Core CPI vs U.S. 10 Year Yield, Something Has to Give

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Something Has to Give Here

In recent years as core CPI has trended this high, the U.S. 10 Year Treasury’s yield has ranged between 2.50% and 2.90% vs. 1.56% today.  This week’s data is pointing to higher bond yields coming at markets near you.

Fed Might Still Manage 1, 2 Hikes This Year, Lockhart Says -Rtrs

Federal Reserve Bank of Atlanta President Dennis Lockhart says in interview with Reuters that there’s no real argument about inflation, and only a modest one over the financial stability implications of continuing to leave rates so low.

  • “Committee is much tighter in its array of opinion, and the differences between points of view are more nuanced and more related to sooner versus a little later on questions of policy”

Friday, we found American consumers moved into a higher gear in the second quarter, spending at the fastest quarterly pace in two years, retail sales figures will probably show on Friday. Economists project a 0.3 percent gain in core sales for June, which would take the three-month annualized gain in the so-called retail control group to 6.6 percent barring revisions. The figure is used to calculate gross domestic product and excludes food services, auto dealers, home-improvement stores and gas stations. – Bloomberg

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CPI vs 10s

The U.S. Bureau of Labor Statistics reported that year over year Core CPI (consumer price index) for June rose to 2.3 percent versus 2.2 percent May. Year over year CPI was 1.0 percent versus 1.0 percent in May. On the month CPI in June rose 0.2 percent, the same as May.
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Turkey: Lira’s largest one-day drop against the dollar since Lehman

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Global economic expansion meets radical Islam.   An increasingly oppressive government in Turkey found itself under fire Friday evening.

For now the coup is contained but the west will not rest until new, rising risks are properly assessed.


Turkey GDP

2016: $940B

2010: $760B

2000: $190B

World Bank

We talking about $1 trillion of Global GDP is under military coup threat, something the world has never seen before.  Civil war and EU migration risks are sharply on the rise as Turkey’s ruthless Erdogan regime crushes civil liberties in their coup retaliation.  Turkey’s political climate is about to become even more oppressive and authoritarian, this increases risks as many will flee the country or stay and fight the regime.


Turkey 5Nearly $60B of total government debt, but near term maturities are on the heavy side for Turkey.



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*Turkish Bank Postpones $300 Million Bond Sale Meeting on Unrest



More than 6,000 people, including military personnel, judges and prosecutors, have been detained.
 DXY new 2
Implications:  We expect a sharp flight to quality next week with the U.S. dollar being the big winner.  G10 currencies with risk correlation will suffer, other safe heaven currencies, the yen and Swiss franc will benefit.   Next week will kick off with heightened uncertainty.  Investors will start to analyze the longer term implications.  First, Turkey’s impact on the EU.  The migrant deal was not signed that long ago.  We expect a mass exodus from Turkey as the risk of a civil war have risen sharply.  We will see foreign capital fleeing the country, political instability provides additional risks that investors don’t need.  Migration from Turkey is the last thing over leveraged European governments need right now.  Brexit removed all doubt, the people of Europe have had it with millions of people jumping over the border and straining already challenged job markets as well as stressed social programs.  By stressed we mean deficit spending in the periphery well above EU stated objectives.


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Turkey 2

Turkey’s currency posted the biggest one-day drop against the dollar since October 2008 as the country’s military said it has seized power. The lira plunged 4.6% to 3.0157 per dollar, the weakest level since late January.

When was the last time a trillion dollar economy has every gone into a military coup regime?  NEVER.

Since 1960 Turkey, a NATO member has been through the drama at least three takeovers by the secular-minded army.

Islamists based Ak Party government came to power in 2002, ever since the political influence of the military has been trimmed, until today.

As it seems now the Turkey is experiencing a full on military coup. Turkey has seen over 14 terrorist attacks in the past year alone.

Turkey’s prime minster Binali Yildrim has said the uprising is from the military ranks, but Prime Minister Yildrim maintains that he and his government is still in control. However, the military, in a email statement, said it had seized power.

Turkey 3

War planes have buzzed the capital, gunfire has been heard and tanks are blocking roads in Istanbul. These developments are ongoing as it is not clear who has control at this point in time.

Gunfire reported in Turkey capital of Ankara; military jets and helicopters heard overhead.

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Turkey CDSTurkey’s 5 Year CDS made a strange reversal this morning, then closed for the day.


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Growing Pressure to throw in the Bail-in Towel for Bailouts

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Defaults on the Rise into Lower Yields??

Moody’s Global High Yield Default Rate Takes Out it’s Long Term Average surpasses long-term average in May.

Breaking News: Deutsche Bank Economist Calls for Bailout

Cost of Deutsche Bank Credit Default Protection


There are rising public cries: The banking crisis is in such urgent need that Germany / Europe should violate the current bail-in rules inside the new Banking Directive.  Existing bail-in rules are NOT realistic Deutsche Bank maintained publicly this weekend, customer deposits would be at risk and a bank run would be likely.  Changing the rules in the middle of the game is the way to go says Deutsche Bank. 

Eight years post-Lehman this is so pathetic, when will the establishment ever learn?

(to be continued below at the bottom of this blog)

Thanks to Central Banks, Bonds are Crushing Stocks in 2016

Junk vs S&P 500


Junk Bond ETF $JNK: +6.4% (w 6.1% yield)
S&P 500 $SPY: +4.2% (w 2.1% yield)


Moody’s trailing 12-month global speculative-grade default rate closed at 4.5% in May, surpassing its long-term average of 4.2% for the first time since August 2010, according to its latest global default monitor. Moody’s expects the rate to finish 2016 at 4.9%, and thereafter for upward default rate pressure to ease off.

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As we stated last year to subscribers, we believe the speculative grade default rate to hit 7% by the end of 2016, with materials and commodity sector bankruptcies leading the way.

Pure Financial Evil

Traditionally insurance companies in Japan and Europe would buy government and investment grade bonds, but today’s $12T of negative yielding government bonds are forcing them to reach for yield in junk bonds.

This week we heard from several sell side trading desks, we’re told negative interest rate torn insurance companies in Europe and Japan now piling into U.S. high yield paper.

After you implement the change in capital standards yields are basically at record lows.  This has become an evil, or perverse incentive for insurers to chase yield at the lower end of the rating spectrum.

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Cost of Credit Default Protection


The cost of credit default protection on some European banks is certainly on the rise.  Above CDS on subordinated financials, Deutsche Bank and UniCredit are shouting, WARNING.

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Credit vs Equities, What are they Telling Us?

When you look at equity prices of Intesa Sanpaolo, Deutsche Bank and UniCredit, we’re talking lows we have not seen since 2012.

Next, contrast with the relationship of subordinated credit default swaps on these banks vs the subordinated financials credit index.

Back in 2012, subordinated cds traded 310bps wide of subordinated financials index, while today only 230ish wide.  We believe the new bailout regime is a game changer, it speaks to evaporation risk to subordinated debt.

Stock Prices of European BanksEU Banks 2
 Taking a look at a banks capital structure is even more important in today’s bail-in regime world.

Breaking News: Deutsche Bank Economist Calls for Bailout

“In Europe, the bailout does not need to be so large. A €150 billion program should be enough to help European banks recapitalize,”

“Europe is seriously ill and needs to address very quickly the existing problems, or face an accident,”

David Folkerts-Landau, Deutsche Bank Chief Economist, July 10, 2016

Banks in Europe should get the money for recapitalization following a similar bail out in the U.S., Deutsche Bank Chief Economist David Folkerts-Landau, tells Welt am Sonntag in interview.

Deutsche Bank pointed to the plunge in bank stocks is only the symptom of a larger problem, negative interest rates impact on bank’s profitability, slow growth and “dangerous” deflation.

  • U.S. helped its banks with $475 billion, and such a program needed in Europe, especially for Italian lenders
    • Est. EU40b money needed by Italian banks “conservative”
  • Bail-in using private money currently not doable, would hit people’s savings, may cause bank run
  • Decline in bank stocks symptom of weak growth, high govt debt and close to “dangerous” deflation
  • Europe “extremely sick” and must solve its problems quickly


Folkerts- Landau is very concerned about Italy and the condition of local banks, the $45B number floated about if far too “conservative.”

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Coming Clean on China

“The seventeen year river of reserve currency buildup is no longer flowing.”

Billionaire Fund Manager, David Tepper


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What used to be called a fringe selection of “perma-bears” has grown to a consensus.

Nine of 15 respondents in a Bloomberg survey at the end of June, including Standard Chartered Plc and Commonwealth Bank of Australia, predicted a China government-funded recapitalization will take place within two years.  Among those who provided estimates of the cost, a majority said it will exceed $500 billion, the smart money puts the tab well over $1T.  Hedge fund managers Kyle Bass puts the number near $10T.

If you do the math, there’s only one way out for China, a colossal currency devaluation.  As we stated to subscriber last July, a recapitalization will happen after the Chinese government comes clean with the true nonperforming loan figure.

Capital Flowing Out

In 2015, we witnessed China’s plunge in reserves of nearly $520B, in the last six months of the year the number has more than $400B, Reuters reported. Reserves fell by nearly $108 billion in December of last year, by nearly $100 billion in January and by around $28.57 billion in February of this year, before rising in March and April.

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China Forex

Survey on China Bank Bailout

% of Respondents see a State Funded Bailout within Two Years

2016: 62%
2015: 41%


In Q1, net capital outflows from China in the first quarter of 2016 were nearly $130 billion, per Goldman Sachs.  China’s four biggest banks now trade at 32% discount to book value, capital flows have even the Bulls concerned.  Over the last 6 months, Goldman’s outflow data on China is 50% greater than SAFE’s onshore FX settlement data, there’s far too much fuzzy math in China.

Goldman notes that around 70 percent of the net outflows were due to Chinese residents buying foreign assets and 40 percent due to repayment of foreign-exchange liabilities. This was offset by an increase in inflows by foreigners buying renminbi-denominated assets.

“While it is possible that some residents’ acquisition of foreign-exchange assets now is intended for repayment of foreign-exchange debt later, this does not appear to be the case for the second half of last year.  We think China has masked (understated) FX outflow data by $20B a month this year.”

Goldman Sachs


File_004 (6)

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The Fed is Holding a Smoking Gun on China’s Debt Explosion

China Debt vs Fed
The Fed’s easy money gravy train has made more than a few stops in China.  As the U.S. Federal Reserve expanded it’s balance sheet in the post Lehman era, a lot of companies in China have sucked in mountains of debt at unrealistically low interest rates.   Just before the Lehman 2008 crisis, $3 in debt to gave you $1 of growth in U.S.   Today, it takes $6.50 of debt to create $1 growth in China.  It’s a colossal failure of common sense all over again.

An analysis by the Bank for International Settlements (BIS), published in March, that suggested a big chunk of the outflows were related to unwinding a once-faddish investment: Buying yuan offshore as a play on expectations the Chinese currency would continue to appreciate against the dollar as well as the mainland’s slightly higher interest rates amid a yield-starved world, says CNBC.

Of the around $175 billion decline in cross-border loans to China in the third quarter of 2015, nearly half came from offshore depositors backing out of the yuan, the BIS said, citing data from banks reporting to it.

File_000 (1)
China debt load and banks are so interconnected.  Wealth Management Products WMPs are worth 27% more than China’s A-share equity market, this represents half of total bank deposits, explosive toxic growth.  China’s $3 trillion corporate bond market is “freezing up” amid rising defaults and canceled debt sales.  Over 18 publicly-traded Chinese bonds have defaulted so far this year, up from six in 2015.  More than 190 companies  have cancelled or delayed debt sales since the end of March.

Another big chunk came from Chinese companies paying down their foreign debt, said the BIS, which acts as a bank to central banks. It found that Chinese firms reduced their cross-border net debt over the third quarter, with the amount denominated in currencies other than the renminbi accounting for around $34 billion of the outflows.

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Goldman highlighted that it was skeptical of the offshore debt repayment narrative.

File_001 (13)
Chinese lenders are struggling with a growing, smelly pile of bad debt after flooding the financial system with cheap credit for years to prop up economic growth. Per Bloomberg, non-performing loans jumped by more than 40 percent in the 12 months ended March to 1.4 trillion yuan ($210 billion), or 1.75 percent of the total, according to government data. The figures are widely believed to understate the true scale of the problem, we believe NPLs were probably closer to 15 trillion yuan  ($2.5T) at the end of last year.

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Memories of 2007, Standard Life Investments Suspends Trading on £2.7bn Property Fund

From Fund Strategy:

The asset manager says it halted trading on the Standard Life Investments UK Real Estate Fund and its associated feeder funds at noon today. The suspension will last for at least 28 days and will remain in place until it is “practicable” to lift it, with the decision being reviewed at least every 28 days.

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Surge in Redemptions

SLI said the move has been taken in response to a rise in redemption requests “as a result of uncertainty for the UK commercial real estate market following the EU referendum result”.

Stan Life

“The suspension was requested to protect the interests of all investors in the fund and to avoid compromising investment returns from the range, mix and quality of assets within the portfolio,” a spokesperson from SLI says.

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The SLI fund has lower risk positioning, which should benefit investors, the spokesperson says. The fund had £2.9bn in assets at the end of May, with 13 per cent in cash. However, just as we saw in 2007, the liquidity mismatch between the fund and the assets it holds is leading to concerns.



The Price of Lower for Longer

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Join our Larry McDonald on CNBC’s Trading Nation, Wednesday at 2pm. 

In 2007, Larry led a team at Lehman Brothers to capture over $100m in bets against the subprime mortgage crisis.  Here’s what he has his eye on today.

“If we look at the Fed’s forecast of where they think their Fed Funds Rate will be at the end of 2016, it’s up at 1.625%.  That’s five 25bps hikes over the next year?  Look for this number to come down substantially, the US 10 Year note is heading below 1.50%.”

Bear Traps Report, September 2015


The Longest Runs with Rates Near Zero

1932-1953: 21 years

2008-2016: 8 years

2001-2004: 3 years


The U.S. has had near zero short-term interest rates before. The period of 1932 to 1953 was defined by rates that were between zero and 2.1%. The last time we hit the zero bound, we stayed very close to it for upwards of 21 years. This is not something you hear often from economists these days.

Lower yields for longer periods of time bring out the animal spirits in investors, the reach for reach for yield gets more excessive EVERY minute interest rates are kept at ridiculously low levels.

U.S. Speculative-Grade Corporate Default Rate Increased To 4.1% in May, highest since September 2010, which saw the rate at 4.2%.


U.S. Household Net Worth

Central Bankers Giveth, but they Will Take it Away

Household Net Worth
The main reason central banks raise and lower rates is to shift consumption around and smooth out periods of stagnation. The Fed’s dual mandate of non-accelerating inflation and full employment defines the characteristics of the smoothing that society wants to see.


The number of  U.S. corporate high-yield bonds on negative rating watch has risen 26 percent in the past year due to increasing leverage and a poor liquidity outlook.  As of June 30, 2015, the list of corporate high-yield bonds on negative watch by one of the three major rating companies as of that date was 119.  Today, this number has surged 26 percent to 149 bonds, even as yields have fallen.  Lower credit quality and lower yields is the evil side effect of modern central banking.


 U.S., Italy and Spain 10 Year Bonds

10 Year Bonds

In a powerful move, Spain’s 10 year bonds have plunged in yield.  Last week at 1.63% to 1.14% as of Friday’s close.  Mario Draghi and the ECB brought out the fire hose to contain markets.  Just a leaked story to the press over a possible “Capital Key” expansion had shorts running for cover and buyers stampeding in.  It’s amazing how regulators are putting stock market players in jail for trading on “inside information” while central bankers are creating their own every other week.  Expanding the capital key would allow the ECB to buy even more, low credit quality, periphery (Spain, Italy) debt.  Today, investors receive 0.30% more interest buying a U.S. 10 year bond over Spain’s 10 year.  Front running the ECB has become a national pastime in Europe.  As someone who sat on the deck of the Titanic that was Lehman Brothers, this is pure evil, central bank induced moral hazard gone rogue.

Since 2008, $33T of wealth has been created in the USA.  The Trillion Dollar question?  What is the U.S. ‘s aging population doing with all this money?  Buying bonds that have doubled in value?  Lending money to commodity companies (oil), financing more exploration and excess supply?   We have a global, aging population positioning capital in places it just shouldn’t be, all because of central bankers.

U.S.  Population 45-64

US Population 54-64

Demographics, the Fed and Wealth Destruction 

There are powerful dynamics hidden inside today’s bond and commodity bubbles that once again clueless central bankers are missing.  There are nearly 4m more Americans age 45-64 today than there were for years ago.  Where are these high net worth investors being forced to put there wealth?  Developed markets around the globe are experiencing the same problem.  Aging populations after years of wealth creation equal a lot of investors with limited choices, so they reach for yield. Investors are putting capital in places it just shouldn’t be and central bankers are holding the smoking gun. They successfully blamed Wall St. for the financial crisis and hid behind the shadow of a tragedy, they will not be so fortunate when markets turn on them again.


Everyday nearly 11,000 people in the USA Turn 65

% of Population Over 65 of Age

Japan: 28%

Germany: 22%

Spain: 22%

Italy: 22%

USA: 15%


Low rates pull consumption and investment forward and allow projects to be undertaken that otherwise would have to wait. Some people call this stealing economic activity from the future, but we must keep our eye on the incentives created by Fed policy.


U.S. 30 Year Mortgage Yield vs. the S&P Case Shiller Average Home Price

US Mortgage Rates

This is a very interesting look at the S&P / Case Shiller U.S. Home Price Index vs the U.S. 30 Year Mortgage Rate. We must learn from financial history, clearly Fed policy had a heavy hand in inflating the U.S. housing bubble. What are their policies disrupting today? Over the years, each financial crisis experiences a metamorphosis into another serpent, another beast. We must prepare for what is coming at us.

On the other hand, higher rates make debt more expensive and push consumption and investment out. Over the last year, most economist have felt the Fed is looking to “tap the brakes” on the improving U.S. economy.   Wall St has been wrong yet again, they’re the gang that can’t shoot straight.

Fed Fund Rate and Bubbles


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Excessive Debt: Handcuffs Or A Noose?

The other pressing issue is high debt levels. The Fed is in no hurry to hike rates with debt levels so high in the post-Lehman era. The U.S. hit its debt ceiling in March of 2015, at $18.1 trillion, but the devil is in the details, or what’s called interest costs as a percentage of federal spending. As you can see below, net interest outlays are on course to more than double by 2017 from 2005 levels. Interest costs on the staggering U.S. debt load, added together with government entitlement spending, is nearing 71% of Federal spending, compared to 26% in the early 1960s. Is this sustainable?


U.S. Government Net Interest Outlays

2017: $335B
2009: $190B
2005: $150B

*Data from CBO


USA National Debt 2009-16

National Debt
It’s pure comedy to listen to the national media in the U.S. talking up the risk of a Donald Trump Presidency to the National Debt.  Debt has exploded under Obama and Congressional policies since 2008.


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