Deutsche Bank and Lehman Brothers, Everything You Need to Know

Last week in Bermuda, our Larry McDonald delivered the keynote speech at the World Alternative Investment Summit (WAIS) 2016.

The event was host to an audience of asset management professionals on September 28, 2016.

We’re looking at their Hank Paulson moment, Europe is set to bail out its “zombie banks” within the next few months – McDonald said.

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From the conference, Larry was interviewed live on CNBC  via phone to discuss his expertise and point of view on the Deutsche Bank Situation.

Join strategist Larry McDonald, NY Times Bestseller Author,  from the 2016 WAIS at Bermuda on CNBC; discussing the large fall in Deutsche Bank shares and the parallels to Lehman Brothers  HERE

Here is a recap of Larry’s Bermuda Conference Presentation:

Lawrence McDonald, who witnessed a bank’s collapse from the inside when he was vice-president of distressed debt at Lehman Brothers when it folded in 2008, said Deutsche Bank’s situation now is eerily similar to his former employer’s plight shortly before its demise.

Deutsche Bank’s shares took a pummelling after the US Justice Department announced its intention to fine Germany’s biggest bank $14 billion over matters relating to the subprime mortgage crisis. This has rekindled fears over the bank’s stability.

Deutsche Bank Subprime

The problems are similar in some other big European banks.

Deutsche Bank has about $16 billion of equity and $162 billion of debt, In the US, Hank Paulson [the former US Treasury Secretary] got the big bank CEOs around a table in 2008 and said ‘you’re taking this money’. They took the pain and did the bailouts.

That did not happen in the same way in Europe and this has been building up for years. The truth has been coming out one drop at a time. Soon six or eight banks will be forced to sit around the table. We expect a major recapitalization to happen within the next three months.

“Zombie banks” were not capable of financing the needs of an EU economy of more than 500 million people.

The German government has stated it does not intend to give Deutsche Bank any help, but McDonald brought up charts that he said suggested that matters were coming to a head.

One graph showed that when the market believes Deutsche Bank’s debt is getting riskier, the same applies to Germany’s debt — an example of “credit spread contagion”.

There were clear signs that banks trusted each other less when lending between themselves — as occurred in the run-up to the global financial crisis — as signified by a widening spread between the Libor rate and the Fed Funds rate, he added.

Larry McDonald, the author of the New York Times bestseller A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers, specializes in identifying political and systemic risk leading to actionable trade advice.  He shares his valuable research at THE BEAR TRAPS REPORT.

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The US presidential election is another source of market risk and he had seen a clear correlation between Donald Trump’s fortunes and stock market volatility. At times when Mr Trump has risen in the polls, the VIX, a measure of S&P 500 Index volatility sometimes known as the “fear index” has risen too. The big banks, in particular, were seen as having a lot to lose if the Republican Party candidate wins in November.

Regardless of whether Mr Trump takes the White House, it is possible that over the coming weeks the perceived likelihood of him winning may increase, offering trading opportunities.

Another strong risk emanates from Asia and particularly China. Credit default swaps on major Asian financial institutions — indicating their perceived level of riskiness — had risen sharply just before the past two double-digit declines in the S&P 500 Index, and they could likewise be an indicator of future dips.

Years of low interest rates had left investors craving yield, and Larry sees a “hot bubble” inflating in the commercial real estate sector and strong demand for high-yield bonds.

Larry said – “I had lunch with a fund manager last week who told me that German and Japanese insurance companies are buying up large quantities of U.S. high-yield bonds. He said it’s like nothing he’s ever seen.”

That was one of the market-warping effects of negative interest rates that exist in both Europe and Japan.  Central banks were creating potentially “catastrophic, unprecedented bond volatility” by keeping rates so low for so long.

The markets were functioning strangely, he warned, with an unusually high correlation — about 23 per cent — between stocks and bonds, which traditionally move in opposite directions.

The conference, which was opened by Michael Dunkley, the Premier, also featured Ross Webber, the chief executive officer of the Bermuda Business Development Agency, who said: “Bermuda’s economy is on the upswing — the recession is behind us.”

Mr Webber said much work had been done to bolster Bermuda’s asset management industry and that was now bearing fruit. Centaur Fund Services set up an office on the island earlier this year and he added that other managers and service providers were making plans to set up in Bermuda.

Mr Webber said there was a tendency among overseas politicians and media to lump all offshore financial centres together as an “axis of evil” and use them as a scapegoat.

Some offshore jurisdictions deserved their bad reputation for ignoring the changing regulatory landscape and embracing secrecy — but Bermuda was not one of them, he said.

Pointing to Bermuda’s success in the international reinsurance markets and its lengthy record of reliable claims-paying, he added: “Bermuda is a place to raise capital, not hide it.

The likely exit of Britain from the European Union makes Bermuda even more attractive as a jurisdiction for fund managers, Mr Webber added, particularly as the island has applied for “passporting” rights to gain free access to EU markets.

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– Special Thanks to Jonathan Kent, Business Editor of the Royal Gazette – Bermuda.



A Credit Risk Shot Across the Bow from China

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

David Tepper

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“Economists are still expecting 4-5 hikes in 2016 and the street (futures market) is pricing in 2-3 over the next year.  We believe volatility and global credit risk will force the Federal Reserve to be on hold for a rate hike in March and for that matter the rest of the year.  Credit risk will veto the Fed’s desired policy path, take the steering wheel out of their hands.  When the market realizes this, the dollar will fall and commodities will surge”.

Bear Traps Report, January 5, 2016

Breaking News: One of our Lehman Risk Indicators is Flashing Bight RED

Credit Stress in China’s Banking System Reaches an All Time High

Credit-to-GDP ‘gap’ exceeds all other nations, says BIS study

This weekend, the Bank of International Settlements announced a warning indicator for banking stress rose to a record in China in the first quarter, underscoring risks to the nation and the world from a rapid build-up of Chinese corporate debt.

In Q1, credit stress in China surged to a fresh record.  As we covered in our Bear Traps reports last year, a nearly 20% spike in the U.S. dollar has the credit impact of a global wrecking ball.  We made the argument the dollar’s accent has had the impact of 3-4 Federal Reserve rate hikes.  Today, it’s rewarding to find much of Wall St’s analysts are finally waking up to this reality.

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China is using debt to generate economic activity at its highest rate EVER.  Unfortunately, they’re getting substantially less return on leverage today then ever before.  Eight years of aggressively accommodative monetary policy from the U.S. federal reserve has consistently shifted capital into places it JUST SHOULDN’T BE.  As the Fed tries to EXIT the zero lower bound, the global credit contraction implications are mind blowing powerful.

China 2006-2016

Credit Growth: 1100%
GDP Growth: 500%

Hayman Capital data

After the Fed made their attempt at one rate hike, the dollar’s surge resulted in a sharp contraction in the total stock of dollar denominated credit to emerging markets.  This is a key measure of global liquidity, it was down at $3.2T at the end of March, off $137B year over year, BIS data.


Credit risk has surged globally, the Fed has this mess on it’s hands.


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China’s credit-to-gross domestic product “gap” stood at 30.1 percent, the highest for the nation in data stretching back to 1995, according to the Basel-based Bank for International Settlements. Readings above 10 percent signal elevated risks of banking strains, according to the BIS, which released the latest data on Sunday, Bloomberg reported.


The gap is the difference between the credit-to-GDP ratio and its long-term trend. A blow-out in the number can signal that credit growth is excessive and a financial bust may be looming.

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Japan Yield Melt Up

Yields on the Japan 10 Year bond are back to 0% for the first time since March.

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Bank of Japan BOJ Assistance

Japan’s bonds are in plunge mode, now suffering their  worst month since at least 2010.   Asset managers are betting the Bank of Japan (meeting September 21st)  is plotting the return the steep yield curve.  Banks borrow short and lend long, so a flat yield curve has been a thorn in the side of lending institutions.  Banks have been suffering in Japan under the weight of negative rates, speculation is building that the BOJ will come to the rescue.

Special thanks to the Bloomberg Terminal

Japan 2s - 40s

The Bank of Japan BOJ is under extreme pressure from their banking system.  Negative rates has backfired into a disaster for Japan’s financial institutions.  There is surging speculation the BOJ will make a major policy shirt later this month.

We have an index which tracks bonds with maturities longer than 10 years.  The basket has suffered the longest losing streak in three years.  Investors are worried Bank of Japan Governor Haruhiko Kuroda will reduce purchases of longer term debt after a comprehensive review of monetary policy on Sept. 20-21.

Japan 10 Year BondThirty-year government bonds capped their biggest weekly slump since April 2013 after the BOJ refrained from purchasing the securities at its regular market operation on Sept. 2nd.

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Saudi Oil Production at Record Levels

“There are many ways to short oil or oil equities based on your risk tolerance and level of sophistication. If you are long oil, we recommend you take down both equity or commodity exposure to crude. Our WTI target is $42-$44 over the next month, $35 over the next three months. Oil is a STRONG SELL in our view.”

The Bear Traps Report, August 18, 2016




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Monthly OPEC Oil Production

August, Million Barrels Day

2016: 33.7*
2015: 32.1
2014: 30.4
2013: 30.1


*OPEC was producing at record levels in August, even as global oil inventories are at multi- year highs.  If you’re the lowest cost producer (Saudi Arabia), why subsidize highly levered / high cost producers when you can just put them out of business?


“Breaking: Saudi, Russia Pledge Oil Cooperation Without Agreeing Freeze”

September 5, 2016

Since the highs of August 19th, oil plunged 11% globally.  In recent weeks, markets have witnessed rumor after head fake.  Around the world, some crude policy makers have been desperate to get prices higher.

Today, two of the largest oil producers on earth pledged to “cooperate” to stabilize global markets, while failing to announce any specific measures to bolster prices.

No concrete plans were announced at the joint press briefing in Hangzhou, and Al-Falih later told Al Arabiya television there’s no current need to cap production.


“Breaking:  Russia, Saudi Arabia set up working group on oil, gas cooperation.”

November 26, 2015

Meanwhile, Iran is Hitting the Oil Production Gas Pedal, Reuters

File_000 (86)

Up on Euphoria, Down on Impatience

Today, after a 5% surge, oil pared gains (+0.81%) on speculation Saudi Arabia and Russia might detail a plan to drive up prices, markets later said; “where’s the beef?”

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Brent Saudi RussiaCreating temporary short squeezes has become a national summer past time in some oil producing nations.  Over the years in oil markets one thing has become very reliable.   When you see “plans” with few ambitious announcements, there’s typically a lack of decisive follow-up action.

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Insider Trading in Rates

“Yesterday, the U.S. 10 year treasury bond hit our long held 1.40% target.  A sea of bond bears has become an ocean of bulls.   Brexit’s risk to the global economy has created an opportunity for those willing to step in and short bonds in the face of a large group of clowns rushing to the exits (abandoning their long held bearish bond positions).”

Bear Traps Report

July 6, 2016


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Rich Stocks
Equities remain extremely expensive.  A look inside the S&P 500 shows the median stock trading at a record PE of 21.3x, this is through the 1999 dot com highs, nosebleed levels.   SEC filings show, Warren Buffett’s cash position has risen from $48B in 2014 to $73B today.  The Oracle of Omaha has NEVER had more dry powder, he’s armed and ready for a large sell off.
 Jobs Friday

Government Jobs: June – August 108,000
Three Month Average: 232,000

Employment growth was weaker than consensus estimates at +151k in August, but above Fed estimates of the breakeven rate.

Japan 10 year North

As U.S. bond yields are moving higher, so are those around the world.

U.S. companies kept adding to payrolls in August while measures of slack in the labor market were little changed, signaling steady hiring in the face of lackluster global growth.

“Our economists therefore see this report as just enough for a large majority of officials to support a September rate increase and have raised their subjective odds of a hike this month to 55% from 40%. They have also lowered their subjective odds for December to 25% from 40%, leaving the cumulative odds of at least one hike this year at 80%. ”

Goldman Sachs

US 10s Wedge

Notice the yield price action in US 10s.  Sixty days ago every sell off was greeted by a stronger bid for bonds.  Today, it’s a 180, every rally in bonds has been over-powered with selling, yields want to move higher.

Bear Traps Report estimates suggest that G4 central bank (ECB, BOE, BOJ) has contributed for nearly 105bp (1.05%) of the reduction in US 10-year yields since the end of 2013.

Jobs and Economic Growth

Bloomberg reported payrolls climbed by 151,000 last month following a 275,000 gain in July that was larger than previously estimated, a Labor Department report showed Friday in Washington. The median forecast in a Bloomberg survey called for 180,000. The jobless rate and labor participation rate held steady, while wage gains moderated.

image (8)August has been light in recent years, so the market was ready for weakness.

The August figure is consistent with a simmering-down of payrolls growth so far this year as the economy slogs through a period of weak investment and some companies have difficulty finding workers. Federal Reserve officials will have to weigh the jobs data as they decide whether to raise the benchmark interest rate for the first time in 2016.


Led by a substantial inventory overhang, in recent quarters, U.S. economic growth has suffered, we’ve seen a pull back in business fixed investment. Last Friday, the second release of Q2 GDP reaffirmed the soft signal from the Bureau of Economic Analysis’ preliminary estimate showing modest growth of +1.1% (qoq ar).

On the other hand, Wall St’s economists expect above-trend growth in Q3 (+2.8% to +3.2% qoq ar) and Q4 (+2.1% to 2.5%), as a turn in the inventory cycle, continued strength in consumer spending, and a bounce back in residential investment offset any lingering weakness in capital spending and drag from trade. Beyond this year, they expect growth to slow to an only slightly above-potential pace of 2% over the course of 2017.


2s Pre Jobs

Someone had the light jobs number early as U.S. two year yield came off aggressively, as bond buyers came into the number.
Jobs Day Recap
•NFP number was 151,000 for the month of August, below the 180,000 estimate
•The Unemployment rate was steady at 4.9%
•Revisions to both June in and July showed 1000 less jobs created than initially reported, very marginal.
•3 month average for job gains at 232,000 (strong)
•12 month average for job gains at 204,000 (strong)
•A little worrying that total private was much softer at 126,000 vs 225 last month
•Much of the losses in jobs were seen in mining which continues to weigh, something the Fed has already priced in.
•Many service sectors showed continue growth.
•In government we saw 25,000 jobs added, seasonally strong. Now 108,000 government jobs over past three months!
•Many of the more structural indicators such as discouraged workers, participation rate and long term unemployed were almost unchanged.


Breaking Point

“Yesterday, the U.S. 10 year treasury bond hit our long held 1.40% target.  A sea of bond bears has become an ocean of bulls.   Brexit’s risk to the global economy has created an opportunity for those willing to step in and short bonds in the face of a large group of clowns rushing to the exits (abandoning their long held bearish bond positions).”

Bear Traps Report

July 6, 2016

The Fed is playing a very dangerous game.  They will do anything to protect their beloved Hillary Clinton’s 2016 election hopes, but in doing so they risk financial instability.  When you get too close to the edge one often gets burnt.   Colossal stakes are on the line.  The 10 year U.S. Treasury hit a yield of 1.63% this week, a seller’s panic has begun.  As long term bond bulls we turned bearish in late June, recommended our clients SELL bonds.

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A Warning from Jackson Hole 

Friday morning, in classic fashion our favorite “labor market” economist in Janet Yellen talked up the U.S. economy.   Yellen reiterated her belief that the U.S. is nearing full employment and meeting their goals.  Heading toward the 2016 election, the Fed’s cheerleading has become a double edged sword.  Central bankers have been talking up the U.S. economy, but in doing so they risk waking up the beast within global equity markets.

Over the last year, every time the Fed has tried to raise rates stock market volatility has surged dramatically.  There’s over $10T of debt globally tied to the U.S. dollar, commodities and emerging markets.   As the Fed has kept rates near zero for eight years the easy money gravy train has exploded in size.  Every second they’ve kept interest rates too low for too long, capital has oozed into places it just shouldn’t be.  As the Fed tries to exit the “lower bound” the U.S. dollar surges along with systemic credit risk.  As we said in January, “the Fed will NOT hike rates this year, but they will try (and fail) to get one in. ” It’s the beast in the market that will stop them once again.

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Bloom Dollar

The global wrecking ball that is the U.S. dollar surged Friday.  After over two months of public silence about her views, Yellen pointed to “continued solid performance of the labor market.” 

VIX Range New

The Fed chair also emphasized the “case for an increase in the federal funds rate has strengthened in recent months” in her speech Friday to central bankers and economists in Jackson Hole, Wyoming.  Complacency had taken control over equity markets globally this summer.  Friday we witnessed a rare surge in volatility, for the first time in months the VIX traded in a 23% range.

us 10s breakout

U.S. ten year Treasuries hit 1.63% today, the highest mark in 3 months. 

Just as the very last bond bear turned bull, Treasuries now in the throes of the most significant sell off this year

“We’re reasonably close to what is thought of as full employment.  The inflation rate this year is higher than last year’s.  It’s still not up to 2 percent. But it’s been growing.”

Stanley Fischer

WIRP SeptFed fund futures have shifted from a 13% chance of a rate CUT in (post Brexit low) to a 43% chance of a rate HIKE in September.

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Breaking: Fed’s Fischer Hints at a Hike

“For the rest of the year, we think global credit risk will veto the Fed’s policy path (no hikes) and therefore, gold and the gold miners are going to do very, very well in that environment in 2016.”

Bear Traps Report’s Larry McDonald, January 2016 on CNBC

Aspen Institute in Aspen, Colorado on Sunday

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Today, Federal Reserve Vice Chairman Stanley Fischer said the U.S. economy moving ever so near to the central bank’s objectives and he expects growth to pick up in the future.

As a key member of Janet Yellen’s inner circle Stan Fischer’s words carry 10x the weight of non voting, regional Fed bank presidents.

Air Pocket

Considering over 3000 current Dow (Dow Jones Industrial Average) points are supported by the easy money Fed gravy train, we recommend keeping yours eyes and ears on him.

Gold vs Dollar

The Bloomberg dollar index is off 3% over the last 20 days while gold has been stuck in a trading range.

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“We are close to our targets..  Looking ahead, I expect GDP growth to pick up in coming quarters, as investment recovers from a surprisingly weak patch and the drag from past dollar appreciation diminishes.”

Stanley Fischer

Over 547,000 new jobs have been created in June and July, so why is the Fed so cautious on the 2016 rate hike?

Fed’s Fischer

U.S. Job Market:  “remarkably resilient”
U.S. GDP Growth: “mediocre at best.”

Fischer trying to balance out is speech here.

December Rate Hike vs Bloomberg Dollar Index*

Today: 52% vs 1166
Month Ago: 43% vs 1198

*weaker dollar with higher rate hike probability

Bloomberg data

We’re witnessing a remarkable divergence between the U.S. dollar and Fed Fund Futures.  The dollar has plunged 3% over the last 20 days while the futures market is pricing in a much higher chance of a December Fed rate hike.

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Fischer Balancing Hawkish Comments with Dovish Concern

“A 1.25 percentage point slowdown in productivity growth is a massive change, one that, if it were to persist, would have wide-ranging consequences for employment, wage growth, and economic policy more broadly,”

Stan Fischer

Fed Fund Futures vs Fed Dots*

Effective Fed Funds

Today: 0.40%
2017: 0.65% v 1.60%
2018: 0.78% v 2.36%

*Fed’s projections on rates

Bloomberg data

The futures market is giving the Fed the Rodney Danderfield, “no respect”.  Traders are pricing in just one rate hike between now and the end of 2018.  On the other hand, the Fed dots are pointing to seven rate hikes over the same time frame.  This disconnect cannot stay this wide, it’s unsustainable.

Fed officials next meet Sept. 20-21.   We will listen closely for additional clues on timing when Fed Chair Janet Yellen speaks Aug. 26 at an annual in Jackson Hole, Wyoming.

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