This week the Dow rallied 1.5% and the S&P500 2.1%. Economically sensitive issues outperformed. The Transports gained 3.3% (up 17.5% y-t-d), and the Morgan Stanley Cyclical index rose 2.8% (up 5.6% y-t-d). The Utilities gained 2.0%, and the Morgan Stanley Consumer index increased 1.7%. The broader market rallied sharply into quarter end, with the small cap Russell 2000 up 5% and the S&P400 Mid-cap index rising 3.2%. The NASDAQ100 gained 1.6%, and the Morgan Stanley High Tech index rose 1.5%. The Street.com Internet Index advanced 2.3% and NASDAQ Telecommunications index 1.5%. The Semiconductors declined 0.8%. The Biotechs surged 4.0%. The Broker/Dealers rose 2.8% and the Banks 1.8%. With bullion rallying $32, the HUI gold index gained 8%.
For the week, two-year Treasury yields dropped 11 bps to 5.15%. Five-year yields fell 11 bps to 5.10%, and bellwether 10-year yields declined 8 bps to 5.14%. Long-bond yields slipped 6 bps to 5.19%. The 2yr/10yr spread ended the week inverted one basis point. Benchmark Fannie Mae MBS yields declined 7 bps to 6.37%, this week slightly underperforming Treasuries. The spread on Fannie’s 4 5/8% 2014 note ended the week 4 wider at 36, and the spread on Freddie’s 5% 2014 note 2 wider at 33. The 10-year dollar swap spread increased 0.25 to 59.0. Corporate bond spreads generally lagged Treasuries, with junk spreads widening this week. The implied yield on 3-month December ’06 Eurodollars dropped 10 bps to 5.595%.
Investment grade issuers included Bank of America $800 million, Universal Health Services $250 million and AGL Capital $175 million.
Junk issuers included Windstream $2.55 billion, Nortel Networks $2.0 billion, Chesapeake Energy $500 million, Willis North America $300 million, Markwest Energy $200 million, National Mentor Holdings $180 million, Stewart & Stevenson $150 million, WCA Waste Corp $150 million, and US Concrete $85 million.
June 27 – Bloomberg (Sebastian Boyd): “What started as another winning year for corporate bonds is now a disaster. Investors lost money on everything from AAA ranked General Electric Co. and Toyota Motor Corp. to junk-rated NRG Energy Inc. and leveraged buyout target Kinder Morgan Inc. Bonds sold by companies lost 1.3 percent on average this year, including interest payments, the worst since at least 1998, according to…Merrill Lynch…”
Convert issuers included Vector Group $85 million.
Foreign dollar debt issuers included SABMiller $1.75 billion.
Japanese 10-year “JGB” yields rose 5 bps this week to 1.92%. The Nikkei 225 index rallied 2.5%, reducing 2006 losses to 3.8%. German 10-year bund yields declined one basis point to 4.06%. Emerging debt markets and equity markets rallied sharply. Brazil’s benchmark dollar bond yields sank 25 bps to 7.11%. Brazil’s Bovespa equity index jumped 5.6%, increasing 2006 gains to 9.4%. Despite nervousness ahead of Sunday’s election, the Mexican Bolsa rose 3.2% this week (up 7.6% y-t-d). Mexico’s 10-year $ yields dropped 21 bps to 6.39%. Russian 10-year dollar Eurobond yields declined 2 bps to 7.03%. The Russian RTS equities index surged 11%, increasing 2006 gains to 33% and 52-week gains to 112%. India’s Sensex equities index rose 2% (up 13% y-t-d).
Freddie Mac posted 30-year fixed mortgage rates rose 7 bps to 6.78%, up 15 bps in two weeks and 125 basis points from one year ago. Fifteen-year fixed mortgage rates jumped 7 bps to 6.43%, 131 bps higher than a year earlier. One-year adjustable rates increased 7 bps to 5.82%, an increase of 158 bps over the past year. The Mortgage Bankers Association Purchase Applications Index dropped 6.2% this week. Purchase Applications were down 18.2% from one year ago, with dollar volume down 17.7%. Refi applications fell 7.5% last week. The average new Purchase mortgage rose slightly to $225,100, while the average ARM gained to $341,800.
Bank Credit declined $9.9 billion last week to $7.930 Trillion, with a y-t-d gain of $424 billion, or 11.7% annualized. Bank Credit inflated $698 billion, or 9.7% over 52 weeks. For the week, Securities Credit declined $13.2 billion. Loans & Leases added $3.3 billion during the week, and are up $270 billion y-t-d (10.3% annualized). Commercial & Industrial (C&I) Loans have expanded at a 13.7% rate y-t-d and 12.5% over the past year. For the week, C&I loans dropped $6.7 billion, while Real Estate loans surged $20.7 billion. Real Estate loans have expanded at a 13.2% rate y-t-d and were up 13.1% during the past 52 weeks. For the week, Consumer loans sank $17.6 billion, while Securities loans added $2.4 billion. Other loans gained $4.4 billion. On the liability side, (previous M3 component) Large Time Deposits increased $6.4 billion.
M2 (narrow) “money” supply jumped $27.4 billion to $6.833 Trillion (week of June 19). Year-to-date, narrow “money” has expanded $144 billion, or 4.5% annualized. Over 52 weeks, M2 has inflated $306 billion, or 4.7%. For the week, Currency added $100 million. Demand & Checkable Deposits declined $2.1 billion. Savings Deposits jumped $15.4 billion (3-wk gain of $45.5bn), and Small Denominated Deposits increased $4.7 billion. Retail Money Fund assets rose $9.2 billion.
Total Money Market Fund Assets, as reported by the Investment Company Institute, were up $10.6 billion last week to $2.117 Trillion. Money Fund Assets have increased $60 billion y-t-d, or 5.8% annualized, with a one-year gain of $222 billion (11.7%).
Total Commercial Paper increased $7.8 billion last week to $1.785 Trillion. Total CP is up $136 billion y-t-d, or 16.5% annualized, while having expanded $243 billion over the past 52 weeks (15.7%).
Asset-backed Securities (ABS) issuance slowed to a pre-holiday level of $12 billion this week. Year-to-date total ABS issuance of $374 billion (tallied by JPMorgan) is running just under 2005’s record pace, with y-t-d Home Equity Loan ABS sales of $266 billion at 9% 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”) increased $0.8 billion to a record $1.638 Trillion for the week ended June 28th. “Custody” holdings are up $119 billion y-t-d, or 15.7% annualized, and $198 billion (13.8%) over the past 52 weeks. Federal Reserve Credit dipped $1.1 billion to $825 billion. Fed Credit has declined $1.7 billion y-t-d, or 0.4% annualized. Fed Credit is up 4.6% ($36bn) during the past year.
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Andy Burt – are up $453 billion y-t-d (22% annualized) and $616 billion (16%) in the past year to $4.50 Trillion.
June 28 – Bloomberg (Jianguo Jiang): “China’s foreign exchange reserves rose to $925 billion by the end of May, China Business News said, citing Zhang Ji, deputy director general…at the Ministry of Commerce. Reserves increased by $30 billion in May…”
The dollar index sank 1.8%. On the upside, the Turkish lira jumped 7.6%, the Romanian leu 4%, the South African rand 3.5%, the Polish zloty 3.4% and the Brazilian real 3.1%. On the downside, the Argentine peso slipped 0.2% and the Costa Rican colon 0.1%.
Commodities ended the quarter with an impressive rally. Gold rose 5.5% to $615.45, and Silver jumped 6.9% to $10.96. Copper gained 6.6%. August crude surged $3.06 to $73.93. July Unleaded Gasoline rose 3.5%, while July Natural Gas dipped 2.0%. For the week, the CRB index gained 3.4% (y-t-d up 4.4%). The Goldman Sachs Commodities Index (GSCI) rose 3.5%, increasing y-t-d gains to 12.3%.
June 30 – Bloomberg (Jason Clenfield): “Japan’s unemployment rate fell to a seven-year low in May, adding to expectations that wage growth will accelerate and drive consumer spending, which accounts for more than half of the economy. The jobless rate dropped for a fourth month to 4.0 percent…”
June 29 – Bloomberg (Christina Soon): “China’s exporters are increasingly using non-dollar currencies for settlement to reduce foreign-exchange risks, China International Business Daily reported. The companies are also raising export prices and using hedging tools to lower the risk of currency fluctuations…”
June 30 – Bloomberg (Wing-Gar Cheng and Ying Lou): “China, the world’s second-biggest energy user, raised electricity prices for the first time in more than a year to help power companies pass on the higher cost of coal. Huaneng Power International Inc., the nation’s biggest generator, today raised tariffs as much as 7.3 percent.”
Asia Boom Watch:
June 29 – Bloomberg (Kim Kyoungwha): “South Korea’s 2006 economic growth may fall short of the central bank’s 5 percent forecast because of rising oil prices and a strengthening currency, Governor Lee Seong Tae said.”
June 26 – Bloomberg (Kenneth Wong): “Taiwan’s economy will grow more than 4 percent this year, helped by overseas demand for the island’s exports, said George Chou, head of the central bank’s foreign exchange department.”
June 27 – Bloomberg (Angus Whitley): “Malaysia’s economy is expected to expand 6 percent this year, said Second Finance Minister Nor Mohamed Yakcop… The economy grew 5.2 percent last year.”
Unbalanced Global Economy Watch:
June 27 – Financial Times (Chris Giles): “Spending on healthcare systems in advanced countries is rising so quickly that tax rises, cuts in other areas or enforced private expenditure will be required to maintain healthcare systems, the Organisation for Economic Co-operation and Development said… The Paris-based international organisation found that between 1990 and 2004, expenditure on health - public and private - rose faster than gross domestic product in all its 30 member countries except Finland.”
June 30 – Globe & Mail (Carolyn Leitch): “The average price of a residential home in Canada jumped surged 13.1 per cent to a record $284,620 in May, according to sales tracked…by the Canadian Real Estate Association. May was also the fifth consecutive month in which year-over-year price growth exceeded 10 per cent… The 13.1 per cent year-over-year price increase was the largest since October, 2002.”
June 28 – Bloomberg (Brian Swint): “An index of U.K. retail sales held at the highest in a year and a half in June, bolstered by the World Cup soccer tournament and the housing market.”
June 30 – Financial Times (Ralph Atkins): “Soaring eurozone private sector borrowing and money supply figures yesterday gave extra ammunition to European Central Bank hardliners in the battle against inflation… The latest data, highlighting the robustness of the eurozone’s economic up-swing, will exacerbate ECB fears about the distortions caused by low interest rates… Lending to the private sector grew by 11.4 per cent in May, unchanged from April, but otherwise the fastest since late 1989…”
June 29 – Bloomberg (Simone Meier): “Money-supply growth in the dozen nations sharing the euro accelerated in May, expanding at the fastest pace since early 2003 after three interest-rate increases by the European Central Bank. M3, the ECB’s preferred measure of money supply, rose 8.9 percent from a year earlier, the fastest pace since April 2003, after gaining a revised 8.7 percent in April…”
June 30 – Bloomberg (Simon Kennedy): “European executive and consumer confidence jumped to a five-year high in June and inflation was faster than expected, fueling speculation the European Central Bank may accelerate the pace of interest-rate increases.”
June 28 – Bloomberg (Matthew Brockett): “Consumer confidence in Germany, Europe’s largest economy, rose to the highest in almost five years as households showed a greater willingness to spend.”
June 28 – Financial Times (Ralph Atkins): “German business sentiment has hit a 15-year high and led a surge in confidence across the eurozone, according to surveys yesterday. The unexpected rise in the Munich-based Ifo institute’s business climate index… suggests that the industrial revival in Europe’s largest economy might have gathered pace. Separate Italian and Dutch surveys showed business sentiment at the highest levels since the end of 2000… Global financial markets might be fretting about a possible world slowdown but ‘Europe is holding up very nicely and if anything there is a slight acceleration’, said Erik Nielsen, economist at Goldman Sachs.”
June 27 – Bloomberg (Gabi Thesing): “Import price inflation in Germany, Europe’s largest economy, accelerated the fastest pace in almost six years in May, driven by increased costs for oil and other raw materials. The cost of foreign goods rose 7.5 percent from a year earlier…”
June 29 – Bloomberg (Sandrine Rastello): “French unemployment declined more than expected in May to the lowest level in more than 3 ½ years as faster growth helped create jobs and the government stepped up subsidies to spur hiring… The jobless rate slid to 9.1 percent…”
June 30 – Bloomberg (Fergal O’Brien): “Irish lending growth expanded at the fastest pace in more than six years in May, led by borrowing by companies and demand for mortgages. Lending rose an annual 29.8 percent, the highest since March 2000…”
June 26 – Bloomberg (Alice Ratcliffe): “Swiss retail sales rose the most on record in April, helped by a falling unemployment rate and increased spending before the Easter holidays. Sales rose 12.2 percent from a year earlier…”
June 29 – Bloomberg (Alice Ratcliffe): “Switzerland raised its economic growth forecast for the fourth time since October, and inflation accelerated to the fastest pace in five years in June, adding to the central bank’s case for another interest rate increase. Gross domestic product will probably expand 2.7 this year…”
June 26 – Bloomberg (Ben Sills): “Producer price inflation in Spain, Europe’s fifth-largest economy, unexpectedly accelerated in May to its fastest pace in 11 years. The price of goods leaving factories, farms and mines rose 6.5 percent from a year earlier…”
June 29 – Bloomberg (Tasneem Brogger): “Denmark’s jobless rate dropped more than expected in May to the lowest in more than 30 years as companies struggle to find qualified workers. The seasonally-adjusted unemployment rate fell to 4.5 percent in May from 4.8 in April…”
June 30 – Bloomberg (Tasneem Brogger): “Danish industrial optimism reached the highest since September 2000 as manufacturing companies expect rising production as growth in Europe picks up.”
June 29 – Bloomberg (Tasneem Brogger): “Norway’s domestic credit growth was unchanged in May, near March’s 18-year high, adding to pressure on the central bank to raise interest rates. Credit for households, companies and municipalities rose an annual 13.7 percent…”
June 29 – Bloomberg (Tasneem Brogger): “Norwegian retail sales surged 3.7 percent in May from a month earlier, more than expected, fueling expectations that the central bank will continue raising interest rates to cool the economy. Retail sales rose 6.7 percent from a year earlier…”
June 26 – Bloomberg (Tasneem Brogger): “Sweden’s trade surplus widened 31 percent in May from a year earlier, more than expected, as export growth outpaced rising imports. The surplus grew to 15.4 billion kronor ($2.10 billion)…”
June 29 – Bloomberg (Ville Heiskanen): “Finnish retail sales picked up in May after growing at the slowest pace in nine months in April, supported by rising wages and higher consumer confidence. Sales rose an annual 6.7 percent…”
June 30 – Financial Times (Neil Buckley): “Memories of Russia’s default on $40bn of domestic debt eight years ago, when people queued outside banks to withdraw roubles that were plummeting in value, have barely faded from the national psyche. Yet, remarkably, with coffers swollen by oil selling at $70 a barrel, Russia will tomorrow lift all currency controls on the rouble and make it fully convertible.”
June 26 – Bloomberg (Aaron Pan): “Moscow and Seoul leapfrogged Tokyo to become the world’s most expensive cities, a survey by Mercer Human Resource Consulting showed. Tokyo, which ranked first in the past two years, dropped to third place.”
June 27 – Bloomberg (Bradley Cook): “Russia’s economy will probably expand 6.5 percent this year, Interfax said, citing the International Monetary Fund…”
June 29 – Bloomberg (Tracy Withers): “New Zealand consumer borrowing for housing and consumption rose 14.1 percent in May from a year earlier, the slowest annual pace since August 2003…”
Latin America Watch:
June 30 – Bloomberg (Adriana Arai): “Mexico posted a budget surplus of 31.2 billion pesos ($2.75 billion) in May as higher prices for crude oil exports boosted revenue. Revenue rose 17.8 percent last month from a year earlier, adjusted for inflation, as spending grew 17.5 percent…”
June 27 – Bloomberg (Eliana Raszewski): “Argentina’s supermarket sales by volume rose 8.9 percent in May from a year earlier, the National Statistics Institute said.”
June 29 – Bloomberg (Daniel Helft): “Argentina’s jobless rate fell below 10 percent in May for the first time since October 1993, President Nestor Kirchner said.”
June 29 – Bloomberg (Daniel Helft): “Argentina’s trade surplus widened in May to $1.3 billion from $1.2 billion in the same period last year… Exports were $4.2 billion, up 13 percent…while imports totaled $2.8 billion, up 14 percent…[y-o-y]…”
Central Bank Watch:
June 27 – Financial Times (Chris Giles): “Central banks will have to move faster to raise interest rates because global inflationary pressures are rising and the economy remains vulnerable to a ‘bang’ of market turbulence, the Bank of International Settlements warned yesterday. Raising the spectre of stagflation - the twin perils of slow economic growth alongside higher inflation - the central bankers’ bank highlighted the threats that now exist after global interest rates have been ‘unusually low for an unusually long time’.”
June 27 – Bloomberg (Matthew Brockett): “European Central Bank council member Nicholas Garganas said the bank is ready to accelerate the pace of interest-rate increases to counter higher inflation risks… ‘Should the need be for a more aggressive interest-rate adjustment, there is nothing to stop us from taking that decision. I would not rule out a higher adjustment to rates than 25 basis points,’ nor quickening the pace of increases from once every quarter…”
June 28 – Bloomberg (Tasneem Brogger): “Sweden’s central Bank may raise interest rates more than warranted by inflation as it tries to slow soaring house prices and borrowing, Deputy Governor Eva Srejber said. ‘To reduce the risk of imbalances building up, we can choose to raise the interest rate slightly more quickly than is warranted by the inflation forecasts,’ Srejber said…”
June 29 – Bloomberg (Nipa Piboontanasawat and Theresa Tang): “Taiwan’s central bank raised its benchmark interest rate for an eighth straight time to the highest in almost five years, and suggested more increases may come. …The island’s central bank, increased the discount rate on 10-day loans to banks by an eighth of a percentage point to 2.5 percent…”
June 28 – Bloomberg (Ben Holland): “Turkey’s central bank increased its overnight lending rate by 200 basis points and borrowed more liras from the market as it seeks to halt a slide in the currency. The Ankara-based bank increased the rate to 22.25 percent…”
Bubble Economy Watch:
May Personal Income was up 5.4% from a year ago, with Personal Spending up 6.7%. The Chicago Purchasing Managers Prices Paid index rose to an 18-year high.
June 29 – Econoplay.com (Gary Rosenberger): “Staffing firms, many of whom were bracing for a summer slowdown, are reporting better-than-expected June orders – and foresee “stable” demand for workers in the third quarter despite copious strains on the economy. Recruiters specializing in finance and accounting, non-residential construction, light industrial, energy, and office clerical continue to see firm orders… But there are downsides from housing-related industries like mortgage lending and from companies exposed to the travails of domestic automotive… Wage pressures are on an upswing – with higher fuel costs and mortgage payments providing strong rationales for pay increases at a time when companies are having an easier time passing increased operating costs to their customers.”
Real Estate Bubble Watch:
May Existing Home Sales met expectations at a 6.67 million annualized rate. Sales were down 6.6% from one year ago, while Average Prices were up 4.1% y-o-y to $276,100. Annualized Calculated Transaction Value (CTV) was at the strongest rate since last November, although down 2.7% y-o-y to $1.842 Trillion. Year-to-date Existing Home Sales are running 3.8% behind 2005, although y-t-d CTV is 1.2% ahead. May New Home Sales were a stronger-than-expected annualized 1.34 million. This was down 5.9% from May 2005, while Average Prices were up 2.4% to $294,300. Year-to-date New Home Sales are running 9.6% below last year’s record level. Total Home Sales are running 4.7% below last year’s record rate, although y-t-d combined CTV is about flat with comparable 2005. The Inventory of unsold Existing Homes jumped to 3.604 million (6.5 months worth!), up 40% in twelve months. The Inventory of New Homes dipped slightly to 556,000, although the level remains 24% higher than a year ago.
June 28 – Wall Street Journal (John M. Biers): “The lunch was a soggy chicken and rice combo, but the commentary was colorful: hottest real-estate market in the nation; best city for job growth; surging metropolis poised to add two million more residents. The euphoria at a recent gathering of commercial real-estate developers reflects the growing confidence in Houston, thanks to persistently high energy prices. ‘Whether you realize it or not, these are boom times’ said longtime developer E.D. Wulfe…”
June 28 – Bloomberg (Kathleen M. Howley and Joseph Richter): “Ko Ueno, a 36-year-old tourism executive moving to San Diego, hasn’t found a buyer for his one-bedroom condominium in Cambridge, Massachusetts -- even after cutting the price three times since October and offering a $6,000 cash rebate. ‘A year ago, this unit would have gone in a matter of days, but now we have to offer incentives and a brand-new kitchen,’ his broker, Brenda van der Merwe, says… Ueno, whose apartment near Harvard University went on the market for $329,000 and is now listed at $299,000, is caught in the first U.S. housing decline since 1999.”
June 27 – PRNewswire: “May home sales remain strong in Illinois, posting the second highest number on record for total sales in the month. According to the Illinois Association of Realtors…in May total homes sales were down 2.2 percent to 17,442 homes sold, compared to the previous record for the month of 17,840 homes sold in May 2005. Year-to-date home sales totaled 66,161 in 2006, off 1.3 percent…”
Global Financial Sphere Bubble Watch:
June 30 – Financial Times (Lina Saigol): “Merger and acquisition activity worldwide is set to reach $1,930bn for the first half of the year, marking the highest half-year volume on record and surpassing even the heady days of the dotcom boom. The unprecedented wave of deals by companies and private equity has been fuelled by growing executive confidence, a tide of competing bids, increasingly aggressive shareholder activists and low borrowing costs. ‘The corporates are in rude health with strong balance sheets...In the absence of a major collapse of the credit markets, this level of activity looks set to continue,” said Gavin MacDonald, European head of M&A. at Morgan Stanley.”
June 30 – Financial Times (Joanna Chung): “A record number of billion-dollar deals pushed the size of the global market for initial public offerings in the first half of the year to more than $100bn – second only to the first half of 2000 at the height of the dotcom boom. Some of the biggest deals were priced in the second quarter, before the recent downturn. For the first six months of the year, the volume of IPOs jumped 56 per cent to $102.2bn, from $65.4bn over the same period in 2005, according to…Dealogic.”
June 27 – Wall Street Journal (Dennis K. Berman and Jason Singer): “There’s no end in sight for this year’s parade of megamergers. In less than 100 hours starting last Friday, around $110 billion in acquisition deals were sealed world-wide in sectors ranging from natural gas, to copper, to mouthwash to steel, linking investors and industrialists from India, to Canada, to Luxembourg to the U.S. The deals…provided striking evidence that 2006 is on pace to be the most-active merger year in history, as measured in absolute dollars. The year-end tally could top $3.5 trillion, based on Thomson Financial figures. As was the case during the merger frenzies of the 1980s and the 1990s, the latest boom is being fueled by abundant credit, changes in technology and global competition.”
June 27 – Bloomberg (Charlotte Nugent): “Sales of U.S. commercial mortgage-backed securities totaled a record $12 billion last week, helping new issues surpass $80 billion this year, according to RBS Greenwich Capital Markets.”
June 29 – Bloomberg (John Glover): “Convertible bond sales almost doubled so far this year as higher interest rates and larger swings in share prices made them more lucrative for borrowers and buyers. Companies issued $60 billion of the debt this year, up from $36.1 billion in the first half of 2005…”
Energy and Crude Liquidity Watch:
June 26 – Bloomberg (Ben Sills): “Everywhere you look these days, people are scrambling for energy supplies. China is scouring the world, from the oil sands of Alberta to the oilfields of Iran. Morgan Stanley and other investment banks have spent hundreds of millions of dollars for petroleum still in the ground. And more than 450 hedge funds (and counting) are busy in the energy market, trading in everything
from coal to solar-power companies.”
June 29 – Financial Times (Roula Khalaf ): “Gulf governments have more than trebled investment in domestic infrastructure projects, buoyed by more than $70 a barrel oil prices and driven by a desire to diversify their economies away from hydrocarbons. The scale of the investments points to growing confidence among Arab oil producers that crude prices will remain strong for years. Middle East Economic Digest, which tracks projects in the region, says current or planned investments exceeded $1,000bn in April, up from $277bn 18 months before. Vast sums of petrodollars are being recycled overseas but economists say the emerging trend in the present oil boom is a greater focus on investing at home… The World Bank says Middle East oil exporters’ current account surpluses rose from an average of only 6 per cent of gross domestic product in 2002 to almost 23 per cent in 2005. As they start spending the windfall, billions of dollars are earmarked for upgrading infrastructure and increasing production in the oil and gas sectors.”
June 29 – Financial Times (Roula Khalaf ): “Saudi Arabia’s King Abdullah criss-crossed the kingdom in recent weeks, unveiling at every stop generous promises and new projects. He laid the foundation stone for a university in Qassim…; announced the construction of an economic city in the holy city of Madinah; and vowed to build another in Hail, with industries, an education zone and an airport... The 82-year-old monarch’s tour…may have been intended to project government largesse at a time of massive oil wealth but depressed spirits. Many Saudis have just seen their wealth disappear in a meltdown on the Riyadh stock market. But the infrastructure binge… also reflects new confidence that oil prices will remain strong… Until recently reluctant to raise spending, the world’s largest oil producer is hoping to exploit the windfall from the $70 per barrel oil price to diversify the economy and bring down an unemployment rate…”
June 26 – Bloomberg (Claudia Maedler): “Trade in the Persian Gulf emirate of Dubai grew 36 percent to 480 billion dirhams ($130 billion) last year, the Khaleej Times reported.”
June 26 – Bloomberg (Elisa Martinuzzi and Todd Prince): “OAO Rosneft, Russia’s state oil company, plans to raise as much as $11.6 billion in an initial public offering that would be the world’s fourth-biggest, gaining funds to boost output as the government cuts its stake.”
June 29 – Financial Times: “Overall entitlement spending is set to rise from 8.7% of GDP in 2006 to 20% by 2030 - roughly the share taken up by all spending today. To underline the consequences of inaction, Standard and Poor’s recently said US treasury bonds would be downgraded to BBB by 2020. Forestalling what would be a disaster for the US and the world should be Mr Bush’s priority in the remainder of his term. Establishing a bipartisan commission to look into both entitlement reform and taxes - as moderate Democrats and Republicans have urged - would be a good start. Given Washington’s charged atmosphere nowadays, that might be difficult. But the new treasury secretary is respected on all sides. He should use that goodwill to start laying the groundwork for America’s long-term fiscal sanity…”
June 28 – Congress Daily (Peter Cohen): “The overall cost of the wars in Iraq and Afghanistan and other global anti-terror operations since the Sept. 11, 2001, attacks will top $500 billion next year, according to congressional estimates and expectations of future funding. The nonpartisan Congressional Research Service said in a report that through the current fiscal year ending Sept. 30, the government will have spent $437 billion on overseas military and foreign aid funding.”
June 27 – Associated Press: “The annual cost of replacing, repairing and upgrading Army equipment in Iraq and Afghanistan is expected to more than triple next year to
more than $17 billion, according to Army documents… From 2002 to 2006, the Army spent an average of $4 billion a year in annual equipment costs. But as the war takes a harder toll on the military, that number is projected to balloon to more than $12 billion for the federal budget year that starts next Oct. 1…”
The Fed is confused; Washington policymakers are confused; the markets trade confused; and pundits certainly speak as if they are confused. Truth be told, the current fixation on every word and nuance from the FOMC has become a farce - a mere heedless distraction from the critical financial/economic issues of the day. Clearly, the Fed lacks a policy/analytical framework other than mindlessly reciting its commitment to “fight inflation”. It’s institutional “brain” has been corroded by an extended period of concurrent relatively stable “core” inflation and extraordinary asset inflation, not to mention years of Greenspan obfuscation.
The Federal Reserve is simply not institutionally prepared for the unfolding challenging environment, although the same could be said for policymakers and the public generally. The Fed is left floundering in the shallowest of central banking doctrine, bereft of any substance as to the key underlying forces driving the economy, the markets and, increasingly, inflationary pressures. At the same time, the Fed’s benign neglect of Credit Bubble excesses is buttressed by the view from the White House to the Halls of Congress that domestic and international growth are the only avenues for rectifying imbalances. It’s quite dangerous dogma, yet the markets are happy to play along.
The Bernanke Fed today plays a dangerous game of sheep in wolf’s clothing, talking tough on (“core”) inflation while praying it can stay soft on excess. Highly speculative marketplaces at home and abroad savor in the gamesmanship. Markets recognize that the Fed will now talk the talk when speculative excess pushes the envelope, although they remain confident that the Fed will obediently retreat when markets come under sufficient pressure. Participants simply wait patiently for a signal from the Fed – as they believe they received yesterday – and get right back to their business.
I do read commentary that the Fed and global central bankers have been “withdrawing liquidity.” I don’t see it. For starters, the vast majority of global liquidity these days emanates from private-sector debt growth and securities leveraging. Keep in mind that Credit is growing at double-digit rates across the globe. The Federal Reserve’s balance sheet has become virtually irrelevant to the global liquidity-creation process, and the Fed has not been selling securities to reduce liquidity in the system (and they would have to sell a large amount today to offset record Credit growth!). For central banks to actually “tighten” policy would require an overall global rate environment sufficiently restrictive to induce private borrowing and leveraging restraint. I’m still waiting.
The Fed does, however, hold (held?) a potentially powerful “stick” over the marketplace. It maintains the capacity to surprise the markets with more aggressive rate hikes, which would likely entail significant Credit market disruption and speculator de-leveraging. At times, this threat can be quite effective in dousing greed and instilling some fear in frothy global equity and commodities markets. But I believe it is important to differentiate this dynamic from the actual tightening of general liquidity conditions for markets and Credit systems. Credit markets are much better indicators of the prevailing liquidity backdrop than equities.
Not only might the Fed’s potential “stick” not cajole lenders and Credit market participants into restraint, it may very well even embolden them with the view that market turbulence will hold the timid Bernanke Fed at bay. Furthermore, the potential “stick” will lose much of its effectiveness over time. The Fed will be less willing to be seen as rattling markets, while inspirited market players will be much more willing to call the Bernanke Fed’s bluff. The stick loses all its punch come the perception that it will not be used. And the sophisticated players are definitely keen to Dr. Bernanke’s well-documented repugnance to “Bubble popping,” and they must today relish that initial missteps have spurred the new chairman to kowtow to the markets.
I feel compelled to remind readers of the abbreviated period of time between the near "seizing up" of global Credit markets in October 1998 and the historic Internet/technology Bubble of 1999/2000. To be sure, powerful inflationary biases had engulfed both the Credit system and the greater technology industry by 1998. But fearing market tumult, the Fed was unwilling to impose sufficient restraint. Speculative markets will invariably take full advantage. And it is worth noting that today’s inflationary biases are more powerful, broader and clearly global in scope, yet the Fed again appears Wedded to Interminable Acquiescence. For the most part, the markets are happy to pretend there is no inflation problem. Amazingly, a few pound the deflation drum as loud as ever.
So, if there were ever a time to step back, take a deep breath, and do a Reality Check - it’s right now. We all read and hear assertions that the Fed is overshooting and inflation is not a serious issue today - and certainly won’t be a problem when the economy slows (that for some time has been right around the corner when housing markets and consumption weaken). This is a myopic view certainly not atypical in the face of changing environments and key inflection points. It does, however, completely disregard a growing list of potentially momentous developments with respect to the future inflationary backdrop.
I suggest this evening that prospects for an unexpected upsurge in intermediate-term inflation risk is high due to an extraordinary confluence of major developments, including unfolding constraints on supply and rising global demand for energy and other commodities; spiraling healthcare costs, especially for baby-boomer retirees; various wars, including the ongoing “war on terror”; untenable government liabilities; and myriad issues related to global warming - to mention just a few. Unless the Credit system buckles, there are endless sources of demand for finance waiting in the wings, regardless of the housing market.
I certainly won’t be able to delve much below the surface on any of these issues this evening, but it is the confluence of developments I hope readers will ponder. Yet another week of extraordinary weather catastrophe should help convince a few more global warming fence-sitters. This week from President Bush: “I have said consistently that global warming is a serious problem. There’s a debate over whether it’s manmade or naturally caused. We ought to get beyond that debate and start implementing the technologies necessary to enable us to achieve a couple of big objectives: One, be good stewards of the environment; two, become less dependent on foreign sources of oil, for economic reasons as for national security reasons.”
No matter where readers stand on this regrettably contentious issue, I strongly suggest viewing Al Gore’s “An Inconvenient Truth.” The potential impact of global warming on our economy, financial markets and, most importantly, our lives is at this point simply too important to ignore or dismiss. The film lays out the issues clearly, and a thorough public debate – certainly directed by leading scientists - is much overdue. Ideology needs to stay out of it.
The costs of life and property from a single storm can, as Katrina showed, be enormous. Much of this cost will be absorbed by government debt or, more aptly stated, “monetized”. The cost to repair and maintain our gulf energy infrastructure has been and will likely remain enormous on an ongoing basis. Meanwhile, the insurance industry lacks the wherewithal to deal with major weather disasters that could now become “routine”, so the burden will largely fall upon additional government debt issuance. We are already seeing the surging price of insurance along the coasts, although the much greater potential costs associated with climate change will remain impossible to quantify. As an aside, the warmest Dallas winter on record forced us to run air conditioning throughout the “cold” season, and we now watch the local corn crop succumb to a problematic drought.
Much more problematic than the SUV predicament, millions of super-sized homes have been built in some of the hottest climates. It will now be a case of waiting to see the scope of the financial burden required to keep homes and business sufficiently cool. We are already seeing the effects of surging energy costs on the pattern of consumer spending, and it is not out of the question that the economic viability of certain cities (Las Vegas and Phoenix come to mind) could be threatened in the event of a major energy shortage/price spike. The availability of sufficient water will surely become an issue for the Southwest U.S. and elsewhere.
June 26 – Bloomberg (Saijel Kishan and Madelene Pearson): “Jean-Marie Messier lost billions of euros turning the world’s biggest water company into entertainment conglomerate Vivendi Universal SA. He should have stuck with water. The lack of usable water worldwide has made it more valuable than oil. The Bloomberg World Water Index of 11 utilities returned 35 percent annually since 2003, compared with 29 percent for oil and gas stocks and 10 percent for the S&P 500 Index. From hedge fund manager Boone Pickens to buyout specialist Guy Hands, the world’s biggest investors are choosing water as the commodity that may appreciate the most in the next several decades.”
At this point, it appears certain that we are in the early stages of an enormous spending boom necessary to deal with the rapidly changing energy and climate backdrop. The scope of the required research and development could be unprecedented. The investment boom throughout the energy and alternative energy sectors appears poised to rival (and likely exceed) the technology boom. The auto companies will need to gear up to develop and sell smaller, more fuel efficient and cleaner automobiles. There will be rising demand for smaller, more energy efficient homes likey in milder climates, as well as demand for efficient appliances and heating and cooling systems. Across the board, businesses will be forced to be more energy efficient. Scores of new companies will seek to profit from new opportunities in what could easily end up overshadowing the telecom/Internet Bubble.
Yesterday in an article by Bloomberg’s Edward Robinson: “SolFocus sounds like a typical Silicon Valley startup: Eight employees, big ideas -- and zero profit. Yet in mid-May, the phones at the eight-month-old company wouldn’t stop ringing. The callers were venture capitalists, and they were dangling millions of dollars in front of the Palo Alto, California-based solar panel maker. Ty Jagerson, vice president of business development, says as soon as he’d start talking to one VC, another would call offering money. ‘It was completely insane,’ Jagerson, 35, says. Up and down Sand Hill Road, the venture capital hub south of San Francisco, the financiers who bankrolled the technology boom of the 1990s are chasing their next big thing: alternative forms of energy… VCs haven’t buzzed like this since the Internet captured investors’ imaginations in the 1990s.”
“Ernest Moniz, co-chairman of the Energy Research Council at Massachusetts Institute of Technology, which is researching noncarbon-based energy sources, says the world must come to grips with its appetite for energy and the environmental havoc being wrought by fossil fuels. There’s no time to waste, he says. ‘These are huge issues that have to be grappled with. We’re talking about a transformation of the global energy infrastructure over the next few decades.’”
If this view proves correct – “a transformation of the global energy infrastructure over the next few decades” – it will prove one very tall order for global economies and Credit systems, especially ours, due to the U.S.’s insatiable appetite for more energy than we can produce as well as the reality that our overheated Credit system is already severely bloated with mortgage debt. For now, it is safe to assume that the current investment boom in ethanol, biodiesel, solar, geothermal, solar, nanotechnologies, oil and gas exploration, and myriad other energy, environmental and conservation technologies create an almost endless source of demand for financial, human and natural resources. And, importantly, for now the Credit system is able and willing to finance this boom.
Yes, vulnerable Credit systems could falter and the potential for systemic debt dislocation should never be ruled out. But to dismiss what today appears the likely probability of an ongoing massive energy/climate-related borrowing and spending binge is unwise. As a witness to the resurgent Texas housing market and economy, I am willing to suggest that the energy boom is already underpinning income growth that is underpinning inflated housing markets. Clearly, there is a powerful inflationary bias that permeates the expansive energy and energy-related technology arenas that is poised to strengthen as long as finance is forthcoming.
When I contemplate the future, I see a U.S. economy that will have no option other than massive restructuring. As an economy, it appears today that we will have little alternative than to consume significantly less oil, produce much more of various types of energy domestically, use energy much more efficiently and cleanly, consume fewer imports, and produce more manufactured goods for domestic consumption and export. This will entail a radical shift away from the service sector to the more arduous (and surely less “productive”) task of producing real things. Again, this is all a very tall order, even without devastating natural and man-made disasters.
Such a massive economic endeavor would require enormous resources – natural, technological, human and financial. Until I see something to alter my view, I would expect such a huge undertaking to entail great dislocation and pack quite an inflationary punch. This radical change in the nature of spending and investment will ensure that wide swaths of our current economy become uneconomic (and depressing for many). At the same time, the new patterns of the flow of finance will strain limited resources and greatly disturb prevailing pricing dynamics. There will be no alternative to massive government deficits at all levels, and I would expect the federal government will have no viable option other than to guarantee significant amounts of private sector debt (similar to what Fannie and Freddie have done in household mortgages). In such a scenario, we should expect the Federal Reserve and Congress to take extraordinary measure to underpin the Credit market on the grounds of national security, openly stated or otherwise.
And if energy and other resources do become in such short supply globally, long-term inflation forecasts must also consider the likelihood of more and larger military confrontations. These would be inflationary, just as the “war on terror” and wars in Iraq and Afghanistan are today.
I have read the argument that Credit Bubbles always end in deflation. This is factually inaccurate, and we can look to Argentina and Indonesia as recent examples of bursting Bubbles and the inflationary havoc wrought by collapsing currencies. Any thoughtful prognostication with respect to the future course of inflation must incorporate a view of the dollar’s prospects, as well as global currencies generally. Currency values are always relative, and we’ve already witnessed over the past two years how inflating (devaluing) foreign currencies can stabilize the nominal value of the dollar. We’ve also seen how concerted currency debasement can have a striking impact on oil and commodity prices.
With a structurally maladjusted, energy glutton, and import-dependent “services” economy, along with an overheated Credit system and massive prospective government deficits, one can easily envision the dollar as a structurally weak currency for years to come. And I certainly expect China and Asia to face similar inflationary pressures, ensuring an inflationary bias for imported energy and goods prices for some time.
The least unfavorable course today would be to impose a meaningful slowdown on the highly imbalanced and overheated U.S. economy, setting the stage for a major redeployment of resources. Ironically, a U.S. recession is today seen as absolutely unacceptable, with policymakers (including our new Treasury Secretary) espousing the notion that the U.S. and our trading partners can grow our way out of imbalances. We need Washington to step back - do a Reality Check - and come to the recognition that the current global financial and economic boom is very much the problem and not the solution. I won’t hold my breath. I also won’t be lining up to buy U.S. bonds anytime soon.