09/25/2003 The Powerful Force *

A weak dollar and palpable financial fragility weighed on the speculative stock market. For the week, the Dow declined 3% and the S&P500 dropped 4%. The Transports were hit for 5% and the Morgan Stanley Cyclicals 4%. The Utilities were unchanged. The highflying small caps gave up some altitude, as the Russell 2000 declined 6%. The S&P400 Mid-cap index dipped 4%. The technology sector came under heavy pressure. The NASDAQ100 declined 6% and the Morgan Stanley High Tech index dropped 5%. The Semiconductors sank 8%. The Street.com Internet index lost 4% and the NASDAQ Telecommunications index shed 6%. The speculative Biotechs were hammered for 9%. The Broker/Dealers declined 5% and the Banks 3%. After touching a seven-year high, gold retreated to end the week down $1. The HUI gold index sank 6%. The Treasury market enjoyed another solid week. Two-year Treasury yields sank 16 basis points to 1.51%. The 5-year yield dropped 20 basis points to 2.90%, the lowest level since Mid-July. The 10-year Treasury yield dropped 16 basis points to 4.00%, with the long-bond slipping 13 basis points to 4.93%. Benchmark Fannie Mae mortgage-backed yields sank a notable 25 basis points. The spread on Fannie’s 4 3/8 2013 note widened 4 to 43, and the spread on Freddie’s 4 ½ 2012 note widened 3 to 42. The 10-year dollar swap spread narrowed 0.5 to 41. Corporate spreads generally widened slightly. It was another week of major corporate bond issuance. In the investment-grade arena, Wells Fargo sold $1.5 billion (up from planned $1 billion), Kraft Foods $1.5 billion, Wal-Mart $1 billion (42 basis points over Treasuries), Bristol-Myers Squibb $1 billion, CRH America $1 billion, Cadbury Schweppes US $2 billion, Merrill Lynch $850 million, National Rural Utilities $700 million, DaimlerChrysler $600 million, Coca Cola Enterprises $500 million, Dayton Power & Light $470 million, Noranda $350 million, Inco $300 million, Estee Lauder $200 million, FPL Group Capital $600 million, Northern States Power $150 million, Australian Gas $150 million, and Transwitch $98 million. Junk bond funds saw inflows of $152.9 million, reversing two weeks of outflows (from AMG). This week’s issuance included Hertz at $500 million (up from planned $350 million), Level 3 $500 million, Rayovac $$350 million, Majestic Star $260 million, Standard Pacific $150 million, MetroPCS $150 million, WCI Communities $125 million, Seminis $190 million, Hines Nurseries $175 million, and Security Benefit $100 million. Convert issuance included Mega Financial’s $690 million, Lonmin $216 million, Doral Financial $300 million, Pharmaceutical Resources $160 million, ExpressJet $137 million, Exult $100 million, CKE Restaurants $90 million, and Memberworks $75 million. Bloomberg today quoted a bond manager: “It’s an environment where all kinds of companies can get anything they need done, and they’re taking advantage of it.” September 26 – Bloomberg (Joe Mysak): “Through the end of last week, states and municipalities sold almost $270 billion in municipal bonds, according to The Bond Buyer… This week, they are expected to sell another $7.5 billion or so. That figure of almost $280 billion already makes 2003 the fourth busiest year ever for municipal bond sales, with a quarter to go. The fourth quarter is typically marked by an increase in bond issuance. The record year for muni bond sales was 2002, when $359 billion in bonds were sold. In second place was 1993, with $292 billion; 1998 ranked third, with $286 billion.” The CRB index remains extraordinarily volatile, ending the week with a small gain. Soybeans traded to a five-year high this week, with prices up nearly a third over the past two months. Global Reflation Watch: Dealogic reported yesterday that nine-month global capital market debt issuance surged 22% to $3.72 Trillion. From Dow Jones: “Issuance of investment-grade corporate bonds rose 21% to $990.4 billion, while junk bond issuance increased from $59 billion to $119.5 billion, the highest level since 1998… By region, the Americas witnessed a 15% rise in…volume to $2.27 trillion… In Europe, the Middle East and Africa…volume jumped 42% to $1.17 trillion.” Japanese officials today tripled growth estimates to 2.1%, a sharp increase which would put GDP at the strongest pace in about three years. Japanese August CPI was down only 0.1% y-o-y, the slowest rate of decline since March 2001. Italian consumer confidence jumped to a 5-month high, while inflation increased at the strongest rate since July 2001. After four months of decline, Singapore factory production surged a much stronger-than-expected 17.8% from July. South Korea’s Commerce Minister stated today that he expects exports to rise more than 10% this year to a new record. Taiwan’s broad money supply expanded at the fastest pace in 2 ½ years during August (4.3%). Taiwan’s jobless rate declined to a two-year low (4.96%). Bloomberg (on Taiwan): “Southeast Asia’s second-biggest economy will probably expand this year at its fastest pace in eight years after exports to China, Japan and Europe surged.” Thai officials raised their forecast for 2003 growth to 6.4% from 6.1%. Retail sales in Chile rose at the strongest pace in at least 3 years (up 6.8% y-o-y). Bloomberg quoted an Indian official as expecting August export growth of 11%, up from July’s 5.8%. September 26 – Bloomberg: “China’s economy may grow as much as 9 percent next year unless the government curbs spending on roads, bridges and railways and the central bank tightens monetary policy, the China Securities newspaper said, citing a report by a government-backed think tank. That pace of growth will probably be achieved if the existing M2-money-supply growth target of 18 percent is maintained and the government raises 120 billion yuan ($14 billion) via treasury-bond sales to finance infrastructure spending, the State Information Center said…” September 23 – Bloomberg: “Ford Motor Co., which lags rival General Motors Corp. in making cars in China, said it will expand its factory to triple production to 150,000 units a year to take advantage of the world’s fastest-growing car market. ‘The market here is expanding incredibly fast, so we need to bring in as many products as soon as we can to take advantage of the growth,’ said Dale Jones, Ford Motor (China) Ltd.’s marketing vice president.” September 23 – Bloomberg: “Taiwan’s export orders rose more than a 10th for a third straight month in August, as consumers in China and the U.S., the island’s top two overseas markets, bought more laptop computers, flat-panel displays and cell phones. Orders -- indicative of shipments in one to three months -- rose 11 percent from a year earlier to $14.4 billion after climbing 15 percent in July…” September 24 – Bloomberg: “New Zealand consumer confidence is at a seven-year high after the jobless rate fell to a 15-year low and housing prices boomed because the central bank cut interest rates three times in four months…. House prices rose 16 percent in August from a year earlier (sales up 26.8%) and the jobless rate fell to 4.7 percent in the second quarter.” ECB broad money supply (M3) expanded at an annual rate of 8.2% during August, down from July’s 8.6%. European Private (business and household) Credit growth was up 5.5% y-o-y, stable from July. This compares to 9.4% U.S. non-federal, non-financial Credit growth during the second quarter. September 25 – Bloomberg: “The number and value of U.K. home-purchase loans surged in August from a year earlier, the British Bankers’ Association said… The average value of a house-purchase loan rose 25 percent to 109,600 pounds ($181,338)… A government index showed the growth in house prices accelerated to 14.6 percent in the year to July from 13.4 percent the previous month.” September 25 – Bloomberg: “India’s tax income from company profit increased by 29 percent in the current financial year that began on April 1, a sign growth in Asia’s third-largest economy is accelerating.” September 25 – Bloomberg: “Neptune Orient Lines Ltd., Mitsui O.S.K. Lines Ltd. and rivals plan to increase rates for carrying cargo to the U.S. from Asia, the world’s busiest container trade route, by as much as 15 percent in May 2004, as cargo demand outpaces growth in capacity. A total of 14 shipping lines, calling themselves the Transpacific Stabilization Agreement, plan to raise rates for carrying cargo to the U.S. West Coast by $450 for each 40-foot container… That would raise rates to the highest level since at least 2000…” Domestic Reflation Watch: September 24 – Washington Times: “Trial lawyers raked in $40 billion last year from lawsuits, according to a report released yesterday by a New York think tank. Lawsuits over issues such as asbestos, mold and medical malpractice — but not tobacco settlement payments — cost a total of $205.4 billion last year, according to the report by the Manhattan Institute, which promotes free-market economics. The study surveyed the lawsuit industry’s size, scope and reach in the U.S. economy, reporting that lawsuits from 1975 through 2001 had cost $2.8 trillion. ‘Most Americans can point to a wacky lawsuit, but many aren’t aware just how large of a big business’ the industry is, said James Copland, director of the institute’s Center for Legal Policy. Attorney fees at large firms have jumped from $500 an hour to as high as $30,000 in the last decade… The high legal fees and large settlements have turned some lawyers into overnight millionaires... About 300 lawyers from 86 firms were projected to earn up to $30 billion total over the next 25 years from the 1998 tobacco settlement, in which four big tobacco companies agreed to pay the states $246 billion. Those lawyers have turned their interests to other industries ‘with deep pockets,’ the report said… Lawyers so far have brought 600,000 asbestos lawsuits, which have bankrupted 67 companies and resulted in $54 billion in settlements. The final price tag is projected to reach $275 billion, the report said.” (My comment: trial lawyers are surely our most “productive” workers) Broad money supply (M3) increased $12.9 billion for the week ended September 15th. Demand and Checkable Deposits increased $3.3 billion, while Savings Deposits Declined $6.1 billion. Small Denominated Deposits declined $1.5 billion and Retail Money Fund deposits dipped $2.1 billion. Institutional Money Fund deposits rose $6.3 billion (up $11.4 billion in 2 weeks) and Large Denominated Deposits gained $6.0 billion (up $15.9 billion over two weeks). Repurchase Agreements jumped $8.6 billion (up $14.7 billion over three weeks), while Eurodollars declined $2.4 billion. Bank Total Assets dropped $59.4 billion the week of September 17. Treasury and Agency Securities sank $25.6 billion. Commercial and Industrial loans declined $5.3 billion and Real Estate loans dropped $14.0 billion (after increasing $43.3 billion the two preceding weeks). Elsewhere, total Commercial Paper (CP) declined $13.4 billion, with a 2-week decline of $23.9 billion. Financial CP was down 9.5 billion (19.2 billion over 2 weeks) and Non-financial CP was down $3.8 billion. Foreign (“custody”) Holdings of U.S. Debt held by the Fed declined $1.1 billion. There were 31,859 bankruptcy filings last week, with y-t-d filings running up 7.6%. August Existing Home Sales surged 6% above the previous record set last month (7% above expectations) to an annualized rate of 6.47 million. Sales were up almost 22% from August 2002 and were up 46% from (pre-Bubble) August 1997. The Average Price (mean) of $224,500 was up 9.0% y-o-y and 44% since August 1997. Calculated Annualized Transaction Value (CTV - annual. sales x average price) was up an alarming 32.9% y-o-y to $1.452 Trillion. CTV is up 110% since August 1997. (Unmistakable evidence that The Great Mortgage Finance Bubble did go parabolic.) The boom is national, with all regions posting sales records during August. By region, sales were up 12.7% in the Northeast from one year ago, 22.1% in Midwest, 22.4% in the South, and 24.8% in the West. Prices were up (y-o-y) 11.5% in the Northeast, 10.9% in the Midwest, 7.9% in the South, and 7.6% in the West. Also above expectations, August New Home Sales were up 12.2% y-o-y to an annualized pace of (and near record) 1.115 million units. Sales were up 32% from two years earlier and 41% from August 1997. Average Prices (mean) were up 7.3% y-o-y to $237,500, with gains of 39% since August 1997. New Homes Calculated Annualized Transaction Value (CTV) was up 20.4% y-o-y to $273 billion. CTV is up 96% since August 1997. By region, sales were up 40% y-o-y in the Northeast, 22.2% in the Midwest, 7.0% in the South, and 4.0% in the West. New Home Sales are on pace to exceed one million units this year, which would be 5% above last year’s record. During August, there were 34,000 New Homes sold with prices at or above $250,000. For comparison, there were 22,000 sold in this category during August 2002. The Mortgage Bankers Association application data was likely impacted by Isabel. For the week, Refi applications were about unchanged, while Purchase applications declined 8.1%. However, Purchase applications were up 11.9% y-o-y, with dollar volume up 23.2%. Freddie Mac posted 30-year mortgage rates declined 3 basis points this week to 5.98%, down 46 basis points in three weeks. One-year adjustable rates declined 4 basis points to 3.77%. There could be a signficant decline in mortgage rates next week. September 24 – Las Vegas Review Journal (Hubble Smith): “Sales of existing homes in Las Vegas have increased by nearly 22 percent through August, pointing to a sixth straight year of double-digit increases in that category… There were 4,697 recorded resales in August, bringing the year-to-date total to 31,328, up 5,618 from a year ago, said Dennis Smith, president of Home Builders Research. ‘It’s just so astonishing to me to see how large those increases are. It’s not just 22 percent. Yeah, 22 percent up from the previous year, which was up 18 percent from the previous year, which was up 15 percent from the year before.’ …The median price of a new home in August was $206,167, up 12.4 percent from the same month a year ago. The median price of an existing home was $172,000, up 13.2 percent… New home building permits continue to be pulled at a record pace… ‘The current thing is still land prices,’ Smith said. ‘We don’t expect them to reverse and they haven’t. They keep going up.” … If the resale market continues at its current pace, there would be almost 50,000 transactions this year, which would translate to a 29 percent increase from 2002.” …Smith expressed concern about investors and speculators who not only help drive up sales prices, but also present a somewhat inflated picture of true consumer demand. ‘It’s good for the present numbers, but could result in some problems down the road,’ he said.” September 23 - Albany BusinessReview: “Home prices in state jump 26 percent: Sales of existing homes declined in August statewide and in the Albany, N.Y., region, but sales prices jumped more than 26 percent, according to data compiled by the New York State Association of Realtors.” September 23 – NBC11.com: “Dreaming about living in Marin County? Be sure to bring money -- lots of it. The median price of a Marin County home soared to a record 756,000 dollars in July. That’s almost 9 percent above the July 2002 figure. Yesterday from the California Association of Realtors: “The median price of an existing, single-family detached home in California during August 2003 was a record $404,870, a 21.1 percent increase over the $334,270 median for August 2002… The August 2003 median price increased 5.6 percent compared to a $383,390 median price in July.” In dollars, the California median price was up an eye-opening $21,480 during August and $70,600 y-o-y. Sales were up 14.7% from the strong year ago level. “All regions of the state recorded a marked increase in sales activity last month.” Condo sales were up 16% y-o-y, with prices up a stunning 25.3% to $290,330. The unsold homes inventory dropped to only 2.1 months supply. Notable y-o-y prices increases included High Desert up 25.4%, Los Angeles 24.5%, Palm Springs/Lower Desert 22%, Ventura 23.6%, and Orange County 19.7% September 25 – Florida Association of Realtors : “Showing no signs of cooling off, Florida’s housing market caught fire in August, with a 19 percent increase in resales activity and a 13 percent rise in the statewide median sales price…” Prices were up 27% y-o-y in West Palm Beach-Boca Raton to $251,900 last month. Prices in Miami increased 24% to $241,000. Fort Lauderdale saw prices jump 21% to $251,000. Prices were up better than 15% in Daytona Beach, Gainesville, Orlando, and Sarasota. September 25 – Illinois Association of Realtors: “A slight uptick in interest rates during August did not damper Illinois home sales statewide, as sales were strongly ahead of last year. Statewide sales of existing homes in August were 11,867, up 10 percent from 11,750 August 2002 sales. The August 2003 statistics are the highest August sales reported on record, since the Association began reporting statistics in 1990. The statewide median price in August was $184,500, up 9.1 percent from last year's price of $169,100. ‘Typically August home sales slow to a more seasonal pace, but this year we saw a surge of sales during the month.’” The median price in greater “Chicagoland” was up 9.9% y-o-y. September 24 – American Banker: “Citigroup Inc.’s CitiMortgage has announced its largest-ever program to provide affordable housing to low- and moderate-income, minority, and underserved families. …executives said the $200 billion initiative, which it expects to run through the end of the decade, could help as many as two million families get homes.” The brokerages reported another big quarter. Lehman Brothers reported Net Revenues up 74% from the year ago quarter to $2.347 billion. By segment, Investment Banking was up 8.4% y-o-y, with Equity Underwriting up 28% y-o-y to $119 million, Debt Underwriting up 11.5% to $232 million, and M&A down 12.8% to $102 million. Meanwhile, Capital Markets Net Revenues surged 129%, with Equity up 138% to $476 million and Fixed Income up $125% to $1.19 billion. At Morgan Stanley, “Third quarter revenues (total revenues less interest expense and provision for loan losses) were $5.3 billion – 13% better than last year’s third quarter and 4 percent ahead of this year’s second quarter… Fixed income sales and trading net revenues more than doubled from third quarter 2002 to $1.5 billion…Equity sales and trading net revenues declined 21 percent from a year ago to $830 million… Advisory revenues were $130 million, down 13 percent…” Goldman Sachs reported net earnings up 30% from the year ago quarter to $677 million. However, earnings were down 3% sequentially. Total Net Revenues were up 4% y-o-y but down 5% q-o-q. Interestingly, Fixed-income, Currency, and Commodities revenues dropped 48% q-o-q (to $828 million), although this was largely offset by a surge in Asset Management and Financial Advisory revenues. Interestingly, after expanding $42.1 billion over the previous two quarters (31% annualized), Total Assets at Lehman declined $7.4 billion during the quarter to $302.4 billion. Total Assets declined $6.2 billion at Morgan Stanley after surging $57.4 billion over the preceding two quarters (22% annualized). Goldman Sachs did not report assets in their earnings release, but Total Assets expanded $49 billion (27% annualized) during the two preceding quarters. For the Security Brokers and Dealers as a group (from the Z1 report), total assets increased by $167 billion during the first half, or 25% annualized, to $1.50 Trillion. Are the securities firms now becoming more risk averse? Freddie Mac is not letting difficulties in puttting it books in order get in the way of enormous balance sheet expansion. For August, Freddie’s Retained Mortgage Portfolio expanded a record $20.8 billion, or 41.9% annualized, to $616.0 billion. Freddie has now increased its Retained Portfolio by $43.2 billion, or 30% annualized, over the past three months. Freddie and Fannie Combined for a record $47.9 billion increase in Retained Portfolios, or 40.1% annualized, during August to $1.479 Trillion. Over three months, Freddie and Fannie have inflated their Retained Portfolios by a stunning $90.8 billion, or 26% annualized. Combined Retained Portfolios were up $207.3 billion, or 16.5%, y-o-y. Combined Books of Business were up $430.9 billion, or 14.7%, y-o-y to $3.40 Trillion. Yesterday’s circumstances seemed to encapsulate the general environment. August Durable Goods Orders were reported at weaker-than-expected down 0.9%. Orders were actually down 1.9% y-o-y. Bonds rallied on the news. In contrast, both New and Existing Home Sales were reported stronger-than-expected. Combined annualized sales of a record 7.72 million units were up 20% y-o-y. Yet bonds couldn’t have been less bothered by the strong housing data, rallying strongly throughout the afternoon. The bond market is not concerned with overheated housing markets because the Fed isn’t. September 22 – Bloomberg quoting Fed governor Dr. Ben Bernanke: “The pattern of response of the Fed to the economy is different now than it might have been in recent years ‘because inflation is so low. We could have a significant amount of growth without inflation’ for some time, and ‘the Fed may not have to respond by tightening as it has in past episodes.’” September 24 – Bloomberg: “A accelerating economic expansion isn’t producing new jobs because productivity is rising faster than growth, so Federal Reserve officials will keep interest rates low longer than in past recoveries, four Fed policy makers said this week.” With the unprecedented degree of leverage throughout the economy and financial sector; out of control leveraged speculation; and an unfathomable interest rate derivative situation, we should not be surprised that the Fed is fixated on interest rates. But it is, nonetheless, amazing to watch the Fed and bond market so eagerly play into the hands of the dangerous mortgage finance Bubble. California and East Coast housing markets inflating at a pace near 20%, with Fed funds at 1% and variable mortgage rates at less than 3.8%? The Fed wants long-term rates lower and the Fed is now in a habit of getting even more than it wants. Fundamentals will have to step aside, for now. Others have used the phrase, “The muddle through economy.” I am not a big fan of this type of analysis, as it strikes me as the ultimate aggregation. Booming housing, “services” and government sectors -- offset by a moribund manufacturing sector -- today “balance” out at around 3 to 4% GDP growth. Yet it remains “muddle through” only as long as the Fed can perpetuate the Credit Bubble that sustains housing, “services” and government expansion. It is determined to do so, but the unavoidable consequence is only more intractable financial fragility. I much prefer the notion of a “Dynamically Hedged Economy.” A truly enormous leveraged speculating community and derivative juggernaut has evolved to dominate the financial markets and Bubble economy: The Powerful Force. As long as it is financially beneficial for this Powerful Force to expand, then liquidity and Credit availability are easily available. Financial and real assets inflate and (unsound) economic expansion follows. Serious problems, however, develop at any point where The Powerful Force becomes less expansive. Meanwhile, the larger and more leveraged they become, the more arduous the task of expanding and the more vulnerable The Powerful Force becomes to market volatility. Last year, it became financially disadvantageous to own corporate bonds – in many cases it was actually quite profitable to short them. The leveraged speculating community was liquidating positions and shorting, fostering a Credit availability disappearing act. Liquidity was evaporating throughout the corporate market, and the dominoes were beginning to fall. Derivative players on the wrong side of a faltering corporate bond market were forced to dynamically hedge their exposure; they were forced to sell bonds that were in decline, causing heightened (self-feeding) market turmoil. The Dynamically Hedged Economy was on the brink. It was the exact opposite of today’s Credit environment: as night is to day. To understand today’s environment it is important to appreciate that the Fed looked at potential debt collapse last year and said, “We’ll have absolutely none of that!” Team Bernanke/Greenspan aggressively cut rates and signaled to the market that they were willing to flood the system with liquidity to resolve the dislocation (couched in terms of fighting “deflation” – much more palatable than fearing “debt collapse”). The rest is history. The leveraged speculators and derivative players began to reverse their short positions, setting in motion a self-reinforcing return of liquidity and Credit availability (not to mention one heck of a speculative stock market run). Not only did the derivative players reverse bearish bets, The Powerful Force began aggressively increasing leveraged long positions. It was one of history’s most precipitous Busts to Booms. A few weeks ago hedge fund manager extraordinaire Leon Cooperman was on “Kudlie and Cramie.” His fund is up big this year, and Mr. Cooperman was pleased to explain his very successful bet on the junk bond market. “The government wanted us to own them,” if I recall his comment accurately. There was also a story this week of a large hedge fund that has a 20% plus y-t-d return, largely on a successful big bet on Conseco Credit default swaps. Conseco bonds and other distressed securities benefited tremendously from the Fed’s aggressive reliquefication. The Fed wanted the speculators to buy, and The Powerful Force has seen repeatedly that it's profitable to play along with the our central bankers. Success stories are easy to find these days throughout the leveraged speculating community. Everyone is fat, happy and complacent. The point being, the Fed has (for too long) been playing to a very captive and expanding audience. And not only has The Powerful Force mushroomed tremendously over the past few years, financial innovation has created only more efficient ways to place leveraged bets. As dire as things looked last fall, the Fed still retained the capacity to call out The Big Guns and entice the leveraged speculators and derivative players to cover short positions and go aggressively long. They did. There are now extraordinary dynamics at play that make today’s environment absolutely fascinating. For one, there is a strong inflationary bias throughout the global Credit system, with overabundant liquidity available for about any individual, company, government entity or country. Our policymakers have made it perfectly clear – to the home owner, to the stock jockey, to the global bond players, to the derivatives trader - that leverage is the way to easy profits. And Everyone has been rushing full-throttle to play inflating asset markets. It is a truly amazing thing to witness. That it has come to seem so normal makes things all the more riveting. To see Everyone on the same side of the boat… The stock market boat has begun to rock. Moreover, virtually no one voices concern about the speculative excess running roughshod throughout the stock, bond and emerging markets, as well as the California/national housing markets. The “good” news is that Everyone is keen to expand holdings (inflationary bias). The bad news is that these holdings are growing exponentially and their liquidation will be a big problem. There will be no one to take the other side of the trade. For now, as is always the case during the halcyon days of expansion and financial excess, things look wonderful to virtually all. Finance is ultra-easy, financial profits and “wealth” creation are ultra-easy, and asset inflation is ultra-seductive. But don’t Credit and speculative excess invariably sow the seeds of their own destruction? Yes they do, but it is today worth pondering that, traditionally, the Credit market begins tightening in anticipation of the Fed’s less accommodative stance. Nowadays, with an unprecedented depth and breadth of financial excess, the Fed is screaming, “Don’t Tighten Credit System!! Please Don’t Tighten!” The Credit system is responding with a, “OK, fine by us.” So bond yields have declined sharply. This is forcing the speculators and derivative players that were short bonds to buy them back. Sinking yields, then, raise the possibility of a reemergence of a destabilizing refi boom (and at the minimum throw gas on the mortgage finance Bubble). Such a potentiality could easily unnerve the crowd of mortgage-back operators, where more hedging activities would only push bond yields lower. And, of course, many a speculator would want to jump on that train, fueling rising bond prices and collapsing yields. Is this any way to run a Credit system? And what about the housing Bubble and forecasts for 5% second half growth? Aren’t yields too low considering the demand for borrowings? Well, yes they are; but that’s missing the point. The Fed has nurtured The Powerful Force and right now it wallows in the strong inflationary bias ingrained throughout the financial system and in key sectors of the real economy. Perhaps bond yields are signaling an economic slowdown, but it appears more like they are being buffeted by financial instability. For now, it appears market dynamics rule and our housing markets and Dynamically Hedged Economy are along for the ride. This is a dangerous creature the Fed has reared and cut loose. Things have really run amok. And that the consensus so confidently holds the view that things are going along absolutely swimmingly only increases our fear of a looming financial surprise. We, today, see many of the necessary ingredients. And reiterating last week’s point, the resurgent bond bull and hyper-resilient Credit Bubble are not good news for the dollar. That the stock market would all the sudden get shaky knees is interesting. Driven to major speculative excess on the back of a glut of liquidity and delusions of benevolent reflation, the stock market is now left to grapple with an exceedingly unruly financial environment.