You Can Only Worry For So Long
Doug Nolan
Ten-year Treasury yields jumped 11 bps this week to 2.66%, moving decisively above the key 2.60% technical level - to the highest yields since July 2014. Two-year yields ended the week up seven bps to 2.07%, the high going back to September 2008. Five-year Treasury yields jumped 10 bps to 2.45%, the high since April 2010. Has the long-delayed bond bear market finally commenced – with barely a whimper? Markets fretted over a potential spike in yields over recent years. I suppose You Can Only Worry For So Long.
The S&P500 has gained 5.1% in three weeks. If this return is lacking, one could have made 6.5% in the Dow Transports, 6.9% in the Nasdaq100, 6.8% in the Nasdaq Composite, 7.0% in the KBW Bank index or 9.5% in the Semiconductors (SOX) – all in the 2018’s first 13 trading sessions.
With equities deep into parabolic melt-up, let’s not expect market participants to be all too fixated on Treasury yields at a mere 2.64%. Why worry over where market yields might be in a few months, not with huge gains to harvest on an almost daily basis in equities markets. No reason to worry about the ECB winding down QE later this year. No basis for fretting a few Fed rate increases spread over many months. Clearly, the Bank of Japan is in no hurry either. Government shutdown - no issue. With tax cuts achieved, gridlock is fine. Liquidity abounds – might abound forever. Meanwhile, the reality is that global bond markets could be ending a three-decade bull market that changed the world.
January 17 – Financial Times (Kate Allen): “Governments are set to increase their borrowing from private investors this year for the first time in four years as central banks step back from the market, underlining market concern that the era of ultra-low bond yields appears vulnerable. The net debt of developed nations is expected to rise this year, chiefly driven by an increase in US bond sales, according to… JPMorgan Chase. The European Central Bank is scaling back its bond-buying programme and the Federal Reserve is shrinking its balance sheet… The Fed is set to roll off $222bn of its holdings of Treasuries this year, the analysis shows, while the ECB’s purchases of eurozone sovereign debt will drop to $221bn from $622bn last year. The US will raise a net $828bn of new issuance after the effects of the scaling back of quantitative easing are taken into account, according to JPMorgan — up from $357bn in 2017.”
January 16 – Bloomberg (Sid Verma): “A ‘dramatic’ increase in U.S. bond supply over the next year risks unhinging global markets from their bullish foundations, warns Torsten Slok at Deutsche Bank AG. The supply of U.S. government debt will almost double to $1 trillion this year to finance a widening budget deficit as the Federal Reserve whittles down its holdings. Unless new buyers emerge, the overhang could be far-reaching. ‘If demand for U.S. fixed income doesn’t double over the coming years then U.S. long rates will move higher, credit spreads will widen, the dollar will fall, and stocks will likely go down as foreigners move out of depreciating U.S. assets,’ the chief international economist at the German lender wrote… ‘And this could happen even in a situation where U.S. economic fundamentals remain solid.’”
Markets have grown comfortable with uncertainty. I would posit that markets have come to adore myriad uncertainties. After all, they ensure the certitude of interminable aggressive monetary stimulus. As the bullish thinking goes, it’s wasted energy to contemplate a spike in yields when, obviously, central banks won’t tolerate one. Waiting anxiously to perform another act of heroism, QE can be revived in an instant.
Unless something dramatic transpires, global central bank balance sheet growth will slow significantly in 2018. At the same time, governments are geared up to issue more debt. Central banks accommodated years of (“counter-cyclical”) massive deficit spending, and now big deficits are the (structural) norm.
Supply/demand dynamics will be shifting substantially, yet bond prices are expected to adjust slightly. The U.S. will be financing a huge fiscal deficit as the Fed pares back its balance sheet. Moreover, there’s an unusual degree of uncertainty surrounding future U.S. fiscal deficits. Tax cuts pay for themselves with bountiful prosperity, or perhaps this a replay of the late-nineties Bubble Mirage that had the U.S. paying off all its debt. There’s a scenario – a not outlandish one at that - where the Bubble bursts and deficits skyrocket toward $2.0 TN. For now, there is also the risk of trade battles coupled with a global economic boom and market Bubbles that create unusually uncertain inflation prospects.
Extraordinary: The end of an unparalleled bull market that saw $14 trillion of experimental “money” printing, along with zero/negative rates, push global yields to historic lows, in the face of unprecedented government debt issuance and record corporate debt sales. There is as well the issue of unquantifiable speculative leverage and derivative exposures, along with a now enormous ETF complex untested in bear market dynamics. Reasons aplenty to take a cautious approach with long-term bonds globally.
When it comes to uncertain 2018 prospects, China joins bond yields near the top of the list. Similar to their approach with bonds, equities buyers are today comfortable with China and feel no compunction to ponder beyond the present. Markets over recent years fretted over a Chinese financial accident. I suppose You Can Only Worry For So Long.
January 12 – Reuters (Fang Cheng and Kevin Yao): “China’s bank lending halved in December as the government kept up its campaign to curb financial system risks, but banks still managed to dole out a record amount for the year amid the tighter scrutiny. Chinese authorities are trying to walk a fine line by containing riskier types of financing and slowing an explosive build-up in debt without stunting economic growth. Banks extended 584.4 billion yuan ($90.46 billion) in December, data from the People’s Bank of China (PBOC) showed…, well below expectations of 1 trillion yuan and November’s 1.12 trillion yuan. But banks lent a record 13.53 trillion yuan of new loans in 2017.”
Total Social Financing (TSF) dropped in December to a weaker-than-expected 1.140 TN yuan (estimates 1.500), or about $178 billion. This was down 30% from both November and from December 2016. The fourth quarter marked a significant slowdown in TSF. Quarterly growth in TSF averaged 5.216 TN yuan ($815bn) during the first three quarters of 2017, but then dropped to 3.795 TN yuan ($593bn) during Q4. For the year, growth in TSF (which excludes government borrowings) was 9.2% ahead of 2016 levels to 19.443 TN ($3.038 TN). Yet for the first three quarters of 2017 TSF was expanding at a rate 16.3% above comparable 2016. The fourth quarter actually saw the growth in TSF 12.7% below that of Q4 2016.
Financial institution loans to Chinese households surged 21% in 2017, with lending remaining strong through year end. Lending to corporations slowed markedly last year, with December lending half of November’s level. Mortgage loans dominate Chinese household borrowings. And with housing prices inflated after years of easy finance, China is becoming increasingly susceptible to a self-reinforcing downturn in both apartment prices and mortgage Credit growth.
China traditionally begins the year with blockbuster Credit growth. January lending data will provide some indication of whether the fourth quarter slowdown was chiefly seasonal or rather the beginning of a more determined effort by Beijing to rein in Credit excess. Chinese regulators this month toughened their crackdown on off-balance sheet “shadow” lending.
January 14 – Bloomberg: “China’s banking regulator pledged to continue its crackdown on malpractice in the $38 trillion industry in 2018, vowing to tackle everything from poor corporate governance and violation of lending policies to cross-holdings of risky financial products. The China Banking Regulatory Commission unveiled its regulatory priorities for the year… Inspecting the funding source of banks’ shareholders and ensuring they have obtained their stakes in a regular manner. Examining banks’ compliance with rules restricting loans to real estate developers, local governments, industries burdened by overcapacity, and some home buyers. Looking into banks’ interbank activities and wealth management businesses.”
Chinese exports were up 10.9% in December. China ran a $54.69 billion trade surplus in December, the largest since January 2016. Foreign reserves rose to a larger-than-expected $3.140 TN, the highest level in 16 months. Fourth quarter GDP was reported at a stronger-than-expected 6.8% - putting 2017 growth at an above target 6.9%.
Chinese 10-year yields closed Friday at 3.98%, the high going back to October 2014. With the global economy humming along and global finance bubbling along, it’s not an inopportune time for Beijing to finally assume an assertive stance in reining in Credit. They will, of course, seek to avoid a shock. Beijing will, as well, focus on assuring productive Credit is readily available to sustain economic expansion. Productive enterprises should be supported, while speculative endeavors will be starved of finance. Easy to plan, not so straightforward to execute (Federal Reserve 1928/29).
“Houses are built to be inhabited, not for speculation,” President Xi proclaimed back in October during the 19th Party Congress. The problem is that tens of millions of Chinese have made fortunes in real estate. Hundreds of millions more aspire to. Not only has housing become the epicenter of Chinese speculative excess, mortgage Credit has inflated to the point of becoming a majority of total Credit growth - as well as a prevailing source of finance for the real economy. It all evolved into a full-fledged mortgage Credit Bubble, surely an expanding black hole of malinvestment, fraud and bank losses.
January 19 – Reuters: “China’s yuan-denominated outstanding housing loans rose 20.9% from a year earlier to 32.2 trillion yuan ($5.03 trillion) at end-December, China’s central bank said... Outstanding individual mortgages at the end of December grew 22.2% to 21.9 trillion yuan…”
January 18 – Bloomberg: “China’s home sales surged to a record high last month, despite a prolonged government campaign to curb property speculation. Sales by value, excluding affordable housing, jumped to a record 1.45 trillion yuan ($225 billion) in December, gaining 21% at the fastest pace in six months… Earlier today, home price data pointed to a similar acceleration. The upswing comes even as officials have sought to tame resurgent buying sentiment in a market that’s seen home prices skyrocket. The resurgence defies predictions that China’s property market will slow amid China’s moves to tackle excessive leverage and maintain curbs on purchases.”
January 16 – Wall Street Journal – “China’s Hot Housing Market Begins to Cool” (Dominique Fong): “China’s housing market has defied gravity and government restraints for two years, floating on a tide of bank loans and speculation. Until now. In Beijing and Shanghai—two of the country’s largest markets—and other megacities, sales have stalled and prices have dropped, falling slightly in some pockets and dramatically in others. Demand has dried up in these areas as a result of government measures including higher mortgage rates, higher down-payment requirements and limits on buying a second or third home. Would-be sellers are increasingly putting plans on hold in hope that prices will rebound.”
January 16 – Reuters: “China's banking regulator chief warned that a ‘black swan,’ or an unforeseen event could threaten the country's financial stability, official People's Daily reported… Guo Shuqing said that while risks in the financial system are manageable, they are still ‘complex and serious.’ Since his appointment as the head of the China Banking Regulatory Commission early last year, Guo has introduced a flurry of new rules to reign in lender risks including from curbs on shadow banking activities to the crackdown on loan fraud. Guo said the dangers stem from the pressure of rising bad debt, imperfect internal risk systems at financial institutions, the relatively high levels of shadow banking activities and rule violations.”
It’s curious to see Chinese housing transactions and prices plateau (in key markets) in the face of rampant mortgage Credit excess. Markets’ lack of concern notwithstanding, we can remind ourselves that this is China’s first mortgage boom – and a rather long and spectacular one at that. And I’m all too familiar with the view that Beijing is adept at managing oh so many things. Yet they’ve sure made a historic mess of mortgage finance – the extent of which will begin to surface as soon as lending slows. It’s one of history’s great ongoing manias, one that these days barely garners attention in The Age of Equities and Cryptocurrencies.
At this point, it’s not clear how Beijing possibly succeeds in reining in housing speculation without bursting an epic apartment Bubble (makes bitcoin look so tiny). With global yields on the rise and Chinese regulators on the case, the Chinese apartment market could be a critical development to monitor in 2018. Hard for me to believe there’s not a black swan holed up in there somewhere. And that goes for global bond markets as well.
The S&P500 has gained 5.1% in three weeks. If this return is lacking, one could have made 6.5% in the Dow Transports, 6.9% in the Nasdaq100, 6.8% in the Nasdaq Composite, 7.0% in the KBW Bank index or 9.5% in the Semiconductors (SOX) – all in the 2018’s first 13 trading sessions.
With equities deep into parabolic melt-up, let’s not expect market participants to be all too fixated on Treasury yields at a mere 2.64%. Why worry over where market yields might be in a few months, not with huge gains to harvest on an almost daily basis in equities markets. No reason to worry about the ECB winding down QE later this year. No basis for fretting a few Fed rate increases spread over many months. Clearly, the Bank of Japan is in no hurry either. Government shutdown - no issue. With tax cuts achieved, gridlock is fine. Liquidity abounds – might abound forever. Meanwhile, the reality is that global bond markets could be ending a three-decade bull market that changed the world.
January 17 – Financial Times (Kate Allen): “Governments are set to increase their borrowing from private investors this year for the first time in four years as central banks step back from the market, underlining market concern that the era of ultra-low bond yields appears vulnerable. The net debt of developed nations is expected to rise this year, chiefly driven by an increase in US bond sales, according to… JPMorgan Chase. The European Central Bank is scaling back its bond-buying programme and the Federal Reserve is shrinking its balance sheet… The Fed is set to roll off $222bn of its holdings of Treasuries this year, the analysis shows, while the ECB’s purchases of eurozone sovereign debt will drop to $221bn from $622bn last year. The US will raise a net $828bn of new issuance after the effects of the scaling back of quantitative easing are taken into account, according to JPMorgan — up from $357bn in 2017.”
January 16 – Bloomberg (Sid Verma): “A ‘dramatic’ increase in U.S. bond supply over the next year risks unhinging global markets from their bullish foundations, warns Torsten Slok at Deutsche Bank AG. The supply of U.S. government debt will almost double to $1 trillion this year to finance a widening budget deficit as the Federal Reserve whittles down its holdings. Unless new buyers emerge, the overhang could be far-reaching. ‘If demand for U.S. fixed income doesn’t double over the coming years then U.S. long rates will move higher, credit spreads will widen, the dollar will fall, and stocks will likely go down as foreigners move out of depreciating U.S. assets,’ the chief international economist at the German lender wrote… ‘And this could happen even in a situation where U.S. economic fundamentals remain solid.’”
Markets have grown comfortable with uncertainty. I would posit that markets have come to adore myriad uncertainties. After all, they ensure the certitude of interminable aggressive monetary stimulus. As the bullish thinking goes, it’s wasted energy to contemplate a spike in yields when, obviously, central banks won’t tolerate one. Waiting anxiously to perform another act of heroism, QE can be revived in an instant.
Unless something dramatic transpires, global central bank balance sheet growth will slow significantly in 2018. At the same time, governments are geared up to issue more debt. Central banks accommodated years of (“counter-cyclical”) massive deficit spending, and now big deficits are the (structural) norm.
Supply/demand dynamics will be shifting substantially, yet bond prices are expected to adjust slightly. The U.S. will be financing a huge fiscal deficit as the Fed pares back its balance sheet. Moreover, there’s an unusual degree of uncertainty surrounding future U.S. fiscal deficits. Tax cuts pay for themselves with bountiful prosperity, or perhaps this a replay of the late-nineties Bubble Mirage that had the U.S. paying off all its debt. There’s a scenario – a not outlandish one at that - where the Bubble bursts and deficits skyrocket toward $2.0 TN. For now, there is also the risk of trade battles coupled with a global economic boom and market Bubbles that create unusually uncertain inflation prospects.
Extraordinary: The end of an unparalleled bull market that saw $14 trillion of experimental “money” printing, along with zero/negative rates, push global yields to historic lows, in the face of unprecedented government debt issuance and record corporate debt sales. There is as well the issue of unquantifiable speculative leverage and derivative exposures, along with a now enormous ETF complex untested in bear market dynamics. Reasons aplenty to take a cautious approach with long-term bonds globally.
When it comes to uncertain 2018 prospects, China joins bond yields near the top of the list. Similar to their approach with bonds, equities buyers are today comfortable with China and feel no compunction to ponder beyond the present. Markets over recent years fretted over a Chinese financial accident. I suppose You Can Only Worry For So Long.
January 12 – Reuters (Fang Cheng and Kevin Yao): “China’s bank lending halved in December as the government kept up its campaign to curb financial system risks, but banks still managed to dole out a record amount for the year amid the tighter scrutiny. Chinese authorities are trying to walk a fine line by containing riskier types of financing and slowing an explosive build-up in debt without stunting economic growth. Banks extended 584.4 billion yuan ($90.46 billion) in December, data from the People’s Bank of China (PBOC) showed…, well below expectations of 1 trillion yuan and November’s 1.12 trillion yuan. But banks lent a record 13.53 trillion yuan of new loans in 2017.”
Total Social Financing (TSF) dropped in December to a weaker-than-expected 1.140 TN yuan (estimates 1.500), or about $178 billion. This was down 30% from both November and from December 2016. The fourth quarter marked a significant slowdown in TSF. Quarterly growth in TSF averaged 5.216 TN yuan ($815bn) during the first three quarters of 2017, but then dropped to 3.795 TN yuan ($593bn) during Q4. For the year, growth in TSF (which excludes government borrowings) was 9.2% ahead of 2016 levels to 19.443 TN ($3.038 TN). Yet for the first three quarters of 2017 TSF was expanding at a rate 16.3% above comparable 2016. The fourth quarter actually saw the growth in TSF 12.7% below that of Q4 2016.
Financial institution loans to Chinese households surged 21% in 2017, with lending remaining strong through year end. Lending to corporations slowed markedly last year, with December lending half of November’s level. Mortgage loans dominate Chinese household borrowings. And with housing prices inflated after years of easy finance, China is becoming increasingly susceptible to a self-reinforcing downturn in both apartment prices and mortgage Credit growth.
China traditionally begins the year with blockbuster Credit growth. January lending data will provide some indication of whether the fourth quarter slowdown was chiefly seasonal or rather the beginning of a more determined effort by Beijing to rein in Credit excess. Chinese regulators this month toughened their crackdown on off-balance sheet “shadow” lending.
January 14 – Bloomberg: “China’s banking regulator pledged to continue its crackdown on malpractice in the $38 trillion industry in 2018, vowing to tackle everything from poor corporate governance and violation of lending policies to cross-holdings of risky financial products. The China Banking Regulatory Commission unveiled its regulatory priorities for the year… Inspecting the funding source of banks’ shareholders and ensuring they have obtained their stakes in a regular manner. Examining banks’ compliance with rules restricting loans to real estate developers, local governments, industries burdened by overcapacity, and some home buyers. Looking into banks’ interbank activities and wealth management businesses.”
Chinese exports were up 10.9% in December. China ran a $54.69 billion trade surplus in December, the largest since January 2016. Foreign reserves rose to a larger-than-expected $3.140 TN, the highest level in 16 months. Fourth quarter GDP was reported at a stronger-than-expected 6.8% - putting 2017 growth at an above target 6.9%.
Chinese 10-year yields closed Friday at 3.98%, the high going back to October 2014. With the global economy humming along and global finance bubbling along, it’s not an inopportune time for Beijing to finally assume an assertive stance in reining in Credit. They will, of course, seek to avoid a shock. Beijing will, as well, focus on assuring productive Credit is readily available to sustain economic expansion. Productive enterprises should be supported, while speculative endeavors will be starved of finance. Easy to plan, not so straightforward to execute (Federal Reserve 1928/29).
“Houses are built to be inhabited, not for speculation,” President Xi proclaimed back in October during the 19th Party Congress. The problem is that tens of millions of Chinese have made fortunes in real estate. Hundreds of millions more aspire to. Not only has housing become the epicenter of Chinese speculative excess, mortgage Credit has inflated to the point of becoming a majority of total Credit growth - as well as a prevailing source of finance for the real economy. It all evolved into a full-fledged mortgage Credit Bubble, surely an expanding black hole of malinvestment, fraud and bank losses.
January 19 – Reuters: “China’s yuan-denominated outstanding housing loans rose 20.9% from a year earlier to 32.2 trillion yuan ($5.03 trillion) at end-December, China’s central bank said... Outstanding individual mortgages at the end of December grew 22.2% to 21.9 trillion yuan…”
January 18 – Bloomberg: “China’s home sales surged to a record high last month, despite a prolonged government campaign to curb property speculation. Sales by value, excluding affordable housing, jumped to a record 1.45 trillion yuan ($225 billion) in December, gaining 21% at the fastest pace in six months… Earlier today, home price data pointed to a similar acceleration. The upswing comes even as officials have sought to tame resurgent buying sentiment in a market that’s seen home prices skyrocket. The resurgence defies predictions that China’s property market will slow amid China’s moves to tackle excessive leverage and maintain curbs on purchases.”
January 16 – Wall Street Journal – “China’s Hot Housing Market Begins to Cool” (Dominique Fong): “China’s housing market has defied gravity and government restraints for two years, floating on a tide of bank loans and speculation. Until now. In Beijing and Shanghai—two of the country’s largest markets—and other megacities, sales have stalled and prices have dropped, falling slightly in some pockets and dramatically in others. Demand has dried up in these areas as a result of government measures including higher mortgage rates, higher down-payment requirements and limits on buying a second or third home. Would-be sellers are increasingly putting plans on hold in hope that prices will rebound.”
January 16 – Reuters: “China's banking regulator chief warned that a ‘black swan,’ or an unforeseen event could threaten the country's financial stability, official People's Daily reported… Guo Shuqing said that while risks in the financial system are manageable, they are still ‘complex and serious.’ Since his appointment as the head of the China Banking Regulatory Commission early last year, Guo has introduced a flurry of new rules to reign in lender risks including from curbs on shadow banking activities to the crackdown on loan fraud. Guo said the dangers stem from the pressure of rising bad debt, imperfect internal risk systems at financial institutions, the relatively high levels of shadow banking activities and rule violations.”
It’s curious to see Chinese housing transactions and prices plateau (in key markets) in the face of rampant mortgage Credit excess. Markets’ lack of concern notwithstanding, we can remind ourselves that this is China’s first mortgage boom – and a rather long and spectacular one at that. And I’m all too familiar with the view that Beijing is adept at managing oh so many things. Yet they’ve sure made a historic mess of mortgage finance – the extent of which will begin to surface as soon as lending slows. It’s one of history’s great ongoing manias, one that these days barely garners attention in The Age of Equities and Cryptocurrencies.
At this point, it’s not clear how Beijing possibly succeeds in reining in housing speculation without bursting an epic apartment Bubble (makes bitcoin look so tiny). With global yields on the rise and Chinese regulators on the case, the Chinese apartment market could be a critical development to monitor in 2018. Hard for me to believe there’s not a black swan holed up in there somewhere. And that goes for global bond markets as well.
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