The New Bond Market: Bigger, Riskier and More Fragile Than Ever

Gigantic debt-trading arena is subject as never before to price reversals and disruptions

By Colin Barr

 Stocks rise and fall, but bonds are starting to make people anxious no matter what they do.

The U.S. bond market is among the biggest financial markets in the world, with $39.5 trillion outstanding at mid-2015, the Securities Industry and Financial Markets Association says. That is equivalent to 1½ U.S. stock markets and nearly twice the aggregate size of the five largest foreign stock exchanges (in Japan, China and Europe), says the World Federation of Exchanges. Foreign bond markets have boomed as well.

Surveying the global bond market of 2015 can be an intimidating exercise. Long associated with safety and predictability, bonds appear vulnerable as never before to price reversals and trading disruptions that could spill over and threaten financing for businesses and individuals.

This is the first in a series of articles exploring the new bond market that has taken shape since the financial crisis. It is a world of low interest rates that fueled massive debt issuance and investor risk taking, tighter regulations that are constraining banks, and the rise of asset managers and fast-trading firms that are changing how bonds are bought and sold.

The market is under scrutiny because the Federal Reserve is preparing to raise interest rates for the first time in nine years, at a time when the global economy is limping and debt ratios of countries around the world are higher than they were heading into the financial crisis.

In the U.S., household, corporate and government debt amounted to 239% of gross domestic product in 2014, the Bank for International Settlements estimates, compared with 218% in 2007.

The U.S. isn’t alone. Dollar credit to nonbank borrowers outside the U.S. hit $9.6 trillion this spring, the BIS said, up 50% from 2009. Repaying those loans and bonds will become costlier in local-currency terms should the dollar rise, as it often does, when the Fed goes ahead with tightening, potentially stressing large borrowers such as emerging-market companies.

Click here to enlarge graph

Domestically, the rise of large bond funds has created new risks. As the funds have grown, so has cross-ownership of the same bonds, increasing the likelihood of contagion if one manager starts selling, the International Monetary Fund says. Regulators worry that many investors may not know what is in their funds. A market downswing could lead to rising redemptions of fund shares, prompting funds to sell assets to raise cash and amplifying selling pressure across the market.

Since 2007, $1.5 trillion has gone into U.S. bond mutual and exchange-traded funds holding assets from government bonds to corporates and municipal debt, according to the Investment Company Institute. That compares with $829 billion into comparable stock funds.

Bond mutual and exchange-traded funds now own 17% of all corporate bonds, up from 9% in 2008, according to the ICI. In periods of market stress, more-concentrated mutual-fund ownership tends to mean larger price drops, the IMF said last year.

Annual U.S. corporate high-yield bond issuance never exceeded $147 billion until 2010, according to Sifma data going back to 1996, but has more than doubled that figure in each of the past three years. Defaults remain low, but portfolio managers say judging when they might rise is difficult with interest rates still near zero six years into the economic recovery.

The issue isn’t that the bond market is in a “bubble” that is about to be popped. The Fed’s decision last week to hold interest rates steady was another reminder that yields will stay low in the years ahead.

Events like the 2013 “taper tantrum” and the “flash crash” in the U.S. Treasury market last Oct. 15 underscore the sense among many analysts and traders that the bond market is alarmingly fragile and increasingly subject to volatility more commonly associated with stocks and commodities. Photo: Andrew Harrer/Bloomberg News

At the same time, events like the 2013 “taper tantrum” and the “flash crash” in the U.S. Treasury market last Oct. 15 underscore the sense among many analysts and traders that the bond market is alarmingly fragile and increasingly subject to volatility more commonly associated with stocks and commodities.

Consider the trading this spring in the 10-year German bund—along with U.S. Treasurys, one of the world’s most trusted securities. On April 17, the yield on the bund plunged to an all-time low of 0.05%. Three weeks later, it spiked to 0.786%, without a major news event or apparent broad shift in investor sentiment. The bund, for this brief period, was a momentum trade, like the Internet stocks of a generation ago.

Asset managers say they have for decades successfully managed periods of outflows and rising rates.

At the same time, many bond funds were hit hard in 2008, raising questions about how they will perform in future upsets. According to Morningstar, the average actively managed bond fund lost 8% that year, thanks to declines in corporate and municipal bonds, especially junk.

Maybe greater volatility is just the price investors pay for progress. By all indications, the market may soon get a chance to find out just how comfortable it is with that tradeoff.

China house sales rocket in September on stimulus, but doubts remain

Beijing has lurched from tough love to feverish salesmanship to drive up home sales, reminiscent of the stock market fiasco.

By Ambrose Evans-Pritchard

The Chinese property sell-off has been overdone, James says  Photo: AFP/Getty
House sales are rising at an explosive pace in China across most regions of the country as stimulus measures kick in and the Communist authorities launch yet another cycle of credit growth.
Fresh data collected by JL Warren Capital show that sales of existing homes surged by 115pc from a year earlier in the second week of September, rising to 135pc for the so-called 'tier two' group of mid-to-large size cities.
It is the second week of vertiginous growth rates and suggests that buyers may be switching to hard assets after losing confidence in the Shanghai and Shenzhen stock markets. The Chinese media has reported the first signs of a buyers' panic in some cities.

Any sign of a rebound is highly significant for a world economy that has been flirting with recession for several months and is now attuned to every move in China. But it is far from clear whether this is yet another sugar-rush or a genuine turning point as the Chinese authorities struggle to handle the aftermath on an epic credit bubble.
Central banks appear to be having great trouble reading events in China, where data is mistrusted and the instruments used to regulate the economy are unfamiliar and often misunderstood.

The US Federal Reserve held fire last week on the first rate rise in nine years because of fears that China may be in deeper trouble than admitted so far. In a rare departure from central banking etiquette, Fed chief Janet Yellen hinted that the Chinese authorities no longer know what they are doing.

"I think developments that we saw in financial markets in August in part reflected concerns that there was downside risks to Chinese economic performance and perhaps concerns on the deftness with which policy-makers were addressing those concerns," she said.

Warren Capital said the sales of new homes were more modest, rising 66pc in the biggest 'tier one' cities and 22pc for the 57 cities tracked across the country. There is still a huge glut of unsold properties in the smaller cities of the interior, where rampant over-building was at its worst, but there may at last be glimmers of hope even in these areas.

The data is collected directly from the government's real estate centres around the country and offers an immediate snapshot of the market.

It follows the release of figures from the National Bureau of Statistics last week showing that house prices rose 1.7pc in August from a year earlier, and have now been recovering for several months. Prices rose 32pc in Shenzhen.

The Chinese central bank (PBOC) has cut interest rates four times since the loosening cycle began in November, when monetary policy was ferociously tight. Average mortgage rates have dropped to near 5pc from 7pc in mid-2014.

Capital Economics

Regulators have lifted curbs on purchases of second homes, cut down-payment requirements from 30pc to 20pc, and are now actively encouraging teachers and civil servants to buy property with special incentives.

The authorities appear to have lurched from a 'tough love' stance last year to a feverish salesmanship, ominously reminiscent of their on-off interventions in the stock market debacle.

It is unclear whether premier Li Keqiang has abandoned his efforts to rein in the credit bubble before it spins out of control completely, or whether he has been overruled by powerful vested interests within the Communist Party. There have constant rumours that he may soon be purged, a development that would shatter any remaining confidence in China's leadership among global investors.

The great unknown is whether the new signs of life will translate into another burst of housing starts and construction, or fizzle out quickly. The developers are still holding back, afraid that the overhang of properties - 31.5 weeks's supply - will take a long time to clear.

Land sales to builders have stabilized after plummeting 32pc, but have yet to bounce back. A number of local governments have been trying to sell development sites to raise revenue, only to discover that nobody turns up at the auctions.

"The structural problem of oversupply may have been eased slightly with better sales and lower housing starts, but is still far from resolved and high inventory pressures persist," said Nomura.

Construction reached 15pc of GDP at the top of the boom - almost exactly the same as in Spain before its property market collapse - and became the biggest single driver of the economy.

This was a 'one-off' effect as migrants from the countryside flooded into the cities. The flow has slowed dramatically over the last five years. China's workforce is now shrinking by 3m a year.

The demographic structure is ageing fast, replicating the pattern in Japan.

"We think that the housing market recovery is unlikely to be sustainable and will weaken in 2016 for structural reasons," said Junheng Li from Warren Capital.

The warnings were echoed by Ma Qingbin from the China Centre for International Economic Exchanges, a state think-tank. "All the problems arising from overcapacity in the property market are unlikely to be solved in six months or one year."

The mismatches in the market are chronic. There is a severe shortage of houses for poor people, yet blocks of glitzy middle-class apartments that can few can afford stand idle in ghost cities across China.

For now the spigot is on again. Credit is growing briskly again. The 'true M1' measure of the money supply is rising at the fastest rate since early 2013. Fiscal stimulus is back to normal after a crunch earlier this year.

The data emerging from China is almost certain to look better for a few months, whatever the underyling health of an economy addicted to $26 trillion of credit. This superficial health is not going to make Janet Yellen's task any easier.

Why The Big Banks Want Higher Interest Rates

By: John Rubino

Something strange is happening in the banking business.

In theory, a low interest rate environment is generally good for banks because it allows them to borrow at, say, zero and lend to auto or home buyers at considerably more, making a nice fat interest spread, which has traditionally been the key measure of a bank's profitability.

And that's pretty much how it's been going. U.S. bank earnings were up 7% y-o-y in the second quarter, to a record $43 billion. Bank lending rose across the board from industrial to auto to mortgage loans, and delinquencies fell for the 21st consecutive quarter.

So the government's care and feeding of the banks is a success, right? Well, no, apparently. From last week's Wall Street Journal:
Fed Stance Squeezes Bank Profits 
No wonder bank-stock investors are feeling a chill. The Fed has left them out in the cold. 
This was supposed to be the year when superlow interest rates stopped squeezing net-interest income at U.S. banks. As recently as June, consensus estimates were that this would decline by just 0.8% in 2015 at large-capitalization banks, according to Sanford Bernstein's John McDonald. Analysts thought next year would see a rebound with 6.6% growth. 
That was predicated on the U.S. Federal Reserve raising short-term interest rates for the first time in nine years. Instead, the decision by the Fed Thursday to stand pat -- along with the fact that the overall tone emanating from the central bank was more dovish than expected -- is forcing investors to rethink banking prospects. 
Namely, that it is now more likely that net-interest income and margins will remain flat, or possibly even decline further, in coming months. That will keep bank stocks under pressure as valuations had already been anticipating a more-favorable interest-rate environment. 
Why is the outlook so grim if the Fed isn't tightening policy? The primary driver of falling net-interest income has been a squeeze on net-interest margins, the difference between what a bank pays for deposits and the yield on its loans. The unusually long period of ultralow rates has compressed margins by more than 27% since 2010.
As a result, bank profits can shrink even if firms grow lending and market share. At some point, you just can't make it up on volumen.

JPM, WFC and BAC Profits

And since it is the pace of rate increases, rather than the timing of the Fed's first move, that shifts the yield curve and drives net-interest margins, lower for longer means the net-interest margin pressure will continue.

So which is it? Are low interest rates great for banks or a problem?

The answer is that extremely low interest rates are good for normal banks (recall those record aggregate earnings). But because low rates lead to massive malinvestment and excessive leverage that turns markets into chaotic casinos, they're bad for the kinds of entities that the biggest banks have become, i.e., diversified hedge funds. If you're Goldman Sachs or JP Morgan Chase you can make money in most reasonably-stable markets by having one trading desk place a bet and another trading desk push the market in the profitable direction. Rinse and repeat and voila, consistent trading profits.

But when things get crazy, as they have in the past few weeks, manic/depressive global markets swamp trading desk manipulation and the big banks find themselves in the same boat as everyone else, tossed in random directions by random waves. Except that the banks are leveraged to the hilt, which makes the waves far bigger and more destructive.

The banks would therefore like to see higher interest rates and, presumably, lower volatility. In other words, a return to markets they can game. The Federal Reserve -- which after all is OWNED by the big banks -- gets this and would like to help. But the volatility that is victimizing its owners is making it scary for the Fed to act. The result: Poetic justice on a vast -- and soon to be much vaster -- scale.

Abandoning Syria

Few Options Left for Stopping the War

By Christoph Reuter in Beirut

A Broken Country: Is It Too Late for Syria?
An exodus of tens of thousands is hemorrhaging out of Syria and into Europe. After four years of civil war horrors, people have given up completely on their country. Is there a shred of hope left for stopping the conflict and rebuilding?

Both men were Syrians -- a taxi driver and his passenger. They met during an hour-long drive in April from the airport in the southern Turkish city of Adana toward the east. Within a few minutes, they realized that they were from the same place, the northern port city of Latakia, which is controlled by the Syrian regime.

Things got tricky when the two men began to wonder whose side the other had been on.

They avoided direct questions for a while. Before, on the other side of the border, they may have shot at each other. But now they were sitting in the same car. Eventually, the driver began to tell his story.

He had been a bank manager and had told jokes about Syrian dictator Bashar Assad. After an informer betrayed him to the government, a man from Syrian intelligence gave him a warning, saying: "Get out now. They're coming to get you in half an hour."

Then the second man told his story. He had been an architecture student. "I had nothing against Assad," he said. But checkpoints had been erected everywhere in recent weeks, where young men were forcibly recruited into the army. "I didn't want to die," he explained. The driver chuckled briefly, and then the two men went silent for a while.

"It's over," the driver finally said. "Yes," his passenger replied. They spent the rest of the trip discussing the best routes to Europe.

Can the Horrors Be Stopped?

A country is hemorrhaging people. Hundreds of thousands of Syrians are on the road, traveling to Germany, Sweden and the Netherlands, or they have already arrived, and millions will follow suit. The exodus is putting a long-ignored question back onto the political agenda in the West: What can be done to stop the horrors in Syria?

Four years after the beginning of the uprising, a quarter of a million are dead and the political proposals by the United Nations, the German foreign minister, the United States government and others sound very much like proposals in 2011: Negotiate, apply pressure and seek a political solution. The situation is complicated by announcements from France and Great Britain of their intention to participate in air strikes against the Islamic State (IS) in Syria. But what they overlook is that the overwhelming majority of Syrians are not fleeing from IS, but from Assad's barrel bombs, the Syrian Air Force and the generally hopeless situation.

IS primarily controls sparsely populated desert areas in eastern Syria. According to reports by the Syrian Network for Human Rights, Assad's soldiers killed about 11,500 people between January and August, while IS killed 1,800. Among civilians, at least 10 times as many people die as a result of the regime's attacks than at the hands of IS.

IS has made adjustments to cope with the air strikes. Its troops now tend to operate in towns, in which they prevent the residents from fleeing by erecting checkpoints and imposing draconian punishments. This prevents Western forces from effectively attacking IS.

The Assad Question

The refugees are responsible for growing political pressure to find ways out of the war, but their plight does nothing to change the status quo, which has led to the failure of every negotiated solution to date. Russia and Iran want to keep Assad in power, and the West is unwilling to overthrow him and oppose the Russian veto in the UN Security Council or jeopardize Iran's compliance with the nuclear treaty. Two UN special envoys have already failed to resolve this conflict situation, and a third one is heading in the same direction. Staffan de Mistura has announced new negotiations for October and wants to introduce decentralized task forces, but he has not even mentioned the central issue: Should the goal be to remove Assad or to allow him to remain in power?

The world had already made more headway in earlier negotiations. When influential Syrians from both camps met for secret negotiations at Château de Bossey on Lake Geneva in October 2013, everyone, after initial difficulties, was surprisingly in agreement. Even an advisor to Assad was acquiescent and was not opposed to a peaceful solution. "We will fight down to the last building in Damascus. But what happens after that? The country is ruined. No side can win or stop fighting."

The meetings were hosted by Switzerland's Center for Humanitarian Dialogue. As one participant recalls, both sides were exhausted and prepared to make extensive compromises. In the end, the negotiations failed because of one person: Assad. Everything was negotiable, but he had to go, the representatives of the opposition demanded. The participants agreed that a solution was in the hands of the Americans and the Russians.

If there is any solution for Syria anymore, it would have to be similar to the tentative plans suggested in 2013, which called for exiling Assad, his clan, key generals and their families.

Those also included extensive amnesties for combatants on both sides, power to be handed over to local authorities -- and a common fight against IS. But this type of solution would have required military pressure on Assad, which Washington was never willing to agree to. Even a proposal to install no-fly zones in several Syrian border regions, so that people there could survive without air strikes, was repeatedly rejected.

But then, in August of this year, there was a brief moment when Western diplomats hoped that Iran's leadership could be willing to agree to Assad's removal in return for concessions. The Iranians had already secured extensive control over what happened in Damascus by having generals and intelligence chiefs who opposed them removed.

One notable deposition involved the longtime head of Syria's Republican Guard, Dhu al-Himma Shalish, a close relative of Assad. "With that, the Iranians have direct physical access to Bashar," said one Western diplomat with good contacts in Damascus. The Iranians also could have deposed Assad, but they didn't want to.

Meanwhile, the Russians have arrived. In recent days, several Russian navy transport ships have landed in Latakia harbor, fully loaded with armored vehicles and other military equipment. Some 300 soldiers with Russia's 810th naval infantry brigade are reportedly also on board. Three giant Antonov 124 cargo aircraft and a passenger jet landed at the nearby airport. Mobile housing for 1,000 men and a command post to monitor air traffic have reportedly been installed. Russia is upping the ante on its already massive military aid for Assad.

It is doing so under the pretext of a joint fight with the West against the "terrorists." But Russia has a very different notion of what constitutes a terrorist than the US or Europe. Putin subscribes to Assad's definition, which ranges from rebel groups supported by the US to IS militants. Based on the involvement of Russian troops in fighting in the east of the Latakia province, it's clear who Moscow sees as the prime target: Syrian rebels. The Islamic State isn't to be found anyhere near that particular theater of battle.

Different Countries, Different Goals

It is unclear what President Vladimir Putin's strategic goals are in Syria. Is he merely trying to secure Assad's home region in the mountains between Latakia and Tartus, and preserve Russia's only naval base in the Mediterranean? Or does Russia intend to re-establish its vassal Assad's control over the entire country?

The Iranian Revolutionary Guards already failed in a similar attempt. In 2012, they began sending their own troops and combatants with the Lebanese Hezbollah group to Syria, as well as arranging for the deployment of thousands of Iraqis and Afghans. Despite these efforts, the Syrian regime is running out of troops. The fronts are softening in the north and south, and IS has been able to capture natural gas fields and the ancient city of Palmyra in the east. Analysts estimate that this year the Assad regime has lost about a fifth of the territory it controlled in 2014.

There has been little international support for the Syrian rebels -- a product of the fact that individual countries are pursuing different goals. The US only wants to fight IS and has implemented a $500-million program to train Syrian fighters. Most of the 54 men in the first of these US-trained units were abducted by radicals with the al-Nusra Front, because the group believed it was the target of the campaign. Saudi Arabia and Qatar tend to fund Islamist groups, which the United States mistrusts.

And Turkey is seeking allies for its war against Kurdish separatists with the Kurdistan Workers' Party (PKK).

A negotiated solution still seems a long way off, at least as long as Assad remains in power. Negotiations can only succeed if both parties stand to benefit. But from the very beginning, Assad and his top leaders chose a path that permits only victory or defeat. And Russia supports them on this path.

Putin is now counting on those in the West who believe that the priority is to fight IS, and that this requires supporting Assad. But his ongoing rule is the original reason for the conflict.

Besides, Assad is unable to fulfill these expectations because he controls less and less territory.

He has no lack of weapons, aircraft or funds, but he does lack soldiers.

The only way Syria can survive as a nation is if the two large camps, consisting of the moderate rebels and the Syrian army, band together against IS to preserve the country. This could easily work without Assad, but not with him.

Failure to Act

Since the days of his father, dynasty founder Hafez Assad, fear was always a major component in Syria's principle of rule. It not only includes subjects' fear of those in power, but also their own followers' fear of everyone else. The Alawite religious community, to which the Assads belong, makes up one-tenth of the Syrian population. The most effective way to preserve the Alawites' unconditional loyalty was not preferential treatment but fear of the Sunni majority.

And this fear was systematically stoked with such campaigns as the bloody suppression of a rebellion by the Muslim Brotherhood in Hama in 1982. Even after Hafez's death, any attempt at conciliation was blocked.

Fear of revenge by their enemies has turned the Alawites into perfect hostages of Assad. The president, in turn, fears that negotiations will lead to his demise, and that loyalties could be destroyed and pave the way for new protests, because tens of thousands of Alawites have also died defending the family dictatorship without the promised victory ever materializing.

Two years ago, it still would have been possible for the West to intervene on behalf of the moderate rebels. But skeptics feared that intervention in Syria would lead to more violence and deaths, the triumph of jihadist radicals and the collapse of public order. All of these things have occurred -- not because, but despite the fact that the West did not intervene.

If US President Barack Obama had ordered air strikes on the military's nerve centers following Assad's poison gas attacks on the Damascus suburbs, the regime probably would have collapsed. At the time, intelligence services were already observing efforts by officers and soldiers to defect. But Obama apparently was unwilling to risk an overthrow of Assad and the resulting power vacuum.

But what could have been worse than what happened after that? In September 2013, IS had not yet begun its victory march, around 130,000 people who are now dead were still alive, and it would have been much easier to preserve the entire country than it is today.

There are many indications today that a partition of Syria is the most likely future scenario. Iran and Hezbollah have withdrawn their forces from large parts of the north and south since the beginning of the year. They want to focus on defending the core region controlled by Assad, which they can hold -- the densely populated strip from Damascus to Latakia.

A partition of Syria would probably be the biggest favor the world could do for IS. A Russian-Iranian protectorate in the west would stand in the way of any unification of the entire country, and it would mean abandoning the rest of the country -- to the delight of IS "Caliph" Abu Bakr al-Baghdadi, who knows that the Syrian rebels alone cannot defeat Islamic State.

No Way Back

The gradual dissolution of Syria makes it extremely difficult to find a solution for the entire country.

Two other parties to the conflict have already taken control of large portions of the country. In the north, troops with the YPG, the Syrian branch of the PKK, control the three traditionally Kurdish areas along the Turkish border. And even though the Kurdish party leadership in Syria consistently denies wanting to establish its own state, this is precisely what Western intelligence officials believe it intends to do. This is why the Turkish government is doing everything in its power to prevent the YPG from capturing more territory. Hezbollah, in turn, has captured a broad strip of land along the Lebanese border in a move that could disrupt the country's delicate confessional balance.

It may simply be too late for Syria.

The hundreds of thousands of Syrian refugees apparently agree. It is often overlooked that their exodus to Europe has only just begun. Many Syrians were already leaving the country before, but now everyone wants to leave -- not just opponents of the regime, but also those who had kept a low profile, Assad's followers and supporters. Syrians in all political camps have lost faith in their country's future.

The wars for control over the decaying country make a peaceful solution virtually impossible. These wars know no borders, as evidenced by IS' campaign of conquest in Iraq and Ankara's fight against the PKK. The longer all of this lasts, the more difficult it will be to stop Syria's demise. And the longer the hundreds of thousands who have left remain in exile, the more unlikely they are to return.

A bombed city can be rebuilt, but a destroyed country, abandoned by those who want to live a life of dignity, work and raise children, is a different story.

Translated from the German by Christopher Sultan.

Refugees and Reform in Europe

Mohamed A. El-Erian

Europe Refugee Crisis Demonstration in London

LAGUNA BEACH – There is a simple truth beneath the growing human tragedy of Europe’s refugee crisis, and the European Union cannot address the massive influx of exhausted, desperate people in a manner compatible with its values unless governments and citizens acknowledge it. Simply put, the historic challenge confronting Europe also offers historic opportunities. The question is whether Europe’s politicians – who have failed to deliver on far less complicated issues over which they had a lot more control – can seize the moment.
The scale of the challenge is immense, with the flow of refugees extremely difficult to monitor and channel, let alone limit. Fleeing war and oppression, tens of thousands of people are risking life and limb to find refuge in Europe – a phenomenon that will continue as long as chaos persists in countries of origin, such as Syria, and countries facilitating transit, such as Iraq and Libya.
In the meantime, Europe’s transport networks are under stress, as are shelters, border crossings, and registration centers. Common asylum policies – including, for example, the basic rule that asylum-seekers should be registered at their point of entry into the EU – are not functioning or are being bypassed. And the cherished concept of effortless travel within the border-free Schengen Area is under threat.
These problems are aggravated by coordination failures. Attitudes toward refugees vary widely across countries, with Germany taking a particularly enlightened approach that contrasts sharply with Hungary’s notably heartless one. Some countries, such as the Czech Republic, have blocked deals to share the burden fairly among European Union members, including through mandatory quotas.
Add to that the preferences of the refugees – who, after risking everything to get to Europe, have strong feelings about where they would like to settle – and the policy challenges are enormous, particularly in the short run. European politicians have yet to catch up with the reality on the ground, let alone get ahead of it. And their failure is exacerbating the risks to the EU’s political cohesion that emerged over the Greek crisis.
Politicians have a powerful incentive to get Europe’s response to the refugee crisis right.

Beyond the need to alleviate the human misery that fills television screens and front pages of newspapers lies the imperative not to miss the significant medium-term opportunities that migration provides.
Although there are pockets of high unemployment in Europe today, the ratio of workers to elderly people will decline considerably in the longer term. And, already, labor-market flexibility has been undermined by structural inertia, including difficulties in retooling and retraining workers, particularly the long-term unemployed.
As the German government and some corporate leaders, including the CEO of Daimler-Benz, have already recognized, an open-minded approach to refugee absorption and integration can help to mitigate some of Europe’s protracted structural problems. After all, a significant proportion of the incoming refugee population is said to be educated, motivated, and committed to building a better future in their new homes. Capitalizing on this, European decision-makers can turn a severe short-term challenge into a powerful long-term advantage.
An enlightened policy response to the refugee crisis could help Europe in other ways as well.

Already, it is unlocking additional fiscal outlays in countries like Germany – which, despite having the means, did not previously have the will to spend – thereby helping to alleviate an aggregate-demand imbalance that, together with structural impediments to growth and excessive indebtedness in some countries, has held back the region’s recovery.
The current situation could also provide the catalyst needed to make decisive progress on the EU’s incomplete political, institutional, and financial architecture. And it could compel Europe to overcome the political obstacles blocking solutions to longstanding problems, such as providing the cover needed for certain European creditors to grant deeper debt relief for Greece, whose already-massive fiscal and employment problems are being exacerbated by the influx of refugees. It can even drive Europe to modernize its governance framework, which allows a few small countries to derail decisions supported by the vast majority of EU members.
Pessimists would immediately point out that Europe has struggled to come together even on far less complex and more controllable issues, such as the protracted economic and financial crisis in Greece. Yet history also suggests that shocks of the scale and scope of the current refugee crisis have the potential to spur remarkable policy responses.
Europe has the opportunity to turn today’s refugee crisis into a catalyst for renewal and progress. Let us hope that its politicians stop bickering and start working together to take advantage of this opening. If they fail, the momentum behind regional integration – which has brought peace, prosperity, and hope to hundreds of millions of people – will weaken considerably, to the detriment of all.

COMEX Available Gold Continues To Drop And Why That Should Matter For Investors

COMEX registered gold inventories fall to under 170,000 ounces available for delivery.
These are the lowest levels on record and a mere $200 million could buy all the available gold in COMEX warehouses.
While this doesn't mean the COMEX will default, it certainly at least suggests that fewer people want to make their gold available for sale.
These are very bullish developments for gold investors as it suggests the market is tighter than many analysts think.
In the previous month, we took a look at COMEX gold inventories which have been reaching lower and lower levels. This week, we continue to see these gold inventories drop to extremely low levels, as registered gold inventories (gold available for delivery) again reached new all-time lows.

We do believe that keeping track of COMEX inventories is something that is recommended for all serious investors who own physical gold and gold ETFs (the SPDR Gold Trust ETF (NYSEARCA:GLD), the Sprott Physical Gold Trust (NYSEARCA:PHYS), the Central Fund of Canada (NYSEMKT:CEF), etc.) because any abnormal inventory declines or increases may signify extraordinary events behind the scenes that would ultimately affect the gold price.

Investors should remember that the gold market is surprisingly opaque for a market that is one of the largest in the world - any data that provides insight into this market should be monitored by serious precious metals investors.

Now, let's take a look at where COMEX gold inventories stand and what investors can learn from them.

Source: ShareLynx

We will take a closer look at these numbers but let us first explain the COMEX a little more for investors who are unfamiliar with it.

Introduction to COMEX Warehousing

COMEX is an exchange that offers metal warehousing and storage options for its clients. The list of their silver warehouses can be found here and their gold warehouses can be found here.

In the case of silver and gold, the metal is stored at these official warehouses on behalf of banks and their clients and can be used to settle futures contracts, transferred between clients, or withdrawn from the warehouse. This offers large holders of precious metals a convenient way to store their metal with minimal storage fees - very convenient indeed if you hold large amounts of gold or silver and you don't want to store them in your basement.

Silver and gold stored in these warehouses can fall into two categories: Eligible and Registered.

Eligible metals are those that conform to the exchange's requirements of size (1,000-ounce bars for silver and 100-ounce bars for gold), purity, and refined by an exchange approved refiner. Eligible metals are stored at COMEX warehouses on behalf of banks or private parties, but are not available for delivery for a futures contract.

Registered metals are similar to eligible metals except that these metals are also available for delivery to settle a futures contract. COMEX issues a daily report on gold, silver, copper, platinum, and palladium stocks, which lists all the metal that is currently stored in COMEX warehouses and how much eligible and registered metal is present.

This information allows investors insight into how much metal is currently backing COMEX futures contracts, what large gold and silver owners are doing with their metals, and how many clients are requesting delivery of their metals.

Catching Up with Changes in COMEX Gold Inventories

Let us now take a deeper look at the gold drawdowns being seen in the COMEX warehouses.

(click to enlarge)

One thing to note here is that this data excludes the newly published Hong Kong warehouse data which we are still looking to incorporate. The Hong Kong stocks add up to a little over 1.1 million ounces, and that is the difference between the 7.18 million total ounces in the table above and the little more than 8 million ounces seen in the earlier graph. Finally, while the Hong Kong stocks increase the total number of ounces held in the COMEX warehouses, none of these stocks are eligible ounces and thus the 162,034 registered ounces above represent all registered ounces available for delivery at the COMEX warehouses.

As investors can see in the chart above, we've seen a major drawdown in COMEX inventories over the past few months, which has accelerated in the first few weeks of September. The 162,034 registered ounces of gold is the lowest that we've seen at the COMEX since our records started.

Investors need to remember that registered gold is the only gold available for delivery unless someone moves eligible gold into the registered category - that is very little gold backing a huge amount of open contracts!

COMEX Gold Open Interest and Registered Gold Owners per Ounce

Finally, let us take a look at possibly the most important number when it comes to COMEX gold inventories - the registered gold cover ratio. We've discussed this in-depth in a previous article so please refer to that article for details, but in a nutshell, it is the number of investors owning a claim to each registered gold ounce (i.e. owner per registered gold ounce).

Source: Sharelynx

As investors can see in the graph above, registered gold stocks have dropped to levels where only 1 ounce of registered gold is backing 255.6 claims on that ounce - the highest levels we've ever witnessed. That is a BIG spike over the past few weeks as the ratios are going parabolic.

This is something that gold bulls should love to see as high owners-per-registered-ounce ratios mean fewer physical ounces per contract ounce - a definite positive. In fact, before 2013 we had never been at even 40 owners per registered ounce - so we're truly entering uncharted territory.

Do COMEX Registered Gold Inventories Matter?

With registered gold inventories dropping to new lows, we have been seeing some "experts" in the gold analyst world remarking there is nothing to worry about. Jeffrey Christian of the CPM Group champions this view as he believes it's a "non-issue" because most of COMEX inventories are cash-settled and very little is actually delivered to contract-holders at expiration.

In a nutshell, it's a paper market and very few people really need the physical gold.

To us that's a bit of a weak argument especially considering that it ignores the fact that registered gold reserves are declining at a faster pace - suggesting there are a number of parties that are removing gold from the market.

Historically, when it comes to the gold market, there's always been a call for calm during times of great stress. When the London Gold Pool collapsed in the late 1960s, government and gold market officials were telling participants everything was okay and that there was plenty of gold to supply demand - in reality, the United States was airlifting gold to London to satisfy demand and prevent a gold market failure. It didn't work and soon the London Gold Pool would collapse.

We are not suggesting that the COMEX gold market will collapse, but when pundits like Mr. Christian say all is okay in the gold market but ignore the actual data, it shouldn't give investors any comfort. Gold blogger "Jesse" of Americain Café says it best:
What if something that is not completely normal and expected happens? What if, instead of 2% of the contracts asking for delivery, a delivery short squeeze in London prompts 4 or 5 percent of the contract holders to attempt to exercise their contracts to receive physical bullion to cover their obligations elsewhere?
The fragility of such an arrangement is bothersome to anyone from outside who looks at it from a systems engineering perspective.
With registered gold inventories around a mere 5 tonnes of gold, it wouldn't take much to cause a bit of a run on the COMEX (if we haven't already been seeing it). What would happen if an entity wanted to take delivery on a mere $200 million worth of gold to satisfy demand elsewhere? Without COMEX participants transferring eligible to registered inventories, the market wouldn't be able to satisfy this request.

Even with a light stress test like this, the COMEX gold market is not prepared to pass. Those are questions that Mr. Christian hasn't addressed and the "it hasn't happened" argument doesn't cut it for us.

Conclusion for Gold Investors

Maybe the COMEX is changing and everything truly is okay in the gold warehouses, but we have yet to hear a good reason why registered gold inventories continue to plummet - other than strong physical demand is taking out these accessible physical gold stocks.

While we are not calling for a COMEX default (though we don't rule out that possibility either), we think the takeaway for investors is that non-committed physical sources of gold are relatively tight.

That means that we think the doomsday calls for sub-$1,000 gold are unlikely as we think if physical demand at $1,100 gold is wiping out these available gold inventories, then sub-$1,000 gold will simply overwhelm gold supplies. This also ignores the fact that major miners' gold reserves have plummeted and at current prices, the future for gold production looks bleak.

We're very bullish on gold as we think it is one of the safest investments that can be made for an investor with a time horizon of 3-5 years. That is why we think that investors should consider keeping a large exposure to gold with positions in physical gold and the gold ETFs (SPDR Gold Trust, PHYS, CEF). Additionally, the miners that have been underperforming gold over the last few months may offer investors considerable leverage to any rise in the gold price. Investors looking for this leverage may want to consider evaluating gold miners such as Goldcorp (NYSE:GG), Agnico-Eagle (NYSE:AEM), Newmont (NYSE:NEM), or even some of the explorers and silver miners such as Tahoe Resources (NYSE:TAHO) (we're not suggesting these companies specifically - only suggesting them for further investor research).

jueves, septiembre 24, 2015



Ready for a US Rate Hike?

Shang-Jin Wei

 Janet Yellen

MANILA – The possibility that the US Federal Reserve could raise the interest rate for the first time in a decade sent jitters across emerging markets for weeks. Though the Fed has now decided to keep its policy rate ‎unchanged, it also stated that a rate hike is still on the table for 2015. The concern is that countries that are dependent on foreign financing could be hit by sudden outflows of international capital, or that currency depreciation following the Fed hike could raise debt-servicing costs for countries and businesses.
Governments in the developing world would be wise to worry less about interest-rate changes in the United States – which, in any case, they cannot control – and think more about policy changes they can make at home to strengthen their economies’ resilience.
An increase in US interest rates is not necessarily bad news for emerging countries. Many developing countries – especially in Asia – are in much better macroeconomic shape than they were just before the Asian financial crisis of the late 1990s or at the onset of the 2008 global financial crisis.
And the Fed is likely to raise rates only if it judges US economic growth to be strong and sustainable, which would be a positive sign for the global economy in general. Furthermore, a delay in raising rates carries its own dangers, encouraging yield-hungry investors to take larger risks – possibly necessitating a sharper or more abrupt change in interest rates in the future.
Emerging countries can enhance their resilience to fluctuations in global interest rates by pursuing sound fiscal and monetary policies, continuing necessary structural reforms, and strengthening their financial systems. In particular, recent research suggests four key policy areas in which governments should consider intervening.
For starters, countries should embrace policies that favor foreign direct investment (FDI) over inflows that can be withdrawn more quickly, such as foreign bank loans, debt, or equity investments.
My research with Hui Tong of the International Monetary Fund shows that countries whose capital inflows that are mainly in the form of FDI tend to be more resilient to foreign financial shocks. When the global financial crisis erupted, countries with high FDI relative to total capital flows tended to experience a less severe liquidity crunch.
Second, exchange rates need to reflect economic fundamentals. But while theory suggests that flexible exchange rates should blunt foreign monetary or financial shocks, in practice, such a currency regime rarely works on its own.
Indeed, my research with the Asian Development Bank’s Xuehui Han has shown that when the US raises or lowers interest rates, most developing countries tend to follow suit, even when they have a flexible exchange rate. The key reason is that they want to avoid large swings in the value of their currency. Appreciation can harm competitiveness, while depreciation increases the cost of servicing foreign-currency debt, erodes market confidence, and leads to higher inflation.
The notable exceptions to this trend are countries that manage cross-border capital flows, especially the corporate sector’s exposure to foreign-currency debt. Indeed, certain types of capital-flow management – including limiting domestic debt denominated in foreign currency for both firms and households – have been shown to increase resilience.
Third, domestic macroprudential and microprudential policies increase resilience. These policies should aim at reducing or eliminating the wedge between activities that are good for individuals, banks, and firms, and those that benefit society as a whole.
One example of such a policy is to link banks’ mandatory reserve ratios to the speed at which credit is expanding or to the stage of the business cycle. Thus, during periods of expansion, when banks are eager to fund ever more risky borrowers, the reserve ratio rises, curbing potentially disruptive asset bubbles or overinvestment. For those countries capable of designing and implementing prudential regulations, management of cross-border capital flows becomes less useful and less desirable.
Finally, it is no longer appropriate to judge whether a country’s foreign-currency reserves are adequate based on how many months of imports they can cover. Instead, the question to ask is whether the reserves can comfortably service the public and private sectors’ debt denominated in foreign currencies.
The US will normalize its interest rate policy sooner or later according to its need. For other countries, it is important to focus on policies that can strengthen resilience to foreign financial or monetary shocks.

Demographics - The Real Opponent The Fed Has Been Fighting For Decades

by: Christopher Hamilton            

Changes in the growth of the US core 15-64 year old population seem to drive economic activity (growth and recessions). Federal Reserve's FFR changes seem highly correlated with changes to core population.
The Federal Reserve's secular changes to FFR and federal government deficit spending seem highly correlated to the accelerations/decelerations of the core population.
With significant further deceleration of core growth, a given for the next decade, can massive deficits and ZIRP (NIRP?) be the answer to maintain growth? Or is change upon us?
In my previous article, I made the assertion that the Federal Funds Rate was nearly, if not solely, driven by the annual change to the US core population of 15-64 year olds. I expected a lot of push-back as demographic changes are somehow not generally considered relevant to most economists.

Still, sometimes it's simply finding the right means to communicate something for it to be accepted. I think the charts below do just that.

However, I'm not implying the numbers alone drive anything but it's what they represent. This core segment represents the highest order of consumption and earnings growth. The relatively minor population changes of this group (in comparison to the total population) seems to have impacts that are magnitudes greater than their numbers would imply.

As the chart below shows, periods of increasing core population growth correlate with periods of low federal deficit spending and periods of decelerating core population growth with increasing déficits.

However, the current declines in deficit spending while core population growth remains at historic lows compounded by further core growth deceleration over the next decade (all according to OECD estimates) looks a bit ominous. Either this relationship has been broken, or significantly larger deficits and/or NIRP are upcoming?

The second chart below adds a third variable; changes in the Federal Funds Rate or "FFR".

The changes in the "FFR" seemingly coincide with secular changes in core population growth, with a year or two lag. The resultant annual federal deficits (absent the rising interest service burdens thanks to the rate cuts) are also highly correlated.

Maybe this focus on 15-64 year olds is a bit unfair, as over time, kids are entering the workforce later and the old are likewise retiring later. So, perhaps a peek at the 20-69 year old population segment is appropriate here. Unfortunately, from this metric (below), there is a triple waterfall from the near high watermark of 2010's population growth. By 2017, the US will be feeling the effects of the second of the three decelerations in population growth, with the final drop beginning around 2020.

Anyone anticipating this slightly older segment to be the savior is likely to be bitterly disappointed.

The US demographics are far better than most advanced and many developing nations where outright core shrinkage is and will be a feature for decades. Also unfortunate is the fact that over half of all global 0-64 year old population growth has shifted to the poor of India and even poorer of Africa, and away from the higher income nations of the world. As the chart below highlights, trading high-income for low-income population growth simply will not provide significant new consumption or growth. The chart below is simply showing the changes in the 0-64 year old populations of all 34 OECD members (including the US, Japan, most EU nations, Canada, Australia, S. Korea, etc.) plus China, Brazil and Russia (about 40% of the world's population) vs. "the rest of the world".

Regardless of international considerations, the data shows quite clearly that absent the strong domestic core population growth, US economic activity suffers. The only answers have been FFR cuts and federal deficit spending along with QE and various other consumption-inducing new "tools" since 2008.

Some, including my wife, will ask "so what"? My point is the policies being undertaken by the Federal Reserve and federal government are entirely inappropriate if the intention is the economic (and likely social) well-being of this and future generations. The intelligence or intentions of the Federal Reserve and leadership of the federal government needs to be openly questioned and quite likely entirely replaced. The path chosen by those in leadership was, is, and will be entirely proven a disaster. The fact that population growth wasn't acknowledged as a secular tailwind which, in time, would blow itself out and be replaced by little, no, or negative growth is astonishing. The data has been collected for a reason and the theory the Fed wasn't aware when and how this population shift would occur seems implausible. Those placed in positions of shepherding this nation who either don't know what they are doing, or know but don't care for the ultimate good of the people, must be reconsidered.

It is truly a time to reconsider everything, take the bought and paid for reins of leadership back, and focus the nation's best brain power behind how best to extricate ourselves from the mess we find ourselves. Only by acknowledging the fact that our present leadership has failed us (whether done so unintentionally or otherwise) can we take the first step in rebuilding.

jueves, septiembre 24, 2015



Op-Ed Columnist

The Rage of the Bankers

Paul Krugman

Last week the Federal Reserve chose not to raise interest rates. It was the right decision. In fact, I’m among the economists wondering why we’re even thinking about raising rates right now.
But the financial industry’s response may explain what’s going on. You see, the Fed talks a lot to bankers — and bankers reacted to its decision with sheer, unadulterated rage. For those trying to understand the political economy of monetary policy, it was an “Aha!” moment. Suddenly, a lot of what has been puzzling about the discussion makes sense: just follow the money. 
By this criterion, it’s hard to argue that current rates are too low. Inflation has been low for years. In particular, the Fed’s preferred inflation measure, which strips out volatile food and energy prices, has consistently fallen short of its own target of 2 percent, and shows no sign of rising.
It’s true that rates — near zero for the short-term interest rates the Fed controls more or less directly — are very low by historical standards. And it’s interesting to ask why the economy seems to need such low rates. But all the evidence says that it does. Again, if you think that rates are much too low, where’s the inflation?
Yet the Fed has faced constant criticism for its low-rate policy. Why?
The answer is that the story keeps changing. In 2010-2011 the Fed’s critics issued dire warnings about looming inflation. You might have expected some change in tune when inflation failed to materialize. Instead, however, those who used to demand higher rates to head off inflation are still demanding higher rates, but for different reasons. The justification du jour is “financial stability,” the claim that low interest rates breed bubbles and crashes.
I suppose this latest excuse for raising rates could be right. But it’s striking how convoluted and dubious the case for rate hikes has become. I like to think of it this way: if left-leaning politicians were to offer rationales for their policies that were this dependent on shaky logic and weak evidence, they would be lambasted for their irresponsibility. Why does anyone take this stuff seriously?
Well, when you see ever-changing rationales for never-changing policy demands, it’s a good bet that there’s an ulterior motive. And the rate rage of the bankers — combined with the plunge in bank stocks that followed the Fed’s decision not to hike — offers a powerful clue to the nature of that motive. It’s the bank profits, stupid.
Many people have been led astray here by trying to figure out whether easy money is good or bad for wealthy people in general. That’s actually a complicated question. What’s clear, however, is that low rates are bad for bankers.
For banks make their profits by taking in deposits and lending the funds out at a higher rate of interest. And this business gets squeezed in a low-interest environment: the rates banks can charge on loans are pushed down, but rates on deposits can only go so low. The net-interest margin — the difference between the interest rate banks receive on loans and the rate they pay on deposits — has fallen sharply over the past five years.
The appropriate response of policy makers to this observation should be, “So?” There’s no reason to believe that what’s good for bankers is good for America. But bankers are different from you and me: they have a lot more influence. Monetary officials meet with them all the time, and in many cases expect to join their ranks when they come out on the other side of the revolving door. Also, it’s widely assumed that bankers have special expertise on economic policy, although nothing in the record supports this belief. (The bankers do, however, have excellent tailors.)
So we shouldn’t be surprised to see institutions that cater to bankers, not to mention much of the financial press, spinning elaborate justifications for a rate hike that makes no sense in terms of basic economics. And the debate of the past few months, in which the Fed has seemed weirdly eager to raise rates despite warnings from the likes of Larry Summers that it would be a terrible mistake, suggests that even U.S. monetary officials aren’t immune.
But the Fed did the right thing last week: nothing. And the howling of the bankers should be taken not as a reason to reconsider, but as a demonstration that the clamor for higher rates has nothing to do with the public interest.

Cashing In on Markets’ Fed Tantrum

Markets took a dovish Fed decision badly. Investors should keep some powder dry.

By Richard Barley

Chairwoman Janet Yellen has cited concerns about China and emerging markets as playing a part in the Federal Reserve’s decision last week to keep rates unchanged.   Chairwoman Janet Yellen has cited concerns about China and emerging markets as playing a part in the Federal Reserve’s decision last week to keep rates unchanged. Photo: Brendan Smialowski/Agence France-Presse/Getty Images

The Fed has left investors feeling dazed and confused. Taking a more cautious tack looks like a good tactic in the face of that.

Thursday’s message from U.S. Federal Reserve Chairwoman Janet Yellen was one that investors have heard before: Interest rates will remain lower for a while longer yet. In the past, that has served to stoke financial risk-taking, sending investors searching for yield and into stocks.

Friday’s reaction was very different. European stocks sank, with the German DAX index down 3%. U.S. stocks fell, too. Credit markets sagged. Only government-bond markets behaved as expected, with yields falling. Risk-taking was notable by its absence.

One worry is global growth. Indeed, Ms. Yellen labeled concerns about China and emerging markets as playing a part in the Fed’s thinking, while acknowledging a domestic case for a rate increase could be built. It isn’t clear how quickly these concerns might be assuaged, as many emerging-market countries face fundamental challenges in changing economic models.

And the importance of such markets also reflects that the world has changed since the Fed last embarked on a rate cycle. In 2004, China accounted for 9.1% of world gross domestic product on a purchasing-power-parity basis, according to the International Monetary Fund; in 2015 it will account for 16.9%. Emerging markets in aggregate now account for 57% of world GDP, versus 46% in 2004.

For some, the fear is that the maintenance of zero interest rates may lead to further misallocation of capital. Already merger-and-acquisition activity has boomed. Companies may be encouraged to engage in further financial engineering to boost shareholder returns as debt remains historically cheap.

And overall, central banks’ ability to suppress volatility is diminishing. In recent years, quantitative easing and forward guidance acted as painkillers for markets. But data dependency is the new buzz phrase for central banks like the Fed looking to raise rates. Higher volatility in markets seems like a likely outcome. That should in the long run be a good thing, as investors shouldn’t rely on central banks to shield them from market moves. But the transition is a bumpy one.

The message is that investors who have built up cash balances—which rose to 5.5% in Bank of America Merrill Lynch’s September global fund manager survey, the highest level since just after Lehman Brothers’ collapse—shouldn’t rush to spend them.

The opportunity cost of holding cash has fallen, and choppy markets will throw up the chance to buy mispriced assets. Keeping some powder dry makes sense.