Booming retail sales and a negative surprise on the inflation front kept the pressure on the bond market. For the week, 2-year Treasury yields rose 14 basis points to 1.99%, the highest yields since early December. Five-year Treasury yields jumped 15 basis points to 3.37%, and 10-year yields climbed 14 basis points to 4.34%. Long-bond yields rose 15 basis points to 5.17%. Benchmark Fannie Mae mortgage-backed yields rose 15 basis points. The spread on Fannie’s 4 3/8% 2013 note widened 3 to 33, and the spread on Freddie’s 4 ½% 2013 note widened 3 to 32. The 10-year dollar swap spread increased 2.25 to 43.5, the widest since October. Corporate debt generally outperformed, with junk spreads narrowing again this week. Investment grade spreads are hovering near 2004 lows. The implied yield on December 3-month Eurodollars jumped 12.5 basis points to 1.93%.
Emerging debt yields continue to march higher. Benchmark Brazilian government bond yields rose 72 basis points to 9.82% and Mexican bond yields rose 25 basis points to 5.40%.
Bloomberg tallied corporate issuance of $6 billion, about half the year’s weekly average. Market analysts pointed to a lack of supply, rather than tepid demand. Investment grade issuers included Glencore Funding $950 million, Principal Life $500 million, Boston Edison $300 million, Cargill $250 million, Developers Realty $250 million, Noble Energy $200 million, Sierra Pacific Power $100 million and Peco Energy $75 million.
Junk issuers included Midwest Generation $1.0 billion, Bombardier $750 million, Farrellgas $250 million, Meritage $130 million, Extendicare Health Services $125 million, XM Satellite $200 million, Atlantic Express $115 million, and Primus International $65 million.
Convert issuance included Walter Industries $150 million and Shuffle Master $125 million.
Foreign dollar debt issuers included Export-Import Bank of Korea $1.35 billion and Korea East-West Power $250 million,
ABS issuance amounted to $7.5 billion (from JPMorgan), with y-t-d issuance of $160.27 billion running up 21% from comparable 2003.
Freddie Mac posted 30-year fixed mortgage rates jumped 10 basis points to 5.89%, the highest rates since early December. Long-term fixed rates were up 49 basis points over three weeks. For the week, 15-year fixed-rate mortgages were up 14 basis points to 5.23%. One-year adjustable-rate mortgages could be had at 3.69%, up 4 basis points for the week (up 33 basis points in three weeks). The Mortgage Bankers Association Purchase application index dropped almost 10% this week. However, comparisons are distorted due to the Easter holiday. Refi applications sank about 30%. The average Purchase mortgage was for $215,800, and the average ARM was for $290,900.
Broad money supply (M3) declined $12.6 billion for the week of April 5. For the first 14 weeks of 2004, M3 expanded $217.8 billion, or 9.2% annualized. For the week, Demand & Checkable Deposits declined $26.3 billion. Savings Deposits surged $35.9 billion, with y-t-d gains of $155.9 billion (18.3% annualized). Small Denominated Deposits dipped $1.0 billion for the week. Retail Money Fund deposits declined $7.6 billion, and Institutional Money Fund deposits dipped $2.7 billion. Large Denominated Deposits gained $15.1 billion. Repurchase Agreements dropped $27.4 billion, while Eurodollar deposits added $1.4 billion.
Total Bank Credit dipped $13.2 billion to $6.156 Trillion (week of April 7). Bank Credit is up $270.6 billion during the first 14 weeks of the year, or 16.1% annualized. For the week, Securities holdings sank $33.1 billion. Loans & Leases jumped $19.8 billion, with Real Estate loans up $16.9 billion. Real Estate loans are up $113.4 billion y-t-d, or 19% annualized. For the week, Commercial & Industrial loans added $1.6 billion and Consumer loans dipped $0.9 billion. Security loans declined $7.4 billion. Elsewhere, Total Commercial Paper dipped $0.2 billion to $1.3217 Trillion. Financial CP increased $3.5 billion to $1.207 Trillion, while Non-financial CP declined $3.7 billion to $114.3 billion. Year-to-date, Total CP is up $53.2 billion, or 14.5% annualized.
Fed Foreign “Custody” Holdings of Treasury, Agency debt rose $4.3 billion. Year-to-date, Custody Holdings are up $113.6 billion, or 36.9% annualized.
Currency Watch:
The dollar index gained almost 1% this week, trading to its highest level since early December.
Commodities Watch:
April 15 – Market News (Gary Rosenberger): “Lumber prices are skyrocketing this spring on unusually strong demand from home builders -- along with a soft dollar and hefty duties against Canadian wood products -- that are keeping the domestic market tightly constrained… Framing lumber composite prices are up on the order of 35% from a year ago, while prices for some engineered products have essentially tripled, according to the latest data from Random Lengths, an industry publication”
April 15 – Bloomberg (Simon Casey): “Aluminum rose to an eight-year high on the London Metal Exchange as inventories fell and speculative investors increased their holdings amid forecasts that demand may exceed production. Inventories of aluminum stored in LME-monitored warehouses fell 0.8 percent to 1.2 million tons. The total has dropped 17 percent this year. Demand for the metal, which is used to make beverage cans and cars, is forecast to increase 4.7 percent this year to 21.7 million metric tons, outpacing production by 200,000 tons…”
Trading in many commodities has turned treacherous. Silver dropped from $8 to $7 in two sessions, before ending the week down 12% at $7.145. Curiously, the Goldman Sachs Commodities index ended the week down only 0.6%. May Crude oil was up about 2% to $37.74.
Asia Inflation Watch:
April 16 – Bloomberg (Rob Stewart): “China’s Vice Minister of Finance Li Yong said the government is concerned that credit growth is fueling inflation and may cause a buildup of bad loans at the nation’s banks. ‘Too high credit growth rate can result in inflation and asset price bubbles, generating new non-performing loans,’ Li said in a speech at the Institute of International Finance conference in Shanghai. 'The Ministry of Finance is very worried about that.’ Investment in steel, cement and aluminum is still rising, in defiance of government attempts to stem lending to overheated industries, according to Li. Total lending by Chinese banks rose 20.7 in the year to the end of March, the central bank said on Wednesday. ‘We are fully aware of the issues emerging in our economy,’ said Li, citing excessive growth of investment and increasing inflation pressure. ‘We should strictly control the start of new projects in certain sectors.’”
April 13 – Bloomberg (Lily Nonomiya): “Japanese wholesale prices rose in March for the first time in 44 months as a global economic recovery prompts companies including Nippon Steel Corp. to charge more. The corporate goods price index, which tracks goods bought by companies and the cost of electricity and other utilities, rose 0.2 percent from a year earlier, the first gain since July 2000. Import prices rose 2.3 percent, and export prices rose 1.3 percent, Bank of Japan figures in Tokyo showed.”
April 15 – Bloomberg (Tian Ying and Rob Delaney): “China’s economy grew a faster-than-expected 9.7 percent in the first quarter, and the government said its failure to curb investment and prevent shortages of raw materials was fueling inflation. The world’s sixth-largest economy barely slowed from growth of 9.9 percent in the fourth quarter from a year earlier, the National Bureau of Statistics said in a statement in Beijing. Consumer prices rose 3 percent in March from a year earlier, faster than the quarter's 2.8 percent average. ‘Irrational investments in redundant low-level construction projects in certain industries and selected areas have not been controlled effectively,’ bureau spokesman Zheng Jingping said.”
April 14 – Bloomberg (Tian Ying): “China’s household savings rose 18.3 percent from a year earlier to 11.2 trillion yuan ($1.35 trillion) at the end of March, the central bank said. Total lending increased by 913.1 billion yuan, or 20.7 percent, to 17.9 trillion yuan, the People’s Bank of China said… China’s broadest measure of money supply grew 19.1 percent in March to 23.2 trillion yuan, the statement said. Central bank Governor Zhou Xiaochuan said yesterday that M2 rose 19.2 percent last month…”
April 13 – Bloomberg (Rob Delaney): “China’s economic expansion will speed up in the first half, pushing full-year growth beyond the official 7 percent target, because the government hasn’t been able to slow new investment, Xinhua news agency reported. Growth will rise to 9.5 percent in the first quarter and to more than 10 percent in the second quarter, the report said, citing Xu Hongyuan, vice-director of the State Information Center’s Development and Research Department. Efforts to slow investment won't show up until the second half…”
April 14 – Bloomberg (Guy Faulconbridge): “Following are comments made by Russian Deputy Prime Minister Alexander Zhukov at a conference in Moscow. ‘The monetarization of the Russian economy has risen at an unprecedentedly high rate. A higher rate of monetarization is in my opinion rather dangerous for the Russian economy. The problem is not that there is not a sufficient amount of money in the economy; rather, the problem is finding a reliable borrower.’”
Global Reflation Watch:
April 15 – Bloomberg (Jonathan Rosenthal): “The average British adult’s credit card borrowing has increased 59 percent since 1999, heightening concerns that an increase in interest rates will cause bad debts to soar, Datamonitor research company said. The average adult’s card debt has risen to 1,140 pounds ($2,029) from 719 pounds in 1999…”
April 15 – Bloomberg (Duncan Hooper and Sam Fleming): “British manufacturing orders rose at their fastest pace in more than four years in the first quarter, suggesting the recovery in Europe’s second-biggest economy is taking hold, the British Chambers of Commerce said.”
April 16 – Bloomberg (Duncan Hooper): “U.K. wage growth accelerated to the fastest pace since August 2001 in the quarter through February amid falling unemployment and increased bonuses at service companies, reinforcing expectations for rising interest rates. Average earnings growth including bonuses jumped to 4.9 percent in the three-month period…”
April 15 – Bloomberg (Jason Gale): “Overseas racehorse buyers including Ricoh Co. executive Katsumi Yoshida, the Crown Prince of Dubai and a former U.K. champion jockey Pat Eddery helped spur a 41 percent surge in prices at Australia's Easter Yearling Sale. Prices at the three-day Sydney sale, the world’s third-biggest auction of year-old thoroughbreds, rose to a record average of A$204,736 ($150,819), from A$145,430 a year earlier, auctioneer William Inglis & Son said. Buyers from Japan, Hong Kong, Ireland and the United Arab Emirates bought more than 50 of the 370 lots. ‘It’s absolute dynamite,’ said John Messara, who sold 26 horses from his Arrowfield stables for A$7.8 million. ‘There were more international buyers, particularly from Japan. People are recognizing just what value is available down here compared with anywhere else in the world.’ Australia is the world’s biggest breeder of racehorses after the U.S., with the A$7.7 billion local industry supplying about 17 percent of the world’s foals. Recent sales suggest demand is rising. Average prices rose 39 percent at January’s Keeneland sale in Lexington, Kentucky. At England's Tattersalls yearling sale in October, Europe’s biggest, prices rose 28 percent.”
April 13 – Bloomberg (Amit Prakash): “Singapore’s economy expanded in the first quarter at almost twice the expected pace, led by exports, prompting the government to say full-year growth may exceed forecasts and to allow its currency to appreciate. Gross domestic product in the quarter ended March 31 grew an annual 11 percent from the previous quarter, compared with the 5.8 percent median growth forecast by 12 economists surveyed by Bloomberg. Export-led manufacturing had its biggest gain in 18 months. From a year earlier, the economy grew 7.3 percent.”
April 15 – Bloomberg (Amit Prakash): “Singapore’s retail sales in February surged 41 percent from a year earlier, more than twice the expected pace, suggesting an export-led recovery in the island’s economy is beginning to fuel domestic spending.”
April 15 – Bloomberg (Peter Wilson): “Venezuela’s economy will grow at least 10 percent in the first quarter as oil production recovers from a strike last year, said Finance Minister Tobias Nobrega. The expansion is being powered by higher oil output compared with the year-ago quarter when a nationwide strike slashed production, Nobrega told the state news agency Venpres.”
California Bubble Watch:
April 13 – Los Angles Times (Roger Vincent and Don Lee): “Home values in Los Angeles County posted the biggest year-over-year increase in at least 15 years in March as frenetic buying activity pushed the median sale price up 29%, to a record $375,000, according to data released Monday. Confounding predictions by the experts, sales were surprisingly strong, jumping 12% from a year ago to 10,875 new and resold houses and condos. Analysts and brokers said the heavy demand was driven by anxious consumers, many of whom are paying more than the asking price to get in the housing market before interest rates rise and supplies thin further. The inventory of houses available for sale has been at historical lows, and the latest flurry of purchases suggests that the market will only heat up as the busy home-buying season nears. ‘It’s going to be a total frenzy,’ said G.U. Krueger, an economist at the Irvine real estate venture capital firm IHP Capital Partners. John Karevoll, an analyst at DataQuick…was as surprised as anyone. ‘We’ve been expecting the rate of appreciation to ease back a bit. This is just the opposite.’”
April 13 – San Diego Union-Tribune (Roger M. Showley): “San Diego County’s housing market, far from settling down, heated up last month to reach a record median price of $424,000, up nearly 17 percent from the year-ago figure, DataQuick…reported yesterday. While price increases had moderated somewhat since mid-2003, a 4.4 percent increase from February’s median price of $406,000 was the biggest one-month jump since May 2003. The median price for single-family resale homes, which represent more than half the housing market, shot up 22.6 percent from March 2003 to a record $456,000. A combined increase of $31,000 in February and March this year was the highest two-month rise on record for single-family resale houses.”
U.S. Bubble Economy Watch:
April 16 – Market News (Steven K. Beckner): “Rep. Richard Baker, R-La., Friday reiterated his desire to eliminate federal subsidies of Fannie Mae and Freddie Mac that are widely seen as providing an implicit federal guarantee, but conceded the two massive government sponsored enterprises are ‘probably’ ... ‘too big to fail’ in the eyes of most of his congressional colleagues… Baker, who chairs the House Financial Services Committee on Capital Markets, Insurance and Government Sponsored Enterprises, continued his effort to reform the government sponsored enterprises Friday by urging a ‘forensic audit’ of mortgage financing giant Fannie Mae. Baker…also voiced concern that another major Wall Street scandal could have serious repercussions for financial markets at a time when many investors are getting back into equities. He also expressed concern about the dramatic growth of hedge funds. Baker was asked flatly if Fannie and Freddie are ‘too big to fail’ as far as the federal government is concerned. ‘In all likelihood, probably,’ he responded. ‘They have extraordinary power within the financial marketplace...and they still are extremely persuasive in the Congress. I can’t see today a mechanism whereby a reversal of market conditions would not be met rather quickly and directly by the Congress, not that I think that would be the appropriate remedy, but I do think it is political reality.’”
April 14 – Bloomberg (Kathleen M. Howley): “Mortgage Bankers Association, the
U.S. industry’s largest trade group, raised its forecasts for 2004 lending volume by 3.1 percent and home sales by 2.1 percent as interest rates remained near historic lows. Lending will rise to $2.57 trillion this year, making it the third-best on record, and sales of new and existing single-family homes will climb to 7.09 million, second to last year's 7.19 million, the Washington group said. A month ago, MBA projected $2.49 trillion in lending and 6.95 million home sales.”
April 14 – Bloomberg (Kathleen M. Howley): “Manhattan apartment prices surged to almost $1 million during the first quarter as the city emerged from a recession and Wall Street bonuses fueled real estate purchases in New York’s priciest borough. The average sale price for a condominium or a cooperatively owned apartment increased 11 percent to $998,905, a record, from $903,259 in the previous three months, according to a report by Miller Samuel Inc., a residential appraiser, and Douglas Elliman, a real estate brokerage. A condominium with four or more bedrooms cost $5.96 million and a studio $328,069… ‘We are knocking on the door of a $1 million average price,’ Paul Purcell, a real estate broker and co-owner of Braddock - Purcell, said in an interview. ‘I’ve always avoided the word ‘bubble,’ but I’m afraid it might be the right word to use when looking at this staggering increase in just one quarter.’… The average price per square foot climbed to an all-time high of $731, pushing up the price of a three-bedroom unit to $3.23 million, a two-bedroom to $1.54 million and a one-bedroom to $566,616.”
April 14 – Daily News (Lore Croghan): “To buy a home in New York, you practically have to be a millionaire. Prices of homes in all five boroughs have risen through the roof, with average selling prices going up as much as $220,000 from a year ago. Manhattan leads the way: The average sales price of an apartment in first-quarter 2004 rose 28.2 percent since a year ago to nearly $1 million... In Brooklyn, the average apartment price in first-quarter 2004 was $438,000, an 18 percent jump over last year, according to residential brokerage Corcoran Group. In Queens, the average price of apartment and single-family-home sales that closed last month in the borough was $355,200… That’s a 10 percent hike from the average in March 2003. Staten Island’s seen a 14 percent increase over the past year in the average price of apartments and single-family homes, to $291,428… In East Bronx neighborhoods including Throgs Neck, Pelham Bay and Morris Park, single-family-home prices average $350,000, up 10 percent to 20 percent in the past year…”
April 14 – Bloomberg (Josh P. Hamilton): “Consumer prices in the New York City area rose by 3.2 percent in the 12 months through March, almost double the national increase of 1.7 percent, as the cost of housing climbed, a government report showed. Rents jumped 4.3 percent and home ownership costs rose 3.9 percent over the year as the nation's largest city exited from a 2 1/2-year recession, according to data from the U.S. Bureau of Labor Statistics.”
April 13 – Baltimore Sun (Daniel Taylor): “The average sale price of homes in the Baltimore area jumped almost 20 percent last month, the highest year-over-year price increase in at least five years and another jolt to the region's torrid housing market. Sales of existing homes in Baltimore and its five surrounding counties jumped 10.62 percent to 3,354 compared with sales in March last year, according to figures released yesterday. The average sale price rose 19.96 percent to $221,812 compared with the price in March of last year…”
April 14 – Arizona Republic (Christine L. Romero): “More seniors wanting to boost their income are spurring the increasing number of reverse mortgages across the nation. The volume of federally backed reverse mortgages more than doubled to 12,848 nationally between October and February, compared with the year-earlier period.”
April 13 – Bloomberg (Aimee Picchi): “Viacom Inc.’s CBS television network will be able to boost prime-time advertising rates more than 10 percent for most of the commercials it sells for the television season beginning in September, network president Leslie Moonves said. Other networks’ ad rates will rise less than 10 percent, Moonves said at a press briefing to discuss the ‘upfront,’ an annual ad-sales market that begins May 17 where networks sell most of their commercial time. ‘Thursday night is where the most money is at stake,’ Moonves said. ‘We’re going to take a lot of the money.’ Ad pricing for the top four networks this year will rise an average of 7 percent, less than last year's 15.4 percent jump, as fewer people are watching TV, according to a report from Goldman Sachs analyst Anthony Noto.”
April 16 – Bloomberg (Scott Soshnick): “The Phoenix Suns were sold to an investor group led by Arizona native Robert Sarver, a real estate and banking executive, for a National Basketball Association record $400 million… The previous record price for an NBA team was $360 million, which an investor group paid for the Boston Celtics in 2002…”
March Housing Starts and Permits were both reported much stronger-than-expected this morning. At 2.007 million annualized units, new Starts were at the fastest pace since December, with the largest monthly increase in one year. Starts were up almost 15.2% from one year ago and up 29% from (pre-Bubble) March 1997. Building Permits were issued at a 1.946 million annualized pace, up 15.3% from March 2003. The number of homes under construction was up almost 17% from one year ago to the highest level in almost 25 years.
Tuesday’s big Retail Sales report – the largest monthly gain in 12 months - confirmed the strength of the current consumption boom. Retail sales were up 8.2% y-o-y. By category, notable gains included Motor Vehicles, Parts up 7.2% y-o-y, Furniture 9.8%, Electronics 10.9%, Building Materials 20.8%, Clothing 9.6%, Health, Personal Care 6.6%, General Merchandise 7.4%, and Eating, Drinking Establishments 11.1%.
March Consumer Prices rose at a stronger-than-expected 0.5%. CPI increased at a 5.1% annual rate during the first quarter. Price gains were broad-based. Transportation costs were up 1.1% for the month, Apparel 0.9%, and Medical Care 0.6%.
The February Trade Deficit was reported at a discouraging $42.09 billion. This was despite record Goods Exports of $65.06 billion, up 12.4% y-o-y. Goods Imports jumped 10.6% to a record $112.3 billion. Goods Exports would have to increase 72.6% to match Goods Imports.
U.S. Financial Sector Bubble Watch:
Countrywide Financial reported March Average Daily Application Volume of $2.455 billion, the strongest volume since last July. Total Fundings were up 25% from February to $32.3 billion, the strongest level since August. Purchase applications of $13.1 billion were up 42% from February and 39% from one year ago (“Refi” fundings down 32% y-o-y). ARM fundings amounted to 43% of total fundings, with volume up 138% from March 2003. Home Equity fundings were up 63% y-o-y and Subprime 111%. Countrywide bank Assets were up 178% y-o-y to $23.7 billion.
Another earnings season is upon us. As we examine results from the financial sector, we will be mindful of our adage, “An economy is how an economy lends (and speculates).”
Merrill Lynch reported record quarterly net earnings of $1.252 billion, up 95% from the year ago quarter. Global Markets and Investment Banking pre-tax earnings were up 49% to $1.1 billion. “All regions reported year-over-year and sequential-quarter net revenue increases.” Global Private Client pre-tax earnings doubled from a year ago to $510 million. Companywide Net Revenues increased 27% to $6.1 billion. “Asset management and portfolio service fees were $1.3 billion, up 17% from the first quarter of 2003.” “Commission revenues were $1.4 billion, up 27%...” “Principal transaction revenues were $1 billion, essentially unchanged…” “Net interest profit was $1.2 billion, up 33%...due primarily to a favorable yield curve environment and increased security lending activity.” “Investment banking revenues were $837 million, 70% higher than the year-ago quarter.” Compensation expenses were up 19% to $3.047 billion. Merrill repurchased 8.2 million shares during the quarter.
Bank of America reported first quarter earnings of $2.68 billion, up 11% from Q103. “Revenue grows 7%.” “Core deposits rise 11%.” “Consumer loans increase 20%.” Total Assets were up $79.6 billion, or 43% annualized, to $816.0 billion. Average Loans & Leases expanded at a 3% rate during the quarter and were up 8% y-o-y. Commercial Loans decreased at a 2% rate, the best performance in some time, but were down 8% y-o-y. Total Consumer Loans expanded at a 6% rate and were up 20% y-o-y. Residential Mortgages were up 25% y-o-y. Yet, for the quarter, the strongest asset growth was in the categories Trading Assets, Fed Funds Sold and “Repos”, and Debt Securities.
Trading Assets expanded at a 44% annualized rate to $105.0 billion, Fed Funds and “Repos” 71% annualized to $113.8 billion, and Debt Securities surged more than $40 billion during the quarter to $99.8 billion. On the liability side, Average Deposits expanded at a 16% annualized rate to $308.0 billion (up 14% y-o-y). Fed Funds & Repos surged $51.4 billion, or 135% annualized, to $203.4 billion, and were up 65% y-o-y.
Citigroup earned a whopping $5.27 billion during the first quarter, a 29% increase from the comparable year ago period. “Globally, managed card receivables increased 23%...” “Client assets for Private Client Services reached nearly $1.1 trillion, rising 23%.” “Revenue growth of 16%, as revenues reached a record $21.5 billion.” “In North America, cards income rose 35% to $832 million.” “Capital Markets and Banking Income was $1.48 billion, a 23% increase…” “Asia’s income was a record $599 million, increasing 49%.” “Latin America’s income of $274 million represented a 36% increase.” Japan’s income rose 14% to $265 million…” Total Assets expanded $53.8 billion during the quarter, a 17% annualized growth rate. Total Assets were up $180.9 billion year-over-year, or 16%. The asset “Investments” increased $20.4 billion, or 44.7% annualized, to $203.3 billion during the quarter, while “Federal Funds Sold and Securities Borrowed or Purchased under Agreements to Resell” increased $11.9 billion, or 28% annualized. Consumer Loans expanded at about a 4% rate to $383.7 billion, while Corporate Loans increased at a respectable 9.6% rate to $100.4 billion. Brokerage Assets surged $8.1 billion to $34.6 billion. On a year-over-year basis, Brokerage Assets were up 35%, “Fed Funds…” 16.5%, Trading 34%, Investments 11.9%, and Consumer Loans 15.4%. Corporate Loans were down 4.7% y-o-y.
SLM Corp (“Sallie Mae”) expanded assets by a record $8.7 billion during the first quarter to $73.3 billion, a 54% annualized growth rate. Total Assets were up $13.3 billion, or 44% annualized, over the past two quarters and were up 35% y-o-y.
Tightening Lite?
The Credit-induced “reflationary” boom and attendant inflationary forces (building for months) have finally captured the attention of the bond market. Apparently, the bond market now cares because it assumes the Fed cares. How much the Fed “cares,” at this juncture, is unclear. There is still no sign that a rate increase is imminent, with Fed officials seeming to signal this week that they would like to remain patient. I have no doubt they hope to remain patient.
And it has quickly become popular to compare the current environment to 1994. Certainly, there are meaningful similarities. Most notably, the Fed was in early 1994 significantly “behind the curve.” Artificially low short-term rates and a steep yield curve had induced enormous leveraged speculation. Furthermore, Credit market excesses were increasingly fueling unbalanced growth and heightened pricing pressures both at home and abroad.
As market analysts, however, there are some major differences between today and the waning days of the previous environment of prolonged monetary laxity. First of all, the degree of current excess is so beyond 1994 that it is difficult to draw reasonable comparisons. The hedge fund community is likely approaching 10 to 15 times the size of 1994. Wall Street proprietary trading positions have ballooned as well (Broker/Dealer assets are up 350% since the end of 1994). GSE assets have ballooned from about $630 billion to begin 1994, to recently surpass $2.8 Trillion. Government security dealer “repo” positions have surged from $766 billion to a recent high of $2.75 Trillion. There is, as well, the explosion of derivative positions since the fledgling days of derivative trading back in the early nineties. And while the frantic excesses of 1993 created liquidity to fuel a Bubble in Mexico (and, to a lesser extent, Latin America), today’s unprecedented liquidity excesses feed myriad Bubbles around the globe.
Systemic risk is today much, much greater than 1994 – domestically and for degenerate global financial systems and maladjusted economies. Importantly, the Fed recognizes as much. The Fed may have been naïve to the growing influence that leveraged speculation and derivative trading were playing in the marketplace back in 1994. Yet they are today exceedingly keen. We are forced to shape our analysis accordingly.
The Fed today faces a massive and endemic U.S. Credit Bubble unlike anything that existed during 1994. Worse yet, it’s gone global. While there were some excesses building, the environment from 10 years ago in few ways resembled today’s dangerously distorted U.S. Bubble economy. Our economy has basically suffered from more than a decade of cumulative monetary disorder. We ran a trade deficit of about $21 billion during the first quarter of 1994, something we accomplish these days in a couple weeks or so. The dollar was certainly on much more stable footing to begin the ’94 tightening cycle. Foreign dollar holdings were a fraction of what they are today.
It is also worth noting that Household Mortgage Debt (HMD) increased $183.5 billion during 1994 (5.8% growth rate), with three-year (‘92-94) expansion of $515.5 billion (18%). In comparison, HMD surged $820 billion during 2003 (12.7% growth rate), with a three-year increase of almost $2.1 Trillion (40%). There was no Mortgage Finance Bubble back during 1994, and there were no California or East Coast housing Bubbles. Prior to the Fed raising rates a decade ago, there had been no major surge in adjustable-rate mortgages. Interest-only mortgages and 100% financing options were considered reckless. Twenty percent down-payments were commonplace, especially for GSE “conventional” loans. Down-payment “assistance” programs had yet to be contemplated.
Thus, it is reasonable to assume that the Fed will approach this rate-tightening cycle with extreme caution – extra-soft kid gloves and ultra-baby steps. They will surely err on the side of waiting and watching. And when they do move, I would not be surprised if the Fed attempts to signal to the markets their intention of implementing some type of a cap on how high the Fed intends to move rates. Extraordinary effort will be taken to avoid the 1994 dilemma where the de-leveraging bond market was forcing the Fed’s hand – each rate hike had the marketplace seemingly discounting only more tightening and the Fed, perceivably, always lagging the markets. Governor Bernanke and others would today love to implement an “inflation targeting” monetary mechanism that would allow the Fed to signal the need to increase rates – in the context of the current inflation rate – perhaps in the range of 2% to 2.5%. I expect the Fed to go to extraordinary measures to appease the leverage players, with the specific purpose of avoiding a 1994-style de-leveraging. The Fed’s goal will be Tightening Lite.
The problem is that Tightening Lite is just not going to cut it. There are historic financial excesses and economic distortions that require tough medicine. Gradualism from the Fed will only prolong this most dangerous “terminal” phase of Credit Bubble excess. Curiously, I have yet to hear much talk of the Fed orchestrating the storied “soft landing.” Well, I would argue that gradualism, in the face of current domestic and global financial and economic maladjustment, equates with an only more problematic hard landing. And the clock is ticking rapidly.
I would today argue that the two key issues are extreme Credit Availability and Bubble Dynamics, and both are likely immune to a few “baby steps” from the Fed. Granted, the entire U.S. Credit system is vulnerable to de-leveraging and dislocation. And all bets are off if market rates surge significantly higher from here. But we should remain mindful of the power of Bubble dynamics and the extraordinary institutional and governmental support for boom perpetuation.
We can, as well, look to the economies and housing markets in England and Australia for evidence as to the resiliency of Bubbles to moderate interest rate increases. If Credit is easily available, somewhat higher rates will not dissuade eager borrowers – especially when borrowing to acquire rapidly appreciating assets!
I expect that rates will need to move considerably higher here in the U.S. to dampen what has evolved to manic enthusiasm for real estate, especially out in California and all along the East Coast. It is worth recalling that the Fed raised rates 25 basis points to 5.0% in June 1999. The Fed came back with 25 basis points more in August and another 25 in November. In February 2000, the Fed hiked rates 25 basis points more to 5.75%, then raised another 25 the next month. In the process of the Fed hiking rates 125 basis points over about nine months (to 6%), the NASDAQ100 more than doubled. Bubble dynamics are powerful, and this is specifically why it is imperative for central banks to be vigilant. They must be on guard and determined to quash Bubbles early, and they must be resolved to avoid “falling behind the curve.” Our Fed has failed miserably on both counts, and there will be a high cost to pay.
I certainly don’t see this week’s 3.67% one-year adjustable rate out in the West discouraging prospective California home buyers. And, for now, I would be surprised to see any meaningful moderation in overall mortgage debt growth. As such, I will err on the side of expecting the current consumption boom/Bubble to run hot for a bit. If this proves to be the case, massive trade deficits will be unrelenting, foreign central bank dollar purchases will be necessarily unrelenting, global liquidity excesses will prevail, and this unsound global inflationary boom will survive to create only more precarious financial and economic fragility.
And an over-liquefied global financial system – if sustained – would continue to provide a powerful counterbalance to Chinese authorities’ efforts to rein in their historic boom. Again, Bubble dynamics are powerful and we are in the midst of a global Credit Bubble unlike anything previously experienced. It is no coincidence that the historic American and Chinese booms run concurrently, a dynamic that will now further complicate and already complex dilemma for respective monetary authorities.
There is a view today that the hedge funds have fueled Bubbles throughout various commodity markets, leaving commodities especially vulnerable to a major bust in the event of tightening global liquidity conditions. Such thinking may certainly have merit. However, I recall (and was sympathetic to) similar analysis going back a decade to when the hedge funds were taking large leveraged positions in the bond market. Well, speculators became only more enamored with bonds each passing year.
My hunch is that speculative interest, having returned to commodities after a long hiatus, will not prove a flash in the pan. And, importantly, the size of the global pool of speculative finance has absolutely mushroomed over the past decade. I expect many commodities will only become more enticing over time, as the dollar and currencies devalue and financial asset prices decline. At the same time, I fully expect that wild volatility is here to stay – Markets Governed by The Law of the Jungle. And unpredictable price behavior should only continue to encourage end-users to stock larger inventories and hedge exposures. Market psychology has been altered; inflation psychology has taken hold and speculative dynamics are only one aspect of this fascinating development. I would expect Tightening Lite to be constructive for commodities.
But how about the dollar? Higher rates would surely help support our vulnerable currency. Yet it is my view that what really weighs on the dollar’s intermediate and long-term prospects is the massive inflation of non-productive dollar claims and the attendant liquidity that flows incessantly abroad. And I am essentially to the point where I will assume that nothing short of financial crisis will interrupt this inflation. Sure, currency markets will be prone to violent moves and the type of erratic ebb and flow associated with indecision and aggressive speculative trading. Especially with the massive amount of hedging taking place these days, we should not be surprised if these “ebbs and flows” are at time astonishing.
I could be wrong on all this. Perhaps the Fed can succeed in tempering Credit and speculative excess just enough without precipitating the bursting of myriad Bubbles (bond market, equities, mortgage finance, housing construction, general economy, etc.). I just don’t see how it’s possible. And I fully expect the Fed to err on the side of caution – Tightening Lite. Yet Tightening Lite is not tightening at all. Rather, it is really only more of the same – easy money and the wholesale acquiescence of lending excess, leveraging, asset inflation and endemic financial speculation. Being so far behind the curve and staring unprecedented risk eye-to-eye, it’s going to take some real guts and determination to rein things in. I’ll believe it when I see it.
