Renewed dollar weakness did not get in the way of another week of frothy but broad-based stock market gains. For the week, the Dow, the S&P500, Transports, and Morgan Stanley Cyclical indices all gained about 2%. The Utilities added about 1.5%, while the Morgan Stanley Consumer index rose slightly. The broader market was solid, with the small cap Russell 2000 and S&P400 Mid-cap indices gaining 2%. The NASDAQ100 added 3%, increasing 2003 gains to 41%. The Morgan Stanley High Tech index’s 2.5% rise increased y-t-d gains to 52%. The Semiconductors advanced 2% (y-t-d up 64%), and the NASDAQ Telecom index gained 3% (y-t-d up 52%). The Street.com Internet index gained 3% (y-t-d up 64%). The Biotechs jumped 4% (y-t-d up 47%). The financial stocks were strong, with the Broker/Dealers surging 6% (up 51% y-t-d). Bank stocks added 4%. With bullion jumping $6.0, the HUI gold index gained 6%.
The yield curve flattened this week, in what was another positive week for the Credit market. Two-year Treasury yields added 5 basis points to 1.67%. Five-year yields dipped 4 basis points to 3.10%, while 10-year Treasury yields dropped 9 basis points to 4.16%. The long-bond saw its yield drop 9 basis points to 5.07%. Benchmark mortgage-backed yields dipped 2 basis points to 5.07%. The spread on Fannie 5 3/8% 2013 note narrowed 1 to 40, with the spread on Freddie’s 4 ½% 2013 note narrowing 2 to 38. These were the narrowest agency spreads in two months. The 10-year dollar swap spread narrowed 2 to 41.5.
With over $23 billion of bonds sold, this was the strongest week of corporate issuance since May (y-t-d weekly average issuance of $12.4 billion). September issuance is quickly approaching $40 billion. The Merrill Lynch index of corporate bond spreads narrowed this week to a 51-month low.
Ford returned to the bond market to issue $3 billion, although orders were said to have surpassed $10 billion. Ten-year Ford bonds were issued at 280 basis points over Treasuries, less than half the premium that existed during those dark days of last October. GM 10-year spreads have narrowed from highs of about 500 basis points last August to this week’s 225 basis points.
Other Investment-grade issuance included SLM Corp. (“Student Loan Marketing”) $2 billion, Liberty Media $2.5 billion, BP Capital $1 billion, Vodafone $1 billion, American Express $500 million, General Mills $500 million, State Street $400 million, CIT Group $500 million, Campbell Soup $300 million, Cox Communications $750 million, Johnson Controls $500 million, Duke Energy $800 billion, PSI Energy $400 million, Principal Life $250 million, John Hancock $250 million, and Cabot Corp $175 million.
Almost $6 billion of junk was issued this week, double 2003’s weekly average. Nextel $2 billion, Echostar $2.5 billion (three times oversubscribed and raised from $1.5 billion), Toys R Us $400 million, Meritage Corp $75 million, Morris Publishing $300 million, Buckeye Tech $200 million, Broder Brothers $175 million, Huntsman LLC $380 million, Perry Ellis $150 million, and Pinnacle Entertainment $135 million. Junk inflows were said to have slowed to $78.9 million (from AMG).
Converts issuance included American Airline’s $400 million, Mega Financial’s $600 million, Alkermes’ $125 million, Invision’s $125 million, and Bowne’s $75 million.
There were $9 billion of ABS issued this week, with almost half home equity securitizations. Year-to-date ABS issuance of $298 billion is up almost 17% from last year.
Global Debt and Currency Watch:
Emerging market debt performed well this week, with notable solid performance from Brazil and Turkey. Mexican debt underperformed, with spreads widening less than 10 basis points. The Republic of Turkey this week issued $1.25 billion of dollar bonds at 550 basis points over Treasuries. The Thai government issued 2 billion baht bonds to yield 3.19%. Russia issued ruble bonds at a yield of 8.90%.
The dollar was hit for over 1% this week. The yen rose to the highest level against the dollar since January 2001. Canadian and Australian dollars rose to 2-month highs against the dollar. Treasury Secretary Snow’s call for Chinese and Asian currency revaluation seems to be falling on deaf ears. Tense currency traders will be captivated by pronouncements from this weekend’s G7 meeting in Dubai.
The CRB index dropped 2% this week, although Gold jumped to a 7-year high. Crude oil prices dropped to 4-month lows.
Global Reflation Watch:
September 16 – Bloomberg: “China and Japan’s holdings of U.S. notes and bonds rose to records in July, the Treasury Department said, as the two largest economies in Asia financed trade surpluses and sought to weaken their currencies against the dollar. China’s portfolio of U.S. Treasuries rose $3.6 billion to $126.1 billion in July, while Japan’s holdings increased $2.2 billion to $443.8 billion, the Treasury said. The two countries in July held 41 percent of $1.39 trillion in U.S. government securities held abroad, up from 39 percent a year ago.”
September 17 – Bloomberg: “South Korea’s foreign-exchange reserves climbed to a record in the first half of this month… The reserves rose $1.9 billion during the first 15 days to $138.1 billion, the Bank of Korea said… South Korea’s reserves, which have risen from a low of $7.2 billion during the 1997-98 financial crisis, are the fourth highest in the world, after those of Japan, China and Taiwan.”
Australian August New Vehicle Sales were up 12.5% y-o-y. Italian industrial production rose during July at the strongest pace since May 2002. From Bloomberg: “U.K. pay raises accelerated at the fastest pace in two years during the third quarter…” “German producer price inflation accelerated to the fastest pace in two years in August…” “South Korea’s exports rose 9.4 percent from a year earlier.” “Russian companies increased investment in productive capacity by 12%” (y-o-y) during August. The IMF raised its forecast of 2003 Russian growth to 6.0%. Polish GDP expanded at the fastest pace in two years (3.8%). On the back of 16% increase in exports this year, Argentina today reported second quarter growth up 7.6% from a year earlier. This was the strongest rate of expansion since 1997.
September 17 – Bloomberg: “China’s fixed-asset investment rose 32 percent in the first eight months of this year as companies such as China United Telecommunications Corp. installed equipment and the government built roads, bridges and dams. Investment increased to 2.2 trillion yuan ($266 billion), from 1.7 trillion a year earlier, the Beijing-based National Bureau of Statistics said…”
September 16 – Bloomberg: “China’s retail sales rose in August at their fastest pace in seven months as consumers splurged on meals out and holidays after disease, heatwaves and floods kept people at home earlier this summer. Sales rose 9.9 percent from a year earlier to 361 billion yuan ($43.6 billion)… Sales growth shows few signs of slowing, even as the central bank tightens lending rules to prevent inflation accelerating. ‘Our sales in China grew well in excess of 25 percent for the year up to June,’ Procter & Gamble Co. former chairman John Pepper said in Beijing on Wednesday. ‘We continue to look very strong.’” (The Financial Times provided more detail: “Car sales rose an annual 60 per cent though total retail sales surged 11.8 per cent year on year in cities but only 6.5 per cent in rural areas.”)
September 15 – Bloomberg: “China’s consumer prices rose in August at their fastest pace in four months as droughts and floods caused food prices to rise and surging home loans pushed up property prices. The consumer price index, which measures the cost of a fixed basket of goods and services, increased 0.9 percent from a year earlier after rising 0.5 percent in July…”
September 15 – Bloomberg: “U.K. annual house-price inflation accelerated in July, boosted by first-time buyers, the government said. The average price of a home increased 14.6 percent from a year earlier to 156,273 pounds ($250,740), according to a new index compiled by the Office of the Deputy Prime Minister. That compares with annual growth of 13.4 percent in June.”
September 17 – Bloomberg: “The number of U.K. claimants of jobless benefits fell in August to the lowest since 1975 when Margaret Thatcher became leader of the Conservative Party… Jobless claims declined by 6,900 to 930,800, following a
revised fall of 10,300 in July, the government said. The unemployment rate stayed at 3.1 percent, also the lowest in almost 28 years.”
Brazil’s central bank this week lowered borrowing costs 200 basis points to 20%, with the Brazilian Bovespa stock index jumping almost 3% for the week. This increases 2003 gains to 50%. The Argentine Merval index is up 49% y-t-d, with major indices up 28% in Mexico, 37% in Chile, 41% in Peru, and 121% in Venezuela.
Domestic Reflation Watch:
Yesterday from the Wall Street Journal: “Don’t get too used to the free breakfast buffets. The strengthening economy is giving hoteliers more pricing power than they have had in four years…” There were also articles this week in the national media highlighting a surge in prices for various common consumer staples including milk, steaks, and ribs. Meanwhile, the Air Transportation Association reported that Domestic Class airline ticket prices jumped 1.9% during August, with notable y-o-y gains of 6.0%. During July, y-o-y prices changes turned positive after months of declines. And for comparison, August 2002 posted y-o-y domestic ticket price declines of 9.4%. Pricing power in the beleaguered airline industry? (The AMEX dollar-weighted Airline index is up 64% y-t-d) One could almost begin to build a case that inflationary pressures are now expanding beyond the key inflationary pressures evident throughout housing, medical, energy, insurance and tuition.
Broad money supply (M3) increased $11.5 billion. Demand and Checkable Deposits declined $1 billion, while Savings Deposits added $3.2 billion. Small Denominated Deposits declined $2.2 billion and Retail Money Fund deposits dipped $4.6 billion. Institutional Money Fund deposits added $5.1 billion. Large Denominated Deposits jumped $9.8 billion. Repurchase Agreements added $1.2 billion, as Eurodollars declined less than $1 billion. Foreign (“custody”) Holdings of U.S. Debt rose $3.2 billion.
The Philadelphia Manufacturing index declined a deceptive 6.5 points to 14.6 (August’s reading was the strongest since June 1998). However, Prices Paid jumped 6.5 points to 22.5, the highest reading since April. New Orders rose 4.7 to 19.3, the strongest reading since March 1999.
The federal government reported a $76.5 billion deficit for August. Total government Receipts dropped 8.3% y-o-y to $124.6 billion, while total Spending jumped 6.4%. Year-to-date Receipts were down 4.2%, as Spending surged 7.0%. Year-to-date Individual Tax Receipts were down 4.2% and Corporate Tax Receipts dropped 13.5%. Year-to-date Spending gains by large departments: Social Security 4.0%, Health and Human Services 8.4%, Defense spending 16.6%, Labor 8.3%, Agriculture 4.3%, Education 23.1%, Veterans 11.9% and Housing and Urban Development 12.9%. Smaller departments are spending as well: Legislative up 8.1%, Energy up 11.8%, National Science up 12.5%, and Civil Defense up 13.4%.
Freddie Mac posted mortgage rates: 30-year fixed rates were down 15 basis points for the week to 6.01%. This was a drop of 43 basis points in two weeks to the lowest level since late July. One-year adjustable rates were down 6 basis points to 3.81%.
September 17 - Dow Jones: “The Chicago Federal Home Loan Bank on Monday reported a 120% increase in net income for the first half of 2003, crediting most of that growth to its popular mortgage finance program. Net income totaled $195.6 million for the six months ended June 30, compared with $89 million during the same period a year earlier. The bank’s increasingly popular Mortgage Partnership Program, which purchases mortgages from lenders, but pays them to retain that credit risk, grew by 91.4% in the 12 months ended June 30 to $39.4 billion in outstanding loans from $20.6 billion… The Chicago FHLBank’s total assets grew by 41.3% to $80.5 billion on June 30, compared with $56.9 billion on June 30, 2002.” (Total FHLB assets expanded at a 12% rate during the first half.)
From Fannie’s August Monthly Summary: “Mortgage portfolio growth surged to a 46.6 percent annualized rate, with record portfolio purchases of $82.7 billion….” Of these purchases, mortgage-backed securities accounted for a record $54.3 billion (Fannie as “Buyer of First and Last Resort for the Leveraged Speculating Community”), with 2-month MBS purchases of $102.6 billion. The company’s Retained Portfolio expanded by $27.1 billion during August to $863.2 billion, following July’s 41.1% growth rate. Average Total Investments (mortgages and “liquid investments”) jumped $32.0 billion to $927.7 billion during the month. Over twelve months, Fannie’s Total Book of Business was up $370.2 billion, or 22% to $2.09 Trillion, while Average Total Assets jumped $127.7 billion, or 16%. For comparison, Federal Reserve assets are up $12.8 billion so far this year to $745 billion.
The Mortgage Bankers Association Purchase application index jumped to the sixth highest level on record. The Purchase index has now increased 15% in the past three weeks to 21% above the year ago level. By dollar volume, Purchase applications were up 32.6% from a year earlier. The average Purchase loan amount was $199,800. On the other hand, Refi applications were down 60% from the elevated level of one year ago.
September 19 – Los Angeles Times: “A slew of fence sitters jumped into Southern California’s housing market last month, boosting home sales and price increases to their highest levels in more than 14 years. The August median price for homes sold in the six-county region, from Ventura to San Diego, rose 22% from a year earlier to $338,000, according to DataQuick… The year-over-year gain was the strongest since May 1989, when the median price of new and existing houses and condominiums was $176,000. San Bernardino County, the Southland’s most affordable area, saw the largest price increase last month, jumping 29% to $207,000. The median price of all homes sold in Los Angeles County in August was $338,000 — up 27% from a year earlier. Sales overall for the Southland also hit their highest monthly count since the late 1980s, with 34,437 properties changing hands in August, 12% more than a year earlier... the number of homes sold in Orange County last month — 5,511 — was the highest of any month since July 1988… The effect of higher interest rates was apparent last month in expensive Orange County, where nearly half of all buyers used ARMs to purchase their homes. That compares with 38% in July and 29% a year ago.”
September 19 – Minn. Star-Tribune: “August’s $207,500 median home-sale price set another record for the Twin Cities area, leaping $5,500 from the previous record set in July. The median -- the point where half the sales are for more, half for less -- was up 9.21 percent from August 2002… Business was strong last month, with closed sales up 24.47 percent from August 2002.”
August Housing Starts dipped slightly from July’s 17-year high. At a 1.828 million pace, total Starts were 11.7% above August 2002, with Single Family up 11.8% y-o-y and Multi-family up 6.8%. Units Under Construction were up 8.3% y-o-y, with Single Family up 10.6% y-o-y and Multi-family up 3.4%. Building Permits were reported at a much stronger than expected 1.8 million pace, up 10.7% y-o-y. For comparison, August Starts were up 31% from August 1997. It is also worth noting that all housing regions remain strong. August permits were up 9.0% y-o-y in the Northeast, 6.6% in the Midwest, 6.0% in the South, and 6.4% in the West. The National Association of Home Builders September index dipped three points from August’s exceptionally strong reading of 71.
The second quarter Current Account Deficit was up 13% y-o-y to $138.7 billion. The past four quarters have seen a deficit of a staggering $529 billion.
Bear Stearns reported “Net Income up 90.6% to $313.4 million, nearly doubling from $164.4 million in third quarter 2002.” Fixed Income Net Revenues were up 76.8% from the year ago quarter to $407.3 million and Investment Banking Net Revenues were up 83.2% to $299.7 million.
September 17 – Bloomberg: Paul McCulley, managing director of Pacific Investment Management Co.: ‘The Fed is supposed to go for maximum employment, stable prices and moderate long-term interest rates. The glaring goal that needs to be met is maximum employment. And there’s no reason that the Fed can’t go for it in the context of those moderate long-term rates, and the downside risk to inflation from a starting point of price stability. ‘Until you get job creation, not a jobless recovery, then the Fed has a mandate to keep the foot on the accelerator, keep money growth strong and short-term interest rates low. So I think it’s an absolutely delightful template for the Fed to let it rip for a bit.’”
Inflationism is such a slippery, slimy slope. After all, it was not all too many weeks ago that The Inflationists were invoking The Evil of Deflation as grounds for the Fed and global central bankers to venture only further into the uncharted muddy waters of ultra-easy international money and Credit. With the case for global deflation today decidedly more difficult to contrive, we are now subject to the seductive nonsense that inflation is, as well, the magic elixir for a bout of stubborn U.S. unemployment.
Yet, overwhelmingly, today’s persistent American joblessness is a structural issue related to a grossly imbalanced economy (and Credit system) and the hollowing of our nation’s manufacturing base. And these separate but related deep structural distortions are categorically the consequences of years of Credit and speculative excess. There is simply no way for today’s deranged Credit system to evenly spread liquidity throughout the economy. Until the next cycle, it remains a safe bet to assume that liquidity will love playing inflating assets markets, while having minimal attraction to goods-producing profits. These dynamics have become so deeply ingrained. Financial institutions, instruments, mechanisms and market psychology have evolved that perpetuate asset Bubbles at the expense of the real economy.
Yes, we can nowadays witness Credit inflation boosting the income of real estate agents, attorneys, insurance salesmen, financial operators, building contractors, defense contractors, and medical professionals. But there are fewer jobs every month for the factory worker. And with the cost of doing business in the U.S. inflating by the month, our manufactures become only less competitive globally. How, again, is greater Fed-induced Credit excess to become the solution to our deepening economic and financial ills?
Pondering Mr. McCulley’s “it’s an absolutely delightful template for the Fed to Let It Rip,” I am reminded of Dr. Richebacher’s prescient warning years ago that an environment of placid consumer prices has the potential to nurture the most conducive conditions for runaway financial Bubbles. Well, we continue to watch in utter amazement as this dynamic plays out in historic dimensions.
Especially considering contemporary uncontrolled market-based Credit systems, an index of consumer prices is a barren analytical wasteland for administering monetary policy. A successful framework must incorporate a disciplined focus on moderate and balanced Credit growth. The effective allocation of real and financial resources is coveted. Financial and economic stability are paramount. Credit and speculative excess must be monitored and subdued early. Trade deficits must be monitored and subdued before unserviceable foreign debts are accumulated and before they impact the underlying structure of the economy. Moderate and balanced economic growth within the context of a stable financial environment must be the goal. Subjective analysis of the nature of economic output and the quality of financial sector assets should play a foremost role in monitoring systemic developments. Asset inflation (financial and real) must play prominently as an indicator of monetary laxity. The system should be guarded against Asset Bubbles, at significant cost if necessary.
How a learned analyst – with a birds eye view of the dysfunctional U.S. Credit system and residing at the epicenter of a dangerous real estate Bubble out in Southern California – can today encourage the Fed to “Let It Rip” is simply beyond me. Yet it is a sign of the times that there is today little concern for intractable trade and fiscal deficits, runaway Credit excess, asset Bubbles, endemic financial speculation (Credit, equity, and real estate markets) and conspicuous economic imbalances. No problem, apparently, as long as the Fed sustains reflation. Indeed, domestic economic thinking has of late sunk to a new low. Curiously, however, it appears that global policymakers are increasingly outspoken regarding “global imbalances.” This is a thinly veiled criticism of unprincipled U.S. economic policy.
It has been an interesting few weeks, with a much celebrated three-month dollar rally having ended abruptly. After approaching 100 during the first week of the month, the dollar index ended today at about 95. Dollar weakness has been broad based. Month-to-date, the Swedish krona, Hungarian forint, Czech koruna, and Norwegian krone have gained almost 5% against the dollar. The Chilean peso, Australian dollar and British pound have increased nearly 4%. The euro is up almost 3.5%. The Canadian dollar, Danish krone and Iceland krona have gained about 3%. The Brazilian real, Thai baht, New Zealand dollar, and Japanese yen are up better than 2%. What’s undermining the value of our currency?
If you surveyed 10 analysts to address recent dollar weakness you would likely garner a dozen conflicting explanations. I’ll throw my hat in the ring. The U.S. financial system remains locked in massive Credit inflation, otherwise labeled financial claims inflation/dollar devaluation. During the summer, the market began discounting a scenario where heightened U.S. economic expansion would incite higher market rates and imminent Fed tightening. Market induced tighter Credit conditions would then see reduced demand for mortgage borrowings and a resulting attenuation of self-reinforcing asset inflation (both real estate and Credit market instruments); hence, sharply reduced Credit inflation. Such a scenario of stronger growth, higher rates, and less non-productive U.S. debt expansion was dollar bullish. But that scenario has been sidetracked.
Since September 2nd, 10-year Treasury yields have dropped 44 basis points to 4.16%. The yield on December 2004 3-month Eurodollars has sunk 68 basis points to 2.36%. And while some would argue that lower market rates are explained by less optimistic U.S. growth prospects, I am not convinced. More likely, the speculative marketplace is fixated on the Fed. It is worth noting that Inflationist Dr. Bernanke spoke September 4, intimating that the Fed would not begin ratcheting rates higher any time soon: “There is a reasonable chance of further disinflation in 2004.” “I would like to see the disinflation risks dissipate.” “This is a job-loss recovery.”
Well, this was music to the ears of the leveraged speculating community, sitting nervously with an unprecedented mountain of security holdings and derivative positions. Fed talk certainly nipped what appeared an unfolding Credit market dislocation in the bud. It also forces me to question my view that the bond Bubble was pierced. It doesn’t act pierced. Expectations that the backup in rates had inflicted pain on the leveraged speculating community have thus far failed to materialize. The hedge fund community appears today unscathed, while the Wall Street firms and major banks haven’t missed a beat.
The bottom line is that the bond market appears to have retained its inflationary bias. Those short bonds are being forced to cover, while those hedging interest rate risk are likely reversing hedges. With the Fed’s encouragement, the Credit market has again become overly sensitive to any indication of tempered economic growth. And while higher rates are needed to cool overheated mortgage finance excesses, rates are instead moving in the direction of perpetuating Bubble excess. The Fed is determined to sustain Credit excesses, while we are provided additional evidence that the Credit market is incapable of self-regulating the demand for borrowings.
So the risk pendulum seems to have swung back to the dollar from the leveraged U.S. Credit system – for now. The Fed is conspicuously determined to accommodate any degree of Credit excess to keep the game going, and seem all too willing to sacrifice the dollar in the process. At the same time, Washington politicians are screaming for higher Asian currencies (a weaker dollar). This is Risky, Risky Business. There will be a high price to pay for our Weak Dollar Policy.
Importantly, at this point The Eternal Credit Bubble ensures unending global dollar liquidity – from massive trade deficits, as well as from the enormous speculative liquidity being unleashed to play global markets. While it may appear the same as before, we’ve entered a New Era of Dollar Global Over-liquefication. At the same time, global central bankers must be examining their ballooning holdings of U.S. securities with increasing trepidation. There is little interest in foreign private investment in the U.S. real economy and insufficient demand for U.S. exports. Moreover, there has been waning private demand for U.S. securities. Foreign central banks have been relegated to the role of dollar buyers of last resort, and the dollars just keep coming, and coming, and coming in droves. Not only must they today ponder the scenario of the dollar liquidity onslaught spiraling out of control, they are on the receiving end of pot shots from American politicians. How Not to Win Needed Friends and Influence Important People.
Ominously, not even the dramatic return of equity market inflation has lent support to the dollar. The promise of higher U.S. yields - that gave temporary respite to the dollar bear market - has had the rug pulled out from under it by Team Bernanke/Greenspan. Little wonder Gold trades so well: Unbridled Global Credit inflation. And while the stock market wallows in today’s reflationary environment, we’ll stick with our view that what is unfolding is not favorable for U.S. financial assets generally. Domestically, this may all be fun and games – reflation, manipulation, intoxication and jubilation. But this financial madhouse is inhospitable – better yet, it’s downright disrespectful – to our foreign creditors. My sense is they will increasingly demand our respect.
One of these days, this wonderful mechanism whereby foreign central banks recycle the global flood of dollar liquidity right back to the inebriated U.S. financial markets will be tested. Dollar weakness in the face of unprecedented central bank purchases is today foreboding. The Inflationists should be careful for what they wish for. The Fed has spoken, “Let it Rip.” Perhaps this has been heard loud and clear by the rest of the world.