The global rout resulting from tensions over the North Korean nuclear standoff continued on Friday as world stocks tumbled for the fourth day, on course for their worst week since November following a third day of escalating verbal exchanges between Trump and Kim, as European and Asian shares tumlbed, volatility spiked, and the selloff in US futures continued albeit at a more modest pace as the escalating war of words over North Korea drove investors on Friday to safe havens such as the yen, Swiss franc and gold. In addition to North Korea, attention will be closely focused on today's US CPI print, which could result in even more currency volatility, should it surprise significantly in either direction.

"What has changed this time is that the scary threats and war of words between the U.S. and North Korea have intensified to the point that markets can't ignore it," said Shane Oliver, head of investment strategy at AMP Capital in Sydney. "Of course, it's all come at a time when share markets are due for a correction, so North Korea has provided a perfect trigger."

All eyes remained on the sharp short squeeze in the VIX, which exploded more than 50% above 16 on Thursday from single digits the day before - the highest print since Trump's election victory - and extended gains on Friday rising nearly 5% to 16.80, after briefly topping 17, a potential "margin calling" nightmare for countless vol sellers over the past year. Thursday also saw the highest VIX volume day on record as 937K VIX futures traded across the curve. The Global Financial Stress Indicator surged positive after trading in negative territory since April.

The global rout that sent the Nasdaq lower by 2% on Thursday, spread to China which saw the Shanghai Composite tumble by 1.6% to 3,208, its biggest drop this year, led by mining and resource stocks, with nearly 20 names halted limit down, after Chinese metals prices tumbled by 5%. The Chinese volatility index jumped by the most since January 2016 to its highest level in more than seven months.

While there wasn't a specific catalyst for the rout, a driver for the sharp commodity selling was the announcement by the China Steel Industry Association which said the recent surge in steel futures was not due to market demand but misunderstanding by some institutions. Adding fuel to the fire was a Reuters report that the Shanghai Futures Exchange told its members it may raise margins on steel rebar contracts if market trade volume is too large. As a result, metals also led declines on the mainland CSI 300 Index: Xiamen Tungsten slides as much as 9.3%, most intraday since September; Jiangxi Copper falls as much as 8.3%; China Molybdenum slips as much as 7.7%; the Bloomberg China Steel Producers Valuation Peers Index tumbled 5.9%, with Nanjing Iron & Steel, Maanshan Iron & Steel, Angang Steel dropping at least 6.9%.

"Chinese investors locked in profits on commodity shares following strong gains which had been driven by bets that capacity cuts would boost prices", said Helen Lau, Hong Kong-based analyst with Argonaut Securities. "Stock markets are in a risk-off mode due to escalating geopolitical risks, so recent outperformers would be the first to take a hit amid a selloff."  In HK trading Aluminum Corp. of China tumbles as much as 7.4%, the biggest intraday drop since February 2016, while China Shenhua Energy dropped as much as 4.8%, among the worst performers on Hang Seng Index.

Also hurting Chinese sentiment was the plunge in Tencent, with the Chinese tech giant dropping as much as 5% in Hong Kong, its biggest intraday decline in more than a month, following news of a Chinese probe into Tencent, Sina and Baidu for cyber-security law violations.  Stocks of related tech companies were all lower with Sina down 3%, Weibo down 4.5%, and Baidu down 2.5%.

Earlier in the session, the onshore Chinese yuan dropped as much as 0.43% vs USD to 6.7080, its biggest drop since Jan. 19, after the PBOC set the fixing at a weaker level than expected. As Bloomberg reported overnight, the PBOC strengthened fixing by 0.19% to 6.66420, compared with forecasts of 6.6477 from Commerzbank, 6.6552 from Mizuho Bank, 6.6559 from Scotiabank and 6.6549 from Nomura. At the same time, the offshore yuan dropped as much as 0.28% to 6.6853, most since June 26, although putting the drop in context, just one day earlier, the CNY rose to its strongest level since August 2016 on Thursday, prompting Bloomberg to call the Yuan the new "safe haven" currency.

Elsewhere in Asia, MSCI's broadest index of Asia-Pacific shares outside Japan had skidded 1.55 percent, its biggest one-day loss since mid-December, to leave it down 2.5 percent for the week. Australia’s S&P/ASX 200 Index fell 1.2 percent at the close in Sydney. The Hang Seng Index in Hong Kong tumbled 2 percent and China’s Shanghai Composite Index was down 1.6 percent. The Japanese yen rose 0.2 percent to 108.96 per dollar, the strongest in more than 15 weeks. Japanese markets are closed for the Mountain Day public holiday.

South Korea's KOSPI fell 1.8 percent to an 11-1/2-week low, but its losses for the week are a relatively modest 3.2 percent; volatility on the Kospi 200 surged as much as 27 percent. "Pretty remarkable, perhaps even extraordinary, considering," said fund manager BlueBay strategist Tim Ash. The Korean won also continued to skid, down 0.45 percent to 1,147.2, falling below its 200-day moving average for the first time in a month.

European markets continued sliding into risk-off mode although at a slower pace; even so Europe's where regional indices were set for the worst week of losses this year as sentiment on ongoing fears about escalation between the US and North Korea. Euro zone volatility jumped to the highest since April, when France's election was rattling the region.  Weakness has been seen across the board (Eurostoxx 600 -1.0%), however mining names have notably underperforming amid Chinese metal prices slumping by some 5% overnight. The iTraxx Crossover extended its recent widening, leading sentiment as hedges are placed into the weekend. European equity markets opened lower led by mining sector, as base metals sell off heavily in Asia after a report saying the Shanghai exchange may raise margins on steel rebar contracts, which was later confirmed. DAX futures dip to approach 200-DMA, financials under pressure after HSBC warns low-vol environment could hit 2H revenues.

CHF and JPY marginally outperform in G-10, EMFX weaker against USD across the board. Core fixed income extends rally and bund curve flattens further, yet UST/bund spread widens 3bps as USTs lag amid focus on U.S. CPI data which may add to the recent dollar pains should inflation come in weaker than expected.

U.S. treasury yields fell to their lowest in more than six weeks ahead of inflation data expected to show a pickup in price growth, which could boost the chances of a further rate hike this year, while the Fed’s Kaplan and Kashkari are due to speak. The dollar declined against the Japanese yen for a fourth day as North Korea tensions remained elevated. The yield on 10-year Treasuries fell one basis point to 2.19 percent, the lowest in more than six weeks. Germany’s 10-year yield decreased three basis points to 0.38 percent, the lowest in more than six weeks.

Oil was modestly higher even though the IEA cuts its OPEC demand estimates for this year and next year by by 400bpd after revising down its demand estimates going back to 2015, rejecting OPEC's own assessment of rising demand growth for the near future.

Aside from North Korea, inflation data is where the market is most sensitive to a surprise at the moment, even if yesterday's weak US PPI doesn't suggest an imminent rise. For the US CPI today, consensus expected core CPI inflation to rise +0.2%, and should finally snap its streak of four consecutive monthly misses which could be important. As recent Fed statements have emphasized, policymakers will be monitoring near-term inflation trends closely. Hence, an in line print would provide tentative evidence that the recent downshift in core inflation may be behind us.

New York Fed President William Dudley cautioned that it will “take some time” for inflation to reach the central bank’s 2 percent target, the latest official warning that price pressures remain muted. The Federal Reserve Bank Dallas President Fred Kaplan speaks this afternoon. Also today, Moody’s may publish a review of South Africa’s credit rating, two months after reducing its foreign- and local-currency assessments to one level above junk.  JC Penney, Magna International and Telus are due to release results. July consumer price data is also due later.

Bulletin Headline Summary From RanSquawk

• Geopolitical tensions continue to act as a driving force for markets amid the latest exchange between the US and NK
• This has seen downside in EU equities (Eurostoxx 50 -1.0%) and a FTQ in other assets
• Looking ahead, highlights include US CPI, Fed's Kashkari and Kaplan

Market Snapshot

• S&P 500 futures down 0.1% to 2,434.25
• STOXX Europe 600 down 1.0% to 372.26
• DAX down 0.3% to 11,980
• MSCI ASIA down 0.8% to 158.49
• MSCI ASIA ex JAPAN down 1.5% to 515.81
• Nikkei down 0.05% to 19,729.74
• Topix down 0.04% to 1,617.25
• Hang Seng Index down 2% to 26,883.51
• Shanghai Composite down 1.6% to 3,208.54
• Sensex down 1.1% to 31,193.00
• Australia S&P/ASX 200 down 1.2% to 5,693.14
• Kospi down 1.7% to 2,319.71
• German 10Y yield fell 3.5 bps to 0.38%
• Euro down 0.1% to 1.1759 per US$
• Brent Futures down 0.9% to $51.45/bbl
• US 10Y yields unchanged at  2.19%
• Italian 10Y yield rose 2.1 bps to 1.743%
• Spanish 10Y yield fell 0.6 bps to 1.452%
• Brent Futures down 0.4% to $51.70/bbl
• Gold spot up 0.1% to $1,287.31
• U.S. Dollar Index up 0.04% to 93.44

Top Overnight News

• China Urges Restraint as Futures Slide; FOMC Voters to Speak After CPI Data; Snap Slammed Amid Facebook Pressure
• The escalating war of words between Trump and North Korean leader Kim Jong-Un sent Asian markets tumbling as the region braced for more provocations from his regime next week
• President Donald Trump stepped up his campaign of pressure on North Korea, warning the regime not to follow through with a missile test near Guam and promising massive response to any strike against the U.S. or its allies
• Treasury yields may climb from a six-week low if Friday’s U.S. consumer- price data merely meet expectations, as the market is on high- alert for evidence that inflation is heating up and supporting the Fed’s case for higher interest rates
• For all the talk that Chair Janet Yellen’s plan to shrink the Fed’s balance sheet will hurt Treasuries, U.S. mortgage bonds face a bigger test
• The International Energy Agency cut estimates for the amount of crude needed from OPEC this year and in 2018, after lowering its historical assessments of consumption in emerging nations including China and India
• All that stands between German Chancellor Angela Merkel and a fourth term is six weeks of campaigning
• Morgan Stanley added its voice to a growing chorus of skepticism surrounding debt valuations, with Pacific Investment Management Co. writing in a report released Wednesday that investors should pare relatively expensive assets like corporate bonds in favor of safer investments like Treasuries
• Credit Suisse Group AG is barring its traders from buying or selling certain Venezuelan securities and business as the political and economic crisis in the South American country intensifies
• Gold advanced to the highest in two months as the spike in tensions between the U.S. and North Korea fanned demand, with hedge fund billionaire Ray Dalio flagging rising risks, including “two confrontational, nationalistic, and militaristic leaders playing chicken with each other”
• President Donald Trump laid out a path for Senate Majority Leader Mitch McConnell to get back in his good graces: replace Obamacare, overhaul the U.S. tax code and find a way to pay for big infrastructure improvements
• RBA’s Lowe says next interest rate move likely up, but could be some time away; RBA prepared to intervene in A$ in ’extreme’ situations
• Snap, Blue Apron Fall Flat as the Incumbents Smash the Upstarts
• IEA Cuts Estimates for Crude Needed From OPEC This Year and Next
• Chinese Regulator Starts Probe Into Tencent, Weibo and Baidu
• Stolen 1MDB Funds Are Focus of U.S. Criminal Investigation
• Health Insurers Face Long Odds to Win Reprieve of Obamacare Tax
• U.S. Stocks Gain, Hong Kong Loses Weight in MSCI Indexes: SocGen
• FBI Says ISIS Used EBay to Send Cash to U.S.: WSJ
• Anbang Ownership Secrets Subject of U.S. Workers’ Complaint
• Hollywood Heads For Its Worst Summer Box Office in a Decade

Asia stock markets were heavily pressured amid continued geopolitical tensions after further fighting talk between US and North Korea, which also saw US indices close negative for a 3rd consecutive day. The fresh goading came from both sides as US President Trump suggested his fire and fury comments maybe was not tough enough and warned North Korea to get its act together or it will be in trouble like few nations have ever been. This evoked a response from North Korea which vowed to mercilessly wipe out the provocateurs and stated the US will suffer a shameful defeat. As such, ASX 200 (-1.2%), KOSPI (-1.7%) Hang Seng (-2.0%) and Shanghai Comp (-1.7%) all traded with firm losses, while Nikkei 225 was shut due to public holiday. PBoC injected CNY 70bln in 7-day reverse repos and CNY 60bln in 14-day reverse repos, for a net weekly drain of CNY 30bln vs. CNY 40bln drain last week.

Top Asian News

• War of Words Between Trump and Kim Has Asia Bracing for Conflict
• South Korean Banks Follow Won Lower Amid Rising Trump Rhetoric
• China Data Dump and Alternative Gauges Both Signal Steady Output
• Maker of India’s Aircraft Carrier Surges 22% on Trading Debut
• Biggest India Lender Slumps as Bad-Loan Surprise Hits Profit
• KKR Completes 26 Investments in China as of Aug. 1
• Freeport Urged to Reinstate Workers to End Indonesian Strike
• India July Local Passenger Vehicle Sales Gain 15% Y/y to 298,997
• BlackRock’s James Lenton Joins Fidelity as Trader in Hong Kong

European indices are set for the worst week of losses this year as sentiment is weighed by the war of words between the US and North Korea. Weakness has been seen across the board (Eurostoxx 50 -1.0%), however mining names have notably underperforming amid Chinese metal prices slumping by some 5% overnight. EGBs supported by flight to quality with Bunds printing fresh session highs, while there had been reports of 5k lots tripping stops at 164.50. Peripherals underperform this morning, led by BTPs, subsequently the GER-ITA spread has widened to 162bps

Top European News

• Morgan Stanley Makes ‘Multi-Year Call’ For Strong Euro on Reform
• Europe Miners Slump as Metals Fall on China Steel Body’s Warning
• Tullow Oil, Genel Energy Drop; GMP Cuts Both Stocks to Reduce
• Old Mutual First-Half Profit Climbs as Insurer’s Split Looms
• Merkel’s Bloc Holds All the Coalition Options in Latest Poll
• Buy BNP Paribas, Credit Suisse; Sell Barclays, Goldman Says
• Nordea Chairman Hints HQ Review Isn’t Limited to the Nordics

In currencies, safe-haven support for the currency has continued as USD/JPY made a brief break below 109.00 overnight. Although, with the war of words showing no signs of stopping, JPY could make a push back to the April low at 108.11. So far, the pair have traded in a narrow range with investor focus for the USD shifting to the US inflation figures due out later in the session. AUD softened in Asian trade as commodities prices slipped. Crude prices fell over 0.5%, despite Saudi Arabia and Iraq's announcement to ensure that all major producers comply to the OPEC production cut, while Saudi also left the door open to deeper cuts. Additionally, Chinese iron ore prices fell some 5%, further weighed on the currency, subsequently pushing AUD to the mid 0.78.

In commodities, China state run newspaper editorial comments state China will remain neutral if North Korea launches an attack on US, but if US strikes first and tries to overthrow North Korean government, China will stop them. Saudi Arabia Energy Minister Al-Falih stated the possibility for continuation of output cuts is on the table and if the size of cuts need to be adjusted, this will be examined and subject to approval by 24 countries. North Korea vows to mercilessly wipe out the provocateurs, says US will suffer a shameful defeat, according to North Korean state media. IEA raises 2017 global oil demand forecast to 1.5mln bpd vs. 1.4mln bpd, global oil supply rose by 520k, while OPEC compliance fell to 75%.

Looking at the day ahead, the main focus will be its inflation stats for July, with expectations at 0.2% mom (for core) and 1.7% yoy. Onto other events, the Fed’s Kaplan and Fed’s Kashkari will also speak today.

US Event calendar

• 8:30am: US CPI MoM, est. 0.2%, prior 0.0%; CPI Ex Food and Energy MoM, est. 0.2%, prior 0.1%
  • US CPI YoY, est. 1.8%, prior 1.6%; CPI Ex Food and Energy YoY, est. 1.7%, prior 1.7%
  • Real Avg Weekly Earnings YoY, prior 1.09%; Real Avg Hourly Earning YoY, prior 0.8%

DB's Jim Reid concludes the overnight wrap

I'm hoping I'll be on this planet for as close to 36,525 days as I can get and I'm also hoping tomorrow will be the only day of that stint that I'm stupid enough to be picking up a brand new car with no miles on it. So in some ways it's exciting and in some way it’s very annoying as I vowed never to waste money on a new car. The twins have forced the issue and I'll be figuratively setting light to wads of bank notes as I roll out the forecourt. I'm driving 80 miles to Poole to collect it and I'm setting off very early as I have to get back to make sure everything is ready at home for the new arrival. The excitement is building, I'm very nervous and hopes and dreams come in abundance with such a fresh start. Yes Liverpool kick off their season at lunchtime tomorrow and I need to make sure I'm back in time to watch it. Wish me luck.

The markets and more importantly the world is wishing for a bit of luck at the moment and a peaceful solution to the North Korean spat. The nuclear fallout from this week's high stakes geopolitical jaw boning couldn't completely unsettle markets on Wednesday but Thursday was a different story. We finally broke the 15 day run of sub 0.3% closes in either direction with the S&P 500 -1.45% after a day where the news we covered yesterday morning concerning North Korea's threat to attack Guam by mid-August increasingly spooked global investors as the day progressed.

Mr Trump then raised the temperature another notch late in the US session last night, saying his ‘fire and fury” comment earlier in the week “wasn’t tough enough” and that “things will happen to them (NK) like they never thought possible..” and has “declined” to rule out a pre-emptive strike on NK, noting “we’ll see what happens”, all of which helped the US close at the lows for the session and shatter the recent low vol environment. Given the previous record low vol run was 10 days in 1966, if I do live to be 100 I'm statistically unlikely to witness anything like what we saw in the 15 days before yesterday.

The S&P 500 had its worse day since mid-May this year when it fell 1.8%. Over at the Vix, the fear gauge broadly traded up most of the day and surged 44% higher to close at 16.04, which is actually the first day the index closed above 16 in CY2017. Across the pond, the Vstoxx was up 26% to 18.9, the highest level since April when Europe had heightened political risks in the run up to the French elections.

Investors pushed safe haven assets higher again, with gold up 0.7% to a 9 week high, the Swiss franc up 0.1% (was +1.1% the day before) and JPY/USD +0.8% higher. Over in European government bonds, changes in core yields were more tempered following the ~5bp fall the day before. Bunds fell 1bp (2Y: unch; 10Y: -1bps), with Gilts down 3bps (2Y: +0.3bp; 10Y: -3bps) at the long end of the curve, while French OATs were broadly flat (2Y: unch; 10Y: -0.5bp). Peripheral bond yields were up slightly across the curve, with Italian BTPs (2Y: +1bp; 10Y: +2bps) and Portuguese yields (2Y: -0.5bp; 10Y: +2bps) not sure whether they  were a flight to quality instrument or a high beta asset. Across the pond, the UST10Y fell 5bps yesterday (2Y -1bp) but is fairly flat this morning.

In Asia, markets have continued to fall. The Kospi recovered a little to be 1.6% down as we type, the Won/USD dipping another 0.2%. The Hang Seng fell for the 3rd consecutive day (-1.9%), with Chinese bourses down 1.1% to 1.6%. We also got a glimpse of what China might be thinking, with the Global times (English paper under the People's Daily) writing that China should make clear that: i) it will stay neutral if the US retaliates after NK launches missile that threaten American soil, but ii) if countries try to overthrow the NK regime, China will prevent them from doing so.

Moving on, if we can pull out attention away from the nuclear threat, inflation data is probably where the market is most sensitive to a surprise at the moment, even if yesterday's weak US PPI doesn't suggest an imminent rise. For the US CPI today, our economists expect core CPI inflation (+0.2% vs. +0.1%) should finally snap its streak of four consecutive monthly misses which could be important. They also remind us that as recent Fed statements have emphasized, policymakers will be monitoring near-term inflation trends closely. Hence, an in line print would provide tentative evidence that the recent downshift in core inflation may be behind us.

Following on the theme of inflation, DB’s Luzzetti examined the impact of recent US dollar depreciation on the inflation outlook. Based on their own inflation models and analysis cited by Fed officials, they think that recent dollar weakness – assuming that it does not reverse – could lift year-over-year core PCE inflation by about 0.2pps by mid-2018 and 0.1pps by mid-2019. More details here.

Turning to Europe, the flip-side of recent currency moves is discussed by DB’s Mark Wall who has written on how euro appreciation will be balanced against growth momentum in determining the ECB’s exit from QE. He argue that all else unchanged the euro’s appreciation since June could reduce the ECB staff core inflation forecast for 2019 from 1.7% yoy to 1.5% yoy. More details here Returning to the equity market sell-off in a little more depth, US bourses all weakened yesterday, with the S&P (-1.5%), the Dow (-0.9%) and the Nasdaq (-2.1%) sharply lower. Within the S&P, only the utilities sector was up (+0.3%) versus larger losses elsewhere (IT -2.2%; Financials -1.8%). European markets also fell across the board, the Stoxx 600 was down 1% to the lowest level since March with all sectors in the red. Across the region the FTSE 100 (-1.4%),  the DAX (-1.2%), Italian FTSE MIB (-0.8%) and CAC (-0.6%) were all lower.

Currencies were mixed but little changed, the USD dollar index dipped 0.2% post the lower than expected PPI data. The Euro continued to edge ahead against the USD and Sterling, up 0.1% and 0.3% respectively, while the Sterling/USD was down 0.2%. In commodities, WTI oil fell 2%, despite OPEC raising its demand forecast for oil and two of the largest OPEC producers (Saudi Arabia & Iraq) agreeing to strengthen their commitments to production cuts. Notably, Iraq's recent compliance to production targets is not exactly great (29% in July).

Elsewhere, precious metals were modestly up (Gold +0.7%; Silver +1%) and aluminium continues to gain (Copper -0.3%; Aluminium +0.9%). Agricultural commodities were broadly lower, with corn, wheat and cotton all down ~4%, while soybeans, coffee and sugar were down ~3%. This follows a USDA report which suggest US farmers will produce more corn and soybeans than analyst forecasts.

Away from the markets, Trump has made his disappointment with Senate majority leader McConnell well known, tweeting “can you believe that McConnell, who has screamed repeal & replace (Obamacare) for 7 years, couldn’t get it done…” and “…Mitch, get back to work…”. However, Trump was more conciliatory on special counsel Mueller, saying he “hasn’t given it any thought about firing Mueller” and that “I’m not dismissing anybody”. Elsewhere, NY Fed president Dudley cautioned that it will "take some time" for inflation to reach the Fed's 2% target, which is consistent with comments made by his colleagues earlier in the week.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the July PPI report was softer than expected. The core measure (ex-food & energy aggregate) was -0.1% mom (vs. 0.2% expected) and 1.8% yoy (vs. 2.1% expected). The PPI for healthcare services, which is closely correlated with that within the PCE deflator, rose a steady 1.4% yoy. Elsewhere, claims data were mixed, with initial jobless claims up 3k to 244k (vs. 240k expected) and continuing claims at 1,951k (vs. 1,960k expected). In Europe,France’s June industrial production (IP) was modestly lower than expectations at -1.1% mom (vs. -0.6% expected, 1.9% previous) and 2.6% yoy (vs. 3.1% expected), while manufacturing production was slightly better at -0.9% mom (vs. -1% expected) and 3.3% yoy (vs. 3.2% expected), which is just a bit weaker than Markit PMI readings had foreshadowed. Over in UK, IP for June was higher than expectations at 0.5% mom (vs. 0.1% expected) and 0.3% yoy (vs. -0.1% expected), while June manufacturing production was flat and in line, at 0% mom and 0.6% yoy. The UK’s trade deficit also unexpectedly widened in June as exports fell but imports rose.

Looking at the day ahead, the final CPI figures for Germany (1.5% yoy expected), France (0.8% yoy expected) and Italy (1.2% yoy expected) will be released. Over in the US, the main focus will be its inflation stats for July, with expectations at 0.2% mom (for core) and 1.7% yoy. Onto other events, the Fed’s Kaplan and Fed’s Kashkari will also speak today.

Overnight bulletin summary

• Global equities trade higher amid easing geopolitical tensions
• Pound tumbles on weaker than expected inflation data
• Today's calendar includes US retail sales, Empire Fed, import prices, NAHB, and API crude oil inventories

Global stocks and US futures are up for a second day, with the VIX sliding 0.65 vols to 11.68 (-5.2%) and haven assets dropping, after a KCNA report report suggested North Korea had pulled back its threat to attack Guam after days of increasingly bellicose "fire and fury" rhetoric with President Trump, and hours after China took its toughest steps to support U.N. sanctions against Pyongyang, while the possibility of a Sino-American trade war was played down. The report, from KCNA on Tuesday, said Kim praised the military for drawing up a “careful plan” to fire missiles toward Guam. Kim was cited by KCNA saying he would watch the U.S.’s conduct “a little more.”

"There is a more relaxed attitude being taken towards the Korean situation in markets. With the report North Korea has put its plans on hold, there is a sense of stepping back from the brink," Rabobank analyst Lyn Graham-Taylor said.

Notably, risk aversion has not totally gone away, as Defence secretary Mattis also warned earlier that if NK fired missiles at Guam, it would be “game on” and “could escalate into war quickly”. That said, he was vague about what would happen if missiles splashed into the sea near Guam.

The result was a continuation of yesterday's "risk-on" sentiment: the USD bounced, the USDJPY spiked as hugh as 110.45, while the pound tumbled on poor UK inflation data, while the EUR was dragged lower on what is a holiday across continental Europe. However, as some trading desks warn, this return of risk appetite may be temporary as the US and South Korea have joint military exercises scheduled for next week, which could spark things off again. For now however, traditional haven assets including gold and core bonds across Europe and TSYs slumped.

Global stocks were roughly unchanged, with the MSCI All-Country World Index declined less than 0.05 percent, while Europe was broadly if modestly higher with the Stoxx Europe 600 Index up 0.1%. Germany’s DAX Index jumped 0.3 percent, as did the U.K.’s FTSE 100 Index. S&P Futures are up 0.2%.

In Asia, Japan’s Topix index finished the day 1.1% higher driven by the sharp drop in the Yen, and Australia’s S&P/ASX 200 Index gained 0.5% at the close. Hong Kong’s Hang Seng index dropped 0.3% following a bout of last hour selling, even as the Shanghai Composite Index rose 0.4%. Markets in South Korea and India are closed Tuesday for holidays. The yen fell 0.7% to 110.41 per dollar, the biggest drop in three weeks.

While the overnight session was generally quiet, aside from the previously noted UK inflation miss which sent sterling tumbling, another indication that Europe may be rolling over was German Q2 GDP data, which missed at 0.6%, below the 0.7% expected, as imports outpaced exports following the recent surge in the Euro.

After hawkish comments from Dudley and UST yields doing well, there is a broad USD bid, even though South Korean markets was closed for national holiday. As noted above, the yen dropped on easing of N.Korean tensions, while the pound weakened after U.K. inflation data missed estimates, and Sweden’s krona gained as headline inflation reached the highest level since 2011.

"We have North Korea saying they will wait, and Trump not saying anything at all, compared to his past promise of 'fire and fury,'" said Mitsuo Imaizumi, chief FX strategist at Daiwa Securities.  "That added up to good news for the dollar, bad news for the yen," he said.

Also overnight, China's credit growth came in higher than expected even as broad M2 plunged to a new all time low of 9.2% (exp. 9.4%): new yuan loans printed 825bn vs 800bn expected while aggregate financing came in at 1220bn vs 1000bn. However both measures of credit growth decreased sharply from June, where aggregate financing was 1776bn and new yuan loans increasing 1540bn.

In rates, the yield on 10-year Treasuries advanced three basis points to 2.25 percent.  Germany’s 10-year yield gained two basis points to 0.43 percent.  Britain’s 10-year yield climbed three basis points to 1.01 percent.

Gold fell 0.6 percent to $1,274 an ounce. Oil prices steadied somewhat after falling more than 2.5 percent on Monday to its lowest in about three weeks on the strength of the dollar and reduced refining in China. Brent was last down 2 cents at $50.71 a barrel.

Market Snapshot

• S&P 500 futures up 0.2% to 2,467.25
• U.S. 10Y Treasury yield: +3bps to 2.25%
• EUR/USD: -0.2% to 1.1758
• USD/JPY: +0.7% at 110.40
• GBP/USD: -0.5% at 1.2901
• STOXX Europe 600 up 0.07% to 376.41
• MSCI Asia up 0.2% to 158.72
• MSCI Asia ex Japan up 0.07% to 520.98
• Nikkei up 1.1% to 19,753.31
• Topix up 1.1% to 1,616.21
• Hang Seng Index down 0.3% to 27,174.96
• Shanghai Composite up 0.4% to 3,251.26
• Sensex up 0.8% to 31,449.03
• Australia S&P/ASX 200 up 0.5% to 5,757.48
• Kospi up 0.6% to 2,334.22
• German 10Y yield rose 1.5 bps to 0.421%
• Euro down 0.2% to $1.1752
• Italian 10Y yield fell 0.9 bps to 1.73%
• Spanish 10Y yield rose 0.2 bps to 1.44%
• Brent futures down 0.1% to $50.68/bbl
• Gold spot down 0.6% to $1,274.68
• U.S. Dollar Index up 0.3% to 93.68

Top Overnight News

• South Korean President Moon Jae-in said that any military action against Kim Jong Un’s regime requires his nation’s approval, and vowed to prevent war at all costs
• EU says frictionless trade with the U.K. is not possible outside the Single Market and Customs Union
• U.K. Brexit Secretary David Davis says he won’t give a figure for Britain’s divorce bill by October
• Germany’s top judges have put the legality of the European Central Bank’s 2.3 trillion euros ($2.7 trillion) bond-buying program in doubt in a ruling that asks the European Court of Justice for guidance in five cases targeting the policy
• Intel CEO Becomes Third Chief to Quit Trump Business Council
• Trump Denounces White Supremacists Amid Backlash to Response
• Mattis Warns It’s ‘Game On’ If North Korea Strikes Guam
• U.K. Seeks Interim Customs Union With EU to Smooth Brexit
• New McDonald’s China Owners to Speed Up Expansion to Catch KFC
• Danone Is Said to Be Targeted by Activist Investor Corvex
• Transocean Agrees to Acquire Songa Offshore for $1.2 Billion
• Wrangler Jeans Owner Will Buy Dickies Maker for $820 Million
• WebMD Sued by Investor Seeking to Block $2.8 Bln KKR Sale
• Paulson And Other Hedge Funds Rewarded as Angst Fuels Gold
• Teva Cedes Spot as Israel’s Biggest Firm in Blow to Prestige
• ECB’s QE Questioned by German Judges Asking for EU Court Review

Asian stock markets traded higher following the gains in US where the NASDAQ led the advances on continued tech outperformance, while global sentiment was also lifted as geopolitical concerns abated after comments from North Korean leader Kim that they will not strike Guam yet. ASX 200 (+0.47%) and Nikkei 225 (+1.11%) were boosted as tensions de-escalated, with markets in Japan the biggest gainer on JPY weakness. KOSPI is shut for holiday while Hang Seng (-0.28%) and Shanghai Comp (+0.43%) for the majority of the session conformed to the upbeat tone after the PBoC released around CNY 400b1n in MLF loans.

Top Asian News

• South Korea to Prevent War at All Costs, President Moon Says
• Hedge Fund Betting on 70% Yuan Devaluation Digs In Amid Gain
• China Money Supply Growth Slips Again as Leverage Crunch Goes On
• China’s Economic Speed Bump May Reignite Bond Default Wave
• Fund Managers’ Positioning Remains Pro-Risk, BofAML Survey Shows
• Unmarried Indonesians Happier Than Those in Wedlock, Index Shows
• Modi Says More Indians Paying Tax After Cash Ban, GST Regime

European equities have started the session off strongly (Eurostoxx +0.3%), as geopolitical tensions appear to have abated from the escalation seen last week. More specifically, North Korean leader Kim Jong Un discussed the Guam strike plan with officers and said they will not attack Guam yet, but could have a change of mind based on US actions. On a sector specific basis, energy and material names are the only sectors in the red with WTI back below USD 48.00 and gold losing ground amid the return of risk appetite. To the upside, Danone (+1.8%) are one of the notable gainers in Europe amid Corvex building a USD 400mln stake in the company. In fixed income, price action has largely been dictated by the broader risk-sentiment in the market in what is a week particularly void of EU sovereign supply amid summer-thinned trading conditions. More specifically, core paper is trading circa higher by 1.5bps with peripheral spreads higher by between 0.5-1.0bps. Note: the German Constitutional Court has declined to hear challenge of ECB's QE programme and will refer case to the European Court of Justice

Top European News

• German Economy Extends Growth Spurt as Nation Heads for Election
• Merkel Jeered on Campaign Trail as Refugee Tensions Boil Up
• Swedish Inflation Hits Target for First Time in Almost Six Years
• U.K. Inflation Unexpectedly Holds Steady as Pound Drop Unwinds
• U.K. Growth, Inflation Outlook Cut, Weakening BOE Rate- Hike Case
• Schibsted Plunges to 8-Month Low as Facebook Expands Marketplace
• Bank of Russia Sells All 150b Rubles of 3-Month Bills
• Danone Undervalued, Scope for Margin Improvement, Bernstein Says
• Next Falls as Berenberg Says Rally Provides Shorting Opportunity

In currency markets, the main data release this morning has come in the form of the latest UK inflation report. Despite expectations for Y/Y CPI to edge towards 3.0% by the year-end, today's metric fell short of consensus (2.6% vs. Exp. 2.7%) and saw GBP/USD fall circa 40 pips from 1.2950 to 1.2910 with the metric possibly dampening some expectations for a rate hike by the BoE in the short-term. Elsewhere, the USD remains firm against its major counterparts amid hawkish rhetoric yesterday from Fed's Dudley as well as gaining ground against JPY as JPY suffered from safe-haven outflows. Going forward, focus will likely be on NZD with the upcoming NZ dairy auction (futures pricing in a 4% increase in WMP).

In commodities, metals markets have seen a mixed performance with gold (-0.5%) pressured amid safe-haven outflows as geopolitical concerns subsided while Copper benefited from the upbeat risk tone. WTI failed to make any significant recovery from yesterday's losses in which prices languished below USD 48/bbl after a bearish Genscape report, OPEC sources and comments from the EIA.

Looking at the day ahead, there will be quite a lot of data, including: July retail sales, import / export price index for July (0.1% mom and 0.3% mom expected respectively), empire manufacturing stats (10 expected), the NAHB housing market index and US foreign net transactions for June. Further, Home depot will report its results today.

US Event Calendar

• 8:30am: Import Price Index MoM, est. 0.1%, prior -0.2%; 8:30am: Import Price Index YoY, est. 1.5%, prior 1.5%
  • Export Price Index MoM, est. 0.2%, prior -0.2%; 8:30am: Export Price Index YoY, prior 0.6%
• 8:30am: Empire Manufacturing, est. 10, prior 9.8
• 8:30am: Retail Sales Advance MoM, est. 0.3%, prior -0.2%; Retail Sales Ex Auto MoM, est. 0.3%, prior -0.2%
  • Retail Sales Ex Auto and Gas, est. 0.4%, prior -0.1%; Retail Sales Control Group, est. 0.4%, prior -0.1%
• 10am: NAHB Housing Market Index, est. 64, prior 64
• 10am: Business Inventories, est. 0.4%, prior 0.3%
• 4pm: Total Net TIC Flows, prior $57.3b; Net Long-term TIC Flows, prior $91.9b

DB's Jim Reid concludes the overnight wrap

Can we get back to August yet? Unless you are well connected to Kim Jong-un or to a lesser extent Mr Trump then it’s impossible to answer. However a lack of escalation over the weekend and more reassuring words from a top US general has been a big relief for markets. As it’s the 15th today we're clearly at the midmonth point that the North Korean leader previously suggested was his timetable to potentially launch missiles at Guam although as we'll see below NK state media has suggested overnight that he is reviewing his plans and will watch the US first. It will be difficult for markets to fully recover their poise until we're out of this mid-month window with no new provocations (or worse). However every day that no news breaks should help markets recover to where they were before last Monday evening's "fire and fury' tweet after the earlier Washington Post story that Pyongyang has produced a nuclear warhead small enough to fit inside one of its missiles.

Following the calmer words from Defence Secretary Mattis and CIA’s director Pompeo over the weekend talkshows, US’s Marine General, Chairman of the Joint Chief of Staff Dunford followed up and told South Korean President Moon that “…everyone hopes to resolve the current situation without going to war…”. Today, President Moon spoke at a separate function and said “there will be no war repeated on the Korean peninsula” and emphasised the need for diplomatic efforts.

The reduced prospect of a US-NK conflict boosted US markets overnight with Asian markets broadly higher this morning. The Kospi (+0.6%), Nikkei (+1.3%), Hang Seng (+0.3%) and Chinese bourses (+0.2%-0.7%) are all higher as we type. Elsewhere, the Korean Won is up 0.5%.

Notably, risk aversion has not totally gone away, as Defence secretary Mattis also warned earlier that if NK fired missiles at Guam, it would be “game on” and “could escalate into war quickly”. That said, he was vague about what would happen if missiles splashed into the sea near Guam. On the other side of the fence, according to the Korean central news agency, Kim Jong-Un has reviewed his missile strike plans and will watch what the US is doing “a little more”.

Looking away from geopolitics, the US’s July retail sales will be out later today. DB’s economist Brett Ryan expect sturdy gains on both headline (+0.6% forecast vs. -0.2% previously) and ex-automobile sales (+0.6% vs. -0.2%) following two consecutive monthly declines. Note that there has been only one other occasion in the current business cycle when ex-auto sales fell for three consecutive months and that was due  to unusually harsh winter weather in late 2014 / early 2015. Elsewhere, US data on June business inventories (+0.4% expected), US foreign net transaction, empire manufacturing (10 expected) and the NAHB housing market index are also due today, all of which should provide us with some clues on the US’s 2H GDP outlook.

Moving back to markets. Remember that steady increase in the S&P we talked about a couple of weeks back. Well before yesterday, it was 77 trading days since the S&P increased by more than 1% in any one day. Clearly the +1.00% S&P gain overnight has just prevented this run continuing. All we needed was 3 more days to beat the prior record set back between November 06 and March 07 (79 trading days). Perhaps we'll now wait another 10 years before the record is threatened again.

In terms of markets performance, lower risk aversion was evident across the board yesterday with the Vix down 21% to 12.3, gold falling 0.6% and the Swiss franc -0.2%. US equities strengthened, with the S&P up 1%, the Dow (+0.6%) and the Nasdaq (+1.3%). Within the S&P, only the energy sector was in the red (-0.3%), while all other sectors rose, particularly real estate (+1.7%) and IT (+1.6%). European markets were also up, with the Stoxx 600 +1.1% higher, with gains in every sector, particularly real estate and utilities (both +1.8%). Elsewhere, the DAX (+1.3%), FTSE 100 (+0.6%), CAC (+1.2%) and FTSE MIB (+1.7%) were also up.

Government bond yields rose modestly reflecting lower risk aversion, with core yields up 1-3bp at the longer end of the curve, including: German bunds (2Y: unch; 10Y: +2bps), Gilts (2Y: +1bp; 10Y: +1bps) and French OATs (2Y: +2bp; 10Y: +3bps). Peripheral bond yields outperformed as tensions eased with Italian BTPs (2Y: -1bp; 10Y: -1bp) and Portugal (2Y: +2bp; 10Y: -4bp) generally rallying. Across the pond, UST 10Y has increased 3bps this morning to 2.25%.

Turning to the currency markets, the USD dollar index gained 0.4% yesterday, supported by the Fed Dudley’s comments on rates outlook (discussed later). Conversely, both the Euro and Sterling dipped 0.4% versus the USD, while the Euro/Sterling was broadly flat. In commodities, WTI oil fell 2.5% following concerns for slowing Chinese demand (softer IP data) and EIA raising forecasts that US shale output will reach an all-time high in September. Elsewhere, precious metals were slightly lower (Gold -0.6%; Silver -0.2%), while base metals were broadly unchanged, with Copper (+0.2%), Zinc (-0.4%), although aluminium fell -1.6% after a strong 9% rise in the prior week.

Away from the markets, NY Fed president Dudley told the AP he expects inflation to move somewhat higher as the labour market tightens further and suggested the Fed will announce its taper plan next month. On the rates outlook, he said "If (economic forecasts) evolves in line with my expectations ... I would be in favour of doing another rate hike later this year." Elsewhere, he said White House economic adviser Gary Cohn is a “reasonable candidate” to head the Fed if Trump does not name Yellen for a second term.

Following on with the economic outlook, Bloomberg surveyed 38 economists recently, ~76% of them expect congress will pass tax cut legislations by November 2018, albeit the tax cuts are likely to be lower than what the Trump administration had originally promised. The potential policy changes are expected to add 0.2ppt to the pace of GDP expansion in 2018.

The latest ECB CSPP holdings were released yesterday. They bought €1.11bn last week which compares to €1.54bn, €0.79bn, €0.72bn, €1.43bn over the previous four weeks. These continue to be low numbers and this week's equate to an average of €221mn per day (vs. €354mn/day since CSPP started). The CSPP/PSPP ratio was 11.4% (previous weeks 12.8%, 8.1%, 6%, 10.4%) which is slightly below the average since the April taper begun but the average since this point of 12.8% is still higher than the pre-taper ratio of 11.6%. So the evidence is still in favour of CSPP having been trimmed less than PSPP since April even if there have been some softer weeks of late. The ECB probably did a little front loading to account for summer credit liquidity being worse than in govt. bonds.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. Adding onto our comments yesterday for the slightly lower than expected July industrial production data in China, our China research term believes that slower growth was mainly driven by surprisingly weak data from the property sector. (eg: growth of property sales cooled to 4.8% yoy in July after a strong rebound to 30.3% yoy in June). Overall, our team think that the slowdown in July is unlikely to change the government policy stance in Q3 (ie: they do not expect a visible loosening of monetary or fiscal policy). With GDP growth at 6.9% in H1, they argue that the government can afford to allow growth to drop moderately in Q3. Elsewhere, the Eurozone’s June industrial production was slightly lower than expected at -0.6% mom (vs. -0.5%) and 2.6% (vs. 2.8% yoy).

Looking at the day ahead, as our note is published, Germany’s preliminary 2Q GDP will be released, with 0.7% qoq and 1.9% expected. Then the UK’s July CPI (0% mom and 2.7% yoy expected), PPI output and retail price index are due. Over in the US, there will be quite a lot of data, including: July retail sales, import / export price index for July (0.1% mom and 0.3% mom expected respectively), empire manufacturing stats (10 expected), the NAHB housing market index and US foreign net transactions for June. Further, Home depot will report its results today.

• Hunt for Driver Widens as Second Attack Hits Spain, Five Suspects Are Killed (WSJ)
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• U.S. Navy, citing poor seamanship, removes commanders of warship in deadly crash (Reuters)
• ACLU Will No Longer Defend Hate Groups Protesting With Firearms (WSJ)
• Erdogan tells Turks in Germany to vote against Merkel and allies (Reuters)
• Merkel Jeered by Immigration Foes in Biggest Campaign Unrest Yet (BBG)
• Trump's attacks could leave him friendless if impeachment comes (Reuters)
• Gore: Trump should resign (The Hill)
• Fracking Jobs Prove Elusive for Coal Miners Looking to Switch (BBG)
• Uber’s Kalanick Fires Back at Investor in Legal Battle (WSJ)
• Women say they quit Google because of racial discrimination: 'I was invisible' (Guardian)
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• Rising migrant flow to Spain could become 'big emergency': U.N. (Reuters)
• In aftermath of Barcelona attack, unease over Ramblas security (Reuters)
• South Africa to grant Grace Mugabe diplomatic immunity (Reuters)

Overnight Media Digest

WSJ

- A van mowed down pedestrians in the heart of Spain's second-largest city, killing at least 13 people in a terror attack claimed by Islamic State. Hours later, police said they killed five alleged terrorists as they responded to a possible attack in Cambrils, a town southwest of Barcelona. on.wsj.com/2w7BLIt

- The government review of AT&T Inc's $85 billion takeover of Time Warner Inc has reached an advanced stage, a significant milestone in a deal that was closely watched for signs of how the Trump administration would view large mergers. on.wsj.com/2w7i6Z3

- U.S. President Donald Trump defended the "beautiful" statues commemorating Confederate leaders and lamented efforts to remove them, weighing in on an issue central to the weekend's deadly violence in Virginia. on.wsj.com/2w7aVQt

- Arista Networks Inc is grabbing Cisco Systems Inc's giant networking business, winning over its customers and rankling its top brass. The battle has divided CEO Jayshree Ullal and Cisco's John Chambers, who were once close colleagues. on.wsj.com/2w7imat

- The White House pulled the plug on a planned council that was to advise U.S. President Donald Trump on rebuilding the nation's infrastructure, an apparent victim of the Charlottesville furor. on.wsj.com/2w75BNd

- Mylan NV agreed to pay $465 million to settle federal government claims that it overcharged the Medicaid program by millions of dollars for its EpiPen products. on.wsj.com/2w73CIA

FT

- Cuadrilla has started drilling on the first UK shale well to bring U.S.-style shale gas production to UK. The drilling is expected to reach 3.5 km beneath its site near Blackpool, Lancashire.

- Data from UK's Office for National Statistics released on Thursday show that retail sales, including fuel, rose 0.3 percent month-on-month basis. The growth in UK retail sales shows a higher spending on food which outweighs the falls in all other categories of expenditure.

- Thirteen people were killed and dozens wounded after a white van crashed into pedestrians in Barcelona's bustling tourist district of Las Ramblas. Police said it as the worst attack in Spain since the Madrid train bombings in 2004.

- The Federal Deposit Insurance Corporation is suing European banks in a London court over the Libor-rigging scandal after parts of a similar New York lawsuit failed.

NYT

- Several of HBO's Twitter accounts were hacked late Wednesday night, raising further security concerns at a moment when the premium cable channel has been dealing with the sustained leaking of proprietary information. nyti.ms/2ibeyz7

- Spain was hit by its worst terrorist attack in more than a decade on Thursday, when a van driver plowed into dozens of people enjoying a sunny afternoon on one of Barcelona's most famous thoroughfares, killing at least 13 people and leaving 80 bloodied on the pavement. nyti.ms/2iaMSu8

- James Murdoch, the chief executive of Twenty-First Century Fox Inc and the son of a frequent ally of President Trump's, condemned the president's performance after the violence in Charlottesville, and pledged to donate $1 million to the Anti-Defamation League. nyti.ms/2iaHwPH

Canada

THE GLOBE AND MAIL

Canada is opening a migrant shelter in Ontario and pulling in police and civilian reinforcements from across the country to handle an accelerating influx of asylum seekers from the United States that shows no signs of abating. tgam.ca/2vOEAvt

The federal government has approved up to C$60 million ($47.4 million) in spending to bring electricity transmission to the remote First Nations community of Pikangikum, where lack of reliable power is contributing to a social and mental-health crisis in the community. tgam.ca/2vOyc7f

First Nations leaders have expressed their concerns about the treatment of Indigenous people in Canada to a United Nations committee that examines racial discrimination and one chief says Prime Minister Trudeau needs a "wake-up call." tgam.ca/2vOFjfX

NATIONAL POST

A group of aggrieved creditors wants to sue the executive officers and directors of Sears Canada Inc for negligence and intends to ask an Ontario judge to schedule a hearing for their motion on whether they can proceed with their claim. bit.ly/2vOQ8P2

Britain

The Times

- Mobile telecom gear maker Ericsson is understood to be seeking sweeping job cuts outside its native Sweden that may affect its workforce of 3,500 in the United Kingdom. bit.ly/2vNnY7j

- Home improvement retailer Kingfisher Plc has blamed the weather for falling sales in the United Kingdom as it continues to be dogged by a slowdown in France. The retail group said that underlying sales at Castorama had fallen by 2.8 percent to 668 million euros ($783.30 million) while sales at Brico Depot were down 5.1 percent at 520 million euros ($609.75 million). bit.ly/2vNGmNo

The Guardian

- Learndirect, the United Kingdom's largest adult training provider, has blamed the government's austerity programme for its failure to meet the education regulator's minimum quality standards. bit.ly/2vN6vvt

- Britain's biggest companies have been told that a lack of diversity in their boardrooms could hinder government plans to increase trade with non-EU countries after Brexit. The warning comes as a report by the executive search company Green Park shows the number of FTSE 100 businesses with no ethnic minority representation at senior level has fallen to 58 from 62. bit.ly/2vMW1fQ

The Telegraph

- Asda, the British supermarket arm of Wal-Mart Stores Inc , has toasted its first increase in quarterly sales for three years on the back of a successful Easter, the return of inflation and early signs that its turnaround efforts are beginning to work. bit.ly/2vNg4KY

- Britain's factories benefited from a surge in sales to the European Union in the first half of this year as export growth outstripped import growth. UK still imports far more than it exports leaving the country with a goods deficit amounting to 53 billion euros ($62.15 billion) for the six months to June in its trade with the EU, but that is down from 57.8 billion euros ($67.78 billion) in the same period of 2016. bit.ly/2vNoFgE

Sky News

- Singaporean fund GIC and KKR & Co LP team up for 6 billion pound ($7.72 billion) Unilever Plc's spreads bid. The emergence of another consortium in the auction will raise hopes among Unilever's investors that the Anglo-Dutch consumer goods giant can attract a bumper price for the division. bit.ly/2vNhjK8

Last week's news that Toys “R” Us has hired bankruptcy lawyers Kirkland & Ellis to help restructure its heavy debt load, came as a shock to the company's creditors, who promptly sent its bond crashing from nearly par at the start of the month to 43 cents on the dollar as of Friday.

As Bloomberg first reported, K&E is focused on the $400MM in bond due 2018, while Toys “R” Us has also retained Lazard to help with debt refinancing. They will have their hands full: in addition to shrinking sales and heightened competition, Toys ‘R’ Us has been burdened with debt from an LBO12 years ago as a result of which Toys “R” Us’s private equity owners, Bain Capital, KKR and Vornado Realty Trust, loaded up the company with $7.5 billion in debt.

Last year, the retailer extended maturities on some of borrowings, giving it more time to execute a turnaround plan by Chief Executive Officer Dave Brandon. As part of his comeback bid, he was looking to spruce up stores with more toy demonstrations and other experiences - seeking an edge on online sites such as Amazon. However, last week's realization that the company is considering a debt-for-equity exchange, confirmed many worst fears that not only was the turnaround faltering but that underlying business was far weaker than expected.

The imminent restructuring, which judging by the shocking bond crash was completely unexpected, would help Toys “R” Us get its house in order ahead of the all-important holiday season, when the company has its biggest sales surge. Alas, now that the iconic toy retailer appears likely to cramdown at least one if not more creditor classes in some form of pre-pack Chapter 11, said sales surge may not happen at all if the company's suppliers suddenly get cold feet and refuse to stock up the company with much needed inventory.

Which is precisely what is happening.

Making matters worse, according to the WSJ, Toys ‘R’ Us could file for bankruptcy as soon as next week, while Bloomberg adds that nervous suppliers have scaled back shipments and tightened terms to the retailer ahead of the crucial holiday selling season, on worries they may not got repaid and their payables would be lumped alongside other unsecured pre-petition claims. 

The vendors are balking as Toys “R” Us continues talks with lenders over a new loan that would allow the company to stay open while it works out a recovery plan through bankruptcy proceedings, said the people, who asked not to be identified because discussions are private. The loan is being marketed by Lazard Ltd. to banks and existing creditors, said one of the people. 

Just like in the case of Sears discussed here at the end of August, suppliers have pulled back in part because the cost to insure their shipments to cash-strapped Toys “R” Us has become too expensive, according to Bloomberg sources. Since vendors traditionally rank among other unsecured creditors under a bankruptcy waterfall schedule, their decision on whether to continue shipping goods can play a large role in determining a retailer’s fate.

Unfortunately for Toys “R” Us, now that it has entered the self-reinforcing death spiral of collapsing liquidity and panicked vendors, it needs to find a financial solution immediately and resume shipments because the cash-strapped chain makes about 40% of its sales during the fourth-quarter holiday season. Much of its strategy revolves around getting exclusive products from key vendors, along with support for advertising and marketing.

For now, the toy merchant has been seeking to refinance $400 million of debt that comes due next year, although media reports suggest that the process has stalled. As a result, the company is now openly flirting with bankruptcy as an option although no decision about seeking court protection has been made.

Still, as Bloomberg calculates, Toys “R” Us has remained oddly profitable, generating $790 million in EBITDA, the most since 2012, yet even that is not enough to appease vendors many of whom now demand payment upfront. Not everyone thought: Hasbro is among toymakers that hasn’t curtailed shipments, spokeswoman Julie Duffy wrote in an email. “We continue to partner and ship, conducting business as usual, while managing our risk across all retailers to the appropriate levels,” Duffy wrote.

Hasbro may regret this decision very soon as according to the the company's 5 Year CDS, which in recent days have soared to 46 points upfront...

... the probability of default in the next five years is now 93%, and 60% over the next 12 months.

A Toys ‘R’ Us restructuring would add to a list of 25 retailers, including Rue21, Gymboree and Payless Shoe Source, that have filed for bankruptcy since the beginning of 2017. Another big box chain, Staples Inc., recently agreed to be taken private in a leveraged buyout.

Source: @ReorgFirstDay

While industrywide, toy sales have been strong in recent years, much of the growth is shifting to online sellers like Amazon.com Inc. and discounters like Wal-Mart Stores Inc. Amazon’s toy sales were up 24% last year, compared with 5% for the overall market and five years of declines for Toys “R” Us, according to analytics firm One Click Retail.

The company is not alone as it finds it is woefully behind in its competition with Amazon: some large toy brands, such as Lego and Star Wars, have also struggled recently, while the collectible Shopkins toys, which Toys ‘R’ Us helped launch, is on the downswing. Earlier this month, Lego AS reported its first decline in sales in 13 years and said it would cut 8% of its workforce. Another toy maker, Mattel Inc., replaced its chief executive earlier this year after a slide in holiday sales.

Ultimately, whatever the fate of Toys 'R' Us may be, it will inevitably go through bankruptcy court: according to the WSJ, in recent weeks Toys ‘R’ Us’s advisers have been hunting for a DIP loan to fund operations under chapter 11, effectively guaranteeing that a bankruptcy filing is now just a matter of days.

Over the weekend, we reported that vendors to iconic toy retailer Toys "R" Us had halted shipments over payment concerns and/or getting their receivables crammed down alongside other unsecured claims ahead of what appeared to be an imminent bankruptcy. Well, they were right, and according to Bloomberg a Chapter 11 filing by Toys "R" Us is to be expected as soon as tonight.

The latest Amazon casualty, Toys "R" Us bankruptcy filing would send America’s largest toy chain to bankruptcy court, dealing another blow to a brick-and-mortar industry that’s already reeling from store closures and sluggish mall traffic and conclude the saga of one of the last pre-crisis LBOs in which Bain Capital, KKR and Vornado Realty Trust saddled up the company with $7.5 bilion in debt.

According to Bloomberg, the retailer has already hired a claims agent meant to help administer a Chapter 11 process. What is unclear is whether the company will have sufficient liquidity to assure its vendors who have imposed an effective COD blockade on the company, to provide it with much needed holiday season merchandise. And speaking of Toys "R" Us vendors, as speculation of a bankruptcy mounted over the weekend, their shares tumbled: Mattel, the maker of Barbie and Fisher-Price, fell 6.2% while Hasbro, which makes Monopoly, Nerf and Transformers, dropped 1.7%, its biggest decrease in almost two weeks.

Predictably, as we showed on Saturday, Toys CDS has exploded as the cost of insuring the company against default surged, with prices of six-month and one-year CDS hitting record highs.

Finally, the most amusing chart is that of Toys "R" Us bonds which crashed some more on the Bloomberg report, and which were happily trading at par until just a few weeks ago, only to be shocked by the recent news report that the company had hired bankruptcy advisors, crushing all hopes that the company's maturing debt would be rolled over, as even its PE sponsors decided they had had enough.

Once the filing hits the docket officially, we look forward to updating the full list of 2017 YTD retail bankruptcies which one can probably also call "Exhibit A" in any Amazon anti-trust hearing. 

Toys “R” Us Inc., the largest US "brick and mortar" toys retailer, filed for bankruptcy late on Monday night, as a result of a crushing post-LBO debt load and relentless competition from warehouse and online retailers, the "latest blow to a retail industry reeling from store closures, sluggish mall traffic and the gravitational pull of Amazon.com" according to Bloomberg.  The Chapter 11 filing is among the largest ever by a specialty retailer and casts doubt over the future of its about 1,600 stores and 64,000 employees. It comes just as Toys ‘R’ Us is gearing up for the holiday shopping season, which accounts for the bulk of its sales, and as vendors halt shipments to the now insolvent retailer.

With assets of $6.9 billion, it’s the second-largest retail bankruptcy, trailing the filing in 2002 by Kmart, which had $14.6 billion in assets.

The company was saddled with debt from a $6.6 billion buyout in 2005 led by KKR, Bain Capital and Vornado Realty Trust. Toys ‘R’ Us has bonds coming due over the next few years that lost most of their value this month.

“While today’s decision does not necessarily mean it is game over for Toys ‘R’ Us, it brings to a close a turbulent chapter in the iconic company’s history,” said Neil Saunders, managing director of GlobalData Retail.

“What they have going for them is they are the last major player in their market,” said David Berliner, a partner and restructuring specialist with BDO Consulting. “The vendors don’t want to see them fail, so I think they have a good opportunity to survive.”

The company listed debt and assets of more than $1 billion in its Chapter 11 filing submitted Monday at the U.S. Bankruptcy Court in Richmond, Virginia (an odd place for such a major bankruptcy filing). Prior to filing, the company said that it had secured more than $3 billion in financing from lenders including a JPMorgan Chase & Co.-led bank syndicate and certain existing lenders to fund operations while it restructures. The money will be critical to provide comfort to Toys "R" Us vendors that they will be paid on time. Yesterday the stocks of some key suppliers such as Hasbro and Mattel were hit in advance of the filing.

When reports surfaced recently that Toys “R” Us was weighing a bankruptcy filing, Chinese toy scooter maker Pinghu Mijia Child Product Co. put all of the retailer’s orders on hold, fearing it wouldn’t get paid, according to sales manager Justin Yu, Bloomberg reported. The toy retailer represents about 10 to 20 percent of the Chinese supplier’s sales. “We were shocked to hear the news last week because their orders to us have been rising every year, so we did not know they were in trouble,” Yu said. “They’re a major buyer and I would say that the majority of toy makers in China would have some contracts with them.”

The bankruptcy filing by the company also may have global implications, especially for Chinese toy manufacturers. Some 38 percent of the company’s revenue came from overseas markets in the latest fiscal year. “It’s a loss for the long-term benefit of the entire industry,” said Lun Leung, chairman of Hong Kong-based Lung Cheong Group, a toy supplier for Hasbro Inc. He said Toys “R” Us accounted for less than 5 percent of the group’s sales.

“We expect that the financial constraints that have held us back will be addressed in a lasting and effective way,” Chief Executive Dave Brandon said. “Together with our investors, our objective is to work with our debtholders and other creditors to restructure the $5 billion of long-term debt on our balance sheet.”

The company's Canadian unit intends to seek protection in parallel proceedings under the Companies’ Creditors Arrangement Act (CCAA) in the Ontario Superior Court of Justice, Toys ‘R’ Us said in a statement. Operations outside of the United States and Canada, including about 255 licensed stores and joint venture partnerships in Asia, which are separate entities, are not part of the bankruptcy proceedings, Toys ‘R’ Us said.

As an indication of the challenges faced by the struggling retailer, the company opened a temporary store in New York City’s Times Square this year to capture more holiday shoppers, almost two years after it closed its flagship store barely a block away, driven out by high rents.

More than a dozen significant retail chains have filed for bankruptcy this year. Among them were Perfumania Inc, apparel chains rue21 Inc and Gymboree Corp, discount shoe chain Payless Holdings LLC and designer clothing chain BCBG Max Azria Global Holdings LLC.

The shakeout is also reverberating across American malls and shopping districts. More than 10 percent of U.S. retail space, or nearly 1 billion square feet, may need to be closed, converted to other uses or renegotiated for lower rent in coming years, according to data provided to Bloomberg by CoStar Group.

Major retailers including Macy’s and Sears Holding have closed hundreds of locations as they struggle to compete discounters such as Wal-Mart and Amazon.com. Amazon’s recent acquisition of high-end grocer Whole Foods Markets Inc stirred speculation that the online giant will use its pricing power and huge reach among U.S. consumers to go after market share of traditional brick-and-mortar grocers.

The company's full bankrtupcy filing is below:

From Bill Blain of Mint Partners

Blain's Morning Porridge - How to catch rabies in the Junk Bond Market

I’m sure everyone has been following the Toy R Us meltdown in the bond market. Alongside chapter 11 bankruptcy, its bonds have crashed from 96 to 18% through the month. Have we seen this before? Of course you have. Happens all the time. But, Blain’s Market Mantra No 3 reminds us: “Markets have no Memory. Buyers have even less.”

There are a number of things that worry me.

First is the market doesn’t seem to think Toy R Us is symptomatic of wider problems across the whole hi-yield and LBO sector. According to some I’ve spoken to, Toys R Us is one of few and even the “only” company caught in a debt trap – oh no it isn’t! Profit of about $500mm per annum covering debt service costs of, say, about $500 per annum. FFS! As the FT comments: the capital structure is “extremely complicated” leading to doubts on what is and isn’t senior or subordinated to what. It’s what we call messy.

Second, high yield spreads continue to tighten against bonds. Why? The risks are very very different across the credit spectrum, yet simplistic credit analysis treats them the same. Mistake to chase yield without understanding the risks. And go read all the stuff from 2007 about LBOs and how diversified risk is not reduced risk.

Third, there was a great article in the FT on Wednesday about Stada – the German drugmaker. It’s subject to an aggressive LBO and issuing substantial amounts of debt (bonds and loans) to fund it, allowing the PE buyers to strip out the cash. However, “buried deep in the 766 page offering memo”, says the FT, is a carve out of the obscure “restricted payments” clause allowing the private equity buyers to raise even more guaranteed debt to pay them dividends – a clear case of “the erosion of European Covenant Protections”.

It feels like a wake up and smell the coffee for the junk market… but I’ve been saying that for years… So I wont say it again…

It looks to me that complacent investors have been misreading the signs – foolishly thinking low rates meant highly levered private equity targets were somehow safe from debt crisis? In fact, debt remains front and centre the problem: as newspapers have noted; “while Toy R Us should have been spending its management resources maintaining relevancy versus Amazon and EBay, it was struggling with a debt mountain.” Doh.

What’s very obvious is holders ignored the first rule of investing in Leveraged Buy Outs: Don’t. Unless the goals of equity holders and debt are very clearly aligned – don’t go near them. Alignment of interest twixt equity and debt is critical and misalignment seems the basis of many takeovers…

Its 12 years since KKR, Bain and Vornado bought out Toy R Us. Guess who is also involved in the Stada buyout? If you guesses Bain, give yourself a big pat on the back.

Anything is possible when markets are so distorted that the hunt for yield overcomes common sense and folk are willing to ignore the need for protection against unrewarded risk. Common sense is a very uncommon thing.

Back in the real world.. I suppose we can spend the weekend fretting about Norte Korea. I tried to read stuff on the German election, hoping to come out with a killer bon-mot about Merkel, but it was just too dull and boring to bother.

I’m off to Edinburgh later this evening… Have a great weekend.

Carlyle, the favorite private equity firm of Washington D.C. and the "military industrial complex", has named two executives as successors to the ageing founders of the $158 billion fund, the latest rare move in an industry where similar succession plans are not usually telegraphed in advance.  Kewsong Lee and Glenn Youngkin have been appointed as co-chief executive officers, while Peter Clare will become co-chief investment officer alongside one of the founders.

Rubenstein, right, and Conway, left, will give up their CEO roles while Daniel
D’Aniello, will relinquish chairmanship.

They replace current co-CEOs David Rubenstein and Bill Conway, both 68, who relinquish their roles and become co-executive chairmen of the board, according to the FT. Conway will continue in his role as co-chief investment officer while Daniel D’Aniello, 71, will relinquish his role as chairman and will become chairman emeritus. D’Aniello will continue to be on Carlyle’s board and executive group. They will both continue to be members of Carlyle’s executive group.

Lee will focus on the company’s corporate private equity and global credit businesses, as well as corporate strategy and development, and capital markets. Youngkin will oversee Carlyle’s real estate, energy and infrastructure businesses, the investment solutions segment as well as investor relations and external affairs.

The new appointees have been groomed for years by the founders and the succession planning has been in the works at Carlyle for months. The promotions follow a similar move by KKR which in July elevated two executives to leadership roles.

Although KKR positioned the roles as potentially succeeding the founders in their roles of chief executives, Carlyle is giving the new co-CEOs leading and full responsibility of the running of the company, people familiar with the appointments said.

As the FT adds, the promotions were timed to coincide with Carlyle disposing of its poorly performing hedge fund businesses and after a group of company executives, including Mr Conway, were exonerated in a case linked to their decisions during the financial crisis.

Carlyle is set to emphasise that it has cleaned up its act and it is offering a clean sheet to the new co-CEOs, people familiar with the thinking behind the appointments said. The promotions also come at a time when the company has performed well. Over the summer it posted better than expected results and it is reporting quarterly earnings in the next few days.

Carlyle is expected to say in a statement that Mr Lee and Mr Youngkin will have “full responsibility, authority and accountability for the firm’s performance”. Only a few people know internally at Carlyle about the promotions and crucial investors have been notified of the move.

The move is likely to add extra pressure on their listed rivals in the US as investors in private equity raise concerns over who is taking control of these fundraising houses with 12% of funds set to close in less than a decade. In recent years, private equity investors — which typically include pension funds and sovereign wealth funds — have been cutting back on under-performing managers, which only adds to the pressure to set out a clear succession plan.

The bond market's reaction to the Trump Tax Plan...

Bonds and Bullion were immediately bid and stocks and the dollar sank on the Trump Tax plan release - but as Europe closed, gold was 'managed' down, leaving bonds outperforming on the day... And stocks back to unchanged as the market realized there is little chance of this bill passing... (So Bonds price out a little more growth hope and stocks flat on status quo and Powell)

The immediate reaction in stocks to the release of the Trump Tax plan was disappointment - sending stocks lower and VIX higher - but that was quickly met by the machines crushing VIX back to a 9 handle...

And as it became clearer that this bill was a non-starter, stocks roared back...

Some of the bigger reactions to the Tax Bill were homebuilders...

And Private Equity shops (Apollo, KKR, KW)... though there did not appear to be anything in the tax bill

And TSLA kept falling (not helped by lower EV credits in the tax bill), tumbling back below $300...

Finally, Bank stocks outperformed the market... as the yield curve crashed...

High yield bonds did not love the tax plan...

Treasury yields were down across the board having fallen in the early European session then legged lower on the Trump Tax plan release...

10Y seems to bid in Europe...

With the 'growth'-related 5s30s curve slumping to new cycle lows...

Breaking down to new cycle lows - flattest since 2007...

The Dollar Index ended lower on the day but was whipsawed around quite a bit... like the other markets, FX seemed to signal no hope for the tax bill passing...

Crude rallied on the day but copper, silver, and gold ended unchanged after jumping on the tax plan...

The bottom line from the reaction by markets seems to be traders are not expecting this bill to pass at all... and bonds are signaling the recent reflation exuberance is now fading fast.

Just over a month ago, Kyle Bass discussed why he was long effectively"long Greece."

Bass penned a Bloomberg editorial in which the hedge fund founder and CIO called on the IMF to stop bullying Greece-  publicizing the fact that he is now effectively long Greece. Greek government bonds have performed reasonably well so far this year: They’re up about 16%, and if Bass is right, they could have another 20% to 30% over the next 18 months if the IMF abandons its insistence on austerity and acknowledges that debt relief will need to be part of the long-term alleviation of debt. Bass added that, in the near future, voters will elect a more business-friendly government that will help reestablish the country’s creditworthiness, much like the government of Mauricio Macri did for Argentina. 

I think you also have an interesting political situation in Greece where I think there's going to be a handoff from the current Syriza government to kind of a more slightly-center-right but very economically independent new leadership in the next, call it, 18 months.

 

And so, I think you asked why now? And I think you're starting to see green shoots. You're starting to see the banks do the right things finally in Greece and you are about to have new leadership.

 

So, I think that you're going to see - and if you remember Argentina as Kirschner was going to hand-off – hand the reins over to someone that was much more let's say focused on business and economics than being a kleptocrat, I think you're going to see something again slightly similar in Greece where you have leadership today that might not be the right leadership and the government-in-waiting, I believe, and I think you know Mr. (Mitsutakous) - I think you're going to see something great happen to Greece in the and next, kind of, two years.

Then, just yesterday, the founder and chief investment officer of Hayman Capital Management, which manages an estimated $815 million in assets under management, told CNBC that he's been invested in Greek bank stocks that are trading at a quarter of book value.

According to Bass, foreign investors are waiting on the sidelines for a tectonic political shift to take place in 2018. The country is now preparing to end its international bailout program next year, with more than €320 billion (US$372 billion) in national debt. On Monday, Greece announced it will distribute 1.4 billion euros ($1.63 billion) as a social dividend to pensioners and others hit hard by the country's austerity program.

"My best guess is a snap election for prime minister will be called between April and September of next year and Prime Minister Alexis Tsipras will lose power.

 

"When that happens, there will be a massive move into the Greek stock market. Big money will flow in as investors feel more confident with a more moderate administration.

 

"It's going to take Kyriakos Mitsotakis, president of New Democracy, the Greek conservative party, to be voted in as prime minister to reform the culture and rekindle investor confidence," said Bass.

 

"I have no doubt €15 billion in bank deposits will come back to Greek banks if he's elected. The stock and bond markets will also jump following the election."

All of which brings us to today.

Greek bank stocks crashed over 8% today - plunging to the lowest since July 2016...

And in context, that's not good...

However, Bass is not pertrubed. As he explains, economic activity will get reenergized with the right leadership. The sectors global investors are eyeing right now are real estate, energy and tourism.

"There is so much potential," he said. "Pimco, Lonestar, KKR are all looking to buy commercial properties in Greece."

He also noted that the country will have marquee privatizations over the next two years.

"From my perspective, we have to fix two things in Greece for the market to take off," Bass said. "First, Greeks have to stop evading taxes. Second, they have to start repaying their loans."

Well if you believe him - you just got an 8% discount on your entry.

In October, we discussed Indian Prime Minister, Narendra Modi’s, decision to hand over $32bn to recapitalise India’s state banks. The motivation was India’s slowing growth rate and the need to add one million Indians to the workforce every month. Crippled by massive bad debts, the state-owned banks were struggling to extend more credit to the economy. The announcement caused a surge in India’s Sensex equity index, led by the banks. India has the second highest bad debt ratio of the world’s largest economies – possibly third since China’s official figure is patently incorrect.

Enter Uday Kotak, Asia’s richest banker (net worth over $10 billion) and managing director of India’s Kotak Mahindra Bank.

Kotak is a self-made man. Turning down a job offer from a multinational, he set up a financial services conglomerate, beginning with bills discounting before adding stockbroking, investment banking, mutual funds and car finance. Kotak thinks he’s spotted a “once-in-a-lifetime opportunity” in Indian finance…so it probably bears considering. Nor is he alone as sovereign wealth funds and pension funds are also taking a close look.The opportunity is in India’s bad loans, as Bloomberg explains.

For India, it’s a $207 billion mess, a pile-up of bad loans years in the making that’s dragging on growth. For the nation’s wealthiest banker, it’s the kind of opportunity that very rarely presents itself.

 

What has billionaire Uday Kotak salivating is the government’s attempt to finally draw a line under delinquent loans, with recent steps to overhaul India’s bankruptcy laws and recapitalize state-owned banks. The moves are intended to lift a burden from the country’s banks and encourage them to accelerate lending, supporting economic growth.

 

Over the next year, the assets and debts of about 50 of India’s biggest defaulters may be sold off by court-appointed professionals, in a process in which banks are expected to take deep haircuts on their loans. The companies’ borrowings total an estimated 3 trillion rupees ($46 billion), close to one-third of total recognized bad loans in India’s banking system.

As the first tranche of bad debts comes up for sale, Kotak is focusing on the very steep discounts on offer from the bankruptcy process, especially in the steel sector.

“The whole insolvency and bankruptcy process is a once in a lifetime event,” said Kotak, the managing director of Kotak Mahindra Bank Ltd., in an interview. “Through this you could actually get assets that would give disproportionate returns for long periods of time.”

 

Funds controlled by Kotak Mahindra are looking at deals involving the assets and debts of some of the first 12 companies going through the bankruptcy courts, Kotak said. Industries including steel are of particular interest, according to the banker. Pricing of assets put up for sale should become clearer by the end of the first quarter, he said. Banks are likely to face losses of up to 60 percent on their loans to the companies headed for bankruptcy courts, according to Kotak.

 

Sovereign wealth funds from the Middle East and Southeast Asia, along with several global pension funds, have also expressed interest, Kotak said. He didn’t name the funds, but TPG, KKR & Co., Caisse de depot et placement du Quebec and Clearwater Capital Partners LLC are among overseas firms who have said they might invest in stressed Indian assets.

In Kotak’s parlance, the Modi government’s move to resolve the bad-debt crisis is a “watershed moment” for India. However, bankruptcy has long had a flexible meaning in the country. Progress is being made as Kotak told Bloomberg.

The insolvency and bankruptcy law put in place by Prime Minister Narendra Modi’s government shifts the balance in favor of the creditor from the borrower, creating greater accountability for the family owners of India’s major companies, Kotak said. “For the first time, founders fear losing control of the company if dues are not paid,” he said.

 

The sense among some Indian executives that they could walk away from their debts without facing consequences was a major factor limiting past efforts to bring delinquent loans in check. The government’s announcement last month that it will inject a record 2.1 trillion rupees into state-owned banks is another sea change, in that it should give the lenders sufficient capital to write off bad loans weighing down their balance sheets.

However, there’s a catch. There is the potential for owners of bankrupt businesses to make bids in order to regain control of their assets at knock-down prices. Kotak is concerned about how the bidding process will be structured, as Bloomberg notes.

Kotak expressed concern about the way that the founders of defaulting companies are free to put in bids to regain control of those same assets through the courts. “In the absence of a change in the law, the promoter is well within his rights to bid,” he noted.

 

As a result, creditors should put in place safeguards, such as forensic audits of any such bidders, to ensure they haven’t willfully defaulted on their loans, he said. “If it is so, then they should not be allowed to bid,” said Kotak. “If the issue is that underlying asset got into trouble because of extraneous circumstances, like the marketplace or government policy, and not because of any issues with the promoter, then it’s a different category.”

 

The federal government has set up a panel to review provisions of the 11-month old bankruptcy law including whether to bar defaulting founders from repurchasing assets, India’s Corporate Affairs Minister P.P. Chaudhary said in a phone interview on Monday. “The implementation of the law has to be reasonable, justified and not opposed to public policy,” Chaudhary said.

Kotak Mahindra’s bad debt ratio stood at 2.6% at the end of March 2017, a quarter of the level of the banking system as a whole…and far superior to some of the worst culprits.

Kotak described India’s attempts to clean up its bad debt problem as a “watershed moment” and he believes that the next few months are critical for the Indian economy.

“You have the Indian courts, policy making system and several other moving parts that have to move in tandem. At this stage I feel reasonably confident that the problems will get resolved. But always be aware of something being different,” he said.

This is India after all.

In the aftermath of the 'great recession,' private equity firms placed massive bets on subprime auto finance companies with the typical "thesis" going something like this:"well, people have to get to work don't they?"...genius, if we understand it correctly.

Of course, the "thesis" seemed to be confirmed when auto securitizations performed relatively well throughout the financial crisis, amid a sea of mortgage bonds getting wiped out, and private equity titans were off to the races with wall street titans from Perella Weinberg to Blackstone and KKR scooping stakes in small niche lenders.

Unfortunately, as Bloomberg points out today, the $3 billion bet on subprime auto lenders hasn't played out precisely to plan as the "well, people have to get to work" thesis has proved to be somewhat less than full proof.

A Perella Weinberg Partners fund has been sitting on an IPO of Flagship Credit Acceptance for two years as bad loan write-offs push it into the red. Blackstone Group LP has struggled to make Exeter Finance profitable, despite sinking almost a half-billion dollars into the lender since 2011 and shaking up the C-suite multiple times. And Wall Street bankers in private say others would love to cash out too, but there’s currently no market for such exits.

 

Since the turn of the decade, buyout firms, hedge funds and other private investors have staked at least $3 billion on non-bank auto lenders, according to Colonnade. Among PE firms, everyone from Blackstone and KKR & Co. to Lee Equity Partners, Altamont Capital and CIVC Partners waded in.

 

Many targeted smaller finance companies that often catered to the least creditworthy borrowers with nowhere else to turn. Overall, subprime car loans -- those extended to people with credit scores of 620 or lower -- have increased 72 percent since 2011. Last year, about 20 percent of all new car loans went to subprime borrowers.

 

“The PE guys sailed into this thing with stars in their eyes. Some of the businesses have done fine and some haven’t,” said Chris Gillock, managing director at Colonnade Advisors, a boutique investment bank. But right now,“it’s about as out-of-favor a sector as I can think of.”

Of course, the turnaround strategy was 'simple.' Given that subrpime auto collateral held up well during the great recession, private equity investors figured they were sitting on rock solid collateral that would holdup under even the most egregious loosening of underwriting standards.  Therefore, given that there was 'no downside', lenders wholeheartedly embraced deteriorating underwriting standards, like stretching out terms so borrowers could 'afford' cars they couldn't really afford, as a way to grow their loans books. 

Alas, it didn't work out as planned as subprime delinquencies are suddenly soaring and used car prices are tanking...making profits somewhat elusive.

Take Exeter. The company, which is licensed in all 50 states and works with roughly 10,000 dealerships, hasn’t been profitable since 2011, when Blackstone took a majority stake, an S&P Global Ratings report in September showed. That’s after the PE firm invested $472 million to help Exeter expand and cycled through three CEOs at the lender.

 

On a pretax basis, Exeter turned a profit in 2016 and 2017, according to Matthew Anderson, a spokesman at Blackstone. He added the New York-based firm hasn’t tried to sell the lender.

 

Blackstone may look to unload Exeter later next year, said a person familiar with the matter, who asked not to be identified because it’s private.

 

Bad loans remain an issue. This year, a rash of delinquencies in two bonds stuffed with loans that Exeter made in 2015 caused the securities to dip into their extra collateral to keep investors whole.

 

Another example is Flagship, which Perella Weinberg bought in 2010. (Innovatus Capital Partners, which manages the lender on behalf of Perella Weinberg, was formed by former Perella Weinberg managers last year after they split from the firm.)

As it turns out, the "well, people have to get to work" thesis only works to the extent that auto manufacturers maintain some level of discipline and refrain from exploiting their captive finance companies to flood the market with new supply...a move which will eventually lead to crashing used car prices and massive subprime securitization losses.

Unfortunately, as we pointed out last month, a review of the latest Fed data on auto loans underwritten by "Banks and Credit Unions" compared to those loans provided by "Auto Finance" companies prove that the nightmare scenario is playing out for subprime lenders...

First, taking a look at auto loans provided by traditional banks and credit unions, one can see some marginal deterioration in subprime auto loans.  That said, the deterioration is certainly nothing substantial with 90-day delinquencies pretty much in line with 2004/2005 levels and no where near the rates experienced in 2008/2009.

 

 

But, a drastically different picture emerges when looking at just the auto loans originated by America's auto finance captives.  To our great 'shock', auto OEMs in the U.S. seem to have been much more "flexible" on underwriting standards over the past couple of years resulting in delinquency rates that nearly rival those last experienced at the height of the great recession.

 

Of course, we're sure that GM Financial and Ford Motor Credit just got unlucky with their deteriorating credit portfolios...certainly they would never knowingly attempt to game their own short-term financial success by putting millions of Americans into cars they can't possibly afford, right?