Month: September 2016

The "most systemically dangerous bank in the world" is in grave trouble. Despite exclamations that there is "no need for additional capital" and that "Deutsche Bank is no Lehman" investors are fleeing the bank's assets en masse as professionals pile in to buy counterparty risk protection. With the only thing standing between bank runs and stability being the confidence of depositors, and knowing full well that everybody lies when it gets serious, one witty trader noted, "if it walks like Lehman, and talks like Lehman… it is Lehman."

 

Deutsche stock is collapsing…

 

And counterparty risk hedges are spiking…

 

as the bottom end of DB's capital structure is starting to reflect a serious haircut…

 

And the DB pain is spreading to the entire EU banking system…

 

When is Draghi going to starting sell CDS Protection?

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The question everyone is asking this morning is who won the debate. The answer is: it depends who you ask.

To be sure, conservative website Drudge Report had Trump a blow out winner with over 82% of the nearly 500,000 votes cast, which however can probably be explained by the self-fulfilling ideology of most of the site’s visitors.

More surprising was a poll by CNBC, where of the 748,000 votes cast as of this morning, Trump had collected nearly two-thirds of the votes, although Trump’s outperformance here may be explained by the fact that this, too, was linked off the Drudge main page, the same as a Time poll.

To be sure, the markets’ take was different, and as we noted last night, looking at the most direct proxy of Trump performance in recent weeks, namely the move in the Mexican Peso, traders “handed” it to Hillary.

As WSJ noted this morning, the Mexican currency was up roughly 1.5% against the U.S. dollar Tuesday, showing a sharp surge during  the debate, which pitted Mrs. Clinton against Donald Trump. Other emerging market currencies, from the South African rand to Indonesia’s rupiah, also rallied on a belief that Trump presidency is now less likely.

Amid the confusion, the Mexican peso has emerged as a market proxy for the chances of a Trump’s presidency on Nov. 8. Mexico is seen as a likely victim of his professed dislike of trade deals, including deals between the U.S. and its southern neighbor. Mr. Trump has also pledged to build a wall along the U.S. border with Mexico to prevent the entrance of illegal immigrants.

 

The implied volatility of the peso against the dollar, which is a gauge of how much money investors are paying to either insure themselves—or bet—against large swings in the currency, has also spiked up for those contracts expiring after the election.

Tuesday’s rally in emerging market currencies, particularly the peso, was widely interpreted by analysts as a sign that investors thought Mrs. Clinton won the debate.  “Anyone who had wondered what had caused [peso] weakness over the past few weeks received a clear answer last night,” said Esther Reichelt, analyst at German lender Commerzbank.

* * *

And then there were the online betting markets, according to which Clinton’s probability of winning the White House gained in online betting following the first debate of the campaign on Monday night between her and Republican Donald Trump.

A Clinton contract on the popular PredictIt betting market gained 6 cents from the previous day’s level to 69 cents, though fading modestly after peaking…

 

… while a contract favoring Donald Trump’s prospects for victory tumbled
7 cents to 31 cents, after which it rebounded modestly to 34. Contracts are priced from 0 cents to 100 cents,
with the contract price equating to a probability of whether that
candidate will win the Nov. 8 election.

The price swings for both candidates were the largest since early August, and placed Clinton’s lead in that market at the widest in about two weeks.

Clinton’s prospects also improved on the Irish betting site Paddy Power. About halfway through Monday’s debate, she was shown as a 1-to-2 favorite, and those odds shortened to 4-to-9 in the moments after the debate ended. Trump’s odds lengthened to 23-to-10 from 9-to-4.

The swing following the debate put the brakes on a big Trump price rally on PredictIt that coincided with a tightening in most public opinion polls. The implied probability of him winning had risen to 38 cents on Sunday from just 28 cents at the end of August. Bets on Trump fell as low as 5 cents on February but went up as high as 44 cents in May. Bets on Clinton, the persistent favorite in most wagering markets, went as low as 37 cents in January and as high as 79 cents in August.

The big caveat here, of course, is that virtually all online bookmakers had Brexit as a sure-on non-event, only to be proven wrong as the Brexit vote unfolded.

Perhaps the biggest take home message from last night’s debate was the lack of a clear winner, and the absence of a “knock out punch” by either candidate. As such the only question is how, if at all, did undecided candidates change their opinion toward either candidate. The answer to that will have to wait until the next set of official polls is released.

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While we await every new headline out of Algiers, overnight Goldman threw in the towel on its “transitory” oil market bullishness, and in a note by Damien Courvalin looking “Beyond Algiers, Weakening Oil Fundamentals”, the bank cut its Q4 oil price target from $50 to $43, as the bank admits the previously anticipated rebalancing will take longer to achieve, and now expects “a global surplus of 400 kb/d in 4Q16 vs. a 300 kb/d draw previously.“

Speaking of the Algiers meeting, Goldman also notes that “while a potential deal could support prices in the short term, we find that the potential for less disruptions and still relatively high net long speculative positioning leave risks skewed to the downside into year-end. Importantly, given the uncertainty on forward supply-demand balances, we reiterate our view that oil prices need to reflect near-term fundamentals – which are weaker – with a lower emphasis on the more uncertain longer-term fundamentals.”

Here is the summary from Courvalin:

Oil prices have remained range bound ahead of the OPEC consultation in Algiers this week and as production disruptions have yet to meaningfully ramp up. Statements by participants suggest potentially greater collaboration between OPEC members than in previous attempts, although the outcome of this advisory meeting remains uncertain. Our production forecast continues to reflect a seasonal Saudi production decline into year-end and no growth elsewhere (the equivalent of a deal) with OPEC exc. Libya/Nigeria production growth only resuming in 1Q17.

 

Nonetheless, our 4Q16 oil supply-demand balance is weaker than previously expected given upside surprises to 3Q production and greater clarity on new project delivery into year-end. This leaves us expecting a global surplus of 400 kb/d in 4Q16 vs. a 300 kb/d draw previously. Importantly, this forecast only assumes a limited additional increase in Libya/Nigeria production of 90 kb/d vs. current estimated output. As a result, we are lowering our 4Q16 forecast to $43/bbl from $50/bbl previously. While a potential deal could support prices in the short term, we find that the potential for less disruptions and still relatively high net long speculative positioning leave risks skewed to the downside into year-end. Importantly, given the uncertainty on forward supply-demand balances, we reiterate our view that oil prices need to reflect near-term fundamentals – which are weaker – with a lower emphasis on the more uncertain longer-term fundamentals.

 

Despite a weaker 4Q16, our 2017 outlook is unchanged with demand and supply projected to remain in balance. We expect demand growth to remain resilient while greater than previously expected production declines in US/Mexico/Venezuela/ Brazil/China are offset by greater visibility in the large 2017 new project ramp up in Canada/Russia/Kazakhstan/North Sea. While our price forecast remains unchanged at $52/bbl on average for next year with a 1H17 expected trading range of $45-$50/bbl, we continue to view low cost and disrupted supply as determining the path of an eventual price recovery with our forecasts conservative on both. As we wait for headlines from Algiers, it is worth pointing out that Iran, Iraq and Venezuela have each guided over the past month to a 250 kb/d rise in production next year.

And then there is the demand side:

July and August data point to demand growth slowing in line with our expectation, in particular in China. We forecast demand growth to average 0.9 mb/d yoy in 3Q, down from its torrid 1H16 pace of 1.8 mb/d. Our expectation for moderating demand growth in 2H16 is driven by strong base effects, a slowdown in growth and continued switching of power generation away from oil in Japan, Brazil and Mexico. Note that our demand estimate remains higher than the IEA’s however given our corrected measure of Mexican demand1. and our expanded accounting of Chinese demand.

To summarize, in Goldman’s base case, the bank’s “forecast continues to reflect a combined decline in OPEC production (exc. Libya and Nigeria) of 340 kb/d in 4Q16, with growth of only 140 kb/d in 1Q17. Despite this forecasted help from OPEC, we find that the improvement in oil fundamentals has stalled in 3Q and that the inventory build is set to resume in 4Q, a weaker outlook than we had previously expected.“

So given Goldman’s outlook for a well supplied market and a crude curve in contango with limited spot upside, it “continues to recommend being short the S&P GSCI Crude Oil index, especially paired with positive yielding oil-exposed assets such as HY E&P credit.“

* * *

Normally, this would suggest buying oil here, which is what Goldman’s flow traders will be doing, however considering the significant volatility potential out of Algiers over the next 48 hours, it may be best to just sit back and observe if only for a few days.

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• Deutsche Bank Returns to Haunt Merkel in an Election Year (BBG)
• Saudis, Iran dash hopes for OPEC oil deal in Algeria (Reuters); Iran Doesn’t Want Oil Deal in Algiers, Won’t Freeze Output (BBG)
• Debate of century lives up to its billing (The Hill)
• Candidates Spar in Debate, Offer Vastly Different Visions for Leading the U.S. (WSJ)
• Clinton gains in online betting markets after U.S. presidential debate (Reuters)
• Presidential Debate Illuminates Voters’ Stark Choice (WSJ)
• Trump goes after Fed Reserve’s Yellen, claims she’s ‘more political’ than Clinton (Fox)
• Undecided Voters React Coolly to Donald Trump During Debate (WSJ)
• Trump Allies Move to Stem Damage From Strong Clinton Debate (BBG)
• Trump questions Clinton’s temperament, calls her ‘out of control’ (Fox)
• Howard Dean calls Trump a ‘coke user’ on Twitter (Hill)
• In first face-off with Clinton, Trump struggles to be ‘change’ candidate (Reuters)
• Syrian army, insurgents in fierce clashes in southwest Aleppo (Reuters)
• BlackRock Issues Warning on Treasuries as Fed Moves Toward Hike (BBG)
• Charlotte protesters demand mayor’s resignation over black man’s slaying (Reuters)
• Goldman Sachs’ top Southeast Asia investment banker to leave (Reuters)
• Wells Fargo Faces ‘Top-to-Bottom’ Review, Labor Department Says (BBG)
• France unlikely to achieve 2017 deficit target: fiscal watchdog (Reuters)

 

Overnight Media Digest

WSJ

– Chinese billionaire Wang Jianlin is in discussions to buy Dick Clark Productions at a valuation of about $1 billion through his Dalian Wanda Group. http://on.wsj.com/2dnD129

– Pfizer Inc said it would remain a single company, deciding not to split into one business focused on patent protected drugs and another on older products. http://on.wsj.com/2dnCEF1

– Lands End Inc chief executive Federica Marchionni stepped down from her role after 19 months on the job in which she tried to fashion broad changes at the catalog retailer. http://on.wsj.com/2dnE0Q9

– Walt Disney Co emerged as another potential bidder for Twitter Inc on Monday as the company struggles with sluggish growth. http://on.wsj.com/2dnFppB

– Mylan NV clarified the profit it said it made from its EpiPen drug days after the House members asked the company’s chief executive to justify the injector’s steep price hikes. http://on.wsj.com/2dnHge0

– Rice Energy Inc agreed to buy shale driller Vantage Energy for about $2.7 billion, including debt. http://on.wsj.com/2dnERjN

 

FT

Deutsche Bank Ag said on Monday it had no need for German government help with a $14 billion U.S. demand to settle claims it missold mortgage-backed securities, as its shares lost more than 7.5 percent.

Britain’s opposition Labour Party clashed with business groups on Monday after setting out a left-wing economic agenda aimed at boosting their chances of winning power by re-engaging with working class voters who backed leaving the European Union.

Standard Life Investments, the fund arm of insurer Standard Life Plc, said on Monday it planned to reopen its 2.5 billion pounds ($3.24 billion) UK Real Estate Fund at midday on Oct. 17, after asset sales helped bolster the fund’s liquidity amid a broader market recovery.

 

NYT

– A federal appeals court ruled that American Express Co could stop merchants that accept its cards from encouraging customers to use rival payment cards that charge the stores lower transaction fees. http://nyti.ms/2dfMCXq

– Berlin ruled out providing government aid to Deutsche Bank, a German magazine reported. A Deutsche Bank spokesman said that John Cryan, its chief executive, had “at no point” asked Chancellor Angela Merkel to intervene in the issue with the Justice Department. http://nyti.ms/2dvhC37

– Richard C. Perry, once one of the hedge fund industry’s most successful investors, is shuttering his flagship fund as clients leave after steep losses. http://nyti.ms/2dfLX84

– A group of aggrieved Wells Fargo & Co workers, who say they were fired or demoted for staying honest and falling short of sales goals, claim that they played by the rules and were punished for it. http://nyti.ms/2dnEjKR

 

Britain

The Times

Delancey is suing Greenland Group’s UK division over a disputed final payment related to the Chinese company’s £135.7 million purchase of the historic Ram Brewery site in Wandsworth two years ago. (http://bit.ly/2dne8PO)

Britain will emerge from Brexit with a stronger economy and be better off than other EU countries within five years, Mathias Döpfner, chief executive of publishing house Axel Springer, said in an interview. (http://bit.ly/2dnobVd)

The Guardian Sainsbury SBRY.L> has developed an app called Chop Chop through which shoppers can order up to 20 items to be delivered from a local store within an hour, in an attempt to compete with Amazon Inc. (http://bit.ly/2dnkdvy)

Dyan Crowther, chief operating officer at Southern’s parent, Govia Thameslink Railway (GTR), will become chief executive at HS1, the link between London and the start of the Channel tunnel in Kent. (http://bit.ly/2dnjQBd)

The Telegraph

German car giant BMW is on a collision course with its UK workers over plans to deter 5,000 employees from making fresh contributions to its two gold-plated final salary pension schemes. (http://bit.ly/2dnkEGn)

EasyJet has appointed Christine Browne, one of its non-executive directors as its next chief operating officer, as the budget carrier grapples with the turbulence caused by the Brexit vote and a string of terrorist attacks in Europe. (http://bit.ly/2dnkT44)

Sky News

UK’s Labour Party has announced it will ban fracking if it wins the next general election. The announcement was made by shadow energy and climate change secretary Barry Gardiner at the party’s annual conference in Liverpool. (http://bit.ly/2dnks9N)

Generator Hostels’ controlling shareholder, Patron Capital, has asked investment bankers at Lazard to oversee an auction of the business for a deal valuing it at more than £400 million ($518.76 million). (http://bit.ly/2dnlbrN)

The Independent

French President Francois Hollande has said Britain’s “sovereign decision” to leave the EU does not excuse the country from its obligations to refugees and has urged the UK to “play its part” in dealing with the crisis. (http://ind.pn/2dnlpir)

 

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When two weeks ago the DOJ announced a far larger than expected $14 billion settlement demand from Deutsche Bank, one which if left unrevised would would leave Deutsche Bank short of billions in capital, has since triggered the latest episode of European bank selling and potential contagion, some wondered if there was an element of punitive retaliation aimed at Europe’s “assault” on Apple’s taxes. That question will surely grow louder when overnight Bloomberg reported that the DOJ is now assessing “how big a criminal fine it can extract from Volkswagen AG over emissions-cheating without putting the German carmaker out of business.“

Volkswagen stock promptly dropped over 3% on the news and was down 2.5% as of the latest refresh.

The government and Volkswagen are trying to reach a settlement by January, Bloomberg reported, before a new U.S. administration comes into office and replaces the political appointees who have been overseeing the process. In criminal prosecutions, the Justice Department may assess the impact of a charge or settlement on a business’s viability, and the resulting effect on shareholders and employees. A prosecution’s potential collateral damage is one of the factors the department considers under principles for prosecuting businesses laid out in the “U.S. Attorney’s Manual.”

Bloomberg adds that while in the DB case the penalty may have been overly demanding, as the U.S.’s Volkswagen calculations show, the department is showing that in some cases, it will take a company’s financial health into account. That said, it’s not clear what penalty range the U.S. is considering in the criminal case against Volkswagen. The company had net liquidity of 28.8 billion euros ($32.4 billion) as of June 30, and Chief Financial Officer Frank Witter said his goal is to keep the target for average net liquidity at 20 billion euros to ensure funding needs and protect the company’s credit rating. The carmaker generates several billions of dollars of cash each quarter and could tap into a credit line or raise capital if necessary to pay its obligations.

Volkswagen has already agreed to pay an industry-record $16.5 billion in civil litigation fines in the U.S. after admitting last year that its diesel cars were outfitted with a “defeat device” that allowed them to game U.S. environmental tests. The carmaker is also on the hook for outstanding civil claims from several states and as much as $9.2 billion in investor lawsuits in Germany, where it’s also under criminal investigation.

 

“The department doesn’t pick a number in a complete vacuum,” said William Stellmach, a former federal prosecutor now at Willkie Farr & Gallagher LLP in Washington. “There are a number of cases where it has acknowledged that the impact of a financial penalty on a company was a factor in deciding what that penalty should be.

Nonetheless, the ability-to pay assessment doesn’t necessarily result in a lower number, according to Stellmach, who isn’t involved in the VW case. Rather, the department can structure an agreement to soften some of the sting, such as an installment plan allowing for deferred payments, he said. Companies can also receive credit for penalties assessed by other regulators or authorities both in the U.S. and abroad.

The good news for Volkswagen is that the automaker, and one of Germany’s largest employers, has plenty of money to meet further fines, particularly because penalties tend to be paid over long time periods, according to Joel Levington, a Bloomberg Intelligence credit analyst. “Despite all the damage that its reputation has taken, VW is still a company that might be back to generating $5 billion in free cash flow in 2018, and when you generate that kind of cash, it absolves a lot of sins,” he said. The Justice Department began negotiations on the criminal penalty in August, one person said.

Bloomberg points out an interesting tangent about Volkswagen’s financing unit: “Volkswagen, like most carmakers, also has a financing unit, which offers buyers loans or lease packages when they are ready to buy their cars at a dealership. Should the company’s cash level fall too low, it could spark ratings downgrades by credit agencies, which risks increasing the costs of that unit.”

Standard & Poor’s Ratings Services said in a note in February that it would consider lowering the carmaker’s rating only if its litigation costs exceeded 40 billion euros ($45 billion) or if its legal costs caused a severe negative impact on the company’s liquidity position, a scenario it considers unlikely. By that measure, after U.S. civil penalties and accounting for maximum damages in German lawsuits, the company would still have a cushion of about $20 billion to absorb other litigation and investigation-related expenses.

 

Volkswagen is currently rated BBB-plus by S&P, three levels above junk. S&P has warned that it may cut Volkswagen’s rating further. “The negative outlook is still there and that reflects the risks that there could be more charges,” said Alex Herbert, the London-based analyst who wrote the February report.

Ultimately, however, the question remains: is the DOJ set out on a crusade to “punish” European some of the most iconic European -or rather German- companies, taking a shot first at Deutsche and now Volkswagen, and if so at what point will it deem its overreach to be sufficient. For now, there is no answer and as questions linger, expect European stocks to suffer for the near-future.

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A rally in global risk that started during last night’s first presidential debate on the market’s take that Hillary Clinton came out on top in the first head-to-head between the two candidates fizzled, and what was a 0.6% jump in futures faded to only a 0.2% rebound after news that the DOJ is assessing how big a criminal fine it can extract from Volkswagen (-3.8%) over emissions-cheating “without putting the German carmaker out of business“, while Iran’s oil minister Zanganeh told reporters in Algiers that it is “not our agenda” to reach an agreement, and that the country is unwilling to freeze output at current levels, and instead if looking to raise output to 4mmbpd.

We start with the debate, where as we pointed out last night, both a post-debate poll and also the positive reaction in relevant markets hinted that Clinton has come out with the advantage following the exchange. A CNN/ORC poll (which targeted a predominantly democratic sample as CNN admitted) had 62% of viewers claiming that Clinton won the debate, compared to 27% which believed Trump was the victor. In terms of markets, following three consecutive weekly losses in which it weakened nearly 9%, the Mexican Peso – which is seen as a bit of a sentiment proxy for the debate given the trade subject – had rallied back 1.95% and the most since February while there are gains also for a number of other EM currencies which are seen as vulnerable if Trump scrutinises trade deals.

As a result, in early trading US equity futures were up over +0.60%, while safe haven barometers like the Yen (-0.38%) and Gold (-0.22%) are weaker.

However, that initial rebound faded on the abovementioned Volkswagen news. Adding to the pain, while Deutsche Bank shares rebounded in early trading, they have since sunk again, dropping to a fresh record low, down as much as -2.8% with CDS rising to new all time highs, as concerns over the troubled German lender persisted. Germany’s second largest lender Commerzbank (-3.0%) also felt the squeeze on a report it plans to eliminate 9,000 jobs and suspend dividend payments.

The weakness spread to global stocks as well: the MSCI All-Country World Index of shares erased an advance, weighed down by the prospect of U.S. fines for Volkswagen AG and Deutsche Bank AG. Crude oil declined after Iran ruled out an immediate agreement on an output freeze, while Saudi Arabian stocks slumped on concern austerity will lower consumer spending. German bunds led gains in European government bonds and Finland’s 10-year yield dropped below zero for the first time.  Norddeutsche Landesbank, Germany’s largest shipping lender, was said to pull plans to sell seven-year euro notes a day after Deutsche Lufthansa AG canceled a similar transaction.

Even Mexico’s peso pared gains, Bloomberg noted, after earlier surging as investors concluded Clinton had won the first presidential debate. An election victory for Republican candidate Donald Trump may hurt bonds in emerging markets such as China and Mexico by weighing on global trade, according to Aberdeen Asset Management.

“Had Trump been stronger then maybe we would have seen a stronger downside reaction in the market,” said Jasper Lawler, an analyst at CMC Markets in London. “Deutsche Bank is the eye of the storm because even if it’s listed in Germany it’s a multinational bank with a big role in U.S. markets and has a history of causing some troubles in the U.S. The European and U.S. banks have strong links in the end. This at least is the going excuse as markets don’t have the impetus to go higher.”

The Stoxx Europe 600 Index slid 0.5% after earlier advancing as much as 0.7%. The benchmark tumbled the most since July on Monday amid concern about the strength of Deutsche Bank’s capital buffers. S&P 500 Index futures were 0.2% higher, paring a gain of as much as 0.7%.

Market Snapshot

• S&P 500 futures up 0.2% to 2144
• Stoxx 600 down 0.3% to 339
• FTSE 100 down 0.2% to 6802
• DAX down 0.7% to 10317
• German 10Yr yield down 3bps to -0.14%
• Italian 10Yr yield down 2bps to 1.17%
• Spanish 10Yr yield down 3bps to 0.89%
• S&P GSCI Index down 0.8% to 353.5
• MSCI Asia Pacific up 0.7% to 142
• Nikkei 225 up 0.8% to 16684
• Hang Seng up 1.1% to 23572
• Shanghai Composite up 0.6% to 2998
• S&P/ASX 200 down 0.5% to 5406
• U.S. 10-yr yield down less than 1bp to 1.58%
• Dollar Index up 0.08% to 95.37
• WTI Crude futures down 1.5% to $45.22
• Brent Futures down 1.7% to $46.54
• Gold spot down 0.2% to $1,336
• Silver spot down less than 0.1% to $19.44

Global Headline Summary

• Clinton, Trump Draw Stark Contrasts With Sharp Debate Attacks: Debate devolved into exchange of accusations, blame regarding each others’ past statements, records.; MXN Jumps, Stocks Rally as Clinton Seen Winning Debate
• BlackRock Issues Warning on Treasuries as Fed Moves Toward Hike: “It’s time to rethink the role of U.S. Treasuries in portfolios,” chief strategist Richard Turnill wrote. “We are cautious on long-term U.S. Treasuries.”
• Rice Energy to Acquire Vantage Energy for About $2b: Deal for closely held Vantage is Rice’s biggest deal yet in core of Marcellus shale.
• Wells Fargo Faces ‘Top-to-Bottom’ Review: Labor Department: Agency agreed to conduct review of WFC requested by lawmakers who said bank may have pressured employees to meet sales quotas; Wells Fargo Sued by Shareholders Over Cross-Selling Scandal
• Possible Disney-Twitter Merger Poses Risks for Iger Legacy: Deal may let Iger leave knowing he’s given Disney big presence in digital media, advertising.
• AmEx Can Bar Merchants From Steering Users to Rival Cards: A federal judge had found AmEx’s policy violated antitrust law, but higher court said retailers aren’t obliged to accept AmEx cards, pay its fees.
• Mylan, Lupin Said to Weigh Bids for Bayer Dermatology Unit: Leo Pharma, Cadila Healthcare, Torrent Pharmaceuticals are also weighing offers.
• Over 50% of Shoppers Turn First to Amazon in Product Search: Co. widening lead over major retailers like WMT, search engines as starting point for online shopping.
• SolarCity Accused of Taking Shingling Technology Secrets: Co. accused of misappropriating trade secrets, other IP in lawsuit over development of shingled-cell solar modules.
• HomeAway CEO Steps Down to Make Way for Former Expedia Exec: CEO Brian Sharples, who co-founded in 2005, took it public in 2011 and oversaw its takeover by Expedia, stepped down.

* * *

Looking at regional markets we start in Asia, where markets shrugged off the broad-based losses from Wall Street and traded mixed, with an improvement in risk appetite seen amid the first US Presidential Debate and strong Chinese industrial profits. ASX 200 (-0.5%) and Nikkei 225 (+0.8%) began with firm losses following the financial-led weakness in EU and US markets. However, Nikkei 225 rebounded off its lows alongside a recovery in risk appetite as markets reflected a composed and consistent effort from Clinton. Chinese markets benefited from strong industrial profit figures which rose by the most in nearly 3 years of 19.5% Y/Y vs. 11% increase in the prior month, resulting to outperformance in Hang Seng (+1.1%) while Shanghai Comp. (+0.6%) traded choppy as a weak liquidity injection capped gains. 10yr JGBs saw minor gains despite the improvement in risk appetite in Japan with the 10yr yield declining to its lowest since early September, while today’s 40yr auction also failed to spur demand with the b/c and lowest accepted price declining from prior.

Top Asian News

• Wall Street Shrinking in Asia Continues With Goldman, BofA Cuts: Goldman Sachs said to be planning steep reductions
• Citigroup Said to Plan India Branch Cuts in Digital Banking Push: Lender may close five outlets in smaller cities
• China’s Shibor Climbs to Seven-Week High as PBOC Withdraws Funds: PBOC policy tilted toward curbing leverage, Huafu says
• Maersk May Target Hanjin, Hyundai in New Acquisition Plan: Jefferies says Maersk needs to buy and Korean lines need help
• Takata Lifelines Scrutinized by Carmakers Stuck in Cost Bind: Troubled supplier said to meet customers on bids, liabilities
• Billionaire Wang in Talks to Buy Producer of Golden Globe Awards: Hollywood Reporter reported that the talks are valuing Dick Clark Productions at ~$1b.

European equities have failed to hold on to their Presidential-debate inspired gains as ongoing concerns around the fragility of Deutsche Bank and Volkswagen continue to hamper sentiment and energy prices ebbed lower as changes of an agreement at Algiers continue to dissipate. More specifically, Deutsche Bank’s (shares -2.8%) 5 year subordinated CDS hit a fresh record high as markets remain concerned about the future of the company in the context of Chancellor Merkel’s unsupportive comments over the weekend. Elsewhere, for financials, Commerzbank (-3.0%) have felt the squeeze as markets were less than impressed with their restricting and dividend plans. Volkswagen (-3.8%) shares have been dealt a fresh blow amid reports that the US are said to vet whether criminal fine would bankrupt the Co. while pondering what size diesel penalty VW can withstand. Finally, downbeat comments from the Algiers meeting have weighed on energy prices with the latest rhetoric indicating the unlikelihood of a deal being struck this week. Given the downside in equities, Bunds have been dealt a fresh bid throughout the session with the yield falling to it’s lowest level since July with prices reclaiming 166.00 (Dec’16 contract at all time highs). Supply today comes in the form of a US 5yr auction with focus for fixed income markets also centred on a slew of Fed speakers today and for the rest of the week.

• Top European News
• Renzi Starts 10-Week Fight for Italian Referendum, His Job: Push for “the mother of all reforms” being closely watched by markets.
• Maersk May Target Hanjin, Hyundai in New Acquisition Plan: Co., which will try to grow through acquisitions, targeting South Korea’s 2 biggest shipping firms: Jefferies.
• VW Scandal Spreading to Audi Risks Hitting Carmaker’s Cash Cow: Audi head Rupert Stadler under increased scrutiny as investigators seek to untangle origins of VW diesel cheat.
• London Mayor Khan Urges Labour to Win Cities in Push for Power: Khan to say at conference that effective local government can prove that Labour is ready for power nationally.
• Carney Enters Corporate Bond Market in Post-Brexit Stimulus: Central bank to seek to buy notes issued by cos. including GE, United Utilities, Rio Tinto, according to list.
• Poland at Risk of Being Left Behind Cheap Debt on Refusal: Amundi, Pekao think government should prefinance 2017 budget, capitalizing on emerging-market debt rally.
• Fast Growing Nordea AM Hits the Brake on Inflows: New money of EU14.6b through Aug. making it harder for Nordea to generate excess returns.

In FX, US election fever put the focus on the likes of USD/MXN and USD/JPY in particular, with Clinton’s narrow lead, giving the MXN some near term relief. USD/JPY is still testing the downside in tandem with the selling pressure seen in stocks. For GBP, Cable has attempted a recovery through 1.3000, but this was short lived, though the pressure from the EUR/GBP rate looks to have eased somewhat as a return to .8700 looks tame as yet. Early days as yet, but the signs are that the market still intends to test and post fresh Brexit lows. No new drivers to prompt this today however. For USD/CAD, the breach of 1.3250 overnight was prompted by comments from BoC Poloz, who stated that the Canadian economy may take 3-5 years to recover from the impact from low Crude prices. The pair snapped back sharply to base out in the mid 1.3100’s, but is back on a 1.3200 handle, with reports the Iran are no willing to freeze Oil output at current levels. Later today we have US services and composite ISM

In Commodities, WTI and Brent crude futures enter the North American crossover in negative territory as the latest rhetoric from the IEA meeting suggests that it is unlikely that markets will be presented with a formal agreement this week. More specifically, the Russian and Saudi energy ministers this morning have firmly stated that this week’s summit will not result in an agreement and that this week’s meeting is purely for consultative purposes. This was then followed up by comments from the Iranian oil minister that the nation is not willing to freeze oil output and therefore it appears that little will be achieved this week in Algeria. Gold has been stuck in a 3-day range between USD 1343/oz and USD 1331.19/oz. Silver today has retraced some of the losses seen in the last 2 days, and is currently consolidating at the USD 19.50/oz.

* * *

US Event Calendar

• 8:55am: Redbook weekly sales
• 9am: S&P CoreLogic CS US HPI m/m SA, July (prior 0.21%)
• 9:45am: Markit US Services PMI, Sept. P, est 51.2 (prior 51)
• 10am: Consumer Confidence Index, Sept., est. 99 (prior 101.1)
• 10am: Richmond Fed Manufacturing Index, Sept., est. -2 (prior -11)
• 11:15am: Fed’s Fisher speak at Howard University
• 4:30pm: API weekly oil inventories

Bulletin Headline Summary from RanSquawk and Bloomberg

• European equities trade lower as ongoing concerns surrounding Deutsche Bank and Volkswagen trim opening Presidential election-inspired gains
• Energy prices enter the North American crossover in negative territory as the latest rhetoric from the !EA
  meeting suggests that it is unlikely that markets will be presented with a formal agreement this week
• Looking ahead, highlights include US Services PMIs, API Crude Oil Inventories and comments from Fed’s Fischer and ECB’s Coeure

DB’s Jim Reid concludes the overnight wrap

Nowhere else to start this morning other than the most watched televised election debate in history and the first of three between Clinton and Trump. Both the post-debate poll just released and also the positive reaction in relevant markets suggests that Clinton has come out with the advantage following the exchange.

Indeed a CNN/ORC poll out a short time ago had 62% of viewers claiming that Clinton won the debate, compared to 27% which believed Trump was the victor. This is the only poll that we have seen officially released so far. In terms of markets, following three consecutive weekly losses in which it weakened nearly 9%, the Mexican Peso – which is seen as a bit of a sentiment proxy for the debate given the trade subject – has rallied back 1.95% and the most since February while there are gains also for a number of other EM currencies which are seen as vulnerable if Trump scrutinises trade deals. US equity index futures are up over +0.60%, while safe haven barometers like the Yen (-0.38%) and Gold (-0.22%) are weaker.

In terms of the debate itself, the subjects of trade, foreign policy, the US economy and race were all debated along with various personal charges of both candidates. It was far from smooth however and at times the moderator lost control of both candidates as the exchanges descended into a tirade of accusations. As a report from the Washington Post out just a short time ago suggested, Clinton came across overly rehearsed but tended to stay more on topic while also coming across as competent and deliberate, and surprisingly didn’t face too many challenges. Trump, meanwhile, was a lot more restless and unprepared. Having said all this Trump has been written off many times and has repeatedly confounded his critics with strong on the ground support. Roll on the next two battles on October 9th and 19th.
The majority of bourses in Asia have rebounded from early declines meanwhile. The Nikkei is back to +0.46% having been down as much as -1.50% prior to the debate, while the Hang Seng (+1.10%) and Kospi (+0.62%) also gained as the debate progressed. China stocks are reasonably flat and just the ASX (-0.56%) is lagging. Sovereign CDS markets in the likes of China and Korea were initially 2-3bps wider but also pared those moves as the debate wore on and are back to flat now.

Moving on to today, we see the start of the BoE’s corporate bond purchases with reverse auctions across the energy, industrial, transport, property, water and financial sectors. Tomorrow and Friday sees more of the same across the communications, consumer cyclical and non-cyclical sectors tomorrow, and electricity and gas sectors on Friday. We published a quick Credit Bites yesterday reviewing where we stand with regards to the market ahead of this new regime. Let Michal.Jezek@db.com know if you didn’t get a copy. Staying with central bank bond purchases, yesterday saw the latest weekly ECB CSPP holdings released. It was another strong week, the fourth largest since the scheme launched in June. Three of the top four weeks have occurred this month suggesting that the ECB is using the rebound in primary to stock up on bonds. They bought €2.316bn last week which equates to €463mn/day. The average daily run rate so far is €372mn.

So central banks continue to keep yields at ultra low levels however there’s obviously been a lot of discussion on whether there is a fresh desire to steepen curves to help financials. Easier said than done but our European Equity strategists have discussed the implications in a note this morning. They suggest that if they could steepen curves there would be scope for significant sector rotation in the European equity market from over-owned defensives into financials and cyclicals. However, they note that yields have continued to track market expectations for the future Fed funds rate, which in turn has continued to move in line with global growth momentum. This suggests low bond yields are not principally due to discretionary central bank policies (which could be reversed at will), but to the weakening in the global growth picture, to which central banks have only responded by making policy more accommodative. They expect global growth momentum to continue weakening (due to rising recession risks in the US and the fading of the Chinese credit stimulus) – and, hence, see limited upside for bond yields. If central banks were to attempt to push up nominal yields against the backdrop of weak growth and low inflation expectations, this would likely lead to higher real bond yields, a negative re-pricing in risk assets and, ultimately, a renewed drop in nominal bond yields. As a consequence, they remain overweight the bond proxies in the European equity market (real estate and our basket of sustainable dividend payers) and are cautious on financials.

Moving on. It was a risk off day to start the week yesterday led by the European banking sector that had its worst day (Stoxx 600 Banks index -2.32%) for nearly 8 weeks. European markets underperformed relative to their US counterparts as a result with the Stoxx 600 and DAX closing -1.55% and -2.19% respectively. The S&P 500 finished -0.86% while the Dow nudged down -0.91%. A sharp leg higher for WTI Oil (+3.26%), which wiped out the bulk of Friday’s losses on the first day of the OPEC meeting, didn’t appear to translate into gains for the energy sector. It appears that prices were up on higher expectations of some sort of action or agreement with the latest headlines suggesting that the UAE is also in favour of freeze should all other participants agree. There were also upbeat comments from Nigeria but it would be no great surprise to see a flurry of back and forth headlines over the next two days before the meeting draws to a close tomorrow.

Meanwhile in FX markets Sterling was busy again, touching an intraday low of $1.292 at one stage (about -0.40% on the day) before then recovering into the close in the US to finish relatively flat. Unsurprisingly it’s a number of negative news articles concerning Brexit which was attributed to the early weakness again. A couple in particular caught our attention. The first was a survey released by KPMG yesterday morning (Source-Reuters) suggesting that three-quarters of CEO’s (in a sample of 100) said that they would consider moving headquarters or operations out of the UK as a result of Brexit. The second was an article in the FT suggesting that senior City figures were growing increasingly alarmed that political momentum is growing behind a ‘hard Brexit’. ECB President Draghi spoke on the subject yesterday and said that ‘any outcome should ensure that all participants are subject to the same rules’ and that ‘it is very hard to imagine that any agreement that will be perceived as discriminatory against some subjects or in favour of other subjects could be a source of stability for the future of our EU’.

Staying with Europe, we’ve got a new date for readers to put into their diaries this morning, that being Italy’s high stake Senate Reform referendum which has been officially scheduled for December 4th. The 10 week countdown is underway then. While we’re in the periphery, yesterday DB’s Marco Stringa published a note touching on what the Spain regional election results from the weekend mean. Following the heavy defeats to the centre-left PSOE and decent performance for the PP, he has left unchanged his 60% indicative probability of a government being formed before the 31st October and continues to see a third election as the only feasible alternative. That said he is becoming increasingly concerned by the lack of progress and sees the balance of risks clearly tilted towards a new election, which would be the third in twelve months, possibly in mid-December.

Elsewhere, in terms of the minimal data that was released yesterday, a bumper IFO survey reading in Germany seemingly did little to boost sentiment. The headline business climate reading printed at 109.5 for September which was up an impressive 3.2pts from August and also well ahead of the consensus expectation of 106.3. It also puts the index at the highest level since mid-2014. The expectations component also jumped 4.4pts to 104.5 which is the largest rise since re-unification, while the current assessment index printed at 114.7, up 1.8pts from the month prior. Our economists in Germany noted that while this data brings the manufacturing IFO roughly in line with the manufacturing PMI, the discrepancy between the two surveys with respect to the services sector has gotten wider with the services and retail IFO improving, too. Moreover, at their September level IFO expectations points to a strong GDP growth pick-up in Q4, while the weakening PMI points to slowing growth. Overall, this data release brought little clarity in the view of our colleagues. On the plus side, it somewhat eases downside risks to their Q4 GDP expectations. On the negative side, they fear that part of the IFO surge is a “relief rally” after initial fears of an immediate large negative Brexit-impact have eased.

Away from this the data in the US was a bit of a sideshow. New home sales declined less than expected in August (-7.6% mom vs. -8.3% expected) to an annualized rate of 609k, while the Dallas Fed’s manufacturing survey rose 2.5pts but to a still softish -3.7.

There was also a bit of chatter out of the Fed yesterday too. The Dallas Fed’s Kaplan said that ‘I would have been comfortable in seeing some removal of accommodation in September’ and that ‘I am concerned about distortions rates this low are creating’. The Minneapolis Fed’s Kashkari said on the other hand that the decision to hold this month was the right move and that he was in support of it. Richmond Fed President Lacker appeared to side with the former after saying in an interview yesterday that ‘our benchmarks point to interest rates that are substantially higher than they are now, and I think we need to get on with it’.

Looking at today’s calendar, this morning we kick off in Germany where we’ll firstly get the import price index reading for August. Shortly following that we’ll get the latest M3 money supply growth reading for the Euro area, followed then by the September CBI retail reported sales numbers in the UK. This afternoon in the US the early data is the S&P/Case-Shiller house price index reading for July. The remaining flash PMI’s then follow (services and composite – the former of which is expected to improve 0.2pts to 51.2) along with September consumer confidence (expected to decline to 99.0 from 101.1) and the Richmond Fed manufacturing survey (expected to improve 9pts to -2). Elsewhere the Fed-Vice Chair Fischer is due to speak this afternoon at 4.15pm BST however there’s no indication that either the economic outlook or monetary policy will be discussed, while the BoE’s Haldane is also due to speak at 6.30pm BST.

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Submitted by David Stockman via Contra Corner blog,

Jesse Felder published an incisive bubble finance chart over the weekend. It is yet another reminder that Janet Yellen and her merry band of money printers are oblivious to the dangerous speculation and valuation excesses that their policies have implanted throughout the financial system.

Relative to disposable income, the value of household financial assets now far exceeds the last two bubble peaks. And that has happened in an economic environment which suggests just the opposite. To wit, valuation multiples and cap rates should be falling owing the fact that the productivity and growth capacity of the US economy has been heading south ever since the turn of the century.

What is even more striking about this chart is what’s hidden behind the denominator. Since the eve of the financial crisis in 2007, a rapidly increasing share of DPI (disposable personal income) has been accounted for by the explosive growth of transfer payments.

Needless to say, transfer payments do not represent newly produced income that can be capitalized into the value of aggregate societal wealth. By definition, transfer payments are extracted via taxation from the incomes of current producers—–or via taxation of future incomes if they are funded with increased government debt.

Either way, the true extent of the bubble excess in Felder’s chart is even more extreme than pictured above. Between 2007 and 2016, in fact, the value of household financial assets soared from $53 trillion to $72 trillion at a time when real personal income excluding transfer payments rose by only 1.2% annually.

And that’s crediting the BLS’ deeply understated inflation indices. In the real world of Flyover America, inflation-adjusted earned income hardly grew at all.

So here’s a newsflash for the clueless school marm who presides over the Wall Street casino. There is no such thing as a timeless “historical norm” when its comes to the valuation of financial assets. The appropriate capitalization rate for a current stream of income or cash flows depends upon the expected growth path into the distant future.

“I would not say that asset valuations are out of line with historical norms.” — Federal Reserve Chairwoman Janet Yellen 9/21/2016

Yet by the Fed’s own reckoning, the expected growth rate of the US economy has been marked down time and again in its economic forecasts. The long-run median real GDP growth rate is now pegged at just 1.9%.

So you might think someone on the fed would connect the dots. For the last six years running, they have drastically over-estimated the growth of real GDP even as the stock indices have soared based largely on multiple expansion.

Thus, after estimating 3.7% growth in 2011 and nearly 4.0% growth in 2012, actual expansion came in at 1.7% and 1.8%, respectively. Yet that wasn’t some kind of temporary aberration. During 2013 and 2014, the shortfall between initial estimates and actual was also nearly 50%; and then, even as the Fed lowered its estimates for 2015 and 2016, the actual rate of growth slowed still more.

In the case of anyone paying attention, of course, the tepid and weakening recovery conveyed in the table below helps explain why S&P 500 profits peaked six quarters ago in the September 2014 LTM period at $106 per share. Since they came in 19% lower at $87 per share in the June 2016 LTM, the actual market multiple at 24.7X is anything but normal, and that’s hardly a temporary condition, either.

As was indicated in a nearby post, the Wall Street hockey stick is bending toward the flat-line yet again. The most recent earnings outlook for Q3 has turned negative on a Y/Y basis—just in time for the next earnings season, and also precisely as needed for another round of Wall Street’s phony earnings “beat” game.

In short, in the context of declining earnings, PE multiples are not even in line with historic norms. Contrary to Yellen’s press conference blather, they are at the very top of the charts.

Worse still, the Fed continues to project that interest rates will “normalize” back to 3% on the federal funds rate and 4.2% on the 10-year treasury note. And in point of fact, sooner or later that must happen or the entire monetary system will be destroyed.

So with a future outlook characterized by slowing growth, weakened earnings and rising interest rates, how in the world can it be said that current valuations are nothing to worry about?

At the same time, even the Fed’s new dissenter, the formerly dovish, Eric Rosengren, remains lost in the Fed’s Keynesian puzzle palace. Rosengren voted to raise interest rates because he apparently thinks the US is nearing full employment, and that it may overshoot by 2019, thereby creating inflationary risks:

By 2019, I expect the unemployment rate to have declined below 4.5 percent. While I have a long track record of advocating for policy that supports robust labor market conditions, that is below the rate that I believe is sustainable in the long run.

Well, that’s some kind of “full-employment”. There are 5 million more prime working age persons in the US today than there were in January 2000, but the number with “jobs”, including part-time gigs a few hours per weak and self-employed e-Bay traders, is nearly 1.0 million lower!

As for inflation, here is another newsflash. It’s already here.

So here’s the danger. The denizens of the Eccles Building see no bubbles in a financial system that is rampant with asset inflation. It sees full-employment when the US economy has more labor slack than any time in modern history. And it keeps the Wall Street gamblers in free carry trade funding because it wants even more inflation than what is already ravaging the real incomes of Flyover America.

No wonder the Trump voters want to throw the bums out. It is none too soon.

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Earlier this year the Brennan Center for Justice released a report analyzing violent crime data in America’s 30 largest cities for the calendar year of 2015.  While the report noted modest increases in violent crime in Baltimore, Chicago and Washington D.C., it concluded that, on the whole, reports of a national crime wave were premature and unfounded, and that “the average person in a large urban area is safer walking on the street today than he or she would have been at almost any time in the past 30 years.”

Now, just a few short months later, the folks at the Brennan Center have updated their study with crime statistics through September 2016 and they’re wishing they could have a “do over” on that previous conclusion after finding that the national murder rate is now projected to increase 31.5% from 2014 to 2016.  Oops.

Moreover, while spikes in violent crime were limited to just a few large cities in 2015, so far in 2016 11 out of 22 of the largest cities in the country, for which the Brennan center was able to collect data, reported a YoY increase of over 20% in murder rates.  To be fair, cities like San Jose reported a large percentage increase off a very low base but a 71% increase is still significant.

Finally, while we often write about murder rates in Chicago, due to the shear number of deadly crimes, when reviewed on a per capita basis the crime rate even in Chicago pales in comparison to Detroit and Baltimore.

 

Moreover, the spike in violent crime over the past two years has seemingly reversed an over 2-decade long trend in declining murder rates per capita for the U.S., overall. 

 

Can anyone spot the outlier in the following chart accounting for the majority in incremental murders in 2016?

 

Of course the real question is why the sudden spike in violent crime is occurring now.  The study attempts to explain the sudden spike with all of the usual excuses including sustained poverty, unemployment, declining police forces etc.  That said, the chart below seemingly debunks many of those theories as several cities have experienced a substantial increase in murders without a corresponding increase in the overall crime rate. 

 

The “why now” question is something we recently addressed in another post entitled “Milwaukee Homicides Soar – What Is Going On In the Murderous Midwest?“.  While the typical explanations for violent crime (e.g. poverty, unemployment, etc.) may explain why crime is higher in certain cities it certainly doesn’t explain why the sudden spike is occurring now. Thomas Abt of the Harvard Kennedy School of Government thinks the sudden spike is more likely due to the “Ferguson Effect” or a concept he refers to as “legal cynicism.” 

The key question is why the spike in violence now?  Ask any “expert” to explain the cause of violent crime and you’ll get a range of responses from systemic problems of poverty, unemployment, lack of education of inner city youth, breakdown of the family unit, etc.  The problem is that none of those things explain the sudden changes in violence we’re currently witnessing in the Midwest.

 

Thomas Abt, senior research fellow with the Harvard Kennedy School of Government, believes the issue is more likely what other political commentators have dubbed “the Ferguson Effect.”  Writing for The Marshall Project, Abt discussed what he thought might be causing the sudden spike in violent crimes in the Midwest:

 

It is unclear what is driving the problem, but my own hunch – and it is still just a hunch at this point – involves a criminological phenomenon called legal cynicism. Multiple studies have demonstrated that, controlling for other factors, when communities view the police and criminal justice system as illegitimate, they become more violent. When people believe the system is unwilling or unable to help them, they are more likely to take the law into their own hands, creating the cycles of violent retribution that were chronicled so vividly last year in Jill Leovy’s Ghettoside.

Certainly, one has to look no further than the recent mainstream media coverage of the protests in Charlotte to find examples of the police being delegitimized.

 

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