It was a short week long on volatility. For the week, the Dow and S&P500 gained less than 1%. Economically sensitive issues performed well. The Transports jumped 2.6%, and the Morgan Stanley Cyclical index gained 1.2%. The Dot.Homebuilder Bubble had the S&P Homebuilding index up 12% over the past two sessions, with a year-to-date gain of 17.4% and 52-week surge of 55%. For the week, the Utilities added 1%, while the Morgan Stanley Consumer index dipped 0.5%. The broader market started the week on the downside but came back strong. The small cap Russell 2000 gained 1.2%, and the S&P400 Mid-cap index rose 1.3% (closing today at a new record high). The NASDAQ100 and Morgan Stanley High tech indices advanced about 1%. The Semiconductors jumped 3.6%, and the Street.com Internet Index rose 1.4%. The NASDAQ Telecommunications index was about unchanged. The Biotechs rose almost 2%. The Broker/Dealers and Banks gained less than 1%. With bullion up $7.85, the HUI index gained 2.5%.
The yield curve continues to do strange things (significantly flatten). Two-year Treasury yields rose for the fifth consecutive week, rising 8 basis points to 3.51% (high since April ’02). Five-year Treasury yields rose 4 basis points to 3.90%. Ten-year Treasury yields were unchanged at 4.26%. Long-bond yields dipped 2 basis points to 4.63%. The spread between 2 and 30-year government yields narrowed 10 basis points to 112. Benchmark Fannie Mae MBS yields gained 2 basis points. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note narrowed 2 basis points to 33, and the spread on Freddie’s 5% 2014 note narrowed 3 basis points to 29. The 10-year dollar swap spread added 0.5 to 39. Corporate bonds continue to trade well. The implied yield on 3-month June Eurodollars rose 3 basis points to 3.43%.
Investment grade issuers included Istar Financial $1.1 billion, BAC Capital Trust $1.0 billion, Pricoa Global $500 million, Enbridge $300 million, Arden Realty $300 million, Liberty Property $300 million, Anixter Intl. $200 million, and MBIA $100 million.
Junk bond funds saw outflows increase to $218.44 million. Junk issuers included Navistar $400 million, Meritage Homes $350 million, Telcordia Tech $300 million, Penn National $250 million, and Buhrmann $150 million.
Convert issuers included Genesis Health $150 million and Unisource Energy $125 million.
Foreign dollar debt issuers included the European Investment Bank $3.0 billion.
February 25 - Bloomberg (Todd Prince): “Emerging Europe, Middle East and Africa stock mutual funds received a net $463 million in the week ending Feb. 23, the second-biggest inflow in at least five years, according to EmergingPortfolio.com.”
Japanese 10-year JGB yields added one basis point to 1.425%. Emerging market debt continues to hold its own. Brazilian benchmark dollar bond yields were unchanged at 7.76%. Mexican govt. yields ended the week up 4 basis points to 5.19%. Russian 10-year dollar Eurobond yields slipped one basis point to 5.90%.
Freddie Mac posted 30-year fixed mortgage rates jumped 7 basis points this week to a six-week high 5.69%. Fifteen-year fixed mortgage rates rose 8 basis points to 5.22%. One-year adjustable rates added 1 basis point to 4.16%. The Mortgage Bankers Association Purchase Applications Index dipped 1.3% the past week. Purchase applications were up 8% from one year ago, with dollar volume up 18%. Refi applications were about unchanged. The average new Purchase mortgage was up slightly to $237,700. The average ARM increased to $333,600. The percentage of ARMs was unchanged at 30.7% of total applications.
Broad money supply (M3) dropped $22.4 billion to $9.456 Trillion (week of February 14). M3 is up $519 billion, or 5.8%, over the past year. For the week, Currency declined $1.9 billion. Demand & Checkable Deposits fell $7.4 billion, and Savings Deposits sank $19.0 billion. Small Denominated Deposits gained $2.0 billion, while Retail Money Fund deposits declined $3.3 billion. Institutional Money Fund deposits dropped $6.5 billion. Large Denominated Deposits expanded $6.4 billion. Repurchase Agreements jumped $11.2 billion, while Eurodollar deposits declined $6.0 billion.
Bank Credit expanded $11.5 billion for the week of February 16 to a record $6.924 Trillion. Bank Credit is up a noteworthy $180 billion during the first 7 weeks of the year. For the week, Securities Holdings were unchanged, while Loans & Leases gained $11.5 billion. Commercial & Industrial (C&I) loans added $0.7 billion. Real Estate loans dipped $2.4 billion. Real Estate loans are up $313 billion, or 13.9%, over the past 52 weeks. For the week, consumer loans increased $6.8 billion, and Securities loans gained $4.7 billion. Other loans added $1.6 billion. Elsewhere, Total Commercial Paper rose $7.5 billion last week to $1.440 Trillion, having expanded at a 12.3% rate y-t-d. Financial CP gained $8.5 billion to $1.298 Trillion. Non-financial CP dipped $1.0 billion to $142.5 billion. Non-financial Commercial Paper is up 18.4% from one year ago.
Fed Foreign Holdings of Treasury, Agency Debt surged $22.4 billion to $1.365 Trillion for the week ended February 23. “Custody” holdings are up $28.9 billion, or 14.1% annualized, year-to-date (up $221.8bn, or 19.4%, over 52 weeks). Federal Reserve Credit declined $3.0 billion for the week to $780.8 billion.
ABS issuance totaled $9.0 billion (from JPMorgan). Year-to-date issuance of $98 billion is running 18% ahead of comparable 2004. At $60 billion, Home equity ABS issuance is running 22% above the year ago level.
The dollar index dropped 1%. The Polish zloty jumped 3.3%, the South African rand 2.5%, Czech koruna 2.0%, and Hungarian forint 1.9%. On the downside, the Chilean peso declined 1.7%, the Brazilian real 1.3%, and Argentine peso 0.9%.
The trading week saw copper trade to a 16-year high and aluminum also to a 10-year high. April Crude Oil surged $2.48 this week to $51.49. The Goldman Sachs Commodities index jumped 5.7%, increasing its year-to-date gain to a notable 13.7%. The CRB index rose 3.3%, increasing 2005 gains to 5.7%.
February 21 – UPI: “Japan’s trade with China in 2004 surged by 26.9 percent year on year to $168 billion, setting a new record for the sixth year in a row. Japanese exports to China rose for the sixth straight year in 2004, surging 29.0 percent year on year to $73.83 billion. This rise was fueled by an increase in exports of parts and materials that Japanese manufacturers operating in China have difficulty sourcing locally…”
February 25 - Bloomberg (Wing-Gar Cheng): “China’s consumption of electricity this year may rise 12 percent, the China Electricity Council said, as the country improves power distribution to meet the needs of the fastest-growing major economy.”
February 21 - Bloomberg (Philip Lagerkranser): “Hong Kong’s unemployment rate fell to a three-year low last month as rising tourism and booming trade with China helped drive the fastest economic growth since 2000. The seasonally adjusted rate, which has dropped from a record 8.7 percent in July 2003, slid to 6.4 percent from 6.5 percent in December…”
Asia Inflationary Boom Watch:
February 25 - Bloomberg (Theresa Tang): “Taiwan’s export orders and industrial production in January had their biggest gains in at least six months as changes in the timing of the Lunar New Year meant there were more working days. Orders -- indicative of shipments in one to three months -- rose 32 percent from a year earlier to $18.4 billion after climbing 26 percent in December…”
February 21 - Bloomberg (Mrinalini Datta): “Indian corporate earnings surged in the first nine months of the fiscal year as the economy expanded, the Confederation of Indian Industry said. Sales at manufacturers jumped 26 percent between April and Dec. 31, three fifths faster than they grew a year ago…”
February 25 - Bloomberg (Bibhudatta Pradhan and Sumit Sharma): “India’s economy is poised to grow 7 percent this year, overcoming rising global prices of crude oil and poor rainfall, critical to the nation’s farms, President A.P.J. Abdul Kalam said.”
February 22 - Bloomberg (Pratik Parija): “India’s crude oil imports increased 8.5 percent in January to 8.62 million metric tons from 7.94 million tons a year earlier, Press Trust of India said…”
February 25 - Bloomberg (Arijit Ghosh and Laurent Malespine): “Thailand posted a trade deficit of $1.34 billion in January, its biggest in almost eight years, the finance ministry said. Exports in the month rose 10.9 percent… Imports rose 33.5 percent…”
February 24 - Bloomberg (Chan Tien Hin and Khoo Hsu Chuang): “Malaysian vehicle sales rose for the 12th straight month in January, rising 23 percent, as low interest rates and the possibility of a new duty policy pushing up car prices prompted buyers to speed up their purchases.”
Global Reflation Watch:
February 25 - Bloomberg (Christian Baumgaertel): “Money supply growth in the 12 countries sharing the euro, the European Central Bank's barometer of future inflation, accelerated in January, adding to pressure on the ECB to raise borrowing costs. M3 increased 6.6 percent from a year earlier after expanding 6.4 percent in December… French and Spanish house prices surged about 15 percent last year compared with 2003, according to the…Royal Institution of Chartered Surveyors. European household debt rose an annual 8.2 percent in the third quarter last year, the most in more than four years… Loans to companies and households increased an annual 7.3 percent last month, compared with a 7 percent gain in December. Lending for house purchases grew 10.1 percent in January from a year earlier, the ECB said in today’s report.”
February 25 - Bloomberg (Laura Humble): “British workers received an average annual pay increase of 3.3 percent in the three months through January, the biggest gain in six years, as inflation accelerated, Industrial Relations Services said.”
February 21 - Bloomberg (Sam Fleming): “U.K. home values rose this month at the fastest rate since June, according to estate agents’ Web site Rightmove, suggesting the property market is steadying after a spell of house-price declines at the end of 2004.”
February 25 - Bloomberg (Jeffrey T. Lewis): “Prices of goods leaving Spanish factories, farms and mines rose in January as the cost of energy and food and drink increased. Producer prices rose 0.5 percent from the previous month and 4.8 percent from a year earlier…”
February 21 - Bloomberg (Hugo Miller): “Swiss watch exports rose 19 percent in January as companies led by Swatch Group AG and Cie Financiere Richemont AG sold more of their timepieces in the U.S and China.”
February 25 - Bloomberg (Halia Pavliva): “Russia’s January exports rose 29.9 percent in the year to $14.6 billion, as prices for major export commodities including oil, gas and metals increased, the Economics Ministry said. Imports rose 10.9 percent to $6.1 billion, the ministry said…”
February 24 - Bloomberg (Michael Teagarden): “Russia’s foreign currency and gold reserves rose to $129.2 billion in the seven days to Feb. 18. The reserves rose from $125.4 a week before, the central bank said in an e-mailed statement today. The reserves were at a record-high $128.3 billion on Jan. 28.”
February 24 – AP: “Russia’s economic trade and development minister said Thursday that Russian goods today are as uncompetitive today as they were before a 1998 financial crisis and ruble devaluation that reinvigorated domestic producers… German Gref, the government’s economic pointman, warned that inflation in the first two months of the year could hit a record 3.9 percent, and said that enterprises’ energy and utility payments should be frozen at their current level.”
February 23 - Bloomberg (Gemma Daley): “Australian wages growth accelerated in the fourth quarter as the jobless rate fell to a 28-year low, reinforcing expectations the central bank will increase interest rates next week. The wage price index, which measures hourly rates of pay, excluding bonuses, rose 1 percent following a 0.9 percent gain in the third quarter, the Australian Bureau of Statistics said…”
February 24 - Bloomberg (Tracy Withers): “New Zealand’s taxation collection figures for January were released in Wellington… They showed the total collected in the seven months ended Jan. 31 was NZ$28.67 billion ($20.7 billion). That’s 9.7 percent more than the year earlier.”
Latin America Reflation Watch:
February 21 - Bloomberg (Adriana Arai): “Mexico received 46 percent more foreign direct investment in 2004, led by the manufacturing and financial services industries, the Economy Ministry said. U.S. companies were the biggest investors in Mexico last year, accounting for 48 percent of the $16.6 billion in direct investment…”
February 24 - Bloomberg (Guillermo Parra-Bernal): “Brazil’s economy will likely grow 5 percent for a second year as investment surges, unemployment declines and industrial output keeps rising, President Luiz Inacio Lula da Silva said. Industrial output and other economic indicators are showing similar readings to those of 2004, suggesting Brazil will have the best back-to-back years of growth since 1985-1986… ‘We waited 10 years to see the Brazilian economy growing 5 percent, and I promise: we will grow 5 percent again this year,’ Lula said’”
February 21 - Bloomberg (Daniel Helft and Andrew J. Barden): “Argentina plans to sell peso-denominated notes maturing in six years for the first time since the country defaulted on $95 billion of debt, central bank President Martin Redrado said…”
February 22 - Bloomberg (Igor Munoz and Andrew J. Barden): “Chilean banks increased their lending 15 percent in January from the year-ago month as the fastest economic growth in seven years boosts consumer confidence and demand for credit to buy new cars and homes.”
February 23 - Dow Jones: “Peru’s exports rose 41.1% year on year in January to reach $1.21 billion, as raw material exports led the strong gain, government agency Prompex said…”
Dollar Consternation Watch:
February 24 - Bloomberg (Janet Ong and Anuchit Nguyen): “Policy makers from Japan, China, South Korea and Southeast Asian nations met in Thailand this week to discuss ways of stemming the dollar’s slide, said Xu Bing, director of the international department of the People’s Bank of China. Xu…confirmed an article in the Korea Times reporting the meeting that took place in Bangkok on Feb. 22… Pongpanu Svetarundra, deputy director-general of the Thai Finance Ministry’s Fiscal Policy Office, said the meeting included deputy central bank governors. ‘The meeting discussed global economic imbalances,’ Pongpanu said… ‘There was an agreement to set up a group, which will exchange information about economies, including foreign exchange markets, among countries.’”
February 24 - Bloomberg (Kate Mayberry): “Malaysia should review its currency’s peg to the U.S dollar now rather than later because the dollar’s decline will continue amid slowing global economic growth, the Malaysian Institute of Economic Research said… ‘The sooner we re-peg the better,’ the institute’s Executive Director Mohamed Ariff Kareem said… ‘The longer you wait, the worse it gets, because the prognosis for the dollar is frightening. Doing it now we will pay a smaller price for the adjustment.’”
California Bubble Watch:
From the California Association of Realtors: “We’re out of the starting gate with a bang. Both sales and the median price of a home hit new records in January as homebuyers continued to flood the market,” said C.A.R. President Jim Hamilton. “Although the inventory of homes for sale increased in January, it’s still low by historic standards. Buyers are taking a little more time before making an offer compared with last year, in part because the specter of significant increases in mortgage interest rates has diminished.” Median prices were up $11,420 to $485,700 during January, an increase of 20.1% for 12 months, 44% for 24 months, 69% for 36 months, and 140% over six years. It is simply hard to fathom that median California home prices have increased $283,500 in 72 months – almost $4,000 a month.
February 25 - Los Angeles Business Journal (Andy Fixmer): “Luxury homes in Los Angeles County posted their largest-ever gains in appreciation last year, according to an annual survey by First Republic Bank. The average price of luxury homes in Los Angeles – those worth more than $1 million – rose nearly 28 percent to a record $1.97 million…”
February 22 - Bloomberg (Greg Chang): “Hotter-than-normal weather may cause power failures in Southern California when demand peaks this summer, the state energy commission said… In hotter-than-normal weather, conditions that occur about 10 percent of the time, Southern California’s supplies may be 2,000 megawatts less than required, or enough power for about 1.5 million homes…”
Bubble Economy Watch:
February 24 – The Wall Street Journal (Sarah Lueck): “Growth in health-care spending will continue to slow, but federal, state and local governments will be picking up nearly half of all U.S. health costs within a decade, a shift that largely reflects Medicare’s new prescription-drug coverage, federal analysts forecast. The government will pay 49% of health costs by 2014, up from 46% currently, according to the agency that runs Medicare… The government’s portion has been rising steadily, from 43% in 1980 and 38% in 1970. ‘The public sector will feel more deeply the financial burden associated with supplying health-care benefits to Medicare and Medicaid enrollees,’ the federal analysts wrote in an article published by the journal Health Affairs.”
February 25 – The Wall Street Journal (Joann S. Lublin): “Bonuses for many chief executive officers surged last year amid rising criticism of what some deem excessive compensation… At 100 major U.S. corporations, CEO bonuses rose 46.4% to a median of $1.14 million, the largest percentage gain and highest level in at least five years… CEOs in the Mercer study enjoyed median total direct compensation of $4,419,300 -- about 160 times as much as the average U.S. production worker made last year.”
Mortgage Finance Bubble Watch:
February 24 - CNN/Money: “The million-dollar house isn’t such a novelty it seems. According to a survey of Coldwell Banker affiliates, which is one of the largest national sellers of luxury property, the number of houses that sold for at least seven figures increased 47 percent in 2004. The firm’s affiliate closed a total of 20,292 such transactions, with the average sale price for this segment ringing in at a record $1.7 million. California accounted for more than half of this segment’s total sales volume, with nearly $20 billion in luxury home sales. Florida took a distant second with about $3 billion in total luxury sales recorded by the firm…”
February 23 – PRNewswire: “The active hurricane season helped drive spending on home improvement products to a new record high estimate of $271.4 billion in 2004, according to the Home Improvement Research Institute (HIRI). The rate of spending represents a 13 percent increase over the $240.6 billion total in 2003… HIRI expects the pace of growth to slow over the next five years. The lumber & building materials category showed the largest percentage increase in spending last year, up almost 19 percent over 2003.”
February 21 - Bloomberg (Curtis Eichelberger): “New England Patriots defender Asante Samuel was flush. He had just pocketed a $122,500 bonus from the National Football League for helping his team win three playoff games, including the Super Bowl. How was he going to spend it? ‘I’m definitely going to invest it,’ Samuel, 24, said at a Super Bowl press conference… ‘I’m a real-estate guy.’”
January Single Family Existing Home Sales were up 12.5% from one year ago to a 5.94 million annualized pace, the strongest y-o-y gain since June. Average Prices were up 10% to $239,900. The month’s supply of homes available for sale declined to a multi-decade low of 3.7 months.
From the CEO of New Century Finance: “Our typical customer is not as rate sensitive as the typical Fannie Mae, Freddie Mac customer. And therefore interest rate adjustments are not as sensitive to our business. We’re expecting another record year in the non-prime lending area. 2004 finished around $500 billion for the industry, and most forecasts are in the $500 billion range or perhaps just a touch below. It should be one additional good year in 2005…”
From the president of luxury homebuilder Toll Brothers: “Even if mortgage rates were to go up a full two points, I don’t think we would see a slowdown in our business. The market is driven primarily by the constraint in supply more than the growth in demand.”
Financial Bubble Watch:
February 24 - Dow Jones: “U.S. banks earned $31.8 billion in the fourth quarter of 2004, the third highest amount ever, and a record $123.0 billion for the full 2004 calendar year, the Federal Deposit Insurance Corp. said… The FDIC said fourth-quarter profits reflected ‘strong loan growth and wider net interest margins’ that could not fully offset the negative impact of merger expenses at large banks and lower gains on sales of securities and other assets… The average return on assets for the fourth quarter was 1.28%, marking the first time in two years that the industry’s quarterly return on assets was below 1.30%. The FDIC noted ‘renewed vigor’ in residential mortgage lending and continued strength in home equity and credit card lending during the fourth quarter. ‘Growth in commercial loans, while less spectacular, was still significant,’ it said. Real estate construction loans were up 5.6%, commercial real estate loans were up 2.4%, and commercial and industrial loans were up 1.7%.”
February 25 – American Banker: “Banks set another earnings record last year… ‘Home equity lending has continued to be a significant driver of loan growth. Home equity lines of credit grew 42% last year, countering the slowdown in home mortgage refinancing,’ said Miguel Browne, an associate director (at) the FDIC… Interest-bearing assets rose by 2.4% to $8.6 trillion. Residential mortgages grew by 3%, to $1.8 trillion; mortgage-backed securities grew 5.9%, to $1.1 trillion; and home equity loans grew 6.7%, to $490.7 billion. These three factors together accounted for 71% of the growth in interest-bearing assets, the FDIC said.”
February 24 - Bloomberg (Rodney Jefferson): “The assets of hedge funds based in London will more than double to $395 billion in the next five years as Europe’s largest center for the investments attracts more firms… The increase would give London a 20 percent share of the world’s hedge fund market, up from 14 percent in 2004, according to a report from the Centre for Economics and Business Research… Hedge funds, designed for institutions and the wealthy because of their riskier nature, attracted a record $27 billion worldwide from investors in the fourth quarter, according to… Hedge Fund Research Inc.”
February 24 – American Banker (Lavonne Kuykendall): “JPMorgan Chase & Co. said it plans to expand its credit card receivables faster than the overall market this year by spending more on advertising, marketing to riskier credits, and possible acquiring other issuers.”
February 24 - Federal Reserve governor Ben Bernanke:
“The current account deficit is a concern. What that is basically – there are two ways of looking at the current account deficit. One is looking at it from the trading perspective, which most people are familiar with the idea that we are actually importing a lot more than we are exporting. So, in that sense we have a current account deficit. But another way to look at it is that we are investing more than we’re saving. If you look at investment in terms of capital investment by firms, you look at residential investment - that is building new houses. You have seen a lot of investment but we have a relatively low savings rate. And so, having a low savings rate, we have to borrow from foreigners to make up the difference between our saving and the investment we want to do. So, what’s called capital inflows – the money flowing in from foreigners to finance our investment is another way of looking at the current account deficit. So these different perspectives give you different ways of thinking about how you would address this problem. The trade perspective says, yes, part of the issue is getting balance in our trade. And that suggests that we should work with the world trade organization and other trade agencies to try to get fairer and free trade with other countries... On the other side, we have the savings and investing perspective. We have relatively low savings, we have a federal deficit which is subtracting from our savings. And that suggests that part of reducing the current account deficit would be to try to stimulate our savings. Reduce the deficit and take other actions that would increase our savings and therefore reduce capital inflows that are coming in – which is the other face of the current account deficit. Depending how you look at it, there are a variety of policies that should be undertaken. I think the current account deficit is going to be with us awhile. It will take a while to unwind. It can’t go on at this level for ever. It is going to eventually have to come down. And I think it will eventually come down. But policies like increasing our savings would probably be a step in the right direction to help that happen.”
The U.S. economy generates $600 billion-plus Current Account Deficits because we “invest” so much? Such econobabble from a prominent central banker does not inspire confidence. And, more than ever, instilling dollar confidence is an imperative. Tuesday the dollar was hammered on news of the Bank of Korea’s plan to diversify its dollar-denominated reserves. There was also the revelation of an Asian policymakers meeting this week to discuss “global economic imbalances” and how to deal with the faltering dollar. And from today’s Australian: “[Australia’s Treasurer] Peter Costello’s closest advisor fears the US is heading for a devastating financial crash that could ravage Australia’s economic growth. …Treasury Secretary Ken Henry likened the flood of money pouring into the US to support its budget and current account deficits to the stockmarket’s dotcom bubble of the late 1990s. Were it suddenly to stop, there would be shockwaves felt throughout the world’s economies.”
Languish over the likelihood that the U.S. is on course to precipitate global financial crisis has spilled out into the open. This is surely related ot the heightened appreciation by market participants and global policymakers that the Federal Reserve is not up to the task of reining in U.S. financial and economic excess. Moreover, the much anticipated marketplace-induced adjustment process has failed to materialize. Indeed, exuberant global markets and propagating asset Bubbles ensure a calamitous future “adjustment.” Global policymakers and central bankers should be apprehensive.
The weak dollar has certainly failed to rectify or even slow imbalances – global, domestic or otherwise - and there is little prospect that further devaluation will be any more successful. In the past, a weak currency would induce higher market rates – rates necessary to tighten financial conditions, temper over-consumption and undermine speculative dynamics. Yet the old rules no longer apply to contemporary finance, a momentous blow to the capacity for orderly market-based corrections and adjustments. The need for strong-minded central bankers to guard against inexorable market distortions has never been as great, while, ironically, never has a central bank (the Greenspan Fed) placed greater faith in the efficiency of market processes. And Dr. Bernanke’s comments above suggest that policy efforts to constrain American consumption aren’t on the table – “consumption” being a four-letter word not even open to discussion. Accordingly, the prospect of the Fed purposely precipitating a meaningful economic slowdown to assist the U.S. Current Account Deficit “unwind” is nonexistent. Commencing the arduous process of reestablishing Monetary Order is, then, at a logjam.
This week from Morgan Stanley’s Stephen Roach: “Global rebalancing does not occur spontaneously. It takes adjustments in economic policies and asset prices to spark a meaningful realignment in the mix of global growth. Shifts in currencies and real interest rates are the two major instruments of rebalancing…In the end, it will also require a narrowing of the growth differentials between the US and the rest of the world… A narrowing of the growth spread between the US and the rest of the world is key for a resolution of America’s trade- and current-account imbalances.”
These excerpts do not do Mr. Roach’s exceptional analysis justice; they instead provide the opportunity to distinguish the focal points of my analysis: I have reached the point of having lost what little faith I had in the efficacy of “global rebalancing.” Imbalances simply cannot be rectified by heady non-U.S. global growth. Such a scenario would ensure myriad problematic bottlenecks, shortages and price pressures including significantly inflating global energy and commodities prices. At the same time, global policymakers – especially the Fed – refuse to take decisive action. They respectively missed their opportunities to act. The costs and risks are these days much too high for aggressive policy response – individually or in concert. There is no will to face The Bubble Issue.
Importantly, asset inflation has become a global systemic issue. Mortgage Credit is growing at double-digit rates in the U.S., Europe, and China (and elsewhere). Meanwhile, speculative securities leveraging and attendant liquidity creation is endemic internationally, and there is no international body or coordinated central bank policy response to moderate – let alone rein in - Global Wildcat Finance. Resulting uncontrolled liquidity excess is The New Global Phenomenon, nonetheless central bank balance sheets balloon on the back of unrelenting dollar flows. It is amazing that marketplace perceptions of quiescent inflation persist in the face of today’s unparalleled global backdrop of abundant liquidity and Endemic Easy Credit Availability.
Importantly, global interest rates have converged like never before, and they have consolidated right down toward artificially low U.S. levels. Moreover, the massive international liquidity pool offers an overhang of constant downward pressure on the converged price of global finance. Less appreciated but no less significant, financial systems internationally have “converged” toward the U.S. model. Depressed interest rates augment already intense worldwide asset-based lending and securities speculation, only exacerbating the Global Liquidity Bubble. The dysfunctional U.S. Credit system has now fully impaired the global financial system, leaving faint hope that market pricing mechanisms will instigate either a gradual or orderly “adjustment process.”
The bottom line is that the entire spectrum of international rates – the global price of finance - needs to shift meaningfully higher. This amounts to the only effective policy measure to rein in asset-based lending and speculating excess. The dilemma is that central bankers from the ECB to China and Asia are frozen by the vulnerable dollar and the prospect of financial crisis. To raise rates would only incite greater financial flows away from the U.S. and its ailing currency. There is, as well, the issue of massive speculative leveraging throughout. The Fed is locked into a policy of “baby steps” that ensures that U.S. rates at best stay barely a half-step ahead of rising inflationary pressures, while inciting only greater speculative excess.
There is much written these days referencing “real” and “neutral” rates, but these notions have little practical meaning without an effort to factor in asset inflation. Asset prices are, after all, the centerpiece of contemporary Credit and liquidity creation. To instead fixate on CPI – the misplaced contemporary inflation target – guarantees ineffectual monetary management. Having succumbed to this analytical misjudgment and, in the process, having fallen so far behind the curve, there is now the prospect that much higher Fed funds may be required to garner any meaningful impact on U.S. and global excesses and imbalances.
Dr. Bernanke is deluding himself if he actually believes that stronger global growth and more equitable trade treaties and practices will work to rectify our Current Account Quagmire. I also think he is too optimistic in expecting that today’s deficits can be sustained “for awhile” and “take awhile to unwind.” The inevitable adjustment period will commence only with the problematic bursting of the Mortgage Finance Bubble; no more, no less. And, not surprisingly, this Mighty Bubble scoffs at Cowardly Little Baby Steps. Are speculators suffering from higher financing costs? Are 4% ARMs to dissuade manic California, Florida, or Manhattan mortgage borrowers? Then how about even lower teaser and interest-only mortgages? And let’s not forget that 2004 saw the greatest inflation of home equity in history, and it’s there just waiting to be tapped to upgrade to a more appealing residence or to boost consumption. January then brought another $10,000 windfall to the average California homeowner. Credit conditions are easier today than they were a year ago – or ever were.
My fear that we are heading toward financial crisis is not rooted in the mindless ranting of an embittered permabear – but from the discipline of my analytical framework. The U.S. Credit Bubble is creating unrelenting and unwieldy dollar liquidity that continues to inundate global financial systems. The marketplace pricing mechanism for global finance is severely impaired, while speculative dynamics are empowered. Excess is only begetting greater excess, and policymakers, meanwhile, function like deer caught in headlights.
The question I ponder this evening is how this expected crisis manifests. Does it unfold first in the currency or interest-rate markets? Is it precipitated by a spike to $60 or $70 crude and a panic “melt-up” in global commodity markets? What market “accident” could set off a chain reaction of speculator unwind? Are spreads an accident in wait? The ten year? MBS? And, of course, the dollar is certainly vulnerable to a marketplace dislocation, although we can also assume that global central bankers are now on heightened alert. I will admit to being absolutely intrigued by the degree of complacency that is now ingrained in The Bulletproof Bond Market. All the recent talk of a shortage of bonds recalls major Bubble tops of years past. The reality of the situation is that it would require only a marginal bout of de-leveraging to create way more than adequate supply.