Wednesday, September 2, 2015

Today's Links

Bill Gross: "Finance based capitalism with its zero bound interest rates has now produced global imbalances that impair productive growth and with it the chances for “old normal” prosperity." Go To Cash

Quote:  Non-financial corporations are more leveraged at 37% than they were in 2007 at 34%. What happens when the borrowing costs rise on the 7-year corporate credit bonds that have been issued?

1---Market Rout Hammers Economic Confidence of Americans

2--Labor costs tumble at fastest pace in a year 

3--EIA misreports data to push oil prices down

consider the agency’s own weekly data, which comes out every Wednesday, and although it is less accurate than the retrospective looks, oil prices move up and down in response to the results. In its weekly data, the EIA shows U.S. oil production above 9.5 mb/d through the middle of July. For the week ending August 21, the EIA says the U.S. is producing 9.33 mb/d, above what the agency now says the U.S. produced in June.

In other words, for several months the oil markets had believed the U.S. was producing much more oil than it actually was. Instead of continuing to climb through much of the spring and leveling off into the summer, oil production actually peaked in April and has declined consistently since then. When the EIA released this latest revision on August 31, oil prices shot up.

4---Central banks to dump $1.5 trillion FX reserves by end-2016 -Deutsche

Central banks will sell $1.5 trillion foreign exchange reserves by the end of next year as they try to counter capital outflows stemming from slowing growth in China, low oil prices and an impending rise in U.S. interest rates, Deutsche Bank said on Tuesday.
This would mark a major shift in global capital flows, ending two decades of reserve accumulation by emerging markets and potentially forcing the Federal Reserve into slowing down the unwinding of its "quantitative easing" crisis-fighting stimulus.

The Fed could be forced to delay the unwinding of its QE programme because of the "significant amount of pressure" reserves selling could put on the Treasuries market.

Saravelos said the upward pressure on U.S. yields from the selling of large quantities of bonds should also put upward pressure on the dollar, with every $100 billion reduction in reserves pushing the euro down three cents against the dollar

5--Stephanie Pomboy: Who will sop up all those USTs?

We used to rely on foreign financiers to fund our borrowing, but those days are long gone. They are buying Treasuries at a rate not much above $100 billion a year, down from $800 billion 3½ years ago.

What’s the implication of this?

Foreigners are buying about $10 billion a month of Treasuries. This compares with deficit financing needs for the U.S. government of roughly $40 billion a month, based on this year’s deficit. So the Fed needs to pick up roughly $30 billion a month in slack. When the Fed slashed its buying to $25 billion, effective this month, it for the first time opened up a demand deficit for Treasuries. If they continue to taper, that gap will expand, and things could get bumpy in the Treasury market. Rates won’t go up five basis points before the Fed would start talking about more QE.

Who is going to buy a 10-year Treasury yielding 2% when inflation in the U.S. is 2%? No profit-oriented domestic investor is going to do that. We were able to rely on foreign central banks to buy our Treasuries, because they were trying to debase their currencies to manage their exports. But that’s not the case anymore. The upshot is that we are out of natural buyers of Treasuries, and that’s where the Fed has been so critical. So unbeknownst to many, the reason why Treasury yields are 2.6% is in part due to the economy, but it is largely due to the fact the Fed has just been sopping up all of the surplus supply that foreigners are leaving behind.

6---A year with Erdogan

What I find particularly absurd is the fact that Erdoğan has been saying that the new election is a choice between stability and instability. Clearly, his game plan since June 7 has been to bring about a climate of political and economic instability as well as create a perilous security situation, all of which would -- according to Erdoğan -- be rapidly resolved with the return of the one-party rule of the AKP. However, with polls showing that an AKP victory is far from guaranteed, it is possible that Erdoğan will go one step further. The already dangerous security situation may become more perilous with Turkey going to war against IS and the government declaring a state of emergency. This would mean elections could be put off until sometime in 2016. However, for this to happen Erdoğan would need to have the full compliance of Turkey's top military officers and I am not sure this would happen. These are desperate measures for a desperate leader and a line-toeing party that has apparently been hypnotized by Erdoğan.

7--Erdogan shuts down opposition media--Police raid İpek Media Group in AK Party-led media crackdown

8--"Except for the fools who are heavily invested in it, China's stock market has little impact in a global sense," said David Wessel, a senior fellow at the Brookings Institution and director of its Hutchins Center on Fiscal and Monetary Policy.

9--More signs of global downturn send stocks plunging again

Over the weekend the newspaper concluded, based on its own research, that “weakness in emerging market currencies is hurting global trade by reducing imports without any benefit to export volumes.” It quoted former Pimco CEO Mohamed El-Erian as declaring, “We risk slipping into a beggar thy neighbour, competitive spiral of currency devaluations.”
The article noted, “Since June 2014, the currencies of Russia, Colombia, Brazil, Turkey, Mexico and Chile have fallen by between 20 per cent and 50 per cent against the dollar, while the Malaysian ringgit and Indonesian rupiah are at their weakest since the Asian financial crisis of 1998.”

The global turbulence is leading to a substantial selloff of assets by mutual funds, particularly those with exposure to emerging markets. CNBC noted that “if current trends hold, July and August will mark the first consecutive monthly net outflow from both bond and equity funds since late 2008.”
A major factor in the financial turbulence is the dramatic economic reversal in emerging market economies, whose export-led booms are collapsing amid slowing global demand, the slump in commoditiy prices and a reversal of massive capital inflows that predominated in previous years. As a result, the prices of both sovereign and corporate bonds are falling, threatening the solvency of financial institutions that speculated in these assets.

Commodity prices also slumped dramatically, with oil prices dropping by 7 percent following a three-day rally. The Financial Times cited hedge fund manager Pierre Andurand as declaring that oil prices were likely to continue falling, possibly sinking as low as $30 per barrel.

10--"Vacation homes" or speculation?

Bottom line: The multi-year “surge” in “second/vacation” home purchases is largely driven by individual buyers and their agents/lenders chasing the rush of “investment” property speculators — who made headlines daily for years – committing fraud to get their slice of the “investment” property miracle. Just like from 2005 to 2007

a) “Vacation” sales surge to historical highs of 1.13mm, slightly greater than Bubble 1.0, as “investment” property demand wanes. This represents 21% of all houses sold in the US; a whopper 57% yoy increase; and a mind-warping 140% surge since 2011.

Bottom line:  “Second/Vacation” home sales “growth” of 21%, 57%, and 140% over the past three years has never been rivaled at any time in housing market history and represents the largest Bubble 2.0 gains — by an order-of-magnitude — of any housing market segment. Of this specific “growth channel”, I estimate that minimum of 33% was based on fraud and never should have occurred....

Combined, “vacation” and “investment” properties made up 40% of all US home sales in 2014, a speculative frenzy only seen one time before…in 2006

11--Quantitative Tightening Accelerates——EM Central Banks To Dump $1.5 Trillion Of FX Reserves By 2016-End  Reuters

Central banks will sell $1.5 trillion foreign exchange reserves by the end of next year as they try to counter capital outflows stemming from slowing growth in China, low oil prices and an impending rise in U.S. interest rates, Deutsche Bank said on Tuesday.
This would mark a major shift in global capital flows, ending two decades of reserve accumulation by emerging markets and potentially forcing the Federal Reserve into slowing down the unwinding of its “quantitative easing” crisis-fighting stimulus.

George Saravelos, currency strategist at Deutsche and co-author of the report, said the $1.5 trillion estimate is based on the pace that emerging markets – especially China – have been drawing down their FX reserves recently to counter capital flight.
“The risks are it’s actually faster than that,” Saravelos said

12---Buybacks, the only game in town

Buybacks may be the Only Support . Stock buyback programs have never been about identifying attractive valuations. They're about the short-term allocation of inexpensively borrowed capital to reduce share count, improve perceived profitability per share and gloss over revenue declines. Unfortunately, when revenue shortfall meets with higher corporate borrowing costs (a la wider credit spreads), those price-insensitive repurchase programs wind up becoming the only support for the market itself. Bank of America/Merrill Lynch recently broke down net stock acquisitions/dispositions by client type and found that corporations are the only net buyers.

4. Corporate Debt Levels Are Hitting Extremes . Are companies sitting on stockpiles of cash? Borrowed cash, and probably not as much as many folks think since so much of that cash went into buying back stock shares. Corporations are highly indebted. They've even increased their debt obligations by 25% since 2009. In fact, non-financial corporations are more leveraged at 37% than they were in 2007 at 34%. What happens when the borrowing costs rise on the 7-year corporate credit bonds that have been issued? Too much leverage is a probable warning sign.
Unsustainable P/S Ratios . Ed Yardeni pegs the S&P 500 at 1.85. That's the second-highest in history when the P/S surpassed 2.0 in 2000. With two consecutive quarters of declining sales (a.k.a. "a revenue recession"), it is difficult to see how that ratio does not get more out of whack....

The Consumer Isn't Spending Enough . Gallup data found that July was the third consecutive month when Americans spent less than they had in the same month in the year earlier...

Credit Spreads are Widening . Narrowing credit spreads demonstrate greater confidence in the creditworthiness of borrowers. In contrast, widening credit spreads indicate trepidation concerning the ability of corporate borrowers to service their debts.

13--Buybacks are the only thing driving stocks higher, but funding source for buybacks (IG) has dried up

US bond markets have suffered the longest barren spell for at least 20 years as stock market volatility has deterred even the bravest investment-grade companies from issuing debt.
It is 10 business days and counting since a company last issued US investment-grade bonds, the longest stretch of inactivity excluding Christmases in the records of Dealogic, which go back to January 1995....

Investment-grade issuance has run at record levels this year as companies have tried to take advantage of low interest rates to refinance, and to fund share buybacks and takeovers. US-marketed IG bond issuance is $567bn this year, according to Dealogic.
But stock market chaos last month put a sharp brake on a rush of companies trying to get through the door before the US Federal Reserve raises rates this year, a move that was previously a certainty but is now up for debate....

The difference between yields on US corporate debt and government Treasuries has climbed by almost a third to 1.55 per cent this year, though these spreads have moderated slightly since their August peak of 1.6 per cent.


Widening Credit Spreads: Credit spreads widened dramatically. High yield has moved from about 225 over to 525 over Treasuries. We shouldn't lose sight that the investment-grade and high-yield markets have had record issuances in recent years and the substitution of debt for equity has been an important fuel for corporate share buybacks. That window of issuances -- or more costly issuances of debt -- have closed some of that window and was the basis for my "Peak Buybacks" thesis .

15---From the archive: Looming Dollar Troubles

When the extraordinary level of official financial flows to the U.S. do dry up, American policymakers will be confronted with some very unpleasant choices. Especially if oil prices, now past $70 a barrel, continue to rise, the trade deficit will become even more insensitive to changes in the dollar’s value. As a result, the dollar may have to fall by commensurately still larger amounts to shrink the trade deficit. The Fed will try to forestall a dollar plunge with growth-crunching hikes in interest rates. This will slow the dollar’s slide, but not stop it.....

Central banks around the world hold roughly two-thirds of their reserves in dollars. Asian central banks alone have amassed an astonishing $2 trillion in reserves, most of it in dollar assets. As the dollar has shed nearly a third of its value against the euro just since 2002, prudence would suggest a re-evaluation of the relative weight of dollar holdings in official portfolios going forward. ....

The dollar has since fully supplanted gold as the foundation of the world’s monetary system; a feat unprecedented in world history for a completely uncollateralized fiat currency. But should the dollar continue an extended decline, under pressure from unprecedentedly high trade deficits, there is every reason to believe that central banks will seek greater diversification in their reserves, most likely into euros. As central banks bailed out of gold in the 1990s, their herding out of dollars will accelerate the dollar’s decline...

The second flaw in a soft dollar policy is the naïve belief that a dollar decline will be orderly and painless. This is what the Administration is banking on, but its own policies are guaranteed to undermine it. As they continue to push forward with unbridled spending and tax-cut plans that raise the trajectory of future budget deficits, foreign investors are certain at some point to turn their backs on the ever-expanding stock of U.S. Treasuries, and turn instead to investments in other countries’ assets. Central banks, such as Sweden’s Rijksbank, are already known to be doing this with their reserves....

A painful period of world economic adjustment appears inevitable without firm and immediate action on the budget deficit, and it will have serious implications for America’s power in the world. A plunging dollar accompanied by rapidly rising interest rates and a weakening American economy will make other nations less deferential to American wishes at the International Monetary Fund, at the World Bank, and in trade negotiations. Oil-producing Arab states will become even more resistant to American pressures for reform of their political and economic systems, and turn increasingly to Europe and Asia to place their investments and to garner political support. It will become ever more difficult for the United States to afford military action abroad. As it is, the wars in Afghanistan and Iraq are costing the U.S. over $70 billion annually. That high a level will soon become politically and economically unsupportable, and it will become clear both to Americans and to others that the U.S. will hesitate to act even where future threats appear to be dire.

America’s standing in the world very directly hinges on what others believe the country can give to them or withhold from them. Washington can prevent a dollar-driven decline of U.S. global power by demonstrating that it has the political leadership and will to make the hard decisions necessary to sustain American economic strength. This must be grounded in restored budgetary responsibility. America is, at this moment, effectively an economic diabetic. Its insulin is fiscal rectitude. It will not cure the trade gap on its own, but it will allow the world to live with it by preserving the dollar as the bedrock of world commerce and finance.

Lost decades, econbrowser

Excerpt: Half of the holdings of US Treasury securities and Treasury and Agency securities were held by China and Japan. While the Chinese and Japanese holdings were about the same size, China's had caught up quickly, over the preceding five years.

--What Predicts a Credit Boom Bust?", econbroswser

Excerpt: From Chapter 1 of the IMF’s recent World Economic Outlook (Box 1.2), a set of findings by Jörg Decressin and Marco Terrones:

The econometric results confirm that net capital inflows, financial sector reform, and total factor productivity are good predictors of a credit boom. Net capital inflows appear to have an important predictive edge over the other two factors....

I think this is a particularly interesting set of findings; credit boom/busts are closely associated with financial crises. As an international finance economist, my view had been that net capital inflows were particularly dangerous for the United States in that they resulted in increasing net indebtedness to foreigners that would eventually lead to foreigners dumping dollar denominated assets (see Chinn (Council on Foreign Relations, 2005)). A competing view was that the net capital inflows signaled financial excess (of course, the two are not mutually exclusive -- both forces could be in effect, but with different strength). The findings reported here are more consistent with the second view....


Here's why it can get much worse: Technician


8---Lost Decades: The Making of America's Debt Crisis and the Long Recovery,

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