BIS

Capitalists have rejoiced, although the workers have been notably less rewarded...

It is easy to get the impression that the naysayers are wrong on Europe. After all the predictions of Armageddon, ten-year government bond yields for Spain and Italy fell to the 4% level, France which is retreating into old-fashioned socialism was able to borrow at about 2%, and one of the best performing bond investments has been until recently – wait for it – Greek government bonds! Admittedly, bond yields have risen from those lows, but so have they everywhere. It is clear when one stands back from all the usual euro-rhetoric that as a threat to the global financial system it is a case of panic over. Well, no. Europe has not recapitalized its banking system the way the US has (at great taxpayer expense, of course). Therefore, it is much more vulnerable. Where European governments and regulators have failed to make their banks more secure it is because they tied their strategy to growth arising from an economic recovery that has failed to materialize. The reality is that the Eurozone GDP levels are only being supported at the moment by the consumption of savings; in orther words, the consumption of personal wealth. Wealth that is not infinite; and held by those not likely to tolerate footing the bill for much longer.

Once again it is all about central banks, with early negative sentiment heading into Asian trading - following the disappointing announcement from the PBOC about "ample liquidity" leading to the 6th consecutive drop in the Shanghai Composite while the PenNikkeiStock index tumbled yet again -  completely erased and flipped as Mario Draghi spoke, although not to explain his involvement with the latest European derivative window-dressing scandal, but to announce that he is, once again, "ready to act" (supposedly through the OMT, which despite the best hopes to the contrary, still DOES NOT OFFICIALLY EXIST) and that while it is up to government to raise growth potentials, growth would "partly come from accommodative policy." In other words, ignore all BIS warnings, for Europe's unaccountable Goldmanite overlord Mario Draghi continues to promise more morphined Koolaid (read record Goldman bonuses) to any banker that comes knocking.

It was shaping up to be another bloodbathed session, with the futures down 10 points around the time Shanghai started crashing for the second night in a row, and threatening to take out key SPX support levels, when the previously noted rumor of an imminent PBOC liquidity injection appeared ex machina and sent the Shanghai composite soaring by 5% to barely unchanged, but more importantly for the all important US wealth effect, the Emini moved nearly 20 points higher from the overnight lows triggering momentum ignition algos that had no idea why they are buying only knowing others are buying. The rumor was promptly squashed when the PBOC did indeed take the mic, but contrary to expectations, announced that liquidity was quite "ample" and no new measures were forthcoming. However, by then the upward momentum was all that mattered and the fact that the underlying catalyst was a lie, was promptly forgotten. End result: futures now at the highs for absolutely no reason.

Lots of sellside squeals this morning following the epic bloodbath in China, where in addition to what we already covered hours ago, has seen at least five companies  (China Development Bank, Shanghai ShenTong Metro, China Three Gorges Corp., Doosan Infracore China Co. and Chongqing Shipping Construction Development) delay or cancel bond offerings as the PBOC's admission of capital "misallocation" is slowly but surely freezing both bond and stock markets. And while the plunge was contained first to China, then to Asia, then to Europe (where the Spanish 10 Year once again surpassed 5% as expected following the carry trade unwind), with the arrival of bleary-eyed US traders the contagion is finally coming home. In a redux of last week, 10 Year yields are shooting up, hitting as high as 2.63% a few hours ago, while equity futures are now at the lows of the session. It could turn very ugly, very fast, especially if the Hamptons crowd were to actually read the stunning BIS annual report released on Sunday, which not even Hilsenrath explaining "what the BIS really meant" will do much to change the fact that the days of monetary Koolaid are ending.

Earlier we noted the rather peculiarly truthful (lack of optimistically-biased bullshit) annual report from the BIS as reading ZeroHedge-sermon-like. There is a smorgasbord of data, charts, and quotes strewn throughout the 204-page melodrama but one caught our eye. Reflecting on the fact that governments in several major economies currently benefit from historically low funding costs, and yet at the same time, rising debt levels have increased their exposure to higher interest rates, the BIS projects the dismal reality that any rise in interest rates without an equal increase in the output growth rate will further undermine fiscal sustainability. Although predicting when and how a correction in long-term rates will unfold is difficult, it is possible to examine the potential impact on the sustainability of public finances and how any normalization of rates (or Abe's success in creating 2% 'inflation' in Japan) leads the nation's debt-to-GDP ratio to explode to a surely-Krugman-mind-blowing 600% debt-to-GDP.

"Can central banks now really do “whatever it takes”? As each day goes by, it seems less and less likely... Six years have passed since the eruption of the global financial crisis, yet robust, self-sustaining, well balanced growth still eludes the global economy. If there were an easy path to that goal, we would have found it by now. Monetary stimulus alone cannot provide the answer because the roots of the problem are not monetary.  Many large corporations are using cheap bond funding to lengthen the duration of their liabilities instead of investing in new production capacity...Continued low interest rates and unconventional policies have made it easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system... Overindebtedness is one of the major barriers on the path to growth after a financial crisis. Borrowing more year after year is not the cure...in some places it may be difficult to avoid an overall reduction in accommodation because some policies have clearly hit their limits." - Bank of International Settlements

Extreme Developed Market (DM) monetary policy (read The Fed) has floated more than just US equity boats in the last few years. Foreign non-bank investors poured $1.1 trillion into Emerging Market (EM) debt between 2010 and 2012 as free money enabled massive carry trades and rehypothecation (with emerging Europe and Latam receiving the most flows and thus most vulnerable). Supply of cheap USD beget demand of EM (yieldy) debt which created a supply pull for EM corporate debt which is now causing major indigestion as the demand has almost instantly dried up due to Bernanke's promise to take the punchbowl away. From massive dislocations in USD- versus Peso-denominated Chilean bonds to spiking money-market rates in EM funds, the impact (and abruptness) of these colossal outflows has already hit ETFs and now there are signs that the carnage is leaking back into money-market funds (and implicitly that EM credit creation will crunch hurting growth) as their reaching for yield as European stress 'abated' brings back memories of breaking-the-buck and Lehman and as Goldman notes below, potentially "poses systemic risk to the financial system."

This past March, Jeroen Dijsselbloem, the head of the finance ministers of the eurozone, shocked the markets with seemingly off-the-cuff comments suggesting that the Cyprus banking solution will, “serve as a model for dealing with future banking crises.”¹ Depositors across Europe took a collective gasp of horror – could banks possibly confiscate depositors’ funds in a form of daylight robbery? Indeed they could, and last week the Bank for International Settlements (“BIS”), the Central Bank's Central Bank, published what we have referred to as ‘the template’; a blueprint outlining the steps to handle the failure of a major bank and the conditions to be met before ‘bailing-in’ deposits.

Now that the BOJ's "interventionalism" in the capital markets is increasingly losing steam, as the soaring realized volatility in equity and bond markets squarely puts into question its credibility and its ability to enforce its core mandate (which, according to the Bank of Japan Act "states that the Bank's monetary policy should be aimed at achieving price stability, thereby contributing to the sound development of the national economy) Japan is left with one wildcard: the Government Pension Investment Fund (GPIF), which as of December 31 held some ¥111.9 trillion in assets, of which ¥67.3 trillion, or 60.1% in Japanese Government Bonds. Perhaps more importantly, the GPIF also held "just" ¥14.5 trillion in domestic stocks, or 12.9% of total, far less than the minimum allocation to bonds (current floor of 59%).  It is this massive potential buying dry powder that has led to numerous hints in the press (first in Bloomberg in February, then in Reuters last week, and then in the Japanese Nikkei this morning all of which have been intended to serve as a - brief - risk-on catalyst) that a capital reallocation in the GPIF is imminent to allow for much more domestic equity buying, now that the threat of the BOJ's open-ended QE is barely sufficient to avoid a bear market crash in the Nikkei in under two weeks.

There are some problems, however.

• BIS lays out "simple" plan for how to handle bank failures (Reuters) - Are we still holding our breath on Basel III?
• Deficit Deal Even Less Likely - Improving U.S. Fiscal Health Eases Pressure for a 'Grand Bargain' Amid Gridlock (WSJ)
• IRS Faulted on Conference Spending (WSJ)
• Deadly MERS-CoV virus spreads to Italy (CNN)
• Turkish PM Erdogan calls for calm after days of protests (Reuters)
• Financial system ‘waiting for next crisis’ (FT)
• Russia to send nuclear submarines to southern seas (Reuters)
• China Nuclear Stockpile Grows as India Matches Pakistan Rise (BBG)

"... equity markets were quick to shrug off the uncertainty and extended their gains as investors expected poor fundamentals to be followed by further policy easing."

Because when your primary stated goal is achieving "price stability" through unprecedented intervention, and instead you break the markets (both bonds and stocks) it may be time to reevaluate. As a reminder: "The Bank of Japan, as the central bank of Japan, decides and implements monetary policy with the aim of maintaining price stability. The Bank of Japan Act states that the Bank's monetary policy should be aimed at achieving price stability, thereby contributing to the sound development of the national economy." Instead, you get this...

China’s credit growth has been outstripping economic growth for five quarters with the corporate debt bubble looking increasingly precarious (as we explained here and here). This raises one key question: where has the money gone? As SocGen notes, although such divergence is not unprecedented, it potentially suggests a trend that gives greater cause for concern – China is approaching a Minsky moment. At the micro level, SocGen points out that a non-negligible share of the corporate sector and local government financial vehicles are struggling to cover their financial expense. At the macro level, they estimate that China’s debt servicing costs have significantly exceeded underlying economic growth. As a result, the debt snowball is getting bigger and bigger, without contributing to real activity (see CCFDs for a very big example). This is probably where most of China’s missing money went.

Does it really make any sense at all that Bernanke would leave gold to trade in an open and transparent market? Hardly. Consider. The Fed has conjured multiple trillions of digital dollars out thin air in the last five years. These efforts have propped up the Treasury market, the domestic TBTF banks, the foreign TBTF banks, the ECB, the BOE, every European sovereign bond market, the RMBS market, the CMBS market, the equity market, the housing market and the entire industrial and soft commodity complexes, to name a few. Since the price of gold we see on our Bloomberg screens is set via derivatives and overwhelmingly settled in USD, the ability for central banks and bullion banks to manipulate the price of gold is way too easy. All the bullion banks have to do is coordinate (as in LIBOR), sell in size and punish anyone in their way. Take losses? No problem, more fiat can be conjured post-haste. So long as no one is taking physical delivery, the band(k) plays on. (Actually, physical demand delivery IS becoming a major new problem for the banks but this is a topic for a different note.) A quickly rising gold price upsets this fiat-engineered, centrally planned, non-market based recovery. Gold left to its’ own devices would signal the unwinding the rehypothecated world of shadow banking where latent monetary inflation goes to summer (think of it as the monetary Hamptons where only the Wall Street elite get to play). Most importantly, it would signal a huge lack of faith in the US dollar. A currency backed by nothing more than faith in central banking.