Bond

The problem with trying to solve all our structural problems by injecting "free money" liquidity into financial Elites is that all the money sloshing around seeks a high-yield home, and in doing so it inflates bubbles that inevitably pop with devastating consequences. As noted yesterday, the Grand Narrative of the U.S. economy is a global empire that has substituted financialization for sustainable economic expansion. In shorthand, those people with access to near-zero-cost central bank-issued credit can take advantage of the many asset bubbles financialization inflates. Those people who do not have capital or access to credit become poorer. That is the harsh reality of neofeudal, neocolonial financialization. It is widely accepted as self-evident that all these bubbles will not pop because the central banks won't let them pop. That's nice, but if this were the case, then why did stocks crater in 2000-2001 and 2008-2009, and why did the housing bubble implode in 2008-2011? Did they change their minds for some reason? No; they assured us right up to the moment of implosion that everything was fine, there was no bubble, etc. The only logical conclusion is that bubbles pop even though central banks resist the popping with all their might.

So the Fed is essentially handcuffed at this point. Increasing QE in any way risks a Japan-bond market style rout.

In the 1940s, the Fed adopted pegging operations to protect the financial system against rising interest rates and to ensure the smooth financing of the war effort. In effect, the Fed became part of the Treasury’s debt management team; as the budget deficit hit 25% of GDP in WW2, it capped 1Y notes at 87.5bps and 30Y bonds at 2.5%. From the massive bond holdings of its domestic banks to its exploding public debt, Japan today faces a situation very similar to the US in the 1940s. When the long-term rate climbs above 2%, the BoJ will probably adopt outright measures to underpin JGB prices to prevent turmoil in the financial system and a fiscal crisis - and just as Kyle Bass noted yesterday, they are going to need a bigger boat as direct financial repression in Japan is unavoidable.

European stocks fell for a second day-in-a-row (notable in its own right as not having happened for 5 weeks) for the biggest drop in 6 weeks capping the worst week in 2 months. Spain and Italy saw their stock indices drop 3.6% on the week. But it was European banks and peripheral sovereign bonds that saw the most damage. As JPY-funded leveraged momo come rapidly undone, Italian and Spanish bond spreads saw their biggest 2-day drop in 8 months to end back at 5-week highs. EURUSD ends the week up 0.6% (and the JPY +2.2%) as repatriation escalates. Europe's VIX is holding around 18.% (up 2.5 vols on the week).

While many would argue that youth unemployment (the real scariest chart here), in fact we suspect it is the following two charts that are really keeping Mario Draghi up at night. The lip service paid by the French and the Germans to growth strategies and youth unemployment pale in relation to the desperation of the European collateralizer-of-last-resort to de-fragment his transmission channels and unleash his own QE to the starving banking systems of Spain and Italy. As BNP notes, recent data on Italian and Spanish banks’ bad and non-performing loans (NPLs) have reignited the debate on the health of the banking sector in the eurozone’s peripheral economies and its implications for the bloc’s credit supply and, ultimately, economic growth. But what is worse is that interest rates on new loans for a company in Italy or Spain are almost double those in Germany and France. It is against this backdrop that Draghi expressed plans to revive the ABS market - but implementation will prove significantly more challenging than market hopers believe (as is clear in credit markets) and direct purchases will probably face vetoes by a number of influential members of the board. To add further salt to these fresh wounds, the FT reports that Spanish banks will need to set aside more than EUR10 billion more reserves to cover the rolling over of EUR 200 billion of 'extend-and-pretend' loans.

As we hinted last night, and as the market is starting to realize, one of the bigger downstream casualties of the first rumblings that Abenomics is starting to crack, have been peripheral bond yields, with Spanish, Italian and Portuguese yields all wider by 10 bps and rising. However, that is only half the story. The other half is that, with its usual 6-8 week delay, the market is finally grasping the biggest danger in Europe - one which we have been pounding the table on week after week after week (most recently here): the soaring non-performing loans held by European banks. In fact, it took the FT to confirm what we have been warning about all along. And just so the market has a sense of how much downside may be imminent if indeed reality reasserts itself and frontrunning the Japanese carry trade both occur at the same time, here is a rather unpleasant chart courtesy of Diapason, of what expects all those who bought up Italian bonds in the recent dash-for-trash, oblivious of the collapsing fundamentals, and driven purely by FOMO. The downside could be big to quite big.

• The deeper agenda behind "Abenomics" (Reuters)
• BoJ governor Haruhiko Kuroda promises to stabilise bond market (FT)
• Obama Sees Sunset on Sept. 11 War Powers in Drone Limits (BBG)
• Lower CPMs for everyone: FTC Begins Probe of Google's Display-Ad Business (WSJ)
• Apple’s Tax Magic Leaves Irish Bondholders Unmoved (BBG)
• Asia Goes on a Debt Binge as Much of World Sobers Up (WSJ)
• All hail Gazpromia: UK gas supply six hours from running out in March (FT)
• Spain’s banks face €10bn more provisions (FT) ... and then more, and more, and more
• Truck strike may have caused Washington state bridge collapse, officials says (Reuters)
• P&G Says A.G. Lafley Rejoins as Chairman, CEO (BBG)
• Five Key Things About the SAC Insider Case (BBG)

"The last 36 hours have perhaps been evidence as to what might happen if stimulus is withdrawn before the global recovery has been cemented and what might happen if Japan makes mistakes along the way to their attempted new dawn. With the Chinese data still ambiguous, Europe still in recession, Japan in the very  early stages of a growth experiment and with the US recovery still historically very weak one has to say that liquidity has been the main market fuel in recent months. So central banks have to tread carefully and the Fed tapering talk and the BoJ's seemingly benign neglect policy towards JGBs has had the market fretting." - Deutsche Bank

UPDATE 1: Japanese stocks turned negative (NKY -600pts from highs, -1.5% on day; and TOPIX down over 4% from highs); Japanese banks -11% from yesterday highs; S&P futures down 10 points from after-hours highs...

UPDATE 2: *KURODA WANTS TO AVOID INCREASING VOLATILITY IN BOND MARKET (yeah thanks... as useful as saying "we all want to avoid syphilis")

UPDATE 3: Nikkei 225 Drops below 14,000 - TOPIX down 11% from highs

For the second day in a row, and in spite of comments from Abe and Kuroda on communicating with the market (as Kuroda says BoJ Monetary easing sufficient), Japanese capital markets are out of control.

What may come as a surprise to most, is that as of this week's H.4.1 update, the amount of ten-year equivalents held by the Fed increased to $1.583 trillion from $1.576 trillion in the prior week, which reduces the amount available to the private sector to $3.637 trillion from $3.668 trillion in the prior week. And also, thanks to maturities, and purchase by the Fed from the secondary market, there were $5.219 trillion ten-year equivalents outstanding, down from $5.244 trillion in the prior week. What this means simply is that as of this moment, the Fed has, in its possession, a record 30.32% of all outstanding ten year equivalents, or said in plain English: duration-adjusted government bonds. It also means that the amount of bonds left in the hands of the private sector has dropped to a record low 69.68% from 69.95% in the prior week. Finally, the above means that with every passing week, the Fed's creeping takeover of the US bond market absorbs just under 0.3% of all TSY bonds outstanding: a pace which means the Fed will own 45% of all in 2014, 60% in 2015, 75% in 2016 and 90% or so by the end of 2017 (and ifthe US budget deficit is indeed contracting, these targets will be hit far sooner). By the end of 2018 there would be no privately held US treasury paper.

It seems the correlation to USDJPY has started to disintegrate and what is more worrisome for the BoJ is the linkage between JGBs and the Nikkei 225. Equities in Japan are about to open to a modest bounce around 1.5% but JGB prices are down around 0.50 (half the limit-down price moves). So, the problem for the BoJ is - do you let JGBs flop to maintain your equity market's appearance of normality? Or are Japanese stocks about to be as implicitly repressed as the bond market? It would appear TPTB are doping their best to ramp the JPY to keep this bounce alive (USDJPY opening just shy of 102.50).

*AMARI SAYS 'ABENOMICS' IS PROGRESSING STEADILY (this is progress?)
*AMARI SAYS BOJ IS COMMUNICATING CLOSELY WITH MARKETS (we suspect the market is communicating back even more)

"Central bankers dream of getting back to "normal" – normal interest rates, a normal balance sheet, and so on. But that point isn't going to come any time soon. They are stuck on a money printing treadmill, and there appears no way off.

One can read "The Lethal Presidency of Barack Obama" to get a true sense of Obama's "the best defense is a relentless drone everyone offense, ignore collateral damage and take out a few Americans in the process" policy. Or one can stare at rising stawks and enjoy their Obamaphones. Obe can't have both.

The surge in Japanese long-term interest rates is likely causing some lost sleep among bond market participants and policymakers (despite their ignorance of the moves in the BoJ minutes) as Nomura's Richard Koo notes, if this trend continues (now added to by the collapse in stock prices) it could well mark the “beginning of the end” for the Japanese economy. Although the stock market has (until now) welcomed the yen’s continued slide against the dollar, Koo warns that this trend needs to be carefully monitored, as simultaneous declines in JGBs and the yen can be interpreted as a loss of faith in the Japanese government and the Bank of Japan. The biggest concerns are that the extreme volatility in Japanese stocks and bonds is occurring at a time when the BOJ was buying large quantities of government bonds. It is now clear that even large-scale BOJ purchases of JGBs cannot stop yields from rising. Simply put, Koo notes, the BoJ needs to rein itself in and state it will not stand for overshooting inflation expectations or the 'bad' rise in rates could crush both the nascent recovery and the nation's banking system.

As Japan has indicated, when bonds start to plunge, it’s not good for stocks. Today the Japanese Bond market fell and the Nikkei plunged 7%. The entire market down 7%... despite the Bank of Japan funneling $19 billion into it to hold things together.

A data-based look at the financial context of the past 30 years from the perspective of Gen X.