Doug Nolan

The Chinese Credit machine sputtered in July. Growth in Total Aggregate Financing dropped to $144 billion, almost 40% below consensus estimates. This was less than half of June’s $320 billion increase and the slowest expansion since February. The sharp slowdown was beyond typical seasonality, with the month’s growth in Aggregate Financing 18% below July 2018. Despite July’s weak growth, Total Aggregate Financing was still up 10.7% over the past year.

New Bank Loans fell to $150 billion from June’s $235 billion, with growth 28% below that from July 2018. At $2.331 TN, New Loans were still up 12.6% over the past year. Consumer Loans dropped to $74 billion, the weakest showing since February. Consumer Loans were nonetheless up 16.5% over the past year, 38% in two, 71% in three and 138% over five years.

Loans to the non-financial corporate sector collapsed in July to $42 billion, about a third June’s level. Somewhat offsetting this decline, Corporate bond issuance almost doubled in July to $32 billion.

The ongoing contraction in “shadow” finance accelerated in July, with declines in outstanding Trust Loans, Entrusted Loans, and Banker Acceptances. On a year-over-year basis, Trust Loans were down 4.3%, Entrusted Loans 10.0% and Bankers Acceptances 15.0%.

China’s July Credit data were alarming on multiple levels. For starters, the sharp Credit slowdown supports the view that financial conditions tightened meaningfully after the government takeover of Baoshang Bank (and attendant money market instability). It also raises the increasingly pressing question as to the willingness of the banking system to continue to take up the slack in the face of a broadly deteriorating backdrop. And in a new development, analysts have begun contemplating the possibility of waning Credit demand.

The sharp pullback in Consumer Loans raises the specter of an inflection point in household mortgage borrowings. Bubbling apartment markets have supported a resilient consumer sector along with an unrelenting housing construction boom. Government tightening measures may be having some impact. It is possible as well that market sentiment has begun to shift.

August 14 – Reuters (Huizhong Wu, Yawen Chen and Stella Qiu): “China’s economy stumbled more sharply than expected in July, with industrial output growth cooling to a more than 17-year low, as the intensifying U.S. trade war took a heavier toll on businesses and consumers. Activity in China has continued to cool despite a flurry of growth steps over the past year, raising questions over whether more rapid and forceful stimulus may be needed, even if it risks racking up more debt. After a flicker of improvement in June, analysts said the latest data was evidence that demand faltered across the board last month, from industrial output and investment to retail sales… Industrial output growth slowed markedly to 4.8% in July from a year earlier…, lower than the most bearish forecast in a Reuters poll and the weakest pace since February 2002.”

August 14 – Reuters (Roxanne Liu): “China’s property investment slowed to its weakest pace this year in a sign the housing market’s resilience may be waning as Beijing toughens its crackdown on speculative investments and holds back on new stimulus… Property investment in July rose 8.5% year-on-year, easing from June’s 10.1% gain and was the slowest since December’s 8.2%...”

China is now only a faltering apartment Bubble away from a period of major economic upheaval and acute financial instability.

Global bond markets were this week nothing short of incredible. Ten-year German bund yields dropped 11 bps to a record low negative 0.69%, and French yields fell 15 bps to negative 0.41%. Swiss 10-year yields sank 19 bps to negative 1.14%. Spanish and Portuguese yields fell 18 bps to 0.08% and 0.11%. Italian yields sank 41 bps to 1.40%. Sovereign yields ended the week at negative 0.69% in Denmark, negative 0.57% in Netherlands, negative 0.49% in Slovakia, negative 0.44% in Austria, negative 0.43% in Sweden, negative 0.42% in Finland, negative 37 bps in Belgium, negative 0.26% in Slovenia, negative 0.18% in Latvia, and negative 0.14% in Ireland. Japanese 10-year yields ended the week down a basis point to negative 0.23%.

Extraordinary in its own right, the Treasury market garnered intense media focus: CNBC: “Bond Market Close to Sending Biggest Recession Signal Yet.” Fox Business: “Recession Indicator with Perfect Track Record Flashing Red.” Business Insider: “The Market's Favorite Recession Indicator Just Flashed its Starkest Warning Since 2007.” NBC: “Wall Street Slides as Inverted Yield Curve Rings Recession Alarm Bells.” Money and Markets: “Yield Curve Blares Loudest Recession Warning Since 2007.”

Ten-year Treasury yields collapsed 19 bps this week to 1.56%, the low going back to August 2016. Thirty-year bond yields traded as low at 1.91% in Thursday’s session, dipping below 2.00% for the first time (ending the week down 22 bps to 2.04%). Two-year yields fell 17 bps to 1.47%, with December Fed funds futures implying a 1.49% funds rate. Wednesday’s inverted Treasury curve was widely cited as the key factor behind the equities' selloff.

August 14 – Reuters (Gertrude Chavez-Dreyfuss and Dhara Ranasinghe): “The U.S. Treasury yield curve inverted on Wednesday for the first time since June 2007, in a sign of investor concern that the world's biggest economy could be heading for recession. The inversion - where shorter-dated borrowing costs are higher than longer ones - saw U.S. 2-year note yields rise above the 10-year yield.”

At this point, Treasury yields have little association with the U.S. economy. The structure of the Treasury curve (along with Federal Reserve monetary policy) has detached from U.S. economic performance. Treasuries are instead caught up in an unprecedented global market phenomenon. Sovereign debt, after all, has traded for hundreds of years. Yet bonds have never traded with negative yields. Never have global bond prices spiked in unison, with yields collapsing to unprecedented lows across the globe.

I understand why market professionals, pundits and journalists focus on the conventional “recession risk” explanation for sinking Treasury yields and the inverted curve. For one, there is insufficient awareness as to the deep structural impairments that today permeate global finance. Besides, no one wants to contemplate that global bond yields might portend serious problems ahead – that global yields are signaling the reemergence of Crisis Dynamics.

Throughout this decade’s long Bubble period, I’ve often written and stated, “I hope things are not as dire as I believe they are.” Along the way, Bubble Analysis has appeared flawed and hopelessly detached from reality. And that’s exactly how these things work.

But I’ve never wavered from the view that this would end badly. Never have I believed that manipulating and distorting markets would achieve anything but epic Bubbles and inevitable terrible hardship. I’ve not seen evidence to counter the view that the longer the global Bubble inflates the greater the downside risk (moreover, such risk grows exponentially over time). And not for one minute did I believe zero rates and QE would resolve deep financial and economic structural issues. Indeed, I have fully expected reckless monetary mismanagement to ensure a global crisis much beyond 2008. From my analytical perspective, the global Bubble has followed the worst-case scenario.

It sounds archaic, but sound money and Credit are fundamental to sound financial systems, sound economic structure, cohesive societies and a stable geopolitical backdrop. The most unsound “money” in human history comes with dire consequences. Global finance now suffers from irreparable structural impairment. Economies across the globe are deeply maladjusted. Global imbalances are unprecedented. The trajectory of geopolitical strife is frightening.

Meanwhile, central banks are locked in flawed inflationist doctrine. Their experiment is failing, yet in failure they will resort to only more reckless market manipulation and monetary inflation. This analysis is corroborated both by collapsing sovereign yields and a surging gold price. The clear and present risk is of an abrupt globalized market dislocation, financial crisis and resulting economic and geopolitical instability. It may sound like crazy talk, except for the fact that such a scenario is alarmingly consistent with signals now blaring from global bond markets.

August 16 – Bloomberg (John Authers): “There has been a tendency since the financial crisis to label any market that is rallying or deemed overvalued to be in a ‘bubble.’ The word has become overused and debased. But if we treat it rigorously, the bubble concept is still vital in navigating financial markets. And the rigorous treatment reveals that bonds really are in a bubble. Longview Economics Chief Market Strategist Chris Watling published a fascinating research note applying the framework introduced by Charles Kindleberger in his book ‘Manias, Panics, and Crashes.’ …Watling reminds us that Kindleberger needed to satisfy four conditions before he diagnosed a bubble: i) cheap money underpins and creates the bubble; ii) debt is taken on during the bubble build-up, which helps fuel much of the speculative price increases (e.g. buying on margin); iii) once a bubble is formed, the asset price has a notably expensive valuation; & iv) there’s always a convincing narrative to ‘explain away’ the high price. Reflecting that, there’s a wide acceptance in certain quarters that the price is rational (and ‘this time it’s different’).”

I’m biased, but what could be more fascinating than Bubble Analysis? My analytical framework owes a debt of gratitude to Charles Kindleberger’s work. I’ll interject my definition: “A Bubble is a self-reinforcing but inevitably unsustainable inflation.” This “unsustainable” facet has become critical in this bizarro world of central bank finance and accompanying runaway Bubbles. At a decade and counting, it is reasonable to assume that the realm of central bank supported bull markets is everlasting. Such optimism is today dangerously misplaced.

I’ll take somewhat exception to John Authers’, “[Bubble] has become overused and debased.”

The key issue is that Bubble Dynamics took root across asset classes and across the world.

Never has “Bubble” applied to so many markets in so many places – never has finance created Bubble Dynamics on an almost systemic basis.

I have argued post-crisis monetary stimulus unleashed a historic global Bubble in “financial assets” more generally, a “global government finance Bubble” that fueled hyperinflation in prices for stocks, bonds, structured finance, real estate, private businesses, collectibles, and so on around the world. The word “Bubble” has not been overused and debased, as much as the overuse of central bank and government Credit has worked to debase “money” more generally.

Authers also states: “But if we treat it rigorously, the bubble concept is still vital in navigating financial markets.” The problem is markets love Bubbles – jump aboard and make easy “money.” And for the past decade central banks have incentivized speculation and speculative leverage across assets classes and around the world.

Bubble Analysis is vital for both navigating markets and for policymaking. For a decade now, speculators have been playing Bubbles, while central bankers have been denying their existence. Global bond markets have become convinced the Bubble is faltering, with the expectation that central banks have no alternative than to drive rates even lower while monetizing further Trillions of government bonds (throwing in some corporate debt and even equities for good measure). This expectation of additional aggressive monetary stimulus has bolstered the view within the risk markets that the bottomless central bank punchbowl will keep the party rocking.

At this point, the overarching issue is not the U.S. vs. China trade war, and it’s not specifically the vulnerable Chinese economic boom. The U.S. economy is certainly not the focal point of global market dynamics. Importantly, the trade war is a catalyst for pushing China’s vulnerable economy to the downside. After a historic Bubble inflation, a faltering Chinese economy is a catalyst for pushing China’s fragile Credit and financial systems beyond the precipice. And as the marginal source of global finance and economic growth, faltering Chinese Credit and economic systems will be a catalyst for bursting Bubbles around the globe.

August 10 – Reuters (Cassandra Garrison and Nicolás Misculin): “Argentine voters soundly rejected President Mauricio Macri’s austere economic policies in primary elections on Sunday, raising serious questions about his chances of re-election in October… A coalition backing opposition candidate Alberto Fernandez - whose running mate is former president Cristina Fernandez - led by a wider-than-expected 14 percentage points with 47.1% of votes, with fourth-fifths of ballots counted.”

Granted, opposition candidate Fernandez’s margin of victory was larger than expected. But what a market reaction. The Argentine peso sank 14.5% in Monday trading. Argentina’s Merval Equities Index collapsed 38% (48% in U.S. dollars) Monday and ended the week down 31.5%. The price of Argentina’s dollar-denominated 30-year bonds sank 25%, as yields surged 300 bps in Monday trading to 12.51%. Yields jumped above 15% during Wednesday’s trading before ending the week at 13.5%.

August 13 – Reuters (Tom Arnold): “The cost of insuring against an Argentine sovereign default jumped again on Tuesday as investors continued to react to the heavy defeat of President Mauricio Macri in the country’s primary elections at the weekend. Argentine 5-year credit default swaps (CDS) were marked at 2,116 basis points, up from what was already a five-year high of 1,994 bps the previous day, according to… IHS Markit. Markit calculations estimate that level prices the probability of a sovereign default within the next five years at more than 72%.”

After ending convertibility to the U.S. dollar at a one-to-one rate with the onset of Argentina’s 2001 financial crisis, it now requires 55 pesos to exchange for one dollar. Oversubscribed when issued in the summer of 2017, Argentina’s 100-year bond lost 30% of its value this week and now trades at 52 cents on the dollar.

Market reaction to Argentina’s primary election is further evidence the global market environment has changed. “Risk off” is gaining momentum. De-risking/deleveraging dynamics have altered the liquidity backdrop, leading to more chaotic market reactions along with heightened contagion risk. This week’s EM currency declines included the Russia’s ruble 1.9%, Brazil’s real 1.6%, Turkey’s lira 1.5%, Poland’s zloty 1.4% and Mexico’s peso 1.3%. Major equities indices were down 4.0% in Brazil, 3.9% in Turkey, 3.3% in Russia and 2.7% in Mexico.

It was not as if there weren’t constructive developments. At least for the week, the People’s Bank of China could stabilize the renminbi (up 0.27% vs. the dollar). Monday’s ugly market performance apparently spurred President Trump to delay imposing additional Chinese tariffs on many goods until December 15th. China announced plans to boost household disposable income. And, from an ECB official, the clearest signal yet that “whatever it takes” is about to shift into overdrive.

August 15 – Wall Street Journal (Tom Fairless): “The European Central Bank will announce a package of stimulus measures at its next policy meeting in September that should exceed investors’ expectations, a top official at the central bank said. …Olli Rehn said the slowing global economy would see the ECB rolling out fresh stimulus measures that should include ‘substantial and sufficient’ bond purchases as well as cuts to the bank’s key interest rate. ‘It’s important that we come up with a significant and impactful policy package in September,’ said Mr. Rehn, who sits on the ECB’s rate-setting committee as governor of Finland’s central bank. ‘When you’re working with financial markets, it’s often better to overshoot than undershoot, and better to have a very strong package of policy measures than to tinker,’ Mr. Rehn said.”

The President’s trade war retreat tweet had a notably short market half-life. It appears markets these days are less invigorated by talk of additional Chinese stimulus. And Olli Rehn’s “significant and impactful policy package” essentially bypassed equities markets while throwing gas on the raging bond fire.

It’s been a full decade of government and central bank backstops, with the “Trump put” a relatively late addition. It sure appears the Trump, central bank and Beijing “puts” have lost some potency. And in about a month we’ll have a better read on the “Fed put.” It’s a reasonable bet the stock market will go into the September 18th FOMC meeting with a gun to its head: “50 bps or we’ll shoot!”

Much can happen in a month – especially at the current mercurial clip of developments. But the Fed will be in a really tough spot. Don’t give the market 50 bps and ultra-dovish commentary and risk getting hit with a heated market tantrum. Give markets what they demand and risk a “sell the news” response and a critical change in market sentiment. It has the feel that a decade of egregious monetary inflation and speculative Bubbles is about to get Some Comeuppance.

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