NOctaper Or Shocktaper: Deutsche Bank's Five Reasons Why The Fed May Stun Everyone Once Again

Remember when minutes before the September FOMC announcement everyone was absolutely certain the Fed would announce tapering, only to leave a lot of very angry traders fuming? Fast forward one month when everyone is absolutely certain, again, that there is no way the Fed can announce anything even remotely suggesting a taper. One wonders though: since the Fed has by now burned all credibility bridges, and since the capital market bubble is now far greater than it was when both Stein and Bernanke, implicitly, warned about a building asset bubble (a chorus which has now been joined by JPM, Pimco and BlackRock) in early 2013, would today not be the best opportunity for the Fed to once again stun the market with a dramatic policy U-Turn, just to teach those momentum wave-riding vacuum tubes who is in charge? Probably not. However, as Lloyd Christamas noted, there is a chance. Deutsche Bank’s Jim Reid explains why.

So will today’s FOMC be as surprising to the market as the September meeting? Almost certainly not but you can’t completely rule out a small taper for the following reasons: 1) In the September meeting a large majority of FOMC participants expected the taper to start before December; 2) the fiscal situation has been kicked down the road for a while; 3) financial conditions have arguably eased since the last meeting with rates lower and equities higher and 4) many of the members won’t be on the committee into next year and may want to make a statement before leaving; and 5) they may feel a little bruised by the market’s verbal reaction last time.

 

Overall we continue to think the Fed are trapped to a large degree by the liquidity they’ve provided financial markets over recent years which could destabilise assets if they reversed course without a strong economic recovery. Indeed the current data uncertainties is probably the biggest reason for holding fire at the moment, especially so soon after the shutdown. Indeed our view is that the Fed may have to adjust their criteria for tapering if they want to make regular cuts to QE in 2014. We’re not sure how employment is going to suddenly pick up at this relatively mature stage of the cycle.

 

However when all said and done, the Fed do seem to want to taper and although we think they won’t until well into next year, we can’t help but think that the Fed are currently unpredictable enough at the moment that we need to be vigilant tonight and indeed in December. The story of the next 6 months could be very little tapering but a swing between liquidity complacency and liquidity fear. Maybe we’re veering towards the former at the moment. DB’s Peter Hooper expects today’s FOMC to be most likely a “wait and see event” though he sees the case for a taper now is about as strong as it was in September when it was a very close call.

To all of the above we add one more reason: the following headline from the Chinese Ministry of Commerce, which hit earlier.

  • MOFCOM: U.S. POLICY CHANGE MAY CAUSE CAPITAL SWING FOR CHINA.

And so, just like in 2011, China is once again openly complaining about QE (and, tangentially, the inflationary implications it has on the Chinese economy). Recall that it was the soaring Chinese inflation in 2011 that sent gold from roughly where it is now, to all time highs. So if we have a repeat, even as the entire world is now effectively begging Mr. Debtfire to taper, will the BIS’ gold selling team headed by Michael Charoze out of Hong Kong be able to contain that one last remnant of the Fed’s idiotic monetary policies? Stay tuned.

As for today, our personal hope is no taper now… or ever. After all, the faster the Fed proceeds to monetize everything, and in unlimited amounts, the faster this centrally-planned charade finally ends.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/RhYULJNkvKg/story01.htm Tyler Durden

NOctaper Or Shocktaper: Deutsche Bank’s Five Reasons Why The Fed May Stun Everyone Once Again

Remember when minutes before the September FOMC announcement everyone was absolutely certain the Fed would announce tapering, only to leave a lot of very angry traders fuming? Fast forward one month when everyone is absolutely certain, again, that there is no way the Fed can announce anything even remotely suggesting a taper. One wonders though: since the Fed has by now burned all credibility bridges, and since the capital market bubble is now far greater than it was when both Stein and Bernanke, implicitly, warned about a building asset bubble (a chorus which has now been joined by JPM, Pimco and BlackRock) in early 2013, would today not be the best opportunity for the Fed to once again stun the market with a dramatic policy U-Turn, just to teach those momentum wave-riding vacuum tubes who is in charge? Probably not. However, as Lloyd Christamas noted, there is a chance. Deutsche Bank’s Jim Reid explains why.

So will today’s FOMC be as surprising to the market as the September meeting? Almost certainly not but you can’t completely rule out a small taper for the following reasons: 1) In the September meeting a large majority of FOMC participants expected the taper to start before December; 2) the fiscal situation has been kicked down the road for a while; 3) financial conditions have arguably eased since the last meeting with rates lower and equities higher and 4) many of the members won’t be on the committee into next year and may want to make a statement before leaving; and 5) they may feel a little bruised by the market’s verbal reaction last time.

 

Overall we continue to think the Fed are trapped to a large degree by the liquidity they’ve provided financial markets over recent years which could destabilise assets if they reversed course without a strong economic recovery. Indeed the current data uncertainties is probably the biggest reason for holding fire at the moment, especially so soon after the shutdown. Indeed our view is that the Fed may have to adjust their criteria for tapering if they want to make regular cuts to QE in 2014. We’re not sure how employment is going to suddenly pick up at this relatively mature stage of the cycle.

 

However when all said and done, the Fed do seem to want to taper and although we think they won’t until well into next year, we can’t help but think that the Fed are currently unpredictable enough at the moment that we need to be vigilant tonight and indeed in December. The story of the next 6 months could be very little tapering but a swing between liquidity complacency and liquidity fear. Maybe we’re veering towards the former at the moment. DB’s Peter Hooper expects today’s FOMC to be most likely a “wait and see event” though he sees the case for a taper now is about as strong as it was in September when it was a very close call.

To all of the above we add one more reason: the following headline from the Chinese Ministry of Commerce, which hit earlier.

  • MOFCOM: U.S. POLICY CHANGE MAY CAUSE CAPITAL SWING FOR CHINA.

And so, just like in 2011, China is once again openly complaining about QE (and, tangentially, the inflationary implications it has on the Chinese economy). Recall that it was the soaring Chinese inflation in 2011 that sent gold from roughly where it is now, to all time highs. So if we have a repeat, even as the entire world is now effectively begging Mr. Debtfire to taper, will the BIS’ gold selling team headed by Michael Charoze out of Hong Kong be able to contain that one last remnant of the Fed’s idiotic monetary policies? Stay tuned.

As for today, our personal hope is no taper now… or ever. After all, the faster the Fed proceeds to monetize everything, and in unlimited amounts, the faster this centrally-planned charade finally ends.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/RhYULJNkvKg/story01.htm Tyler Durden

Frontrunning: October 30

  • Morning Humor from Hilsenrath – Fed Balance Sheet Not Seen Returning to Normal Until at Least 2019 (WSJ)
  • Health Policies Canceled in Latest Hurdle for Obamacare (BBG)
  • Was there anything RBS was not manipulating? RBS Said to Review Currency-Trading Practices Amid Probe (BBG)
  • Sebelius to Testify Before House Panel (WSJ)
  • And more humor: Spain’s Statistics Institute Confirms End of Recession (WSJ) … and now we await the triple dip
  • Finally some credible reporting on Yellen’s “foresight” – Yellen feared housing bust but did not raise public alarm (Reuters)
  • Japan government moves closer to Fukushima takeover (FT)
  • China to step up own security after new NSA allegations (Reuters)
  • Blackstone Vies With Goldman in Spain Rental Housing Bet (BBG)
  • In new U.S. budget talks, Republican proposal has flipped the script (Reuters)
  • Madoff Money to Japan Mob Ties Breed Banks’ Global Pains (BBG)
  • German Unemployment Rises a Third Month as Growth Slows (BBG)
  • China Detains Five Over Tiananmen Crash, Calls It ‘Terrorist Attack’ (WSJ)
  • Top Central Banker in Norway Prefers Housing Slump to Gains (BBG)

 

Overnight Media Digest

WSJ

* U.S. officials said electronic spying that ignited a political firestorm in France and Spain recently was carried out by their own intelligence services and not by the NSA. The phone records were shared with the U.S.

* Problems surrounding the launch of the federal health-care law broadened, as concerns that thousands of Americans are getting insurance-cancellation notices bubbled over at a hearing on Capitol Hill.

* SAC Capital will plead guilty to securities fraud as part of a landmark criminal insider-trading settlement with federal prosecutors set to be announced by next week.

* Dutch lender Rabobank agreed to pay $1.07 billion to settle accusations that it skewed key financial benchmarks and its chief executive resigned, the latest casualty of a global interest-rate-rigging scandal.

* A multibillion-dollar settlement between JPMorgan Chase and the U.S. over soured mortgage bonds is at risk of collapsing because of disagreements related to a criminal probe of the bank and its effort to get penalties reimbursed by a government-controlled fund, according to people familiar with the discussions.

* Operators of U.S. truck fleets are accelerating a shift to natural gas fueled trucks, betting on new engines that promise to drop the cost of shifting from diesel fuel.

* BlackBerry Ltd executives flew to California to meet with Facebook Inc last week to gauge its interest in a potential bid for the struggling smartphone maker, according to people familiar with the matter.

* Google Inc’s smartwatch is in late-stage development and the company is in talks with Asian suppliers to begin mass production of the device, people familiar with the matter said.

 

FT

Rabobank agreed to a $1 billion fine to U.S., British and Dutch authorities, admitting that dozens of employees manipulated the Libor and other key benchmark interest rates over six years.

Barclays may need to pay out as much as $700 million to U.S. hedge fund Black Diamond, after losing an appeal in a five-year legal struggle when a New York supreme court found the bank liable for breach of contract over a vast credit derivatives transaction.

Creditor banks of Brazilian tycoon Eike Batista’s OGX on Monday struck a private deal to sell off the troubled oil company’s natural gas business. The move has other creditors and shareholders anxious that they will be left with next to nothing if OGX files for bankruptcy.

BP’s Chief Executive Bob Dudley said the UK oil major plans to sell a further $10 billion worth of assets by the end of 2015, which could signal higher payouts to investors.

DVD rental chain Blockbuster’s British arm is set to go back into administration for the second time in 10 months, putting 2,000 jobs at risk after poor retail and rental sales.

 

NYT

* Twitter, which has been built around 140-character snippets of text since its founding in 2006, has added photo and video previews to the feed of items that users see when they log onto the service from the Web or mobile applications.

* When Brian Sozzi, the Chief Executive of Belus Capital Advisors, visited Sears locations in New York and New Jersey this month, he said, he found barren shelves, haphazard displays and badly stained carpets. Also missing: customers.

* The Senate voted unanimously to confirm President Obama’s two picks for the Federal Communications Commission, Tom Wheeler as chairman and Michael O’Rielly as a commissioner.

* Samsung recorded its highest share of smartphone shipments to date in the third quarter, while Apple showed more modest gains, according to a new report from Strategy Analytics.

* The White House has long been aware in general terms of the National Security Agency’s overseas eavesdropping, the nation’s top spymaster told a House hearing on Tuesday.

* The CBS Corp is developing a 24-hour news channel that would be streamed online and would mainly repurpose video and reporting already produced by CBS News, according to executives involved in the planning.

* LinkedIn announced strong user growth and better-than-expected third-quarter revenue on Tuesday, but issued a conservative revenue forecast for the fourth quarter and the 2013 fiscal year.

* After months of wrangling and tough negotiating, Dell Inc is finally going private. The computer company said on Tuesday that its $24.9 billion sale to its founder, Michael Dell, and the investment firm Silver Lake had closed.

* Nextdoor, a social network for neighbors, is moving into elite territory. The San Francisco startup announced a $60 million investment on Tuesday, led by Kleiner Perkins Caufield & Byers and Tiger Global Management, two prominent venture capital firms.

* Infosys, the giant Indian technology outsourcing company, has agreed to pay $34 million in a civil settlement after federal prosecutors in Texas found it had committed “systemic visa fraud a
nd abuse” when bringing temporary workers from India for jobs in American businesses, according to court documents and officials familiar with the case.

 

Canada

THE GLOBE AND MAIL

* Canada has promised the European Union it will be able to take advantage of any further loosening of foreign investment restrictions on the country’s telecom sector.

* A heated debate is raging among some of the biggest names in the food world over a boycott of Canadian seafood, a move aimed at ending the annual seal hunt.

Reports in the business section:

* United States Steel Corp will permanently cease steel production at its Hamilton mill at the end of the year, ending an era that goes back more than a century. The permanent end of steel making in what was the cradle of the Canadian steel industry is the latest step in what has been a troubled history for U.S. Steel.

* The race is on for one of Canada’s hottest retail sites after Sears Canada Inc abandoned its flagship store at the Toronto Eaton Center. U.S. department store Nordstrom Inc is in talks with the mall’s owner, Cadillac Fairview Corp, to move into the space – and could be close to a deal, industry sources said.

NATIONAL POST

* A report tabled Tuesday by the federal Conservative government in the House of Commons, explaining the final negotiated outcomes of the Canada-EU free-trade agreement, has shed more light on what is being billed as the largest and most wide-ranging free trade deal for Canada since the North American Free Trade Agreement.

* The unsteady sand of who is considered a terrorist in Canada has once again shifted in favor of a Tamil woman living in Toronto, whose politician husband was assassinated in Sri Lanka while attending Christmas Eve mass in 2005. Weeks after Joseph Pararajasingham, a member of parliament in Sri Lanka, was shot dead, Canada granted residency to his widow. In 2011, however, the Immigration and Refugee Board concluded that the woman was a member of a terrorist group and should be deported because of her ties to her husband, who had ties to the Tamil Tigers.

FINANCIAL POST

* Stephen Poloz, Canada’s new head of monetary policy, is already being credited with putting a kinder, gentler face on the Bank of Canada, and cutting through decades-old jargon that is central-bank speak.

* Any chill in foreign investment resulting from tougher Industry Canada reviews hasn’t caught up with the British, who are warming up to the Western Canadian energy economy like never before. Energy giants such as Centrica, BG Group, BP, Royal Dutch Shell, are all growing their Western Canadian operations, encouraged by the British government, the recently announced Canada-EU free trade deal and perception that the Canadian government welcomes their business.

 

China

CHINA SECURITIES JOURNAL

– The net profit of 116 Chinese property companies increased 30.6 percent in the first nine months of this year, according to Wind, a financial data provider.

SHANGHAI SECURITIES NEWS

– China Development Bank Corp is working with local governments and enterprises to review re-mortgage financing issues of photovoltaic power plants, according to sources. The bank is developing new finance rules to address industry financing difficulties, they said.

CHINA BUSINESS NEWS

– China Vanke Co Ltd confirmed on Tuesday that it will buy up to HK$3 billion ($386.9 million) worth of shares in the Hong Kong IPO of Huishang Bank, making it the largest shareholder.

SHANGHAI DAILY

– China’s central bank has set up a firewall that can distinguish between accounts set up within and outside of Shanghai’s pilot free-trade zone so that authorities can monitor transactions in real time, said Li Xunlei, chief economist at Haitong Securities.

CHINA DAILY

– Sixteen percent of Chinese households have had their homes demolished or seized during China’s urbanization drive, but few have received support in gaining employment or access to social security services, a survey of some 12,500 people nationwide showed.

Less than 80 percent of those who had land seized said they received compensation, while 94 percent of those whose homes were demolished had received compensation.

 

Fly On The Wall 7:00 AM Market Snapshot

ANALYST RESEARCH

Upgrades

Agree Realty (ADC) upgraded to Outperform from Market Perform at Raymond James
BP (BP) upgraded to Buy from Hold at Societe Generale
Baidu (BIDU) upgraded to Buy from Hold at Brean Capital
Baidu (BIDU) upgraded to Buy from Hold at Jefferies
Electronic Arts (EA) upgraded to Strong Buy from Hold at Needham
Facebook (FB) upgraded to Buy from Neutral at BTIG
Masco (MAS) upgraded to Market Perform from Underperform at Raymond James
Nanometrics (NANO) upgraded to Outperform from Sector Perform at Pacific Crest
Nike (NKE) upgraded to Overweight from Equal Weight at Morgan Stanley

Downgrades

Aflac (AFL) downgraded to Market Perform from Outperform at Raymond James
Ambarella (AMBA) downgraded to Equal Weight from Overweight at Morgan Stanley
Axiall (AXLL) downgraded to Neutral from Buy at Citigroup
Bed Bath & Beyond (BBBY) downgraded to Hold from Buy at Canaccord
Buffalo Wild Wings (BWLD) downgraded to Market Perform at Raymond James
CAI International (CAP) downgraded to Neutral from Outperform at Credit Suisse
Calix (CALX) downgraded to Market Perform from Outperform at Raymond James
Carpenter Technology (CRS) downgraded to Neutral from Buy at Goldman
Changyou.com (CYOU) downgraded to Neutral from Buy at Citigroup
Chesapeake Granite (CHKR) downgraded to Sell from Neutral at Goldman
Cirrus Logic (CRUS) downgraded to Underweight from Equal Weight at Barclays
Cyan (CYNI) downgraded to Hold from Buy at Jefferies
Cyan (CYNI) downgraded to Sector Perform from Outperform at Pacific Crest
Dana Holding (DAN) downgraded to Fair Value from Buy at CRT Capital
Dana Holding (DAN) downgraded to Hold from Buy at KeyBanc
Digital Realty (DLR) downgraded to Equal Weight from Overweight at Evercore
Digital Realty (DLR) downgraded to Market Perform from Outperform at Raymond James
Edwards Lifesciences (EW) downgraded to Underweight from Neutral at JPMorgan
Plantronics (PLT) downgraded to Market Perform from Outperform at Raymond James
Questcor (QCOR) downgraded to Fair Value from Buy at CRT Capital
SanDisk (SNDK) downgraded to Neutral from Buy at BofA/Merrill
Sensata (ST) downgraded to Market Perform from Outperform at BMO Capital
U.S. Steel (X) downgraded to Hold from Buy at Deutsche Bank
UBS (UBS) downgraded to Neutral from Buy at BofA/Merrill
Union Pacific (UNP) downgraded to Neutral from Outperform at RW Baird
Western Union (WU) downgraded to Market Perform from Outperform at Raymond James
Willis Group (WSH) downgraded to Neutral from Buy at BofA/Merrill
Xylem (XYL) downgraded to Hold from Buy at KeyBanc

Initiations

Cherry Hill Mortgage (CHMI) initiated with an Outperform at FBR Capital
Dick’s Sporting (DKS) initiated with a Hold at Jefferies
Ecolab (ECL) initiated with a Buy at UBS
Skechers (SKX) initiated with a Buy at Brean Capital

HOT STOCKS

Barclays (BCS) said cooperating with foreign exchange trading probe
Nidec (NJ) to acquire Honda Elesys (HMC) for about $500M
Teleflex (TFX) to acquire Vidacare for $262.5M
Western Union (WU) no longer expects operating profit growth in 2014
LinkedIn (LNKD) said mobile continues to be ‘fastest’ growing product
Aflac (AFL) sees FY14 share repurchases $800M-$1B
Wi-LAN (WILN) to explore strategic alternatives

EARNINGS

Companies that beat consensus earnings expectations last night
and today include:
Pioneer Energy (PES), TE Connectivity (TEL), AU Optronics (AUO), Range Resources (RRC), Trulia (TRLA), Charles River Labs (CRL), NuVasive (NUVA), Ameriprise (AMP), Ryland Group (RYL), Take-Two (TTWO), DreamWorks (DWA), Questcor (QCOR), IAC (IACI), Western Union (WU), LinkedIn (LNKD), Electronic Arts (EA), Buffalo Wild Wings (BWLD), Gilead (GILD)

Companies that missed consensus earnings expectations include:
Praxair (PX), Universal Health (UHS), SL Industries (SLI), EXCO Resources (XCO), Genworth (GNW), Wabash (WNC), Arthur J. Gallagher (AJG), Aflac (AFL), Cabot (CBT), CBRE Group (CBG), Big 5 Sporting (BGFV), Rubicon (RBCN), Caesar’s (CZR), Yelp (YELP), Plantronics (PLT), CAI International (CAP)

Companies that matched consensus earnings expectations include:
NICE Systems (NICE), Ocean Shore Holding (OSHC), RPX Corp. (RPXC), FEI Company (FEIC), PAREXEL (PRXL), Kforce (KFRC), Danaos (DAC), Sonus Networks (SONS)

NEWSPAPERS/WEBSITES

  • Operators of some of the largest U.S. truck fleets, including Lowe’s (LOW), Procter & Gamble (PG) and UPS (UPS) are accelerating a shift to natural gas fueled trucks (CMI, VOLVY, CNW, SWFT), betting on new engine technology that promises to lower the cost of shifting from diesel fuel, the Wall Street Journal reports
  • For the holidays, Barnes & Noble (BKS) is heavily discounting Nook HD tablets originally introduced in the fall of 2012. The only new device it will sell during the holidays is an updated version of its Nook GlowLight black and white e-reader. The device will be unveiled today, the Wall Street Journal reports
  • The Federal Reserve is expected to maintain its massive bond-buying campaign when it concludes a two-day meeting on Wednesday and may point to softer readings on the U.S. economy to signal that the policy will be extended into 2014. An announcement will come at  2 p.m., Reuters reports
  • Adobe Systems (ADBE) said the scope of a cyber-security breach disclosed on October 3 was far bigger than initially reported, with attackers obtaining data on more than 38M customer accounts. Hackers also had stolen part of the source code to Photoshop editing software widely used by professional photographers, Reuters reports
  • Allowing Americans more time to enroll for health coverage under Obamacare may increase premiums and cut into profits, insurers (AET, WLP, UNH, HNT) are telling members of Congress in a bid to stop such a move, Bloomberg reports
  • Pioneer Natural Resources (PXD), with over 7,000 wells in the largest U.S. oil field, may draw buyers from Chevron (CVX) to ConocoPhillips (COP) to one of the industry’s biggest takeover targets. Pioneer’s market value more than doubled this year to $29B, Bloomberg reports

SYNDICATE

Ascent Solar (ASTI) raises $10M in a registered direct offering
Brixmor (BRX) 41.25M share IPO priced at $20.00
Criteo (CRTO) 8.08M share IPO priced at $31.00
HCA Holdings (HCA) files to sell 30M shares of common stock for holders
Mazor Robotics (MZOR) 2.4M share Secondary priced at $17.00
Surgical Care Affiliates (SCAI) 9.778M share IPO priced at $24.00
Veracyte (VCYT) 5M share IPO priced at $13.00
Yelp (YELP) files to sell $250M of Class A common stock


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/W4Uj4vqEZ0c/story01.htm Tyler Durden

Despite (Or Thanks To) More Macro Bad News, Overnight Futures Levitate To New All Time Highs

The overnight fireworks out of China’s interbank market, which saw a surge in repo and Shibor rates (O/N +78 to 5.23%, 1 Week +64.6 to 5.59%) once more following the lack of a follow through reverse repo as described previously, and once again exposed the rogue gallery of sellside “analysts” as clueless penguins all of whom predicted a quick resumption of Chinese interbank normalcy, did absolutely nothing to make the San Diego’s weatherman‘s forecast of the overnight Fed-driven futures any more difficult: “stocks will be… up. back to you.” And so they were, despite as DB puts it, “yesterday saw another round of slightly softer US data that helped drive the S&P 500 and Dow Jones to fresh highs” and “the release of weaker than expected Japanese IP numbers hasn’t dampened sentiment in Japanese equities” or for that matter megacorp Japan Tobacco firing 20% of its workforce – thanks Abenomics. Ah, remember when data mattered? Nevermind – long live and prosper in the New Normal.

Heading into US trading, today the markets will be transfixed by the FOMC announcement at 2 pm, which will likely say nothing at all (although there is a chance for a surprise – more shortly), and to a lesser extent the ADP Private Payrolls number, which as many have suggested, that if it prints at 0 or goes negative, 1800 on the S&P is assured as early as today.

On today’s US docket

  • US: MBA mortgage applications, cons (12:00)
  • US: ADP employment change 150k (13:15)
  • US: CPI m/m cons 0.2% (13:30)
  • US: FOMC rate decision, cons unch 0.25% (19:30)

Market Recap from Ransquawk

Despite the looming risk event (FOMC), credit spreads tightened and stocks traded higher, with oil & gas sector outperforming following earnings from ENI. In spite of supply from Italy and Germany, Bunds also traded higher, supported by the positive NCR, with coupons & redemptions coming from Spain and Italy this week.  Italy successfully sold EUR 6bln in 5 and 10y BTPs, while German raised EUR 3.413bln in 2% 2023.

In terms of macroeconomic releases this morning, German joblessness rose to its highest level since June 2011 in October, but the unemployment rate remained close to its lowest level since reunification. Going forward, market participants will get to digest the release of the latest ADP Employment Change, CPI report for the month of September and also await the outcome of the FOMC meeting. On the corporate front, Visa, GM, Facebook and Starbucks are set to report earnings today.

Overnight bulletin recap from Bloomberg and RanSquawk

  • EU’s Rehn sees a quite broad-based economy recovery in Europe and said that rapid initial fiscal tightening was essential in crisis and that Europe can now afford slower fiscal consolidation.
  • Apart from another round of earnings and a slew of macroeconomic releases, market participants will await FOMC rate decision due out later today.
  • Treasuries gain before Fed’s two-day policy meeting ends in Washington, statement due at 2pm, and as week’s $96b note auctions conclude with $29b 7Y notes.
  • Fed expected to leave asset purchases unchanged at $45b in Treasuries, $40b in MBS; for roundup of views
  • 7Y to be sold today yield 1.890% in WI trading; drew 2.058% in Sept. after 2.21% in August, highest in two years. 5Y notes sold yesterday drew 1.300%, near 1pm WI level
  • ECB says euro-area banks expect to ease credit standards on loans to companies in 4Q, the first such expectation since 4Q 2009; also said banks expect to ease standards on consumer credit and mortgages in 4Q
  • China’s yuan fell for a fourth day, the longest losing streak since July, as the central bank cut the currency’s reference rate amid a rally in the dollar
  • Sovereign yields mostly lower, EU peripheral spreads widen. Nikkei +1.2%, leading Asian equities higher; European stocks, U.S. equity-index futures gain. WTI crude lower; gold and copper rise

Asian Headlines

Movements in Chinese money market rates reflect temporary liquidity shortage and the PBOC is not tightening policy by limiting interbank funding, according to a unidentified person from the PBOC.

China’s overnight repo weighted average rate hit highest since June at 5.28%, whilst the 7 day repo weighted average rate also hit highest since June at 5.68%.

Japanese Industrial Production (Sep P) M/M 1.5% vs. Exp. 1.8% (Prev. -0.9%); Y/Y 5.4% vs. Exp. 5.5% (Prev. -0.4%)

The BoJ is likely to raise FY 2014 Japan GDP forecast from 1.3% on government stimulus measures.

EU & UK Headlines

EU’s Rehn sees a quite broad-based economy recovery in Europe and said that rapid initial fiscal tightening was essential in crisis and that Europe can now afford slower fiscal consolidation.

German Unemployment Change (000’s) (Oct) M/M 2k vs. Exp. 0k (Prev. 25k, Rev. 24k)
German Unemployment Rate (Oct) M/M 6.90% vs. Exp. 6.90% (Prev. 6.90%)
German CPI – Saxony (Oct) Y/Y 1.1% (Prev. 1.5%)
German CPI – Hesse (Oct) Y/Y 0/9% (Prev. 1.1%)
German CPI – Bavaria (Oct) Y/Y 1.0% (Prev. 1.4%)
German CPI – Brandenburg (Oct) Y/Y 1.2% (Prev. 1.3%)
German CPI – North Rhine Westphalia (Oct) Y/Y 1.4% (Prev. 1.5%)

Eurozone Business Climate Indicator (Oct) M/M -0.01 vs. Exp. -0.19 (Prev. -0.20, Rev. -0.19)

BoE governor Carney said 7% unemployment threshold right time to adjust policy. Carney said won’t tighten policy until recovery is sustained. Carney added that the UK’s recovery was being driven by the housing market.

Germany sells EUR 3.413bln in 2% 2023 Bund Auction, b/c 1.7 (Prev. 1.3) and avg. yield 1.71% (Prev. 1.79%), retention 14.6% (Prev. 18.8%)

Italian bond auction results, sells EUR 6bln vs. Exp. EUR 6bln
– Sells EUR 3bln in 3.50% 01/18, b/c 1.65 (Prev. 1.43) and avg. yield 2.89% (Prev. 3.38%)
– Sells EUR 3bln in 4.50% 03/24, b/c 1.53 (Prev. 1.38) and avg. yield 4.11% (Prev. 4.50%)

Barclays month-end extension: Euro Agg +0.08y
Barclays month-end extension: Sterling Agg +0.02y

US Headlines

A handful of Democratic senators, many facing tough elections in conservative states next year, are beginning to echo longstanding Republican demands for delays and other technical changes in the law, including to the individual mandate that will impose a tax penalty on every uninsured American beginning
next year.

Equities

Looming risk event failed to dent investor appetite for risk and instead stocks traded higher, with oil & gas sector outperforming following an impressive earnings report from ENI. Elsewhere, Barclays shares also rose after the bank reported inline with exp. adjusted pretax profits, while also noting that the amount that it has set aside to pay compensation for mis-sold personal protection insurance is unchanged at GBP 3.95bln.

FX

EUR/USD and GBP/USD traded steady this morning, with GBP/USD moving back towards its 21DMA line as market participants refrained from committing ahead of the key FOMC rate decision later on today.

Combination of higher gold prices, together with touted demand from Asian central bank saw AUD/USD trend higher overnight in Asia and in Europe this morning. Technically, upside resistance level is seen at the 21DMA line.

Commodities

Gold on the spot
market is cheaper in Shanghai than in London for the first time in 2013,
afte
r trading at a premium for most of the year. In fact, the premium
had widened in April to USD 30 a troy ounce as tumbling prices prompted a
rush of buying by Chinese consumers and investors.

China’s
alumina capacity may rise to to 60mln tonnes by end of 2013 57.2mln
tonnes in 2012, according to Chalco’s Zhengzhou research alumina
division director Yin.

Senator Menendez has said that new
sanctions are to be debated in the Senate that will halve Iran’s oil
sales by around 500,000bpd. However, analysts have said that these
measures are unrealistic.

Rosneft have asked Russian President Vladimir Putin to sell the states 20% holding in the Novorossiisk Commmercial Sea Port to the Russian oil producer.

SocGen summarizes the key macro catalysts of the day

The outcome of the FOMC meeting today should be straightforward, with no change expected to the current asset purchase rate of USD85bn per month thanks to sluggish US economic data and a H2 drag on growth due to the government shutdown. There is no press conference, or for that matter even economic projections, planned after the FOMC meeting ends. So, from where will the markets take their cue, given the certainty in the status quo? Every wording in the outlook statement will be carefully scrutinised by the markets to discern how the Fed’s thinking has evolved after the recent softness in the labour market as well as the added uncertainty that the federal shutdown has induced. As a result, the FOMC minutes due to be released on 20 November will be of greater importance, and the markets will weigh the probability of tapering starting based on statements from Fed speakers in the interim. Profit taking and positioning ahead of the FOMC meeting have meant that the USD cut some losses vs most G10 counterparts yesterday. The Aussie remained the worst performer within the G10 space, registering a ~0.8% drop after RBA Governor Stevens commented that it will be “materially lower” than it is today. The rates markets, however, were calm as 10y treasuries continued to swing between gains and losses, with 10y rates ranging between 2.50% to 2.53%.

Ahead of the seminal FOMC outcome tonight, we have the KOF leading indicator from Switzerland, German unemployment and CPI data as well as consumer confidence data from the eurozone. In the US, we also have MBA mortgage applications, ADP employment and CPI data.

Within emerging markets, China continues to hog the limelight, as a cash injection of CNY13bn seemed to be insufficient to pull down the benchmark 7-day repo rate below 5%. By resetting the 7-day reverse repos at 4.1% (up 20bps) vs the 3.9% that was being offered at previous auctions since mid August, is the PBOC hinting at an upcoming mild tightening?

DB’s Jim Reid complete the overnight event walkthrough.

Aside from the FOMC, today will also see the release of the October ADP employment report which has become an increasingly good guide to payrolls over the last few months. DB’s Joe Lavorgna points out that since October 2012, when the vendor responsible for compiling the ADP survey changed from Macroeconomic Advisors to Moody’s, the absolute forecast miss between ADP and private payrolls has been just 38k. Looking just at the last six months to September, the average discrepancy between the two surveys has been around 36k on an absolute basis, including a couple of recent months (June and August) where the two measures were virtually the same. For the record, the consensus is expecting today’s ADP report to show a +150k gain, lower than last month’s +166k result. At the moment, Bloomberg consensus is pointing to a +155k gain in next week’s BLS private payrolls, and just a 115k gain in nonfarm payrolls (though these estimates will probably get revised after today’s ADP). The ADP report is due before the opening bell in New York, which will set the tone for trading before we get to the FOMC later in the day.

Overnight markets are trading with a positive tone across the board led by the TOPIX (+0.8%) and Hang Seng (+1.0%). The release of weaker than expected Japanese IP numbers (1.5% MoM vs 1.8% expected) hasn’t dampened sentiment in Japanese equities, and a strong gain in USDJPY (+0.5%) is probably helping. The Chinese seven day repo rate continues to climb (+45bp to 5.85%) after yesterday’s small RMB13bn liquidity injection by the PBoC was seen as mostly a symbolic move. Market chatter continues to suggest that the PBoC is attempting to limit recent consumer and house price inflation while others are attributing the recent money market rate rises to month-end effects and corporate tax payments. The rise in the repo rate hasn’t stopped A-shares from posting solid gains (+1.0%) today. Elsewhere S&P500 futures are flat, after a strong run late yesterday.

Indeed yesterday saw another round of slightly softer US data that helped drive the S&P 500 (+0.6%) and Dow Jones (+0.7%) to fresh highs. European markets started off on a weaker footing, after a number of earnings misses from banks saw financial stocks struggle at the open. The sentiment improved later in the day, thanks to stronger earnings from the likes of BP. Indeed, the DAX (+0.48%) managed to break above the 9000 mark for the first time in the minutes before the close. The positive sentiment was evident across asset classes including credit where the European senior and sub financials indices grinded to new series tights. In the UK, there is increasing market chatter about what the Chancellor will decide in terms of RBS’ problem assets. RBS subordinated paper continues to be better bid, perhaps on reports that Osborne will avoid a breakup of the group.

Yesterday’s US dataflow supported those arguing for a later start to the taper. US retail sales for September were down 0.1% MoM (vs 0% expected) and retail sales ex auto and gas were up 0.4%, lower than the 0.5% expected. On the inflation side, September PPI was lower than expectations in the headline (- 0.1% vs. +0.2% expected). Consumer confidence for October dropped sharply to 71.2 (vs 75.0 expected, 79.7 previous) probably due to the impact of the fiscal standoff in Washington. Most surprising of all was the gain in the USD (dollar index +0.46%) which strengthened in spite of the weaker than expected US data. This weighed on EURUSD (-0.3%) which had its sharpest fall in three weeks. Treasuries traded in a tight range between 2.50% to 2.53%. An uneventful 5yr UST auction helped 10yr yields close at 2.50%, not far from where they are trading this morning.

Today will be mostly about the FOMC announcement and the ADP employment report. Ahead of that, German CPI and unemployment data will be released together with the Spanish preliminary Q3 GDP report. It will be a busy day on the government bond calendar with new Italian 5 & 10yr, German 10yr and 7yr UST supply. In the US, the other data releases of note are the monthly budget statement and CPI (consensus 0.2% MoM vs 0.1% in August). General Motors reports earnings today before the opening bell – its always interesting to hear management’s views on global demand, particularly in light of Ford’s upbeat assessment last week.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/2X2P573gO6M/story01.htm Tyler Durden

Obamacare Data Hub Crashes For Second Time In Three Days, Verizon Blamed Again

The first and last time a critical data center for Obamacare crashed this past Sunday night, leading to healthcare.gov becoming completely inaccessible and thus halting enrollment (assuming there had been any in the first place but of course allowing the government to blame any lack thereof on Verizon), we said “whether or not Verizon fixes the glitch any time soon, or merely lets it linger, one thing is becoming obvious: the Obamacare delay, which was hard fought by the Teaparty, and which was so opposed by the administration leading to the grotesque 16 day government shutdown, has all but become a reality with every passing day. Only instead of someone actually taking responsibility, said delay will be scapegoated on Verizon’s data centers, faulty fiber-optic and copper cables, Cisco switches, Syrian hackers, millions of lines of faulty (Fortran?) code, inept contractors, end users who never read the Help.doc file, and everyone and everything else. Just never the government itself.” Once again, we were proven correct when overnight the Connecticut state healthcare exchange, “Access Health CT”, announced that the Obamacare data hub was “experiencing an outage” on Tuesday evening. The culprit – Verizon once again. Which answered our question: not Syrian hackers or Cisco but, conveniently, Verizon Terremark.

Conveniently, because recall which company was first implicated in the avalanche of Edward Snowden revelations – why Verizon, which before the NSA disclosure, was first said to be the major communication interception hub used by the government. So when Obama asks the firm that gets unknown kickbacks from the government for providing private client data to the NSA, to take one for the team, well… Verizon promptly obliges.

More on this hilarious “coincidence” from Reuters:

“Access Health CT was informed by CMS (Center for Medicare and Medicaid Services) that the Federal Data Services Hub is currently experiencing an outage,” a statement from the Connecticut state exchange said.

 

A similar outage on Sunday halted online enrollment on the federal Healthcare.gov website as well as similar state sites.

 

An official at the U.S. Department of Health and Human Services (HHS) acknowledged the Obamacare website had been impacted by the problem.

 

“Tonight, Verizon Terremark again experienced network issues in their data center that caused a system outage impacting the federal data services hub and the Healthcare.gov marketplace application,” the official, who asked not to be named, said in an email to Reuters.

 

“Verizon Terremark is conducting maintenance overnight to resolve their issue with our technical team and when that is complete we will bring our systems back online,” the official said.

 

Verizon’s Terremark operates the data services hub that links online health insurance marketplaces with numerous federal agencies and can verify people’s identity, citizenship, and other facts.

 

“We are now undertaking infrastructure maintenance, which should be complete overnight. We anticipate the strengthened infrastructure will help eliminate application downtimes,” said a statement by Jeff Nelson, vice president of global corporate communications at Verizon Enterprise Solutions.

 

“Verizon is committed to supporting our HHS client and stabilizing their www.healthcare.gov website. Since HHS asked us to provide additional compute and storage capacity, our engineers have worked 24/7 to trouble-shoot issues with the site,” the statement said.

And once the Verizon wildcard is used a few more time, ostensibly every single day allowing the Obama administration’s apparatchiks an explanatory loophole why Obamacare enrollment is in the single digits, then come the Syrian hackers of course.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/qekaV0IHJng/story01.htm Tyler Durden

Despite PBOC Liquidity, Chinese Repo Rates Blow-Out To 4-Month Wides

The last two weeks have seen US equity markets on a one-way path to the moon, breaking multi-year records in terms of rate of change and soaring to new all-time highs. However, away from the mainstream media's glare, another 'market' has been soaring – but this time it is not good news. Chinese overnight repo rates – the harbinger of ultimate liquidity crisis – have exploded from 6-month lows (at 2.5%) to 4-month highs (5.8% today). The PBOC even added liquidity for the first time in months yesterday (via Reverse Repo – at much higher than normal rates) but clearly, that was not enough and the banks are running scared once again that the re-ignition of the housing bubble in China will mean more than 'selective' liquidity restrictions.

“The surge in money rates and the very volatile intraday trading shows the market is totally confused about the PBOC’s intentions,” says Frances Cheung, Hong Kong-based rate strategist at Credit Agricole CIB. “The central bank’s reverse-repo operations yesterday are deemed not enough by the market.”

It would seem yesterday's reverse repo – at considerably higher than normal rates – was a shot across the bow of Chinese banks that the liquidity spigot may not be as open they hoped.

As MNI reports, the 1Y Chinese Treasuries went off at 4.01%, significantly higher than market rates at 3.8% and were only 1.22 times oversubscribed (as opposed to a more normal 2x).

Traders said demand was weak because liquidity is tight on end-of-month squeeze…

 

Is the Fed finally getting to China?

 

As we noted previously,

Naturally, it is not rocket science that the only reason why China is growing at its current pace is because it is once again injecting record amount of liquidity into the system, and if the credit spigot is open, the country grows; if it's shut – it stagnates, as we described in "China: No Leverage, No Growth."

But a far bigger problem is that while China's debt is already at record levels, it needs an increasingly greater "credit impulse" to generate the same or smaller amount of GDP "growth" as before, a phenomenon we described in April.

The nation’s debt-to-GDP ratio, excluding central government and financial debt, widened to 207 percent as credit growth continued to outpace productivity gains, Mike Werner, an analyst at Sanford C. Bernstein & Co. in Hong Kong, wrote in an Oct. 21 note to clients. That’s making investors nervous about bad loans rising at banks, he said.

But while banks are finally starting to catch up to the reality that their balance sheets are woefully unprepared for what may be an epic superbubble house of cards crashing on everyone's head, a key issue is that the price discovery process of insolvent entities in China is simply non-existent.

 

Which all ties rather nicely into Michael Pettis recent note that China's hidden debts still need to paid…


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Y1vtYkFsn5c/story01.htm Tyler Durden

The Second Dot-Com Bubble Is Raging, But "This Time Is Different"

“It’s gotten pretty frothy,” is how one portfolio manager describes the behavior in internet-based companies currently as signs of pre-2000 exuberance can be seen in Silicon Valley and the nearby area. As WSJ reports, home prices in San Francisco and surrounding counties rose more than 15% in the past year. Office rents in San Francisco are 23% above their 2008 peak. As SnapChat, Pinterest, and Twitter are set to join such illustrious names as RocketFuel; asset managers are careful to remind suckers investors that it’s not at all like 1999 – companies going public are more mature, the leadership teams more seasoned, the business models more proven – but the “reach for growth” at all costs echoes Kyle Bass’ remarks that “financial memory is no longer than two years,” with even younger and more revenue-deprived companies come to market at massively elevated multiples.

 

 

Via WSJ,

“It’s gotten pretty frothy,” says Daniel Cole, a senior portfolio manager at Manulife Asset Management who has invested in highflying IPOs, including for Rocket Fuel Inc. The Redwood City, Calif., online-advertising company sold shares to the public last month at $29 each. They traded at $61.72 a share Friday, giving Rocket Fuel a market valuation of $2 billion, without having recorded a profit.

 

 

Technology and finance veterans say this time is different—and it is. Companies going public are more mature, the leadership teams more seasoned, the business models more proven. Social networks such as Twitter and Pinterest are drafting off the success of Facebook Inc., which sports a market value of $126.5 billion, or about 70 times next year’s expected earnings.

 

But the current surge is accelerating, aided by some little-appreciated factors. Big companies are scarcely growing, and interest rates remain near zero, boosting zeal for investment opportunities in companies with high-growth potential. Moreover, a federal law enacted last year will allow startups to raise money from smaller investors, opening a vast new pool of potential funding.

 

“People are reaching for growth,”

 

 

“The big difference now, is companies like LinkedIn, Twitter, Facebook have demonstrated an ability to generate sales, and with the exception of Twitter, profits,” Mr. Ritter says. In the dot-com days, “there were all sorts of companies going public that were essentially startups.”

 

But investor enthusiasm is filtering down to younger, less-proven companies today, too. Pinterest, an electronic-scrapbook service that began testing ads this month, said Wednesday that it had raised $225 million from venture-capital firms. Pinterest didn’t need the money; the company said it hadn’t spent any of the $200 million it raised in February when it was valued at $2.5 billion.

 

The new investment values the three-year-old company at $3.8 billion, a 52% jump in eight months.

 

Snapchat, a two-year-old mobile-messaging service popular with teens, is considering raising up to $200 million at a valuation exceeding $3 billion, people briefed on the matter said Friday. That would be more than triple the valuation that venture firms placed on Snapchat in June, when it raised $60 million.

 

 

Another factor: Last year’s Jumpstart Our Business Startups Act soon will make it easier for less-wealthy individual investors to back startups. Already, the law has made it easier for financiers to pool money from individuals.

 

Some people worry that the looser rules may end up hurting small investors.

 

 

As less-sophisticated investors jump into backing embryonic companies, “the odds aren’t in those people’s favor,” he says. A lot of those companies will fail, “then all of a sudden all you have is a piece of paper to stick on the wall.”


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/jFJmmt7_ZUw/story01.htm Tyler Durden

The Second Dot-Com Bubble Is Raging, But “This Time Is Different”

“It’s gotten pretty frothy,” is how one portfolio manager describes the behavior in internet-based companies currently as signs of pre-2000 exuberance can be seen in Silicon Valley and the nearby area. As WSJ reports, home prices in San Francisco and surrounding counties rose more than 15% in the past year. Office rents in San Francisco are 23% above their 2008 peak. As SnapChat, Pinterest, and Twitter are set to join such illustrious names as RocketFuel; asset managers are careful to remind suckers investors that it’s not at all like 1999 – companies going public are more mature, the leadership teams more seasoned, the business models more proven – but the “reach for growth” at all costs echoes Kyle Bass’ remarks that “financial memory is no longer than two years,” with even younger and more revenue-deprived companies come to market at massively elevated multiples.

 

 

Via WSJ,

“It’s gotten pretty frothy,” says Daniel Cole, a senior portfolio manager at Manulife Asset Management who has invested in highflying IPOs, including for Rocket Fuel Inc. The Redwood City, Calif., online-advertising company sold shares to the public last month at $29 each. They traded at $61.72 a share Friday, giving Rocket Fuel a market valuation of $2 billion, without having recorded a profit.

 

 

Technology and finance veterans say this time is different—and it is. Companies going public are more mature, the leadership teams more seasoned, the business models more proven. Social networks such as Twitter and Pinterest are drafting off the success of Facebook Inc., which sports a market value of $126.5 billion, or about 70 times next year’s expected earnings.

 

But the current surge is accelerating, aided by some little-appreciated factors. Big companies are scarcely growing, and interest rates remain near zero, boosting zeal for investment opportunities in companies with high-growth potential. Moreover, a federal law enacted last year will allow startups to raise money from smaller investors, opening a vast new pool of potential funding.

 

“People are reaching for growth,”

 

 

“The big difference now, is companies like LinkedIn, Twitter, Facebook have demonstrated an ability to generate sales, and with the exception of Twitter, profits,” Mr. Ritter says. In the dot-com days, “there were all sorts of companies going public that were essentially startups.”

 

But investor enthusiasm is filtering down to younger, less-proven companies today, too. Pinterest, an electronic-scrapbook service that began testing ads this month, said Wednesday that it had raised $225 million from venture-capital firms. Pinterest didn’t need the money; the company said it hadn’t spent any of the $200 million it raised in February when it was valued at $2.5 billion.

 

The new investment values the three-year-old company at $3.8 billion, a 52% jump in eight months.

 

Snapchat, a two-year-old mobile-messaging service popular with teens, is considering raising up to $200 million at a valuation exceeding $3 billion, people briefed on the matter said Friday. That would be more than triple the valuation that venture firms placed on Snapchat in June, when it raised $60 million.

 

 

Another factor: Last year’s Jumpstart Our Business Startups Act soon will make it easier for less-wealthy individual investors to back startups. Already, the law has made it easier for financiers to pool money from individuals.

 

Some people worry that the looser rules may end up hurting small investors.

 

 

As less-sophisticated investors jump into backing embryonic companies, “the odds aren’t in those people’s favor,” he says. A lot of those companies will fail, “then all of a sudden all you have is a piece of paper to stick on the wall.”


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/jFJmmt7_ZUw/story01.htm Tyler Durden

Michael Pettis Cautions China's Hidden Debt Must Still Be Repaid

Debt always matters because it must always be paid for by someone – even if the borrower defaults, of course, the debt is simply “paid” by the lender. As China Financial Markets' Michael Pettis notes, this is why the fact that debt in China seems to be growing much faster than debt-servicing capacity implies slower growth in the future. The author of "Avoiding The Fall", explains that if the debt cannot be fully serviced by the increase in productivity created by the investment that the debt funded, unless it is funded by liquidating state sector assets it must cause a reduction in demand elsewhere, most probably in household consumption. Therefore, in spite of all the hope among global stock-buying hope-mongers, this reduction in demand implies slower growth in the future and, of course, a more difficult rebalancing process.

 

Via Michael Pettis of China Financial Markets,

Five or six years ago, a few skeptics first started pointing out that the credit dynamics underlying Chinese growth was creating an unsustainable increase in debt. This, they warned, would ultimately undermine the banking system and cause growth to collapse if it were not addressed in time.

There were three standard rejoinders to the warnings.

First, analysts argued that investment was not being misallocated, and because credit growth poured mostly into investment, it did not therefore follow, as the skeptics argued, that debt was rising faster than debt servicing capacity. Although I think few analysts still support this argument, there remain some analysts who do not think China has an overinvestment problem. For example my Carnegie colleague Yukon Huang, who has argued, for example in one of the FT blogs that China is actually underinvested:

The perception that China has invested too much is also misleading. Actually, China’s capital stock relative to GDP is lower than other comparable east Asian countries. Moreover, much of the surge in investment over the past decade is due to housing construction, where the country is still making up for the shortfalls from the Mao era.

Because I have addressed this issue many times before in my newsletters, especially the common and distressingly ahistorical fallacy that one can determine whether a very poor country like China is over- or under-invested by comparing its capital stock per capita to more advanced countries with much higher levels of social capital and the consequent ability to absorb investment efficiently, I will not do so again. Needless to say, I think that the evidence of investment misallocation has continued to rise, and in the past two years the number of analysts that are not worried about a systematic tendency for debt to rise faster than debt-servicing capacity has dropped significantly. I have no doubt that their refusal to accept the consensus on the subject is useful in that it helps sharpen the debate, but this is a losing battle and, like the capital stock argument, distressingly ahistorical.

The second rejoinder, which has also largely faded away as an argument over the past few years, is that debt in China doesn’t matter. Sometimes, these analysts argue, it doesn’t matter because it is funded domestically. Sometimes it doesn’t matter because the banks are implicitly guaranteed by the central government. Sometimes it doesn’t matter because China was able to resolve its last debt crisis, 10-15 years ago, in an environment of rapid growth and at no cost, and so of course it can do so again.

Again I have addressed all of these arguments as to why debt doesn’t matter in China many times before and it is pretty easy to show that all of these claims are fairly nonsensical, and this is especially obvious from the very wide range of historical precedents. Debt always matters. Either it must be repaid out of the proceeds of the investment that was funded by the debt, or – if the debt funded consumption or was misallocated into insufficiently productive investments – it must be repaid by transfers from some other sector of the economy, and these transfers reduce growth by reducing real demand.

The third rejoinder should have been, in principle, the easiest to refute, and for a while it looked like it had been refuted to everyone’s satisfaction, but in the past year I have seen a revival. China doesn’t have to worry about rising bad debts in its banking sector, according to this argument, because the PBoC’s extensive reserves will make it easy to recapitalize the banks.

Ray Chan, of the South China Morning Post, for example, had an interesting article last Saturday that made this point. He starts off the article by warning that the rapid growth in credit in China has uneasy parallels with rapid credit growth in the US before the 2007 crisis:

Parallels between the United States and China have started to look more ominous after several years of rampant credit growth and the emergence of an increasingly uncontrollable and unsustainable shadow banking system. China’s massive foreign reserves could, however, be the last tool in the bag for its bank-centric financial system if no timely regulations are implemented.

 

With the memory of the collapse of Lehman Brothers in 2008 still fresh, investors are fretting over the growth of thinly regulated shadow banking activity. Trusts, entrusted loans and bank acceptance bills shot up sharply to a record 294 billion yuan (HK$370 billion) last month. According to Moody’s Analytics, China’s core shadow banking products, which are often opaque and subject to little or no regulation, almost doubled to 20.5 trillion yuan last year from 11.7 trillion yuan in 2010. The US firm excludes entrusted loans and trust loans as they own underlying assets.

Debt and reserves

The article does a good job of listing many of the problems that have emerged in the past few years, but then quotes a number of analysts who argue that China’s problems is very different from that of the US and it is unlikely to suffer the same kind of crisis. The article continues:

China’s credit situation is somewhat different, though, as it has a high saving rate and massive foreign reserves. Mervyn Davies, a former head of Standard Chartered and British government minister, said: “China is very rich in reserves … At the end of the day, the [Chinese] banks do need recapitalising, which is not a huge challenge to them because the government can recapitalise the banks.”

I agree that China is in a very different position than the US, but this isn’t necessarily a good thing. The main relevant difference is that because all the banks are perceived to be guaranteed by the central government, and Chinese households have a limited number of ways to save outside the banking system, it is unlikely that China will experience a system-wide bank run as long as the credibility of the guarantee survives, and runs on individual banks can be resolv
ed by regulatory fiat (banks that receive deposits will be forced to lend to banks that lose deposits). We are not likely to see a Lehman-style crisis.

We are also not likely to see, however, the advantages of a Lehman-style crisis, and these are a relatively quick adjustment in the process of investment misallocation. I have always said that the resolution of the Chinese banking problems is far more likely to resemble that of Japan than the US, and instead of three of four chaotic years as the system adjusts quickly, and at times violently, we are more likely to see a decade or more of a slow grinding-away of the debt excesses. The net economic cost is likely to be higher in a Japanese-style rebalancing, but American-style rebalancing is risky except in countries with very flexible institutions – financial as well as political.

But I do disagree very strongly with Mervyn Davies’ claim that because the PBoC is “very rich in reserves” it will not be much of a challenge to recapitalize the banks. China’s reserves only matter to its credit position if China faced a problem of external debt.

It doesn’t, and so the amount of reserves are almost wholly irrelevant, because this argument seems to be reviving, it makes sense, I think, to repeat why central bank reserves cannot in any way help China resolve the crisis. I will leave aside the problems of whether the reserves are transferred in the form of foreign currency, in which case it does little to satisfy domestic RMB-denominated funding needs, or in RMB, in which case the PBoC must stop buying dollars in order to hold down the value of the RMB and in fact must sell dollars, which would cause the value of the RMB to soar, thereby wiping out the export sector in China.

A much more important objection is that the idea that reserves can be used to clean up the banks (or anything else, for that matter) is based on a misunderstanding about how the reserves were accumulated in the first place. There seems to be a still-widespread perception that PBoC reserves represent a hoard of unencumbered savings that the PBoC has somehow managed to collect.

But of course they are not. The PBoC has been forced to buy the reserves as a function of its intervention to manage the value of the RMB. And as they were forced to buy the reserves, the PBoC had to fund the purchases, which it did by borrowing RMB in the domestic market.

This means that the foreign currency reserves are simply the asset side of a balance sheet against which there are liabilities. What is more, remember that the RMB has appreciated by more than 30% since July, 2005, so that the value of the assets has dropped in RMB terms even as the value of the liabilities has remained the same, and this has been exacerbated by the lower interest rate the PBoC currently earns on its assets than the interest rate it pays on much of its liabilities.

In fact there have been rumors for years that the PBoC would be insolvent if its assets and liabilities were correctly marked, but whether or not this is true, any transfer of foreign currency reserves to bail out Chinese banks would simply represent a reduction of PBoC assets with no corresponding reduction in liabilities. The net liabilities of the PBoC, in other words, would rise by exactly the amount of the transfer. Because the liabilities of the PBoC are presumed to be the liabilities of the central government, the net effect of using the reserves to recapitalize the banks is identical to having the central government borrow money to recapitalize the banks.

This is the point. Any government that is able to borrow money can borrow money to recapitalize its banks, whether or not it has large amounts of foreign currency reserves. The amount of central bank reserves that China or any other country has is wholly irrelevant, except perhaps to the extent that without those reserves the central government would lack the credibility to borrow domestically, which hardly seems to be a concern in China’s case.

Bailing out the banks, it turns out, is conceptually no different than transferring debt from the banks to the central government. China can handle bad debts in the banking system, in other words, by transferring the net obligations from the banks to the central government, and the large hoard of reserves held by the PBoC does not make it any easier for China can resolve any future debt problems. In fact if anything it should remind us that when we are trying to calculate the total amount of debt the central government owes, the total should include any net liabilities of the PBoC, and that these net liabilities will increase by 1% of GDP every time the RMB strengthens against the dollar by 2%.

Does hidden debt matter?

Before finishing on this topic, I want to address another related fallacy that pops up a surprisingly large number of times when I discuss the net liabilities of the central bank. I am often told that because these liabilities are hidden in the central bank books, and so no one really knows how much debt the PBoC adds to the central government’s debt burden, they really shouldn’t matter in our calculations. The central bank will presumably never default because its obligations are guaranteed by the central government, and the its net liability position is hidden, so why bother even consider the PBoC’s balance sheet when assessing China’s debt position?

Even those who do not understand why this reasoning is incorrect should know that it must obviously be incorrect. If it weren’t, any country could solve all of its debt problems merely by borrowing in a non-transparent way through the central bank. As the Greeks and the Italians most recently showed us, non-transparent borrowing may cause us to recognize a problems later than we otherwise would have, but it cannot solve the problem.

The reason is because in any case debt must either be serviced or the borrower must default. If the assets which were funded by the debt do not create enough wealth with which to service the debt, and if the borrower does not default, then by definition there must have been a transfer from some other entity to cover the difference between the debt servicing cost and the returns on the asset.

Typically this other entity, in China and elsewhere, has been the household sector, and in the case of China the transfer occurred primarily in the hidden form of severely repressed interest rates. Whether the transfer is from the household sector, however, of from other sector, this is where the problem of debt lies for China.

If the central bank (or the commercial banks or any other borrower whose obligations are covered by the central government) is unable to service its debt – and remember that the “economic” debt servicing cost is not the coupon, which is repressed by policymakers, but consists of whatever the “natural” interest rate would have been – the difference will be paid for by someone else, and the economy will suffer slower growth because of the reduction in demand caused by the transfer payment.

So who is likely to cover the cost of NPLs in Chinese banks? This isn’t an easy question to answer. If the household sector continues to pay, either in the hidden form of repressed interest rates, or in the more explicit form of taxes, the existence of bad debt in the Chinese banking system must act to repress future household consumption growth. The transfers from the household sector to pay what may turn out to be a huge NPL bill will significantly lower the household income share of GDP, making it very unlikely that the household consumption share of GDP will rise.

If however the state sector covers the difference (perhaps by privatizin
g state assets and using the proceeds to pay down debt), we are left with the very difficult political problems
, which China currently faces, of assigning the costs to different sectors or groups that control the state sector in China. The potentially very large cost of cleaning up NPLs must be assigned to groups that are likely to be both powerful and reluctant to pay the cost.

Debt always matters because it must always be paid for by someone –even if the borrower defaults, of course, the debt is simply “paid” by the lender. This is why the fact that debt in China seems to be growing much faster than debt-servicing capacity implies slower growth in the future. If the debt cannot be fully serviced by the increase in productivity created by the investment that the debt funded, unless it is funded by liquidating state sector assets it must cause a reduction in demand elsewhere, most probably in household consumption. This reduction in demand implies slower growth in the future and, of course, a more difficult rebalancing process.


    



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Michael Pettis Cautions China’s Hidden Debt Must Still Be Repaid

Debt always matters because it must always be paid for by someone – even if the borrower defaults, of course, the debt is simply “paid” by the lender. As China Financial Markets' Michael Pettis notes, this is why the fact that debt in China seems to be growing much faster than debt-servicing capacity implies slower growth in the future. The author of "Avoiding The Fall", explains that if the debt cannot be fully serviced by the increase in productivity created by the investment that the debt funded, unless it is funded by liquidating state sector assets it must cause a reduction in demand elsewhere, most probably in household consumption. Therefore, in spite of all the hope among global stock-buying hope-mongers, this reduction in demand implies slower growth in the future and, of course, a more difficult rebalancing process.

 

Via Michael Pettis of China Financial Markets,

Five or six years ago, a few skeptics first started pointing out that the credit dynamics underlying Chinese growth was creating an unsustainable increase in debt. This, they warned, would ultimately undermine the banking system and cause growth to collapse if it were not addressed in time.

There were three standard rejoinders to the warnings.

First, analysts argued that investment was not being misallocated, and because credit growth poured mostly into investment, it did not therefore follow, as the skeptics argued, that debt was rising faster than debt servicing capacity. Although I think few analysts still support this argument, there remain some analysts who do not think China has an overinvestment problem. For example my Carnegie colleague Yukon Huang, who has argued, for example in one of the FT blogs that China is actually underinvested:

The perception that China has invested too much is also misleading. Actually, China’s capital stock relative to GDP is lower than other comparable east Asian countries. Moreover, much of the surge in investment over the past decade is due to housing construction, where the country is still making up for the shortfalls from the Mao era.

Because I have addressed this issue many times before in my newsletters, especially the common and distressingly ahistorical fallacy that one can determine whether a very poor country like China is over- or under-invested by comparing its capital stock per capita to more advanced countries with much higher levels of social capital and the consequent ability to absorb investment efficiently, I will not do so again. Needless to say, I think that the evidence of investment misallocation has continued to rise, and in the past two years the number of analysts that are not worried about a systematic tendency for debt to rise faster than debt-servicing capacity has dropped significantly. I have no doubt that their refusal to accept the consensus on the subject is useful in that it helps sharpen the debate, but this is a losing battle and, like the capital stock argument, distressingly ahistorical.

The second rejoinder, which has also largely faded away as an argument over the past few years, is that debt in China doesn’t matter. Sometimes, these analysts argue, it doesn’t matter because it is funded domestically. Sometimes it doesn’t matter because the banks are implicitly guaranteed by the central government. Sometimes it doesn’t matter because China was able to resolve its last debt crisis, 10-15 years ago, in an environment of rapid growth and at no cost, and so of course it can do so again.

Again I have addressed all of these arguments as to why debt doesn’t matter in China many times before and it is pretty easy to show that all of these claims are fairly nonsensical, and this is especially obvious from the very wide range of historical precedents. Debt always matters. Either it must be repaid out of the proceeds of the investment that was funded by the debt, or – if the debt funded consumption or was misallocated into insufficiently productive investments – it must be repaid by transfers from some other sector of the economy, and these transfers reduce growth by reducing real demand.

The third rejoinder should have been, in principle, the easiest to refute, and for a while it looked like it had been refuted to everyone’s satisfaction, but in the past year I have seen a revival. China doesn’t have to worry about rising bad debts in its banking sector, according to this argument, because the PBoC’s extensive reserves will make it easy to recapitalize the banks.

Ray Chan, of the South China Morning Post, for example, had an interesting article last Saturday that made this point. He starts off the article by warning that the rapid growth in credit in China has uneasy parallels with rapid credit growth in the US before the 2007 crisis:

Parallels between the United States and China have started to look more ominous after several years of rampant credit growth and the emergence of an increasingly uncontrollable and unsustainable shadow banking system. China’s massive foreign reserves could, however, be the last tool in the bag for its bank-centric financial system if no timely regulations are implemented.

 

With the memory of the collapse of Lehman Brothers in 2008 still fresh, investors are fretting over the growth of thinly regulated shadow banking activity. Trusts, entrusted loans and bank acceptance bills shot up sharply to a record 294 billion yuan (HK$370 billion) last month. According to Moody’s Analytics, China’s core shadow banking products, which are often opaque and subject to little or no regulation, almost doubled to 20.5 trillion yuan last year from 11.7 trillion yuan in 2010. The US firm excludes entrusted loans and trust loans as they own underlying assets.

Debt and reserves

The article does a good job of listing many of the problems that have emerged in the past few years, but then quotes a number of analysts who argue that China’s problems is very different from that of the US and it is unlikely to suffer the same kind of crisis. The article continues:

China’s credit situation is somewhat different, though, as it has a high saving rate and massive foreign reserves. Mervyn Davies, a former head of Standard Chartered and British government minister, said: “China is very rich in reserves … At the end of the day, the [Chinese] banks do need recapitalising, which is not a huge challenge to them because the government can recapitalise the banks.”

I agree that China is in a very different position than the US, but this isn’t necessarily a good thing. The main relevant difference is that because all the banks are perceived to be guaranteed by the central government, and Chinese households have a limited number of ways to save outside the banking system, it is unlikely that China will experience a system-wide bank run as long as the credibility of the guarantee survives, and runs on individual banks can be resolved by regulatory fiat (banks that receive deposits will be forced to lend to banks that lose deposits). We are not likely to see a Lehman-style crisis.

We are also not likely to see, however, the advantages of a Lehman-style crisis, and these are a relatively quick adjustment in the process of investment misallocation. I have always said that the resolution of the Chinese banking problems is far more likely to resemble that of Japan than the US, and instead of three of four chaotic years as the system adjusts quickly, and at times violently, we are more likely to see a decade or more of a slow grinding-away of the debt excesses. The net economic cost is likely to be higher in a Japanese-style rebalancing, but American-style rebalancing is risky except in countries with very flexible institutions – financial as well as political.

But I do disagree very strongly with Mervyn Davies’ claim that because the PBoC is “very rich in reserves” it will not be much of a challenge to recapitalize the banks. China’s reserves only matter to its credit position if China faced a problem of external debt.

It doesn’t, and so the amount of reserves are almost wholly irrelevant, because this argument seems to be reviving, it makes sense, I think, to repeat why central bank reserves cannot in any way help China resolve the crisis. I will leave aside the problems of whether the reserves are transferred in the form of foreign currency, in which case it does little to satisfy domestic RMB-denominated funding needs, or in RMB, in which case the PBoC must stop buying dollars in order to hold down the value of the RMB and in fact must sell dollars, which would cause the value of the RMB to soar, thereby wiping out the export sector in China.

A much more important objection is that the idea that reserves can be used to clean up the banks (or anything else, for that matter) is based on a misunderstanding about how the reserves were accumulated in the first place. There seems to be a still-widespread perception that PBoC reserves represent a hoard of unencumbered savings that the PBoC has somehow managed to collect.

But of course they are not. The PBoC has been forced to buy the reserves as a function of its intervention to manage the value of the RMB. And as they were forced to buy the reserves, the PBoC had to fund the purchases, which it did by borrowing RMB in the domestic market.

This means that the foreign currency reserves are simply the asset side of a balance sheet against which there are liabilities. What is more, remember that the RMB has appreciated by more than 30% since July, 2005, so that the value of the assets has dropped in RMB terms even as the value of the liabilities has remained the same, and this has been exacerbated by the lower interest rate the PBoC currently earns on its assets than the interest rate it pays on much of its liabilities.

In fact there have been rumors for years that the PBoC would be insolvent if its assets and liabilities were correctly marked, but whether or not this is true, any transfer of foreign currency reserves to bail out Chinese banks would simply represent a reduction of PBoC assets with no corresponding reduction in liabilities. The net liabilities of the PBoC, in other words, would rise by exactly the amount of the transfer. Because the liabilities of the PBoC are presumed to be the liabilities of the central government, the net effect of using the reserves to recapitalize the banks is identical to having the central government borrow money to recapitalize the banks.

This is the point. Any government that is able to borrow money can borrow money to recapitalize its banks, whether or not it has large amounts of foreign currency reserves. The amount of central bank reserves that China or any other country has is wholly irrelevant, except perhaps to the extent that without those reserves the central government would lack the credibility to borrow domestically, which hardly seems to be a concern in China’s case.

Bailing out the banks, it turns out, is conceptually no different than transferring debt from the banks to the central government. China can handle bad debts in the banking system, in other words, by transferring the net obligations from the banks to the central government, and the large hoard of reserves held by the PBoC does not make it any easier for China can resolve any future debt problems. In fact if anything it should remind us that when we are trying to calculate the total amount of debt the central government owes, the total should include any net liabilities of the PBoC, and that these net liabilities will increase by 1% of GDP every time the RMB strengthens against the dollar by 2%.

Does hidden debt matter?

Before finishing on this topic, I want to address another related fallacy that pops up a surprisingly large number of times when I discuss the net liabilities of the central bank. I am often told that because these liabilities are hidden in the central bank books, and so no one really knows how much debt the PBoC adds to the central government’s debt burden, they really shouldn’t matter in our calculations. The central bank will presumably never default because its obligations are guaranteed by the central government, and the its net liability position is hidden, so why bother even consider the PBoC’s balance sheet when assessing China’s debt position?

Even those who do not understand why this reasoning is incorrect should know that it must obviously be incorrect. If it weren’t, any country could solve all of its debt problems merely by borrowing in a non-transparent way through the central bank. As the Greeks and the Italians most recently showed us, non-transparent borrowing may cause us to recognize a problems later than we otherwise would have, but it cannot solve the problem.

The reason is because in any case debt must either be serviced or the borrower must default. If the assets which were funded by the debt do not create enough wealth with which to service the debt, and if the borrower does not default, then by definition there must have been a transfer from some other entity to cover the difference between the debt servicing cost and the returns on the asset.

Typically this other entity, in China and elsewhere, has been the household sector, and in the case of China the transfer occurred primarily in the hidden form of severely repressed interest rates. Whether the transfer is from the household sector, however, of from other sector, this is where the problem of debt lies for China.

If the central bank (or the commercial banks or any other borrower whose obligations are covered by the central government) is unable to service its debt – and remember that the “economic” debt servicing cost is not the coupon, which is repressed by policymakers, but consists of whatever the “natural” interest rate would have been – the difference will be paid for by someone else, and the economy will suffer slower growth because of the reduction in demand caused by the transfer payment.

So who is likely to cover the cost of NPLs in Chinese banks? This isn’t an easy question to answer. If the household sector continues to pay, either in the hidden form of repressed interest rates, or in the more explicit form of taxes, the existence of bad debt in the Chinese banking system must act to repress future household consumption growth. The transfers from the household sector to pay what may turn out to be a huge NPL bill will significantly lower the household income share of GDP, making it very unlikely that the household consumption share of GDP will rise.

If however the state sector covers the difference (perhaps by privatizing state assets and using the proceeds to pay down debt), we are left with the very difficult political problems, which China currently faces, of assigning the costs to different sectors or groups that control the state sector in China. The potentially very large cost of cleaning up NPLs must be assigned to groups that are likely to be both powerful and reluctant to pay the cost.

Debt always matters because it must always be paid for by someone –even if the borrower defaults, of course, the debt is simply “paid” by the lender. This is why the fact that debt in China seems to be growing much faster than debt-servicing capacity implies slower growth in the future. If the debt cannot be fully serviced by the increase in productivity created by the investment that the debt funded, unless it is funded by liquidating state sector assets it must cause a reduction in demand elsewhere, most probably in household consumption. This reduction in demand implies slower growth in the future and, of course, a more difficult rebalancing process.


    



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