$150 Billion Global Corporate Bond Binge

Doug Nolan

After an extraordinary August, markets are showing no inclination for stability to begin September. Jumping 1.3% Thursday on news of an October restart of trade talks, the S&P500 gained 1.8% for the week. The S&P500 ended the week less than 2% from all-time highs. The Semiconductors surged 4.2%, increasing 2019 gains to almost 36%. The Nasdaq100 advanced 2.1% (up 24.1% y-t-d), now also less than a couple percent from record highs. The Broker/Dealers jumped 2.7%.

Not uncharacteristically, the more dramatic market trading dynamics were visible throughout fixed-income. Curiously, Thursday’s bout of “risk on” (and much stronger-than-expected ADP and ISM Non-Manufacturing reports) finally captured the attention of safe haven bonds. Ten-year Treasury yields surged nine bps to 1.56% - which equated to a painful 1.8% one-day drop in the popular iShares Treasury Bond ETF (TLT). Intraday, TLT was down as much as 2.4%. Bullish pundits were quick to dismiss a single-session yield jump. But of the crowd piling into bond ETFs, how many are unaware of how quickly money can be lost in “safe” bonds?

“Biggest Bond Rout in Years Whiplashes Bulls Who Were Right,” read a Bloomberg article (Liz McCormick) headline. Jumping 9.5 bps to 1.53%, two-year Treasury yields posted their largest one-day jump since February 2015. At one point up 14 bps, two-year Treasuries were on the cusp of the biggest single-session spike in a decade. Interestingly, the implied yield for December Fed funds futures was little changed for the week at 1.61%.

Investment-grade corporate bonds were under pressure as well. The iShares Investment-Grade Bond ETF (LQD) was down as much as 0.9% intraday before ending Thursday’s session with a loss of 0.7%. While declining almost 1% early in the trading day, the “risk on” backdrop pushed junk bond indices into positive territory by the close.

After trading at a record low negative 0.74% in Tuesday trading, German bund yields spiked to as high as negative 0.575% during Thursday’s session (before ending the week at negative 0.64%). Safe haven Swiss bonds were similarly unstable. After trading as low as negative 1.05% in Wednesday trading, Swiss 10-year yields surged to negative 0.90% - before closing Friday at negative 0.95%.

Curiously, there were bond rallies that didn’t miss a beat. This week’s 12 bps drop in Italian 10-year yields narrowed the spread to German bunds by 18 bps to a 16-month low 151 bps. Greek 10-year yields declined three bps, narrowing the spread to bunds to a near decade-low 222 bps. I’ll assume there have been some bearish bets on Italian and Greek yields and spreads that have “blown up.”

Argentine 30-year dollar bonds had a wild ride. After opening Monday trading at 16.69%, yields spiked to as high as 18.25% in Tuesday trading before reversing course and closing out the week at 13.55%. The Argentine peso rallied 6.6% this week, reducing 2019 losses versus the dollar to 32.5%.

And while risk showed its face in (most) bond prices, corporate debt issuance was nothing short of incredible. A Bloomberg headline described the week: “A $150 Billion Global Corporate Bond Binge Is Smashing Records.”

September 6 – Financial Times (Joe Rennison): “Companies across the world, from iPhone maker Apple to German financial technology group Wirecard, sold more bonds this week than ever before, abruptly waking the market from its summer slumber to take advantage of historically low borrowing costs. Investors lapped up more than $140bn of new corporate bonds, marking the biggest weekly volume to hit global markets on record, according to… Dealogic. The debt binge was fuelled by investment-grade companies in the US where $72bn was raised across 45 deals in a single week, roughly equalling the total issued in the whole of August. ‘We have had a month of issuance in three days,’ said Andrew Brenner, head of international fixed income at National Alliance Securities. ‘There is tremendous demand out there.’”

September 4 – Wall Street Journal (Matt Wirz and Nina Trentmann): “Apple… joined U.S. companies including Deere & Co. and Walt Disney Co. in a recent sprint to issue new bonds, taking advantage of the steep decline in benchmark interest rates and a surge in investor demand. Apple launched its first bond deal since 2017, selling $7 billion of debt. All three companies issued 30-year bonds with yields below 3%, a first for the corporate debt market. Twenty-one companies with investment-grade credit ratings issued bonds totaling about $27 billion on Tuesday, said Andrew Karp, head of investment-grade capital markets at Bank of America Corp. ‘That’s equivalent to a busy week for us—in one day,’ he said.”

September 5 – Bloomberg (Brian W Smith and Michael Gambale): “U.S. investment-grade bond issuance is hitting $74 billion for this week, the most for any comparable period since records began in 1972. Thursday’s $20 billion total adds to the $54 billion already sold, thrashing the week’s forecast of $40 billion. With a rally in Treasuries pushing the high-grade bond yield to a three-year low of just 2.77%, companies are borrowing cheap money now to refinance more expensive debt, spurred by a positive tone in global markets.”

September 6 – Financial Times (Joe Rennison): “…In a further sign of investors’ increasingly desperate search for yield, Restaurant Brands, which owns the Popeyes and Burger King chains, was set to issue an 8.5-year bond with a coupon under 4% on Friday, entering a tiny club of junk-rated issuers that have managed to sell debt below that level — and breaching what is typically expected from ‘high yield’ issuers. ‘The conventional heuristics are getting tossed out of the window,’ said John McClain, a portfolio manager at Diamond Hill Capital Management. ‘These are paltry returns.’”

It's difficult to envisage a more manic bond market environment – at home or abroad. In Europe, it’s tulip mania reincarnated, with a third of European investment-grade bonds now trading with negative yields. Draghi had best not disappoint the markets next Thursday. And when he comes through, markets will raise the stakes even higher for next month. From the Financial Times (Robert Smith): “JPMorgan’s analysts say September is shaping up to be the ‘first issuance window where negative yielding bonds are a common feature, rather than an occasional oddity’. ‘In our view, investors still have cash to deploy, and few other alternatives to buy,’ they say.”

September 5 – Bloomberg (Hannah Benjamin): “Sales of new bonds in Europe will pass 1 trillion euros ($1.1 trillion) on Thursday, earlier in the year than ever before as companies take advantage of ultra-low borrowing costs ahead of potential year-end volatility to raise funds. BT Group Plc, Continental AG and Snam SpA joined the deluge on Thursday, fanning what may be the busiest week for corporate issuance since March 2018. The day’s 13 offerings marketwide will also likely lift sales for the year above 1 trillion euros, about six weeks earlier than last year and two weeks quicker than 2017’s record…”

Beijing was determined to do its share to make the week noteworthy.

September 6 – Bloomberg: “China’s central bank said it will cut the amount of cash banks must hold as reserves to the lowest level since 2007, injecting liquidity into an economy facing both a domestic slowdown and trade-war headwinds. The required reserve ratio for all banks will be lowered by 0.5 percentage points, taking effect on Sept. 16… The PBOC also cut the reserve ratios by one percentage point for some city commercial banks, to take effect in two steps on Oct. 15 and Nov. 15. The cuts will release 900 billion yuan ($126bn) of liquidity, the PBOC said, helping to offset the tightening impact of upcoming tax payments. That is more than the previous cuts in January and May, which released 800 billion yuan and 280 billion yuan, respectively, the PBOC said…”

Though China’s latest cut in bank reserve requirements was well-telegraphed, it along with the restart of trade talks pushed the Shanghai Composite 3.9% higher. The renminbi rallied 0.56% versus the dollar. But before we get too excited by the “release” of an additional $126 billion of lending power, keep in mind that Chinese Credit in 2019 has been expanding abundantly. After seven months, Total Aggregate Financing had already increased $2.022 Trillion, running 26% ahead of comparable 2018. Reserve reductions can be expected to somewhat extend China’s historic mortgage finance and apartment Bubbles.

And on the topic of mortgage finance Bubbles…

September 5 – Wall Street Journal (Andrew Ackerman and Kate Davidson): “The Trump administration said it would support returning mortgage-finance giants Fannie Mae and Freddie Mac to private hands, a development that could keep the companies at the center of the housing market for decades to come. The principles announced Thursday represent a major reversal from what leaders of both parties over the past decade promised—to abolish the companies, which guarantee roughly half the U.S. mortgage market. The approach, which doesn’t require approval by Congress, would mark an important win for investors who have been betting politicians wouldn’t follow through on those promises. Treasury officials said they would aim to privatize the government-controlled firms without making it tougher and more expensive for people to get mortgages.”

September 5 – Wall Street Journal (Aaron Back): “America’s mortgage-finance system isn’t going to change in a fundamental way for the foreseeable future. That is the inescapable—though to many parties deeply disappointing—takeaway from the U.S. Treasury Department’s housing reform plan… Mortgage guarantors Fannie Mae and Freddie Mac, which have been wards of the state for 11 years, are likely to remain so for some time. For years a debate has raged over how to deal with the companies that back most mortgages in the U.S. Some, especially holders of their volatile shares, want them recapitalized and released from government control as soon as possible. Others want a fundamental reform of the system, which would require new laws and likely include an explicit government guarantee for the mortgage-backed securities they issue. The Trump administration is trying to straddle the two camps by recommending that Congress get to work on the more fundamental reforms while the executive branch gets started recapitalizing and releasing the companies. But exhortations to Congress are likely to fall on deaf ears. Meanwhile, the route to recapitalizing the companies outlined in the report is tentative and vague. The report uses the term ‘Congress should’ 40 times.”

A factor fundamental to the predicament was captured succinctly by Barron’s (Bill Alpert): “Both Fannie and Freddie now have negative net worths. The Treasury would like to end their government conservatorship and have them stand on their own. But to capitalize them well enough to weather another financial crisis could require a couple of hundred billion dollars.”

Predictably, Washington has failed to resolve the serious systemic risk posed by the GSEs, risk made disastrously clear in 2008. Indeed, the Trump administration has followed Obama’s in lacking the fortitude to even commence the process. It’s been more than a decade since the crisis and resulting Fannie and Freddie government receivership. At the minimum, these two failed institutions should have shrunk. But after ending 2008 at $8.167 TN, Total GSE Securities (chiefly Fannie and Freddie’s) closed out Q1 at a record $9.147 TN.

It’s worth noting GSE Securities surged $626 billion since the end of 2016 – in what is reckless late-cycle growth for institutions with zero capital buffers. But as a wing of the Department of Treasury (and a probable target of the Fed’s next QE program), GSE debt and MBS have enjoyed insatiable demand. In one of history’s great debt issuance booms, combined outstanding Treasury and GSE securities have increased $3.0 Trillion over just the past ten quarters.

In theory, it would be prudent to push hard for less Washington monopolization of mortgage Credit. But at this point, the idea of “privatizing” Fannie and Freddie would simply be a return to the disastrous system of privatizing profits while nationalizing risk. There is simply no mechanism to effectively privatize this risk, as markets will invariably recognize these bigger than ever colossal institutions as much too big to fail.

Confident in the Washington backstop, GSE securities will continue to trade with meager risk premiums. This distortion creates extraordinarily attractive profit opportunities for equity investors clamoring for a so-called “privatization.” As before, cheap financing costs and the gross under-reserving for future losses would create the illusion of sound and highly profitable institutions. These “private” companies would surely reward investors with strong earnings growth and dividends, ensuring a hopelessly insufficient capital base for the downside of the cycle.

The Trump administration punted. Yet I would prefer to see these institutions remain under the Treasury umbrella rather than be part of some sham “privatization.” The administration should, however, at the very minimum demand a moratorium on expansion. It would take years, but Fannie and Freddie exposures could be meaningfully reduced. I won’t hold my breath. Cheap mortgage Credit has been a staple for U.S. economic and financial systems now going on three decades. One of many historic market distortions that these days passes as normal and sustainable.

Radio Silence

German-U.S. Ties Are Breaking Down

By Matthias Gebauer, Christiane Hoffmann, René Pfister and Gerald Traufetter

Angela Merkel and Donald Trump at NATO headquarters in Brussels

Never since the founding of postwar Germany have relations between Berlin and the United States been as fragile as they are today. There is virtual radio silence between Chancellor Angela Merkel and President Donald Trump and U.S. Ambassador Richard Grenell is doing more to agitate the situation than to mediate.

When it comes to fostering relations between Germany and the United States, the Atlantik-Brücke in Berlin is the most important player. For almost 70 years, the non-profit organization has worked, according to its statutes, to "deepen the collaboration between Germany, Europe and America on all levels."

The American ambassador usually plays a key role in this process. When a new chief U.S. diplomat arrives in the German capital, the Atlantik-Brücke organizes a big dinner, an event that has become a regular tradition.

When U.S. Ambassador Richard Grenell took up his posting in Germany last year, there were plans to welcome him according to that custom, but Grenell didn't want to. He wasn't interested.

The ambassador also turned down the invitation to speak at a meeting of the organization's members in late June of last year. Nor did Grenell want to hold a talk at the ensuing barbecue, where he was described as the "guest of honor." He instead gave two students an interview that mostly centered on his dog and its importance to the ambassador's life. Then he disappeared again.

Since then, there has been radio silence between Donald Trump's representative in Berlin and the most important German-American lobby group. The only thing that exceeds Grenell's demonstrative disinterest in the Atlantik-Brücke, it seems, is his pretension to power. When it comes to who should lead the group, the U.S. ambassador still wants to have his say.

When Friedrich Merz of the center-right Christian Democratic Union (CDU) party announced he was stepping down as the longtime chair of the group and suggested former Foreign Minister Sigmar Gabriel of the center-left Social Democratic Party (SPD) as his successor, Grenell personally called the group to voice his misgivings. The organization, however, politely rejected his recommendations. Grenell didn't answer a request for comment about his actions and communicated that he was not available for an interview with DER SPIEGEL.

The Antithesis to Trump's America

The quarrel between Trump's man in Germany and the most important organization in the trans-Atlantic relationship may seem like a bizarre facet of political life in Berlin, but it is also symptomatic of a German-American relationship that has reached a new low-point in recent months. "There is a crisis in the U.S. German relationship of a type that I would never have expected to occur in our time," says Nicholas Burns, the former U.S. ambassador to NATO ambassador and current foreign policy adviser to Democratic presidential candidate Joe Biden.

Germany has become the antithesis to Trump's America -- that much is clear from Grenell's tweets. The conflict centers on concrete interests and political issues, but of course also on the personal chemistry between Trump and Chancellor Angela Merkel.

In no other area are the stances of Berlin and Washington as far apart as they are on the issue of Iran. For the first time in the history of the Federal Republic of Germany, the German government has explicitly based a decision not to take part in a military deployment on the fact that the deployment is being led by the U.S.

Germany could face new punitive tariffs in November as part of the trade conflict, and Grenell has even indirectly threatened to pull its troops out of the country in the dispute with Berlin about increasing its military spending to 2 percent of gross domestic product (GDP) in line with the target for NATO members.

Elsewhere, Trump is openly calling for the European Union to split up. He is publicly encouraging the new British prime minister, Boris Johnson, to embark on a hard Brexit. Trump's national security adviser, John Bolton, traveled to London last week to communicate that the U.S. would "enthusiastically" support a decision by the UK to leave the EU with no deal.

Trump has shaken the relationship between the Germans and the Americans in ways that extend far beyond politics. The U.S. is more unpopular with Germans than ever before. A survey conducted for the Atlantik-Brücke found that 85 percent of Germans view the relationship with the U.S. as negative or very negative. Now, 42 percent see China as a more reliable partner. "It worries me that it has become popular even among the leading elites of the German business community to bid farewell to America," says Sigmar Gabriel, the new head of Atlantik-Brücke. "Many now see the U.S. as a bigger problem than China and Russia."

Little Communication Between Merkel and Trump

The communication between the chancellor and the U.S. president has been scaled back to a minimum. Whereas Merkel at times spoke with Trump predecessor Barack Obama once a week, contact with Trump has been extremely sparse. "Spontaneous phone calls are not a part of their relationship," says one U.S. diplomat. They often go for several months without speaking to each other.

From a German perspective, conversations with the president are mostly just seen as futile. The have "little practical use," says one government representative. What is Merkel supposed to talk to Trump about? Should she tell him she believes his Iran policy is wrong? The representative says he knows that. Should she try to get him to change course? The official says that's pointless.

According to people who have been present during meetings between Trump and Merkel, when the two leaders do see each other, the exchange is direct and open. "There is no understanding, but there are also no misunderstandings," says one U.S. diplomat. One could say the same of Merkel's relationship with Russian President Vladimir Putin and Recep Tayyip Erdogan.

According to participants, Merkel's tone during the meetings is relaxed, often slightly ironic. She teases Trump at times, but never treats him disrespectfully. Trump, meanwhile, according to one government representative, affords her a "perverse respect," in part because she doesn't ingratiate herself to him. The official claims Trump sees Germany as a model of success, as an export nation that doesn't get involved in military conflicts and allows others to foot the bill. "If Trump could do that himself, he would."

Trump is being faced with a German chancellor who clearly wants to go down in history as his opponent. Although Merkel described it as "absurd" and "ludicrous" that she was described as the leader of the free world after Trump's election, she does like the posture.

In May, she flew to Boston to deliver a commencement speech at Harvard University that can safely be described as an anti-Trump manifesto. She was also accidentally caught by photographers reading an anti-Trump book during her vacation: "Tyrant," by Stephen Greenblatt, about Shakespeare's despots - some of whom have an unmistakable similarity to the current U.S. president.

It has now become normal for Merkel not to ask for a meeting with Trump when she visits the U.S. There was no meeting with Trump during the Harvard trip, and when Merkel attends the United Nations General Assembly in New York in mid-September, no meeting with Trump is planned. "From the beginning, the chancellor made it clear that she would concentrate on UN issues," says a German government source.

An Anti-German Undertone

For Trump, Germany is a "flyover country" when he visits Europe. The American president has been in Rome, Paris and London during his presidency, but he has not paid a single visit to Berlin.

When Trump embarks on his extended European trip in late August, he will visit Copenhagen and Warsaw after the G-7 in Biarritz, in southern France. Nobody in Berlin has any illusions about the symbolism of the trip: the right-wing populist Polish government has, like Trump, attacked Merkel's refugee policy. To the delight of the president, the Polish government is also fulfilling its NATO pledges. In Denmark, a new prime minister has taken office following a campaign with anti-migration tones. The Danes will now decide whether the Nord Stream 2 pipeline Trump is so vehemently fighting against will be allowed to be built. "The trip has an anti-German undertone," says a high-ranking German government representative.

In the good old days of the German-American friendship, the U.S. ambassador tried to keep the lines of conversation between the Chancellery and the White House open. "We actually need an American ambassador who mediates, who tells the Americans, even if he doesn't share our position, why we think the way we do," says Gabriel.

A Style That 'Took Getting Used To'

But from the start, Grenell has shown that he is primarily interested in garnering headlines. He had hardly taken up his posting when he suggested in a tweet that German companies should limit their business with Iran, prompting Martin Schulz, who was the head of the Social Democrats at the time, to say that the ambassador was behaving like a "right-wing extremist colonial officer." Grenell then gave an interview to the right-wing news portal Breitbart in which he made it sound like he was hoping for a Trump-style right-wing revolution in Europe.

Soon after, pretty much anyone with a reputation to lose began keeping their distance from Grenell. No U.S. ambassador in recent German history seems to have been so isolated. On the American side, people have noticed that Merkel's people are constantly trying to organize panel discussions with American guests at which there is no space for Grenell at the table. Sometimes, however, the Americans insist -- as happened during the Munich Security Conference in February, which U.S. Vice President Mike Pence attended. In conversation, Merkel made it clear in no uncertain terms how little regard she has for Grenell. She told Pence that the U.S. ambassador cultivates a style that "took getting used to."

Grenell has been in his posting for about one and a half years, but the chancellor still hasn't offered him a personal meeting. Merkel's people say that is not typical for a head of government to meet with an ambassador. But even German Foreign Minister Heiko Maas hasn't had a significant conversation with Grenell in almost one year. The last time they spoke in depth was at a party held by the tabloid newspaper Bild last September. Grenell didn't want to comment on this either.

Maas and the ambassador appeared to make small talk at the Bild event, but even that went awry. That same evening, Grenell said that, of all people, Maas was a fan of Kid Rock, one of the few Trump supporters in the U.S. showbusiness world. Maas had never even heard of Kid Rock. He had mentioned Pearl Jam, a left-wing grunge band.

Trump and Grenell are astonishingly similar. Both are happy to dish it out, but they are highly sensitive when they are the subject of attacks. Like Trump, Grenell also has a penchant for right-wing conspiracy theorists. Grenell recently shared a tweet by right-wing columnist Katie Hopkins in which she claimed that "Merkel's media" had explained that a recent killing by a migrant in Stuttgart using a sword had merely been the result of "differences in culture." Like Trump, Grenell is also a virtuoso at self-promotion.

'I'm Making them Pay Their Bills'

Four weeks ago, the ambassador gave an interview to Fox News. Grenell is often a guest on the channel, which is the most reliable way of getting the president's attention. That day, Grenell spoke broadly about U.S. foreign policy. He spoke about how America is viewed in the world. "Barack Obama was wildly popular in Germany," said Grenell. And yet, he said, during his presidency, the Germans didn't raise their defense spending and they began planning the Nord Stream 2 pipeline. "So, I'm not sure popularity is really what we should be going for," he said.

Apparently, Trump was listening closely. Only one day after that interview, the president flew to North Carolina for the campaign appearance where he held the now infamous speech in which he attacked Muslim congresswoman Ilhan Omar until the crowd shouted, "Send her back!" The backlash against the president and his supporters was enormous.

But in the hubbub, people missed the fact that the speech also included an attack against Angela Merkel. "There was a recent poll -- Germany likes Obama better than Trump," he said. "I said, of course, because I'm making them pay their bills. Obama would go and make a speech, leave. I go and make a speech and say: Let me speak to Ankela. Ankela, you gotta pay your bills, you're way behind!" The crowd was amused -- particularly about the president's deliberately botched pronunciation of the German chancellor's name.

In the meantime, some in the Berlin government are starting to wonder whether it might be more prudent to tread more lightly with Trump and his ambassador. They argue that simply declaring Grenell a pariah will only further radicalize him.

Most recently, Grenell last week issued the vaguely veiled threat of pulling American troops out of Germany. "It is actually offensive to assume that the U.S. taxpayer must continue to pay to have 50,000-plus Americans in Germany, but the Germans get to spend their surplus on domestic programs," he told the German news agency DPA. Just shortly before, the U.S. ambassador in Warsaw, Georgette Mosbacher, suggested that Washington should transfer more of its troops stationed in Europe to Poland. She noted how, in contrast to Germany, Poland is actually fulfilling the constantly repeated demand from Trump that NATO member states spend 2 percent of GDP on defense spending. Trump personally retweeted Mosbacher's message to his 63 million followers.

The latest tirade provides a good example of the fact that, like Trump, Grenell is mainly about the show. Because Grenell should know from his visits to the U.S. bases in Germany that they benefit Americans at least as much as they do the Germans. Indeed, the Pentagon even wants to upgrade the bases.

Today, huge U.S. bases like the ones in Ramstein or Stuttgart no longer primarily serve as protection against the enemy in the East -- they operate as hubs for operations in the Middle East. Soldiers injured in areas where the U.S. military is deployed are flown to the giant military hospital at Landstuhl for treatment. The Miesau Army Depot is home to one of the U.S. Army's largest munitions depots worldwide. The Vilseck and Grafenwöhr sites are also essential for training operations for the U.S. Army together with its NATO partners.

In addition, the U.S. Army commands a large share of its worldwide missions from Germany. In the Stuttgart area, for example, the military controls all troop movements in Europe and each of the numerous operations in Africa. It's unlikely that any American commander would voluntarily give up the well-developed bases in a stable country like Germany, which has given the Americans many properties more or less for free.

In any case, Trump wouldn't have the political support for a withdrawal of U.S. troops from Germany. "You would not get anywhere close to a majority of members of Congress who would want to strike a blow against our alliance with Germany," says Biden adviser Burns. He argues that Germany is one of the most important allies the U.S. has anywhere in the world. For Burns, a withdrawal of U.S. troops is out of the question. "It would be a betrayal of our alliance with Germany," he says.

A Symbol for the Breakdown in Ties

If there is a symbol for the breakdown in German-American relations, then it's two steel pipes, each 1,230 kilometers (764 miles) long. Once laid, they will run along the bottom of the Baltic Sea from Vyborg in Russia to Lubmin in the northern German state of Mecklenburg-Western Pomerania. As early as next year, gas flowing from northern Russia through the Nord Stream 2 pipeline could be used to heat millions of German households.

But Trump is doing what he can to prevent the project's completion. Washington is exerting pressure on the Danish government in particular because its approval is required for construction of one section of the pipeline, meaning Copenhagen has a certain amount of power over the entire project.

Trump was planning a trip to Copenhagen in September, though he has since canceled. But even if Denmark is able to withstand American pressure, Washington will continue to fight the project. The Americans are even threatening to levy sanctions against the members of the consortium. "Stiff sanctions can be imposed at any time," says Joachim Pfeiffer, the conservative CDU party's economics affairs expert in parliament. "They hang like a sword of Damocles over relations between Germany and the U.S."

Trump has publicly stated that the Germans should not build Nord Stream 2 because it would increase German dependence on Russia. "We're supposed to be guarding against Russia and Germany goes out and pays billions and billions of dollars a year to Russia," Trump said last year. But in their talks with the German government in Berlin, representatives of the U.S. government have bluntly admitted it is also about their own economic interests: They want the Germans to purchase liquefied natural gas (LNG) from Texas rather than natural gas from Siberia.

On his last trip to the U.S. in July, German Economics Minister Peter Altmaier, likewise from the CDU, attempted to assuage the Americans he was visiting. He said a port would be built for LNG tankers in the town of Brunsbüttel near Hamburg. He also said that even if Nord Stream 2 is connected to the German gas network, there will still be an excellent market for American gas. U.S. Trade Representative Robert Lighthizer listened patiently to what Altmaier had to say, but that's about all. The minister was perplexed as he flew home. "President Trump sees the European Union almost solely as an economic competitor," Burns says. "That is a grave mistake. Every president since Harry Truman has supported the European project because it is always in our interest that the EU succeeds."

Making Life Difficult for German Carmakers

The situation is no better for executives in the German automobile industry. For more than a year now, Trump has been making life difficult for the bosses of Daimler, BMW and Volkswagen. Trump even prompted them to convene a joint meeting at the White House in the hope of preventing punitive tariffs against German cars.

Last summer, outgoing European Commission President Jean-Claude Juncker and Trump agreed that they would negotiate a deal over tariffs on industrial goods that would also clarify the issue of levies on cars. Trump assured him that no import tax would be levied until that agreement was reached, but that pledge expires in November. The European Commission is still negotiating the modalities of talks on eliminating tariffs with the U.S. administration but has so far enjoyed little success. Given its popularity as a campaign issue, there is little hope within the German government that Trump will abandon his threat of imposing punitive tariffs on Germany's automobile industry. "In order to protect itself from Trump's whims, Germany must take a leading role in the fight for free trade in Europe so that Brussels can forge a coalition of multilateralists," says CDU economics expert Pfeiffer.

In Berlin, many are still holding out hope that the good old days of trans-Atlantic cooperation can resume once the Trump era has passed. But that could prove illusory. "The U.S. won't remain the way it is under Trump, but it will also never be the same as it was before him again," says Gabriel.

The fact is that the Democrats agree with many of the points where Trump is critical, and Washington would remain an uncomfortable partner even if a Democrat is elected into the White House next year. Trump, in all his brutal openness, has made it clear that the U.S. is no longer willing to pay for Europe. The Democrats are also raising the question of military spending. And even Biden adviser Burns thinks the Germans should have taken part in the military action in the Strait of Hormuz.

A Convenient Excuse for Germany

Indeed, Trump has become a convenient excuse for the Germans. Whatever he says is rejected almost reflexively. This is true for both the military mission in the Strait of Hormuz and NATO's 2-percent target. The Germans need to finally get over the idea that they can remain a kind of giant Switzerland in the middle of Europe forever, says Peter Rough from the conservative Hudson Institute think tank.

Robert Kagan, a former adviser to two Republican presidential candidates who now works at the Brookings Institution think tank in Washington, generated considerable buzz with an essay he published in May in Foreign Affairs magazine. In it, he wrote that the German question, which led to two world wars and millions of deaths, could return. America's role in Europe has historically been a guarantor against Germany's hegemonic tendencies, Kagan argued.

America, according to Kagan, made a stable Europe possible after 1945 by providing economic and military security, promoting democracy and suppressing nationalist tendencies. "Trump is actually fanning the flames of nationalism ... again and again by supporting basically nationalist parties in Europe," Kagan told DER SPIEGEL. "He's clearly destroying the global free trade regime by pursuing protectionist American policies which are directly harming Germany, which depends on a free trade regime to be economically successful."

So, what can be done? "I wish I had an answer to that," Kagan says, noting that Europe's success following World War II has been closely linked to support from the U.S. "I don't know how Europe can do it in the absence of the United States' role."

How much stimulus will the European Central Bank serve up?

Market Questions is the FT’s guide to the week ahead

FT Reporters

How much stimulus will the ECB serve up?

At its last meeting in July, the European Central Bank all but committed itself to delivering a package of easing measures as it battles to spark growth and drive up stubbornly low inflation.

Markets responded accordingly, pricing in rate cuts as well as a reactivation of the bond-buying programme that was wound down last December. Two-year government bond yields, which are highly sensitive to interest rate expectations, are below the ECB’s current deposit rate of minus 0.4 per cent in nearly all eurozone markets.

Mario Draghi, the ECB’s soon-to-depart president, has a tough job on his hands to exceed market expectations — particularly given the doubts about the need for further quantitative easing expressed in recent days by his colleagues on the ECB’s governing council. But some analysts think he will.

“We expect an aggressive easing package from the ECB,” said Priya Misra, head of global rates strategy at TD Securities in New York. TD thinks the ECB will cut rates twice, by 0.1 percentage point this Thursday and again at Christine Lagarde’s first meeting as president in December, while announcing €40bn of new monthly bond purchases.

That should be enough to drive bond yields lower still, according to Ms Misra, who is expecting Germany’s 10-year yield to end the year at minus 0.8 per cent compared with minus 0.61 per cent currently.

A smaller package of purchases could disappoint bond investors. Axa chief economist Gilles Moëc thinks Mr Draghi will compromise with his more sceptical colleagues and opt for €25bn of monthly purchases for the next six months, particularly given growing doubts about the effectiveness of more agressive easing.

A programme of that size would probably allow the ECB to avoid the politically tricky step of raising the limit on how much of each country’s bonds it can own, currently set at 33 per cent.

“I’m not sure the balance is right for a bazooka right now,” Mr Moëc said.

Tommy Stubbington

A graphic with no description

Will the deluge continue in US bond markets?

After a record-breaking week in the US for investment-grade bond sales, investors are asking whether the market can sustain the rapid pace of issuance, and what the deluge of debt might do to corporate borrowing costs.

Investors lapped up a total $74bn worth of investment grade bonds for the week ending September 6, according to Bloomberg data, the most ever — both by the sheer number of deals and the dollar value of the total.

The slew of sales comes after a global bond rally that has pushed prices so high, and yields so low, that the total amount of negative-yielding debt around the world has soared to around $16tn. The US has been luring foreigners by offering relatively high returns on its debt, according to bankers and investors.

Bank of America analysts note that many of the new bond sales have been used to pay down other debt while lengthening maturities, without adding to the overall leverage of many companies. That means that the total pool of bonds is not increasing.

Nonetheless, analysts and bankers expect the selling frenzy to continue, noting that September tends to be the busiest month for the corporate bond market all year.

Joe Rennison

Will the US crop report produce another surprise?

After a shocking report in August, analysts will be watching to see if the US Department of Agriculture’s monthly update on crop progress, due on Thursday, yields any further surprises.

Larger than expected corn supply forecasts from the USDA last month upset the market, pushing the futures price in Chicago down 6 per cent in the largest daily sell-off in six years.

Despite record rainfall earlier in the year, which turned many fields across the Midwest into lakes, the USDA predicted just a 4 per cent drop from 2018’s average yield to 13.9bn bushels. This was much higher than average private estimate of 13.2bn bushels.

Analysts and traders were taken aback by the planted area of 90m acres, which was higher than the top range of consensus estimates, but also the yield, or output per acre, at almost 170 bushels.

For the August report, the USDA made a change to the way it gathers data by eliminating its on-field “objective” survey. Instead, it relied on phone and online surveys of 21,000 growers.

This month’s report will include the on-field survey, and traders will be looking to see whether the yield forecasts change as a result. “The market will have to accept the large 90m acres planted in the US, which is a key bearish factor,” said analysts at Rabobank. But if yield estimates rise further, “prices would further be pressured,” it said.

On the other hand, a fall in the yield could help corn prices. But downgrades to the forecast would have to be substantial for the market to rise above $4.50 a bushel, from the current $3.45, the bank added.

Emiko Terazono

The Volcker revamp was a small victory in a wider war

If banks are intent on getting back to the old days, they need to start somewhere

Robert Armstrong

Traders on the floor of the New York Stock Exchange © AP

When the updated version of the Volcker rule landed last week, all of Wall Street had something to say about it. Among bankers, investors, lobbyists, lawyers and analysts, there were normal differences of opinion. But it was striking that various natural allies of the banks took views that were, at least on some level, logically inconsistent with arguments they have for years made about the burdens imposed by the rule.

Publicly, the banks stayed largely mum: they know there is little to be gained from rejoicing at deregulation. But their institutional views are clear. The Volcker rule was designed to prevent banks that enjoy Federal guarantees from gambling with depositors’ money. It said banks were allowed to trade on behalf of clients or “make markets”. Gambling with the bank’s money, known as “prop trading”, was out.

The banks objected that it is often impossible to tell the two apart, as evidenced by the fact that the rule had to refer to traders’ intentions to distinguish them. Jamie Dimon, boss at JPMorgan Chase, summed it up: for “every trader, we are going to have to have a lawyer, a compliance officer, a doctor to see what their testosterone levels are, and a shrink, [to ask] ‘what is your intent?’.”

The result of all this ambiguity, banks have long warned, is less trading, less liquid markets and higher volatility.

The amended rule effectively shifts the burden of proof regarding intent away from banks and on to bank supervisors, cutting banks’ requirements to keep records and to file reports. The core premise — that banks are assumed to be prop trading unless they can show they are not — has been overturned.

Bank lobbyists celebrated on behalf of their clients. The Bank Policy Institute, run by a former top lawyer at JPMorgan and Bank of America, noted the “damage the original rule has done to responsible banking activity and legitimate market making activity, and the massive and needless compliance costs it imposed”.

Wall Street lawyers agree. The law was hellacious to comply with and probably did very little to discourage risk taking, they said, over and above what tougher capital requirements and regular stress testing were doing anyway. Good riddance.

Analysts and investors also praised the watering down of Volcker — in principle, at least. But in economic terms (the terms Wall Street cares about) their view was sharply different. On bottom lines, they insisted, the change to Volcker would make little difference.

Analysts saluted a change that means banks’ trading operations can rid themselves of heavy compliance-related costs — but they have not upgraded revenue or profit forecasts in response. (Then again, an analyst in the employ of an investment bank might not feel comfortable contravening their employers’ view that the fight over Volcker is about healthy markets, not profit).

Investors were equally unmoved. Bank stocks sustained their longstanding, meandering movements this week, as if nothing much had happened.

So there you have it: the Volcker rule imposed terrible burdens on banks while clogging up the business of trading. But a big reduction in the stringency of the rule will not matter much to bank profits.

This may be a bit less paradoxical than it looks, however. The post-crisis capital requirements and the Volcker rule overlap in the way they discourage risky trades. The former makes the risks unprofitable, the second prohibits them. Removing just one of the regulations — the one that is harder to enforce — naturally does not make a big difference.

But, if the banks are, in fact, intent on getting back to the old swashbuckling days, they need to start somewhere. They may see their victory on Volcker as the first battle in a larger war.

The post-crisis rules are not the only reason that banks behave differently today. The Lehman era diminished investors’ appetites for businesses that take market risk. Look at how bank stocks now trade: Even with low interest rates pressing profits, investors will pay premiums for well-run, boring, take-deposits-and-lend-money banks.

Meanwhile, firms more sensitive to market action, like Goldman Sachs or Jefferies, are trading not far off historically low valuations, on a price/book value basis. The amendment to Volcker makes little immediate impact because the stuff it prohibits just does not pay like it once did.

Or rather, it does not pay right now. It may not be long before bank bosses once again fancy themselves smarter than the markets, and investors are again ready to play along. The key question is what the regulatory regime looks like then, not now.

Volcker has lost its punch. Now the fight moves on to capital rules, liquidity requirements, stress tests and the rest. Each round may look like a squabble over details. But that should not obscure how much is at stake.

lunes, septiembre 09, 2019




The Japanification of bond markets

The eternal moment

IN THE 1920S E.M. Forster, an English novelist, set out the difference between a story and a plot. “The king died and then the queen died” is a story, he wrote. But a sense of causality is needed to make a plot more than just a sequence of events. “The king died and then the queen died of grief” is a plot.

Investors like stories as much as anyone. They like plots even more. A durable narrative, and one that is on everybody’s lips once again, is “Japanification”. A Forsterian summary might read: “The bubble burst, people became cautious and the economy got stuck in too low a gear to stop prices and interest rates from falling.”

In its strongest form Japanification is a pure tragedy, in which rich, debt-ridden economies are destined to follow the path set by Japan. In another, softer version only countries with rapidly ageing workforces, such as Germany, are thus fated.

Germany’s bond market is now priced for endless stagnation. Its interest rates are negative on everything from overnight deposits to 30-year bonds. But it is striking how depressed bond yields are in countries with only a passing resemblance to Japan.

A 30-year American Treasury yields just 2%, for instance. As currently scripted, Japanification is narrowly defined but broadly applied. It is the fear that policymakers have lost for good their ability to gin up the economy. A big question is whether the current situation is just one act in an unfolding drama, or where the story ends.

Japan’s experience was the trailer for all this. When its ten-year bond yields fell below 2% in 1998, there was a lot of head-scratching, says Peter Tasker, a seasoned analyst of Japan’s economy. At the time, Japan’s government had a huge budget deficit. For its long-term interest rates to fall made little sense. Hedge funds began to short Japanese government bonds (a lossmaking trade that became known as the “widowmaker”). But the country’s consumer prices kept drifting lower. And so did its interest rates.

Ever since, Japanification has been a fear that is alternately raised and dismissed. In November 2002 Ben Bernanke, then a governor of the Federal Reserve, gave a famous it-can’t-happen-here speech about Japan. The lessons drawn from Japan’s failures were: own up to bad debts; fix the banks; use policy tools to spur the economy; don’t let asset prices collapse. After the 2008 crisis, some of these lessons were applied, if unevenly.

A decade on, Japanification is back. People continue to be astonished by how far long-term interest rates can fall, just as they were earlier in Japan. And the declines have been broadly felt. In Australia, which has a young population and has not suffered a recession in a quarter-century, ten-year bond yields are below 1%.

The cause of all this is renewed concern about global stagnation. A synchronised pickup in the world economy in 2017 has turned to synchronised slowdown. Central banks, including the Fed, are cutting interest rates. But there is more to it than that. With short-term interest rates already so low, there are grave doubts that central banks have the power to get the economy back on track.

You see this pessimism in forecasts of medium-term inflation derived from the swaps market, which are markedly lower than they were earlier this year. “The problem with being Japan is that if you get an economic shock, monetary policy has nowhere to go,” says Steve Englander of Standard Chartered, a bank. Europe has already reached this point.

There is an alternative script. In this version today’s Japanification spurs a response that leads to its defeat. If monetary policy has run out of road, there is always fiscal policy. If the economy lacks demand, governments can help to fill it by borrowing cheaply to cut taxes and raise spending.

The politics are not there yet, but the Japanification of bond markets will move things along. “Before there is a consensus on a shift in policy, you need to see the downside risks [to the economy] clearly,” says Mr Englander. Once that shift takes place, the fear of stagnation recedes.

The political response to the threat of stagnation is likely to be more radical than it was in Japan, says Mr Tasker. The tricky part for bond investors is guessing how long this takes.

There are already stirrings of a rethink in Germany, a country hostile to fiscal stimulus. For now, these are only stirrings. Bond yields may languish for a while, before they rise in anticipation of fiscal stimulus. But the queen need not die of grief. After a period of mourning, she may find happiness again. The plot thickens.