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BOND BUBBLE - Falling Earnings

The Beginning of the End of the $100 TRILLION Bond Bubble 01-19-15 Phoenix Capital Research's blog

The big story in the world is the bond bubble.

ENTITLEMENTS - "The Spending of Other Peoples Money"

For over 30 years, sovereign nations, particularly in the West have been buying votes by offering social payments in the form of welfare, Medicare, social security, and the like.

The ridiculousness of this should not be lost on anyone. Politicians, in order to be elected, promise to allocate taxpayer funds on social programs that will benefit said taxpayers down the road (we’re simply talking about social spending, not infrastructure or other costs.

The concept that taxpayers might simply just keep the money to begin with never enters the equation. And because everyone believes that they are somehow spending someone else’s money, they play along.

When you believe that you are spending someone else’s money, it’s very easy to write a blank check, which is precisely what Western nations have been doing for years, promising everyone a safe and secure retirement without ever bothering to see where the money would come from.

When actual bills came due to fund this stuff, Governments quickly discovered that current tax revenues couldn’t cover it… so they issued sovereign debt to make up the difference.

SOVEREIGN DEBT & BANKING

And so the bond bubble was created.

The large banks, that have a monopoly on managing sovereign debt auctions, were only too happy to play along with this. The reasons are as follows:

1. They can use these alleged “risk-free” assets as collateral to backstop tens of trillions worth of derivatives trades. A $1 million investment in your typical US Treasury can backstop over $15 million worth of derivatives if not more. The profits from the derivatives markets remains a primary source of revenue for the banks.

2. Sovereign Governments are only too happy to bail out the big banks if the stuff ever hits the fan on the trades that are backstopped by the sovereign debt (see 2006 onwards). Since the banks are the ones holding the sovereign debt, they can always threaten to dump bonds, which would render the whole social welfare Ponzi bankrupt (see what happened in Europe when sovereign bonds collapsed in 2011-2012).

3. In a debt-based financial system such as the current one, sovereign bonds are the senior most assets in the system. Those who own these in bulk are at the top of the financial food chain in terms of financial, economic, and political clout.

Since it was rarely if ever a problem to issue sovereign debt, Governments kept promising future payments that they didn’t have until we reach today: the point at which most Western nations are sporting Debt to GDP ratios well north of 300% when you consider unfunded liabilities (the social spending programs mentioned earlier).

Now, cutting social spending is usually considered political suicide (after all, the voters put you in office in the first place based on you promising to pay them welfare payments down the road). So rather than default on the social contract made with voters, the political class will simply push to issue MORE debt to finance old debt that is coming due.

The US did precisely this in the fourth quarter of 2014, issuing over $1 trillion in new debt simply to pay back old debt that was coming due.

BOND BUBBLE - In the 8th Inning

This is how the bond market becomes a bubble. Between 2000 and today, the global bond market has nearly TRIPLED in size. Today, it’s north of $100 trillion in size. And it’s backstopping over $555 trillion in derivatives trades.

There is literally no easy fix to any of this. The pain will be severe. And so

everyone in charge of the important decisions (the political elite, the big banks, and the Central Banks) will push this as far as it can possibly go before taking the inevitable hit.

The fact that Central banks are now openly cutting interest rates to NEGATIVE should tell you how far along we are in terms of funding problems (at these rates, bond holders are PAYING the Government for the right to own bonds). From a baseball analogy we’re in the late 8th, possibly early 9th inning.  When the game ends, the entire mess will collapse. And it will make 2008 look like a joke.

US STANDARD OF LIVING - A 'Shadow" State of the Union

A SHADOW STATE OF THE UNION

Please use the following scorecard during the State of the Union to see what is mentioned, what is not and what is being done about any on the list of 27 items below.

A product of the Chicago Cook Country political apparatus

It is our studied opinion that anything discussed will have almost no signficance to the American people once all the spin, happy-talk and platitudes are stripped away!

27 Facts That Show How The Middle Class Has Fared Under 6 Years Of Barack Obama 01-18-15 Michael Snyder - The Economic Collapse blog,

During his State of the Union speech on Tuesday evening, Barack Obama is going to promise to make life better for middle class families.  Of course he has also promised to do this during all of his other State of the Union addresses, but apparently he still believes that there are people out there that are buying what he is selling.  Each January, he gets up there and tells us how the economy is “turning around” and to believe that much brighter days are right around the corner.  And yet things just continue to get even worse for the middle class. 

The numbers that you are about to see will not be included in Obama’s State of the Union speech.  They don’t fit the “narrative” that Obama is trying to sell to the American people.  But all of these statistics are accurate.  They paint a picture of a middle class that is dying.  Yes, the decline of the U.S. middle class is a phenomenon that has been playing out for decades.  But without a doubt, our troubles have accelerated during the Obama years. 

When it comes to economics, he is completely and utterly clueless, and the policies that he has implemented are eating away at the foundations of our economy like a cancer.

The following are 27 facts that show how the middle class has fared under 6 years of Barack Obama…

#1 American families in the middle 20 percent of the income scale now earn less money than they did on the day when Barack Obama first entered the White House.

#2 American families in the middle 20 percent of the income scale have a lower net worth than they did on the day when Barack Obama first entered the White House.

#3 According to a Washington Post article published just a few days ago, more than 50 percent of the children in U.S. public schools now come from low income homes.  This is the first time that this has happened in at least 50 years.

#4 According to a Census Bureau report that was recently released, 65 percent of all children in the United States are living in a home that receives some form of aid from the federal government.

#5 In 2008, the total number of business closures exceeded the total number of businesses being created for the first time ever, and that has continued to happen every single year since then.

#6 In 2008, 53 percent of all Americans considered themselves to be “middle class”.  But by 2014, only 44 percent of all Americans still considered themselves to be “middle class”.

#7 In 2008, 25 percent of all Americans in the 18 to 29-year-old age bracket considered themselves to be “lower class”.  But in 2014, an astounding 49 percent of all Americans in that age range considered themselves to be “lower class”.

#8 Traditionally, owning a home has been one of the key indicators that you belong to the middle class.  So what does the fact that the rate of homeownership in America has been falling for seven years in a row say about the Obama years?

#9 According to a survey that was conducted last year, 52 percent of all Americans cannot even afford the house that they are living in right now.

#10 After accounting for inflation, median household income in the United States is 8 percent lower than it was when the last recession started in 2007.

#11 According to one recent survey, 62 percent of all Americans are currently living paycheck to paycheck.

#12 At this point, one out of every three adults in the United States has an unpaid debt that is “in collections“.

#13 When Barack Obama first set foot in the Oval Office, 60.6 percent of all working age Americans had a job.  Today, that number is sitting at only 59.2 percent…

#14 While Barack Obama has been in the White House, the average duration of unemployment in the United States has risen from 19.8 weeks to 32.8 weeks.

#15 It is hard to believe, but an astounding 53 percent of all American workers make less than $30,000 a year.

#16 At the end of Barack Obama’s first year in office, our yearly trade deficit with China was 226 billion dollars.  Last year, it was more than 314 billion dollars.

#17 When Barack Obama was first elected, the U.S. debt to GDP ratio was under 70 percent.  Today, it is over 101 percent.

#18 The U.S. national debt is on pace to approximately double during the eight years of the Obama administration.  In other words, under Barack Obama the U.S. government will accumulate about as much debt as it did under all of the other presidents in U.S. history combined.

#19 According to the New York Times, the “typical American household” is now worth 36 percent less than it was worth a decade ago.

#20 The poverty rate in the United States has been at 15 percent or above for 3 consecutive years.  This is the first time that has happened since 1965.

#21 From 2009 through 2013, the U.S. government spent a whopping 3.7 trillion dollars on welfare programs.

#22 While Barack Obama has been in the White House, the number of Americans on food stamps has gone from 32 million to 46 million.

#23 Ten years ago, the number of women in the U.S. that had full-time jobs outnumbered the number of women in the U.S. on food stamps by more than a 2 to 1 margin.  But now the number of women in the U.S. on food stamps actually exceeds the number of women that have full-time jobs.

#24 One recent survey discovered that about 22 percent of all Americans have had to turn to a church food panty for assistance.

#25 An astounding 45 percent of all African-American children in the United States live in areas of “concentrated poverty”.

#26 40.9 percent of all children in the United States that are living with only one parent are living in poverty.

#27 According to a report that was released late last year by the National Center on Family Homelessness, the number of homeless children in the United States has reached a new all-time record high of 2.5 million.

Unfortunately, this is just the beginning.

The incredibly foolish decisions that have been made by Obama, Congress and the Federal Reserve have brought us right to the precipice of another major financial crisis and another crippling economic downturn.

So as bad as the numbers that I just shared with you above are, the truth is that they are nothing compared to what is coming.

We are heading into the greatest economic crisis that any of us have ever seen, and it is going to shock the world.

I hope that you are getting ready.

SWISS PEG FAILURE - First Central Bank to Lose Control

As we noted last week, the Swiss National Bank's decision to un-peg from the Euro (thus strengthening the CHF dramatically) will have very significant repercussions - not the least of which is for Hungarian and Polish Swiss-Franc-denominated mortgage-holders. The 20% surge in Swiss Franc translates directly into a comparable jump in the zloty value of loan principles and and monthly payments for about 575,000 Polish families owing a total $35 billion in mortgages denominated in the Swiss currency which has prompted calls for Poland's government to bail them out. Never mind the FX risk, the low-rates were all anyone cared about and now yet another 'risk-free' trade has exploded, Deputy PM Piechocinski says, if the franc "remains above the 4 zloty level, the government may provide support" to debtors but Poland's Central Bank is not supportive of the bailout.

As Bloomberg reports,

The SNB’s abandonment of its franc floor roiled markets in some eastern European countries, where policy makers have tried to wean borrowers off of foreign currency loans.

While Polish banks stopped granting franc-denominated home loans after the global economic crisis caused the zloty to plunge in 2008, mortgage holders in the country of 38 million are still paying off debt taken last decade when they saw the franc as a way to borrow cheaply in an environment of a strengthening zloty.

How big a problem is this? (via Goldman Sachs)

Poland.

Total balance of SFr denominated mortgage loans in Poland stood at PLN131 bn at the end of November which corresponds to 22% and 15% of retail and total lending respectively, and some 8% of Polish GDP. The individual exposures of banks under our coverage differ significantly with MBK, PKO having >20% of Swiss franc loans while the balances of PEO and BHW amount to <5%. SFr lending remains a legacy product, the balance of which has been declining over the recent years (-22% since 2009) and is expected to fall further.

Implications from strong depreciation of PLN vs. SFr predominantly relate to the risks of asset quality and to a lesser extent capital and liquidity. Strong performance of SFr denominated exposures over the last 5 years (2009-14) that came against 28% depreciation of PLN vs. SFr is largely attributable to the fact that mortgage installments remained stable because of declining LIBOR rates. In a press release published today (January 15), the KNF disclosed that according to their stress test, the depreciation of PLN by 30% to circa 4.5 level should not have meaningful and systemic implications for the sector (CET1 - 20bp to 13.3%), while a 50% move (towards 5.1 level) could see banks’ CET1 ratios come under moderate pressure (CET1 -100bp to 12.5%).

We cut our earnings estimates for Polish banks by 3% in 2015 and -3% in 2016 to better reflect weaker asset quality and topline trends; we modestly lower our CET1 forecasts.

And despite the Polish Central Bank's comments that:

• *POLISH CENTRAL BANK GOVERNOR BELKA SPEAKS ON RADIO TOK FM
• *BELKA SAYS CHF LOANS CONVERSION `NOT WISE'
• *BELKA SAYS MOST POLISH CHF BORROWERS WILL BE ABLE TO PAY DEBT
• *POLISH C. BANK MEMBER ZIELINSKA-GLEBOCKA SPEAKS ON TVNBIS
• *ZIELINSKA SAYS IS AGAINST STATE ACTIONS TO HELP CHF BORROWERS
• *ZIELINSKA SAYS IS AGAINST HUNGARY'S STYLE MEASURES ON CHF LOANS
• *ZIELINSKA SAYS POLISH C.BANK SHOULD TAKE NO `NERVOUS' ACTIONS

Here come the populist politicians to the rescue...

The government will watch “further developments on the FX market,” Krystyna Skowronska, head of the parliamentary finance committee and a representative of the ruling Citizens Platform party, said in an interview with Radio 1 on Monday.

Poland’s Financial Stability Committee, whose members include the finance minister, the central bank governor and the financial market watchdog, is meeting tomorrow to discuss the loans. Some commercial banks will also attend, Jacek Bartkiewicz, a central bank management board member, said in interview with Radio 1.

“The Polish government could help borrowers with franc-denominated home loans if monthly repayments are too high compared with their income,” Bartkiewicz said. Such measures could include helping borrowers with monthly installments exceeding “say, 40 percent” of their income or the“transfer of some government aid for new home buyers to those in trouble now,” he said.

Banks should also agree to renegotiate loan contracts with clients, helping them ease the burden of higher debt costs by, for example, extending loan maturities, he said. He added the zloty may remain above 4 against franc “in the mid-term.”

*  *  *
Perhaps - just perhaps - the 575,000 mortgage holders that exposed themselves directly to FX translation risk all with the aim of lower interest rates to afford thaty bigger home - should learn a lesson from this... one which, it appears, few in the new normal are ever allowed to experience.

*  *  *

But Poland has a bigger problem than just mortgages. As Goldman Sachs goes on to explain...

Poland appears to be most exposed to CHF strength, given the size of remaining CHF debt. But although a stronger CHF will hit the budgets of households with CHF loans, CHF appreciation should not trigger systemic growth or stability problems.

At PLN131bn, the stock of the remaining CHF loans is still substantial (an equivalent of EUR30.5bn, or 7.7% of GDP), even though banks have not been extending CHF or other FX mortgages for a few years now and the vast majority of new lending has been in the Polish Zloty. Some 550 thousand households still have CHF loans, out of some 700 thousand with FX loans in total (in a country of 38 million) And, unlike in Croatia and Hungary (where FX loans had constituted larger shares of GDP), there has been no policy induced transfer of the currency exposure to banks. FX loans are one of the best performing bank assets (NPL at 3.1%, against an average NPL of 8%).

At current market pricing, a stronger CHF, even if partially offset by lower Swiss interest rates, will still have a discernible impact on household budgets, although it should not trigger a systemic growth problem. Looking at an average household with a CHF mortgage, we calculate that a combination of CHF appreciation against the PLN (some 22%), and the fall in interest rates after the cut by the SNB of around 50bps (CHF mortgages are indexed to CHF rates), will increase an average monthly mortgage payment by some PLN350, or EUR85. In total, the increase would add up to some 0.15%-0.2% of Polish GDP, or 0.25% of private consumption.

While this might not seem that much on a macro scale, an extra PLN350 in loan repayments could subtract some 9% from an average gross wage, or nearly 5% for a higher earning person (CHF loans were more popular among higher earners). Assuming the average income tax burden, higher mortgage payments would reduce disposable income for those earning twice the average salary and having an average CHF mortgage by some 6.6%. Also, more households will be pushed into negative equity (the size of the mortgage will exceed the value of the property); the negative impact on households' net wealth could also affect consumption. And given the high growth multiplier of consumer spending, the impact could be deeper than the initial 0.2% of GDP.

According to the recent stress tests from the Polish regulator KNF and the NBP, a stronger CHF should have a limited impact on overall financial stability. Recent tests indicated that banks can handle a stronger CHF (given that households carry most of the FX risk) and the increase in non-performing loans should also be limited. Also, banks should remain well capitalized even with the CHFPLN at 5.0 (the PLN traded at around CHFPLN 3.5 ahead of the SNB decision). Given that Polish (and many European) mortgages are full recourse, a higher share of negative equity loans will not necessarily trigger a wave of defaults or banks demanding extra collateral (like deposit blocks) or insurance protection from the households. But an even higher share of households with negative equity could cause the real estate market to stagnate.

However, a large CHF depreciation would require additional hedging by banks funded through cross-currency swaps (and not by FX lending from parent banks or FX deposits). We would assume that the regulator has been monitoring these risks; high liquidity in the banking sector should also help with covering those extra funding needs. But with banks being well capitalized, the cost impact should not have a large impact on the sector, although the demand for FX may put additional, occasional pressure on the Zloty. An externally driven increase in PLN volatility increases the risk of the NBP intervening in the FX markets, should the Zloty weaken rapidly over the course of a few days, without a clear domestic driver.

*  *  *

The Repercussions are only just starting...

SWISS PEG FAILURE - First Central Bank to Lose Control

The Financial System Broke Last Week 01-17-15 Phoenix Capital Research via ZH

Global Central banks’ reputations are on borrowed time.

ALL of the so called, “economic recovery” that began in 2009 has been based on the Central Banks’ abilities to rein in the collapse.

• CRISIS: The first round of interventions (2007-early 2009) was performed in the name of saving the system.
• RECOVERY: The second round (2010-2012) was done because it was generally believed that the first round hadn’t completed the task of getting the world back to recovery.
• KEYNESIAN LUNACY: However, from 2012 onward, everything changed. At that point the Central Banks went “all in” on the Keynesian lunacy that they’d been employing since 2008. We no longer had QE plans with definitive deadlines. Instead phrases like “open-ended” and doing “whatever it takes” began to emanate from Central Bankers’ mouths.

However, the insanity was in fact greater than this. It is one thing to bluff your way through the weakest recovery in 80+ years with empty promises; but it’s another thing entirely to roll the dice on your entire country’s solvency just to see what happens.

JAPAN

In 2013, the Bank of Japan launched a single QE program equal to 25% of Japan’s GDP. This was unheard of in the history of the world. Never before had a country spent so much money relative to its size so rapidly… and with so little results: a few quarters of increased economic growth while household spending collapsed and misery rose alongside inflation.

This was the beginning of the end. Japan nearly broke its bond market launching this program (the circuit breakers tripped multiple times in that first week). However it wasn’t until late 2014 that things truly became completely and utterly broken.

We are, of course, referring to the Bank of Japan’s decision to increase its already far too big QE program, not because doing so would benefit the country, but because it would bring economists’ forecast inline with governor Kuroda’s intended inflation numbers.

BROKEN

This was the “Rubicon” moment: the instant at which Central Banks gave up pretending that their actions or policies were aimed at anything resembling public good or stability. It was now about forcing reality to match Central Bankers’ theories and forecasts. If reality didn’t react as intended, it wasn’t because the theories were misguided… it was because Central Bankers simply hadn’t left the paperweight on the “print” button long enough.

At this point the current financial system was irrevocably broken. We simply had yet to feel it.

SWISS PEG

That is, until, last week, when the Swiss National Bank lost control, breaking a promise, and a currency peg, losing an amount of money equal to somewhere between 10% and 15% of Swiss GDP in a single day, and showing, once and for all, that there are problems so big that even the ability to print money can’t fix them.

Please let this sink in: a Central bank lost control last week. This will not be a one-off event.

With the Fed and other Central banks now leveraged well above 50-to-1, even those entities that were backstopping an insolvent financial system are themselves insolvent.

The Big Crisis, the one in which entire countries go bust, has begun. It will not unfold in a matter of weeks; these sorts of things take months to complete. But it has begun.

SWISS PEG FAILURE - Keynesian Central Banking Is Destroying Money And Markets

The SNB's Wake-Up Call: Keynesian Central Banking Is Destroying Money And Markets 01-17-15 Jeffrey Snider of Alhambra Investment Partners via Contra Corner blog,via ZH

It seems everyone was short the franc (CHF) as a matter of taking monetarism at face value. In other words, it amounted to believing the central party line about the economy and normalcy despite the fact that markets have been increasingly pessimistic about it all and actively and aggressively betting against it. Goldman Sachsis just one of many:

In our portfolios with currencies, we have been short the CHF on the grounds that it was an expensive currency which we expected would experience capital outflows as European growth normalized. We were surprised by the sudden removal of the peg.

The only way to be surprised about the removal of the peg, or even to be short the franc in the first place, was spelled out in the first sentence, “as European growth normalized.” Being short the franc was essentially the same thing asbeing long the European economy. Given all that has transpired in the past seven or even eight months, there was no shortage of contrary indications that such an assumption was more than precarious and ultimately asymmetric against.

Of course, the counter opinion is the same old “it wasn’t big enough last time but it will be this time.” In other words, the ABS, covered bond buying and negative nominal rates were just the warmup to the real QE event. Unfortunately, that is revisionist as the ECB has been taking intense monetary measures pretty steadily since the day it first announced the original OMT in the middle 2010. The only accomplishment in that time has been an internalrecalculation about “the economy” itself.

Nothing about Switzerland’s financial system in the latter half of 2014 was anything like a positive interpretation on the state of the European economy. In fact, the Swiss debauchery was as much screaming about the insanity of the ECB and just how ineffective and impotent the entire practical operation was right down to the smallest detail. The most obvious interpretation of the chart below is short the recovery in not just Europe, and not just from the past two days:

The utter lunacy of the ECB is reaching its inevitable end because lunacy itself cannot create economic, or even financial, normalcy. The Keynesian heart of all of this is that they fully believe redistribution can make for potent economic tonic, but redistribution is at its root a very negative factor. So monetary theory attends to that by placing what it believes are limitations upon its usage and scale; “yes, inflation is bad, but we will only be using the slightest amount.”

And you can easily see exactly what that “slightest amount” gains, as instead the failure of “just a little” redistribution is but added to; and then a little more; and a little more. It doesn’t take long before the constant hold of interventionary redistribution mangles even the most basic of functions in finance – the time value of money (credit). Central bankers will talk about “term premiums” as if that mattered to them in the slightest, rather speaking about such essential market function as if a field researcher gazing upon the rudimentary research subject. The object of redistribution is to kill money as if that will make people spend for the sake of spending. Instead they only kill basic interpretations of “money” and lead that suppression toward unbridled euphoria elsewhere.

Just in these most basic terms, how low do interest rates have to be suppressed in order for this all to work?Well, if you believe the IS-LM framework then it all depends on the natural rate of interest, which has been “calculated”, apparently, even more negative than it supposedly has been since 2007. To an economist, let alone a central banker, the world is but a spreadsheet with equations that need to be balanced, and if there is no economic momentum than the balancing factor must be that natural interest rate. The more the economy fails to respond to “just a little” redistribution, the more negative the “natural” rate is equalized in the regression; in programming, this is referred to as an “infinite loop.”

Alan Greenspan once queried the FOMC, in mid-2003, about what might happen once the zero lower bound was reached. That thought applied only to the shortest end of the credit space, the overnight rate at which the Fed thought it could control all the rest. In other words, because Greenspan, and the rest of them worldwide, believed that they could exert tremendous influence just from an overnight rate (that turned out to be more anachronistic than anesthetic) the economy’s variability might easily be corralled. That was the primary mistake of all of this, really, in that monetary authorities far overestimated (and continue to do so) their influence and the influence of the tools they used (which were relevant in the 1970’s far, far more than the 2000’s).

It seems these same central bankers, in a mad dash toward proving they have at least some control, are going to take the whole damn thing, bills to notes to bonds, down to the zero lower bound. It started in Japan and has spread now to Europe, where Germany and Switzerland (and Denmark) are seeing negative rates out to 6 or even 9 years.

The zero lower bound was supposed to be a narrow and dangerous obstacle, not a universal standard.

PATTERNS - Falling Earnings

WHY THE SPX MACRO BIA$ IS NEGATIVE FOR Q1

1- DRAMATICALLY FALLING EARNINGS

• Strength of US$ on "repatriated global reported earnings"
• Collapse in Energy stocks, profits and CAPEX

2- WEAKENING MARGIN GROWTH

3- BOND SPREADS

4- WEAKENING BUYBACKS

5- BUSINESS CYCLE - 5 YEARS