still so gradual, it will go on for a long time, with the goal of deflating the Everything Bubble very “gradually.” That would be the ideal scenario. No economic upheaval, no sudden collapse in asset prices, but also no spike in inflation that would push the Fed to abandon the “gradual” approach and go for some kind of monetary shock. Just smooth gliding at ever lower altitudes for many years. That’s the best-case scenario after nearly a decade of rampant asset price inflation generated by experimental monetary policies. The corporate bond market, particularly the junk-bond market, is happily dreaming in La-la-land till the rude awakening. It’s actually true that “companies”, a generic term, are flush with cash. But that’s only 1/4 of the story. Here is the other 3/4 that the media forgets to tell:
1. Most of this record cash on corporate balance sheets is borrowed money. There is a massive pile of debt on the other side of the balance sheet. Hence, corporate debt is at a record, even as cash is at a record.
2. Some companies, Apple, Microsoft, Google, etc, do have a lot of cash and not all that much debt. These are a few huge companies that distort the overall stats, and they’re not going to get in trouble.
3. Many companies have a too much debt and very little cash, and what little cash they have is borrowed money.
These are the junk-rated companies. There has never been more junk-rated debt. The overall quality of debt has deteriorated sharply over the past few years. And these companies are the ones that are going to cause the next credit meltdown, not Apple and Microsoft. This is part of the problem when we report averages. The average creditor is not going to collapse. It’s the lower 20% that is vulnerable. During the Financial Crisis, about 10% of the mortgages went bad and caused the mortgage meltdown. So by looking at the averages, we’re looking at the wrong thing and miss the problem....

Don Quijones; EU Moves To Protect Financial System From Failing Banks

Too Little, Too Late? The European Commission gave its blessing to a plan proposed by Italian authorities to liquidate small troubled banks in Italy with total assets of less than €3 billion. Under the plan, as a failing bank is “resolved,” its assets and liabilities will be transferred to another lender under national insolvency proceedings. When liabilities (including deposits) exceed the value of good assets (mostly loans), the gap would be dealt with by giving haircuts to unsecured creditors, including insured depositors who would then be made whole by the respective national deposit guarantee fund, and by mobilizing taxpayers. The new resolution plan will be available not only to Italy. Each Eurozone member state will have the option to “set up schemes to support the orderly exit of small failing banks, adapted to the conditions in each market.” Italy, like many other EU countries (including France, Spain and Germany), has pathetically inadequate funds in its deposit guarantee fund, hence the need to mobilize taxpayer funds. Under rules passed in 2014, EU member states need to have funds in deposit guarantee schemes equivalent to at least 0.8% of the covered deposits, but given that most countries don’t even come close to that, they’ve been given until 2024 to reach the target.
The last time the European Banking Authority checked, at the end of 2016, Italy, like Ireland and the Netherlands, had guarantee funds equivalent to just 0.1% of covered deposits. In Spain the figure was around 0.2%, while in France and Germany it was 0.3%. All EU bank deposits are guaranteed up to €100,000, regardless of how much is in a member state’s fund. Senior bondholders are also protected from any financial fallout. But if a large enough bank collapses in a disorderly enough fashion, trying to plug the massive financial holes it leaves behind can suddenly become a very difficult task, as Spanish and European authorities learned in June last year when Spain’s then-sixth biggest bank, Banco Popular, succumbed to a run on deposits following years of chronic, if not criminal, mismanagement. In its final days, Popular was bleeding funds at an average rate of €2 billion a day. In the end, Europe’s Single Supervisory Mechanism decided that the bank was insolvent. Popular, warts and all, was sold for €1 to Banco Santander, which had to raise €13 billion of fresh capital to digest the deal. At least part of those funds will be returned to Santander through tax credits. If Santander hadn’t intervened and Popular had been allowed to collapse in disorderly fashion, some of its €60 billion of deposits would have been at risk, El País reported. A total of €35.4 billion were guaranteed.
But Spain’s Deposit Guarantee Fund (DGF) didn’t have nearly enough liquidity to cover those deposits and would itself have had to be bailed out by the Spanish state in order to reimburse Banco Popular’s customers. It’s not clear exactly how much money Spain’s DGF has in its coffers today, but there’s good reason to believe it has even less than it had at the end of 2016, when it had a paltry €1.6 billion, far short of the €6.4 billion it’s supposed to have by 2024. It might be drained by now. So, what happens if another mid-sized lender like Popular begins to wobble? Given that in June 2017 the EU was home to 597 medium-size banks, which the ECB defines as banks whose assets represent between 0.5% and 0.005% of the total consolidated assets of EU banks, this is not a hypothetical question. And it’s one the ECB is apparently beginning to take very seriously. The ECB is considering launching a new policy tool that would allow it to inject cash into banks that are being rescued from the threat of insolvency. And that cash, once again, will come from government coffers. ECB vice president Vitor Constancio cited Britain, where the Bank of England can request an indemnity from the government on loans extended to banks in resolution, and the United States as possible models.
At the moment European rules bar the ECB or its affiliate nation central banks from supporting a failing lender while the European Union’s Single Resolution Board mounts a rescue mission. “The UK and U.S. have a solid, whole process of resolution that includes those liquidity problems during that period of time, and I hope that Europe will get to some solution to this problem,” Constancio told the European Parliament. To that end, the ECB has already created a new lending facility called Eurosystem Resolution Liquidity. All it’s waiting for is a green light from the Eurogroup of euro zone finance ministers. But that could be a long time in coming, especially given fears among richer countries that the new rules could be used to prop up failing banks with public money, fears that the last raft of EU banking laws was explicitly designed to put to rest. In the meantime, one thing is abundantly clear: Even at this stage of proceedings, six years after Europe’s debt crisis, the Eurozone is far from prepared for another rash of banking failures. UK regulators may be on the verge of doing something right, but doubts remain over how genuine their stated intentions are....

Another Big Retailer Gets Liquidated

Retailers in bankruptcy are notoriously hard to restructure. Bon-Ton Stores, it operates department stores in 23 states under the brands of Bon-Ton, Bergner’s, Boston Store, Carson’s, Elder-Beerman, Herberger’s, and Younkers, filed for bankruptcy in February in the hopes of being able to restructure its debt in court and go on as a going concern. But it has now thrown in the towel, so to speak. The bankruptcy judge today approved the sale of Bon-Ton Stores’ assets to a joint venture of two liquidators and creditors holding Bon-Ton’s second-lien secured notes:
# The liquidators: Great American Group and Tiger Capital Group.
# The creditors: PE firms, hedge funds, and investment banks that had scooped up the bonds for cents on the dollar: Brigade Capital Management, Wolverine Asset Management, B. Riley FBR, Riva Ridge Master Fund, Bennett Management, and Alden Global Capital.
Their joint bid was about $777 million, “a person familiar with the matter” told the Wall Street Journal. The joint venture will close all remaining 250 department stores no later than August 31, on top of the 40 stores Bon-Ton had already closed before filing for bankruptcy, sell the inventory and other assets, and layoff off the remaining 24,000 employees. Bon-Ton Stores had already warned on April 6 that it would close a 743,000-square-foot distribution center in Ohio that it had opened three years ago. At the time of the bankruptcy filing in February, Bon-Ton Stores had obtained a debtor-in-possession (DIP) loan commitment of up to $725 million to get it through the bankruptcy process. Of this commitment, $575 million are outstanding. The purchase price approved today has enough cash in it to repay the outstanding DIP balance. The payment for the $725 million purchase price also includes the “value” of the bonds of $125 million that the group of bondholders contributed to the deal.
The joint venture won in the bankruptcy auction on Tuesday against a bid from a group of liquidation firms Hilco Merchant Resources and Gordon Brothers Retail Partners. A third group never never submitted a bid. The group included the credit-focused hedge fund DW Partners and mall owners Washington Prime Group and Namdar Realty Group. Their intent had been to acquire Bon-Ton Stores as a going concern and keep the stores open. When Bon-Ton stores announced the winning bid on Tuesday, it said in a statement:
* While we are disappointed by this outcome and tried very hard to identify bidders interested in operating the business as a going concern, we are committed to working constructively with the winning bidder to ensure an orderly wind-down of operations that minimizes the impact of this development on our associates, customers, vendors and the communities we serve. We are incredibly grateful to all of our associates for their dedicated service to Bon-Ton and to our millions of loyal customers who we have had the pleasure to serve as their hometown store for more than 160 years. 
That Bon-Ton Stores would face liquidation if it could not find a buyer became clear in bankruptcy court on March 12, when the company set out the rules for an auction of its business as a going concern. The company said if there’s no bid that satisfies the court and the creditors, it would likely be forced into liquidation. These creditors, namely said holders of the second-lien secured notes, had been clamoring all along for asset liquidation and did what they could to stymie the restructuring negotiations before and during bankruptcy. Now they got what they wanted. This will be the second liquidation of a major retailer this year. The first was that of Toys “R” Us. After filing for Chapter 11 bankruptcy last September and promising that it would remain in business, it announced on March 15 that it would close all its 735 stores in the US, liquidate the inventory, and be done with it. About 33,000 jobs will disappear over the next few months. The retail sector is the second largest employer in the US, with 15.7 million jobs.
Over the past 12 months, it actually created 63,000 jobs. But that was in segments that are not under all-out attack from e-commerce, such as gasoline stations, grocery and beverage stores, and auto dealers. The segments that are under attack have shed nearly 70,000 jobs. These 12-month totals were as of March and do not include the 33,000 Toys ‘R’ Us jobs and the 24,000 Bon-Ton jobs that will disappear over the next few months. Bon-Ton and Toys ‘R’ Us, before they filed for bankruptcy, occupied nearly 60 million square feet of retail space, which will be vacated by this summer. Toys ‘R’ Us stores are already wreaking havoc among commercial mortgage backed securities. No wonder that two mall owners tried to keep Bon-Ton from liquidating by buying it. It was a move of desperation. It’s a big job to do something useful with 60 million square feet of retail space that becomes vacant all of a sudden in the middle of the brick-and-mortar meltdown. More broadly, there could be about 12,000 store closures this year in the US, according to data from Cushman & Wakefield, cited by the Wall Street Journal. Last year, which was bad enough, there were about 9,000. While retail sales overall are growing at a healthy clip, the segments that are under attack from e-commerce are getting crushed. And it has started to impact the national averages for commercial real estate....

Socialist Venezuela's State-Owned PDVSA Oil Company Near Total Collapse

Socialist Venezuela's state-owned oil company Petróleos de Venezuela S.A. (PDVSA) is close to collapse, beset with an ever-growing array of new and growing problems. Venezuela's oil refineries worked at 31% of their in the first quarter in 2018, well below 2017 levels. Venezuela has not seen such low levels of oil production since the 1980s. Average oil production declined dramatically over the past two years, by 12% in 2016 and again by 13% in 2017. Production in December 2017 was 27% lower than a year earlier. Late last year, Venezuela's Socialist president Nicolás Maduro appointed a military man, Major General Manuel Quevedo, head of PDVSA, with a mandate to increase production and rid the company of corruption. Quevedo and his team of military officers had no experience in the oil industry, and replaced long-time experienced employees with soldiers. According to an executive, "The military guys arrive calling the engineers thieves and saboteurs." There has been a stampede of PDVSA workers resigning from the company. Already, 25,000 of the company's 146,000 employees resigned in 2017, and the exodus has accelerated in 2018, as General Quevedo "quickly alienated the firm’s embattled upper echelon and its rank-and-file," according to union leaders. Curaçao Chronicle
Many of those leaving now are engineers, managers, or lawyers, professionals that are almost impossible to replace. Some offices now have lines outside with dozens of workers waiting to resign, and there have been so many resignations that some offices are refusing to accept any more of them. The loss of all these workers is one of the causes of the fall in production, and also the inability of the company to properly maintain its equipment. Many drilling rigs work only intermittently for lack of crews, and several small fires have broken out because there are no longer enough supervisors. The apparent oil industry collapse is a major factor in Venezuela's economic deback. More than 90% of the country's hard currency is obtained through oil exports. The country is also suffering the worst economic depression ever recorded in Latin America. The International Monetary Fund (IMF) estimates gross domestic product (GDP) contracted by 16.5 percent in 2016 and 12 percent in 2017, and forecasts a 15 percent contraction for 2018. Inflation reached more than 2,600 percent in 2017, the highest in the world by a wide margin, and the IMF forecasts 13,000 percent for 2018.... OilPrice and Reuters
# Will China or Russia save Venezuela? Only China and Russia can provide Venezuela with enough money to keep it from going into full-blown default, but it's doubtful that they will. However, Russia has been purchasing Venezuelan oil fields in exchange for loans, extending Russian influence in Venezuela. The Soviet Union propped up Cuba's economy for decades, but it seems unlikely that Russia will do the same for Venezuela, which is several times larger and more expensive than Cuba. It's worth repeating that this disaster is the fault of Socialism. As I discussed in my article yesterday on Cuba's Socialism, Socialism has a 100% failure rate. Socialism killed hundreds of millions of people during the twentieth century, far more than Naziism killed, and now it's destroying Venezuela. Cuba seems to be stepping back from the brink, having implemented a few reforms, though there's still a very long way to go. But Venezuela under Nicolás Maduro refuses to implement any reforms at all, and seems willing to destroy Venezuela for his own benefit.... Atlantic Council (PDF) and Bloomberg and Council on Foreign Relations

woensdag 18 april 2018

Uneven Economy And The Hidden Depression

# Are we in a depression? The question seems absurd. There has been GDP growth since 2009 and some mild inflation to go with it. In fact, this is the second longest economic expansion on record. As Robert Shiller said over the weekend (though in the context of warning against complacency), “[i]f the economy manages to expand for 16 more months, the United States will have set a record.” Unemployment is the lowest in history, nothing like the 17% we had by a U.S. Bureau of Labor Statistics estimate a decade after the stock market crash in 1929 and the average of 18% in the 1930s. House prices have come screaming back across the nation. The stock market has increased by more than 15% annually beginning in 2009. And even middle-class wages have shown signs of picking up lately.
# Depression-Era Demographics In Some Exurbs; And yet, even overlooking the opioid epidemic and the 42 million Americans on food stamps (happily down from nearly 48 million in 2013), there are disturbing signs around the country that all is not well. For example, a recent article in the New York Times by Robert Gebeloff focusing on Hunterdon County in New Jersey shows that many suburban and exurban Northeast and Midwest counties have stopped booming. More people are dying than being born or moving in through immigration or migration. Hunterdon County, 60 miles from New York City, is the sixth richest county nationally with a median household income is over $100,000. Young people are having fewer children, and the recession-stalled migration patterns are only resuming in certain parts of the country. According to Geberloff, “Some of the once-fastest-growing counties in the United States are growing no more, and nationwide, the birthrate has dropped to levels not seen since the Great Depression.” Since a recent peak in 2007, lifetime births per woman in the U.S. is down 16%. Because deaths are outnumbering births in so many outer-ring counties, flummoxing demographers waiting for a trend reversal, migration is crucial. But lower immigration puts stress on Northeastern suburban counties losing population to the South and West. And while more people living in cities may lower long-distance commuting and urban decay, “population stagnation in places that had been growing will most likely bring its own sets of problems, including pressures on real estate values and eventual shrinking of political representation.” While births have declined, migration within the U.S. has resumed to pre-recession levels. However, the trend is toward Florida, Texas, and Arizona, which have all seen population inflows. Rural parts of the country have been struggling with these demographic problems for a while now, but Gebeloff’s article shows that they are hitting what have been much more well-off areas now. In Hunterdon County, a 460-acre Merck campus sits abandoned, and enrollment in some school districts is down 20%.
# Patio Man Still Thrives; But if outer ring Northeastern suburbs are in jeopardy, that’s not the situation everywhere. In 2002, when it looked like exurbia or life in what he called “Sprinkler Cities” was the future, David Brooks wrote a column for the Weekly Standard called “Patio Man and the Sprawl People” partly about how urban types were annexing old line, inner ring suburbs, while more traditional suburbanites were claiming the outer rings where they could enjoy peaceful patios, happy kids, slender friends and “the massive barbecue grill towering over it all.” Now, it seems, the outer rings are struggling mightily, but perhaps only in the Northeast and Midwest. In other words, Brooks’s 2002 analysis somehow holds up today. This is how he described the trend in defending suburbia, or the movement from old suburbia to new suburbia, “The truth, of course, is that suburbia is not a retreat from gritty American life, it is American life. Already, suburbanites make up about half of the country’s population (while city people make up 28 percent and rural folk make up the rest), and American gets more suburban every year.” And they make up 53% of America now, according to Jed Kolko in a post for the statistically oriented news site, FiveThirtyEight. Moreover, in a 2017 post, Kolko wrote, “The suburbanization of America marches on,” as he noted the fast growth of Southern and Western metro areas, including Cap Coral-Fort Myers, FL, Provo-Orem, UT, and Austin-Round Rock, TX. Kolko also highlighted educated rural areas and the Pacific Northwest as growing regions. Those include Olympia and Spokane in Washington and Eugene and Salem in Oregon. Boise also made his list for growth of metro areas with 250,000 or more people. The big population losers, unsurprisingly, have been rural areas. And while the “urban revival” is real, according to Kolko, it has mostly been for rich, educated people, in particular hyperurban neighborhoods rather than broad-based return to city living. Patio Man continues to thrive – just not in Hunterdon County, New Jersey. Overall, the country is hardly in a depression, but things are grimmer than many think in some surprising places....

Optimism of U.S. Manufacturers “Plunged” The Most Ever

Corporate America fears that a Trade War would hit supply chains in China. Something strange happened in the Empire State Manufacturing Survey released by the New York Fed this morning. The survey has two headline components: The index for current conditions and the index for future conditions six months down the road. The first index behaved reasonably well; the second index plunged the most ever. Executives are notoriously optimistic. In the survey, which goes back to 2001, expectations for future conditions are always higher than current conditions, and often by a big margin, even early on in the Financial Crisis before all heck was breaking loose. The index of future conditions reacts to events. For example, it spiked after Trump’s election. So today’s biggest plunge in survey history is a reaction to an event. “Optimism tumbles,” the New York Fed’s report called it. And more emphatically: “Optimism about the six-month outlook plunged among manufacturing firms.”
The headline index is based on a question about “general business conditions.” The sub-indices are based on questions about specific aspects of the manufacturing business, such as new orders, shipments, unfilled orders, employment, etc. In this “diffusion index,” respondents rate their business on each question, with conditions either rising or falling. The number of respondents who said the level was falling is subtracted from the number who said it was rising. Respondents who say there has been no change don’t count. If half say the level is falling and half say the level is rising, the index is at zero. The index for current “general business conditions” in April dropped slightly: 37.9% of the executives reported better general business conditions; 22.1% reported worse conditions. The difference between the two, 15.8 points, the index value for April, was down 6.7 points from March, and as the report said, “firmly in positive territory.” But the index for future conditions, which is usually highly optimistic, got crushed, with only 40.3% of the respondents saying “general business conditions” are getting better and 21.9% saying they’re getting worse. This pushed the index down to 18.3, the lowest level since February 2016. The 25.8-point plunge from March to April was the steepest monthly plunge in the history of the survey. This chart shows the General Business Condition indices for current conditions (black line) and forward-looking conditions (blue line) with the plunge circled. The thin vertical red line indicates the last survey period before the November 2016 election...

The 25.8-point April plunge took the index from 44.1 points in March to 18.3 points in April, the largest monthly plunge ever. The second largest plunge (25.1 points) occurred in January 2016 as credit in the energy sector was freezing up and as the S&P 500 index was on its way to drop 19%. The third steepest plunge (24.3 points) occurred in January 2009, during the Financial Crisis. The chart below shows the month-to-month changes in the forward-looking general business conditions index...

Among the forward-looking sub-indices were some standouts, in terms of by how many points they plunged from March to April:
*New Orders: -24.5
*Shipments: -24.8
*Number of Employees: -10.2
*Average Employee Workweek: -11.0
Over the history of the survey, the index for future conditions has been on average 31 points higher than the index for current conditions, attesting to the rampant and enduring optimism of the executive mindset about the future. But in April, the difference plunged to just 2.5 points, the smallest difference since 9-11, when it had plunged to 0.6 points.
# Why the plunge in optimism? The report did not explain why optimism among manufacturers, after the 16-month Trump surge, plunged to this extent, so suddenly, and to such a low level even as the economy was clicking along, as long-term interest rates remained low, and as current conditions didn’t signal any major deterioration. The future conditions index reacts to events. And there was only one major economic event that cropped up in the US during the survey period: Fear of a trade war with China. It’s not that US manufactures export that much to China, they don’t, and that’s part of the problem. As a group, they worry less about China cracking down on manufactured goods exported from the US to China. But they worry about their supply chains. They’re going all over China and through China, importing into the US essential components and materials, thus contributing to the horrendous trade imbalances between the US and China. And these components and materials are now being specifically targeted by US tariffs. The proposed tariffs would not stop those imports but would raise their costs, and the rising costs of those imports, or the costs of switching to another supplier outside of China, would eat into the profit margins of the US manufacturers. This would be the opposite of what happened when these executives decided to cut costs by offshoring their supply chains to China. For now, no actual tariffs have been imposed. And it’s possible that Trump will cave under the pressure of Corporate America and that nothing will change, in which case we could expect this optimism gauge to spike once again....

US-China Trade-War Threats Rattle Germany AG

But unlike the New York Fed, ZEW named names and pointed fingers. Yesterday, I speculated about what might have caused the optimism of manufacturing executives in the New York Fed’s district to collapse by the most in the survey’s history. The forward-looking index plunged in the April survey more than it had during the worst month of the Financial Crisis. The survey didn’t say why. So I speculated that it reflected the fear in Corporate America of a trade war between the US and China, not because US companies might see their exports to China get hit with retaliatory tariffs, there are woefully few manufactured exports from the US to China, but because Corporate America’s supply chains have been offshored to China and beyond, and the proposed US tariffs would make the components and materials more expensive for US manufactures, thus squeezing their profit margins extracted from offshoring.
Today, it’s the turn of Germany AG to express its fears about the trade war and slowing conditions in Germany and the Eurozone via the Financial Market Survey by the Center for European Economic Research (ZEW). But unlike the New York Fed yesterday, the ZEW report named names and pointed fingers. The ZEW’s Indicator of Economic Sentiment for Germany in the future dropped sharply, and very unexpectedly, given how swell things are with negative interest rates and the ECB’s purchases of corporate bonds, and all. It fell by 13.3 points to -8.2, the lowest level since November 2012, when the Eurozone was still trying to dig itself out of its debt crisis. Over the three reports since January, the index has plunged by 28.6 points. Note in the chart below that the index has remained stubbornly below the long-term average of 23.4 (green line) since July 2015...

The above chart is the forward-looking sentiment indicator, thus reflecting expectations for the future. But the index for current economic conditions in Germany, a reflection of what is going on right now, edged down only a little (2.8 points), at at 87.9 remains high...

The ZEW surveys about 350 analysts from finance, research, and economic departments at banks, insurance companies, and large industrial enterprises, “as well as traders, fund managers, and investment consultants” (methodology). So what is it with expectations for future economic conditions to deteriorate suddenly and by so much, just as the New York Fed’s survey had indicated yesterday, but with the sentiment about current economic conditions remaining high? “The reasons for this downturn in expectations can mainly be found in the international trade conflict with the United States,” the ZEW report explained. It named other reasons for the decline in expectations about future economic development, including “the current situation in the Syrian war,” and internal issues, such as the “significant decline in production, exports, and retail sales in Germany in the first quarter of 2018.”
So things aren’t so hunky-dory at home either at the moment. And it’s broader too. Even as the indicator for current economic conditions for the entire Eurozone edged up 1.5 points to 57.7, and thus remains high, the indicator of economic expectations, a reflection of future developments, for the Eurozone fell by 11.5 points to “merely” 1.9. The report blames “the same factors as in Germany,” including the “trade conflict” with the US and “the figures for production and retail sales in the first quarter of 2018” that turned out to be “surprisingly negative”, and all are “having a negative impact on the economic expectations for the Eurozone.” So, different scenarios in the US and Germany, but similar worries: While they’re still feeling good about current economic conditions, these executives and experts have suddenly started to see some nasty clouds. Something to keep our eyes on....

Junk Bond Market Still In Total Denial, Fighting The Fed

Happily dreaming in La-la-land till the rude awakening. The Fed’s efforts to raise interest rates across the spectrum have borne fruit only in limited fashion. In the Treasury market, yields of longer-dated securities have not risen as sharply (prices fall when yields rise) as they have with Treasuries of shorter maturities. The two-year yield has surged to 2.41% on Tuesday, the highest since July 2008. But the 10-year yield, at 2.82%, while double from two years ago, is only back where it had been in 2014. So the difference (the “spread”) between the two has narrowed to just 0.41 percentage points, the narrowest since before the Financial Crisis...

This disconnect is typical during the earlier stages of the rate-hike cycle because the Fed, through its market operations, targets the federal funds rate. Short-term Treasury yields follow with some will of their own. But the long end doesn’t rise at the same pace, or doesn’t rise at all because there is a lot of demand for these securities at those yields. Investors are “fighting the Fed”, doing the opposite of what the Fed wants them to do, and the difference between the shorter and longer maturities dwindles, and it dwindles, and it causes a lot of gray hairs, and it dwindles further, until it stops making sense to investors and they open their eyes and get out of the chase, and suddenly long-term yield surge higher, as bond prices drop sharply. That’s why short sellers have taken record positions against the 10-year Treasury recently: they’re waiting for yields to spike to the next level. But this disconnect, this symptom of investors fighting the Fed, in the Treasury market is mild compared to the disconnect in the junk bond market. There, investors have completely blown off the Fed. At least in the Treasury market, 10-year yields have risen since the Fed started getting serious about rate increases in December 2016.
In the junk bond market, yields have since fallen. In other words, despite the Fed’s tightening, the junk bond bubble has gotten bigger. And investors are not yet showing any signs of second thoughts. At the riskiest end, the average yield of junk bonds rated CCC or lower dropped two percentage points since the Fed got serious about tightening, from 11.9% in December 2016 to 9.9% currently (per ICE BofAML US High Yield CCC or Below Effective Yield index)...

The difference in yield between junk bonds (high risk) and Treasury securities (low risk) is how much investors insist on getting paid for taking more risks. When the spread narrows, hence, when the “risk premium” shrinks – investors are chasing yield and are taking ever larger risks for ever smaller amounts in compensation. And the spread between the broad junk-bond index and equivalent Treasury yields has narrowed to 3.33 percentage points. Beyond the brief dip on January 26 (to a spread of 3.23 points), it’s the narrowest spread since the la-la days in July 2007 before the Financial Crisis put an end to it (ICE BofAML US High Yield Master II Option-Adjusted Spread via St. Louis Fed)...

These days, investors are so eager to chase yield that they’re engaging in huge risks with little extra compensation. This is precisely one of the conditions in the financial markets that the Fed is targeting with its tightening policies. It wants yield spreads to widen. It wants risk premiums to grow. It wants long-term Treasury yields to rise, and it wants junk bond yields of equivalent maturities to rise faster than Treasury yields. All this means is that the Fed wants bond prices to head south. Eventually, the Fed wins. And when it does, junk bond yields have a tendency to blow out as the companies that issued those bonds suddenly get caught in a credit squeeze and have trouble servicing that debt. The last two charts above show how far and how suddenly junk bond yields can blow out, as bond prices collapse: during the Financial Crisis and during the oil bust, and that was just an oil bust for crying out loud, and not even a recession. But not yet. For now, the market is in total denial and happily chasing yield and taking on more risks. And for the Fed, it’s a sign that its tightening job has really just begun....

dinsdag 17 april 2018

Syria Blocks OPCW Inspectors From Visiting Site Of Chemical Attack

Syria has been for several days blocking the Organization for the Prohibition of Chemical Weapons (OPCW) from inspecting the Douma site. The OPCW held an emergency meeting in Hague on Monday, and demanded immediate unfettered access to the site of the attack. Russians have already been inspecting the site since the day after the April 7 chemical attack. We know that because the Russians have said that these "experts" had visited and determined that there was no evidence of a chemical attack. So these "experts" have already had ten days to clean up as much evidence as they can. There were also reports by a correspondent on al-Jazeera that local Syrians in Douma are being threatened by Syrian security forces with violence to themselves and their families if they give the OPCW inspectors any evidence of the chemical attack. Late on Monday, Syria said that they could go on Wednesday, April 18.... Deutsche Welle and Tass (9-Apr) and Al-Jazeera
# As Syria's al-Assad attacks Idlib, he may consider chemical weapons essential. The military strategy used by Bashar al-Assad in Douma and Ghouta, and earlier in Aleppo, depends heavily on repeated use of chemical weapons, particularly chlorine attacks. His objective in these cities is genocide and ethnic cleansing, to kill as many Sunnis as possible, since he says that all Sunnis in these cities are terrorists, including women and children. The problem that al-Assad has faced is that people hide in basements, and so clearing out the entire population of Sunnis requires destroying all buildings as much as possible, then house to house searches to find all the Sunnis still hiding from the army. That process will work, but it can take many months. Use of chlorine gas speeds things up considerably. Chlorine is heavier than air, and the chlorine gas seeps into the basement of every home, forcing the women and children out into the open, where al-Assad can mop them up and kill them all simultaneously. This could save considerable time, and undoubtedly has already. Idlib province presents special problems for al-Assad. Whereas Ghouta and Aleppo each had just a few hundred thousand residents, Idlib has over two million. In fact, many of the people who fled the violence in Aleppo and Ghouta ended up fleeing to Idlib. So for al-Assad, Idlib contains over two million terrorists. Reuters
To exterminate all those residents of Aleppo with just conventional weapons will take al-Assad a long time, possibly years. Al-Assad would like to mop up the entire population a lot more quickly than that. There have been news reports that al-Assad has been smiling and happy since Saturday's coalition airstrikes, because even though a few buildings were demolished, the airstrikes actually gave al-Assad the green light he needs to proceed with ethnic cleansing and genocide in Idlib: 
- Saturday's attack was little more than a slap on the wrist for al-Assad. He undoubtedly has other labs that can produce chemical weapons, and he undoubtedly has other stocks of chemical weapons elsewhere.
- The West has only condemned chemical weapons use by al-Assad, meaning that any other form of mass slaughter is perfectly acceptable. In fact, al-Assad has conducted numerous chlorine attacks.
- The one on April 7 has been called out only because of the horrific videos. So al-Assad can even conduct further chemical weapons attacks, provided that he does something to prevent any viral videos.
- Furthermore, if al-Assad uses chlorine gas again, it's likely that the international opposition to another strike on al-Assad's assets will make it impossible.
So Bashar al-Assad has plenty of reason to be smiling and happy now. He will undoubtedly use chlorine gas to force women and children out into the open where his missiles can kill masses of them simultaneously. Basically, there is nothing stopping him from committing any war crimes or ethnic cleansing or genocide in Idlib. Bashar al-Assad is the worst genocidal monster so far this century, and Vladimir Putin and Ayatollah Khamenei are war criminals for participating in his genocide.... France Diplomatie and  and AFP and Syria Deeply (29-Mar)

Russia Ties Itself In Knots Diplomatically Over Syria Chemical Attack

On Friday, Russia's foreign minister Sergei Lavrov said that he had "irrefutable evidence" that the April 7 chemical attack Syria's Damascus suburb Douma had been staged: "We have the irrefutable data that this [chemical attack] was staged. And special services of a country, which is now seeking to be in the first ranks of the Russophobic campaign, were involved in this staged event." Lavrov did not name the country, but other Russian officials have said that Lavrov was referring to the UK, and said that the British government has paid a group of volunteer rescue workers, known as the White Helmets, "to stage a provocation with an alleged use of chemical weapons." In an interview of Lavrov by BBC's HardTalk, Steven Sachur repeatedly asked what this "irrefutable data" was, and Lavrov never answered the question, but kept personally attacking Sachur. Not surprisingly, no such irrefutable data exists.
According to a statement by the British government: "Russia has argued that the attack on Douma was somehow staged, or faked. They have even suggested that the UK was behind the attack. That is ludicrous. The attack on Douma was not reported by just a sole source in opposition to the Regime. There are multiple eye witness accounts, substantial video footage, accounts from first responders and medical evidence." Russia is tied up in knots about this subject because lie after lie have caught up with one another. After Bashar al-Assad used Sarin gas on his own people in 2013, Lavrov first denied that any Sarin attack had taken place, then denied that al-Assad had any stockpiles of Sarin gas, and then committed to US Secretary of State John Kerry that all stockpiles of chemical weapons would be removed. Under international pressure, Lavrov committed that Russia would guarantee that all chemical weapons would be removed. So you can see the problem. Russia has to deny that any attack took place on April 7, because Russia has guaranteed that al-Assad has no stockpiles of chemical weapons. UK Government
That's why Russia is diplomatically tied up in knots. Lavrov made an additional interesting statement during the interview. He was asked whether relations between Russia and the West are worse than during the cold war: "Well I think it's worse because during the cold war there were channels of communication, and there was no obsession with Russophobia, which looks like genocide by sanctions." His accusation of "genocide by sanctions" is startling, and the "Russophobia" remark is common to both of Lavrov's comments quoted above, and reflects a pervasive paranoia in Russia's leadership. I've previously quoted a high-level Russian official claiming that the West has been attacking Russia for 200 years. All this talk about staging the chemical attack as a kind of Hollywood horror film and blaming it on the UK, combined with paranoia, seems highly delusional and worrying. Russia's leadership is in a very dangerous state right now, and could make a miscalculation and mistake.... Tass (13 April) and  NBC News (13-Apr) and Russia Today (13-Apr) and BBC HardTalk

maandag 16 april 2018

Why Aren’t Big Banks Paying Higher Interest Rates On Deposits Though Rates Have Surged?

Well, they do pay higher rates, but not to their own clients. Interest rates from the very short-term through two-year maturities have surged since the Fed got serious about raising rates. In terms of the Treasury market, for example, the three-month yield is now at 1.76% and the two year yield at 2.37%...

And the interest rates that banks offer on deposits should in theory be about in line with Treasury yields in a competitive market. For example, a three-month FDIC-insured CD, which is roughly equivalent to a three-month Treasury bill in terms of risk, should offer a rate similar to the 3-month treasury yield of 1.76%. A one-year CD should offer around 2.1%, a two year CD around 2.4%...

# Do they? Well, no. Case in point: The bank, one of the largest in the country, where I have my personal and corporate checking accounts and other accounts and services, though I use other banks as well, offers on its website a 9-month CD with a rate of 0.3%, a 19-month CD with a rate of 0.70%, and a 36-month rate of 0.80%. These are piss-poor rates, given where Treasury yields are today. The interest it pays on checking and savings accounts is so minuscule it’s not even worth looking at. Clearly, the bank doesn’t want to pay its existing clients more for the money they already have in their accounts at the bank. But here’s the thing. The very same bank currently offers a 13-month CD at 2.2% and a two-year CD at 2.6%. But not on its website. And it didn’t tell me about it. I found it when I checked CDs at my main broker. Then I checked my other broker. Same CD offers from my bank, same rates: 2.2% for a 13-month CD and 2.6% for a two-year CD. Brokers sell so-called “brokered CDs” like they sell bonds. But it’s a lot easier to buy CDs than bonds. And my broker doesn’t even charge a fee for selling CDs, which is not the case with bonds. And you can sell these “brokered CDs” in the secondary market through your broker, as you would sell a bond, if you need to have the cash, though in an environment of rising interest rates, selling CDs and bonds usually involves capital losses.
At my brokers, all kinds of other banks offer CDs in the one-year range at a rate of 2.1% or higher, including Morgan Stanley Bank and UBS. And banks at my broker are offering two-year CDs at 2.6% or higher, including my own bank, plus a slew of others such as Morgan Stanley, Citibank, Goldman Sachs, Ally Bank, and so on. And five-year CDs are offered at 3.1% by Sallie Mae Bank and Synchrony Bank, and at 3.05% by Citibank and Discover Bank. I also know that Citibank offers its own clients ludicrously low rates on their deposits. To get Citibank to pay up for your money, you have to go to a brokered CD. In terms of savings accounts, American Express Bank offers 1.55%. Marcus, the new retail bank Goldman Sachs launched, offers 1.60%. Both are trying to attract new depositors, and they advertise those rates on their websites, and their existing depositors get the same rates, unlike at my bank or at Citibank and others. So it’s a cat-and-mouse game. Clearly, banks are interested in attracting new deposits and are offering competitive rates in competitive market places. Those competitive market places are the brokers. At my two brokers, there are dozens of CDs on offer from all kinds of banks. The CD with the highest rate in a specific maturity, for example one year, is listed at the top and will sell the quickest. And no one looks at the bottom CDs that offer lower rates.
That’s a competitive market. But when your bank already sits on your money, it doesn’t feel like it needs to compete. It just wants to keep its funding costs low. And it is doing that by paying insultingly low rates on existing deposits. It will continue to do so until clients are starting to move money out of this bank to greener pastures. Credit unions and smaller banks might offer higher rates if they feel they need to compete with the big boys for clients and deposits. So for people hunting down higher deposit rates, the time is now to start looking for competitive market places. The fact is even the biggest banks offer competitive rates because they want and need to attract new deposits, but they’re not offering those rates to their existing clients. Leverage, the risk it poses to banks, is why the Fed has been worried about the price bubble in commercial real estate....

Wolf Richter; Is The “Petro-Yuan” A Credible Challenge To Dollar Supremacy?

China latest effort to get its currency to be used globally is the “petro-yuan.” Is it a credible challenge to the supremacy of the US dollar? If China dumped US Treasuries, what would that accomplish? Central banks around the world seem leery about the Chinese yuan.... Youtube

zondag 15 april 2018

Iran, Hezbollah And Syria Threaten Retaliation Against Israel

Although the debate over Saturday's airstrikes has dominated news coverage since the April 7 chemical attack, there's a completely different parallel issue in play, which may be even more dangerous. On Monday last week, Israel attacked Syria's T4 airbase (Tayfur airport), because the airbase is considered a threat to Israel. Apparently seven Iranians were killed in the attack. Hezbollah leader Sayyed Hasan Nasrallah says that the attack put Israel into direct combat with Iran: "You made a historic mistake and a great folly which brings you into direct confrontation with Iran. This is the first time in 7 years that the Israelis have deliberately killed Iranian revolutionary guards. Attacking T-4 airport is a pivotal incident in the history of the region that can’t be ignored. Iran is not a weak or a cowardly state, and you know that well. The Israeli have false calculation. You will have to face the Islamic Republic of Iran. All those thousands of terrorists in Syria do not concern the Israeli while they have every kind of weapons, however, they are afraid of just few revolutionary guards there." Al Manar (Hezbollah)
According to the BBC, Syria, Iran and Russia are all expressing quiet relief that Saturday's missile attack was considerably more limited than was expected. But it did evoke a sense of greater defiance, with the three entities calling themselves the "Axis of Resistance," and referring to Western powers as "paper tigers," a phrase used by China's Mao Zedong in the 1960s to describe the United States. It's generally believed that Iran must retaliate for Israel's airstrike, killing several Iranian revolutionary guards. This could be a far more dangerous confrontation than even Saturday's missile strikes. Reuters
#  Long time readers are aware that we predict that the Mideast is headed for a major regional war, pitting Jews against Arabs, Sunnis against Shias, and various ethnic groups against each other. Events appear to be moving very quickly now.... Al-Jazeera

Britain Publishes Its Legal Justification For Military Action

I've always believed that there was plenty of legal justification for American and Western military intervention in Syria. After al-Assad began targeting peaceful protesters in 2011, and particularly after he massacred thousands of innocent women and children in a Palestinian refugee camp in Latakia in August 2011, millions of Syrian citizens began fleeing into neighboring countries, including over a million reaching Europe. Any country has a responsibility to control its own population, but al-Assad had essentially weaponized refugees. If al-Assad can't control its own population, but instead uses them as a weapon, then any target is justified in intervening in the country. In addition, al-Assad's attack on the Palestinian camp caused tens of thousands of Sunni jihadists to travel from around the world to fight al-Assad. These foreign jihadists formed the so-called Islamic State (IS or ISIS or ISIL or Daesh), which has launched terror attacks on other countries.
Once again, if al-Assad can't control ISIS, then any country threatened by ISIS is justified in intervening. In fact, the US military intervention in Syria has succeeded in recapturing all territory formerly occupied by ISIS, although ISIS is far from completely defeated. So the West certainly has plenty of justifications for military intervention in Syria, but al-Assad's use of chemical weapons doubles down on those justifications. But in the end, the justification for this kind of military action has less to do with international law, and more to do with domestic politics. For that reason, the British government has published a humanitarian justification policy paper for Saturday's military action. Here's a brief summary: The Syrian regime's use of chemical weapons is a war crime and a crime against humanity. Under international law, the UK may use force for humanitarian intervention, provided that three conditions are met:
- Convincing evidence of extreme humanitarian distress on a large scale, requiring immediate and urgent relief;
- There is no practicable alternative to use of force, if lives are to be saved.
- The proposed use of force must be necessary and proportionate to the aim of relief of humanitarian suffering,
The policy paper goes on to explain why all three conditions have been met.... BBC and UK Government

American, British, French Attack On Syria Signals Sharp Change In Western Policy

The joint attack on Syrian targets by American, British and French forces ended as quickly as it started. The attack was in retaliation for the attack on April 7 by Syria's president Bashar al-Assad on civilians in Douma, using chemical weapons. The attack occurred at 4 am Syrian time, and was over in minutes. 105 missiles were launched, striking three Syrian chemical weapons targets. The military said that all missiles reached their target, and denied Syrian claims that most (or any) were shot down. The attack was "one and done," according to Secretary of Defense James Mattis. Mattis and other US officials have stated clearly that another attack will follow if al-Assad uses chemical weapons again. So America's message to Bashar al-Assad is pretty clear: "You may use barrel bombs, missiles, gunfire, and any other conventional weapons on neighborhoods, markets, schools and hospitals, and you may massacre and kill as many women and children as you want, with no retribution. Just don't use chemical weapons." The targets and time of day of Saturday morning's attack were carefully chosen so as to avoid civilian casualties, particularly Russian casualties.
# The Russian military did not respond, and it was clear that both the US and Russian side did everything possible to avoid confronting each other. However, the language used by Russia on Saturday was extremely bitter and angry. And according to Pentagon spokesman Dana White, "The Russian disinformation campaign has already begun. There has been a 2000 per cent increase in Russian trolls in the last 24 hours." As someone who is attacked constantly by Russian trolls, this is disheartening news. At Saturday's UN Security Council meeting by Russia's ambassador Vasily Nebenzya expressed deep anger: "The US and its allies continue to demonstrate blatant disregard for international law. You are constantly tempted by neocolonialism. You have nothing but disdain for the UN charter, and the Security Council. As a pretext for aggression, you mention the alleged use of chemical weapons in Douma, but after an investigation by Russian experts, it was proven unequivocally that no such attacks took place." The invocation of international law by Russia is really laughable, as Russia has done everything from invading and annexing Crimea to support the worst genocidal monster so far this century, Bashar al-Assad, without getting approval for anything from the UN Security Council, yet Russian officials become apoplectic when the US or the West does anything to avoid their UNSC veto.
As I've been writing starting in 2011, Russia's president Vladimir Putin adopted a policy of using the UN Security Council to take control of US, Nato and Western foreign policy. Russia took any military action it pleased without getting UNSC approval, but demanded that any other country got UNSC approval for everything. By using its UNSC veto, Russia could effectively control American foreign policy. This Russian policy has been extremely successful for years, crippling not only Western foreign policy, but the UN Security Council itself. I believe that success reached its peak with the March 4 poisoning of former Russian double agent Sergei Skripal and his daughter Yulia, using a Russia-developed nerve agent Novichok. The British public was incensed that Russia put ordinary British citizens at risk by using Novichok in public, where anyone could be affected, but Russia made matters worse when Russia's president Vladimir Putin smirked and gave a sarcastic answer when a BBC reporter asked about it.
This was following by a series of moronic claims by Russia, including accusing Britain of poisoning the Skripals in order to embarrass Russia. Britain's foreign secretary Boris Johnson gave a furious response to these claims: "There is something in the kind of smug, sarcastic response that we’ve heard that indicates their fundamental guilt. They want to simultaneously deny it, yet at the same time to glory in it." The Skripal poisoning was an international tipping point, uniting Britain and other nations to no longer tolerate Russia's strategy to use the UNSC to cripple Western foreign policy. That's why Russian ambassador Vasily Nebenzya and other Russian officials are so bitterly angry. The policy they had successfully used for years is now collapsing in front of them. Further remarks by the Russians have the appearance of hysterical desperation. There have been horrifying videos of al-Assad's April 7 chemical attack on Douma, but Nebenzya and other Russian officials are claiming that the chemical attack didn't even occur. They claim that the British government paid the "White Helmet" humanitarian workers in Douma to stage the horrifying videos as a Hollywood production. One gets the impression that the Russians as a nation are becoming completely delusional. Meanwhile, Syrians in Damascus were dancing in the streets on Saturday, because the military strikes were not as bad as feared.... Guardian (Australia) and The Hill

zaterdag 14 april 2018

John Rubin; This Really Is The Everything Bubble, Even Subprime Mortgage Bonds Are Back

Record student loan balances? Check. Trillion dollar credit card debt? Check. Six tech stocks dominating the Nasdaq? Check. Subprime auto loans at record levels? Check. All that’s missing is subprime mortgages and we’d have every bubble base covered. Oh wait, those are back too, just under a different name:
# Subprime mortgages make a comeback, with a new name and soaring demand. They were blamed for the biggest financial disaster in a century. Subprime mortgages, home loans to borrowers with sketchy credit who put little to no skin in the game. Following the epic housing crash, they disappeared, due to strong, new regulation, and zero demand from investors who were badly burned. Barely a decade later, they’re coming back with a new name, nonprime, and, so far, some new standards. California-based Carrington Mortgage Services, a midsized lender, just announced an expansion into the space, offering loans to borrowers, “with less-than-perfect credit.” Carrington will originate and service the loans, but it will also securitize them for sale to investors. “We believe there is actually a market today in the secondary market for people who want to buy nonprime loans that have been properly underwritten,” said Rick Sharga, executive vice president of Carrington Mortgage Holdings.
“We’re not going back to the bad old days of ninja lending, when people with no jobs, no income, and no assets were getting loans.” Sharga said Carrington will manually underwrite each loan, assessing the individual risks. But it will allow its borrowers to have FICO credit scores as low as 500. The current average for agency-backed mortgages is in the mid-700s. Borrowers can take out loans of up to $1.5 million on single-family homes, townhomes and condominiums. They can also do cash-out refinances, where borrowers tap extra equity in their homes, up to $500,000. Recent credit events, like a foreclosure, bankruptcy or a history of late payments are acceptable. All loans, however, will not be the same for all borrowers. If a borrower is higher risk, a higher down payment will be required, and the interest rate will likely be higher. “What we’re talking about is underwriting that goes back to common sense sort of practices. If you have risk, you offset risk somewhere else,” added Sharga, while touting, “We probably are going to have the widest range of products for people with challenging credit in the marketplace.”
 Carrington is not alone in the space. Angel Oak began offering and securitizing nonprime mortgages two years ago and has done six nonprime securitizations so far. It recently finalized its biggest securitization yet, $329 million, comprising 905 mortgages with an average amount of about $363,000. Just more than 80 percent of the loans are nonprime. Investors in Angel Oak’s nonprime securitizations are, “a who’s who of Wall Street,” according to company representatives, citing hedge funds and insurance companies. Angel Oak’s securitizations now total $1.3 billion in mortgage debt. Angel Oak, along with Caliber Home Loans, have been the main players in the space, securitizing relatively few loans. That is clearly about to change in a big way, as demand is rising. “We believe that more competition is positive for the marketplace because there is strong enough demand for the product to support multiple originators,” said Lauren Hedvat, managing director, capital markets at Angel Oak. “Additionally, the more competitors there are, the wider the footprint becomes, which should open the door for more potential borrowers.” Big banks are also getting in the game, both investing in the securities and funding the lenders, according to Sharga. “It’s large financial institutions. A lot of people with private capital sitting on the sidelines, who are very interested in this market and believe that as long as the risks are managed well, and companies like ours are particularly good at managing credit risk, that it’s a good investment opportunity,” he said.
# So today’s subprime mortgages are being written with lots of common sense safeguards. But demand for the resulting bonds is soaring and lots of new players, big and small, are getting into the game. Wonder what that means for underwriting standards going forward…...