For the week, the Dow dropped 1.7%, and the S&P500 sank 2.6%. The Transports fell 2.4%, and the Morgan Stanley Cyclical index dropped 2.5%. The Utilities were hit for 2.9%, and the Morgan Stanley Consumer index declined 1.6%. Many of the favorites came under heavy selling pressure this week. The small cap Russell 2000 sank 5%, and the S&P400 Mid-cap index lost 3.3%. Technology stocks were battered. The NASDAQ100 fell 4.6%, and the Morgan Stanley High Tech index dropped 5.9%. The Semiconductors were hammered for 7%. The Street.com Internet Index fell 3.3%, and the NASDAQ Telecommunications index dropped 6.2%. The Broker/Dealers sank 5.6%, and the Banks declined 2.4%. Although bullion surged $31.00, the HUI Gold index declined 3%.
For the week, two-year Treasury yields jumped 7.5 bps to 5.01%, and five-year yields rose 10 bps to 5.08%. Bellwether 10-year yields gained 9 bps to 5.19%, a high since May 2002. Long-bond yields surged 11 bps to 5.30%. The 2yr/10yr spread added one basis point, ending the week at a positive 18 bps. Benchmark Fannie Mae MBS yields rose 8 bps to 6.26%, trading about in line with Treasuries. The spread on Fannie’s 4 5/8% 2014 note ended the week one wider at 25, and the spread on Freddie’s 5% 2014 note one wider to 27. The 10-year dollar swap spread was little changed at 52.0. Corporate bond spreads were stable. The implied yield on 3-month December ’06 Eurodollars rose 2 bps to 5.36%.
May 11 – Financial Times (Jennifer Hughes): “Highly rated companies have raised record amounts from the US debt market so far this year, outstripping bankers’ expectations as executives seek to fund takeover activity and refinance old debt coming due. Companies have issued more than $312bn in high-grade bonds, according to data from Thomson Financial, beating the previous record, in 2001, of $271bn… If the current borrowing rate continues, high-grade issuance could reach a record for the full year, beating the 2004 peak of $689bn. Last year, total issuance was $674bn.”
It was a huge week of corporate debt issuance. Investment grade issuers included Abbott Labs $4.0 billion, Merrill Lynch $2.0 billion, JPMorganChase $1.75 billion, Citigroup $1.5 billion, Wells Fargo $1.5 billion, Countrywide Financial $1.0 billion, UBS $1.0 billion, Lincoln National $800 million, Simon Properties $800 million, Lehman Brothers $750 million, Toyota Motor Credit $750 million, Union Bank of California $700 million, Hartford Financial $690 million, Dean Foods $500 million, Chubb Corp $460 million, American Express $400 million, Harvard $400 million, Burlington Northern $350 million, Pacific Life $350 million, Genworth Global $300 million, Ace Ina Holdings $300 million, DaimlerChrysler $250 million, Questar $250 million, Tampa Electric $250 million, and Jersey Central Power & Light $200 million.
Junk issuers included Embarq $4.5 billion, Amkor Tech $400 million, Plains All America Pipeline $250 million, CCSA Finance $250 million, Dobson Cellular $250 million, Gallery Capital $175 million, Transtel $170 million, and Amerus Group $140 million.
Convert issuers included Sandisk $1.15 billion, JDS Uniphase $375 million, Manor Care $250 million, Broadwing Corp $150 million and Merix Corp $60 million.
Foreign dollar debt issuers included KFW $3.0 billion, Kaupthing Bank $1.25 billion, Russ Agric Bank $700 million, and Sagicor Financial $150 million.
Japanese 10-year JGB yields jumped 6 bps this week at 1.98%. The Nikkei 225 index fell 3.2% (up 3.0% y-t-d). German 10-year bund yields rose 8 bps to 4.08%. Emerging debt markets took it on the chin, while equities were down but generally resilient. Brazil’s benchmark dollar bond yields surged 34 bps to 7.05%. Brazil’s Bovespa equity index declined 2.9%, reducing 2006 gains to 20%. The Mexican Bolsa traded to a new record high, before ending the week down 0.4% (up 18.8% y-t-d). Mexico’s 10-year $ yields jumped 13 bps to 6.25%. Russian 10-year dollar Eurobond yields rose 9 bps to 6.85%. The Russian RTS equities index declined 2.5%, lowering 2006 gains to 49% and 52-week gains to 160%. India’s Sensex equities index slipped 0.6% (up 30.7% y-t-d).
May 9 – Financial Times (Tony Tassell and Neil Dennis): “World equities jumped to a record high on Monday on expectations that the current cycle of US interest rate increases was approaching an end. The MSCI All Country World Index hit a new high of 349.06, passing the previous record of 349.04 struck at the height of the dotcom equity bubble in March 2000. Monday’s rally was led by surging Asian markets, which rose on continued strong earnings news across the region… The index, widely followed by global fund managers as a benchmark for their portfolios, has rallied 105.2 per cent from its bear market low of 169.48 struck on October 9, 2002… Emerging and non-US developed markets have been the main driver of the overall rally in global equity markets. While the S&P 500 index…has risen 70 per cent from its October 9, 2002 nadir the MSCI Emerging Markets Index has powered ahead 241 per cent over that period. The trend has continued in the current year with a 23.2 per cent rise in the MSCI Emerging Markets index…”
Freddie Mac posted 30-year fixed mortgage rates slipped one basis point to 6.58%, up 81 basis points from one year ago. Fifteen-year fixed mortgage rates declined 5 bps to 6.17%, 84 bps higher than a year ago. One-year adjustable rates fell 5 bps to 5.62%, an increase of 139 bps over the past year. The Mortgage Bankers Association Purchase Applications Index dropped 3.9% last week. Purchase Applications were down 20.7% from one year ago, with dollar volume down 18.2%. Refi applications dropped 8.8% last week. The average new Purchase mortgage rose modestly to $232,100, while the average ARM increased to $347,500.
Bank Credit surged another $24.9 billion last week to a record $7.851 Trillion, with a blistering y-t-d gain of $345 billion, or 13.3% annualized. Over the past year, Bank Credit inflated $781 billion, or 11.1%. For the week, Securities Credit jumped $17.6 billion. Loans & Leases gained $7.4 billion for the week, with a y-t-d gain of $190 billion (10.1% annualized). Commercial & Industrial (C&I) Loans have expanded at a 17.5% rate y-t-d and 15.0% over the past year. For the week, C&I loans gained $6.6 billion, and Real Estate loans added $5.5 billion. Real Estate loans have expanded at a 10.6% rate y-t-d and were up 12.8% during the past 52 weeks. For the week, Consumer loans dipped $2.4 billion, and Securities loans slipped $0.1 billion. Other loans were down $2.1 billion. On the liability side, (previous M3 component) Large Time Deposits jumped $9.7 billion.
M2 (narrow) “money” supply declined $15.6 billion to $6.795 Trillion (week of May 1). Year-to-date, M2 has expanded $105 billion, or 4.5% annualized. Over 52 weeks, M2 has inflated $305 billion, or 4.7%. For the week, Currency added $1.7 billion. Demand & Checkable Deposits fell $16.7 billion. Savings Deposits slipped $0.9 billion, while Small Denominated Deposits gained $2.6 billion. Retail Money Fund deposits fell $4.2 billion.
Total Money Market Fund Assets, as reported by the Investment Company Institute, rose $5.9 billion last week to $2.044 Trillion. Money Fund Assets are down $13 billion y-t-d, with a one-year gain of $171 billion (9.1%).
Total Commercial Paper declined $2.3 billion last week to $1.760 Trillion. Total CP is up $110 billion y-t-d, or 18.3% annualized, while having expanded $275 billion over the past 52 weeks, or 18.5%.
Asset-backed Securities (ABS) issuance this week increased to $11 billion. Year-to-date total ABS issuance of $243 billion (tallied by JPMorgan) is running slightly behind 2005’s record pace, with y-t-d Home Equity Loan ABS sales of $176 billion 8% above last year.
Fed Foreign Holdings of Treasury, Agency Debt (“US marketable securities held by the NY Fed in custody for foreign official and international accounts”) jumped $9.2 billion to $1.621 Trillion for the week ended May 10th. “Custody” holdings are up $102 billion y-t-d, or 18.4% annualized, and $222 billion (15.9%) over the past 52 weeks. Federal Reserve Credit increased $1.6 billion last week to $825 billion. Fed Credit has declined $1.7 billion y-t-d, or 0.6% annualized. Fed Credit expanded 4.9% ($38.2bn) during the past year.
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – are up $348 billion y-t-d (23% annualized) and $552 billion (14.4%) in the past year to a record $4.394 Trillion.
May 11 – Bloomberg (Alan Purkiss): “Foreign-exchange reserves of Asian countries apart from China rose last month by more than $38 billion, to $2.84 trillion, the Wall Street Journal reported…”
May 11 – Bloomberg (Bradley Cook): “Russia’s foreign currency and gold reserves, the world's fourth largest, surged $5.4 billion in a week to a record amid higher prices for oil and natural gas, the country’s biggest exports. The reserves climbed to $231.1 billion…”
The dollar index dropped 1.3% to the lowest level since March 2005. On the upside, the Swiss franc surged 2.5%, the Norwegian krone 2.3%, the British pound 1.9%, the Danish krone 1.7%, and the Euro 1.7%. On the downside, the Turkish lira fell 6.8%, the South African rand 3.8%, Brazil’s real 3.3%, the Colombian peso 2.1% and the Mexican peso 1.5%.
May 9 – Dow Jones: “China plans to start building strategic reserves for uranium, iron, copper and other key mineral resources, and accelerate the construction of strategic petroleum and coal reserves as part of the government’s official five-year plan, said the Ministry of Land and Resources. The ministry is targeting adding proven reserves of 4.5 billion-5.0 billion metric tons of oil, 2 trillion-2.25 trillion cubic meters of natural gas, 100 billion tons of coal, 5 billion tons of iron, 20 million tons of copper and 200 million tons of bauxite by 2010.”
May 9 – Bloomberg (Saijel Kishan): “Citigroup Inc., the world’s largest bank by market value, plans to almost double staff at its commodities-trading unit worldwide as competition increases on Wall Street for a greater share of growing energy and metals markets... ‘Our goal is to take what we do in interest rates, foreign exchange and credit risk and apply it to commodities,’ said John Casaudoumecq (global head of commodities), who is also global head of fixed income at… Citigroup. ‘We are in a long-term commodities cycle, which may last 15 to 20 years.’”
Gold surpassed $720 (26-year high), before ending the week up 4.5% to 714.80. Silver rose 2.5% to $14.24. Copper surged 10.6% to another record high. June crude gained $1.85 to $72.04. June Unleaded Gasoline jumped 6.8%, while June Natural Gas dropped 7.3%. For the week, the CRB index jumped 2.8% (y-t-d up 9.0%), trading to a new record high yesterday. The Goldman Sachs Commodities Index (GSCI) surged 4.1%, increasing y-t-d gains to 14.0%, also an all-time high yesterday.
May 11 – Bloomberg (Lily Nonomiya): “Japan’s bank lending had the biggest increase in more than nine years as companies borrowed in anticipation that the Bank of Japan is preparing to raise interest rates. Loans climbed 1.2 percent in April from the same month a year earlier, the biggest gain June 1996 and the third straight increase…”
May 9 – Financial Times (David Pilling): “The market value of some golf memberships in Japan, a keenly watched proxy for property prices and economic activity, has soared in recent months, sparking talk of a mini-bubble. The stirring of golf course membership fees after years in the deflationary bunker coincides with evidence that land prices, which have been falling since the economic bubble burst in 1990, could finally be rising again. According to Bank of Japan weighted-average estimates, released yesterday, the total value of land in the country rose 1.4 per cent in calendar 2005, the first increase in 15 years. Keen watchers of golf fees, which are actively traded on the secondary market, had already noticed a flurry of activity. The price of membership at the Yokohama Country Club, for example, more than doubled in the first four months of this year alone, from Y5.6m ($50,000) to Y13.5m yesterday…”
May 8 – Bloomberg (Samuel Shen): “China’s retail sales jumped 16 percent from a year earlier to 278 billion yuan ($34.7 billion) during the week-long May holiday, as consumers increased spending on home appliances, cars and travel, the Ministry of Commerce said.”
May 9 – Bloomberg (Allen T. Cheng): “Chronic diseases will cost China $558 billion in health spending and lost productivity in the coming 10 years, roughly equivalent to a quarter of its current annual gross domestic product, the World Health Organization said today.”
May 11 – UPI: “China is facing a serious shortage of nurses as the demand for medical services rises, the Ministry of Health has warned. Ministry spokesman Mao Qun’an said at a press conference that the problem is becoming more serious as China’s population ages… At the end of 2005, there were approximately 1.35 million nurses in China, or one nurse to every 1,000 residents… The World Health Organization standard is one to 500.”
Asia Boom Watch:
May 11 – Bloomberg (Jacob Greber): “Inflation in India may accelerate to about 5 percent this year as energy costs increase, Yaga Venugopal Reddy, [said the] governor of the country’s central bank… ‘Last year prices increased by a little less than 4 percent…”
May 8 – Bloomberg (Theresa Tang): “Taiwan’s exports rose at the fastest pace in four months in April as the island’s electronics makers boosted sales to the U.S., China and Europe. Overseas sales jumped 15 percent from a year earlier…”
May 9 – Bloomberg (Wahyudi Soeriaatmadja): “Indonesia’s economic growth may accelerate to 6.4 percent next year as lower interest rates boost consumer spending and foreign investment increases, Coordinating Minister for Economic Affairs Boediono said.”
May 10 – Bloomberg (Francisco Alcuaz Jr.): “Philippine exports rose in March at the fastest pace in more than six years as companies shipped more electronics. Overseas sales increased 25.8 percent from a year earlier to $4.1 billion, the National Statistics Office said in Manila today. That’s the fastest pace since October 1999…”
Unbalanced Global Economy Watch:
May 10 – Bloomberg (Alexandre Deslongchamps): “Canadian new-home prices rose 7.6 percent in March from a year earlier, the biggest increase since 1990, led by Calgary, where demand was spurred by workers coming from other provinces to work in Alberta’s booming oil industry.”
May 9 – Bloomberg (Simone Meier): “German industrial production dropped in
March… Output fell 2.4 percent, the biggest decline since February 1999, after increasing 1 percent in the previous month…”
May 11 – Bloomberg (Fergal O’Brien): “Ireland’s annual inflation rate rose to a three-year high in April, which may stoke demands for higher wage increases from labor unions at national pay talks. Inflation, gauged by an Irish measure, accelerated to 3.8 percent from 3.5 percent in March…”
May 11 – Bloomberg (Jacob Greber): “Swiss consumers were more optimistic in April than at any time since July 2001, as an economic expansion and falling unemployment eased concern about job security.”
May 10 – Bloomberg (Jonas Bergman): “Swedish apartment prices rose 23 percent in March from the same month last year amid a drop in supply and accelerating economic growth. The average apartment price increased to 1.04 million kronor ($142,387) from a year earlier…”
May 10 – Bloomberg (Jonas Bergman): “Swedish unemployment in April fell for a third consecutive month…. The jobless rate, without adjustment for seasonal factors, fell to 4.6 percent from 4.8 percent…”
May 10 – Bloomberg (Harry Papachristou): “The Greek economy accelerated in the first three months of 2006 as new laws helped investment rebound from a slump last year, the country’s economy minister said. Gross domestic product expanded ``close to 4 percent' from a year earlier…”
May 9 – Bloomberg (Tracy Withers): “New Zealand’s wages rose 0.7 percent in the first quarter as a jobless rate close to a record low put pressure on employers to pay more, boosting the spending power of workers.”
Latin America Watch:
May 10 – Bloomberg (Andrea Jaramillo): “Colombia’s exports rose 22 percent in February, the statistics agency said.”
Bubble Economy Watch:
May 10 – Bloomberg (Sree Vidya Bhaktavatsalam and Mike Schneider): “Rents for U.S. offices and apartments will rise faster than inflation over the next three to four years as the economy expands and mortgage rates increase, said Sam Zell, the billionaire real estate investor. Office rents may rise 7.5 percent a year on demand from companies adding employees, Zell, 64, said today in an interview. Apartment rents may climb 6 percent to 7 percent annually… ‘We’re in a situation right now where we’ve come through three years of low rents… It’s going the other way as occupancy is increasing across the country in response to a strong economy.’”
May 10 – Bloomberg (Greg Bensinger): “New Yorkers who haven’t already lined up a summer place in the Hamptons may be in for disappointment. The choicest houses were booked by March, at least a month earlier than in previous years, leaving latecomers to pick among smaller homes in less desirable locations… The Hamptons, where a three- month rental can cost more than $600,000, is the enclave of Wall Street executives, movie stars and socialites… In past years, vacationers began looking for summer rentals in late January and February and could expect to rent a home of their choice as late as mid-April, says Peter Turino, 54, principal broker for Brown Harris Stevens… ‘With the record bonuses on Wall Street, as there were this year, homes in the range of $400,000 or $500,000 for the summer go very fast.’”
May 10 – MarketNewsInternational (Claudia Hirsch): “U.S. import volumes rebounded in March, as Asian shipments returned to the West Coast following lunar New Year celebrations… Nationally, import volumes rose more than 13% in March vs. the same month of 2005, according to PIERS, a leading source of waterborne data. Export volumes expanded nearly 5% in March vs. a year ago…”
May 9 – Bloomberg (Bob Willis): “More U.S. companies expect prices to rise this year… a survey by the Institute for Supply Management showed… Seventy-four percent of manufacturing executives expect higher prices by the end of the year, up from 71 percent in the last survey taken in December…”
May 11 – Bloomberg (James Gunsalus): “Boeing Co., the world’s second-largest commercial-jet maker, raised the average list price of its airliners by 4 percent… Prices rose on all models… The increases reflect a rise in costs for manufactured parts used to make airliners…”
Financial Sphere Bubble Watch:
May 11 – Bloomberg (Erik Schatzker): “Merrill Lynch & Co., preparing for its biggest expansion since the 1990s, plans to buy a mortgage lender, triple its corporate investments and increase trading bets to boost shareholder returns that trail those of rivals. Merrill’s top managers spent the past six months determining how to spend ‘excess capital,’ Chief Administrative Officer Ahmass Fakahany said…”
Mortgage Finance and Real Estate Bubble Watch:
May 9 - Freddie Mac May 2006 Economic Outlook: “…Home sales are…expected to decline 7% in 2006 from 2005’s record levels… Our current estimate for home price appreciation in 2006 is 7.5%... Higher mortgage rates are expected to curtail mortgage refinance originations by nearly one-third, while home-purchase originations should be about the same or slightly higher than in 2005. Overall, originations are expected to decline 14% in 2006 to $2.4 trillion. Mortgage debt outstanding is expected to increase 12.5% over the year, reflecting still strong but lower home sales, solid house price appreciation and high cash-out refinance activity.”
May 12 – EconoPlay.com (EconoPlay): “The housing market slowed sharply in April as mortgage rates climbed to near four-year highs, homebuyers took to the sidelines to await the next fire sale, and more “for sale” signs sprouted up as investors abandoned real estate for greener pastures, home builders say. Some publicly traded builders are changing tack, vowing to beef up revenues by increasing community counts and focusing on volume sales in lieu of high-margin MacMansions. Others are pulling back to please jittery shareholders… Either way housing starts could remain fairly elevated in a down market. Every place reported sluggishness but for Texas and North Carolina, and flat-out depreciation is occurring in once-hot markets like Florida and California. Elsewhere, the Northeast and the Midwest are “spotty,” and Arizona saw some gains stemming from Florida’s newfound reputation as Hurricane Central.”
May 10 – New York Times (Michael Pollick): “Until the summer, investors were crawling over each other trying to get their hands on Southwest Florida homes. In some cases, their plans were haphazard, built on heavily marketed low-interest loans with escalation clauses, or marked by a lack of attention to what the carrying costs would be, or how much of their costs would be covered by rent. Now that lemminglike rush seems to be operating in reverse. Listings are stacking up, prices are going flat and words that haven't been heard much in some time are being spoken: ‘non-performing loans’ and ‘foreclosures.’”
Energy and Crude Liquidity Watch:
May 9 – Financial Times (Andrew Ward): “North America’s two largest railway operators have agreed a $100m expansion of the line serving Wyoming’s Powder River Basin coal fields, amid surging demand for the fossil fuel. Union Pacific and BNSF have come under fierce pressure from the power industry to tackle rail bottlenecks that have left some power stations short of coal over recent months. Rail operators are struggling to cope with a resurgence in demand for coal in the US, as soaring natural gas prices have caused power companies to revert to traditional fuel sources.”
Fiscal Deficit Watch:
May 9 – San Francisco Chronicle (Kathleen Pender): “Internet giant Google’s stock has soared since it went public almost two years ago -- and that has created a windfall for state government coffers. California took in a record $11.3 billion in personal income tax receipts in April, $4.3 billion more than it collected last April. It’s almost certain that a significant chunk of April’s haul came from Google employees…”
May 10 – Bloomberg (Brett Cole): “Thomas H. Lee Partners LP plans to raise $9 billion for its sixth and biggest buyout fund, 20 percent more than an initial target set about a year ago... The industry may attract a record $170 billion for new funds this year, according to estimates from Private Equity Intelligence Ltd.”
Today’s Financial Times headline read, “Greenback undermined by unlucky combination of events.” Bad luck has nothing to do with the dollar’s predicament. Financial, economic, and policymaking trends have been in place for years that will culminate in a dollar crisis. It’s more likely a fortuitous combination of factors has held the dollar together for this long.
We are all witnessing first hand an extraordinary period in financial market history. A strong case can be made that global asset-market speculation has gone to a whole new level of extremes from that experienced in the late-nineties, yet the amount of skepticism, concern, and foreboding these days is a fraction of what prevailed during the technology boom. And while U.S. Credit system and Bubble economy excesses have reached a point unimaginable back during the 1998-2000 precursor-Bubble, there is today virtual unanimity that underlying U.S. and global fundamentals are exceptionally strong and sustainable. There is today virtually no talk of a Bubble.
During what was a most unimpressive dollar bear market, the Pollyanna notion of a sustainable Bretton Woods II global monetary “regime” became all the rage. Others spoke eloquently about economic “dark matter” and benign U.S. Current Account Deficits. Similarly, the idea that U.S. and global yields would indefinitely be pressed lower by a “global savings glut” took (our new Fed chairman and) the world by storm. So far this year, 10-year Treasury yields have jumped 80 basis points to the highest level since May 2002. Over this period, the dollar index has declined about 7%. It should be noted that, as the dollar index sank from 120 to 93 between early-2002 and mid-2003, bond yields collapsed from 5.4% to a low of just above 3%.
Through much of the dollar bear market, U.S. bonds continued to generate decent returns. Of late, however, Treasuries and the dollar have been locked together in poor performance, in the process slapping our distended foreign creditors with stinging losses. Not since turbulent 1994 have the markets had to deal with an extended period of simultaneous dollar and bond market weakness. Not for 25 years have U.S. securities suffered such acute relative underperformance to gold, oil, and other global commodities. Additionally, U.S. stocks are now well into their second year of major underperformance versus global equities. The reality and ramifications of U.S. securities as an out of favor asset class are now just beginning to sink in.
I’ve always assumed that behind closed doors the Fed frets about the dollar. I’ll be the first to admit I lack even a little shred of supporting evidence. But I just assume… There are, however, too many anecdotes that they worry little if at all. As part of the FOMC announcement panel discussion on CNBC, former Dallas Fed president Robert McTeer stated, “I don’t think they’re (the FOMC) worried about the weak dollar. I think we may need a weak dollar and even weaker for awhile.” If the Bernanke Fed is at this point actually seeking a weaker dollar, their burgeoning credibility problem quickly becomes irreversible.
For good Reason, markets today believe the Administration and suspect the Bernanke Fed are decidedly in favor of a weak dollar policy. There remains a steadfast view that a gradually devalued dollar will work toward rectifying U.S. imbalances, despite the reality that imbalances have worsened measurably over the four-year dollar drubbing. Everyone wants to believe that an orderly decline in the dollar poses few problems. And after four years of an extraordinarily orderly fall, few see any Reason for an abrupt shift to disorderly. But there are Reasons.
For one, do not downplay that importance of Wall Street having had four fruitful years to develop instruments, products, derivatives and strategies to generate heady profits (for clients and themselves) from a declining dollar. As I have written previously, a strong inflationary bias has developed in non-dollar asset classes – the emerging markets, commodities, metals, global private-equity, and global equities and securities generally. The global leveraged speculating community is infatuated with the “un-dollar” trade. And, increasingly, U.S. institutions and individuals combine for huge and escalating flows from dollars to better-performing global asset classes. Any policy shift from “benign neglect” to “weaker dollar” would at this point be playing with (a disorderly) fire.
And there’s another key Reason why the four-year period of “orderly” might be winding down: marketplace perceptions of unending U.S. Credit excess. While there are deep structural issues, the root cause of the dollar’s problem is the excessive dollar liquidity creation and incessant outbound flow to the Rest of World. This liquidity excess largely emanates from an overheated U.S. Credit system that cannot cool. And for the past four years, the Credit Bubble has been dominated by the mortgage finance Bubble. There has been a perception in the markets that U.S. Credit and liquidity excesses would be sharply curtailed with the inevitable bursting of the housing Bubble. Less marketplace liquidity and household consumption would have been supportive of the dollar – would have.
Today, however, there is increased recognition of the manifestation of myriad other sources of heightened Bubble Economy Credit expansion – the expansive energy sector, commodities, capital goods investment, commercial real estate, booming services, M&A, equity and asset market inflation, derivatives and the global Credit Bubble generally (Classic Credit Bubble Inflationary Bubble Propagation). Bank Credit has accelerated to a 13% annualized y-t-d growth rate, and total Credit growth is likely proceeding at record pace. It is also becoming apparent that, despite slowing home sales and a developing mess in key markets, the system is on track for another huge year of mortgage Credit growth. Freddie Mac economists this week predicted 12.5% mortgage debt growth for the year. As for gross dollar liquidity excess and its propensity to flow abroad, there is today simply no end in sight.
And there is little doubt in my mind that the dollar’s drop would have some time ago turned disorderly if not for the yeoman’s work of foreign central banks. Derivatives markets, in particular, function swimmingly with a backstop of unlimited liquidity. As long as traders employing dynamic hedging strategies - in this case, contemporaneously selling dollars to hedge underlying derivative risk – can readily offload unbounded dollar exposure to foreign central banks, there is Reason for hope that the dollar decline might remain orderly. But not only are central banks loaded with dollars after four years of unparalleled support, these positions are losing nominal value and significant relative value to other tangible assets (notably gold, metals, energy and commodities).
If foreign central bankers are not losing patience losing “money,” perhaps they are tired of being Washington’s whipping boy. There is also Reason to presume that Asian central bankers are increasingly concerned by the unwieldy liquidity inundating their region, as well as heightened inflationary pressures. By now, they should clearly recognize the relationship between ballooning holdings of dollar securities and the global surge in energy, commodities and asset prices/Bubbles.
Financial flows are always a fundamental aspect of Macro Credit Analysis. With this in mind, there is today the distinct possibility for a confluence of ongoing massive U.S. Current Account Deficits; increasing speculative flows from the U.S. to the world; and heightened dollar selling (foreign currency buying) by the trend-following leveraged speculators and derivatives traders. Even if they remain dedicated buyers, this unprecedented flood of dollar liquidity would appear to hold the potential to finally overwhelm global central banks. Central bankers today have every Reason to turn more cautious. Any backing away from dollar support would likely instigate a dollar crisis.
Another Reason. While this is purely conjecture on my part, I can envisage changing central banker perceptions. Perhaps they are finally beginning to appreciate that their efforts to ensure orderly currency markets have been self-defeating. The Reason is, orderly means accommodating only greater U.S. Credit Bubble excess. Buying dollar-denominated securities today ensures that an ever greater supply will arrive on the doorstep tomorrow. There comes a point when bulging holdings of dollar “IOU” reserves seems more like a growing problem than growing wealth.
It was a decidedly bearish week for financial assets. The dollar, stocks and bonds fell, while gold, the metals, energy, and commodities generally rose. Curiously, the dollar was not helped by higher U.S. yields or even by some weakness in emerging market currencies. Also interesting, bond prices were not supported by sinking stock prices. The Swiss franc had a big week (up 2.5%), perhaps buoyed by a rush to cover short positions in this favored source for low-rate borrowings (“swissy carry trade”). The franc likely also benefited from its status as a safe-haven currency. I hesitate to make too much out of one week in the markets. But in its fascinating entirety, it did appear important.
The bond market is recognizing that the general Credit and liquidity backdrop ensures that “Gentle Ben” will be locked in hibernation for some time, yet. For years, it seems, fixed-income prices have been underpinned by the notion that the Fed would be preparing to cut rates at the first sign of a housing downturn. This bedrock of bond bullishness can now be tossed out the window.
And, in the markets, no longer do bonds instinctively rally with each and every dollar downdraft. This interesting dynamic of dollar securities price support can similarly be thrown in the scrap heap. I’ll for now assume that markets are increasingly anxious with respect to the willingness and ability of central banks to lap up the potentially massive supply of dollar instruments that could be hit the currency market, as well as to what extent the unfolding dollar problem will force the Fed to actually tighten financial conditions. There is today great uncertainty as to how the markets would respond to the Fed pausing next month.
Let there be no doubt. There is a great deal riding on an "orderly” dollar decline. The Reason? Well, if we are, as I suspect, entering a period of more disorderly currency markets, the risk profile of shorting the yen, the Swiss franc, the Euro or other low-yielding currencies (as a source of funds for leveraged positions in higher-yielding securities or assets) becomes immediately much less attractive. What this might mean for the proliferation of global “carry trades” is this evening not at all clear, but it can’t be good. To what extent “carry trades” have fueled global liquidity overabundance – and, in the process, the “conundrum” and the “global savings glut” - is unknown but clearly substantial.
With the yen, the swissy and Euro surging against the dollar concurrently with sinking global bond prices, some speculators have been hurt and are being forced to retrench, which often leads to more selling, losses, further retrenchment and liquidity issues. Unwinding leveraged trades always poses the risk of getting out of hand, and this is especially the case currently for lots of Reasons.