Peter Schiff: ‘The Fed Is Like Mr. Magoo! We Are Headed For A Massive Financial Crisis’

Peter Schiff has been saying that even though the stock market is on a slow downward slide, the biggest problem is actually in the bond market. Last week, Schiff warned us to be wary of the calm before the storm, and this week, he said most, including the Federal Reserve, are oblivious to the upcoming crash.

Yields have risen to levels not seen since before the 2008 crash. More significantly, the yield curve is flattening, according to Schiff. 

According to Seeking Alpha, Schiff pointed out, if you go back to the Second World War and look at average bond yields, these low rates are an aberration. They’ve been low for a long time, but they aren’t going to stay low forever. And yet the market seems to think it’s going to go on for another 30 years.

“Clearly, the market assumes that interest rates on 10-year government bonds are going to stay just barely over 3% for the next 20 or 30 years. I mean, that is crazy. Why would anybody think that?”

Just consider the deficits as well. The federal government is running $100 billion per month budget deficits – and this is during a supposed economic expansion. What’s going to happen when we hit a recession? And of course, rising interest rates just compound the problem. As Treasuries come due, the government has to replace them with higher interest rate bonds. This expands the deficit even further.

Also compounding the problem is the money printing scheme the Federal Reserve has taken to.  Why in the world would any rational person assume inflation will remain low?

We also have interest rates at around 3% and there is already some handwringing and nervousness. But as Peter said, they could easily blow through four or even 5%. The Fed keeps saying it plans to reduce its balance sheet, but it hasn’t sold very many bonds to date. What happens if they follow through with tightening plans and start dumping bonds on the market?

If [the Fed] continues to stay on this path, or at least the rhetoric is on this path, rates could blow through 3% like a hot knife through butter.”

Schiff then discussed Minneapolis Fed President Neel Kashkari, who said they [the elite globalists that run the Federal Reserve] can’t find any signs of an impending crisis. He said there are no warning signs at all.

“Well, of course, that’s exactly what they said in 2007 and 2008. In fact, even when there was the mother of all warning signs – the crash of the subprime market – the Fed looked at that and said, ‘That’s nothing. It’s contained.’ We’re not worried about that.’ So the Fed has already proved when it comes to warning signs and seeing them in advance, they’re like Mr. Magoo. They have no idea what’s going on. And in fact, just like Mr. Magoo, they create all kinds of havoc all around them as they blindly move through the economy having no idea what’s going on, and there’s just all kinds of carnage.We are headed for a massive financial crisis.”

Schiff has yet to change his mind: we are headed for some major problems in the economy and most are unaware and unprepared.

Peter Schiff Economy Warning : ‘Enjoy The Calm Before The Storm’

Financial analyst Peter Schiff is warning to “enjoy the calm before the storm.” Schiff, who predicted the 2008 recession says that inflation and interest rates are about to go up much more than expected.

In his most recent podcast, Schiff basically said to enjoy things now, because the storm will eventually hit. With the United States missile strike in Syria, rumblings of a trade war and a generally weak dollar, gold briefly flirted with $1,365 last week. But the anticipation of Federal Reserve rate hikes continues to create strong headwinds against the yellow metal. Many people now think the Fed will nudge interest rates up again in June, leaving six months to get in the much-anticipated third hike of the year, and possibly even get in a fourth.

The Fed is not going to be able to deliver the rate hikes the Fed is expecting, and again, it’s the expectation of more rate hikes that is what is keeping the lid on the price of gold. But it’s only a matter of time before the market blows the lid off and the price of gold goes up. –Peter Schiff

Peter said gold is basically trading sideways right now, in advance of a breakout. Meanwhile, the dollar is doing the same thing in the other direction. The greenback is weak but not breaking down. On the other hand, it isn’t recovering any of its losses. Peter thinks it’s treading water right now before it heads lower again, according to Seeking Alpha. 

Of course, the economic growth was supposed to help “pay for” the tax cuts and the massive amounts of deficit spending. If the economic growth doesn’t materialize, the deficits will be even bigger and they are already going sky-high. On top of that, rising interest rates are going to increase the annual payments on the debt.

So, these deficits are blowing through the roof and this is going to be the driving force in moving the dollar substantially lower and moving gold substantially higher.

We are in the perfect storm, I think, of massive explosion in deficits, not just the budget deficit but the trade deficit, these tariffs or a trade war is only going to compound the problem. We’ve got the economy weakening. We’ve got the dollar teetering on the brink of collapse. We’ve got gold about to break out and the bond market is in the same thing.

Right now, everything seems pretty calm on the horizon, but we are in the calm before the storm.

The three major markets – bonds, gold, and the dollar – are all moving sideways, getting ready to continue their most recent moves, which for gold is up, for the dollar is down, and for bonds are down, which means interest rates are up – and it’s one, two, three strikes and you’re out.

Gold Expert: ‘If Deep State Is pushed In A Corner Much Further, They Can Pull The Plug

Gold and silver expert David Morgan recently appeared in an interview with USA Watchdog‘s Greg Hunter.  Morgan said point blank that “if the Deep State gets pushed into a corner much further, they can basically pull the plug,” and may just crash our economy.

Morgan explains why he thinks it is a great idea to have some physical gold and silver in your portfolio.  “That means the stock market could come tumbling down, and then they [the deep state] could blame the Trump Administration,” said Morgan.

“If you are losing the chess game, you just get up and turn the table over and the pieces go flying everywhere. That is a metaphor for a war. That’s a metaphor for crashing the stock market. That’s a metaphor for crashing the bond market, and it’s a metaphor for it happening on its own. I am concerned that if you win, you lose. This is why the unraveling is being done extremely carefully,” he continued.

“I am not saying it is going to happen. I am saying it could happen. These people are so used to winning a rigged game, if they start being caught, and they have been caught, then they are going to do things that are not necessarily predictable. They are not going to act in a rational manner. They are going to do anything possible to protect themselves. You cannot rule out the possibility that they will turn the table over and that’s it.”

Morgan explains that the problem with the market is its manipulation by the deep state. Once they begin to lose their grip on those they feel are underneath them, they could just “end the chess game” by “flipping the table.”

A good portion of the interview shows Morgan discussing the importance of silver.

There is some free information on TheMorganReport.com regarding precious metals. You can also become a subscriber to The Morgan report and get much more timely and detailed analysis of the financial markets.  If you want to find out more about the “cryptographic silver monetary system” mentioned by Morgan in the interview, click here to go to Ag.Lode.One.

Make Your Choice: Change By Pain Or Insight

This report was originally published by Chris Martenson at PeakProsperity.com

Most experienced investors know the four most dangerous words are: This time is different.

It never is.

And yet one of my key predictions here at Peak Prosperity is that The next twenty years will be completely unlike the last twenty years.

So am I saying that things really will be different this time?

Yes, I am. But to understand why, you have to look closely at the unprecedented moment in history in which we live, as well as how the Three E’s – the Economy, Energy and Environment – all tie together now in a way they never have before.

For those who prefer their conclusions right up front, the simplest summary I can provide is that everything we think we know about “how things work” is just plain wrong.

This explains why, among many other grotesque distortions, the stock and bond markets are spectacularly overpriced and overvalued right now.

This danger is important to be aware of because when things correct, as they inevitably must, the next crash will be incredibly damaging. It could be as profound as that which dethroned Spain as a world power, permanently.

Peak Prosperity user Gyurash put this risk in context within his comment to our recent podcast on Economics for Independent Thinkers:

The mention of Paul Volker was interesting. I remember listening to a lecture given by Mr. Volker played on public radio in the mid 80s. He talked about the Spanish empire in the 16th century and the easy money train they had coming from South American gold and silver. He said that although it seemed to create great wealth it also made for a false economy in Spain. In addition to creating price bubbles, the Spanish did not use it to build much of anything other than big villas, built by itinerant foreign labor by the way, so when the gold and silver flow slowed when the biggest mines were effectively depleted, their economy crashed so hard that it never recovered, even up to today.

(Source)

Delusional Thinking

What’s worse than wishful thinking? Delusional thinking.

The sort of ideas that harm rather than help those who hold them.

Of the many current policy delusions I could rail about, perhaps the greatest of them all is the quite-impossible belief that we can have infinite growth on a finite planet.

I know, I know, refuting this is so brain-dead easy to debunk that it seems pedestrian, if not childishly so, to raise it here again. It’s quite an impossible proposition.

Even the most cursory of reviews of mining data (just one of many possible examples), show that many critical ores and minerals are vastly more difficult and expensive to extract and bring to market than they were just a few decades ago. And the trendlines keep getting worse.

But let’s go through this once again, because it’s such an important point. For those of you already on my side of the boat, please bear with me. Perhaps something new will emerge for you on this next go around.

The Harsh Math

Exponential expansion requires not just some new minerals coming to market, but exponentially more.

It works out like this. Suppose that 100 units of copper were produced in year 1, and output (as demanded by economic growth) was expanding at a 3% rate. How long would it take for production to double? The answer is that after 24 years we’d find that 203 units were being produced. So a 3% growth rate means that it takes only 24 years to fully double production.

However, the more interesting fact is that over that same 24-year stretch, if we add up each year’s production into a cumulative total we discover that 3,546 units of copper had been produced. How much copper would you guess was produced over the prior 24-year stretch (the one that got us to 100 units in the first place)?

The answer is just 1775 units. In other words, half the amount produced during the next doubling. Going back further and adding up all of the doublings of copper production throughout all of history  we’d discover that each new doubling produced (and consumed) as much as the sum total of all the prior doubling periods combined.

You can prove this to yourself by looking at a doubling sequence such as 0.25, 0.5, 1, 2, 4, 8, 16, 32 etc. Note that 4 is larger than (0.25 + 0.5 + 1 + 2) and that 8 is larger than (0.25 + 0.5 + 1 + 2 + 4) and that 16 is larger than (0.25 + 0.5 + 1 + 2 + 4 + 8) and so on — into infinity.

Again, each new doubling involves an increase that is larger than the combined values of all the prior doublings in history.

For the visually-minded, here’s that same idea expressed in an image:

How Many More Doublings Can We Possibly Have From Here?

Only the most delusional would argue that we can dependably double our extraction of key natural resources forever.

Every two decades (or so), will we always be able to use twice as much farmland, twice as much fish in the sea, twice as much oil in the ground, as has been used before throughout all of human history?

Of course not. Planet Earth is a finite system.

This is why I claim that everything we think we know about “how things work” is wrong. Our entire economic and financial systems, their associated monetary models and their current financial asset prices, are predicated on the principle of continuous growth. And not just any sort of growth: Exponential growth. Predictable doubling — forever.

Look, it’s ridiculously easy to prove that there won’t always be twice as much copper (or nearly any other key natural resource) as has been extracted throughout all of prior human history. Things run out. They deplete. They become more dilute as the high grades are exploited first.

At some point, doubling becomes impossible. That’s when you’re past the point where half has been extracted and half still remains in the ground.  After that, there are exactly zero doubling periods remaining! That’s just elementary math.

Why care?

Because once the doubling periods are over, every single economic model and financial asset that is predicated on continuous expansion breaks. Our systems stop  steadily growing; and instead start increasingly shrinking.

This not a hard concept to grasp, intellectually, for most people with an open mind. But in practice, because it challenges our comfortable understanding of the world, because it collides with an entire Disney World of incompatible social belief systems, it’s pretty much impossible for the many people to even begin to wrestle with. Forget about a mainstream economist or central banker, whose salary requires them to adhere to the status quo.

The warning here is that we our deluding ourselves as a society. We are herding ourselves, lemming-like, straight towards the cliff ledge.

Think Critically!

Our mission here at PeakProsperity.com is to Create a World Worth Inheriting. While we help people make informed decisions to imbue their lives with greater abundance and satisfaction today, it’s our dedication to the long-term picture that shapes everything we do.

Very few voices are standing about waving their arms in the air like we are, warning of the approaching cliff. We’re aware that the point of no return might still be several decades out into the future, but we also realize that it could already be behind us. It’s nearly impossible to know right now given the complex system that is our planet — but given the existential risks involved, our opinion is that everyone should be mobilizing in response to this arriving (arrived?) crisis.

We often get labeled as narrow-minded “Malthusians”. Or accused of failing to account for human ingenuity. (Neither is accurate, we think.)

But in reality, we’re simply data driven. The facts are what they are. Logic is what it is.

And we get it. It’s both a factual and a logical nightmare for the infinite growth crowd that the earth is finite.

But as Einstein famously quipped:

And as you wrap your brain around the limits to growth, remember that you’re subject to the same comprehensive programming that envelops us all. The messaging that constantly reinforces the idea that endless growth is what we need, and what we can expect.

This programming is subtle, reassuring and ubiquitous; which makes it hard to resist. Here’s a prime example:

(Source)

To an economist like Bernanke, there are only virtuous expansions. Of course, the sort of expansion he refers to is exponential growth. Which is absolutely destined to fail in the long run (and now, maybe, the short).

And when that happens, the fallout will be spectacular and highly destructive to the hopes and dreams of literally billions of people.

Make Your Choice: Change By Pain Or Insight

What’s unclear to me is if there can be any meaningful recovery from this next crash, whenever it happens and however long it takes.

To return to the opening piece of this article, while I know that this time is different are dangerous words for investors to believe, the impending collision between delusional infinite growth thinking and resource limits and other realities will appear to the average observer like a gigantic change. But, in fact, it simply will mean that humans are subject to the same limits as any other life form on earth.

In other words, it really won’t be different this time.

In boy-meets-girl story form, the plot line of the natural process for all forms of life is:

1. organism finds tasty energy source


2. organism expands exponentially into that energy source


3. energy source dwindles even as organism continues into population overshoot, and then


4. happy times turn into tough times, and organism population plummets

Given that literally everything we hold dear and take for granted, such as well-stocked supermarkets, 24/7 electricity, and an appreciating retirement portfolio are all themselves dependent on an economic model that requires perpetual exponential expansion, several questions emerge.

How can I protect myself, my family and those I care about? How can I secure a prosperous future? What do I need to do to develop the right mental models and belief system to deal effectively with the coming challenges?

You can either address these questions head-on now, while the world still works the way we’re accustomed to. Or later, under crisis conditions.

We’ve learned that there are two ways that people change their beliefs and then their actions: by pain or by insight.

Most people go the pain route. And in the process, they waste a lot of valuable time that could have been spent constructively. It’s only after the heart attack, the divorce, the backing over the family dog while drunk—moments of extreme pain—that most people will begin to actively face the idea that they need to make different decisions in life.

But it doesn’t have to be that way. Part of the beauty of being human is that we can learn from observation, reflection and experience, and can adapt. Critical thinkers have this ability to change by insight. They use new information to put new behaviors into practice until those practices become new habits. And with better habits, we achieve better destinies.

So which route will you choose? Pain or insight?

The story told by the Three Es is loaded with the potential for plenty of painful moments over the next few decades. Sadly, a lot of people will not take precautionary steps far enough in advance to matter. They’re just not focusing on the risks right now. As a result, much of the world will be forced to change its behavior via the pain route.

Use this awareness as a sense of urgency to prepare now. To secure your future prosperity, as well as to help those regretting that they didn’t follow your lead.

In Part 2: Steps For Changing By Insight, we lay out our prescriptive guidance what what to do now, in a world saddled with record debts, and a debt-based system of money that itself is utterly and completely dependent on infinite expansion, where something’s got to give.

If you believe in eternal infinite growth, then sure, stay invested in stocks and bonds and go ahead and buy the dips.

But if you don’t, take steps today to change your life by insight, secure your future prosperity, and serve as a model for others.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

Central Banks Will Let The Next Crash Happen

This report was originally published by Brandon Smith at Alt-Market.com

If you have been following the public commentary from central banks around the world the past few months, you know that there has been a considerable change in tone compared to the last several years.

For example, officials at the European Central Bank are hinting at a taper of stimulus measures by September of this year and some EU economists are expecting a rate hike by December. The Bank of England has already started its own rate hike program and has warned of more hikes to come in the near term. The Bank of Canada is continuing with interest rate hikes and signaled more to come over the course of this year. The Bank of Japan has been cutting bond purchases, launching rumors that governor Haruhiko Kuroda will oversee the long overdue taper of Japan’s seemingly endless stimulus measures, which have now amounted to an official balance sheet of around $5 trillion.

This global trend of “fiscal tightening” is yet another piece of evidence indicating that central banks are NOT governed independently from one another, but that they act in concert with each other based on the same marching orders. That said, none of the trend reversals in other central banks compares to the vast shift in policy direction shown by the Federal Reserve.

First came the taper of QE, which almost no one thought would happen. Then came the interest rate hikes, which most analysts both mainstream and alternative said were impossible, and now the Fed is also unwinding its balance sheet of around $4 trillion, and it is unwinding faster than anyone expected.

Now, mainstream economists will say a number of things on this issue — they will point out that many investors simply do not believe the Fed will follow through with this tightening program. They will also say that even if the Fed does continue cutting off the easy money to banks and corporations, there is no doubt that the central bank will intervene in markets once again if the effects are negative.  I would say that this is rather delusional thinking based on a dangerous assumption; the assumption that the Fed wants to save markets.

When mainstream economists argue that the Federal Reserve could conceivably keep low interest rates and stimulus going for decades if necessary, they often use the example of the Bank of Japan as some kind of qualifier. Of course, what they fail to mention is that yes, the BOJ has spent decades increasing its balance sheet which now sits at around $4.7 trillion (U.S.), but the Fed exploded its balance sheet to around $4.5 trillion in only eight years. That is to say, the Fed inflated a bubble as large if not larger than the Bank of Japan in less than half the time.

Frankly, the comparison is idiotic. And clearly according to their own admissions, the Fed is not going to be continuing stimulus measures anyway. People cling to this fantasy because they WANT to believe that the easy money party will never end. They are sorely mistaken.

I have been battling this delusion for quite some time. When I predicted that the Fed would taper QE, I received a predominantly negative reaction. The same thing occurred when I predicted the Fed would begin hiking interest rates. Now, I’m finding it rather difficult to break through the narrative that the Fed will intervene before the next crash takes place.

There is something so intoxicating about the notion that central banks will stop at nothing to prop up stock markets and bond markets. It generates an almost crazed cult-like fervor in the investment world; a psychedelic high that makes financial participants think they can fly. Of course, what has really happened is that these people have jumped off the roof of their overpriced condo; they think they are flying but they are really falling like a brick weighted down with stupidity.

Former Fed chairman Janet Yellen upon exiting her position stated:

“If stock prices or asset prices more generally were to fall, what would that mean for the economy as a whole?”

“I think our overall judgment is that, if there were to be a decline in asset valuations, it would not damage unduly the core of our financial system.”

Yellen also said when asked about high stock prices:

“Well, I don’t want to say too high. But I do want to say high. Price/earnings ratios are near the high end of their historical ranges…”

“Now, is that a bubble or is too high? And there it’s very hard to tell. But it is a source of some concern that asset valuations are so high.”

Since the middle of last year, the Fed has been calling the stock market overpriced and “vulnerable.” This rhetoric has only become bolder over the past several months. Dallas Fed president Robert Kaplan dismissed concerns over the affect rate hikes might have on markets and hinted at the potential for MORE than the three hikes planned for 2018. The Dow fell 666 points that same day.

New York Fed’s Bill Dudley shrugged off concerns over recent volatility, saying that an equity rout like the one that occurred in recent days “has virtually no consequence for the economic outlook.”

Jerome Powell, the new Fed chairman, has said while taking the chair position that he will continue with the current Fed policy of rate hikes and balance sheet reductions, and reiterated his support for more rate hikes this past week (while the mainstream media hyperfocused on his lip service promise to watch stock behavior closely). This indicates once again that it does not matter who is at the wheel of the Fed, its course has already been set, and the Chairman is simply there to act as the ship’s parrot mascot. The Fed is expected to raise interest rates yet again in March.

Now, all the evidence including the Fed’s surprise balance sheet reduction of $18 billion in January shows that at least for now, the central bank no longer cares about stocks and bonds.

In the meantime, 10 year Treasury Yields are spiking to the ever present danger level of 3% after a hotter than expected inflation report, and the dollar index is plunging. Showing us perhaps the first signs of a potential stagflationary crisis. Bottom line – markets are not long for this world if yields pass 3% and the falling dollar provides yet another excuse for faster interest rate hikes. More rate hikes means eventually cheap loans will become expensive loans.

My question is, if the Fed is not going to feed cheap fiat into banks and corporations to fuel stock buybacks, then WHO is going to buy equities now?

What about corporations? Nope, not going to happen. With corporate debt skyrocketing to levels far beyond that seen just before the 2008 crash, there is no chance that they will be able to sustain stock buybacks without aid from the Fed.

What about retail investors? I doubt it. Retail investors are the primary pillar boosting stocks at this stage in the game, but as we saw during the panic last week, it is unlikely that retail investors will maintain hands strong enough to refrain from selling at the first sign of trouble. They do tend to hastily jump back into markets to buy every dip because for many years this simplistic strategy has worked, but if the Fed continues to back away from stimulus and we seen a few more incidences like the 1,000+ point drops of recent days, investor conditioning will be broken, and blind faith will be replaced by doubt.

What about the American consumer? Will consumer profits boost companies and give them and they stock shares a solid foundation? I can barely write that question without laughing out loud. There was a time (it seems like so long ago) when company innovation and solid business strategies actually meant something when it comes to equities. Those days are over. Now, everything is based on the assumption of central bank intervention, and as I already noted, central banks are pulling the plug on life support.

Beyond that, U.S. consumers are now buried in historic levels of personal debt.

What about the Trump administration’s latest $1.5 trillion infrastructure plan? Will this act as a kind of indirect stimulus program picking up where the Fed left off? Unlikely.

Perhaps if such a plan had been implemented eight years ago in place of the useless bank bailouts and TARP, it might have made a difference. Though, a similar strategy did not work out very well for Herbert Hoover. In fact, many of the Hoover-era infrastructure projects were not paid off for decades after initial construction. Hoover was also a one term Republican president that oversaw the beginning of the Great Depression.

The system is too far into debt and too far gone for infrastructure spending to make any difference in the economic outcome. Add to that the fact that Treasury yields are liable to continue their upward trajectory due to the increased deficit spending, putting more pressure on stocks.

Interestingly, Trump’s budget director has even admitted that the plan will lead to even faster increases in interest rates, and Fed officials have been using this as a partial rationale for why they plan to continue cutting off stimulus measures.

I think anyone with any sense can see the narrative that is building here. The Federal Reserve is going to let markets crumble in 2018. They are going to continue raising interest rates and reducing their balance sheet faster than originally expected. They will not step in when equities crash. And, they don’t really need to. Trump continues to set himself up as the perfect scapegoat for a bubble implosion that had to happen eventually anyway. Now, the central banks can sufficiently avoid any blame.

***

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You can contact Brandon Smith at: brandon@alt-market.com

After 8 long years of ultra-loose monetary policy from the Federal Reserve, it’s no secret that inflation is primed to soar. If your IRA or 401(k) is exposed to this threat, it’s critical to act now! That’s why thousands of Americans are moving their retirement into a Gold IRA. Learn how you can too with a free info kit on gold from Birch Gold Group. It reveals the little-known IRS Tax Law to move your IRA or 401(k) into gold. Click here to get your free Info Kit on Gold.

Financial Expert: ‘Phony Wealth Created Since The Last Crisis Is Going To Evaporate’

Former Reagan White House Budget Director David Stockman is warning that the wealth created since the 2008 financial crisis is “phony.”  He also wants everyone to know that they only safe asset right now, is gold or silver.

David Stockman sat down with USA Watchdog‘s Greg Hunter, and plainly laid out the terrifying state of affairs our financial system is currently in. Stockman contends that record high stock and bond prices are flashing danger signs and that everyone should be aware of that.  He’s also not trusting of Bitcoin and sees it’s collapse as inevitable.

There’s a lot to talk about in “the midst of all this craziness that’s happening both in Washington and on Wall Street,” said Stockman.

David Stockman

 “I don’t think we are going to have a liquidity crisis.  I think it’s going to be a value reset.  I think there is going to be a jarring downward price adjustment both in the stock market and in the bond market.  This phantom or phony wealth that has been created since the last crisis is going to basically evaporate.”

Stockman’s appraisal of the tax cuts mirrors rational Americans’ thoughts.

“I think it’s going to be a fiscal calamity of Biblical proportions.  I want to be clear.  I am always for tax cuts and shrinking the size of government, but you have to earn it.  You have to cut spending and entitlements and this massive defense budget.  Obviously, they didn’t do that.  If you look at honest accounting . . .  this bill will add $2.5 trillion to the public debt which, and this is a key point, is already going to rise by $10 trillion over the next decade based on the current law and taxes that is still in.”

Stockman also places the blame of the “phantom wealth” on the government’s money printing scheme.

“More importantly, the central banks realize they cannot keep printing money at these crazy rates, and by that I mean the bond buying. Now, they are going to begin to normalize and shrink their balance sheet. . . . By the fall (of 2018), they (the Federal Reserve) will be shrinking their balance sheet by $600 billion a year.  What that means in plain simple English is that they (the Fed) are dumping $600 billion a year of existing bonds into the market just as Uncle Sam will be attempting to borrow $1.25 trillion more.  Now, if you don’t think that is a financial collision waiting to happen, then I am not sure what would be.  We are heading for a thundering collision in the bond market that will drive yields upward far more than the market is expecting.  The stock market operates on the illusion of permanently low interest rates.  When interest rates start to rise, everything is going to come apart because cheap debt has been priced in forever, and we are heading for far more expensive debt. . . . Bond prices are going to collapse when yields begin to rise. . . . Stock prices are going to collapse big-time when the underlying predicate of cheap debt, massive stock buy backs and M&A deals and everything else supporting the market today finally reverses.  So, we are going to have deflation in the canyons of Wall Street, and that will not be a happy day.”

But there’s one safe asset.  And Stockman explains:

“I think the time to buy (gold and silver) is ideal.  Gold is the ultimate and only real money.  Gold is the only safe asset when push comes to shove.  They tell you to buy the government bond, that’s a safe asset.  It’s not a safe asset at its current price.  I am not saying the federal government is going to default in the next two or three years.  I am saying the yield on a 10-year bond of 2.4% is way below of where it’s going to end up.  So, the only safe asset left is gold.  This crazy Bitcoin mania has drained off what would otherwise be a demand for gold. . . . When Bitcoin collapses, spectacularly, which it will because it’s sheer mania in the markets right now.  When it collapses, I think a lot of that demand will come back into gold, as well as people fleeing the standard stock and bond markets for the first time in 9 or 10 years.”

So, in other words, the time to buy gold is now, before Bitcoin’s collapse leaves people scrambling.

China Deleveraging Hits Corporate Bonds As Cascade Effect Begins

Following the market lockdown during October’s Party Congress, many commentators were disturbed by the continued rise in Chinese government bond yields as we returned to “business as usual”, with the 10-year rising to 4%. At the beginning of this month, we discussed the sell-off (see “China: Shadow Bank Inflows Are Critical To Sustain The Ponzi…But They’re Falling”) and noted a useful insight from the Wall Street Journal.

An important anomaly to note about the bond rout: as government bonds sold off, yields on less-liquid, unsecured Chinese corporate bonds barely moved.

 

That is atypical in an environment of rising rates - usually, bond investors shed their less-liquid holdings and hold on to assets that are more easily tradable, like government debt.

The question was…why had corporate bond yields barely moved? The answer, according to the WSJ, was that China’s deleveraging policy led to redemptions in the shadow banking sector, e.g. in the notorious $4 trillion Wealth Management Products (WMP) sector. Faced with redemptions, shadow banks had to sell something…quickly…and highly liquid government bonds were the “easiest option”. Furthermore…and this is potentially significant…the WSJ noted.

Meanwhile, the nonbanks have held on to their higher-yielding corporate bonds, which at least have the benefit of helping them to maintain high returns.

Not any more (see below).

We agreed with the WSJ’s explanation at the time, but noted that the government bond sell-off was actually a sign of the unravelling of the WMP Ponzi scheme. The Chinese authorities are wise to the Ponzi which is why they announced the overhaul of shadow banking and WMPs last Friday (see “A ‘New Era’ In Chinese Regulation Means Turmoil For $15 Trillion In China"s ‘Shadows"). However, the new regulations don’t kick in until mid-2019, a sign to us that when they looked “under the bonnet”, they didn’t like what they saw.  

We doubt that China can achieve an orderly restructuring of its shadow banking sector, never mind its much larger credit bubble. A sign that we have taken another step towards China’s “Minsky moment” is that the bond sell-off has spread to the corporate bond market. The chart shows how spreads versus sovereign bonds have blown out during the last few weeks.

Bloomberg noted how the 10-year yield on China Development Bank notes, a quasi-sovereign issue, closed above 5% for the first time since 2014 today while, in another report, it put the corporate bond sell-off in a wider context.

China’s deleveraging campaign is finally starting to bite in the nation’s corporate-bond market, a shift that will make 2018 a clearer test of policy makers’ appetites to let struggling companies fail. Yields on five-year top-rated local corporate notes have jumped about 33 basis points since the month began, to a three-year high of 5.3 percent, according to data compiled by clearing house ChinaBond. Government bonds, which have far greater liquidity, had already moved last month as the central bank warned further deleveraging was needed.

With more than $1 trillion of local bonds maturing in 2018-19, it will become increasingly expensive for Chinese companies to roll over financing -- and all the tougher for those in industries like coal that the nation’s leadership wants to shrink. Two companies based in Inner Mongolia, a northern province that’s suffered from a debt-and-construction binge, missed bond payments on Tuesday, in a demonstration of the kind of pain that may come.

Bloomberg tries to put a positive spin on the corporate bond sell-off, defaults are healthy in terms of differentiating good and credits.

In the long haul, that all may be good for China. Allowing more defaults could see its bond market become more like its overseas counterparts, with a greater differentiation in price. And that could mean it channels funds more productively. “The deleveraging campaign and the new rules on the asset management industry will further differentiate good and bad quality credits, and make the onshore credit market more efficient,” said Raymond Gui, senior portfolio manager at Income Partners Asset Management (HK) Ltd. “Weaker companies will find it harder to roll over their debts because funding costs will stay high.” Gui predicts yields will keep climbing. The average for top-rated corporate bonds is already 2.2 percentage points above what investors demanded to hold them in October last year.

The rise comes as authorities show greater determination to shift the economy onto a more sustainable footing, with less debt. The latest move was a plan to discipline the asset-management industry, including banning guaranteed rates of return. People’s Bank of China Governor Zhou Xiaochuan graphically depicted the risk of excess leverage, by evoking a "Minsky moment," or sudden collapse of asset values. Key to that endeavor will be scaling back some of the implicit credit guarantees that have backed a broad swathe of Chinese borrowers. The country only started allowing corporate defaults in 2014. Last year there was a record, coming in at at least 29. It’s unclear yet whether that total will be met in 2017.

Bloomberg spoke to an analyst who also believes the recent sell-off in Chinese bonds is more to do with separating the “wheat from the chaff”, rather than anything more profound.

"We expect the divergence of performance between different bond categories (Chinese government bonds, policy bank bonds and credits) to become more prominent into 2018," Albert Leung and Prashant Pande, rates strategists at Nomura Holdings Inc., wrote in a note Wednesday.

We disagree. From our perspective, it looks like early signs of cascading sell-offs within Chinese financial markets, which have long been abused by excessive leverage and Ponzi characteristics. Talking of which, the Shanghai Composite Index suffered its biggest one-day drop since June 2016.

What caused the sell-off? According to some commentators it was fear that the local bond rout was getting out of control...hence "cascade". We noted last week that traders had been stunned by the official warning from Beijing that some stocks - in this case Kweichow Moutai - had risen "too far, too fast". Zhengyang Shen, a Shanghai-based analyst at Northeast Securites commented.

"The decline in Moutai has triggered selloffs in some of this year"s best performing stocks."

Which sounds an awful lot like another example of cascading selling...

Venezuela Officially Declared In Default

Today at 11am, the ISDA Determinations Committee sits down to decide whether an event of default has occurred due to the delayed principal payment on the Petroleos de Venezuela SA, or PDVSA, bond that matured Nov. 2, in the process triggering PDVSA (and perhaps Venezuela) CDS, and officially declaring Venezuela in default.

We won"t have to wait that long: moments ago, Wilmington Trust, the Trustee of the 8.5% bonds due 2018, issued by Corpoelec, Venezuela"s electricity company, declared that the missed interest payment originally due October 10, and whose 30 day grace period expired on November 9, and for which no pament was sent or received, officially constitutes an event of default.

From Bloomberg:

From the statement:

Wilmington Trust, National Association is communicating the following to you in its capacity as successor trustee (the “Trustee”) to The Bank of New York, as trustee, under the Indenture dated as of April 10, 2008 (the “Indenture”) for the $650,000,000 8.50% Senior Notes due 2018 (the “Notes”) of C.A. La Electricidad de Caracas (the “Issuer”). In a letter to the Trustee and various other parties dated November 30, 2012, National Electricity Corporation, S.A. (CORPOELEC) advised that it is the successor by merger to the Issuer. Capitalized terms used herein but not defined herein shall have the respective meanings set forth in the Indenture.

 

Please be advised that the Paying Agent with respect to the Notes has advised the Trustee that the payment of interest on the Notes that was due on October 10, 2017 was not received by the Paying Agent. The Issuer’s failure to pay interest on the Notes when due on October 10, 2017 constitutes a Default under the Indenture. The Paying Agent has further notified the Trustee that the interest payment was not received by November 9, 2017.

 

The Issuer’s failure to pay the overdue interest on the Notes on or before November 9, 2017 constitutes an Event of Default under Section 5.1(ii) of the Indenture. Pursuant to Section 5.1(b) of the Indenture, if an Event of Default shall occur and be continuing and has not been waived, the Holders of at least 25% in principal amount of Outstanding Notes may declare the principal of, and premium, if any, accrued interest and Additional Amounts, if any, on all the Notes to be due and payable by notice in writing to the Issuer and the Trustee specifying the Event of Default and that such notice is a “notice of acceleration”, and the same shall become immediately due and payable.

It is unclear if this formal default declaration makes today"s ISDA determinations committee decision moot, however it now looks quite certain that Monday"s meeting between creditors and the country"s vice president and chief debt negotiatior, who also happens to be a US-sanctioned drug kingpin, will no longer be necessary.

Today"s news will not come as a surprise to CDS holders, who had already priced in a 99.99% probability of default in 5 years.

The full statement is below:

Are "Happy Days" In Credit Over? According To BofA, Just One Thing Matters

Just one month ago, we showed a chart according to which the corporate bond spreads as tracked by the BofA/ML Corporate Master Index had tumbled to a level not seen since July 2007...

 

... while European high yield bonds have sunk below 2%, a head-scratching plunge in European "high" yields. As we have observed previously, the catalyst for the dramatic collapse in yields has been an obvious one: central banks, which have not only crushed asset volatility, but through the ECB"s explicit guarantee to be the buyer of last resort for corporate bonds, pushed yields to unprecednted low levels.

How unprecedented? Commenting on recent market moves, BofA"s credit strategist Barnaby Martin writes that even when accounting for Draghi"s pledge to buy "sizable" amounts of corporate bonds next year, the bullish spread reaction over the last few weeks "has caught us by surprise."

As the charts below show, the credit market is posting eye-catching - and now somewhat perverse - valuations in places. Valuations that start to challenge the "natural order" of relative value…

 

HY vs. USTs

 

For example, high-yield bond yields in Europe are now yielding just 1.9%, a 50bp drop since the start of October. And Euro high-yield yields are lower than those on ICE BofAML"s US Treasury Master Index.

 

AT1s vs dividend yields

 

Moreover, as Chart 3 shows, the aggressive move of late has been in the AT1 space, where yields have declined over 70bp since the start of October. This has left CoCo yields very close to the dividend yield on European bank stocks. And what if AT1 yields dip below this threshold? We think this would create a fairly unique - and perhaps troubling - pricing point for the credit market, given that fixed-income securities with less upside than (but with all the downside of) equity are yielding less for investors.

However, in the subsequent weeks - especially on this side of the Atlantic - there has been a sharp repricing of corporate debt, especially junk bonds, which as we showed earlier today have dropped sharply in the past month...

... leading also to a sharp divergence in equity vs credit risk.

 

So is the recent move wider the end of what Martin "happy days" in credit? There are two main catalysts that could pop the credit euphoria observed in markets:

The first is a surprise in the form of higher-than-expected inflation: this would be the big negative for credit markets down the line. The irony, of course, being that as Martin observes this is exactly what central banks would love to see materialize, as it would safeguard the health of the European periphery, in particular. Signs of success with inflation could easily provoke central banks to rethink their patient and dovish monetary stance…with higher rate volatility stunting the big "reach for yield" underway in corporate bonds.

Then again, considering that central banks have been desperate to boost inflation - at least the "flawed" inflation as captured by erroneous CPI measures - for nearly a decade while injecting $15 trillion in liquidity, this is probably not an immediate worry.

What else may cause central banks to exit sooner than expected?  Here, we once again go back to central banks, because the other major risk listed by Martin is that financial stability concerns and fears over misallocation of capital prompt central banks to curtail stimulus sooner than expected.

We sense some central banks are already becoming more cognizant of the financial stability implications of low for long rates. And given how much monetary support has already been doled out (Chart 6), reducing stimulus would at least build some ammunition for any slowdown in the future. Likewise, we think surprise rate hikes from central banks - on financial stability grounds - would be very problematic for credit markets.

To this end, Martin admits that even Bank of America is worried that a bubble in credit is forming:

We think the last few weeks of impressive tightening have shown that credit bubbles are a legitimate risk in Europe down the line, and we think central banks should pay attention to this. After all, it was extremely tight credit markets in "05 and "06 that provoked higher levels of risk taking by investors, and the advent of riskier products.

Meanwhile, many of the other pre-crisis hallmarks of investor exuberance have returned today. Martin also notes in the charts below that LBO leverage levels have climbed again over the last year. In the US in particular, LBO leverage levels are close to their 2007 highs (although US tax reform may slow this). Europe is a bit further behind, though, however the creep higher in LBO leverage over the last year is still visible.

Fast forwarding to BofA"s conclusion, just as it all started with central banks, so it will eventually end with them: with little vol, investors are incentivized to keep crowding into high-beta parts of the bond market. But if central banks begin to contemplate curbing stimulus on the grounds of financial stability, then we think the end of "predictable" monetary policy would be a game changer for credit."

If This Line Breaks, We"re in Serious Trouble

Let’s talk about Junk Bonds.

Junk Bonds are corporate debt issued by companies that have a significant chance of defaulting (meaning they don’t pay you back).

Why would anyone want to lend these companies money?

Because these bonds are risky, they typically pay very large yields to compensate for the increased risk. Think yields of 8% or even 10%.

Put simply, these are high risk, high reward bonds. They typically rally more than safer bonds when the bond market is healthy… and conversely, they typically crash a lot harder when the bond market is in trouble.

With that in mind, take a look at this chart:

The Junk Bond Index is beginning to roll over. As I write this, it’s right at THE line for its two-year bull-market run.

This is a MAJOR warning that the bond market is beginning to enter a “risk-off” stage. If we take out this line, Junk Bonds will be in very serious trouble.

What could be triggering this?

Inflation.

As I’ve explained time and again, bonds trade based on inflation expectations among other things. So to see Junk Bonds starting to roll over (meaning Junk Bond yields are rising) "tells" us that the riskiest segment of the bond market is beginning to adjust to the future threat of inflation.

It"s not alone.

The yields on the 10-Year US Treasury are beginning to rise as well, breaking a multi-year downtrend. Remember, this is the single most important bond in the world. And it"s signalling that inflation is on the rise.

Put simply, BIG INFLATION is THE BIG MONEY trend today. And smart investors will use it to generate literal fortunes.

Imagine if you"d prepared your portfolio for a collapse in Tech Stocks in 2000... or a collapse in banks in 2008? Imagine just how much money you could have made with the right investments.

THAT is the kind of potential we have today. And if you"re not already taking steps to prepare for this, it"s time to get a move on.

We just published a Special Investment Report concerning FIVE secret investments you can use to make inflation pay ou as it rips through the financial system in the months ahead

The report is titled Survive the Inflationary Storm. And it explains in very simply terms how to make inflation PAY YOU.

We are making just 100 copies available to the public.

To pick up yours, swing by:

https://www.phoenixcapitalmarketing.com/inflationstorm.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Ray Dalio Warns Of "Significant" Bond Market Risk

Casting his vote in the ongoing debate of which is a bigger bubble, bonds or stocks, Bridgewater"s billionaire founder Ray Dalio, who has continued his whirlwind of media appearances in recent years, said that he sees a "significant amount of risk in the bond market" envisioning a growing risk to stability as the U.S. moves toward a bigger deficit and the Federal Reserve unwinds its balance sheet. He is, of course, referring to this projection by the CBO of the US debt over the next 30 years which, sadly, remains quite unsustainable especially in a rising rate environment and in which central banks no longer monetize deficits (which is precisely why the Fed will promptly resume QE after a brief cool off period).

Addressing this, Dalio said that "tightenings become progressively more concerning because as you move along they’re more and more difficult to get perfect." Speaking to Bloomberg radio, Dalio also warned that "as we’re progressing, we’re entering a period of greater risk in the nature of the market."

Meanwhile, confirming what anyone who has seen the fund"s 13F knows, Dalio said that Bridgewater has been long equities, but didn’t provide more details on how the world’s biggest hedge fund is trading the market. He also said he doesn’t think the Fed can continue the pace at which it has begun to unwind its $4.5 trillion balance sheet. Dalio also said he expects the U.S. budget deficit to increase to 1.5% of GDP, growing the supply of debt at the same time the central bank is offloading bonds.

“I think they’ll be cautious in this but when you’re caught in this part of the cycle it’s very delicate,” he said.

As we have discussed previously, with total federal debt over $20.4 trillion, rising interest rates will increasingly redirect a growing portion of US tax revenues to covering interest expense; the question is at what point will this become prohibitively high, and detract from other critical spending programs.

Bank Of America: "This Could Send The Nasdaq To 10,000"

Last weekend, One River"s CIO Eric Peters explained what he thought would be the nightmare scenario for the next Fed chair, who as we now know will either be Jerome Powell or John Taylor, or both (with an outside chance of Yellen remaining in her post). According to the hedge fund CIO, the "worst case scenario" is one in which despite an improving economy, yields simply refuse to go up, leading to the final asset bubble and Fed intervention that "pops" it:

“if we don’t see a sustained cyclical jump in wages, then yields won’t go up. And if yields don’t go up, then the asset price ascent will accelerate,” continued the strategist. “Which will lead us into a 2018 that looks like what we had expected out of 2017; a war against inequality, a battle for Main Street at the expense of Wall Street, an Occupy Silicon Valley movement.” He paused, flipping through his calendar.  "Then you’ll have this nightmare for the next Federal Reserve chief, because they’ll have to pop a bubble.”

While Peters never names names in his pieces, the "strategist" in the weekend letter was BofA"s Michael Hartnett, who several days after Peters penned the above, followed up with some thoughts of his own on precisely this topic, and in a note released this week, described what he believes is the "biggest market risk" for the market. Not surprisingly, it is precisely what Peters was referring to in the above excerpt.

Responding to the question of "What is the biggest market risk", Hartnett writes that "in our gut, it’s that the two most important investment trends of the past decade, central bank liquidity & technological disruption, ends in a bubble for tech stocks (Chart 7), & High Yield & EM bonds, the epicenters of the “scarce growth” & “scarce yield” themes.

As with Peters, for Hartnett it all comes down to one thing: inflation and higher yields, specifically among long-dated yields: 

Multi-year lows in unemployment, multi-year highs in consumer confidence, soaring global PMIs, soaring profits, a doubling of the oil price, fiscal stimulus…little wonder the world is short bonds in 2017.

 

And yet inflation & bond yields refuse to rise.

The reason is simple: in attempting to stimulate wage growth, and thus benign inflation, the Fed continues to target the symptom of a condition which it no longer has any control over. Remember: Deflation = Debt + Demographics + Disruption? Well, they"re back. Quote Hartnett:

Aging Demographics and excess Debt remain structural impediments to higher inflation. But the biggest impediment is technology, and the potential for the labor market to be permanently disrupted, as AI and robotics crush wage expectations, particularly in the service sector.

For now the bond market still gives the Fed the benefit of the doubt, with 10Y yields occasionally pushing higher when the nearly extinct bond vigilantes make a surprise appearance, pushing rates up at least until the next deflationary scare emerges. But what happens if the bond vigilantes finally throw in the towel? Well, that"s what unleashes the final bubble... and sends 30Y yields toward 2% and the Nasdaq  to 10,000.

Capitulation of bond bears would send 30-year Treasury yields toward 2%, the Nasdaq toward 10,000, and high yield & Emerging Market bond spreads 100bps tighter (all-time lows…241bps in the US, 179bps in Europe, 139bps in EM). The outperformance of “deflation” versus “inflation” could turn exponential (Chart 8).

And while the market may or may not have a major correction in the coming months (Hartnett also predicted last week that the next major market drop will take place between Thanksgiving and Valentine"s Day), the longer-term implications as this tension is finally resolved either way, most likely with the intervention of the Fed - whose next chair will have no choice but to burst the bubble - will define the market for the next generation, or as the BofA strategist puts it:

"“Icarus Unleashed” in coming quarters would then set-up 2018/2019 as a period of volatility, aggressive Fed tightening to pop bubbles, and more hostile War on Inequality & Occupy Silicon Valley politics, setting the stage for the end of the bull market as Icarus crashes back to earth."

Bank of America Stumbles On A $51 Trillion Problem

At the end of June, the Institute of International Finance delivered a troubling verdict: in a period of so-called "coordinated growth", total global debt (including financial) hit a new all time high of $217 trillion in 2017, over 327% of global GDP, and up $50 trillion over the past decade. Commenting then, we said "so much for Ray Dalio"s beautiful deleveraging, oh and for those economists who are still confused why r-star remains near 0%, the chart  below has all the answers."

Today, in a follow up analysis of this surge in global debt offset by stagnant economic growth, BofA"s Barnaby Martin writes that he finds "that as global debt has been mounting to more than $150 trillion (government, household and non-financials corporate debt), global GDP is just above $60 trillion." His observation is shown in the self-explanatory chart below. 

As a result, both the global economy and central banks are now held hostage by both the unprecedented stock of debt injected into capital markets over recent years to offset the financial crisis depression, and the record low interest rates associated with it. 

As Martin writes, "the global fixed income market (as captured by the GFIM index) is now above the $51trillion mark", which means that "more than $51 trillion at risk if rates vol spikes and yields move higher" and adds that "amid a record amount of assets acquired by the central banks we have seen the global fixed income market growing to the largest size it has ever been." This is shown in the left panel on the chart below, while the right side chart shows the accompanying housing bubble: "amid record low funding costs the housing market is also experiencing rapid price gains in some regions as prices are now higher than pre-GFC levels. All main housing markets (US, Europe, Japan and UK) are above the 2007 highs, propped-up by record low yield levels."

As a consequence of the above, both sides of the global wealth effect are at risk: not only the wealth effect for the "1%" via equity prices, but also for the middle class, in the form of real estate , which is traditionally where global middle classes have parked the bulk of their net worth, and which is now in a bubble thanks to said record low interest rates.

Of course, central banks are all too aware of the risk that this record debt stock presents, and specifically, the threat of sudden, damaging spikes in interest rates cascading into overall volatility surges, which explains why, as BofA puts it, "central banks have been sellers of vol" through QE. Quote Martin:

QE programs around the globe have had a clear target: to reduce uncertainty and dampen market volatility. As we have highlighted before, every time the Fed embarked on the different phases of its QE programme, credit implied vols declined significantly (chart 6). On the other hand, during periods of no monetary easing or when the market started pricing the possibility of easing policy removal (tapering tantrum and the subsequent tapering phase) implied vols advanced (chart 6). Same happened in the case of the ECB: implied vols have re-priced lower post the announcements of the PSPP and the CSPP.

However, when both the Fed and the ECB attempted to communicate that these policies will have an end-date, implied vols repriced significantly higher. A good example is the market reaction post the May 2013 Bernanke’s mention of the idea of gradually reducing the Fed’s monetary expansion. The same reaction was seen back in October last year, when tapering fears hit Europe: implied vols moved higher over the  following couple of months.

So on one hand there is the threat of central bank balance sheet normalization which may, at any moment, prompt a violent repricing of volatility. On the other, Barnaby writes that "our work shows that the majority of vol spikes over the past years have taken place during periods of geopolitical uncertainty. Since 2013 we have seen a number of vol spikes and most of them had been the result of rising geopolitical risk."

In 2013 it was the Syrian crisis and in 2014 was the Russia–Ukraine conflict. In late 2015 it was the Paris terrorist attacks and in middle last year it was the UK referendum. Recently we find that rising risks on the Korean peninsula has pushed spreads and vols higher. Note that European credit spreads have been in a constant tightening momentum since the CSPP announcement in March last year, but have moved wider in the past month or so.

Needless to say, the persistent threat of "geopolitical risk" at this moment is close to the highest on record. Ironically, when considering all potential threats, BofA concludes that "the risk for credit spreads and volatility is only on the moderate side as central banks are becoming more cognisant that “uncertainty” anda volatility shock could be damaging for the world economy. Hawkish messages are followed by dovish ones to introduce a “low vol monetary policy normalisation”. This is keeping vols and spreads in check."

Or, said otherwise, for all the bluster of normalization, central banks will immediately backtrack the moment there appears to be even a moment of "miscommunication" between the Fed and capital markets, i.e., either a rate spike, or a jump in vol, or any other form or unauthorized selling of assets.

The implication is, of course, dire: with central banks trapped, this would suggests that the current pattern of relentless debt growth will persist indefinitely - or at least until it can"t go on any more - leading to an exponential growth in the "financial" economy at the expense of the "real" one, until finally the former swamps the latter.

This observation, brings us back to an analysis made by Bain several years ago:

Looking beyond today’s market conditions, however, our analysis found that capital superabundance will continue to exert a dominant influence on investment patterns for years to come. Bain projects that the volume of total financial assets will rise by some 50%, from $600 trillion in 2010 to $900 trillion by 2020 (all figures are in US dollars at the 2010 price level and market foreign exchange rates), even as the world economy increases by $27 trillion over the same period.

As it has for more than the past two decades, the large volume of global financial assets will continue to sit on a small base of global GDP (totaling $90 trillion by 2020 versus $63 trillion in 2010). At that level, total capital will remain 10 times larger than the total global output of goods and services and three times bigger than the base of nonfinancial assets that help to generate that expanded world GDP. 

Nearly $1 quadrillion in financial assets (excluding derivatives) covered by $90 billion in global GDP in just a few years? That, much more than even the abovementioned $51 trillion in non-financial debt, is not only a major problem: it is an unprecedented disaster just waiting to hit.

French Market Regulator Sees "Brutal Repricing Of Assets"; Valuations, Volatility "Don't Reflect Real Uncertainty"

High valuations and low volatility don’t reflect the level of economic growth nor the geopolitical uncertainty facing the market, the Autorité des Marchés Financiers says in a mid-year report on main risks to global markets. While stock markets have shown resiliency, the French regulator warns of the "systemic threat" fromn a "sharp market correction."

As AMF continues... Equity market volatility therefore now appears to be decorrelated from political uncertainty indexes...

Confirming Deutsche Bank"s perspective of market complacency.

This trend, combined as we have already seen with high valuations on some equity markets, especially in the US...

And extremely low spreads on the bond markets, raises questions as to whether the risks affecting the financial markets are being underestimated, which may lead to a brutal repricing of assets.

Aside from equity markets, AMF points to three other concerns...

• Risk of a sharp increase in interest rates amid rising private debt and low risk premiums. In this environment, the European Central Bank’s policy will have a decisive impact on the euro area. Some emerging countries may find the cost of debt unsustainable in the event of a substantial increase in long-term interest rates or domestic currency depreciation (because their debt is denominated in foreign currencies);


• Risk of regulatory competition and reduced international cooperation, with voting results (US elections, UK Brexit vote) opening up a period of uncertainty that financial markets do not appear to have priced in. The supervision, recovery and resolution of central counterparties (CCPs) represent a key issue in this regard, insofar as counterparty risk is now largely concentrated with CCPs;


• Cyber-risk in a persistently uncertain geopolitical environment.

The isolated corrections we have seen, accompanied by temporary spikes in volatility, are understandable if the markets continue to be dominated by expansionist monetary policy conducive to supporting them. However, a return to the norm is well under way in the United States, and if this trend continues could prove destabilizing without a backdrop of fundamental support for valuations.

Full Outlook below...

Japan Slashes 2017 Bond Issuance By 5% In Implicit Boost To QE; First Reduction In 10Y JGBs Since 1998

Just days after raising its economic outlook, Japan"s ministry of finance announced on Thursday that for the first time since 1998 it would slash government bond issuance in fiscal 2017 which starts on April 1.  The MOF plans to issue Y154.0 trillion in JGBs in coming fiscal year, down 5% from an initial Y162.2 trillion for the current fiscal year, as a result of sliding demand for debt amid continued very low to negative interest rates.

The JGB plans also feature a rare year-on-year cut in the issuance of 10-year JGBs: such a reduction is the first since fiscal 1998.

According to MarketNews, the government is also trying to reduce its dependence on debt issuance for financing a budget deficit for the third consecutive year. In fiscal 2017, it plans to meet rising social security and other costs by using funds set aside for currency market operations in the face of slow tax revenue growth.

Looking to capitalize on still record low , and in many cases negative, rates around the curve, the MOF will reduce the issuance of 20-, 10-, 5-, 2-, and 1-year debt while raising the share of 40-year bonds to take advantage of continued low bond yields caused by the Bank of Japan"s aggressive monetary easing, which has pushed some yields into negative territory. The amount of the JGBs to be sold to institutional investors through auctions in a calendar year will decrease for the fourth consecutive year in fiscal 2017 by Y5.8 trillion to Y141.2 trillion.

A partial breakdown of the shorter-end in proposed 2017 issuance:

• Y27.6 trillion of 10-year bonds, down from Y28.8 trillion in the current fiscal year;


• Y26.4 trillion in five-year notes, down from Y28.8 trillion in the current year;


• Y26.4 trillion in 2-year notes, down from Y27.6 trillion;


• Y23.8 trillion in 1-year bills; down from Y25.0 trillion.


• The ministry will also sell inflation-indexed 10-year bonds worth Y1.6 trillion, down from Y2.0 trillion in this fiscal year.

Additionally, the government will continue issuing more 40-year debt totaling Y3.0 trillion on a calendar year basis, up from Y2.4 trillion in the current year. The issuance of 30-year debt will be unchanged at Y9.6 trillion. Meanwhile, the MOF will decrease the sale of 20-year bonds to Y12.0 trillion in fiscal 2017 from Y13.2 trillion in fiscal 2016 in response to declining investor demand.

The ministry plans to auction liquidity-providing bonds worth Y10.8 trillion next fiscal year, up from Y9.6 trillion. These auctions are aimed at providing the market with additional bonds to cope with specific shortages.

While the ECB has been fighting with a lack of eligible collateral in recent months, which have sent the 2Y Bund to record low yields in a year-end scramble by banks to window dress their books, a similar problem has emerged for Japan, where massive asset purchases by the BOJ are "drying up the bond market" according to MNI. At the end of September, the BOJ held about 38% of Japan"s debt outstanding that has topped Y1 quadrillion (Y1,000 trillion), double of its GDP.

The MOF assumes an interest rate for fiscal 2017 of a record low 1.1%, down from 1.6% in the current year. It is based on the BOJ"s new policy framework under which it is trying to  keep the 10-year Japanese government bond yield around zero percent. Indicatively, a 0.5% point drop in the assumed interest rate is estimated to trim borrowing costs by Y500 billion.

Some additional details of the proposed budget:

• The MOF will sell Y34.37 trillion in new bonds to finance the fiscal 2017 budget, down from this year"s initial plan to sell Y34.43 trillion. The issuance of JGBs to refinance maturing bonds will fall to Y106.1 trillion from Y109.1 trillion.


• Bonds issued to help rebuild Japan"s northeastern region hit by the 2011 earthquake will also decrease to Y1.5 trillion from Y2.2 trillion while bonds to finance the Fiscal Investment and Loans Program will fall to Y12.0 trillion from Y16.5 trillion.

What does this mean from a market standpoint?

Well, if nothing changes on the BOJ QE side, the 5% reduction in gross issuance means that, "all else equal" Japan"s QE just got a 5% boost as the BOJ will have Y8 trillion less primary issued bonds to monetize, leading to even greater purchases from private holders to offset the difference. Implicitly, it means an expansion of QE, not a taper as some have speculated.

Perhaps in confirmation of this, the USDJPY spiked on the report...

... while 10Y JGB yields have continued to decline:

The question is whether all else will be equal, or if Kuroda will take the hint from the MOF and at the next BOJ conference cut the amount of BOJ QE by a similar, if not greater, amount, especially if indeed the central bank is expecting faster growth and a pick up in global inflation.

Finally, with the ECB recently tapering as well, many have wondered if and when the BOJ will join the global tightening party. Today"s MOF announcement may be just the catalyst to get the ball rolling.