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So Much for the Exit Strategy |
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Written by Doug Noland
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Friday, 13 August 2010 00:00 |
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For the week, the S&P500 dropped 3.8% (down 3.2% y-t-d), and the Dow fell 3.3% (down 1.2%). The Banks sank 5.1% (up 7.6%), and the Broker/Dealers fell 5.7% (down 9.9%). The Morgan Stanley Cyclicals were hit for 5.6% (down 0.4%), and the Transports dropped 5.7% (up 2.5%). The Morgan Stanley Consumer index declined 2.5% (down 0.1%), and the Utilities dipped 1.1% (down 1.7%). The S&P 400 Mid-Caps dropped 4.8% (up 1.1%), and the small cap Russell 2000 sank 6.3% (down 2.5%). The Nasdaq100 fell 4.4% (down 2.3%), and the Morgan Stanley High Tech index sank 5.9% (down 8.4%). The Semiconductors were pounded for 8.2% (down 10.3%). The InteractiveWeek Internet index fell 3.9% (up 3.7%). The Biotechs declined 3.4%, reducing 2010 gains to 14.5%. Although bullion gained $10, the HUI gold index declined 1.3% (up 5.6%).
One-month Treasury bill rates ended the week at 13 bps and
three-month bills closed at 15 bps. Two-year government yields were little changed at 0.51%. Five-year T-note yields declined 4 bps to
1.39%. Ten-year yields dropped 14 bps to 2.68%. Long bond yields sank 14 bps to 3.86%. Benchmark Fannie MBS yields fell 13 bps to
3.43%.
The
spread between 10-year Treasury yields and benchmark MBS yields widened one basis point to 75 bps. Agency 10-yr debt spreads were 3 wider at 21 bps.
The
implied yield on December 2010 eurodollar futures increased 2.5 bps to 0.47%. The 10-year dollar swap spread declined 3 to negative 2.25.
The
30-year swap spread declined 13.5 to negative 43. Corporate bond
spreads widened. An index of investment grade spreads rose 5 to 108
bps. An index of junk bond spreads jumped 29 to 573 bps.
It was another strong week of debt issuance. Investment grade
issuers
included Direct TV $3.0bn, International Lease Finance $4.0bn, Anadarko Petroleum $2.0bn, Toyota Motor Credit $1.0bn, Simon Properties $900 million, Keycorp $750 million, Wellpoint $1.0bn, Nustar Logistics $450 million, Cott Beverages $375 million, Great Plains Energy $250 million, and Orange & Rockland $160 million.
A record week of junk issuers included Ally Financial $1.75bn, Goodyear Tire $900 million, SPX Corp $600 million, Chesapeake Energy $2.0bn, American Tower $700 million, Peabody Energy $650 million, Rite Aid $650 million, QEP Resources $625 million, First Data $510 million, International Lease Finance $500 million, Building Materials Corp $450 million, Diamond Resorts $425 million, Pinnacle Food $400 million, Gentiva Health Services $325 million, Developers Diversified $300 million, Regal Entertainment $275 million, and Targa Resources $250 million.
I saw no converts issued.
International dollar debt sales included Statoil $2.0bn, Banco Bradesco $1.1bn, Opti Canada $825 million, Tembec Industries $255 million, KWG Property $250 million, Elan $200 million and Barclays Bank $100 million.
U.K. 10-year gilt yields sank 10 bps to 3.12%, and
German bund yields dropped 13 bps to 2.39%. Greek 10-year bond yields jumped 33 bps to 10.48%, and 10-year Portuguese yields rose 22 bps to
5.21%. The German DAX equities index declined 2.4% (up 2.6% y-t-d).
Japanese 10-year "JGB" yields fell 7 bps to 0.98%. The
Nikkei
225 was hit for 4.0% (down 12.3%). Emerging equity markets were under some pressure. For
the
week,
Brazil's Bovespa equities index dropped 2.7% (down 3.4%), and Mexico's
Bolsa fell 2.5% (down 0.1%). Russia’s RTS equities index sank 5.1%
(down 0.1%). India’s Sensex equities index was little changed (up 4.0%).
China’s Shanghai Exchange declined 1.9% (down 20.5%). Brazil’s
benchmark
dollar bond yields fell 10 bps to 4.00%, and Mexico's benchmark bond
yields dropped 12 bps to 3.88%.
Freddie Mac 30-year fixed mortgage rates declined another 5 bps last
week
to 4.44% (down 85bps y-o-y). Fifteen-year fixed rates fell 3 bps to
3.92% (down 77bps y-o-y). One-year ARMs dipped 2 bps to 3.53% (down
119bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had
30-yr fixed jumbo rates down 8 bps to 5.37% (down 105bps
y-o-y).
Federal Reserve Credit declined $142 million last week to $2.309
TN. Fed Credit was up $89bn y-t-d (6.5% annualized) and $320bn, or
16.1%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury,
Agency Debt this past week (ended 8/11) jumped another $10.6bn (8-wk gain of $84.6bn) to a record
$3.164 TN. "Custody holdings" have increased $209bn y-t-d (11.5%
annualized), with a one-year rise of $349bn, or 12.4%.
M2 (narrow) "money" supply rose $16.9bn to $8.636 TN (week
of
8/2). Narrow "money" has increased $123bn y-t-d, or 2.4% annualized.
Over the past year, M2 grew 2.5%. For the week, Currency added $1.4bn,
and Demand & Checkable Deposits increased $9.0bn. Savings Deposits rose $11.4bn, while Small Denominated Deposits declined $4.3bn.
Retail
Money Fund assets were little changed.
Total Money Market Fund assets (from Invest Co Inst) added $3.5bn to $2.822 TN. In the first 32 weeks of the year, money fund
assets dropped $475bn, with a one-year decline of $771bn, or 21.5%.
Total Commercial Paper outstanding jumped $8.6bn to $1.105 TN.
CP has declined $65bn, or 9.0% annualized, year-to-date, while it was up $31bn from a year ago.
International reserve assets (excluding gold) - as tallied by
Bloomberg’s Alex Tanzi – were up $1.457 TN y-o-y, or 20.6%, to a record
$8.543 TN.
Global Credit Market Watch:
August 12 – Bloomberg (Tim Catts and Sapna Maheshwari): “Junk bonds are losing momentum as the busiest week on record for sales of the debt and a warning from the Federal Reserve about the outlook for the economy drives up relative borrowing costs. The extra yield investors demand to own high-yield debt climbed the most in two months… at least $12.9 billion of bonds [were] sold or marketed this week…”
August 9 – Bloomberg (Zeke Faux and Jody Shenn): “Wall Street banks are creating the ‘next investment bubble’ by selling opaque and unregulated structured notes to investors hunting for yield, according to Christopher Whalen, managing director of Institutional Risk Analytics. Using the same ‘loophole’ that allowed over-the-counter sales of collateralized debt obligations and auction-rate securities, firms are pitching illiquid structured notes whose value is partly derived from bets on interest rates… ‘The only trouble is that the firms originating these ersatz securities, as with the case of auction-rate municipal securities, have no obligation to make markets in these OTC structured assets or even show clients a low-ball bid,’ Whalen wrote.”
August 12 – Bloomberg (Emma Ross-Thomas and Esteban Duarte): “Prime Minister Jose Luis Rodriguez Zapatero may face a second front in his battle to contain Spain’s fiscal crisis as borrowing costs for the country’s regional governments climb. Catalonia, which accounts for a fifth of Spanish gross domestic product, has been shut out of public bond markets since March and the extra yield it pays over national government debt has almost tripled this year. Galicia, in the northwest, has asked to freeze payments of debt it owes the central government and the Madrid region postponed a bond sale last month.”
August 9 – Bloomberg (Christine Harper): “Goldman Sachs…, the bank that makes the most revenue trading stocks and bonds, lost money in that business on 10 days in the second quarter, ending a three-month streak of loss-free days at the start of the year. Losses on Goldman Sachs’s trading desks exceeded $100 million on three days during the period that ended on June 30… Today’s filing also shows that the firm’s traders generated more than $100 million on 17 days during the quarter. Of the 65 days in the quarter, Goldman Sachs traders made money on 55 days, or 85% of the time.”
August 13 – Bloomberg (Zachary R. Mider): “More than half of the 100 biggest takeovers made during the last mergers-and-acquisitions boom have something in common: By one measure, they never should have happened. The stocks of 53 companies that made the biggest purchases from 2005 to 2008 lagged behind industry peers two years later, according to… Bloomberg’s ranking group.”
August 10 – Bloomberg (Gabrielle Coppola and Veronica Navarro Espinosa): “Banco Bradesco SA’s $1 billion bond sale is making this month the busiest August since 2000 in the Brazilian market as a rally sends corporate borrowing costs to near the lowest on record.”
Global Government Finance Bubble Watch:
August 11 – Financial Times (Sam Jones): “Hedge fund trading of US government bonds has surged in 2010, according to a comprehensive new survey of fixed income investors. Hedge fund managers now account for a fifth of all trading volume in the $10,000bn US Treasury bond market, up from just 3% in 2009, according to Greenwich Associates.”
August 13 – Bloomberg (David Yong and Lilian Karunungan): “Global investors are pumping record amounts of money into developing nations’ domestic bonds this year… Funds investing in emerging-market local-currency debt have attracted $16.9 billion of net inflows so far, more than triple the record annual intake of $5 billion recorded in 2007, according to… EPFR Global.”
August 11 – Bloomberg (Renee Bonorchis): “Nassim Nicholas Taleb, who warned that unforeseen events can roil markets in ‘The Black Swan,’ said he is ‘betting on the collapse of government bonds’ and that investors should avoid stocks. ‘I’m very pessimistic,’ he said… ‘By staying in cash or hedging against inflation, you won’t regret it in two years.’ …The financial system is riskier than it was than before the 2008 crisis that led the U.S. economy to the worst contraction since the Great Depression, Taleb said.”
August 10 – Bloomberg (Kathleen M. Howley): “Harvey Collier, a mortgage broker in Fort Lauderdale, Florida, says he gets as many as 10 calls a month from people planning to default on their loans. The twist: They first want financing to buy another home. Real estate professionals call it ‘buy and bail,’ acquiring a new house before the buyer’s credit rating is ruined by walking away from the old one because it’s ‘underwater,’ or worth less than the mortgage. It’s an attempt to escape payments on a home whose value may never recover while securing a new property, often at a lower price with a more affordable loan. The practice, which constitutes fraud if borrowers lie on loan applications, is continuing even after Fannie Mae and Freddie Mac, the biggest U.S. mortgage-finance companies, beefed up standards to prevent it…”
Currency Watch:
August 9 – Bloomberg (Masaki Kondo and Keiko Ujikane): “China bought more Japanese bonds than it sold for a sixth straight month in June, heading for the biggest annual increase on record… China purchased a net 456.4 billion yen ($5.3bn) of Japanese debt in June, following net buying of 735.2 billion yen in May that was the most in records dating from 2005… China should pare its holdings of dollars to counter the risk of a ‘sharp depreciation,’ former adviser to the central bank Yu Yongding wrote in the China Securities Journal last month.”
August 11 – Bloomberg (Jungmin Hong and Saeromi Shin): “Korea Teachers Pension, the nation’s second-largest public pension fund, favors bonds and stocks of Brazil, China, Indonesia and Malaysia over developed countries because their economies are expanding faster. ‘We may invest more there,’ Chief Investment Officer Lee Yun Kyu, who oversees 8.3 trillion won ($7.1 billion), said… ‘Emerging nations, relatively free from the sovereign debt crisis, will be in good shape.’
The dollar index rallied 3.1% to 82.92 (up 6.5% y-t-d). For
the week on the downside, the Swedish krona declined 4.9%, the Norwegian krone 4.2%, the euro 4.0%, the Danish krone 3.9%, the New Zealand dollar 3.8%, the Australian dollar 2.8%, the British pound 2.2%, the South Korean won 1.8%, the Canadian dollar 1.4%, the Singapore dollar 1.2%, the Swiss franc 1.2%, the Japanese yen 0.8%, and the Brazilian real 0.6%.
Commodities Watch:
August 12 – Bloomberg (Jeff Wilson): “World wheat stockpiles before next year’s Northern Hemisphere harvests will be 6.6% smaller than forecast a month ago after adverse weather decimated crops in Russia, Kazakhstan and Ukraine, according to the Department of Agriculture.”
August 12 – Bloomberg (Jeff Wilson and Whitney McFerron): “The world’s appetite for meat, flour and ethanol is expanding faster than the supply of the crops needed to produce them, eroding inventories and increasing the chance of accelerating food prices. Wheat stockpiles may slip to a two-year low… according to 17 analysts in a Bloomberg survey. Inventories of corn, used to feed livestock and make fuel, probably will drop to the lowest level since 2008, even as output tops a record…”
The CRB index fell 2.2% (down 5.1% y-t-d). The Goldman
Sachs Commodities Index (GSCI) sank 4.1% (down 2.3% y-t-d). Spot
Gold added 0.8% to $1,216 (up 10.8% y-t-d). Silver fell 2.0% to
$18.165 (up 7.8% y-t-d). September Crude sank $5.31 to $75.39
(down 5% y-t-d).
September Gasoline was hit for 8.2% (down 5.5% y-t-d), and September Natural Gas declined 3.1% (down 22% y-t-d). September Copper declined 2.6% (down 2%
y-t-d). September Wheat retreated 3.2% (up 30% y-t-d), while September
Corn rose 1.7% (down 1% y-t-d).
China Watch:
August 10 – Bloomberg (Jungmin Hong and Saeromi Shin): “China’s trade surplus reached an 18-month high as exports rose to a record and import gains slowed… The gap surged 170% from a year earlier to $28.7 billion… Exports increased 38.1% to $145.5 billion and imports advanced 22.7% to $116.8 billion…”
August 9 – Bloomberg: “China’s industrial output growth may have weakened in July as the government shuttered energy-intensive factories, highlighting how environmental goals risk damping growth just as export orders soften. Industrial production climbed 13.4% from a year earlier… China is lagging behind a target for reducing the amount of energy used relative to gross domestic product, with only months to run in Premier Wen Jiabao’s five-year plan.”
August 10 – Bloomberg (Jungmin Hong and Saeromi Shin): “China’s banking regulator ordered banks to transfer off-balance-sheet loans onto their books and make provisions for those that may default… The assets linked to wealth management products provided by trust companies must be shifted onto banks’ balance sheets by the end of 2011, the people said… The move may increase pressure for capital-raising at Chinese banks, which Fitch Ratings last month said had more than 2.3 trillion yuan ($339 billion) of off-balance sheet assets.”
August 10 – Bloomberg: “China’s property prices rose at the slowest pace in six months in July as the government cracked down on speculation to prevent asset bubbles. Prices in 70 major cities climbed 10.3% from a year earlier… The value of sales fell 19.3 percent from a year earlier…”
August 12 – Bloomberg: “Shanghai’s new mortgage loans plunged 98% in July from a year earlier as a government crackdown on property speculation deterred investors from buying homes in China’s richest city.”
August 10 – Bloomberg (Jungmin Hong and Saeromi Shin): “China’s auto sales may rise to 16 million this year, an auto makers’ group said, boosting its forecast from a previous estimate of 15 million. Vehicle sales will be higher than previously expected judging by deliveries in the first half of the year…”
August 12 – Bloomberg: “China’s households hide as much as 9.3 trillion yuan ($1.4 trillion) of income that is not reported in official figures, with 80% accrued by the wealthiest people, a study showed. The money, much of it likely ‘illegal or quasi-illegal,’ equates to about 30% of China’s gross domestic product, the study, conducted for Credit Suisse… found. The average urban disposable household income in China is 32,154 yuan, or 90% more than official figures, according to the report.”
August 13 – Bloomberg (Sophie Leung): “Hong Kong’s economy expanded a more- than-estimated 6.5% in the second quarter and the government announced measures to limit the risk of bubbles in the property market… Hong Kong’s economy will grow between 5% and 6% for the full year, the government said…”
India Watch:
August 12 – Bloomberg (Kartik Goyal and Unni Krishnan): “India’s industrial production rose at the slowest pace in 13 months in June… Output at factories, utilities and mines rose 7.1% after a 11.3% gain in May from a year earlier…”
Asia Bubble Watch:
August 10 – Bloomberg (Sarah McDonald): “Corporate bond sales in Asian currencies reached a record last month as companies seek capital to fund power plants, tower blocks and railways in the world’s fastest-growing economic region.”
August 10 – Bloomberg (Karl Lester M. Yap and Cecilia Yap): “Philippine exports gained for an eighth month in June as demand for electronics rose… Shipments abroad increased 33.4% from a year earlier…"
Latin America Watch:
August 10 – Bloomberg (Drew Benson and Boris Korby): “Argentine securities linked to gross domestic product are outperforming the country’s bonds by the most in five months… South America’s second-biggest economy is ‘scorching’ and may grow 9.7% this year, the most since 1992…"
Unbalanced Global Economy Watch:
August 13 – Bloomberg (Christian Vits): “Germany’s economy grew in the second quarter at the fastest pace since the country’s reunification two decades ago, driving faster-than-forecast expansion in the 16-nation euro area. German gross domestic product surged 2.2% from the first quarter, fueling euro-area growth of 1%, the fastest in four years.”
August 12 – Bloomberg (Johan Carlstrom): “Swedish inflation accelerated in July after consumer confidence rose to its highest level in nearly a decade… Headline consumer prices increased an annual 1.1%...”
August 12 – Bloomberg (Maria Petrakis): “Greece’s economy contracted for a seventh quarter and unemployment rose as the wage-cuts and tax increases that aim to trim the European Union’s second-biggest budget deficit deepened a recession. Gross domestic product shrank 1.5% in the second quarter from the previous three months…”
August 11 – Bloomberg (Maria Levitov): “Russia’s economic expansion accelerated in the second quarter as commodities prices rose and a recovery in domestic demand gathered speed. Gross domestic product grew 5.2% from a year earlier…”
August 10 – Bloomberg (Lucian Kim and Maria Levitov): “Russia’s record heat wave may already have taken 15,000 lives and cost the economy $15 billion, or 1% of gross domestic product…”
August 10 – Bloomberg (Maria Levitov): “Russia’s federal budget deficit widened in July… The seven-month shortfall swelled to 538.84 billion rubles ($17.96bn), or 2.2% of gross domestic product… Russia posted a budget deficit of 5.9% of GDP last year, its first shortfall since 1999…”
U.S. Bubble Economy Watch:
August 11 – Bloomberg (Bob Willis): “The trade deficit in the U.S. unexpectedly widened in June to the highest level since October 2008 as consumer goods imports rose to a record and exports declined. The gap expanded $7.9 billion, the most since record-keeping began in 1992, to $49.9 billion in June… Exports from the U.S. decreased to $150.5 billion from $152.4 billion, reflecting fewer shipments abroad of semiconductors, computers and steelmaking materials. Imports increased in June to $200.3 billion from $194.4 billion…”
August 9 – Bloomberg (Courtney Schlisserman and Shobhana Chandra): “The U.S. economy will improve slowly and another round of fiscal stimulus probably wouldn’t be effective, former Treasury secretaries Paul O’Neill and Robert Rubin said.”
Central Bank Watch:
August 11 – Bloomberg (Jennifer Ryan): “Bank of England Governor Mervyn King said inflation will probably slow below the bank’s target in 2012 and growth will be weaker than previously forecast, signaling the U.K. economy may need more emergency stimulus.”
GSE Watch:
August 9 – Bloomberg (Lorraine Woellert): “Freddie Mac, the mortgage company operating under federal conservatorship, is seeking $1.8 billion in aid from the U.S. Treasury Department after a fourth straight quarterly loss. The… company lost $4.7 billion in the second quarter… ‘High unemployment and other factors still pose very real challenges from the housing market and with that in mind we continue to focus on the quality of the new businesses we are adding to our book to be responsible stewards of taxpayer funds,’ Chief Executive Officer Charles E. Haldeman Jr. said…”
Muni Watch:
August 12 – Bloomberg (Michael B. Marois): “Washington state… may need to cut spending by as much as 7% if declining revenue widens a $3 billion budget deficit, according to Governor Christine Gregoire. Gregoire… said she’ll order all state agencies to prepare spending cuts of 4% to 7% starting Oct. 1 if September tax collections miss a state forecast.”
August 10 – Bloomberg (Martin Z. Braun): “Bell, the Los Angeles suburb that paid its city manager almost $800,000 a year, had its credit cut five steps to junk by Standard & Poor’s on concerns about the city’s ability to refinance or pay debt due Nov. 1.”
California Watch:
August 10 – Bloomberg (Michael B. Marois): “California’s tax revenue in July came in $91 million below Governor Arnold Schwarzenegger’s latest estimate, according to state Controller John Chiang. Revenue of $4.67 billion trailed projections produced in May by 1.9%... Personal income tax collections were $210.3 million, or 6.6% below the May forecast… Spending surpassed the May forecast by $963.3 million, or almost 13%... Outlays exceeded receipts by $1.23 billion for the month… California, the biggest issuer of debt among U.S. states, has been operating without a spending plan since July 1 as Schwarzenegger and the Legislature remain at odds over how to fill a $19.1 billion budget deficit. Chiang has said he may need to issue IOUs to pay bills for the second straight year if the impasse extends into next month.”
Speculator Watch:
August 10 – Bloomberg (Tomoko Yamazaki and Warren Giles): “Hedge funds posted their biggest gain in four months in July as a rally in equity, commodity and bond markets contributed to positive performances across all regions, according to Eurekahedge Pte. Ltd. The Eurekahedge Hedge Fund Index, which measures the performance of more than 2,000 funds worldwide, rose 1.42% in the month… The index climbed 1.17% in the first seven months of the year.”
So Much for the Exit Strategy:
I had limited time to write today, but I’m hoping a few paragraphs will be better than nothing. The environment beckons for more thorough analysis.
Ten-year Treasury yields dropped another 14 bps this week to 2.68%. Benchmark Fannie MBS yields sank 13 bps to a record low 3.43%. Tuesday’s announcement from the Federal Open Market Committee (FOMC) further emboldened a highly-speculative fixed-income marketplace.
Some analysts argue that the Fed’s move to reinvest cash receipts from its MBS portfolio into Treasurys is no big deal; the decision will not involve sums of Treasury purchases sufficient to move market and economic needles. A former Federal Reserve Governor – and noted “Fed watcher” – commented on CNBC that this amounts to “neutral” monetary policy. It is his view that it would be a case of “tight” policy if the Fed’s balance sheet were allowed to shrink with a drawing down of its MBS portfolio. Conversely, Federal Reserve holdings would need to expand for monetary policy to remain loose. The size of the Fed’s balance sheet is now viewed as a key policy tool.
I see things differently - and view this week’s decision by the Bernanke Federal Reserve as yet another dangerous leap into experimental monetary management. Market perceptions remain the key facet of Bubble analysis – and not week-to-week changes in Fed holdings.
Not many weeks ago the focus was on the Fed’s “exit strategy.” Apparently, policymakers now recognize that there is no way out. It was suppose to have been a case of the Federal Reserve having used its balance sheet as an extraordinary policy tool in response to the 2008 Credit seizure, with the Fed dedicated to unwinding this unprecedented stimulus as the system stabilized. Today, not only is the Fed unwilling to normalize its securities holdings, it has signaled to the markets that it is able and willing to expand its balance sheet on an as needed basis. At least that’s the way the markets will see things: the Fed is there ready to act quickly and forcefully as a reliable system backstop. No more worries about “exit” issues; and as the debt markets turn increasingly overheated, it’s sure comforting the markets know the Fed is there to ensure marketplace liquidity. This is a very big deal.
There were many crosscurrents in the markets this week. The dollar rallied sharply, immediately reinstituting pressure on various global risk markets. Euro weakness quickly translated into widening risk premiums in periphery European debt markets – that then tend to feed further euro vulnerability. The dollar pop also slammed crude prices and pressured some of the other commodities. And reminiscent of the Greek debt crisis period, dollar strength pressured global equities markets more generally. The global “reflation trade” seems these days to hinge day-to-day on the direction of the dollar – especially versus the euro.
Market pundits pointed to the Federal Reserve’s downbeat economic assessment as the main reason behind the equity sell-off, although the currency markets continue to be the driving force behind wildly volatile global markets. Perhaps the Fed’s downbeat assessment and announcement of Treasury purchases was somehow behind the dollar’s rally; or perhaps it was instead that traders had become sufficiently bearish on the dollar to ensure that Mr. Market did an about face - with a “rip their faces off!” rally.
Stocks were weak and the dollar was generally strong. But the real show was provided – once again - in fixed income. Prices continued their melt-up – yield meltdown – with Bubble Dynamics becoming only more conspicuous each passing week. And I know that most dismiss the Bubble thesis and view prices as reflecting poor economic prospects and the deflationary backdrop. I would respond that the environment remains extraordinarily conducive to Bubble expansion.
Barron’s Jonathan R. Laing captured the current mood with his article, “Time to Print, Print, Print.” With inflation risks so low and the scourge of deflation so potentially devastating, many believe it would be a dereliction of the Federal Reserve’s duty not to aggressively expand its securities holdings (“print money”). Similar reasoning was used to justify the ultra-loose monetary policies earlier this decade that inflated the mortgage/Wall Street finance Bubble.
Today, extreme activist fiscal and monetary policies inflate the Global Government Finance Bubble. After the 2008 fiasco, I have a difficult time comprehending how analysts can remain dismissive of Bubble risks. And with an increasingly conspicuous Bubble at the heart of our monetary system, our central bank should not be reinforcing the market perception that the Fed is there to backstop the markets and economic recovery with open-ended Treasury purchases. Instead of a well-functioning marketplace (and central bank) working to discipline a profligate Washington, dysfunctional monetary and market environments continue to accommodate perilous Credit excess. |
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Last Updated on Saturday, 14 August 2010 11:13 |
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Written by Doug Noland
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Friday, 06 August 2010 00:00 |
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For the week, the S&P500 (up 0.6% y-t-d) and the Dow Jones Industrials (up 2.2%) both jumped 1.8%. The Morgan Stanley Cyclicals increased 2.0% (up 5.4%), and the Transports added 0.8% (up 8.7%). The Morgan Stanley Consumer index gained 1.6% (up 2.5%), and the Utilities rose 1.8% (down 0.6%). The Banks slipped 0.4% (up 13.4%), while the Broker/Dealers jumped 3.0% (down 4.4%). The S&P 400 Mid-Caps increased 1.5% (up 6.2%), while the small cap Russell 2000 index was little changed (up 4.0%). The Nasdaq100 jumped 2.1% (up 2.3%), and the Morgan Stanley High Tech index gained 1.3% (down 2.7%). The Semiconductors added 0.8% (down 2.3%). The InteractiveWeek Internet index jumped 3.5% (up 7.8%). The Biotechs surged 5.4%, boosting 2010 gains to 18.5%. With bullion rallying $24, the HUI gold index jumped 3.9% (up 7.0%).
One-month Treasury bill rates ended the week at 13 bps and
three-month bills closed at 14 bps. Two-year government yields declined 4 bps to 0.47%. Five-year T-note yields sank 9 bps to
1.43%. Ten-year yields declined 9 bps to 2.82%. Long bond yields added one basis point to 4.00%. Benchmark Fannie MBS yields jumped 12 bps to 3.56%.
The
spread between 10-year Treasury yields and benchmark MBS yields widened a notable 21 bps to 74 bps. Agency 10-yr debt spreads were little changed at 18 bps.
The
implied yield on December 2010 eurodollar futures was little changed at 0.44%. The 10-year dollar swap spread increased 2 to 0.75.
The
30-year swap spread declined 2 to negative 29.5. Corporate bond
spreads continued to narrow. An index of investment grade spreads narrowed 2 to
102
bps. An index of junk bond spread narrowed 18 to 538 bps.
Debt issuance began August with a flurry. Investment grade issuers
included Metlife $3.0bn, Citigroup $2.5bn, IBM $1.5bn, Pride International $1.2bn, Altria Group $1.0bn, Omnicom Group $1.0bn, AFLAC $750 million, PNC $750 million, Expedia $750 million, Corning $700 million, Newell Rubbermaid $550 million, Northern States Power $500 million, CNA Financial $500 million, Magellan Midstream $300 million, AMB Property $300 million, and Public Service E&G $250 million.
Junk issuers included Mylan $1.0bn, Continental Airlines $800 million, Petrohawk Energy $825 million, Marina District $800 million, Tenet Healthcare $600 million, Arch Coal $500 million, Trilogy International $370 million, Energy Solutions $300 million, and Ferro $250 million.
Convert issuers included Teleflex $400 million.
International dollar debt sales included Arcelormittal $3.5bn, HSBC $3.25bn, Credit Suisse $2.0bn, Volkswagen $1.75bn, Intesa Sanpaolo $1.0bn, Tech Resources $750 million, Stats Chippac $600 million, Australia & New Zealand Bank $1.5bn, Macquarie Group $500 million, and ENAP $500 million.
U.K. 10-year gilt yields dropped 10 bps to 3.22%, and
German bund yields sank 15 bps to 2.52%. Greek 10-year bond yields fell 14 bps to 10.15%, and 10-year Portuguese yields sank 18 bps to
4.99%. The German DAX equities index gained 1.8% (up 5.1% y-t-d).
Japanese 10-year "JGB" yields dipped one basis point to 1.05%. The Nikkei
225 gained 1.1% (down 8.6%). Emerging markets were higher. For
the
week,
Brazil's Bovespa equities index increased 0.9% (down 0.7%), and Mexico's
Bolsa jumped 1.9% (up 2.5%). Russia’s RTS equities index gained 1.9%
(up 4.3%). India’s Sensex equities index rallied 1.5% (up 3.9%).
China’s Shanghai Exchange increased 0.8% (down 18.9%). Brazil’s
benchmark
dollar bond yields dropped 15 bps to 4.11%, and Mexico's benchmark bond
yields sank 31 bps to 3.94%.
Freddie Mac 30-year fixed mortgage rates declined 5 bps last
week
to 4.49% (down 73bps y-o-y). Fifteen-year fixed rates fell another 5 bps to
3.95% (down 68bps y-o-y). One-year ARMs sank 9 bps to 3.55% (down
123bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had
30-yr fixed jumbo rates unchanged at 5.45% (down 81bps
y-o-y).
Federal Reserve Credit declined $3.2bn last week to $2.309
TN. Fed Credit was up $89.2bn y-t-d (6.7% annualized) and $331bn, or
16.7%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury,
Agency Debt this past week (ended 8/4) increased $8.2bn (7-wk gain of $74.1bn) to a record
$3.154 TN. "Custody holdings" have increased $198.6bn y-t-d (11.3%
annualized), with a one-year rise of $343.8bn, or 12.2%.
M2 (narrow) "money" supply increased $4.4bn to $8.619 TN (week
of
7/26). Narrow "money" has increased $106.6bn y-t-d, or 2.2% annualized.
Over the past year, M2 grew 2.0%. For the week, Currency added $1.4bn,
and Demand & Checkable Deposits jumped $19.4bn. Savings Deposits declined $7.3bn, and Small Denominated Deposits fell $3.7bn.
Retail
Money Fund assets declined $5.3bn.
Total Money Market Fund assets (from Invest Co Inst)
jumped $19.2bn to $2.819 TN. In the first 31 weeks of the year, money fund
assets dropped $475bn, with a one-year decline of $787bn, or 21.8%.
Total Commercial Paper outstanding declined $4.6bn to $1.097 TN.
CP has declined $73.4bn, or 10.5% annualized, year-to-date, while it was up $20bn from a year ago.
International reserve assets (excluding gold) - as tallied by
Bloomberg’s Alex Tanzi – were up $1.394 TN y-o-y, or 19.7%, to a record
$8.483 TN.
Global Credit Market Watch:
August 6 – Bloomberg (Katie Evans): “Expedia… and International Business Machines… sold bonds with coupons at historic lows this week… Debt sales reached $35.9 billion this the week, the most since March 26…”
August 6 – Bloomberg (Tim Catts): “U.S. corporate bond sales in August may reach $100 billion, the most on record for the month, as companies benefit from falling borrowing costs and seek to raise debt before financial firms come to market in September, according to Aladdin Capital LLC.”
August 4 – Bloomberg (John Detrixhe): “Junk bonds are closing in on par for the second time this year as fixed-income investors bet recent signs of economic weakness won’t be enough to derail corporate profits and the ability of the neediest borrowers to repay debt. High-yield bonds rose to 98.99 cents on the dollar yesterday after falling as low as 94.47 cents on May 25… Investors are pouring money into bond funds at the fastest pace in 15 months…”
August 5 – Bloomberg (Bryan Keogh and Kate Haywood): “Relative yields on Europe’s junk bonds are poised to fall below their U.S. counterparts for the first time since June 2008 as concern the sovereign deficit crisis will derail the region’s economic recovery recedes.”
August 4 – Bloomberg (Dawn Kopecki and Jody Shenn): “The Federal Reserve Bank of New York may seek to require banks to buy back its holdings of faulty mortgages and other assets acquired through the rescues of Bear Stearns Cos. and American International Group…, a spokesman said. ‘We are involved in multiple efforts related to exercising our rights as investors in non-agency RMBS or CDO securities,’ New York Fed spokesman Jack Gutt wrote…referring to residential mortgage-backed securities and collateralized debt obligations. Steps include ‘those that require originators to repurchase ineligible loans,’ Gutt wrote… ‘These efforts support our primary goal of maximizing the value of these portfolios on behalf of the American taxpayer.’”
August 6 – New York Times (Graham Bowley and Eric Dash): “They are the elite among the elite at Goldman Sachs, highfliers who are the envy of Wall Street. But on Washington’s orders, Goldman is now considering a step that once would have been unthinkable: disbanding the corps of market wizards at the heart of its lucrative trading operation. Under the new Dodd-Frank financial regulation, Goldman must break up its principal strategies group, the wildly successful trading unit that has helped power the bank’s profits. Goldman is considering several options, including moving the traders to another division or shutting the unit altogether, according to people briefed on the matter. Across Wall Street, other financial giants are also embarking on the delicate task of complying with the new rules governing their trading and investments.”
Global Government Finance Bubble Watch:
August 2 – Bloomberg (Caroline Salas and Jody Shenn): “For all the good the Federal Reserve’s $1.25 trillion of mortgage-bond purchases have done, they’ve also left part of the market broken. By acquiring about a quarter of home-loan bonds with government-backed guarantees to bolster housing prices and the U.S. economy, the Fed helped make some securities so hard to find that Wall Street has been unable to complete an unprecedented amount of trades. Failures to deliver or receive mortgage debt totaled $1.34 trillion in the week ended July 21, compared with a weekly average of $150 billion in the five years through 2009…”
Currency Watch:
August 5 – Bloomberg (Liz Capo McCormick): “Investors reaped bigger gains since the start of June by funding investments in higher-yielding currencies with dollar-denominated loans than similar strategies using Japanese yen- or Swiss franc-based funding… Expectations that the Federal Reserve will keep interest rates at record lows into next year combined with traders’ speculation that policy makers may be forced to resume buying securities to help provide additional stimulus to the economy makes dollar-based funding attractive… ‘The outlook for a return to a dollar-funded carry trade is becoming compelling,’ said Ray Farris, head of foreign-exchange strategy at Credit Suisse…”
The dollar index slumped 1.4% to 80.363 (up 3.2% y-t-d). For
the week on the upside, the Norwegian krone increased 2.2%, the Swedish krona 1.8%, the South Korean won 1.8%, the Danish krone 1.8%, the euro 1.8%, the British pound 1.7%, the Australian dollar 1.5%, the Japanese yen 1.2%, the South African rand 1.0%, the New Zealand dollar 1.0%, the Taiwanese dollar 0.7%, the Swiss franc 0.3%, and the Canadian dollar 0.3%. For the week on the downside, the Mexican peso declined 0.3% and the Brazilian real 0.3%.
Commodities Watch:
August 4 – Financial Times (Jack Farchy): “Wheat prices surged more than 7% on Wednesday to a fresh two-year high even as the United Nations attempted to quell growing panic in the markets. CBOT September wheat rose to a fresh peak above $7.30 a bushel, the highest since September 2008, amid rising alarm over the state of the wheat crop in the Black Sea region, which has been ravaged by the worst drought in more than a century. The UN’s Food and Agricultural Organisation said that fears of a repetition of the 2007-08 food crisis were unjustified. But it also cut its forecast for global wheat production by 25m tonnes to 651m tonnes, making the biggest revision in 20 years, and warned that a continuation of the current weather conditions could affect planting of the next Russian crop, with ‘potentially serious implications’ for global wheat supplies in the 2011-12 season.”
August 5 – Bloomberg (Maria Levitov and Maria Kolesnikova): “Russia will impose an export ban on grain and grain products from Aug. 15 to Dec. 31 as the country’s worst drought in half a century cuts yields… Earlier, Putin said a ban would be ‘appropriate’ after drought and record heat in central Russia and along the Volga River forced the government to declare a state of emergency in 28 crop- producing regions… ‘As of today, Russia has no grain market,’ said Kirill Podolsky, chief executive officer of Valars Group, the country’s third-biggest grain trader. ‘This will be a catastrophe for farmers and exporters alike.’”
August 3 – Bloomberg (Maria Kolesnikova): “Russia’s worst drought in at least 50 years, which already drove wheat prices to the biggest jump since 1973, shows no signs of easing and now threatens sowing plans for winter grains, the national weather center said. Plantings scheduled to start in August in the northeastern areas of Russia’s European regions will be hampered by dry soil…”
The CRB index added 0.1% (down 3.1% y-t-d). The Goldman
Sachs Commodities Index (GSCI) jumped 1.8% (up 1.8% y-t-d). Spot
Gold rallied 2.1% to $1,205 (up 9.8% y-t-d). Silver jumped 2.6% to
$18.465 (up 9.6% y-t-d). September Crude rose $1.97 to $80.92
(up 2.0% y-t-d).
September Gasoline slipped 0.2% (up 3% y-t-d), and September Natural Gas sank 9.1% (down 20% y-t-d). September Copper added 1.5% (up 0.4%
y-t-d). September Wheat surged another 9.7% (up 56% y-t-d), and September
Corn gained 3.1% (down 2% y-t-d).
China Watch:
August 5 – Bloomberg: “China’s central bank said inflation risks persist as growth stabilizes in the world’s third-biggest economy. There’s ‘still a need to strengthen the management of inflation expectations,’ the People’s Bank of China said… China’s inflation accelerated to 3.3% in July, the fastest pace in 21 months… Rising labor and resource costs and ‘relatively loose’ global monetary conditions may add to price pressures, the central bank said.”
August 2 – Bloomberg: “China’s July manufacturing data were the weakest in more than a year as the government clamped down on property speculation and investment in polluting and energy- intensive factories. A purchasing managers’ index released today… slid to 49.4 from 50.4 in June. A separate, government-backed PMI fell to 51.2 from 52.1…”
August 5 – Bloomberg (Bryan Keogh and Kate Haywood): “China’s banking regulator told lenders last month to conduct a new round of stress tests to gauge the impact of residential property prices falling as much as 60% in the hardest-hit markets… Banks were instructed to include worst-case scenarios of prices dropping 50% to 60% in cities where they have risen excessively, the person said… Previous stress tests carried out in the past year assumed home-price declines of as much as 30%.”
August 3 – Bloomberg: “China will let more banks import and export gold and open trading further to foreign companies as near-record prices and falling stock markets spur demand in the world’s second-largest buyer of the metal. Gold prices gained. China may ‘increase foreign members on the Shanghai Gold Exchange and will also study ways to allow foreign qualified bullion suppliers to deliver to the exchange,’ the People’s Bank of China said… Banks may also be allowed to hedge onshore gold positions overseas to encourage the development of yuan-denominated derivatives trading, it said. Gold demand in China, the world’s largest producer, gained in the first half as government measures to cool the property market and falling equities spurred investment… ‘China’s domestic production of gold, albeit the largest in the world, cannot satisfy its demand,’ said Ellison Chu, managing director at the precious-metals desk at Standard Bank Asia… ‘By allowing more foreign participation and more Chinese commercial banks to import and export, China can better balance its demand and supply.’”
India Watch:
August 2 – Bloomberg (Kartik Goyal): “India’s manufacturing growth accelerated in July, increasing pressure on the central bank to raise interest rates. Bond yields touched a three-month high. The Purchasing Managers’ Index rose to 57.6 from 57.3 in June… The data, along with rising bank credit and automobile sales, adds to evidence of strengthening consumer demand in Asia’s largest economy after Japan and China.”
Asia Bubble Watch:
August 2 – Bloomberg (Simon Kennedy, Matthew Bristow and Shamim Adam): “The high-speed rail link China Railway Construction Corp. is building in Saudi Arabia doesn’t just connect the holy cities of Mecca and Medina. It shows how Asia, the Middle East, Africa and Latin America are holding the world economy together. Ties between emerging markets form what economists at HSBC Holdings Plc and Royal Bank of Scotland Group Plc call the ‘new Silk Road’ -- a $2.8-trillion version of the Asian-focused network of trade routes along which commerce prospered starting in about the second century.”
August 2 – Bloomberg (Shamim Adam and Novrida Manurung): “Indonesia’s inflation rate climbed to the highest level in 15 months in July… Consumer prices rose 6.22% last month from a year earlier…”
August 5 – Bloomberg (Greg Ahlstrand and Berni Moestafa): “Indonesia’s economy expanded at a faster-than-estimated pace last quarter… Gross domestic product in Southeast Asia’s largest economy grew 6.2% in the three months to June 30…”
August 5 – Bloomberg (Suttinee Yuvejwattana and Daniel Ten Kate): “Thailand’s economy may expand as much as 8% this year, more than previously forecast, as exports and spending gather strength, Finance Minister Korn Chatikavanij said.”
Latin America Watch:
August 5 – Bloomberg (Sebastian Boyd and Randy Woods): “Chile’s economic activity expanded 6.8% in June from a year earlier, beating economists’ forecasts, the central bank said…”
August 5 – Bloomberg (Daniel Cancel and Corina Rodriguez Pons): “Venezuela, the largest oil producer in South America, is shipping 200,000 barrels a day of oil to China to repay $20 billion of debt borrowed from the Asian nation to finance power, agriculture and technology projects.”
Unbalanced Global Economy Watch:
August 4 – Bloomberg (Simone Meier): “Growth in Europe’s services and manufacturing industries accelerated in July… A composite index based on a survey of euro-area purchasing managers in both industries rose to 56.7 from 56 in June…”
U.S. Bubble Economy Watch:
August 6 – Bloomberg (Shobhana Chandra): “The U.S. participation rate fell to 1985 levels in July as job seekers gave up their search in a ‘worrying sign’ the labor market remains weak, according to Ryan Wang of HSBC Securities… The… participation rate, or the share of people who are either working or looking for a job, dropped to 64.6% in July… The labor pool shrank by 181,000 in July, the third consecutive monthly decline. ‘Potential job seekers are not seeing any real improvement,’ Wang…said..”
August 6 – Bloomberg (Simone Baribeau): “The number of workers employed by U.S. state and local governments fell to the lowest since 2007 as municipalities cut payrolls to balance their budgets. Local governments such as cities and counties shed 38,000 jobs in July… Local payrolls shrank to 14.35 million in the second-largest monthly drop since 2003…”
Fiscal Watch:
August 6 – Associated Press (Randolph E. Schmid): “The Postal Service was $3.5 billion in the red for the third quarter and may not be able to make a required payment for future retiree health benefits, the agency said… Losses for the April through June quarter were $1.1 billion more than the post office lost in the same period a year ago… ‘Given current trends, we will not be able to pay all 2011 obligations,’ Joseph R. Corbett, the Postal Service’s chief financial officer, said…”
Central Bank Watch:
August 5 – Bloomberg (Jennifer Ryan): “The Bank of England kept its bond-stimulus plan in place and left its benchmark interest rate at a record low as officials sustained emergency aid for the economy during the biggest budget squeeze since World War II. The nine-member Monetary Policy Committee… held the target for bond holdings at 200 billion pounds ($318 billion)…”
Muni Watch:
August 5 – Bloomberg (Martin Z. Braun and Justin Doom): “New York City’s Transitional Finance Authority increased its offer of top-rated Build America Bonds by 31% to $614 million in its biggest sale of the taxable debt since October.”
Real Estate Watch:
August 2 – Bloomberg (John Gittelsohn): “Gulf of Mexico coastal homes may lose as much as $56,000 each in value as buyers shun areas marred by the worst oil spill in U.S. history, according to CoreLogic Inc. Waterfront properties in Gulfport, Mississippi, face the biggest average declines, followed by those in Mobile, Alabama, and Pensacola, Florida, the real estate data company said…”
2010 vs. 2007:
Greek and periphery European debt markets have stabilized. The euro is above 133, having now recovered back to April levels. Global risk markets have rallied, and commodities markets are again heading north. Throughout the markets, risk premiums have contracted meaningfully. Debt issuance at home and abroad has rebounded. I have posited that the Greek debt crisis provided another critical juncture for global markets. Others contend that Greece is a small country with limited global impact. Moreover, possible effects from Greek problems have diminished as the crisis has subsided. I’m unswayed.
The current environment increasingly reminds me of the long, scorching summer of 2007. The subprime crisis turned serious in early June. And not to pick on Ben Stein, but this week I went back and reread his August 12, 2007 New York Times article, “Chicken Little’s Brethren, on the Trading Floor.” Mr. Stein’s perspective at the time was in tune with the majority of analysts and pundits: subprime was just not that big of a deal; markets had way overreacted.
From his article: “The total mortgage market in the United States is roughly $10.4 trillion. Of that, a little over 13%, or about $1.35 trillion, is subprime… Of this, nearly 14% is delinquent… Of this amount, about 5% is actually in foreclosure… Of this amount… at least about half will be recovered in foreclosure. So now we are down to losses of about $33 billion to $34 billion… But by the metrics of a large economy, it is nothing. The total wealth of the United States is about $70 trillion. The value of the stocks listed in the United States is very roughly $15 trillion to $20 trillion. The bond market is even larger.”
Efforts to quantify potential damage from subprime or, more recently, Greece completely miss a fundamental facet of analyzing Bubble Dynamics: both were examples of the marginal borrower abruptly being denied access to liquidity/Credit in a highly speculative, hence susceptible, (“Ponzi Finance”) financial environment - thus marking critical junctures for their respective Bubbles. The Mortgage/Wall Street Finance Bubble, in the case of subprime, and the Global Government Finance Bubble, with respect to Greece, marked critical inflection points for both market perceptions and stability.
Amid this past month’s global market rally, perceptions have shifted to the view that the European debt crisis is behind us. Recalling the summer of ’07, the subprime crisis “officially” erupted in early June with the halting of redemptions by two structured mortgage product mutual funds managed by Bear Stearns (these funds collapsed later in the month). From a July high of 1,555, subprime worries hit the S&P500 for about 10%, with the market trading below 1,400 intraday on August 16th. Living up to market expectations, the Fed was quick to the rescue.
In an atypical inter-meeting move, the Federal Open Market Committee (FOMC) cut the discount rate 50 bps on August 17th, 2007. With an escalating subprime crisis, speculative markets moved confidently in anticipation of another aggressive round of monetary easing. The S&P500 rallied over 12% in less than two months. After having traded at almost 5.30% in mid-June, 10-year Treasury yields sank below 4.33% by early-September. Despite escalating mortgage tumult, (“safe haven”) benchmark Fannie MBS yields fell from 6.40% in June to 5.40% by late-November. The drop in market yields incited a rush to refi mortgages in late-2007 and into 2008. Dynamics that would culminate in a historic Credit market seizure and liquidity crisis were being masked by melt-up/dislocation in the Treasury and agency markets.
With fed funds at near zero, the FOMC has had little room to cut rates in response to the Greek/European debt crisis and a faltering U.S. recovery. The markets, however, clamored and the Fed delivered assurances that additional quantitative ease would be forthcoming as necessary. Akin to the summer of 2007, markets have rallied in anticipation of a further loosening of monetary conditions. Ten-year Treasury yields closed today at 2.82%, down 113 basis points from the early-April (pre-Greece) high. Benchmark MBS yields are down 111 bps to 3.56%.
The 2007 subprime eruption and the Fed’s response had a profound impact on perceptions throughout various markets. The dollar index – which had traded above 82 on August 16th 2007 – was down to 75 by late-November. The prospect for additional dollar devaluation gave further impetus to buoyant commodities markets. The Goldman Sachs Commodities Index jumped from 485 in August to end 2007 above 600 - on its way to almost 900 by mid-2008. Crude prices almost doubled in 10 months. Many of the “emerging” markets ran to frothy new highs – right before the big fall.
The implosion of the Mortgage/Wall Street Finance Bubble unfolded over about 18 months. There were powerful countervailing forces. On the one hand, a marked change in market perceptions was leading to a reduction in the availability of mortgage Credit. As new buyers/speculators lost their ability to obtain mortgages, it quickly became apparent that many key housing market Bubbles would soon burst. The U.S. housing mania and economic boom were doomed. This led to a broadening panic out of private-label MBS and a liquidity crisis for the overheated ABS/CDO marketplace. The dominoes had started to tumble.
Meanwhile, the behemoth Treasury, Agency and GSE MBS markets (with GSE securities enjoying a combination of explicit and implicit government guarantees) enjoyed big rallies. Liquidity problems in subprime-related sectors were for awhile more than offset by liquidity overabundance in the more dominant fixed-income markets. Ironically, the initial bursting of the mortgage finance Bubble – with all eyes fixated on the Bernanke Fed – fostered destabilizing liquidity excess. The declining dollar; leveraged “dollar carry trades;” an unwind of bearish bond positions and interest-rate hedges; a mortgage refi boom and resulting hedging against MBS pre-payment risk; Fed-induced speculation on lower market yields; a bout of safe-haven buying; and large foreign central bank Treasury purchases all combined to create an over-liquefied and highly-speculative market backdrop. The resulting liquidity-induced rally throughout global risk and commodities markets only exacerbated systemic vulnerabilities to the unfolding Credit and economic crises.
I highlight the 2007/08 experience as a reminder of how bursting Bubbles and financial crises can (tend to) evolve over many months – with surprising ebbs and flows and occasional confounding twists and turns. I don’t see anything in the current backdrop that tempts me to back away from my view that the Greek crisis marked a critical change in market perceptions. Those that dismissed how the subprime eruption had fundamentally altered the financial landscape would later regret their complacency.
Today, I believe global faith in government policymaking has been badly shaken. There is now an appreciation that policymakers are running out of options. Confidence that fiscal and monetary stimulus ensures a sustainable global recovery has waned. There is recognition that massive stimulus can’t assure market stability; in fact, profligate fiscal and monetary measures will likely prove destabilizing. There is appreciation that global central bankers can’t guarantee normally-functioning markets. There is, these days, no denying that structural debt issues will be a serious ongoing problem. And, importantly, the world is increasingly keen to the severity of U.S. financial and economic problems. Indeed, the post-Greece backdrop beckons for reduced risk and less leverage. Yet the markets can – at least for a period of time – luxuriate in destabilizing policymaking-induced liquidity excess and dysfunctional markets.
The dollar is in trouble. Our currency has now dropped for nine straight weeks, sinking to a near 15-year low against the yen. Crude oil traded above $82 this week. Wheat prices are up about 50% over the past month. The last thing our struggling economy needs right now (in common with 2007/08) is surging energy and food prices.
And there is clearly interplay at work between tumult in the currencies and dislocation in our fixed income markets. Fed talk of QE2; rumors of the Administration forcing Fannie Mae/Freddie Mac to refinance and/or reduce principal on troubled mortgages; the potential for a wave of mortgage refinancings; and the likelihood that many have been caught on the wrong side of a major move in market yields have Treasury, agency and MBS yields in near freefall.
August 2 – Bloomberg (Caroline Salas and Jody Shenn): “For all the good the Federal Reserve’s $1.25 trillion of mortgage-bond purchases have done, they’ve also left part of the market broken. By acquiring about a quarter of home-loan bonds with government-backed guarantees to bolster housing prices and the U.S. economy, the Fed helped make some securities so hard to find that Wall Street has been unable to complete an unprecedented amount of trades. Failures to deliver or receive mortgage debt totaled $1.34 trillion in the week ended July 21, compared with a weekly average of $150 billion in the five years through 2009… The difficulty of executing transactions may eventually drive investors away from the $5.2 trillion mortgage-bond market, which has historically been the most liquid behind U.S. Treasuries, potentially causing yields to rise, according to Thomas Wipf… The unsettled trades also stand to exacerbate the damage caused by the collapse of a bank or fund. ‘You’re adding systemic risk into the market,’ said Wipf, chairman of the Treasury Market Practices Group and the… head of institutional-securities group financing at Morgan Stanley. ‘Investors are taking on counterparty risk in trades they didn’t intend to take on.’ An incomplete agreement can lead to a ‘daisy chain’ of unsettled trades because a broker-dealer acting as a buyer in one transaction may fail to deliver those bonds as a seller in another, according to Alexander Yavorsky, a senior analyst at Moody’s… Investment banks are required to hold capital against both sides of the trades, which also makes the agency mortgage-backed market less attractive to make markets in…”
It is worth noting that Treasurys held in reserve by foreign central banks at the New York Federal Reserve Bank have surged $74bn in just seven weeks. Dollar weakness appears, once again, to be forcing foreign central banks back into the role as “backstop bid” for the dollar in global currency markets. These dollar balances are then “recycled” back into our Treasury market, a dynamic that does not go unrecognized by the speculator community. This presses market yields only lower, increasing the risk of prepayment on mortgage securities and forcing additional interest rate hedging (further exacerbating the decline in market yields). And once a market dislocates, many will pile on in search of easy speculative profits.
With Treasury, Agency and MBS prices melting up (yields in melt down), key markets enjoy extraordinary, albeit destabilizing, liquidity abundance. Understandably, market participants dismiss talk of U.S. structural debt issues. Many will justify the move on fundamental grounds – “It’s deflation, stupid!” Ironically, collapsing yields, the sinking dollar, surging commodities, recovering global risk markets and the onslaught of global liquidity create a backdrop conducive to future inflation surprises.
Reminiscent of 2007/08, the initial crisis phase has unleashed wild volatility and instability throughout various markets. Some can see that the glass is less than half empty, while attentive central bankers and sinking yields have most viewing things as positively full. The havoc and misperceptions create an increasingly dysfunctional market landscape. Over time, the volatility, uncertainty and escalating market stress will prove a subprime-like wrecking ball on confidence. I need to go back and count the number of trading sessions in 2008 between seemingly over-liquefied markets and Credit market seizure.
My expectation remains that markets, having disciplined Athens and initiated austerity in the euro-zone, will inevitably set its sights on Washington profligacy. Too reminiscent of the Mortgage/Wall Street Finance Bubble, the markets seem determined to ensure that this disciplining process is methodically delayed until the very maximum levels of Credit excess, speculative froth, market distortion, and systemic vulnerability have been achieved.
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Last Updated on Saturday, 07 August 2010 10:56 |
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Written by Doug Noland
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Friday, 30 July 2010 00:00 |
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For yet another volatile week, the S&P500 ended little changed (down 1.2% y-t-d), while the Dow added 0.4% (up 0.4%). The Banks gained 1.5% (up 13.9%), and the Broker/Dealers jumped 1.9% (down 7.2%). The Morgan Stanley Cyclicals declined 0.8% (up 3.4%), while the Transports rose 1.2% (up 7.9%). The Morgan Stanley Consumer index slipped 0.3% (up 0.9%), while the Utilities fell 0.6% (down 2.4%). The S&P 400 Mid-Caps dipped 0.4% (up 4.6%), and the small cap Russell 2000 ended the week unchanged (up 4.1%). The Nasdaq100 declined 0.6% (up 0.2%), and the Morgan Stanley High Tech index fell 1.4% (down 3.9%). The Semiconductors dropped 4.3% (down 3.1%). The InteractiveWeek Internet index fell 1.4% (up 4.1%). The Biotechs gained 0.7%, increasing 2010 gains to 12.5%. With bullion down $9, the HUI gold index fell 2.0% (up 3.0%).
One-month Treasury bill rates ended the week at 14 bps and
three-month bills closed at 14 bps. Two-year government yields fell 5 bps to 0.52%. Five-year T-note yields sank 17 bps to
1.52%. Ten-year yields fell 9 bps to 2.91%. Long bond yields dipped 2 bps to 3.99%. Benchmark Fannie MBS yields dropped 18 bps to 3.47%.
The
spread between 10-year Treasury yields and benchmark MBS yields narrowed 9 bps to 56 bps. Agency 10-yr debt spreads narrowed 6 bps to 18 bps.
The
implied yield on December 2010 eurodollar futures fell 8.5 bps to
0.435%. The 10-year dollar swap spread declined 2.5 to negative 1.0. The
30-year swap spread declined 3 to negative 27.5. Corporate bond
spreads narrowed. An index of investment grade spreads narrowed 2 to
104
bps.
Debt issuance was brisk. Investment grade issuers
included AT&T $2.25bn, Crown Castle Towers $1.55bn, Alcoa $1.0bn, McDonald's $750 million, Commonwealth Edison $500 million, Safeway $500 million, Union Pacific $500 million, and Kimberly-Clark $250 million.
Junk issuers included Ford Motor Credit $1.25bn, Texas Industries $650 million, AMD $500 million, Range Resources $500 million, Inventive Health $275 million, and Tenneco $225 million.
Converts issuers included Gilead Sciences $2.2bn.
International dollar debt sales included Canadian Imperial Bank $4.25bn, UBS $2.5bn, Turkey $2.0bn, Brazil $1.5bn, Air Canada $1.1bn, Chile $1.0bn, Westpac Banking $3.0bn, Offshore Group $1.0bn, Noble Group $750 million, Berau Capital Resources $450 million, Viterra $400 million, Aircastle $300 million, Banco BMG $250 million and Barbados $200 million.
U.K. 10-year gilt yields dropped 11 bps to 3.32%, and
German bund yields declined 4 bps to 2.67%. Greek 10-year bond yields fell 12 bps to 10.28%, and 10-year Portuguese yields sank 35 bps to
5.18%. The German DAX equities index slipped 0.3% (up 3.2% y-t-d).
Japanese 10-year "JGB" yields were little changed at 1.06%. The Nikkei 225 gained 1.1% (down 9.6%). Emerging markets were mixed to higher. For the
week,
Brazil's Bovespa equities index rose 1.8% (down 1.6%), while Mexico's
Bolsa declined 1.5% (up 3.7%). Russia’s RTS equities index increased 2.3%
(up 2.7%). India’s Sensex equities index fell 1.4% (up 2.3%).
China’s Shanghai Exchange rallied another 2.5% (down 19.5%). Brazil’s benchmark
dollar bond yields declined 4 bps to 4.25%, and Mexico's benchmark bond
yields sank 11 bps to 4.19%.
Freddie Mac 30-year fixed mortgage rates declined 2 bps last week
to 4.54% (down 71bps y-o-y). Fifteen-year fixed rates fell 3 bps to
4.00% (down 69bps y-o-y). One-year ARMs dropped 6 bps to 3.64% (down 116bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had
30-yr fixed jumbo rates up one basis point to 5.45% (down 91bps
y-o-y).
Federal Reserve Credit declined $3.4bn last week to $2.312
TN. Fed Credit was up $92.4bn y-t-d (7.2% annualized) and $302bn, or
15.0%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury,
Agency Debt this past week (ended 7/28) jumped another $13.9bn (6-wk gain of $65.9bn) to a record
$3.146 TN. "Custody holdings" have increased $190bn y-t-d (11.2%
annualized), with a one-year rise of $353bn, or 12.6%.
M2 (narrow) "money" supply expanded $11.9bn to $8.614 TN (week
of
7/19). Narrow "money" has increased $103bn y-t-d, or 2.2% annualized.
Over the past year, M2 grew 2.1%. For the week, Currency added $1.3bn,
while Demand & Checkable Deposits slipped $0.2bn. Savings Deposits increased $13.6bn, while Small Denominated Deposits declined $3.9bn.
Retail
Money Fund assets increased $1.0bn.
Total Money Market Fund assets (from Invest Co Inst) increased $3.6bn to $2.802 TN. In the first 30 weeks of the year, money fund
assets fell $492bn, with a one-year decline of $832bn, or 22.9%.
Total Commercial Paper outstanding increased $1.5bn to $1.101 TN.
CP has declined $69bn, or 10.2% annualized, year-to-date, while it was up $36bn from a year ago.
International reserve assets (excluding gold) - as tallied by
Bloomberg’s Alex Tanzi – were up $1.421 TN y-o-y, or 20.2%, to a record
$8.445 TN.
Global Credit Market Watch:
July 26 – Bloomberg (Andrew MacAskill): “European Union stress tests found banks need to raise 3.5 billion euros ($4.5 billion) of capital, about a tenth of the lowest analyst estimate, leaving doubts about whether regulators were tough enough. ‘The stress tests are a helpful step forward in a number of areas,’ Huw van Steenis, head of European banks research at Morgan Stanley… said… ‘But they are not going to be the game changer that we were really hoping and in some cases are a missed opportunity.’”
July 30 – Wall Street Journal (Mark Gongloff, Chris Dieterich and Alex Frangos): “The global corporate-bond boom is gathering steam as companies rush to take advantage of some of the lowest borrowing costs in history. Companies from global giants McDonald's Corp. and Kimberly-Clark Corp. to Indonesian telecommunications company PT Indosat Tbk are rushing to sell debt. This month has been the busiest July on record for sales by U.S. companies with junk-credit ratings. Asia’s debt market is on pace for a record year, and European companies are also raising money apace.”
July 30 – Bloomberg (Sapna Maheshwari and Tim Catts): “U.S. corporate bond sales soared 31% this month, the busiest July on record… Issuance of $85.7 billion exceeded the previous high for the month of $71.1 billion set last year… Global issuance of $223.9 billion this month trails June’s total of $226.3 billion…”
July 30 – Bloomberg (Jason Webb): “Emerging-market bonds are heading for their biggest monthly rally since September, cutting yields to a record low, as accelerating economic growth and Argentina’s debt restructuring spur confidence. Developing nation bonds rallied 4.3% in July, reducing the average yield to 5.89%...”
July 28 – Bloomberg (Yalman Onaran): “Banks worldwide applauded changes to proposed capital and liquidity standards that relaxed aspects of the rules and gave lenders as much as eight years to comply. Lobbying groups in Europe and the U.S. praised the changes announced July 26 by the Basel Committee on Banking Supervision as steps in the right direction, while firms including Deutsche Bank AG and UBS AG welcomed the softening of rules proposed by the committee in December. European and Japanese bank stocks surged. ‘To a large extent, the committee has taken into account the concerns of the industry,’ said Charles Dallara, managing director of the… Institute of International Finance… ‘It’s too early to reach a firm conclusion because they still haven’t finalized many issues, but the announcement included a series of important clarifications.’”
July 28 – Bloomberg (Bradley Keoun): “Citigroup Inc. may move a team of proprietary traders into its hedge-fund unit, one of at least three alternatives the U.S. bank is studying to comply with the Dodd-Frank Act… The bank would set up the traders as hedge-fund managers and seed their funds, then raise money from outside investors to redeem its stakes, the people said. ‘This may be a way of keeping a high-margin capital- markets business in the fold, within the language of the law,’ said David Hendler, a senior analyst at… CreditSights Inc. ‘They would be transforming it from an- interest-plus-capital-gain business into a fee business.’”
July 27 – Bloomberg (Patricia Kuo): “Leveraged loans prices climbed to the highest in nine weeks as investors shifted money out of equity into debt. The average bid price for actively-traded European leveraged loans rose 45 bps to 94.3%... Fixed-income funds had $122.9 billion of inflows this year while $4.2 billion of assets left stock funds, according to U.S. research firm EPFR Global.”
July 28 – Bloomberg (Alex Kowalski and Tom Keene): “Economist David Rosenberg and investor Marc Faber have wagered a bottle of scotch whisky on whether U.S. 10-year Treasury yields can go lower than 2%. Rosenberg, chief economist at Gluskin Sheff & Associates Inc., predicted yields on the 10-year note will drop to less than 2%. Faber, the publisher of the Gloom, Boom & Doom report, said he doesn’t believe they’ll fall to less than December 2008’s low of 2.08%.”
Global Government Finance Bubble Watch:
July 30 – Bloomberg (Michael McDonald and Esme E. Deprez): “New York City will sell $470 million of Build America Bonds next week with the amount of the federally subsidized securities issued on pace to total $165 billion by year-end, when the program is set to expire… Build America Bonds became the fastest-growing part of the $2.8 trillion municipal bond market after they were created last year in President Barack Obama’s economic-stimulus package. More than $124 billion of the securities have been sold so far… The federal government pays 35% of the interest cost of Build Americas, saving states and cities money on public works projects… The subsidy helps issuers offer higher yields on the taxables than on tax-exempt debt, making them attractive to international investors and others who aren’t seeking tax shelters.”
Currency Watch:
July 26 – Bloomberg (Yasuhiko Seki and Hiroko Komiya): “The yen may climb next month as tighter regulations force Japanese households controlling about $76 billion in daily exchange trading to unwind bets on higher-yielding currencies, analysts said. The government will cap debt used to boost trading bets, or leverage, at 50 times committed cash from August 2010, down to 25 times in 2011… ‘If margin traders decide to discontinue highly leveraged transactions, it will put upward pressure on the yen as those positions are unwound,’ said Yuji Kameoka, senior economist… at Daiwa Institute of Research…”
July 26 – Bloomberg (Matthew Brown): “The combination of growing confidence in Europe’s economy and mounting evidence of a slowdown in the U.S. is driving euro bears into hiding… Goldman Sachs Group Inc. and Wells Fargo & Co. raised their estimates in the past two weeks, joining HSBC Holdings Plc and Deutsche Bank AG in predicting a stronger euro.”
July 26 – Bloomberg (Frances Yoon): “The dollar will fall against the yuan, euro and yen as China sells excess U.S. currency so that its reserves reflect trade flows, Faros Trading LLC said… ‘The net effect of China rebalancing its reserves in a slow and deliberate manner will result in a lower U.S. dollar,’ said Douglas Borthwick… managing director and head of trading at Faros. ‘We believe the foreign-exchange markets are at the beginning of a significant shift.’”
July 26 – Bloomberg (Daniel Kruger and Rebecca Christie): “For all the criticism of record budget deficits, President Barack Obama can take comfort knowing that for the first time in half a century, government bond yields are declining during an economic expansion and Treasury Secretary Timothy F. Geithner is selling two-year notes with the lowest interest rates ever. The combination of record-low yields on two-year notes, 10- year rates below 3% and a deficit projected to surpass $1.4 trillion for a second consecutive year is a signal that the bond market is less concerned with government spending than with getting the economy back on track.”
The dollar index fell 1.1% to 81.546 (up 4.7% y-t-d). For
the week on the upside, the South African rand increased 1.9%, the British pound 1.7%, the Norwegian krone 1.6%, the South Korean won 1.4%, the Swedish krona 1.4%, the Swiss franc 1.3%, the Japanese yen 1.1%, the euro 1.1%, the Danish krone 1.1%, the Brazilian real 1.0%, the Australian dollar 1.0%, the Singapore dollar 0.7%, the Mexican peso 0.7% and the Canadian dollar 0.7%. For the week on the downside, the New Zealand dollar declined 0.2%.
Commodities Watch:
The CRB index jumped 2.9% (down 3.2% y-t-d). The Goldman
Sachs Commodities Index (GSCI) gained 1.8% (unchanged y-t-d). Spot
Gold was down 0.7% to $1,180 (up 7.6% y-t-d). Silver declined 0.5% to
$18.005 (up 7% y-t-d). September Crude slipped 19 cents to $78.79
(down 1% y-t-d).
September Gasoline added 0.2% (up 3% y-t-d), and September Natural Gas jumped 7.6% (down 12% y-t-d). September Copper jumped 3.9% (down 1%
y-t-d). September Wheat surged 10.9% (up 22% y-t-d), and September
Corn jumped 5.8% (down 5% y-t-d).
China Watch:
July 30 – Bloomberg (Shamim Adam): “China sees little need for an imminent increase in interest rates, standing apart from Asian counterparts that are raising borrowing costs… People’s Bank of China officials said ‘that with a benign inflation outlook there was less need for higher nominal interest rates at this point,’ the International Monetary Fund said…after annual consultations with the Chinese government. ‘Also, they were concerned that higher interest rates could risk fueling capital inflows.’”
July 27 – Bloomberg: “The Chinese government’s fiscal revenue rose 27.6% in the first six months of the year to 4.3 trillion yuan, according to a statement from the Ministry of Finance…”
July 26 – Bloomberg: “Chinese banks may struggle to recoup about 23% of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects, according to a person with knowledge of data collected by the nation’s regulator. About half of all loans need to be serviced by secondary sources including guarantors because the ventures can’t generate sufficient revenue…”
July 27 – Bloomberg: “Credit ratings assigned to yuan- denominated bonds issued on behalf of local governments in China are misleading and don’t reflect risks investors face, Dagong Global Credit Rating Co.’s chairman said. Local government-backed borrowers shop around for the best rankings from Chinese ratings companies and ‘whoever gives them a better rating gets the business,’ Guan Jianzhong, chairman of privately owned Dagong… ‘This is very dangerous.’”
July 27 – Financial Times (Jamil Anderlini): “China’s banks are facing serious default risks on more than one-fifth of the Rmb7,700bn ($1,135bn) they have lent to local governments across the country, according to senior Chinese officials. In a preliminary self-assessment carried out at the request of the country’s regulator, China’s commercial banks have identified about Rmb1,550bn in questionable loans to local government financing vehicles – which are mostly used to fund regional infrastructure projects.”
July 27 – Bloomberg: “China’s banking regulator tried to ease concern over risks from bank lending to local government financing vehicles, saying such loans won’t necessarily go bad. The China Banking Regulatory Commission said in a statement that risks can be contained through measures to secure repayment… Chinese banks may struggle to recoup about 23% of the 7.7 trillion yuan ($1.1 trillion) lent to finance local infrastructure projects…”
July 29 – Financial Times (Robert Cookson): “China’s quest to transform the renminbi into an international reserve currency – and thereby challenge America’s dominance of the global monetary system – may take decades, if it happens at all. But this month, for the third time this year, China took another big step in that direction. Regulators lifted a raft of restrictions blocking the free flow of renminbi in Hong Kong… ‘[The new rules are] a big step in promoting the international use of the renminbi,” said Frances Cheung, a strategist at Crédit Agricole in Hong Kong.”
Japan Watch:
July 27 – Bloomberg (Toru Fujioka): “Japan’s government will ask ministries to cut their budgets by 10% for the year starting April 2011 as Prime Minister Naoto Kan tries to rein in the world’s largest debt load. The reductions will help the government keep spending at this year’s 71 trillion yen ($813 billion)…”
July 26 – Bloomberg (Keiko Ujikane): “Japan’s exports rose faster than economists estimated… Shipments abroad advanced 27.7% in June from a year earlier…”
July 29 – Bloomberg (Wes Goodman and Garfield Reynolds): “Japanese bond yields are approaching the lowest in seven years as the nation’s aging population snaps up securities in the world’s biggest debt market… ‘Older people are reluctant to take risk, and they love Japanese government bonds,’ said Tsutomu Komiya, who helps oversee the equivalent of $106 billion at Daiwa Asset Management… ‘The relationship between the bond yield and the age of the population is very strong.’”
India Watch:
July 27 – Bloomberg (Kartik Goyal): “India’s central bank increased a key interest rate more than economists forecast, battling to contain a surge in inflation that’s led to strikes and street rallies. The central bank raised the reverse repurchase rate a half point to 4.5%, and the repurchase rate to 5.75% from 5.5%...”
Asia Bubble Watch:
July 26 – Bloomberg (William Sim and Eunkyung Seo): “South Korea’s economy grew faster than expected in the second quarter, bolstering the case for a further increase in interest rates as Asia weathers global risks. Gross domestic product increased 1.5% from the previous three months…”
Latin America Watch:
July 28 – Bloomberg (Jonathan Levin and Andres R. Martinez): “Mexico’s central bank maintained its forecast for economic growth of 4% to 5% this year, bank Governor Agustin Carstens said.”
Unbalanced Global Economy Watch:
July 29 – Bloomberg (Simone Meier): “European confidence in the economic outlook rose to the highest in more than two years in July and German unemployment declined for a 13th month as exports sustained a recovery in the region.”
July 30 – Bloomberg (Simone Meier): “European inflation accelerated to the fastest pace in more than 1 1/2 years on rising energy costs and unemployment held at the highest in almost 12 years. Euro-area consumer prices rose 1.7% from a year earlier in July… The jobless rate remained at 10% for a fourth month in June… That’s the highest since August 1998.”
July 27 – Financial Times (Ralph Atkins): “Eurozone mortgage borrowing surged last month to the highest level in almost two years in a sign that bank lending across the 16-country region may be flickering back to life. Lending for house purchases rose at an annual rate of 3.4% in June… The acceleration pointed to a revival in consumer confidence and an increased willingness by banks to fuel the economic recovery with loans to the private sector.”
July 30 – Bloomberg (Candice Zachariahs and Lisa Pham): “Spain will probably lose its Aaa credit rating after the country was put under review for possible downgrade in June, and the U.S. needs a ‘clear plan’ to tackle its deficit, Moody’s… said.”
July 29 – Bloomberg (Flavia Krause-Jackson): “Italian business confidence advanced to a two-year high in July after the economy returned to growth and exports benefited from the euro’s decline.”
U.S. Bubble Economy Watch:
July 27 – Bloomberg (William Selway): “U.S. local governments may cut almost 500,000 jobs through next year to cope with sliding property taxes, a decline in state and federal aid and added need for social services, according to a report… The report, a result of a survey by the National League of Cities, the U.S. Conference of Mayors and the National Association of Counties, showed local governments are moving to cut the equivalent of 8.6% of their workforces from 2009 to 2011… ‘Local governments across the country are now facing the combined impact of decreased tax revenues, a falloff in state and federal aid and increased demand for social services,’ said the study… They called on Congress to pass a bill that would provide $75 billion in the next two years to local governments and community-based groups to stoke job growth and forestall deeper cuts.”
July 27 – New York Times (Nelson D. Schwartz): “By most measures, Harley-Davidson has been having a rough ride. Motorcycle sales are falling in 2010, as they have for each of the last three years. The company does not expect a turnaround anytime soon. But despite that drought, Harley’s profits are rising — soaring, in fact… Many companies are focusing on cost-cutting to keep profits growing, but the benefits are mostly going to shareholders instead of the broader economy, as management conserves cash rather than bolstering hiring and production.”
July 28 – Bloomberg (Bob Willis): “Americans in the second quarter tapped the smallest amount of home equity in a decade… Owners took out $8.3 billion while refinancing prime home loans…Twenty-two percent chose to reduce loan principal, matching the third-highest rate since records began in 1985.”
July 27 – Bloomberg (Prashant Gopal): “U.S. apartment landlords are seeing a surge in rentals as mounting foreclosures reduce homeownership and an improving job market for young adults encourages them to find their own places to live. The number of occupied apartments increased by 215,000 in the 64 largest U.S. markets in the first half of the year, according to MPF Research, almost twice the units added in all of 2009 and the most since the firm began tracking the data in 1992. The vacancy rate declined to 6.6% last month from 8.2% in December. ‘Overall demand is pretty stunningly strong in the first half,’ Greg Willett, a vice president at the… research firm, said…”
Central Bank Watch:
July 29 - New York Times (Sewell Chan): “A subtle but significant shift appears to be occurring within the Federal Reserve over the course of monetary policy amid increasing signs that the economic recovery is weakening. On Thursday, James Bullard, the president of the Federal Reserve Bank of St. Louis, warned that the Fed’s current policies were putting the American economy at risk of becoming ‘enmeshed in a Japanese-style deflationary outcome within the next several years.’ The warning by Mr. Bullard… comes days after Ben S. Bernanke, the Fed chairman, said the central bank was prepared to do more to stimulate the economy if needed… Mr. Bullard had been viewed as a centrist and associated with the camp that sees inflation, the Fed’s traditional enemy, as a greater threat than deflation. But with inflation now very low… and with the European debt crisis having roiled the markets, even self-described inflation hawks like Mr. Bullard have gotten worried that growth has slowed so much that the economy is at risk of a dangerous cycle of falling prices and wages. Among those seen as already sympathetic to the view that the damage from long-term unemployment and the threat of deflation are among the greatest challenges facing the economy, are three other Fed bank presidents: Eric S. Rosengren of Boston, Janet L. Yellen of San Francisco and William C. Dudley of New York. As the Fed’s board of governors shifts, the doves are getting more attention.”
July 29 – Bloomberg (Steve Matthews): “Federal Reserve Bank of St. Louis President James Bullard said the central bank should resume purchases of Treasury securities if the economy slows and prices fall rather than maintain a pledge to keep rates near zero. ‘The U.S. is closer to a Japanese-style outcome today than at any time in recent history,’ Bullard said… ‘A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.’”
July 28 – Bloomberg (Jennifer Ryan and Svenja O’Donnell): “Bank of England Governor Mervyn King said there may be a ‘considerable’ way to go before U.K. interest rates return to ‘normal’ as policy makers debate when to start withdrawing emergency stimulus from the economy. ‘There will come a point when we will certainly need to ease off the accelerator and return Bank Rate to more normal levels,’ King told lawmakers…”
Muni Watch:
July 27 – Bloomberg (William Selway): “U.S. state governments project revenue will climb in the current fiscal year after they raised taxes and cut spending to close budget gaps of $84 billion, a report from the National Conference of State Legislatures found. Revenue will increase 3.7%, after falling 1.5% in fiscal 2010. Even so, deficits of more than $12 billion may open for at least 29 states should Congress fail to extend extra aid, while two-thirds already forecast fiscal 2012 gaps of $72 billion… ‘The revenue chasm was so deep that climbing out of it is going to take some time.’”
California Watch:
July 28 - Los Angeles Times (Shane Goldmacher): “As California staggers toward the fifth week of the fiscal year without a spending plan, a month of closed- door talks in the Capitol have produced little but tension and finger-pointing. The calendar is flipping toward August with no resolution in sight. Top officials don't even publicly agree about what they agree upon. The two parties are staging stunts at the Capitol and trading barbs in dueling radio addresses, each side accusing the other of being dug in or disengaged, or both. Gov. Arnold Schwarzenegger has demanded overhauls of the public pension system, the state tax code and the budgeting process, on top of the annual budget-balancing struggle. He has said he won’t sign a spending plan that lacks those things, and California could languish without one until he leaves office -- in 2011… Meanwhile, California’s unpaid bills are piling up, the state’s worst- in-the-nation credit rating faces another downgrade and the prospect of printing IOUs for the second time in as many years threatens on the horizon… The state’s $19.1-billion shortfall remains despite a temporary increase in taxes last year and lawmakers' slashing of billions from school budgets. Tuition at public universities has skyrocketed, and healthcare and other services for the poor have been scaled back.”
Real Estate Watch:
July 27 – Bloomberg (Kathleen M. Howley): “About 18.9 million homes in the U.S. stood empty during the second quarter as surging foreclosures helped push ownership to the lowest level in a decade… The ownership rate… was 66.9%, the lowest since 1999.”
July 29 – Bloomberg (Dan Levy): “Foreclosure filings climbed in three-quarters of U.S. metropolitan areas in the first half… according to RealtyTrac… Notices of default, auction or bank seizure rose more than 50% in areas including Salt Lake City; Savannah, Georgia; and Atlantic City… ‘Foreclosures are spreading out from areas that had been hardest hit,’ Rick Sharga, senior vice president… at RealtyTrac, said…”
July 28 – Bloomberg (Sharon Smyth): “Greek island homes, long coveted by millionaires and Hollywood stars such as Tom Hanks, are being marked down by as much as 45% as the country’s debt crisis destroys demand for holiday getaways. A half-built villa on Mykonos, an island in the Aegean Sea known for its all-night beach parties, is being offered by brokers… for 2 million euros ($2.6 million) after the price was reduced by 500,000 euros.”
Quantitative Easing Two:
Not even a week had passed since ECB President Trichet’s article, “Stimulate No More – It Is Now Time to Tighten,” before Federal Reserve Bank President James Bullard thrusts himself into the debate with his paper, “Seven Faces of ‘The Peril.’”
Dr. Bullard’s concluding sentences: “To avoid [the Japanese] outcome for the U.S., policymakers can react differently to negative shocks going forward. Under current policy in the U.S., the reaction to a negative shock is perceived to be a promise to stay low for longer, which may be counterproductive because it may encourage a permanent, low nominal interest rate outcome. A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.”
The New York Times (Sewell Chan) had a reasonable spin on Bullard’s piece: “A subtle but significant shift appears to be occurring within the Federal Reserve over the course of monetary policy amid increasing signs that the economic recovery is weakening. … James Bullard, the president of the Federal Reserve Bank of St. Louis, warned that the Fed’s current policies were putting the American economy at risk of becoming ‘enmeshed in a Japanese-style deflationary outcome within the next several years.’ The warning by Mr. Bullard… comes days after Ben S. Bernanke, the Fed chairman, said the central bank was prepared to do more to stimulate the economy if needed…”
Reading Dr. Bullard’s paper - and listening carefully to his comments – recalls Dr. Bernanke’s historic speeches back in late-2002: “Asset-Price ‘Bubbles’ and Monetary Policy”; “On Milton Friedman’s Ninetieth Birthday”; and “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” Dr. Bernanke fashioned the backdrop – erudite academic justification for aggressive “activist” monetary management - and today the Federal Reserve appears poised to embark only farther into perilous uncharted waters. Last week, I presumed that Mr. Trichet’s stark warning against further stimulus was in response to market clamoring for additional quantitative easing from the Fed. It would now appear his comments may have been directed squarely at our central bank.
“The Peril” in Dr. Bullard’s title is in reference to a 2001 academic article “The Perils of Taylor Rules.” In simple terms, many accept the thesis that there is potential “peril” confronting a monetary management regime at the point when policymakers have lowered rates to near zero – yet the inflation rate remains stuck in negative territory (“deflation”). Japan is used as a contemporary example of how policymakers failed to act convincingly to ensure operators throughout the markets and real economy understood that deflationary pressures would not be tolerated.
From Bullard: “The policymaker is completely committed to interest rate adjustment as the main tool of monetary policy, even long after it ceases to make sense (long after policy becomes passive), creating a second steady state for the economy. Many of the responses to this situation described below attempt to remedy this situation by recommending a switch to some other policy in cases when inflation is far below target. The regime switch required has to be sharp and credible. Policymakers have to commit to the new policy and the private sector has to believe the policymaker.”
Ten-year Treasury yields dropped to 2.92% today. Benchmark MBS yields sank 15 bps in two sessions to 3.49%. The markets are taking Dr. Bullard’s talk of a “sharp and credible” regime switch – Quantitative Easing Two – seriously. The dollar dropped another 1.1% this week and the CRB Commodities index jumped 2.9 %. The market backdrop is increasingly reminiscent of the summer of 2007. The initial ’07 eruption in subprime incited market weakness and volatility, an aggressive Federal Reserve response, a weak dollar and quite a run for commodities markets.
Back in 2002, I thought (and wrote as much) Dr. Bernanke’s monetary views were radical and dangerous. He burst onto the scene as the right guy at the right time to lead an epic battle against the scourge of deflation. I view the period 2001 through 2006 as a historic period of faulty analysis and failed monetary management. In short, zealous policy measures were implemented from a flawed analytical framework. While fighting so-called deflation risk, our central bank accommodated a perilous Bubble throughout mortgage and Wall Street finance. The Fed’s “activist” approach was an unmitigated disaster. Dr. Bullard’s paper addresses this period from an opposing perspective: “2003-2004… This period was the last time the FOMC worried about a possible bout of deflation.”
From Bullard: “The Thornton [St. Louis Fed economist] analysis emphasizes how the FOMC communicated during this period, and how the market expectations of the longer-term inflation rate responded to the communications. At the time, some measures of inflation were hovering close to one percent, similar to the most recent readings for core inflation in 2010. At its May 2003 meeting, the Committee included the following press release language: .... ‘the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level.’ At several subsequent 2003 meetings the FOMC stated that ‘…the risk of inflation becoming undesirably low is likely to be the predominant concern for the foreseeable future.”
During the three-year period ’02-’04, benchmark MBS yields averaged 5.22%, down significantly from the 7.16% average from 2000-’01. The Fed was “successful” in jawboning rates lower, in spite of the unprecedented surge in demand for mortgage borrowings. “Activist” monetary policymaking circumvented market forces, allowing a huge increase in the demand for mortgage Credit to be satisfied at historically low market yields.
Well, you either believe that the market forces of supply and demand should be left to determine the price (market yield) of finance - or you don’t. And you either appreciate that the price of finance plays a fundamental role in the effective allocation of financial and real resources in a Capitalistic system – or you disregard this critical dynamic at the system's peril. Inarguably, Federal Reserve rate policy and communications strategy were instrumental in distorting market prices (MBS, real estate, stocks, etc.) and perceptions of risk and, in the process, fomenting the great mortgage/Wall Street finance Bubble.
Focusing instead on the general price level, or “inflation,” Dr. Bullard comes to a very different conclusion with respect to policy performance during this crucial period: “In the event, all worked out well, at least with respect to avoiding the un-intended steady state. Inflation did pick up, the policy rate was increased, and the threat of a Japanese-style deflationary outcome was forgotten, at least temporarily. Was this a brilliant maneuver, or did the economic news simply support higher inflation expectations during this period?”
Regular readers know that I use the terms “Keynesian” and “inflationism” interchangeably. Inflationism has been an influential concept for centuries; Keynes just created the most sophisticated and alluring conceptual framework. I argued against the Keynesians earlier in the decade. The critical flaw in their theoretical construct is that the Federal Reserve somehow controls “THE” general price level. This is a dangerous myth perpetuated by those committed to activist monetary management.
The Keynesians take Credit for thwarting the deflationary forces from earlier this decade. After declining to about a 1% y-o-y rate during the first half of 2002, inflation was a “safer” 4% or so by 2006. This, it was said, provided policymakers the latitude they required to ensure the U.S. did not succumb to the Japanese predicament. In the process, total U.S. mortgage Credit almost doubled in just six years. The aggregate of consumer prices may have been reasonably tame, but asset prices and economic maladjustment were not. The Fed used mortgage Credit to reflate the system and, not surprisingly, we now face a much worse predicament.
The problem with inflationism has always been that once it gets ingrained within the system – in the Credit system, the real economy, within market perceptions, expectations and asset prices – there’s just no turning back. The more protracted the inflationary Credit boom – and the more problematic the associated Bubbles – the more unpalatably painful the bust is viewed in the minds of politicians and central bankers. Historically, it often became a case of “just one more bout of money printing to get us over the hump.” Just get through the pressing crisis and then it will be time to find monetary religion.
It is the nature of protracted Credit Bubbles that devastating busts are held at bay only through increasingly expansive monetary stimulus. Invariably, this corrosive process destroys the soundness of system debt and the underlying currency. Too often, a crisis of confidence in private debt incites a dangerous cycle of public Credit (“money”) inflation. Commenting this morning on CNBC, Dr. Bullard stated, “In monetary policy, you can never say you’re done.” This is precisely the nature of inflationism.
Dr. Bullard makes passing mention of Bubble risk: “The FOMC’s near-zero interest rate policy and the associated ‘extended period’ language has caused many to worry that the Committee is fostering the creation of new, bubble-like phenomena in the economy which will eventually prove to be counterproductive. One antidote to this worry may be to increase the policy rate somewhat, while still keeping the rate at a historically low level, and then to pause at that level.”
When I read (and listen) to such comments from our leading central bankers, I can only scratch my head and ponder the degree to which they appreciate financial and economic history – including recent financial crises. Dr. Bullard’s paper suggests that the Japanese predicament of long-term substandard growth is the worst-case scenario for the U.S. economy. It is more likely the best-case.
And I find myself increasingly frustrated by the ongoing “inflation vs. deflation debate.” With today’s low level of consumer price inflation, those arguing that deflationary forces are the paramount systemic risk now dominate policy dialogue. Most tend to be inflationists. Most argue for additional stimulus and see little risk in such activist policymaking.
I see risks altogether differently. We are in the late-phase of a multi-decade historic Credit Bubble. The greatest risk at this point is that massive issuance of non-productive governmental debt foments a crisis of confidence at the very heart of our monetary system. The top priority must be to ensure that such a devastating outcome is avoided – and at significant unavoidable cost. It is imperative that we as a nation come to the recognition that real financial and economic pain must be endured to protect the long-term viability of our monetary system. The inflation rate is not the key issue. And efforts to try to inflate our way out of structural debt problems are a lost cause. We must instead move forcefully to rein in our deficits and avoid further debt monetization in order to protect the soundness of our money and Credit - or else risk a financial crash.
Most regrettably, Washington policymaking (fiscal and monetary) is on a trajectory that will inevitably destroy the creditworthiness of our nation’s vast liabilities. With ominous parallels to the mortgage/Wall Street finance Bubble, Federal Reserve policies have fostered Bubble dynamics throughout our Treasury, agency and debt markets, more generally. Instead of market dynamics working to discipline Washington’s profligate debt expansion, Federal Reserve interventions ensure that a distorted marketplace again accommodates perilous Credit excess. Our central bankers should heed Mr. Trichet’s warning. Additional quantitative ease will only fuel the Bubble and risk calamity.
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Last Updated on Sunday, 01 August 2010 11:31 |
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Trichet Challenges Inflationism |
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Written by Doug Noland
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Friday, 23 July 2010 00:00 |
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For the week, the S&P500 jumped 3.5% (down 1.1% y-t-d), and the Dow gained 3.2% (unchanged). The broader market was quite strong. The S&P 400 Mid-Caps jumped 5.0% (up 5.1%), and the small cap Russell 2000 surged 6.6% (up 4.0%). The Banks rose 1.8% (up 12.2%), and the Broker/Dealers jumped 3.1% (down 8.9%). The Morgan Stanley Cyclicals surged 7.1% (up 4.3%), and the Transports gained 6.1% (up 6.6%). The Morgan Stanley Consumer index rose 2.9% (up 1.2%), and the Utilities increased 2.3% (down 1.9%). The Nasdaq100 gained 4.0% (up 0.8%), and the Morgan Stanley High Tech index increased 3.4% (down 2.5%). The Semiconductors rose 4.4% (up 1.3%). The InteractiveWeek Internet index jumped 5.1% (up 5.6%). The Biotechs increased 3.6%, increasing 2010 gains to 11.7%. Although bullion declined $5.50, the HUI gold index rallied 1.8% (up 5.1%).
One-month Treasury bill rates ended the week at 14 bps and
three-month bills closed at 14 bps. Two-year government yields slipped one basis point to 0.56%. Five-year T-note yields jumped 6 bps to
1.695%. Ten-year yields gained 8 bps to 3.00%. Long bond yields rose 8 bps to 4.02%. Benchmark Fannie MBS yields jumped 13 bps to 3.65%.
The
spread between 10-year Treasury yields and benchmark MBS yields widened 5 bps to 65 bps. Agency 10-yr debt spreads declined 2 bps to 25 bps.
The
implied yield on December 2010 eurodollar futures fell 5.5 bps to
0.525%. The 10-year dollar swap spread was little changed at 1.5. The
30-year swap spread declined 1.5 to negative 24.25. Corporate bond
spreads were mixed. An index of investment grade spreads declined 4 to 109
bps, while an index of junk bond spreads rose 14 to 702.
Debt issuance has picked up. Investment grade issuers
included Goldman Sachs $4.25bn, Morgan Stanley $3.0bn, Noble International $1.25bn, US Bancorp $1.0bn, Ralcorp $750 million, and Charles Schwab $600 million.
Junk issuers included Wynn Las Vegas $1.3bn, Calpine $1.1bn, Interactive Data Corp $700 million, Entravision Communications $400 million, Accuride $310 million, and Esterline Technologies $250 million.
Converts issuers included Genco Shipping $110 million.
International dollar debt sales included European Investment Bank $3.0bn, Toronto Dominion Bank $2.0bn, Quebec $1.5bn, Banco Votorantim $1.1bn, State Bank India $1.0bn, Braskem Finance $750 million, JBS $700 million, Myriad International $700 million, Indosat Palapa $650 million, Bancocolombia $620 million, National Agriculture $500 million and Banco Mercantile $250 million.
U.K. 10-year gilt yields jumped 10 bps to 3.43%, and German bund yields jumped 10 bps to 2.71%. Greek 10-year bond yields rose 13 bps to 10.37%, and 10-year Portuguese yields increased 9 bps to
5.53%. The German DAX equities index gained 2.1% (up 3.5% y-t-d).
Japanese 10-year "JGB" yields declined 2 bps to 1.065%. The Nikkei 225 declined 2.6% (down 10.6%). Emerging markets moved higher. For the week,
Brazil's Bovespa equities index jumped 6.4% (down 3.3%), and Mexico's
Bolsa gained 3.2% (up 2.1%). Russia’s RTS equities index jumped 4.8%
(up 0.8%). India’s Sensex equities index gained 1.0% (up 3.8%).
China’s Shanghai Exchange jumped 6.1% (down 21.5%). Brazil’s benchmark
dollar bond yields fell 8 bps to 4.29%, and Mexico's benchmark bond
yields sank 16 bps to 4.30%.
Freddie Mac 30-year fixed mortgage rates dipped another basis point last week
to 4.56% (down 64bps y-o-y). Fifteen-year fixed rates declined 3 bps to 4.03% (down 65bps y-o-y). One-year ARMs dropped 4 bps to 3.70% (down
107bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had
30-yr fixed jumbo rates down 3 bps to 5.43% (down 95bps
y-o-y).
Federal Reserve Credit was little changed last week to $2.316
TN. Fed Credit was up $95.8bn y-t-d (7.7% annualized) and $305bn, or
15.2%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury,
Agency Debt this past week (ended 7/21) surged $18.1bn to a record
$3.132 TN. "Custody holdings" have increased $176bn y-t-d (10.7%
annualized), with a one-year rise of $345bn, or 12.4%.
M2 (narrow) "money" supply expanded $14.0bn to $8.603 TN (week of
7/12). Narrow "money" has increased $90.4bn y-t-d, or 2.0% annualized.
Over the past year, M2 grew 2.0%. For the week, Currency was unchanged,
while Demand & Checkable Deposits dropped $21.4bn. Savings Deposits surged $40.0bn, while Small Denominated Deposits declined $3.4bn. Retail
Money Fund assets dipped $0.9bn.
Total Money Market Fund assets (from Invest Co Inst) dropped $17.8bn to $2.798 TN. In the first 29 weeks of the year, money fund
assets fell $496bn, with a one-year decline of $858bn, or 23.5%.
Total Commercial Paper outstanding increased $2.5bn to $1.100 TN.
CP declined $70bn, or 10.8% annualized, year-to-date, while it was up $6.0bn from a year ago.
International reserve assets (excluding gold) - as tallied by
Bloomberg’s Alex Tanzi – were up $1.425 TN y-o-y, or 20.3%, to a record
$8.442 TN.
Global Credit Market Watch:
July 23 – Bloomberg (Jann Bettinga and Charles Penty): “Seven of the 91 European Union banks subject to stress tests failed with a combined capital shortfall of 3.5 billion euros ($4.5bn), stirring concern the evaluations were too lenient… The banks are in ‘close contact’ with national authorities over the results and the need for more capital, said the Committee of European Banking Supervisors… ‘The amount of capital needed is much lower than the market expected,’ said Mike Lenhoff… chief strategist at Brewin Dolphin Securities… ‘The amount does seem quite trivial considering the concerns about losses from the sovereign crisis.’”
July 20 – Bloomberg (Chan Tien Hin): “Emerging-market equity fund inflows jumped to more than $3 billion in the week to July 14 as the start of the U.S. earnings season prompted a rebound in optimism, according to EPFR Global.”
July 20 – Bloomberg (Edith Balazs and Balazs Penz): “Hungary’s short-term borrowing costs rose to a 19-week high at its first debt sale since international creditors suspended talks, weakening the forint and stoking concern that interest rates may increase.”
July 21 – Bloomberg (Steve Scherer): “The mafia has cranked up money laundering activities in Italy after the credit crunch prompted banks to stop lending, leaving a funding gap that criminal capital has filled, according to the Bank of Italy. ‘The crisis has given organized crime room to thrive because access to credit has become more difficult,’ said Anna Maria Tarantola, the central bank’s deputy general director… ‘Whoever holds large amounts of cash, like crime groups, can make investments that aren’t possible for others. They can now invest in fully legal businesses.’”
Global Government Finance Bubble Watch:
July 22 – Bloomberg: “Chinese banks face rising credit risks and their non-performing loan ratios are likely to climb as the nation’s economy slows and lending for government projects comes due for repayment, according to Standard & Poor’s. It’s ‘highly likely’ that some loans to local government financing vehicles will turn bad over the next few years… Loans to these entities account for about 18% to 20% of total lending… Chinese policy makers are grappling with risks from last year’s $1.4 trillion credit boom that fueled the nation’s comeback from the global recession. The banking regulator aims to cap new loans at 7.5 trillion yuan ($1.1 trillion) this year, down 22% from 2009…”
July 22 – Bloomberg (David Welch): “General Motors Co., the automaker 61% owned by the U.S., is buying subprime lender AmeriCredit Corp. for $3.5 billion to help it reach more customers with leases and loans to borrowers with faulty credit records.”
Currency Watch:
July 19 – Bloomberg: “China should reduce its holdings of U.S. dollar assets to diversify risks of ‘sharp depreciation,’ Yu Yongding, a former adviser to the central bank, wrote in a commentary in the China Securities Journal. The nation should convert some holdings currently in U.S. dollars into assets denominated in other currencies, commodities and direct investments overseas, he recommended. China’s dollar assets are surplus to requirements and the proportion is too high, Yu said. ‘It’s completely possible and also necessary for China to expand direct investments in Asia, Africa and Latin America,’ he wrote. ‘It’s also a rare opportunity for Chinese companies to acquire businesses overseas.’”
The dollar index was unchanged at 82.49 (up 5.9% y-t-d). For
the week on the upside, the Australian dollar increased 3.2%, the New Zealand dollar 2.4%, the South African rand 2.3%, the Canadian dollar 2.1%, the Mexican peso 1.7%, the Brazilian real 1.5%, the Norwegian krone 1.4%, the British pound 0.8%, the Singapore dollar 0.4%, and the Swedish krona 0.4%. For the week on the downside, the Japanese yen declined 0.9%, the Swiss franc 0.4%, the Danish Krone 0.2%, and the euro 0.2%.
Commodities Watch:
July 19 – Wall Street Journal (Spencer Swartz): “Powered by years of rapid economic growth, China is now the world’s biggest energy consumer, knocking the U.S. off a perch it held for more than a century, according to… the International Energy Agency.”
The CRB index gained 1.7% (down 5.9% y-t-d). The Goldman
Sachs Commodities Index (GSCI) surged 2.6% (down 1.7% y-t-d). Spot
Gold was down 0.5% to $1,187 (up 8.2% y-t-d). Silver added 1.8% to
$18.10 (up 7.5% y-t-d). September Crude jumped $2.59 to $78.97 (unchanged y-t-d).
August Gasoline rose 3.4% (up 3.2% y-t-d), and August Natural Gas increased 0.6% (down 18.4% y-t-d). September Copper surged 9.1% (down 4%
y-t-d). September Wheat added 1.5% (up 10% y-t-d), while September
Corn declined 6.0% (down 10% y-t-d).
China Watch:
July 23 – Bloomberg: “China’s stocks rose, capping the benchmark index’s best week in seven months, on speculation the government won’t introduce more measures to curb bank loans and property prices after leaders pledged policy stability… ‘The macro adjustment will be very modest in the second half and you won’t see any draconian measures like what the government did in the first half,’ said Li Jun, a strategist at Central China Securities… ‘Sentiment is improving and very favorable for a rebound in stocks.’”
July 23 – Bloomberg: “Chinese banks may struggle to recoup about 23% of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects, according to a person with knowledge of data collected by the nation’s regulator. About half of all loans need to be serviced by secondary sources including guarantors because the ventures can’t generate sufficient revenue…”
India Watch:
July 19 – Bloomberg (Kartik Goyal): “India’s economy may expand faster than 8.5% in the financial year that began April 1, Finance Minister Pranab Mukherjee said…”
July 22 – Bloomberg (Tushar Dhara): “India’s food inflation rate stayed above 10% for a 14th straight month, increasing pressure on the central bank to raise interest rates…”
Asia Bubble Watch:
July 19 – Bloomberg (Kyung Bok Cho): “South Korea will ‘soon’ announce plans to stimulate the nation’s property market, Yonhap News reported… The nation’s land ministry is drawing up measures to boost real-estate prices, and the ruling Grand National Party may begin discussions on easing debt-to-income restrictions on homeowners…”
Latin America Watch:
July 22 – Bloomberg (Matthew Bristow): “Brazil’s unemployment rate fell to the lowest level for the month of June since at least 2002. Unemployment fell to 7.0% in June…”
July 23 – Bloomberg (Andre Soliani and Cecilia Tornaghi): “Brazil’s government is considering tax breaks to stimulate long-term lending for infrastructure investment, helping to reduce the lending burden on the state development bank, Finance Minister Guido Mantega said. Mantega… said that among the measures being considered is to cut income taxes for investment in debentures and to develop a secondary market for them.”
Unbalanced Global Economy Watch:
July 22 – Bloomberg (Emma Ross-Thomas and Simone Meier): “Growth in Europe’s services and manufacturing industries unexpectedly accelerated in July as concern over the sovereign-debt crisis eased and an increase in global trade spurred exports. A composite index based on a survey of euro-area purchasing managers in both industries rose to 56.7 from 56 in June…”
July 23 – Bloomberg (Svenja O’Donnell): “The U.K. economy grew almost twice as much as economists forecast in the second quarter in the fastest expansion for four years… Gross domestic product rose 1.1% in the three months through June after increasing 0.3% in the previous quarter…”
July 23 – Bloomberg (Christian Vits and Simon Berberich): “German business confidence unexpectedly surged to a three-year high in July after exports boomed and economic growth accelerated. The Ifo institute said its business climate index, based on a survey of 7,000 executives, jumped to… the highest since July 2007… the biggest monthly increase since records for a reunified Germany began in 1990.”
U.S. Bubble Economy Watch:
July 23 – Bloomberg: “China’s trade surplus with the U.S. is set to remain ‘persistently large’ even as the Asian nation’s imbalance with the world narrows, according to International Strategy & Investment Group. U.S.-China trade tensions will pose ‘the most serious economic threat to the world for the next five years,’ Donald Straszheim, senior managing director for China research at International Strategy, said… ‘China and the Americans are the Group of Two, and if the G-2 are at each other’s throats, that’s troubling.’”
July 23 – Bloomberg (William Selway): “Most U.S. states cut government jobs last quarter as cities, counties and public agencies coped with falling tax revenue in the wake of the recession, a study found. State government payrolls dropped in 28 states in April through June… while employment in local government fell in 30 states, according to… the Nelson A. Rockefeller Institute of Government…”
July 22 – Bloomberg (Bob Willis): “Sales of U.S. previously owned homes fell in June for a second month, adding to evidence the market will slump as the effects of a federal tax credit fade… The number of transactions will be ‘very low’ in coming months, reflecting the end of the government incentive…"
Central Bank Watch:
July 20 – Bloomberg (Sandrine Rastello): “Central banks should have policies that are ‘the first defense against’ asset bubbles without losing their focus on price stability, an International Monetary Fund official said. ‘There is still much work to be done in developing a new policy framework to marry monetary and financial stability,’ Jose Vinals, who heads the IMF’s Monetary and Capital Markets department, said… ‘Tools should be sharpened to counter the build-up of financial imbalances at their root.’”
July 20 – Bloomberg (Greg Quinn): “The Bank of Canada increased its benchmark lending rate for a second month… Governor Mark Carney raised the target rate… a quarter point to 0.75%...”
GSE Watch:
July 21 – Bloomberg (Jody Shenn): “Fannie Mae and Freddie Mac’s regulator may identify as much as $30 billion of debt included in mortgage bonds that the companies can force sellers to repurchase, according to Joshua Rosner, an analyst who in 2007 predicted the collapse in the market for the securities. The Federal Housing Finance Agency this month said it issued 64 subpoenas seeking loan files and other documents related to so-called non-agency mortgage securities bought by the two government-supported companies.”
Fiscal Watch:
July 23 – Bloomberg (Roger Runningen): “President Barack Obama’s budget office said this year’s federal deficit will be a record $1.47 trillion, about $84 billion less than forecast in February because of lower spending for unemployment and some government programs. The administration predicted in its mid-session review that the deficit for the 2011 spending year, which begins Oct. 1, will be $1.42 trillion, $150 billion more than estimated at the beginning of this year, mostly because of lagging tax receipts.”
July 20 – Bloomberg (William Pesek): “Moody’s…, Standard & Poor’s and Fitch… can’t be happy. Last week, the world’s credit-rating giants got scooped on the biggest rating decision: whether to strip the U.S. of AAA status. Worse, the U.S. was downgraded by a company that few people have ever heard of, and a Chinese one at that. While Moody’s and S&P ignore the wreckage that America’s finances have become, Beijing-based Dagong Global Credit Rating Co. is uncorrupted by the system that enables developed-world debt addicts to appear fiscally clean. It rates U.S. debt AA, two levels below the top grade.”
Muni Watch:
July 23 – Bloomberg (Andy Fixmer and Christopher Palmeri): “U.S. cities and states may need more than $1 trillion of federal assistance in the next three years to stave off financial failure, former Los Angeles Mayor Richard Riordan said. Local governments are in a ‘race to the bottom’ and U.S. taxpayers will inevitably be called on to bail them out, Riordan said… The federal government should make pension, health-care and school reform a condition of receiving the aid, he said… ‘It’s not just L.A., it’s not just California, it’s all over the country, you’re going to see all these entities become totally insolvent,’ Riordan said. ‘I think the federal government has to come in and have a list of what the states have to do to be saved.’”
July 20 – Bloomberg (Terrence Dopp): “New Jersey, the third-most indebted U.S. state, faces a $10.5 billion deficit next year, nearly matching the one Governor Chris Christie closed in his current $29.4 billion budget, the Office of Legislative Services said.”
Crude Liquidity Watch:
July 21 – Bloomberg (Zainab Fattah): “A dearth of Dubai home sales and foreclosure auctions is stalling a recovery because buyers aren’t able to gauge how far prices have fallen… ‘There are very few transactions at the moment,’ said Craig Plumb, head of Middle East research at… Jones Lang LaSalle… ‘We are not going to see the bottom of the market until we see transactions through the foreclosure process.’ Home prices in the sheikhdom have dropped about 50% from their peak two years ago…”
Speculator Watch:
July 20 – Bloomberg (Saijel Kishan): “Investments in hedge funds slowed by 30% in the second quarter, according to Hedge Fund Research… Investors added a net $9.5 billion to hedge funds in the three months ended June… down from $13.7 billion in the prior period. The industry’s assets declined 1.2% to $1.65 trillion in the second quarter. Hedge funds posted an average decline of 2.5% in the three months ended June…”
Trichet Challenges Inflationism:
“The acute fiscal challenges across all industrial economies are no surprise. Our economies are emerging from the worst economic crisis since the second world war, and without the swift and appropriate action of central banks and a very significant contribution from fiscal policies, we would have experienced a major depression. But now is the time to restore fiscal sustainability. The fiscal deterioration we are experiencing is unprecedented in magnitude and geographical scope. By the end of this year, government debt in the euro area will have grown by more than 20 percentage points over a period of only four years, from 2007-2011. The equivalent figures for the US and Japan are between 35 and 45 percentage points. The growth of public debt has been driven by three phenomena: a dramatic diminishing of tax receipts due to the recession; an increase in spending, including a pro-active stimulus to combat the recession; and additional measures to prevent the collapse of the financial sector.” European Central Bank President Jean-Claude Trichet, Financial Times, July 23, 2010
The title of Mr. Trichet’s remarkable op-ed piece in today’s FT was direct and to the point: “Stimulate No More – It Is Now Time For All To Tighten.” The head European central banker has spoken publicly and in no uncertain terms: unrelenting government stimulus is today fraught with great risk. Mr. Trichet should be commended for courageously taking to the next level one of the most important debates of our time.
From Mr. Trichet: “…Given the magnitude of annual budget deficits and the ballooning of outstanding public debt, the standard linear economic models used to project the impact of fiscal restraint or fiscal stimuli may no longer be reliable. In extraordinary times, the economy may be close to non-linear phenomena such as a rapid deterioration of confidence among broad constituencies of households, enterprises, savers and investors. My understanding is that an overwhelming majority of industrial countries are now in those uncharted waters, where confidence is potentially at stake. Consolidation is a must in such circumstances.”
Perhaps his stern message was directed at Dr. Bernanke, the Federal Reserve and the Administration. More likely, it was in response to the recent chorus of calls for even more extreme government stimulus and intervention. Especially from some notable American economists, there has been a movement afoot to press Washington (and global policymakers) to completely throw caution to the wind in a crusade of further government spending programs and monetization. From the astute Mr. Trichet: “With hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto: ‘stimulate’, ‘activate’, ‘spend’!”
Meanwhile, the markets this week seemed to demand that our Fed Chairman arrive for his Congressional testimony with a lengthy list of additional measures our central bank is prepared to immediately implement to ensure buoyant markets and a robust recovery. Over the years, top European central bankers argued against U.S.-style “activist” central banking. The ECB decisively won this debate, yet the Fed is today under intense pressure to become only more radically “activist.” Mr. Trichet must have been compelled to interject.
With today’s noon release of the European bank “stress test,” Mr. Trichet’s message didn’t garner the attention it deserved. Not unexpectedly, “test” results were met with skepticism. The most popular complaint seemed to be that they lacked credibility because the tests didn’t factor in the banks’ capital exposure to sovereign debt risk. Well, I doubt there are many banking systems around the world these days that would perform satisfactorily in the event of a domestic sovereign debt crisis. Our banking system would surely not function well in the event of a crisis of confidence – and spike in yields – throughout our Treasury, agency debt and MBS markets.
These days, the marketplace can fixate on deflation risk and feel comfortable holding our debt instruments. With perceptions of scant inflation risk and a Fed predisposed toward additional monetization, bonds are viewed as a low-risk proposition. And, of course, with market yields at historic lows it is especially easy to dismiss the seriousness of today’s unfolding fiscal problems.
I’m of the view that our fiscal predicament has been decades in the making and is much worse than generally appreciated. At about 66% of GDP, most believe our federal government's fiscal position is quite manageable – and is certainly better than many others. At worst, market participants perceive there are still a few years before they must concern themselves with U.S. debt service issues. There is, as well, faith in the prospect of economic recovery rectifying our massive deficits. I fear we have reached the stage where our deficits are unmanageable: in this post-mortgage/Wall Street finance Bubble backdrop, economic recovery will disappoint and prospective governmental receipts and expenditures will really disappoint.
Hear me out on this. I – along with others – believed our fiscal position back in the early-nineties was a disaster in the making. Were we wrong? Our federal debt expanded 134% during the seventies to $779bn. The eighties saw federal borrowings increase another 247% to $2.701 TN. “Fortunately,” GDP inflated massively as well, ending the eighties up 457% in 20 years to $5.482 TN.
As a percentage of GDP, federal debt ended the sixties at 33.8% and the seventies at 30.4%. Enormous deficits, however, saw this ratio deteriorate markedly during the eighties, ending 1989 at 49.3%. A few years of record deficits resulted in this ratio jumping to 58.9% by 1993. Miraculously, the economy set course on a protracted boom, and governmental receipts skyrocketed. By 2001, federal debt had dropped to 41.8% of GDP. Many were contemplating the ramifications of Washington paying back all its borrowings.
My thesis holds that the rapid deterioration of our fiscal standing was only interrupted by an extraordinary (and unrepeatable) 15-year boom in private-sector Credit creation. In particular, this historic debt expansion was dominated by a profound change – including a massive expansion - in financial sector risk intermediation. Between 1993 and 2008, GSE assets ballooned from $631bn to $3.4 TN. Over this period, the agency MBS market expanded from about $1.4 TN to end 2009 at $4.96 TN. The asset-backed securities market surpassed $4.5 Trillion in 2007, up from about $400bn to begin 1993. Broker/Dealer assets began 1993 at less than $400bn and grew to about $3.1 TN. After ending 1993 at $3.3 TN, total U.S. financial sector borrowings closed 2008 above $17.0 TN. In the ten years 1998 through 2007, total mortgage debt jumped from $5.13 TN to $14.5 TN, a historic gain of 183%. These were “once-in-a-lifetime” financial and economic developments.
This enormous increase in debt inflated asset prices, inflated incomes, inflated spending, and inflated government receipts and expenditures. In particular, the huge expansion of household and financial sector debt was chiefly responsible for filling government coffers from Washington to Sacramento. Politicians extrapolated this bonanza and spent unwisely. But the 2008 bursting of the mortgage/Wall Street finance Bubble abruptly ended this cycle of Credit inflation. Much of the debt intermediated through the U.S. Credit system was discredited. The housing mania was terminated, resulting in a collapse in demand for mortgage Credit.
In the post-Bubble backdrop, private-sector (household and financial sector) Credit has contracted, and there is little prospect for meaningful expansion for some years to come. Unlike the early nineties, there will be no miraculous new type of finance to fuel booms in the economy, asset prices, and government receipts. Financial innovation and the reckless expansion of Wall Street finance will not bail out Washington. We're basically left with a massive expansion of government debt until the markets decide to impose discipline.
Our recovery has been completely dependent upon government spending and ultra-loose monetary policy. This has entailed an incredible increase in Treasury borrowings. The markets assume our rapidly deteriorating fiscal situation will improve as the economy recovers. On the spending side, the economy is now dependent on massive federal stimulus. I don’t expect any self-imposed restraint on government expenditures. And, importantly, it would take renewed expansion of private-sector debt to meaningfully boost the ratio of governmental receipts to expenditures. Washington – or the states – can’t spend its way to fiscal recovery. Instead, we’re witnessing a fiscal train wreck. Our policymakers, economists, and pundits should read Mr. Trichet carefully and contemplate a course other than inflationism. |
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Last Updated on Saturday, 24 July 2010 11:28 |
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