“Here Comes the Policy Response!”

For more than a year now, I have posited the thesis that unstable global finance is highly vulnerable to a problematic bout of de-risking and de-leveraging. The unfolding European debt crisis was viewed as the likely catalyst. Importantly, as this thesis began to play out during 2011’s second-half, it was my view back then that “developing” financial systems and economies would prove more susceptible than generally anticipated. The consensus viewed China and the developing world as robust - and that, in the unlikely event of an expanding European crisis, they would prove a source of stability, much as they did back in 2008/09.

It’s been my view that several years of extreme financial excess and resulting imbalances created latent fragilities throughout the “developing” world, certainly including China, India, and Brazil, as well as more generally throughout Latin America, Asia and Eastern Europe. The LTRO-induced rally in global risk markets pushed out the resolution of this thesis. Yet with the European debt crisis now spiraling out of control, the markets have turned increasingly focused on the health of the “developing” world. There are global elements that recall the environment heading into the collapse of Asian currency pegs and economies back in 1997/98.

For the week, the Indian rupee declined 1.7%, the Philippine peso 1.4%, the Indonesian rupiah 1.1%, the South Korean won 1.1%, and the Thai baht declined 0.8%. Over the past month, the rupee is down 5.1%, the South Korean won 3.7%, the Malaysian ringgit 3.0%, the Singapore dollar 2.8%, and the Thai baht 2.5%. Curiously, the Chinese renminbi declined 0.3% this week, increasing its one-month loss to 0.6%.

May 25 – Bloomberg: “China’s biggest banks may fall short of loan targets for the first time in at least seven years as an economic slowdown crimps demand for credit, three bank officials with knowledge of the matter said. A decline in lending in April and May means it’s likely the banks’ total new loans for 2012 will be about 7 trillion yuan ($1.1 trillion), less than an estimated government goal of 8 trillion yuan to 8.5 trillion yuan, said one of the officials…”

The above referenced Bloomberg article was one more piece of evidence that a major Chinese Credit slowdown has commenced. The article noted comments from the director of the Chinese Academy of Social Sciences, who stated that lending from China’s four largest banks (40% of lending) had increased a meager $5bn during the first 20 days of May. This follows April’s weaker-than-expected loan growth that was fully 30% below March lending. Sinking demand for Credit is consistent with data pointing to rapidly slowing demand for apartments and autos, as well as mounting inventories and excess capacity throughout the economy.

So far this month, the Shanghai Composite has declined 2.6%. South Korea’s Kospi is down 8.0%, with stocks down 13.9% in Hong Kong, 5.7% in Taiwan, 6.4% in India, 6.7% in Indonesia, and 5.3% in the Philippines. Credit default swap prices are up 22 bps so far this month in South Korea, 23 bps in China, 56 bps in Indonesia, 25 bps in Malaysia, 24 bps in Thailand and 44 bps in the Philippines.

In Europe, the situation this week went from bad to worse. The 18th emergency EU summit was acrimonious and unproductive. It is clear that with its new Socialist President, the political landscape has shifted dramatically in France. Importantly, the breakdown of the German and French policymaking axis has only made the policymaking backdrop more dysfunctional. In a quote worthy of note, French President Hollande this week asked: “Is it acceptable that some sovereigns can borrow at 6% and others at zero in the same monetary union?” Not surprisingly, this line of thinking - and his hard line approach with the Germans - has been warmly embraced in Spain and Italy. We’ll see if the Germans can be bullied.

The thought is that, with Greece at the precipice and Chancellor Merkel under intense political pressure internationally, throughout Europe and even within Germany, the German position must soften. Indeed, there were reports that Germany is working on a “six-point plan” to stimulate European growth. Reports (Spiegel), however, suggest that the focus is on fostering targeted growth through the creation of “special economic zones.” There is no indication the Germans are softening their stance against Eurobonds, the ESM borrowing from the ECB, or European-wide deposit guarantees.

Importantly, officials from Germany’s Bundesbank have taken a harder line. Strong comments were heard today from Bundesbank President Jens Weidmann. From MarketNews International: “The European Central Bank has reached the limit of its mandate, especially in the use of its non-conventional measures, ECB Governing Council member Jens Weidmann said… ‘In the end, these [measures] are risks for taxpayers, most notably in France and Germany,’ the Bundesbank chief told France's daily Le Monde.” In reference to Eurobonds, Mr. Weidmann stated (from Reuters) that ‘this debate irritates me a bit… You cannot give someone your credit card without having the means to control the spending.” Earlier in the week, it was the Bundesbank that was taking a hard line with respect to Greece living up to its EU commitments. As capital flight and bank solvency become critical issues, it’s the ECB that controls the purse strings.

While it remains obvious that Greece is Europe and the euro’s weakest link, it is also apparent that the financial and economic situation in Spain is weakening rapidly. With the Spanish economy faltering and the banking system hemorrhaging, the situation has turned perilous. Spanish 10-year yields ended the week at 6.27%, as fears of a massive bank capital shortfall and stressed regional governments weighed further on market confidence.

Trading in Bankia, the struggling Spanish lender, was halted today ahead of another government recapitalization plan. Only two weeks after the government took a 45% stake with a euro 4.5bn capital injection, the Financial Times is reporting that the Spanish government “is poised to invest up to 19bn euro in its most troubled lender… in a bold attempt to end market skepticism about the health of the country’s banking sector.” We’ll see to what extent such a move actually bolsters confidence and slows deposit and capital flight. It will surely give more credence to estimates for a capital shortfall as high as $250bn for Spain’s faltering banking system.

If things weren’t bad enough, today from Reuters (Fiona Ortiz): “Spain’s wealthiest autonomous region, Catalonia, needs financing help from the central government because it is running out of options for refinancing debt this year, Catalan President Artur Mas said on Friday. ‘We don’t care how they do it, but we need to make payments at the end of the month. Your economy can’t recover if you can’t pay your bills,’ Mas told a group of reporters…”

When Spain imposed a level of “austerity” at the federal level to rein in out of control deficits, regional governments just kept borrowing and spending. They’ve now apparently hit the wall. Reuters noted that 17 regions have $45bn of debt to refinance this year. Over the past two years, Catalonia has borrowed through the issuance of “patriot bonds,” although with “a quarter of all Catalan savings… already in patriot bonds” retail demand is apparently sated. Bank borrowing is expensive – and risky for the banking system. Invoking a term becoming troublingly common throughout Europe, officials in Catalonia are calling for the “mutualization” of region debt loads.

Wednesday was one of those days that left a bad feeling in the pit of my stomach. European shares were getting hammered. Spanish, Italian and periphery bonds were under heavy selling pressure. Emerging equities were under pressure, and key “developing” currencies were under heavy selling pressure. Interestingly, Credit default swap prices were rising meaningfully for key “developing” countries such as Brazil and Mexico. U.S. stock prices began sinking, with the S&P500 falling below the 1,300 level. There was notable weakness in the stocks of major multinational companies with significant exposure to the developing economies. Things looked bleak. Miraculously, U.S. stocks rallied sharply to lead recoveries in global risk markets.

I think I understand the bullish view for U.S. stocks and our economy. I am the first to point out how the U.S. economic system, predominantly fueled by Treasury Credit, is these days strangely immune to stress associated with global de-risking/de-leveraging. Yet we live these days in highly-integrated global financial and economic systems. “Risk on, risk off” is a global dynamic; the hedge funds, leveraged speculators, international financial conglomerates and global derivatives markets link all markets and economies tightly together.

It is not a low probability that a cataclysmic event is unfolding in Europe. Over the past twenty years, cataclysms have been anything but rare occurrences (1995, ‘97, ‘98, 2000, ‘01, and ‘08 come quickly to mind). European finance is not functioning effectively; policymaking is dysfunctional; confidence is breaking down; and the region’s economies are in serious trouble (I know, "markets are oversold”). It is also apparent that major Credit Bubbles in China, India, Brazil and elsewhere are showing their age. While talk of capital flight from Greece, Spain and Italy garners most of the focus, there are maladjusted economic/financial systems round the globe that are quite susceptible to de-risking/de-leveraging dynamics and attendant reversals in “hot money” flows. Heightened global market stress, bouts of financial dislocation and a resulting global economic slowdown now appear likely. The extent to which dollar carry trades (shorting/selling dollar instruments to finance the purchase of higher-returning global risk assets) have accumulated over the years remains an important unknown.

My broad Credit-centric framework analyzes the situation in terms of a series of interrelated global Bubbles. Developing economy Bubbles appear increasingly vulnerable to the bursting of the European Credit Bubble. Speculators, investors and corporations have over recent years positioned for ongoing dollar devaluation versus emerging currencies. Hedge funds have enjoyed spectacular windfall returns, while U.S. multinationals have benefited from an international profits bonanza. And while I appreciate the notion of U.S. stocks and our economy as today’s so-called “least dirty shirts,” I at the same time see the potential for major disappointment and dislocation. The U.S. Bubble may very well prove resilient – but I don’t expect our risk markets to avoid what is potentially a radical change in the global financial and economic backdrop. And when things looked like they might spiral out of control mid-week, market excitement was almost palpable: “Here Comes the Policy Response!”

For The Week:

The S&P500 rallied 1.7% (up 4.8% y-t-d), and the Dow increased 0.7% (up 1.9%). The S&P 400 Mid-Caps surged 3.2% (up 6.3%), and the small cap Russell 2000 rallied 2.6% (up 3.4%). The Morgan Stanley Cyclicals surged 3.6% (up 4.3%), and the Transports jumped 4.2% (up 1.2%). The Morgan Stanley Consumer index gained 1.3% (up 2.3%), and the Utilities increased 0.7% (down 1.3%). The Banks were up 2.3% (up 11.9%), and the Broker/Dealers were 1.2% higher (up 3.3%). The Nasdaq100 was up 2.0% (up 10.9%), and the Morgan Stanley High Tech index added 0.5% (up 7.8%). The Semiconductors rallied 2.1% (up 2.1%). The InteractiveWeek Internet index increased 1.5% (up 5.2%). The Biotechs rose 3.3% (up 34.5%). Although bullion was down $19, the HUI gold index rallied 8.0% (down 14.2%).

One-month Treasury bill rates ended the week at 6 bps and three-month bills closed at 8 bps. Two-year government yields were down about a basis point to 0.29%. Five-year T-note yields ended the week up one basis point to 0.76%. Ten-year yields increased one basis point to 1.74%. Long bond yields rose 3 bps to 2.84%. Benchmark Fannie MBS yields jumped 5 bps to 2.72%. The spread between benchmark MBS and 10-year Treasury yields widened 4 to 98 bps. The implied yield on December 2013 eurodollar futures declined 2.5 bps to 0.725%. The two-year dollar swap spread declined 1.5 to 35.5 bps. The 10-year dollar swap spread increased 3 to 15 bps. Corporate bond spreads reversed course for the week. An index of investment grade bond risk ended the week down 5 to 118 bps. An index of junk bond risk fell 52 to 657 bps.

Debt issuance was OK. Investment grade issuers included United Technologies $9.8bn, Blackrock $1.5bn, Caterpillar $1.5bn, AIG $750 million, McDonald's $900 million, and Energizer $500 million.

Junk bond funds saw outflows surge to $2.46bn (from Lipper). Junk issuers included NGPL Pipeco $550 million, Global Brass & Copper $375 million, Wolverine Healthcare $327 million, Consolidated Communications $300 million, Roofing Supply $200 million, and Carrols Restaurant $150 million.

I saw no convertible debt issued.

International dollar bond issuers included Interamerican Development Bank $1.5bn, Covidien $1.25bn, and Swedish Export Credit $1.0bn.

Spain's 10-year yields rose 4 bps to 6.29% (up 125bps y-t-d). Italian 10-yr yields declined 14 bps to 5.65% (down 138bps). Ten-year Portuguese yields increased 3 bps to 11.99% (down 78bps). The new Greek 10-year note yield jumped another 90 bps to 29.44%. German bund yields were down 6 bps to a record low 1.37% (down 46bps), and French yields sank a notable 34 bps to 2.51% (down 63bps). The French to German 10-year bond spread narrowed 28 to 114 bps. U.K. 10-year gilt yields fell 7 bps to 1.75% (down 22bps). Irish yields declined 6 bps to 7.20% (down 106bps).

The German DAX equities index rallied 1.1% (up 7.5% y-t-d). Spain's IBEX 35 equities index slipped 0.4% (down 23.6%), while Italy's FTSE MIB recovered 0.8% (down 12.8%). Japanese 10-year "JGB" yields jumped 6 bps to 0.88% (down 10bps). Japan's Nikkei declined 0.4% (up 1.5%). Emerging markets were volatile and mixed for the week. Brazil's Bovespa equities index ended unchanged (down 4.0%), while Mexico's Bolsa rallied 1.7% (up 1.1%). South Korea's Kospi index rallied 2.3% (down 0.1%). India’s Sensex equities index increased 0.4% (up 4.9%). China’s Shanghai Exchange dipped 0.5% (up 6.1%).

Freddie Mac 30-year fixed mortgage rates declined one basis point to a record low 3.78% (down 82bps y-o-y). Fifteen-year fixed rates were unchanged at 3.04% (down 74bps). One-year ARMs were down 3 bps to 2.75% (down 33bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down one basis point to 4.38% (down 75bps).

Federal Reserve Credit increased $2.1bn to $2.843 TN. Fed Credit was up $92bn from a year ago, or 3.3%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 5/23) jumped $16.4bn to $3.507 TN. "Custody holdings" were up $86bn y-t-d and $64bn year-over-year, or 1.9%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $640bn y-o-y, or 6.5% to $10.468 TN. Over two years, reserves were $2.116 TN higher, for 25% growth.

M2 (narrow) "money" supply increased $7.3bn to a record $9.876 TN. "Narrow money" has expanded 6.5% annualized year-to-date and was up 9.3% from a year ago. For the week, Currency increased $1.3bn. Demand and Checkable Deposits jumped $38.3bn, while Savings Deposits dropped $25.2bn. Small Denominated Deposits fell $3.1bn. Retail Money Funds declined $4.0bn.

Total Money Fund assets were little changed at $2.564 TN. Money Fund assets were down $131bn y-t-d and $184bn over the past year, or 6.7%.

Total Commercial Paper outstanding rose $14.9bn to surpass a Trillion ($1.009TN) for the first time since last November. CP was up $49bn y-t-d, while declining $190bn from one year ago, or down 16.1%.

Global Credit Watch:

May 23 – Bloomberg (Jana Randow and Gabi Thesing): “Greece may have only a 46-hour window of opportunity should it need to plot a route out of the euro. That’s how much time the country’s leaders would probably have to enact any departure from the single currency while global markets are largely closed, from the end of trading in New York on a Friday to Monday’s market opening in Wellington, New Zealand, based on a synthesis of euro-exit scenarios from 21 economists, analysts and academics. Over the two days, leaders would have to calm civil unrest while managing a potential sovereign default, planning a new currency, recapitalizing the banks, stemming the outflow of capital and seeking a way to pay bills once the bailout lifeline is cut. The risk is that the task would overwhelm any new government in a country that has had to be rescued twice since 2010 because it couldn’t manage its public finances. ‘Leaving is difficult and messy, so anyone who thinks it’s easy is just wrong,’ said Lorenzo Bini Smaghi, who left the European Central Bank’s executive board last year… ‘The Greeks must be rational and protect themselves from rash decisions that they will live to regret. Leaving the euro is not the answer to their problems.’”

May 24 – Dow Jones: “Greece's radical left Syriza party is leading in the race to win the country's elections next month, a public opinion poll showed Thursday, outpacing the rival conservative New Democracy party by a four-point margin. According to the poll… Syriza, which opposes Greece's austerity measures, would garner 30% of the vote if elections were held today, versus 26% for the conservatives.”

May 25 – Bloomberg (Nicholas Comfort): “Greece is a ‘failed state’ and the population and business community don’t see a path out of the crisis, said Juergen Fitschen, who takes over as Deutsche Bank AG’s co-chief executive officer next week. ‘Greece is the only country, I feel, where we can say ‘it’s a failed state,’ it is a corrupt state, corrupt as far as its political leadership is concerned and obviously other people had to be willing to support this,’ Fitschen said…”

May 23 – Bloomberg (Jana Randow): “Germany’s Bundesbank said the consequences of Greece reneging on the terms of its bailout program would be manageable for the euro area. ‘The current situation in Greece is extremely worrying,’ the… central bank said… ‘Greece is threatening not to implement the reform and consolidation measures it agreed to in return for sizeable rescue programs.’ …Greece is ‘jeopardizing the continuation of aid payments,’ the Bundesbank said. ‘Greece would have to bear the consequences of such a decision. The challenges for the euro area and Germany would be significant but manageable with the help of cautious crisis management.’ The ECB, in an effort to protect its balance sheet, last week excluded some Greek banks from regular refinancing operations, moving them to an emergency-liquidity program run by the Greek central bank until they are sufficiently recapitalized. ‘In supplying extensive liquidity to Greece, the Eurosystem believed in the implementation of the programs, and has thus taken on considerable risks,’ the Bundesbank said. ‘In light of the current situation, it shouldn’t increase these significantly any more.’”

May 23 – MarketNews International: “A possible Greek exit from the Eurozone would be challenging but manageable for the Eurozone, the Bundesbank said… The Bundesbank cautioned that renegotiating the bailout terms, could indeed prove more costly to the common currency area in the long run. ‘A significant softening of agreements on the other hand would damage trust in the agreements and treaty of the European Monetary Union and significantly weaken incentives for responsible reform and consolidation measures,’ the report said.”

May 25 – MarketNews International: “The European Central Bank has reached the limit of its mandate, especially in the use of its non-conventional measures, ECB Governing Council member Jens Weidmann said… ‘In the end, these [measures] are risks for taxpayers, most notably in France and Germany,’ the Bundesbank chief told France's daily Le Monde. Commenting on the ECB's longer-term refinancing operations, Weidmann said that the measures had bought time, but have not resolved the structural issues of the crisis. ‘It’s like morphine,’ Weidmann said. The LTROs ‘provide relief from the pain, but are not a cure for the illness. They could even have side effects, including delayed adjustments in the banking sector, for example.’ Weidmann also reiterated his opposition to the idea of granting a banking license to the European Stability Mechanism so that it could obtain funding directly from the ECB… it would amount to ‘subjugating monetary policy to budget policy, which greatly harm the credibility of the ECB. And also because monetary financing of states, for good reasons, is strictly prohibited by the [EU] treaties.’”

May 25 – Reuters: “German central bank chief Jens Weidmann dismissed French-backed calls for the use of euro bonds to boost economic growth in Europe, saying… ‘this debate irritates me a bit’. ‘It's an illusion to think euro bonds will solve the current crisis… ‘You cannot give someone your credit card without having the means to control the spending,’ he said… Weidmann, who is also part of the governing council of the European Central Bank, also said that financial aid for Greece should stop if Athens did not respect commitments it made in return for outside help. ‘Otherwise the agreements would lose all credibility and we would be engaging in unconditional transfers,’ he said.”

May 25 – Bloomberg (Dara Doyle and Jeff Black): “The first rule of ELA is you don’t talk about ELA. The European Central Bank is trying to limit the flow of information about so-called Emergency Liquidity Assistance, which is increasingly being tapped by distressed euro-region financial institutions as the debt crisis worsens. Focus on the program intensified last week after news leaked that the ECB moved some Greek banks out of its regular refinancing operations and onto ELA until they are sufficiently capitalized… ‘The lack of transparency is a double-edged sword,’ said David Owen, chief European economist at Jefferies Securities International… ‘On the one hand, it increases uncertainty, but at the same time we do not necessarily want to know how bad things are as it can add fuel to the fire.”

May 22 – Dow Jones: “German Chancellor Angela Merkel reiterated her opposition to euro-zone bonds Wednesday, saying they wouldn’t contribute to growth and aren't legal under European Union law. Merkel said the EU's founding treaties ‘forbid a taking-on of joint liability’ of debt ‘and according to our opinion that also includes euro bonds.’ ‘In addition, I believe that they do not contribute to growth in the euro zone, because the very similar interest rates that we had for many years led to very grave misguided developments,’ she told reporters on her way into a summit of EU heads…”

May 24 – Dow Jones (Laurence Norman, Vanessa Mock and Gabriele Steinhauser): “A drum beat of recent calls for some form of euro-zone debt issuance ran into a phalanx of opposition at a European Union summit Wednesday, with a number of leaders saying the idea was premature or counterproductive. The election of French President Francois Hollande has shifted the debate within Europe to what measures can be taken to boost growth.”

May 25 – Bloomberg (Martijn van der Starre): “The Netherlands will continue to oppose joint euro-area bonds, Dutch Prime Minister Mark Rutte says at weekly press conference…”

May 25 – Bloomberg (Elena Logutenkova): “UBS AG Chief Investment Officer Alexander Friedman said there’s a ‘material risk’ of a run on banks in peripheral countries even before Greek elections in June. ‘Contagion fears might compel individuals in Portugal, Ireland, Italy, and Spain to withdraw bank deposits due to concerns over solvency, redenomination, or otherwise,” Friedman said… ‘This could spark a major banking collapse, requiring truly unprecedented action from the European Central Bank.’”

May 25 – Bloomberg (Charles Penty): “The Bankia group, a Spanish lender nationalized earlier this month, will seek 19 billion euros ($23.8bn) of government funds as it provisions against real estate and non-property loans. The group will ask the state’s bank rescue fund to provide the money by buying shares in its parent company, Banco Financiero y de Ahorros, it said in a filing… The unraveling of Bankia has deepened concern about the health of Spain’s banks and increased the government’s financing costs as it struggles with the debt crisis.”

May 25 – Bloomberg (Andrew Davis and Rebecca Christie): “The cost of Greece exiting the euro would be unmanageable and probably exceed the 1 trillion euros ($1.25 trillion) previously estimated by the Institute of International Finance, the group’s managing director said. The… IIF’s projection from earlier this year is ‘a bit dated now’ and ‘probably on the low side,’ Charles Dallara said… ‘Those who think that Europe, and more broadly the global economy, are really prepared for a Greek exit should think again.’”

May 25 – Reuters (Fiona Ortiz): “Spain’s wealthiest autonomous region, Catalonia, needs financing help from the central government because it is running out of options for refinancing debt this year, Catalan President Artur Mas said… ‘We don't care how they do it, but we need to make payments at the end of the month. Your economy can't recover if you can't pay your bills,’ Mas told a group of reporters… The debt burden of Spain's 17 highly devolved regions, and rising bad loans at the country's banks, are both at the heart of the euro zone debt crisis because investors are concerned they could strain finances so much that Spain, the currency bloc's fourth biggest economy, will need an international bailout.”

May 24 – Bloomberg (Angeline Benoit): “Spanish Prime Minister Mariano Rajoy called on the European Central Bank to take action to bring down rising borrowing costs in some of the 17 member countries of the euro region. ‘If public debt isn’t sustainable, we have a problem,’ he said… ‘I insist it is up to the ECB to take this decision that it has already taken in the past.’”

May 23 – Bloomberg (Lorenzo Totaro): “Foreign investors will keep cutting their holdings of Spanish and Italian public debt in coming months, reflecting a shift already seen in Ireland, Portugal and Greece, Fitch Ratings said. ‘The proportion of Spanish and Italian public debt held by non-resident investors continued to fall in the first quarter of 2012 as banks funded with cheap ECB money replaced international institutional investors,’ the rating company said… Fitch sees ‘a high risk of outflows in Spain and Italy continuing in the coming quarters.’ Holdings of Spanish debt by non-residents, excluding the European Central Bank, dropped in the first quarter to 34%, Fitch estimated, from 40% at the end of 2011 and 60% in 2008. Foreign ownership of Italian debt fell to 32% from 50% in 2008, Fitch said… ‘The outflows have been offset by significant flows within the Eurosystem of central banks,’ according to today’s report. ‘If the outflows continue, we see the ECB, and the European Stability Mechanism if needed, as willing and able to prevent self-fulfilling liquidity crises and buy sovereigns’ time to implement consolidation and structural reform.’”

May 23 – Bloomberg (Elena Logutenkova, Liam Vaughan and Gavin Finch): “Europe’s banks, sitting on $1.19 trillion of debt to Spain, Portugal, Italy and Ireland, are facing a wave of losses if Greece abandons the euro. While lenders have increased capital buffers, written down Greek bonds and used central-bank loans to help refinance units in southern Europe, they remain vulnerable to the contagion that might follow a withdrawal, investors say. Even with more than two years of preparation, banks still are at risk of deposit flight and rising defaults in other indebted euro nations. ‘A Greek exit would be a Pandora’s box,’ said Jacques- Pascal Porta… at Ofi Gestion Privee in Paris… ‘It’s a disaster that would leave the door open to other disasters. The euro’s credibility will be weakened, and it would set a precedent: Why couldn’t an exit happen for Spain, for Italy, and even for France?’”

May 22 – Bloomberg (Abigail Moses): “The record rally in bank debt fueled by the European Central Bank injection of $1.3 trillion into the region’s financial system has evaporated as the worsening Greek crisis triggers deposit withdrawals and ratings downgrades. The Markit iTraxx Financial Index of credit-default swaps on the senior debt of 25 European banks and insurers including Spain’s Banco Santander SA and Italy’s UniCredit SpA reached 308.398 on May 18, up from this year’s low of 181.472 on March 20 and the highest since Dec. 19.”

May 23 – Bloomberg (Helene Fouquet and James G. Neuger): “French President Francois Hollande challenged Germany’s handling of the financial crisis as he headed to his first European Union summit with calls for joint borrowing and cash injections to struggling banks. Hollande teamed with Spanish Prime Minister Mariano Rajoy to press for tonight’s meeting of EU leaders to break with German-dominated budget-cutting policies that have failed to stabilize the 17-nation euro area and led to speculation that Greece might be forced out.”

May 23 – Bloomberg (Adam Ewing): “Denmark’s regional bank industry faces more insolvencies, adding to five since last year, as capital levels remain too low to survive impairments, said Niro Invest Aps, which predicted most of 2011’s failures. ‘The banking industry is doing what it can, but we haven’t seen the last crash yet,’ Nicholas Rohde, managing director at Denmark-based Niro, said… ‘There are still some lenders where the capital base is so thin they will have difficulties in absorbing unforeseen losses.’”

Global Bubble Watch:

May 25 – Bloomberg (Elizabeth Ody and Margaret Collins): “Facebook Inc.’s initial public offering, plagued by trading errors and a 16% drop in the share price, will push more individual investors out of a stock market they already distrust after the financial crisis. ‘This is clearly the latest in a long string of events that is eviscerating the confidence investors have in the market,’ said Andrew Stoltmann, a Chicago attorney who represents retail investors. ‘The perception is Wall Street jiggered this IPO so the underwriters made money, Facebook executives made money and the small investor got left holding the bag.”

May 25 – Bloomberg (Lisa Abramowicz): “Investors pulled $3.05 billion from junk-bond funds globally in the week ended May 23, the most since August, as a worsening political crisis in Greece roiled credit markets.”

May 25 – Bloomberg (Lilian Karunungan and Yumi Teso): “Emerging-market dollar bonds may start to match declines for developing-nation stocks as the Greek debt crisis further weakens the risk appetite of investors, according to Mizuho Securities Co. ...JPMorgan Chase & Co.’s Emerging Market Bond Index has dropped 2.4% this month, while the MSCI Emerging Markets Index of stocks plunged 12%.”

May 24 – Bloomberg (Sarah Mulholland): “Wall Street’s on-again, off-again love affair with commercial-mortgage-backed securities is on the rocks as markets get whipsawed by Europe’s debt crisis. Goldman Sachs Group Inc., Deutsche Bank AG and other banks sold $2.4 billion of new deals this month with the widest spreads this year. An index tied to lower-rated bonds issued before the financial crisis fell 7.4% to 56 cents on the dollar, approaching the lowest level in almost six months.”

May 23 – Bloomberg (Mary Childs): “The biggest surge in credit derivatives prices in eight months is dragging corporate bonds toward a second monthly decline in 2012 on bets JPMorgan Chase & Co.’s trading losses will grow and Greece’s crisis will deepen. The extra yield investors demand to own U.S. company notes due in three to five years climbed 16 bps in the five days ended May 21, the biggest jump for a comparable period since November…”

Currency Watch:

The U.S. dollar index jumped 1.4% this week to 82.40 (up 2.8% y-t-d). For the week on the the upside, the Brazilian real increased 1.8%. On the downside, the Swiss franc declined 2.1%, the euro 2.1%, the Danish krone 2.0%, the Mexican peso 1.5%, the South Korean won 1.1%, the British pound 1.0%, the Australian dollar 0.9%, the Norwegian krone 0.8%, the Japanese yen 0.8%, the South African rand 0.8%, the Canadian dollar 0.7%, the Swedish krona 0.5%, the Singapore dollar 0.5%, the New Zealand dollar 0.3%, and the Taiwanese dollar 0.1%.

Commodities Watch:

The CRB index sank 2.9% this week (down 7.6% y-t-d). The Goldman Sachs Commodities Index declined 1.4% (down 3.8%). Spot Gold fell 1.3% to $1,573 (up 0.6%). Silver declined 1.1% to $28.39 (up 1.7%). July Crude slipped 94 cents to $90.86 (down 8%). June Gasoline was little changed (up 9%), while June Natural Gas fell 6.3% (down 14%). July Copper declined 0.6% (unchanged). June Wheat fell 2.2% (up 4%) and June Corn sank 9.0% (down 11%).

China Watch:

May 25 – Bloomberg (Fion Li and Rachel Evans): “Sales of yuan-denominated bonds in Hong Kong are poised to fall to their lowest level in 21 months as record borrowing costs erode the advantage of selling debt in the city. Issuers have sold 2.1 billion yuan ($331 million) of Dim Sum bonds this month, the least since August 2010 and half of sales in April… Average yields on yuan bonds rose 21 bps… this month to a record 4.41%... Issuance of yuan bonds in Hong Kong… is down 86% compared with May last year…”

India Watch:

May 25 – Bloomberg (Jeanette Rodrigues): “India’s rupee fell for an eighth week, the longest losing streak since 2008, as investors sought the perceived safety of the dollar on concern Greece will leave Europe’s currency union… The rupee’s weakness ‘has been driven by a potent combination of deteriorating global risk sentiment and weak domestic fundamentals,’ analysts at Barclays Plc’s…Singapore-based Olivier Desbarres, wrote… ‘Policy options to support the rupee currently appear limited.”

Asian Bubble Watch:

May 24 – Bloomberg (Eunkyung Seo): “South Korea needs to fortify its protection against volatility in flows of foreign capital as Europe’s deepening sovereign-debt crisis roils financial markets, a government policy adviser said. ‘Various measures can be contemplated including some tax for the duration of how long the money has been inside the country,’ Choi Byung Il, president of the Korea Economic Research Institute, said… South Korea’s won approached a five-month low yesterday on concern Greece will leave the euro, disrupting financial markets and dragging down regional and global economies.”

Latin America Watch:

May 23 – Bloomberg (Blake Schmidt and Andre Soliani): “Brazil’s bid to bolster flagging car sales by freeing up 18 billion reais ($8.6bn) in financing is deepening investor concern that government stimulus will fan inflation. The difference in yields on interest-rate futures contracts due in January 2013 and January 2021, an indication of traders’ wagers on the outlook for increases to Brazil’s benchmark lending rate, widened 25 bps to 2.55 percentage points… the highest since March.”

May 22 – Bloomberg (Nacha Cattan): “Mexico attracted 8.7% less foreign direct investment in the first quarter of this year compared with the same period a year earlier, the Economy Ministry reported…”

European Economy Watch:

May 25 – Telegraph (Fiona Govan): “Even in the good, pre-recession days, Catalonia resented sending funds to Madrid and subsidising poorer regions around Spain. With a population of 7.5m, the fiercely independent region is Spain's richest, with an annual GDP that is one-fifth of the country’s total. But it is now also the country’s most indebted region and has seen the country's most violent, anti-austerity protests as the region slashes public services and attempts to sell off its assets, including some public hospitals. The threat, however, of central intervention will only raise fears of inflaming nationalist sentiment.”

May 23 – Bloomberg (Alex Webb, Joseph de Weck and Eleni Chrepa): “German taxi driver Rudolf Kugel, who says he’s visited Greece more times than he can count, won’t be going again anytime soon to the Mediterranean sunspot because he’s concerned about the reaction of local people. ‘They hold Germans responsible for all their misery,’ said the 62-year-old… ‘You want to go on holiday to have a comfortable break, not to be lynched.’”

May 23 – Bloomberg (Lorenzo Totaro): “Italian consumer confidence plunged to the lowest in more than 15 years in May as Prime Minister Mario Monti’s austerity drive deepens the recession in Europe’s fourth-biggest economy.”

May 23 – Bloomberg (Fergal O’Brien and Gonzalo Vina): “U.K. retail sales fell the most in more than two years in April as record rainfall reduced demand for clothing and fuel sales plunged. Sales including auto fuel declined 2.3% from March…”

Global Economy Watch:

May 23 – Bloomberg (Jason Corcoran and Paul Abelsky): “Russia’s economy would shrink 2.1% in a worst-case scenario, with as much as $95 billion in capital leaving the country, if Greece quits the euro area, Ksenia Yudaeva, chief economist at OAO Sberbank, said...”

U.S. Bubble Economy Watch:

May 22 – Bloomberg (Esmé E. Deprez): “New York City cab riders may see fares rise by as much as 20%, the biggest increase in eight years, under a proposal before the Taxi and Limousine Commission.”

May 20 – Bloomberg (Dex McLuskey): “Babe Ruth’s earliest-known jersey has sold at auction for $4.42 million, a record for an item of sports memorabilia.”

California Watch:

May 21 – Bloomberg (Brian Chappatta): “California’s swelling budget deficit is proving no match for investors desperate to boost returns with municipal interest rates close to 45-year lows. The extra yield investors demand to hold debt of California issuers instead of top-rated local-government bonds matched a three-year low on May 15… The day before, Governor Jerry Brown proposed cutting state workers’ pay 5% to save money after the state’s spending gap grew 71% since January.”

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