Recalling 1994

Doug Nolan
Equities rallied to begin the week. With Syrian missile strikes more limited than feared and no military response from Russia, there was immediate impetus to unwind hedges. That it was option expiration week ensured plenty of firepower. The S&P500 had rallied 2.3% at Wednesday's trading high, before a resumption of selling cut the gain for the week to 0.5%.

WTI crude dropped $1.17 in Monday's trading, though selling was short-lived. Crude gained $1.01 for the week to $68.40, trading to the high since December 2014. WTI is now up a rather inflationary 13% y-t-d. The President's Friday morning tweet - "Looks like OPEC is at it again. With record amounts of Oil all over the place, including the fully loaded ships at sea, Oil prices are artificially Very High! No good and will not be accepted!" - generated media attention but only brief selling pressure. The market seems to think it knows more about crude supply dynamics than the Commander and Chief.

The GSCI Commodities Index rose another 1.2% this week (up 7.1% y-t-d), also to the high since December 2014. It wasn't only energy driving commodity gains. Silver rose 3.0% this week, with Palladium up 4.2%, Aluminum 8.1%, Zinc 3.7%, Nickel 6.4%, Tin 3.2% and Copper 2.8%.

Trade frictions, Middle East instability and general geopolitical uncertainty add up to mounting inflation concerns. The 10-year TIPS breakeven rate (implied inflation rate calculated by subtracting the 10-year TIP yield from the 10-year Treasury yield) rose four bps this week to 2.18%, the high since August 2014. It's worth noting that the breakeven rate bottomed at 1.26% in February 2016. It rallied to 2.07% by early-2017 before settling back to 1.68% near mid-year - and has been on a reasonably steady ascent now for nine months.

Ten-year Treasury yields rose 13 bps this week to 2.96%, surpassing the February 21st level to the high going back to January 2014. If 10-year Treasuries surpass 3.0% next week, it will mark the highest yield since July 2011. Two-year yields jumped nine bps to 2.45%, the high going back to August 2008. Generating surprisingly little attention, Benchmark MBS yields surged 14 bps this week to 3.66% (up 66bps y-t-d!), the high all the way back to September 2013. Expect more discussion about mortgage convexity.

Notably, 10-year Treasury yields rose eight bps during Thursday and Friday trading, despite a 1.4% fall in the S&P500. The safe haven status of Treasuries is anything but iron clad these days. Treasuries did, however, outperform investment-grade corporates. The iShares investment-grade ETF (LQD) fell 1.27% this week - most of the decline coming Wednesday through Friday - to trade below March lows. Sell Treasuries to hedge mortgage and corporate interest-rate risk. Between new issuance and hedging related selling, that's a supply glut that risks a bout of market indigestion.

Yet this week's jump in yields was not isolated to U.S. fixed-income. Key emerging bond markets were under pressure, particularly during Friday's session. Mexico saw its 10-year (dollar) yields jump 17 bps this week to 4.31%. Mexican bond yields are now up 70bps y-t-d and close to breaking out to highs going back to 2011. Brazilian bond (dollar) yields rose seven bps (to 4.99%), Peru's 15 bps, Colombia's nine bps, and Indonesia's 12 bps. Indonesia saw its local currency 10-year yields jump 20 bps to 6.74%, and India's local bond yields surged 21 bps to 7.74%.

Friday EM trading was notable. Currencies came under pressure, as the South African rand dropped 1.15%, the Colombian peso 1.0%, the Turkish lira 0.85%, the Russian ruble 0.8% and the Brazilian real 0.7%. For the week, the Mexican peso dropped 2.6%, the Colombian peso 1.8% and the Indian rupee 1.4%. Combining currency and bond losses, there was some pain this week in key emerging markets. In equities, the Shanghai Composite dropped 1.5% Friday, increasing losses for the week to 2.8% (down 7.1% y-t-d). EM inflows have been unrelenting in the face of a lengthening list of issues. Why do I sense these flows are about to reverse?

April 18 - Financial Times (Peter Wells): "The chances of the Federal Reserve delivering four interest rates in 2018 have ballooned in recent days. There is a 35.3% chance the US central bank will deliver three more rate rises this year, following its 0.25 percentage lift in March…, which is the highest probability in the history of the contract. As such, the chance of the Fed delivering at least three interest rate rises this year is sitting at 82%, also a contract-era high."

It's a far cry from "slamming on the brakes," yet the Fed is finally feeling some heat to get short-term rates up to a more reasonable level. A novel idea was offered by Dallas Federal Reserve Bank President Robert Kaplan: "I don't have a problem with being restrictive." As notably, the doves have really come around. Federal Reserve Bank of Minneapolis President Neel Kashkari: "I think it's likely that the fiscal actions that have been taken are going to on the margin help us achieve our inflation target. I was much more skeptical… It now seems much more likely that we are going to actually achieve our inflation target in the near future…" And from Governor Lael Brainard: "My anticipation is that the outlook is for continued, solid growth. The outlook looks consistent to me for continued gradual increases in the federal funds rate."

Imagining a murkier inflation outlook doesn't come easily. The global boom has decent momentum, although lurking financial fragilities could rather abruptly haunt economic prospects. Tariffs, protectionism and trade wars have the potential for consequential pricing impacts. There is, as well, significant ramifications for the global economy in the event trade disputes really heat up. And let us not forget an extraordinarily uncertain geopolitical backdrop, with myriad potential consequences for inflation and growth. Last but not least, there's the great uncertainty associated with myriad interdependent global Bubbles.

One thing we know with certainty: the world has added tremendous amounts of debt since the last debt crisis. And debt is poised to continue rising rapidly until sober markets impose some discipline on profligate borrowers. This is a momentous festering issue that will come to a head at some point. Ten-years of ultra-loose global finance destroyed discipline - by borrowers and lenders alike. "Deficits don't matter." In the markets, the view holds that central banks won't tolerate a problematic backup in market yields. So, as central bankers gaze submissively from the sidelines, governments just keep issuing debt and markets keep buying it.

April 18 - Bloomberg (Andrew Mayeda): "The world's debt load has ballooned to a record $164 trillion, a trend that could make it harder for countries to respond to the next recession and pay off debts if financing conditions tighten, the International Monetary Fund said. Global public and private debt swelled to 225% of global gross domestic product in 2016, the last year for which the IMF provided figures, the fund said… in its semi-annual Fiscal Monitor report. The previous peak was in 2009, according to the… fund. 'One hundred and sixty-four trillion is a huge number,' Vitor Gaspar, head of the IMF's fiscal affairs department, said… 'When we talk about the risks looming on the horizon, one of the risks has to do with the high level of public and private debt.'"

For posterity, I've pulled a few paragraphs from the IMF's most recent Fiscal Monitor report:

"At $164 trillion-equivalent to 225% of global GDP-global debt continues to hit new record highs almost a decade after the collapse of Lehman Brothers. Compared with the previous peak in 2009, the world is now 12% of GDP deeper in debt, reflecting a pickup in both public and nonfinancial private sector debt after a short hiatus. All income groups have experienced increases in total debt but, by far, emerging market economies are in the lead. Only three countries (China, Japan, United States) account for more than half of global debt -significantly greater than their share of global output...

"A large number of countries currently have a high debt-to-GDP ratio, as suggested by critical thresholds identified in the IMF's debt sustainability analysis. In 2017, more than one-third of advanced economies had debt above 85% of GDP, three times more countries than in 2000. One-fifth of emerging market and middle-income economies had debt above 70% of GDP in 2017, similar to levels in the early 2000s in the aftermath of the Asian financial crisis. One-fifth of low-income developing countries now have debt above 60% of GDP, compared with almost none in 2012."

"From a longer-term perspective, global indebtedness has been driven by private sector debt-which has almost tripled since 1950. For almost six decades, advanced economies spearheaded the global leverage cycle, with the debt of the nonfinancial private sector reaching a peak of 170% of GDP in 2009, with little deleveraging since. Emerging market economies, in contrast, are relative newcomers. Their nonfinancial private debt started to accelerate in 2005, overtaking advanced economies as the main force behind global trends by 2009. Private debt ratios doubled in a decade, reaching 120% of GDP by 2016."

"The ongoing recovery presents a golden opportunity to focus fiscal policy on rebuilding buffers and raising potential growth. Forecasts indicate that economic activity will continue to accelerate, which implies that fiscal stimulus to support demand is no longer a priority in most countries. Governments should avoid the temptation of spending the revenue windfalls during good times. Starting to rebuild buffers now will ensure that policymakers have sufficient fiscal ammunition to respond in case of a downturn and prevent fiscal vulnerabilities themselves from hurting the economy."

Wishful thinking with respect to "a golden opportunity." The global government finance Bubble has been fueled by almost a decade of near zero rates, massive central bank monetization and unprecedented amounts of government borrowing. My view holds that myriad global Bubbles have become only more vulnerable to any meaningful tightening of financial conditions. And there are pressing issues that increasingly put the loose financial landscape in jeopardy.

China has belatedly moved to slow system Credit growth. On the surface, it appears they are having some success. Overall Credit expansion has decelerated, mainly on the back of significant regulator pressures over shadow banking. At the same time, mortgage and household lending has accelerated. One can make a case that the overall ongoing expansion of non-productive Credit growth remains highly problematic. Underlying financial fragility continues to worsen. Along with sinking stock prices, China's interbank lending market this week indicated tightened liquidity conditions. The People's Bank of China announced Tuesday that it would support lending with lower bank reserve requirements.

April 17 - Wall Street Journal (William A. Galston): "I know that worrying about the deficit and debt is hopelessly retro, but please indulge me for a few minutes. Last week the Congressional Budget Office issued its outlook for the next 10 years. The news was not good. Over the next decade, the annual federal deficit averages $1.2 trillion. It rises from 3.5% of gross domestic product in 2017 to 5.1% in 2027. The national debt, which is driven by annual deficits, rises from $15.7 trillion to $28.7 trillion over the same period, and surges from 78.0% to 96.2% as a share of GDP-the highest mark since just after World War II. These projections have worsened significantly since the CBO's report last June, and public-policy decisions are the culprit."

April 18 - Bloomberg (Vincent Del Giudice and Alexandre Tanzi): "Mamma Mia! In five years, the U.S. government is forecast to have a bleaker debt profile than Italy, the perennial poor man of the Group of Seven industrial nations. The U.S. debt-to-GDP ratio is projected widen to 116.9% by 2023 while Italy's is seen narrowing to 116.6%, according to the latest data from the International Monetary Fund. The U.S. will also place ahead of both Mozambique and Burundi in terms of the weight of its fiscal burden."

If China's Bubble doesn't pose enough risk for global finance, there's the unfolding fiscal fiasco in Washington. Put on so much debt and you sacrifice flexibility - that's the case for the U.S., China and globally. Especially for the behemoth importer U.S. economy, tariffs and trade wars risk stronger inflation. There is as well the risk that our foreign creditors might find less appetite for additional bonds and other U.S. financial assets. Then there's the pressure such egregious late-cycle fiscal stimulus places on the Federal Reserve. For a Fed that is already far behind the curve, the prospect of stimulus-induced economic expansion with heightened inflationary pressures must be unsettling. Long convinced that inflation was dead and buried, doubt is now making some headway.

It's hard for me to believe there's not massive leverage throughout U.S. and global fixed-income markets. This historic speculative Bubble was at risk of being pierced back in late-2016. 2017, however, proved to be a year with still enormous ongoing global QE (chiefly BOJ and ECB), rampant Chinese Credit expansion and global inflation dynamics that just didn't quite attain momentum. Along the way, financial conditions remained extraordinarily loose and markets ever more complacent.

With the bond vigilantes long extinct, an overindulgent Washington embarked on massive tax cut fiscal stimulus. Mission Accomplished. Next on the agenda, trade and China. This week saw 10-year Treasury yields a mere four bps away from the 3.00% bogey. U.S. and emerging bond markets would appear unusually poised for a negative surprise. Things get interesting if the Fed ever ponders whether monetary tightening might be necessary to calm a frazzled bond market. Thinking back, I've always been intrigued by how the bond (and derivatives!) market was so caught by surprise in 1994. IO's and PO's and such and, of course, ghastly amount of speculative leverage.

This time, sanctions on Russia are having the desired effect

The country’s integration in global finance has made it vulnerable

Tom Keatinge

When the US imposed sanctions last week on 24 Russian oligarchs and officials, and 12 related companies, in response to “worldwide malign activity” by the Russian state, the impact was not immediately clear. But by Monday morning it was unmissable.

The share prices of Rusal, one of the world’s largest producers of aluminium, and its parent company EN+ Group, both sanctioned for their material connection to Oleg Deripaska (also on the sanctions list), fell roughly 50 per cent. The wider Russian market was down 10 per cent. Those, such as commodity traders, transacting with designated companies found related payments blocked as banks reacted to the news. Clearstream, a key component of investment market infrastructure, announced it would stop processing related securities transactions.

Sanctions have become the preferred tool of policymakers feeling an imperative to act — a step short of conflict. The UN, the EU and the US have made extensive use of sanctions against Iran for a range of issues, including its nuclear programme and human rights abuses. The UN and US have imposed sanctions on North Korea in response to its continued development of a nuclear capability. Each missile launch or underground test is greeted with a further round of economic pressure.

In 2014, the US and EU imposed sanctions on Russia following the annexation of Crimea, military incursions into Ukraine and the shooting down of a Malaysia Airlines passenger aircraft over eastern Ukraine.

On the face of it, the latest sanctions designations, declared by the US Office of Foreign Assets Control, seemed little different from those that have gone before. But a week on from that announcement, there is a sense that this time things might be different. Why?

Despite the rise of China and the growth in economic prosperity across the globe, the US — and, importantly for sanctions, the dollar — remain dominant. Alternative payment methods have emerged — currencies such as the euro and the Chinese renminbi have increased in liquidity and asset markets outside the US have grown. Yet approximately 50 per cent of global trade is still conducted in dollars and nearly two-thirds of global currency reserves are held in the US currency.

During the past two decades, the US has taken advantage of its economic and financial hegemony. Successive administrations have sought to “weaponise” the dollar against those acting counter to its interests and beliefs.

What does this mean for Russia and the latest round of sanctions? Why does the impact seem so immediate and severe, in contrast to previous sanctions put in place by the US against Iran and North Korea?

Russia is a very different target from either of those countries. Since Russia emerged from its debt crisis in 1998, its banks and corporates have benefited from globalisation. The former have tapped the deep capital markets in Europe and the US for funding, and corporates, particularly those from the extractive sector, have benefited from the global demand for commodities and have listed their shares in London, Hong Kong and New York.

Russia has thus become integrated into global supply chains and global finance. But just as globalisation has benefited Russia, this integration presents a vulnerability if the markets in which these companies operate are turned against them.

The recent history of banking is scarred by enforcement actions against an extensive roll-call of names. HSBC, Standard Chartered and many others have paid fines to settle claims that they breached US sanctions. In the case of BNP Paribas of as much as $8.9bn. Any bank that uses the dollar can find itself subject to the long-arm of US law enforcement. This extraterritorial reach is often criticised but, as long as it lasts, the US will exert pressure to conform with its priorities on any bank that wishes to have access to the American market or the dollar.

The extent to which Russian banks, companies, oligarchs and officials are exposed to the dollar means that no bank, whether US-based or not, will want to risk handling funds that could bring unwelcome attention from American authorities. Guidance accompanying last week’s sanctions announcement played on this fear. It underlined that foreign persons are also covered by these new designations if they “knowingly facilitate significant transactions, including deceptive or structured transactions, for or on behalf of any person subject to US sanctions with respect to the Russian Federation, or their child, spouse, parent, or sibling”.

In London this week, US Treasury undersecretary Sigal Mandelker warned there would be “consequences” for UK financial institutions that maintain business relations with the newly listed individuals and entities.

In January, the US Treasury, at the direction of Congress, published a list of more than 200 senior Russian political figures and oligarchs. While those listed were not initially subject to sanctions, it was made clear that additional, classified information had been prepared which might support sanctions decisions in the future. Last week’s designations would seem to have borne out that fear. There are potentially a further 180 names to go.

The direct impact of the latest sanctions applied to Russia has been striking. But perhaps most concerning for markets, banks and investors, and therefore damaging for Russia in the long term, is the uncertainty surrounding what future action might be taken by a US administration that is clearly willing to use far-reaching economic warfare to counter its adversaries.

The writer is director of RUSI’s Centre for Financial Crime and Security Studies

Deficits Won’t Matter—Until They Do

By Randall W. Forsyth

     Photo: Getty Images 

Interesting times? You can have them. Investors would love to return to those stolid days of yesteryear when volatility was AWOL and stocks moved steadily higher on a path that could be traced by a ruler. Welcome to the world in which the Dow Jones Industrial Average swings hundreds of points, not only from day to day, but also from hour to hour.

On the week, the pogo-stick bounces left the major indexes up, from 1.8% for the Dow to 2% for the Standard & Poor’s 500 index to 2.8% for the Nasdaq Composite. That was after a series of swings in reaction to news that the trade war with China, once looming over the market, now may be off; a strike on Syria with new and smart missiles was imminent, until it wasn’t; and, of course, the ongoing soap opera regarding the president’s alleged misdeeds that occupy so much of the media’s time and space, and don’t need repeating here.

Arguably more relevant to investors was the news from House Speaker Paul Ryan that he won’t run for re-election, which came two days after the Congressional Budget Office forecast that the federal deficit is heading toward $1 trillion annually. That follows the passage of the Tax Cuts and Jobs Act, which Ryan called his proudest achievement in a congressional career in which he has tried to burnish his image as a deficit hawk.

There are clear political and economic implications of these developments. As for the former, Cowen Washington watcher Chris Krueger notes that nearly half of House GOP committee chairmen—10 of 21—are opting out of running for re-election. “There is no precedence for this. It is hard to numerically underscore how bearish this reality is for the tenuous 23-seat House Republican majority,” he writes in a research note. Even more retirements are possible, given that the deadlines by which candidates must file to run haven’t yet been reached in 19 states, he adds.

The flight of putative fiscal hawk Ryan comes as deficits are set to soar. And in his previous roles as chairman of the House Ways and Means Committee and the House Budget Committee, he helped fashion some of the most perverse policies ever. Coming out of the Great Recession and during one of the most tepid recoveries ever, austerity was imposed, including after the debt-ceiling fiasco of 2011 that led to Standard & Poor’s stripping its triple-A rating from the U.S. Conversely, with the economy at full employment, Congress late last year passed $1.5 trillion in tax cuts and boosted spending by $300 billion.

The CBO forecasts a $1 trillion-plus deficit for fiscal 2020, even with bullish economic assumptions that the economy will grow 3.3% this year, up from the 2% previously expected, and that unemployment will average 3.8% in the current fiscal year and 3.3% in fiscal year 2019. Those predictions are more optimistic than those of most private-sector forecasters or the Federal Reserve, according to Morgan Stanley, and pose the risk of wider deficits if the economy falls short of those wonderful numbers.

Trillions are an incomprehensible quantity. Taken as a percentage of gross domestic product, the annual deficit is expected to run at 4% this year, up from 3.5% in fiscal 2017, and rise to 4.6% in fiscal 2019. The Congressional Budget Office sees the shortfall peaking at 5.4% of GDP in fiscal 2022 and levelling off at about 5% after fiscal 2023.

But the CBO’s more realistic “Alternative Fiscal Scenario” is even worse, writes Jim O’Sullivan, chief economist of High Frequency Economics. It points to a deficit above 6% of GDP by fiscal 2022 and debt exceeding 100% of GDP by fiscal 2027. “Moreover, none of the projections allows for a recession at any point, which is highly implausible,” he adds. “At some point, a recession will inevitably make the deficit and the level of debt even higher.”

Trillion-dollar deficits and debt-to-GDP ratios nearing 100% conjure fear of a fiscal crisis. Looking at history, JPMorgan economists find that such crises are anything but rare. Since 1900, one has struck somewhere in the world within five years 30% of the time. But when it comes to countries such as the U.S., the probabilities are far lower. Among developed countries, a debt crisis within five years occurred just 9% of the time.

The United Kingdom was forced to seek a loan from the International Monetary Fund in 1976, when its debt-to-GDP was just over 50%. The key difference was in the currency; the run on sterling pushed up inflation and interest rates, forcing the need for the IMF bailout. Conversely, Japan has a staggeringly high debt-to-GDP ratio—over 250%—but has near-zero interest rates and a strong yen. The difference, explains Tom Clarke, co-manager of the William Blair Macro Allocation fund, is the high level of domestic savings and being a net international creditor.

The U.S., in contrast, has a low savings rate and is the world’s largest debtor, making it dependent on foreign capital. The Treasury’s debts are denominated in dollars, however, which are controlled by the Fed. As the cliché goes, the U.S. can always print greenbacks to pay its debts, unlike Greece, whose obligations are
in euros controlled by the European Central Bank.

“Nevertheless, we should not ignore the lessons from history on the fragility created by debt, and we must recognize some tail risk of a crisis,” the JPMorgan economists write. That’s contrary to former Vice President Dick Cheney’s assertion that Ronald Reagan proved that deficits don’t matter. But that might not hold under Donald Trump, who has dubbed himself the King of Debt, and has the defaults and bankruptcies to prove it.

While the Congressional Budget Office projects trillion-dollar deficits and a federal debt closing in on the size of the U.S. economy, we ought to be enjoying good times now, even if it’s on borrowed money. But according to a new Bank of America Merrill Lynch survey, Americans aren’t going for the buy-now, pay-later ethos. And that’s especially true of millennials, who, contrary to the popular image of their spending everything on avocado toast, are being far more fiscally responsible than their older cohorts, notably Generation X.

BofA ML had anticipated that a third of the respondents to its “Word From Main Street” survey would spend the cash from the tax cuts. Instead, just 16% of respondents said they’d use the money for big-ticket purchases or day-to-day expenses, while 22% said they’d save the tax cuts, and 20% said they’d pay down debt. In other words, close to half of those polled plan to use the tax savings to shore up their personal balance sheets, although the bank suggested that people might be more responsible in surveys than in reality. (Some 20% said they didn’t get a tax cut, although the bank hypothesized that there might have been delays in getting the reductions or that the respondents didn’t notice them.)

Millennials (ages 22 to 37) said they’d be more likely to save the tax-cut money than Gen Xers (ages 38 to 53). Millennials also were less likely to use the windfall for daily spending and more likely to invest or pay down debt, most likely student loans. All of which suggests a “greater sense of responsibility than is often credited to this cohort,” the bank commented.

None of this comes as news to Barron’s readers, who were warned by our longtime pal, MacroMavens boss Stephanie Pomboy, that consumers’ situations are more parlous than the consensus belief. In her interview last month (“How the Fed Will Trigger the Next Crash,” March 22), she shared with our readers what she has been pointing out to her big-bucks institutional clients: Jane and Joe Six-Pack are largely tapped out. And not from spending on fun stuff, either, but on necessities such as food, energy, health care, and housing.

At the same time, the Federal Reserve sees the economy chugging along, with inflation reaching its 2% goal. So the monetary authorities are on track to raise interest rates twice more this year after last month’s quarter-point increase in the federal-funds rate range, to 1.5%-1.75%. Minutes of last month’s Federal Open Market Committee meeting suggest the possibility of faster rate hikes, in part owing to expectations of the tax cuts’ stimulative effect.

For the past three months, however, retail sales have fallen, something that has happened only five times outside recessions, according to the Liscio Report. “As we all know far too well, this is a very noisy series, but any way you look at the trends, they are weakening,” the newsletter’s client note says. That’s even after taking out lumpy automobile and gasoline sales, which largely reflect price changes.

That said, the Liscio Report says, the past three months’ weakness may be “payback for the vigorous spending of late summer and early fall 2017, which may have been driven above trend by storm recovery efforts.” In which case, it’s understandable if consumers would use any extra cash to replenish savings or pare debt incurred as a result of last year’s storm expenses.

All of which makes Monday’s release of March retail-sales data key for investors. The Liscio crew is forecasting both a 0.1% uptick overall and a 0.1% increase, excluding autos and fuel.

That’s below the consensus of a 0.4% overall retail sales rise last month and a similar gain ex–autos and fuel.

Slowing spending growth and rising inflation suggest the worst of all possible worlds. For now, the Fed remains focused mainly on the latter, while investors are ignoring the former. That’s not a good combination.

Getting Tight! Not Just Here But Everywhere

Let’s start with Caterpillar, the maker of earth moving equipment that has for years been the poster child for global slowdown. Every quarter was worse than the last as mining and construction companies around the world cut back on orders. Here’s a typical 2015 headline from Zero Hedge: “If Caterpillar’s Data Is Right, This Is A Global Industrial Depression”.

Then it all changed. The report Cat issued today showed huge gains in earnings on far better than expected order flows. Everybody, it seems, is suddenly moving earth out there. As MSN trumpted this morning: “Caterpillar gives huge vote of confidence to global economy”.

US home prices, meanwhile are “surging.” In the most recent reporting month they were up 6.3% nationwide and are now 6.7% higher than their 2006 bubble peak. Seattle, Las Vegas and San Francisco are all seeing double-digit y-o-y gains.

Now for the big (and maybe bad) one:

Why the U.S. Bond Milestone Will Ripple Across Global Markets
(Wall Street Journal) – In globally connected markets, what U.S. consumers and businesses pay for their mortgages and loans can affect financial assets from Beijing to Buenos Aires. 
The yield on the 10-year U.S. Treasury reached 3% Tuesday for the first time since the beginning of 2014, a long-awaited landmark in the move away from years of ultralow borrowing costs. 
Asset prices, currencies and borrowing costs around the world are steered by movements in U.S. government bonds, considered by many investors to be the ultimate safe asset. 
A shift in yields can hit dollar-denominated debt issued in emerging markets or the global currencies that move against the greenback as it reacts to higher yields. As rates rise in the U.S., global investors may be shifting cash to take advantage of higher returns, affecting trillions of dollars’ worth of assets in markets around the world. 
The benchmark 10-year bond yield has climbed from a low of 1.36% in July 2016. 
“Three percent in some ways is just a psychological level, but it does prompt investors to start to ask the question about who’s exposed to interest rate risk,” said Charles St-Arnaud, senior investment strategist at Lombard Odier IM. 
“If the spillover effect of higher global yields spread to corporates or households you could see some pain there,” he added. 
Companies and governments that issue their debt in U.S. dollars, particularly in emerging markets, feel the squeeze when U.S. yields rise. 
The amount of dollar bonds issued in developing countries has more than tripled to nearly $3 trillion since 2008 and the start of the financial crisis, according to Bank for International Settlements data. 
Yields are rising as a rally in the oil price brings anticipation of higher inflation and expectations that global central banks will act to curb it. But U.S. yields have been gradually rising anyway, as the Federal Reserve raises rates. 

Emerging market bonds typically suffer more when inflation is driving U.S. yields higher. 
When yields rise on stronger growth prospects, the premium or spread to emerging market debt tends to shrink, according to Michael Biggs, macro strategist and investment manager at asset management firm GAM. But when Treasury yields rise because of inflationary pressure or other risk factors those in emerging markets generally rise in tandem or move higher. 
“We’re not worried when U.S. yields go up on the back of stronger growth, but on the back of stronger inflation, that’s a whole different story,” Mr. Biggs said.

Financial crises frequently start at the periphery (subprime mortgages in 2007, for instance) and then start toppling dominoes on the way to the center. That’s why spiking yields for emerging market debt scare so many analysts. If countries that had been buying lots of stuff from the rest of the world with borrowed money lose the ability to borrow more, then global growth takes a hit. AND all the banks and hedge funds that have lent money to these guys or written derivatives on their bonds are in potentially big trouble.

In today’s world of New Age finance, as goes the leveraged speculating community, so goes everything else.

3% Isn’t the Most Important Number in the Bond Market

The 10-year Treasury yield hitting 3% underscores a healthy economy that should put the stock market in a sweet spot

By Justin Lahart

The real action has been driven by expectations the Federal Reserve will keep raising interest rates, which has pushed the 2-year yield to 2.47% from 1.89% this year. Photo: Joshua Roberts/Bloomberg News

The bond market is getting very exciting because the yield on the 10-year Treasury has finally crossed 3%. And while 3% is just a number, it is an important marker for the rise in long-term rates, which weigh on the economy. The 10-year yielded 2.41% at the start of the year.

The march higher in yields comes at an odd time, since the recent economic news hasn’t been great. But inflation does appear to be firming, and the rise in oil prices suggests the global economy is running a bit warmer.

Investors who are focused on 3% are missing the more important development in the market. The real action has been driven by expectations the Federal Reserve will keep raising interest rates, which has pushed the 2-year yield to 2.47% from 1.89% this year. As a result, the yield curve, or the difference between the yields on the 10-year and 2-year notes, has narrowed to just 0.5 percentage point.

That is a good spot to be. Healthy economic growth will keep the Fed on track to raise rates further, while modest inflation will keep long-term yields from spiking. This flattening of the yield curve makes people worried because the market gets closer to the dreaded inverted yield curve, meaning the 2-year yield rises above the 10-year. An inverted yield curve has often predicted a recession.

S&P 500 12-month performance, by the spread between the 2-year and 10-yearTreasury yields*

Source: WSJ Market Data Group (S&P 500); Treasury Department (spread)
*The 10-year Treasury yield minus 2-year yield at the beginning of the 12-month period

We aren’t there yet. The current curve is still positive, which suggests bond investors believe the economy will be able to absorb Fed rate increases. An inverted curve, on the other hand suggests they believe the Fed has raised rates to the point where the economy risks faltering, and the central bank will need to cut rates in an attempt to head off a recession.

Rich Bernstein of Richard Bernstein Advisors says the way to think of the yield curve isn’t as a dimmer switch, but as an on-off switch—off is when the yield curve inverts. There is no reason to worry until switch gets thrown, and there is no big rush to get out when that happens. Stocks have tended to perform well when the yield curve is relatively flat. Since 1976 when the difference between the 10-year and 2-year yields has been between 0 and 0.5 percentage point, the S&P 500 has gained 13%, on average, over the following year.

When the curve has inverted, the S&P has gained just 5%, on average, and experienced some of its most harrowing declines. That counts as a cautionary message, but the Treasury market isn’t declaring last call yet.

Trump, Syria, and the Threat of Region-Wide War

Fawaz A. Gerges

BEIRUT – The die, it seems, is cast for a rapid end to the United States mission in Syria – and, with it, the chances of a peaceful and sustainable resolution to that country’s brutal seven-year civil war. The chemical attack allegedly carried out last week by President Bashar al-Assad’s forces in Douma, the last rebel-held town in the Eastern Ghouta region, shows just how dangerous that prospect is for Syria and the world.

US President Donald Trump’s bluster in the wake of the chemical attack exposes the incoherence and contradictions of his approach, as well as his lack of any real strategy in Syria. Ordering an attack or two against Assad’s forces, as he might do, would neither alter the balance of power there, nor improve Trump’s position in the war-torn country, let alone the Middle East in general.

To be sure, Trump’s top military advisers have persuaded him to keep in place the 2,000 military personnel currently stationed in Syria. But he has already limited America’s objectives there to eliminating the small remaining Islamic State (ISIS) presence – an effort that should take about six months.

In constraining America’s commitment, Trump has forfeited the opportunity to help shape Syria’s future, reinforcing the widespread perception – which has taken hold among friends and foes alike – that US global leadership is in retreat. He has also disregarded the country’s ongoing humanitarian crisis, the worst since World War II.

Ironically, this narrow approach also undermines the effort to achieve Trump’s sole objective, as a lasting defeat of ISIS and other jihadists will demand a credible political transition that permanently ends the civil war. Such a transition will be possible only through diplomatic engagement by actors with stakes in Syria.

With Trump’s withdrawal implying that the US and its allies have lost the war, Assad already feels emboldened to forge ahead – with Russian and Iranian support – with his plan to recapture the remaining rebel-held territories at all costs. After establishing “facts on the ground,” Assad and his allies would be able to present the world with a fait accompli: Assad remains in power, without making any real concessions to the opposition.
Local and regional actors that placed their faith in America’s commitments will pay a bloody price. In particular, the Kurds – America’s most reliable and effective ally in the fight against ISIS – are likely to be left out in the cold, despite official US assurances about security arrangements after the US withdrawal.

Already, Kurds have criticized the Trump administration for sacrificing them at the altar of America’s strategic relations with Turkey. The US turned a blind eye to Turkey’s recent invasion and occupation of the Kurdish-held city of Afrin in northwest Syria, which led to the slaughter of more than 1,000 Kurds, including scores of civilians.

With a US withdrawal, the Kurds may feel compelled to ally with Assad for protection.

Hundreds of Kurdish fighters have already deserted the fight against ISIS in northeast Syria, journeying to Afrin to resist the joint assault by Turkey and a splinter group of Syrian rebels. Some young Kurds have begun to join Assad’s paramilitary units to avenge the loss of Afrin.

But it will be a difficult battle, as America’s departure is likely to strengthen Turkey’s hand further. After all, without the US, the other main foreign powers in the Syrian conflict – Turkey, Russia, and Iran – will be able to consolidate their spheres of influence and divide the spoils of the post-war reconstruction among themselves. While their specific interests may differ, all three countries share a vision of a “soft” partition of Syria that reduces Assad and the rebels to mere proxies.

Russia and Iran will be the two biggest winners. Russian President Vladimir Putin is the kingmaker whose timely military intervention saved Assad’s regime from defeat and turned the war’s tide in his favor. Whereas the US is almost nowhere to be seen in Syria, Russia is everywhere, constantly rearranging the pieces on the conflict’s chessboard.

Russia’s coordination with all major regional powers – including Turkey, a NATO member – attests to the dynamism (and cynicism) of the Kremlin’s foreign policy. As the US pulls up stakes in Syria, Turkey’s military and economic ties to Russia will only deepen.

Like Russia, Iran has invested plenty of blood and treasure to save Assad’s regime – and reaped handsome returns. Iran is now the most influential regional power in Syria, as it is in Iraq and Lebanon. But the rush to fill the vacuum left by the US might provide the spark that ignites a region-wide war. There are legitimate concerns that Israel might use the withdrawal of US troops as a pretext to intensify its attacks on Iran and Hezbollah in Syria – a decision that could escalate into all-out regional conflict, one that draws in the US, Iraq, and Saudi Arabia, Iran’s main rival for regional hegemony.

Even leaving aside Trump’s hostility to the 2015 Iran nuclear agreement – which adds yet another source of risk to an already perilous situation – there is now a real and present danger that Syria will become the site of a conflagration even more destructive than the one raging there since 2011.  

Fawaz A. Gerges, Professor of International Relations at the London School of Economics and Political Science, is the author of ISIS: A History and Making the Arab World: Nasser, Qutb and the Clash That Shaped the Middle East.