Tuesday, June 25, 2013

Today's links

1---Good explanation for tight interbank liquidity conditions in China - finally,  sober look (wonkish)

As discussed earlier, it is clear that the PBoC does not have a good handle on banks' risk-based capital and the smaller banks in China have been playing the game of regulatory capital arbitrage. This is similar to US banks using off-balance-sheet vehicles funded with commercial paper to "convert" long-dated illiquid assets into short term (less than 365 days) exposure.

2---Mortgage Rate Shock Likely to Dent the Housing Market, naked capitalism

Fannie Mae Chief Economist Doug Duncan said the concern should be less about what the rates have risen to and more about the speed at which they are rising.
Duncan noted that in 1994, for instance, rates rose 2% over a 12-month period, resulting in a huge impact on home prices, which fell significantly.
“If the rise happens rapidly, it tends to have an impact,” said Duncan, who added that once rates rise 100 basis points, home sales may begin to slow.

3--Is China Central Bank Back-Dating Info to Cover for Unprecedented Credit Bubble?, GEI

Exploding Local Government DebtThere has been much focus on the wild credit spending of local governments.  Since February 2012 banks have received instructions to roll over many of the $1.7 trillion of local government loans when they come due in 2012, 2013 and 2014 rather than seek repayment or restructuring.  (See GEI News.)
After only a year into this rollover program, Simon Rabinovitch reported (April 2013)  in the Financial Times that local government debt was estimated at various amounts up to $3.2 trillion.

China Debt-Deflation Risk
Nearly a year ago John Hempton wrote a GEI Opinion article which warned that China faced a serious debt-deflation risk.  Since then CPI has shrunk and PPI has spent nearly a year in deflation.  Is the debt burden part of that prediction coming to pass?

Ponzi Finance by Manufacturers?
Also a year ago, Craig Tindale (GEI Opinion) wrote an article which discussed what appeared to be Ponzi financing by Chinese construction equipment manufacturers.

Special Investment Vehicles, Chinese Style
Last week Ambrose Evens-Pritchard reported in The Telegraph that the credit rating agency Fitch declared that China's shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts.  Fitch listed as problems $1.4 trillion in so-called trust products in the shadow banking system and $2 trillion in wealth products.  Much of these shadow banking system assets are "hidden second balance sheet" items for banks.
According The Telegraph, half of the wealth products niche must be rolled over every three months and another 25% within six months.

4---How Austerity Has Failed, Martin Wolfe, NYRB

Austerity has failed. It turned a nascent recovery into stagnation. That imposes huge and unnecessary costs, not just in the short run, but also in the long term: the costs of investments unmade, of businesses not started, of skills atrophied, and of hopes destroyed.

What is being done here in the UK and also in much of the eurozone is worse than a crime, it is a blunder. If policymakers listened to the arguments put forward by our opponents, the picture, already dark, would become still darker....

The right approach to a crisis of this kind is to use everything: policies that strengthen the banking system; policies that increase private sector incentives to invest; expansionary monetary policies; and, last but not least, the government’s capacity to borrow and spend.

Failing to do this, in the UK, or failing to make this possible, in the eurozone, has helped cause a lamentably weak recovery that is very likely to leave long-lasting scars. It was a huge mistake. It is not too late to change course.

5---Share selloff points to new crisis, wsws

But such has become the extreme dependence of financial capital on continuous injections of ultra-cheap liquidity from the Fed that even the hint of a future cutback in the flow of funds brought an instant paroxysm on the markets. Bond prices fell, bringing a rise in bond yields (interest rates). On Wall Street, the Dow fell, losing some 200 points in the period immediately following Bernanke’s press conference and dropping a further 350 points the next day before recovering slightly on Friday.

The selloff has had a major impact around the world, especially in so-called emerging markets, where currencies that had been rising against the dollar have suffered significant falls. The Turkish lira and the Indian rupee hit record lows last week....

Since the global financial crisis erupted in 2008, central banks around the world, with the US Fed leading the way, are estimated to have shoveled at least $10 trillion into financial markets. The initial assistance took the form of bailouts. Now it is being delivered in the form of quantitative easing, in which hundreds of billions of dollars at ultra-cheap rates is made available to banks and finance houses through central bank purchases of bonds.

The official rationale for this policy is that purchasing bonds and driving down the yields on the safest financial assets will eventually lead to greater risk-taking by investors, including the injection of money into the real economy.

That has not taken place. Rather, quantitative easing has promoted unprecedented financial speculation, leading to a situation in which share markets have risen sharply while the real economy has either grown very slowly, stagnated or contracted.

6---Market eyes fresh 'fix' as Fed plans QE withdrawal, USA Today

In the past 4½ years, QE has proliferated wildly on Wall Street trading desks, passed along from trade to trade like a marijuana cigarette at Woodstock in 1969. QE has also infiltrated Wall Street's financial spreadsheets, as well as its super-smart computer programs, or algorithms, that automatically execute all those lightning-quick trades. In short, most trades, risk-taking and the way investors have positioned their portfolios in recent years have been driven with QE in mind.
The problem now? The Fed, headed by Chairman Ben Bernanke, hinted strongly Wednesday that it plans on cutting back its bond-buying program later this year and could end the experimental policy by mid-2014 -- if the economy continues to improve. And that has caused massive disruptions in financial markets, including sharp drops in the prices of stocks and bonds and many other assets around the globe.

The Standard & Poor's 500, for example, has dropped nearly 4% in the three trading sessions since the Fed outlined its exit strategy.

The reason for the current market hemorrhage? Global investors are starting to unwind many of the trades they've put on in recent years that were based on the Fed's cheap money policies. Investors also recall that stocks also lost altitude and momentum in 2010 and 2011 after the Fed ended its first two rounds of bond-buying, known as QE1 and QE2, suffering double-digit declines in both instances, according to USA TODAY research.

In a nutshell, the market is undergoing a real-life reality check that will show just how much of the market's gains were due to the so-called "sugar rush" caused by the Fed's QE program, which is currently injecting more than $1 trillion into the financial system annually.

"Investors are saying, 'Yikes!' at the thought of a $1 trillion withdrawal of liquidity from the stock market," says Carmine Grigoli, chief investment officer at Mizuho Securities USA. "No one quite understands what the removal of that amount of liquidity over the next year will do to interest rates or stock prices. As a result, the stock market starts to behave like a junkie without a fix."

There is a general perception on Wall Street that the nearly 150% gain during the current bull market is "based on Fed intervention," says Bruce Bittles, chief investment strategist at R.W. Baird.
Investors and markets are now undergoing the financial version of "withdrawal" symptoms as the Fed starts to taper off stimulus.

7--The Punch Bowl Speech: William McChesney Martin, conversable economist

My own sense, as I've argued on this blog more than once is that that extraordinary monetary policy steps taken by the Fed made sense in the context of the extraordinary financial crisis and Great Recession from 2007-2009, and even for a year or two or three afterward. But the Great Recession ended four years ago in June 2009. The extreme stimulus policies of the Fed--ultra-low interest rates and direct buying of financial securities--don't seem to pose any particular danger of inflation as yet, but they create other dislocations: savers suffer, and some will go on a "search for yield" that can create new asset market bubbles; money market funds are shaken; and banks and governments that can borrow cheaply are less likely to carry out needed reforms.  And of course, there is the problem of economic and financial problems that arise when the Fed does take away the punch bowl.

8---Consumer Confidence Hits 5-Year High, WSJ

9---Exit From the Bond Market Is Turning Into a Stampede, WSJ (Serious bond wackage)

Wall Street never thought it would be this bad.

Over the last two months, and particularly over the last two weeks, investors have been exiting their bond investments with unexpected ferocity, moves that continued through Monday.
A bond sell-off has been anticipated for years, given the long run of popularity that corporate and government bonds have enjoyed. But most strategists expected that investors would slowly transfer out of bonds, allowing interest rates to slowly drift up.

Instead, since the Federal Reserve chairman, Ben S. Bernanke, recently suggested that the strength of the economic recovery might allow the Fed to slow down its bond-buying program, waves of selling have convulsed the markets...

The recent pain has spilled over into stock markets, pushing the Standard & Poor’s 500-stock index down an additional 1.2 percent on Monday. But the real pressure has been felt in the bigger and more closely watched bond market. The value of outstanding United States government 10-year notes has fallen 10 percent since a high in early May.

The selling has been most visible among retail investors, who have sold a record $48 billion worth of shares in bond mutual funds so far in June, according to the data company TrimTabs. But hedge funds and other big institutional investors have also been closing out positions or stepping back from the bond market.
“The feeling you are getting out there is that people are selling first and asking questions later,” said Hans Humes, chief executive of the hedge fund Greylock Capital.
The anxiety has been heightened by recent instability in the Chinese banking sector, where lending has shown signs of freezing up. That led Chinese stocks down particularly sharply, with the Shanghai composite index ending Monday down 5.3 percent....

It was the strength of the underlying economy that Mr. Bernanke emphasized last Wednesday at a news conference where he explained the central bank’s impulse to pull back on its $85 billion a month bond-buying program.
The money the Fed spends on bonds is supposed to bolster the economy, but the cheap money coming from the Fed has also made it less expensive and easier for investors to make large, increasingly speculative bets on bond prices....

TrimTabs estimates that $1.2 trillion flowed into bond funds over the last four years.
But those good times bred complacency, and Mr. Bernanke’s recent comments have caused an abrupt change in perceptions.

The S.& P. 500 recovered from large losses early in the day to finish down 19.34 points, to 1,573.09, on Monday. The Dow Jones industrial average fell 0.9 percent, or 139.84 points, to 14,659.56. The Nasdaq composite index dropped 1.1 percent, or 36.49 points, to 3,320.76.

In the current fear-soaked atmosphere, market participants are looking over their shoulders, seeking to identify which firms or funds are sitting on big losses and might be forced to sell large lots of bonds. The most obvious contenders are those that bought bonds with borrowed money. In Wall Street parlance, that is called leverage. It can magnify returns when rates are low and prices are rising, but unwinding leveraged trades can deepen losses.

“The fact that we’re seeing these violent moves is a reflection that there was leverage there,” George Goncalves, a fixed-income strategist at Nomura, said. “This is definitely more than a hissy fit. Some people are being forced to sell.”

Usually the preserve of banks and hedge funds, leverage even spread into retail-focused bond funds in recent years when rates were at very low levels. Since 2008, about one-fifth of the exchange-traded funds that invest in longer-term bonds were leveraged, according to Savita Subramanian, an equity strategist at Bank of America Merrill Lynch.

The signs of stress have also been evident in the more ordinary exchange-traded funds, or E.T.F.’s, that hold bonds. These E.T.F.’s are very easy to sell at moments of panic, but the operators of the E.T.F.’s have found it harder to sell off the actual bonds. This has caused the value of the E.T.F.’s to sink further than the value of the underlying bonds.

On Friday, a municipal bond E.T.F. that is popular with retail investors fell 3.7 percent below the value of the bonds it was supposed to be holding, the so-called net asset value, according to ETF Global. On average over the last two months, the E.T.F., which trades under the ticker symbol MUB, was only 0.6 percent below the value of its net asset value.

“It’s a self-fulfilling cycle until everyone gets exhausted,” said Peter Tchir, the founder of TF Market Advisors. “We don’t think we’ve seen the capitulation we need to hit bottom yet.”

10---The bond market rout has just begun, live mint

11--10-year bond yield soars to 2.64%, USA Today

12---Heckuva Job, Bernanke: Bond Market Suffers Biggest Sell-Off In 50 Years On Fed Panic , mark gongloff, Huff Post

13---China's capital markets dry up, IFR

A worsening interbank squeeze all but closed the domestic capital markets for China’s small and medium-sized firms in the past week, raising fears of a credit crunch in the world’s second-largest economy.

Banks withheld credit and investors shunned bond issues as liquidity in the short-term market evaporated and interbank rates soared. While traders remained confident that the central bank would step in to avert disaster, the fallout on corporate funding underlines the risk that the turmoil will spread beyond the banking sector.

Twelve companies cancelled plans to issue a combined Rmb8.83bn (US$1.44bn) of MTNs last week amid the worsening turmoil. The biggest scheduled deal was a Rmb2.5bn offering from Tianjin Binhai New Area Construction and Investment. The deal was postponed until next year due to the market volatility, the company said.

Bankers said lenders and investors were choosing to hoard cash after the one-week Shanghai interbank offered rate soared to 11% on Thursday, the highest level in recent years and more than treble the rate charged just a fortnight earlier. The overnight repo rate was quoted as high as 30% at one point on Thursday, the highest in more than a decade.

“Our head office has approved certain amounts to loan borrowers, but I just don’t have the money to give them right now,” said one banker at a Chinese lender on the mainland. “They will have to wait. This is not just happening to us


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