December 1 – Financial Times (Anuj Gangahar): “November was the best month for initial public offerings on US stock markets for more than five years, with 32 companies across the world, raising a combined $8bn, according to…Dealogic… Last month was the best November for US stock market floats since 1999 and the best single month since June 2001… For the year so far, deal volume is up by 19 per cent on last year.”
Two-year government yields sank 21 bps to 4.52%. Five-year yields fell 16 bps to 4.39%, and 10-year Treasury yields dropped 11.5 bps to 4.435% (low since January). Long-bond yields declined 8 bps to 4.55%. The 2yr/10yr spread ended the week inverted 8.5bps. The implied yield on 3-month December ’07 Eurodollars sank 23.5 bps to 4.535%. Benchmark Fannie Mae MBS yields sank 21 bps to 5.49%, this week significantly outperforming Treasuries. The spread on Fannie’s 5 1/4% 2016 note ended the week one narrower at 31, and the spread on Freddie’s 5 1/2% 2016 note was two narrower at 29. The 10-year dollar swap spread declined 3 to 46.5, the low since October 19, 2005. Corporate bonds rallied along with Treasuries, with junk spreads narrowing 20 bps.
November 30 - Dow Jones (Anusha Shrivastava): “No matter how it’s sliced and diced, the investment-grade corporate bond market will post record amounts of new debt from companies taking advantage of historically cheap financing… Data-provider Dealogic is on the cusp of calling 2006 a record year. Investment-grade supply, not including preferred securities and medium term notes, has already reached $610.3 billion as of Friday, just $2 billion short of the record set in 2001.”
Investment grade issuers included Suntrust $1.0 billion, Cox Communication $1.0 billion, Wells Fargo $750 million, Con Edison $500 million, Potash $500 million, Manufacturers and Traders Trust $500 million, PNC $500 million, Healthcare Properties $400 million, WPS Resources $300 million, Emerson Electric $250 million, Mass Mutual $250 million, Federal Realty Investment Trust $135 million, Wisconsin Public Service $125 million, and Gulf Power $110 million.
Junk bond issuers included Momentive Performance $1.565 million, Complete Production $650 million, CDRV Investors $350 million, United Auto Group $325 million, and Angiotech Pharmaceutical $325 million.
November 28 – Bloomberg (Mark Pittman): “Citadel Investment Group LLC plans to sell as much as $2 billion in notes in what may be the first-ever bond sale by a hedge fund, Fitch Ratings said. The fund, which has more than $12 billion under management, will receive an investment-grade rating of BBB+ from Fitch for the offering.”
Convert issuers included Ventas $230 million, AGCO $175 million and Goodrich Petroleum $125 million.
November 30 – Bloomberg (Agnes Lovasz): “Emerging market local-currency bond trading rose to a record last quarter because creditworthiness is improving as developing nations succeed in slowing inflation and reducing budget deficits, according to trading association EMTA. Trading volume in local currency debt instruments totaled $1.024 trillion, a 9 percent increase from the previous quarter and 63 percent gain from the third quarter of 2005, according to a survey conducted by EMTA…”
International dollar debt issuers included Standard Chartered $750 million, Manitoba $500 million and Ciliandra $160 million.
Japanese 10-year “JGB” yields declined 5.5 bps this week to 1.60%. The Nikkei 225 index jumped 3.7% (up 1.3% y-t-d). German 10-year bund yields dipped 3.5 bps to 3.66%. Emerging markets were, once again, notably resilient. Brazil’s benchmark dollar bond yields declined 5 bps to 6.04%. Brazil’s Bovespa equities index dipped 1.0% this week (up 23.5% y-t-d). The Mexican Bolsa added 0.9%, increasing 2006 gains to 40.2%. Mexico’s 10-year $ yields fell 7.5 bps to 5.525%. Russia’s 10-year Eurodollar yields declined 4 bps to 6.55%. The Russian RTS equities index jumped 3.4% (up 58.2% y-t-d). India’s Sensex equities index added 1.0%, increasing 2006 gains to 47.3%. China’s Shanghai Composite index rose 2.5%, raising y-t-d gains to 81.0%.
This week, Freddie Mac posted 30-year fixed mortgage rates declined 4 bps to 6.14%, down 66 bps from July highs (down 12 bps y-o-y) to the lowest level since January. Fifteen-year fixed mortgage rates fell 4 bps to 5.87% (up 6 bps y-o-y). And one-year adjustable rates dipped 3 bps to 5.46% (up 30 bps y-o-y). The Mortgage Bankers Association Purchase Applications Index added 1.3% this week. Purchase Applications were down 14.1% from one year ago, with dollar volume 14.7% lower. Refi applications dropped 9.6%. The average new Purchase mortgage declined to $224,400 (down 7.1% y-o-y), and the average ARM dropped to $366,000 (up 0.9% y-o-y).
Bank Credit expanded $23.5 billion last week to a record $8.191 TN. Year-to-date, Bank Credit has expanded $685 billion, or 10.1% annualized. Bank Credit inflated $719 billion, or 9.6%, over 52 weeks. For the week, Securities Credit rose $13.5 billion. Loans & Leases gained $10.1 billion, with a y-t-d gain of $514 billion (10.4% annualized). Commercial & Industrial (C&I) Loans have expanded at a 14.1% rate y-t-d. For the week, C&I loans increased $3.5 billion, and Real Estate loans gained $7.8 billion. Real Estate loans have expanded at a 14.4% rate y-t-d. For the week, Consumer loans added $0.5 billion, while Securities loans dipped $1.9 billion. Other loans were about unchanged. On the liability side, (previous M3 component) Large Time Deposits dipped $1.1 billion.
M2 (narrow) “money” supply surged $25.5 billion to $6.971 TN (week of 11/20). Year-to-date, narrow “money” has expanded $284 billion, or 4.7% annualized. For the week, Currency added $1.5 billion, and Demand & Checkable Deposits increased $18.2 billion. Savings Deposits gained $4.7 billion, and Small Denominated Deposits rose $2.8 billion. Retail Money Fund assets dipped $1.7 billion.
Total Money Market Fund Assets, as reported by the Investment Company Institute, jumped $18.6 billion last week to $2.329 Trillion. Money Fund Assets have increased $272 billion y-t-d, or 14.3% annualized. It is also worth noting that Money Fund Assets have expanded at a 21.1% rate over the past 20 weeks.
Total Commercial Paper rose $6.8 billion last week to $1.928 Trillion. Total CP is up $287 billion y-t-d, or 18.9% annualized. Total CP has expanded at a 21% rate over the past 20 weeks.
Asset-backed Securities (ABS) issuance slowed this week to $15 billion. Year-to-date total ABS issuance of $678 billion (tallied by JPMorgan) is running about 7% below 2005’s record pace, with 2006 Home Equity Loan ABS sales of $450 billion about 5% under comparable 2005. Also reported by JPMorgan, y-t-d US CDO (collateralized debt obligation) Issuance of $319 billion is running 80% ahead of 2005.
Fed Foreign Holdings of Treasury, Agency Debt increased $1.7 billion during the week to a record $1.711 Trillion (week of 11/29). “Custody” holdings were up $192 billion y-t-d, or 13.7% annualized. Federal Reserve Credit expanded $5.1 billion to $844 billion. Fed Credit is up $17.6 billion y-t-d, or 2.3% annualized.
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $712 billion y-t-d (19.1% annualized) and $747 billion (18.6%) in the past year to a record $4.758 Trillion.
December 1 – Bloomberg (Anoop Agrawal): “India’s foreign-exchange reserves rose $2.43 billion to $172.78 billion in the week ended Nov. 24...”
November 27 – Bloomberg (Jake Lee and Yumi Kuramitsu): “The Hong Kong dollars 23-year-old link to the U.S. currency is getting strained as the city’s economy grows closer to China. The interest rate banks charge each other to borrow the Hong Kong dollar for one year is 1.16 percentage points lower than that for the U.S. dollar, the widest gap in 18 months. Since the Hong Kong Monetary Authority keeps the currency at HK$7.8 to the U.S. dollar, there should be no difference in borrowing costs.”
November 28 – Bloomberg (Michael Heath): “Russian inflation is slowing as the
population switches savings to rubles from dollars, the Organization for Economic Cooperation and Development said. Russia has managed to combine rapid money-supply growth with a falling inflation rate due to the ‘on-going de-dollarization’ of the economy, the Paris-based organization said…”
The dollar index sank 1.4% to 82.42, the low going back to March 2005. On the upside, the Iceland krona gained 4.0%, the Hungarian forint 3.3%, the Norwegian krone 3.1%, the British pound 2.5%, the New Zealand dollar 2.4%, the Swedish krona 2.0% and the Euro 1.9%. On the downside, the Peruvian sol declined 2.7%, the South African rand 1.0%, the Canadian dollar 0.9%, the Ukraine hryvnia 0.5%, and the Indonesian rupiah 0.4%.
November 28 – Bloomberg (Shruti Date Singh): “Coffee rose to a 17-month high on speculation growers in Brazil, the largest producer of the beans, are withholding supplies because drought may reduce the crop that will be harvested in 2007.”
Gold gained 1.1% to $645.80, and Silver surged 7.3% to $14.19. Copper dipped 2.1%, reducing y-t-d gains to 64%. January crude jumped $4.43 to end the week at $63.67. January Unleaded Gasoline rose 6.2%, and January Natural Gas gained 3.9%. For the week, the CRB index gained 4.0% (down 3.2% y-t-d), and The Goldman Sachs Commodities Index (GSCI) jumped 4.6% (up 7.1% y-t-d).
December 1 – Bloomberg (Jason Clenfield): “Japan’s unemployment rate fell to near an eight-year low and household spending declined less than expected, supporting the central bank’s view that consumption may accelerate… The jobless rate declined to 4.1 percent in October from 4.2 percent…”
November 30 – Bloomberg (Lily Nonomiya): “Japan’s industrial production unexpectedly rose to a record, backing the central bank’s assessment that the world’s second-largest economy is strong enough to withstand higher interest rates. The yen rose. Factory October output climbed a seasonally adjusted 1.6 percent from a month earlier, the Ministry of Economy, Trade and Industry said in Tokyo today. Gains were led by autos and semiconductors as production rose 7.4 percent from a year earlier, the biggest jump in more than two years.”
November 27 – Bloomberg (Yanping Li): “The Chinese government risks causing
asset prices to rise with its policy of capping interest rates and keeping a rate spread with the U.S., the Shanghai Securities News said, citing the central bank’s deputy governor Wu Xiaoling. Low interest rates have flooded the market with liquidity, which can easily cause asset prices to rise, the paper said, citing Wu’s comments at a Nov. 25 economic conference.”
November 29 – Bloomberg (Jianguo Jiang): “General Motors Corp., the world’s largest carmaker, plans to invest more than 8 billion yuan ($1.02 billion) annually in China, the company’s most profitable overseas market….”
November 27 – Bloomberg (Nipa Piboontanasawat): “Hong Kong’s export growth accelerated in October for the first time in three months as the city’s port shipped more Chinese-made toys and electronics bound for the U.S. and Europe. Overseas sales rose 7.9 percent from a year earlier…”
November 30 – Bloomberg (Cherian Thomas): “India’s economic growth unexpectedly accelerated to 9.2 percent last quarter, driven by government and consumer spending that may force the central bank to raise its key interest rate a fourth time in a year to curb inflation.”
November 30 – Bloomberg (Chitra Somayaji): “India had the highest average salary increase in the Asia-Pacific region in the past year, according to…a survey by human-resources consulting firm Hewitt Associates Inc. Wages in India gained 13.8 percent, compared with 14.1 percent in 2005… The Philippines was second, recording an 8.2 percent increase. China’s wage-growth slowed to 8 percent from 8.3 percent the previous year, the survey showed.”
November 30 – Financial Times (Joe Leahy): “Investor enthusiasm to gain exposure to the booming Indian real estate market has seen a leading property developer soar 75 per cent on its stock market debut… ‘They’re all trying to catch the momentum but they’ll be lucky if the market continues to be the way it is right now,’ said Harendra Kumar, head of research at ICICI Direct, the online brokerage arm of India’s biggest private sector bank. Price rises in Mumbai and New Delhi of more than 40 per cent in the past year have prompted warnings from the central bank and even some developers that parts of the market may be overheating.”
Asia Boom Watch:
December 1 – XFN: “South Korea’s exports surged 19.8% year-on-year to a record $30.94 bln in November, the Ministry of Commerce, Energy and Industry said… The rise was mainly driven by robust overseas shipments of vessels, semiconductors, LCD panels, vehicles and steel products, the ministry said. Imports rose 12.7% year-on-year to $26.87 bln, taking the trade surplus for November to $4.07 bln.”
Unbalanced Global Economy Watch:
November 28 – Bloomberg (Simon Kennedy): “The Organization for Economic Cooperation and Development said the world economic expansion will fade in 2007 to its weakest in four years, dragged down by a U.S. slowdown that will force the Federal Reserve to cut interest rates. Growth among the group’s 30 members will cool to 2.5 percent in 2007 from 3.2 percent estimated for this year and the weakest since 2 percent in 2003…”
November 30 – Financial Times (Chris Hughes): “Investment in the global infrastructure sector is inflating into a dotcom-style bubble, suffering the ‘dual curse’ of overvaluation and excessive leverage, Standard & Poor’s warned today. The gloomy prognosis follows expansion of the sector this year, with transactions so far totalling $145bn globally - a 180 per cent increase on 2000 - and up to $150bn of funds raised and waiting to be placed, according to the rating agency.”
November 30 – Bloomberg (Greg Quinn): “Canada’s economic growth unexpectedly slowed to a 1.7 percent annual rate in the third quarter, the lowest in three years, as homebuilding and manufacturing declined and the government completed a census. Gross domestic product growth in the world’s eighth-largest economy eased from 2 percent in the second quarter…”
November 29 – Bloomberg (Alexandre Deslongchamps): “Canada’s current-account surplus unexpectedly widened in the third quarter, as exports grew and Canadians boosted profits on their overseas investments. Receipts from outside Canada minus payments sent abroad expanded to C$5.09 billion ($4.47 billion)…”
November 29 – Bloomberg (Craig Stirling): “U.K. mortgage approvals unexpectedly rose in October to the highest level in almost three years, a sign the $7 trillion housing market is shrugging off higher interest rates.”
November 28 – Market News International: “Eurozone M3 money supply growth was steady in October at September’s 8.5% y/y rate, defying expectations of a further acceleration… Among the counterparts to M3, loans to private sector expanded by 11.2% y/y in non-seasonally adjusted terms, which was down slightly from September’s 11.4% reading.”
November 28 – Financial Times (Ralph Atkins): “Eurozone borrowing by businesses has hit a fresh record, highlighting the strength of economic activity in the 12-country region as the European Central Bank prepares to lift interest rates again. Lending to non-financial corporations was increasing at an annual rate of 12.9 per cent in October - the highest recorded since the launch of the euro in 1999, according to figures released by the ECB. September’s figures had shown a growth rate of 12.7 per cent.”
November 30 – Bloomberg (Rainer Buergin): “German unemployment fell more than expected in November to the lowest in four years… The number of people out of work…fell 86,000 to 4.24 million, the lowest since Nov. 2002…”
November 28 – Bloomberg (Gabi Thesing): “Consumer confidence in Germany, Europe’s largest economy, rose to the highest level in five years as the prospect of a sales-tax increase in 2007 led shoppers to bring forward purchases.”
November 30 – Bloomberg (Sills and Todd White): “The inflation rate in Spain, Europe’s fifth-largest economy, rose in November for the first time in six months as the effect of higher energy prices was exacerbated by declines a year ago. Consumer prices rose 2.7 percent from a year earlier…”
November 30 – Bloomberg (Tasneem Brogger): “Denmark’s economic expansion
accelerated to 3.8 percent in the third quarter led by exports and investments. Growth quickened from a revised 3.1 percent in the second quarter…”
November 30 – Bloomberg (Dorota Bartyzel and Marta Waldoch): “Poland’s economy expanded in the third quarter at the fastest pace in two years as record-low interest rates spurred corporate investment and consumer demand. Gross domestic product grew an annual 5.8 percent…”
November 30 – Bloomberg (Robin Wigglesworth): “Norway’s domestic credit growth slowed to 14.6 percent in October from an 18-year record the month before… Credit growth for households, companies and municipalities slowed from 15 percent in September… Household borrowing growth slowed to 12.8, from 12.9 percent, while borrowing by non-financial companies eased to 20.4 percent from 21.6 percent.”
November 29 – Bloomberg (Robin Wigglesworth): “Norwegian retail sales growth
unexpectedly accelerated to an annual 8.3 percent in October, the fastest pace since 1998.”
November 30 – Bloomberg (James Brooke): “In central Moscow, construction cranes loom over the Kremlin, as hotel and office towers rise up to accommodate Russia's newly minted companies and the flood of foreign business visitors. Downtown apartments that cost $100,000 a few years ago now cost $1 million. On weekends, shoppers by the thousands line up behind cash registers at the 150,000-square-meter Tyoply Stan suburban mall, loading up on home furnishings, televisions and cell phones. Stockholm-based Ikea, which owns the mall, reported that it received 52 million shoppers in 2005, making it the most-visited shopping center in Europe. Moscow is adding 100,000 cars to its roads every year…”
November 30 – Bloomberg (Nasreen Seria): “The cost of goods leaving South African factories and mines rose an annual 10 percent in October, the fastest pace in almost four years, after the rand’s decline against the dollar boosted import costs. Producer-price inflation accelerated from 9 percent in September…”
November 29 – Bloomberg (Tracy Withers): “New Zealand consumer borrowing for housing and consumption rose 13.4 percent in October from a year earlier, the slowest annual pace since July 2003…”
Latin American Boom Watch:
November 30 – Bloomberg (Telma Marotto): “Brazil’s economic growth accelerated in the third-quarter as lower interest rates boosted consumption, leading companies to invest in expanding capacity. Brazil’s economy, Latin America’s largest, grew 3.2 percent in the third quarter from a year earlier, compared with 1.2 percent in the second quarter…”
November 30 – Bloomberg (Fabio Alves): “Brazil’s decision to cut its benchmark lending rate a half percentage point yesterday was challenged by three dissenters on the central bank board, a sign the bank may slow the pace of reductions in coming months. Policy makers last night reduced the overnight rate to 13.25 percent…”
November 29 – Bloomberg (Alex Kennedy): “Venezuelan housing prices have risen 25 percent this year as a growing economy boosts demand for apartments and houses, El Nacional reported…”
November 30 – Bloomberg (Alex Emery): “Peru’s economy grew at the fastest rate in 44 quarters in the July-through-September period as silver and natural gas output and construction surged. Gross domestic product expanded 8.4 percent in the third quarter after the economy grew 5.8 percent in the second quarter…”
Central Banker Watch:
November 28 - Dow Jones: “If the U.S. Federal Reserve had been aware of actual
inflation prior to its recent tightening cycle, policy would probably have been
more restrictive sooner, the Fed’s Bank of Dallas President Richard Fisher said… If we had had the correct figures at the time, we probably wouldn’t have kept interest rates so low, for so long,’ Fisher is quoted as saying by the German daily Handelsblatt newspaper… ‘In hindsight, one is always the wiser,’ he said, noting inflation at the time was higher than was visible from the then-available data.”
November 30 – Market News International: “A Bank of England official has warned on the dangers posed by the rapid rise in commercial property and other asset prices in recent years. Nigel Jenkinson, Executive Director, Financial Stability at the BOE says…that the ‘generalised search for yield’ in financial markets and in other asset prices may have ‘gone too far’ and led to a potential under-pricing of risk in some asset markets.”
Bubble Economy Watch:
November 30 – Bloomberg (Carlos Torres): “A jump in U.S. corporate profits last quarter combined with smaller wage gains eased concern businesses will need to raise prices to maintain earnings, economists said… Profits from current production rose 4.2 percent and were up 31 percent in the year through September, the biggest 12-month gain in 22 years, according to the Commerce Department’s update of third-quarter gross domestic product. Wages and salaries were revised down by $100.3 billion.”
November 30 – Bloomberg (Jeff Wilson): “Net farm income in the U.S. will plunge 20 percent this year because of lower government subsidies and higher expenses, the Department of Agriculture said. Income will drop to $58.9 billion from $73.8 billion last year, which was the second-highest total ever after a record in 2004… The total is still the third-highest ever. Cash expenses will rise 5 percent to a record $237.2 billion, and gross cash sales are forecast to rise 1.3 percent to $242 billion from a record $239.6 billion, USDA said.”
Real Estate Bubble Watch:
October Existing Homes Sales were reported at a 6.24 million annualized pace (roughly 2003’s annual pace), up slightly from September but down 11.5% from one year ago. For perspective, Existing Home Sales averaged 3.993 million annually during the nineties. At $265,700, Average Prices were down 3.2% from October 2005 but still up 12% from October 2004. Year-to-date Existing Home Sales are running 11.5% below 2005’s record pace. October New Home Sales were reported at a 1.004 million annualized pace (roughly 2003’s annual pace), down 25.4% from record sales from one year ago. For perspective, New Home Sales averaged 698,300 during the nineties. New Home Average (mean) Prices jumped to $309,700, up 5.5% from October 2005. Year-to-date New Home Sales are running 17% below last year’s record pace.
November 28 – Florida Association of Realtors: “The pace of home sales in Florida continued to slow in October, though some markets report that the inventory of homes available for sale also eased last month. A total of 12,773 existing single-family homes sold statewide last month, a decrease of 22 percent from the 16,407 homes sold during the previous October… Statewide, the existing-home median price remained level at $242,500 last month; a year ago, it was $243,400, according to FAR.”
November 30 – Bloomberg (Kathleen M. Howley): “U.S. home prices grew at the slowest pace in eight years during the third quarter, a sign the housing market has not yet reached bottom… Prices for single-family homes rose an average of 0.86 percent during the three months, the slowest rate since 0.79 percent in the second quarter of 1998, according to the Office of Federal Housing Enterprise, known as Ofheo…”
November 28 – Market News International (Ted Kim): “As the commercial mortgage-backed securities market moves into the final weeks of 2006, analysts are anticipating 2007 CMBS issuance will surpass this year’s record volume by about 10% to total roughly $233 billion. Tighter bond spreads and deteriorating underwriting standards in late 2006, surprisingly enough, have not deterred robust demand for CMBS from real money investors, total return investors and CDO managers leading to the flattest credit curve in history.”
M&A and Private-Equity Bubble Watch:
December 1 – Financial Times (Paul J Davies ): “The appetite among banks to lend ever more money to private equity groups shows no signs of abating and such institutions expect leverage ratios on buy-outs to keep rising, according to a survey from Deloitte… James Douglas, a partner in Deloitte’s debt advisory business, said about 60 per cent of respondents expected ‘the good times to keep rolling’ in the debt markets, with banks the most bullish. ‘Something like $400bn has been raised by private equity funds this year and with the banks still in there this is only going to increase liquidity for buy-outs next year,’ he said. Indeed, mergers and acquisitions activity was seen as the main driver for continued strong growth in the debt markets, he said…”
November 30 – Dow Jones (Marietta Cauchi): “Buyout veteran Wilbur Ross…warned that highly indebted companies owned by private equity firms could be the next source of supply for distressed buyers. Echoing recent comments by the U.K. financial regulator, Ross said that today’s leveraged buyouts and in particular the syndication of debt to a diverse array of new lenders would lead to a unique set of problems.”
Financial Sphere Bubble Watch:
November 29 – Financial Times (James Mackintosh): “Hedge funds have taken on more than $300bn in the past six months and now manage more than $2,000bn, according to a survey of hedge fund administrators. HFM Week, a specialist magazine, said its survey of all the major administrators showed net assets in hedge funds substantially ahead of the $1,300bn estimation typically used by investment banks. The rapid growth - matched by a 20 per cent rise in fund-of-hedge-funds assets to $954bn in the same period - comes as wealthy individuals and institutional investors continue pouring cash into hedge funds, in spite of lower average returns than stock markets this year.”
Energy Boom and Crude Liquidity Watch:
November 28 – Bloomberg (Mahmoud Kassem): “Egypt’s industrial output rose 9.4 percent in the year ended June 30, Al-Alam al-Yom reported, citing Trade and Industry Minister Rachid Mohamed Rachid.”
December 1 – Financial Times (Clive Cookson and Fiona Harvey): “India is experiencing worse rainstorms owing to global warming and has a greater risk of damaging floods, a group of scientists have found… ‘A substantial increase in hazards related to heavy rain is expected over central India in the future,’ the authors said. They concluded that climate change was to blame for the differences in the monsoon, because rises in air temperature are linked to increased precipitation. India’s greenhouse gas output is rising rapidly as its industrial base grows.”
December 1 – Financial Times (Gillian Tett ): “If prizes were being awarded for financial wizardry right now, some bright sparks at ABN Amro might be proudly waving their wands. A few months ago the Dutch bank invented a product with the ugly name of constant proportion debt obligation (CPDO). So many other banks have since tried to copy this structure, that it has triggered sharp swings in the price of the credit derivatives that go into the CPDO pot - not to mention wild controversy about the merits, and dangers, of this product. Why all the fuss? In short, because CPDOs appear to offer an extraordinary conjuring trick: namely a 200 basis point return for investors, along with an AAA credit rating. The technique behind this return is not, in itself, so clever: what a CPDO basically does is collect investors' cash, leverage up and use the proceeds to write credit default swaps - instruments that offer protection against default. Thus, in its most grossly simplified form, a CPDO is a highly leveraged bet on whether a basket of corporate bonds will default. But the real magic, and its importance for the wider financial world, lies in the credit rating. In the summer, ABN Amro somehow persuaded the agencies to give the CPDO a top-notch rating, thus enabling the scheme to be marketed widely - while also cutting leverage costs. On one level, this simply shows just how ingenious bankers can be in producing schemes in response to a low-return world. But on another, it begs big questions about the role that rating agencies are now playing in the modern banking system - and all its financial conjuring tricks.”
The Big Wildcard:
A Bloomberg News headline from earlier today read “Pimco’s Gross Says Corporate Bond Rally May Be Over.” From the article (by Elizabeth Stanton and Shannon Harrington): “[Bill] Gross has said a jump in derivatives trading is distorting debt prices and recommends investors buy two-year Treasuries to profit from Federal Reserve interest rate cuts. The corporate bond market’s situation is similar to when the Fed’s target rate for overnight loans reached 1 percent in 2004 or when Japanese government 10-year yields reached a record low in 2003, he said.”
The unfolding Bubble in Global Corporate Finance (investment grade, junk and foreign bonds, Credit derivatives, business and M&A lending, syndicated “leveraged lending,” and “structured finance” broadly) has been the major financial development of 2006. Undoubtedly, the happenings of this expansive Bubble will be a principal issue for 2007: A faltering Corporate Finance Bubble would likely prompt multiple Fed rate cuts, while a typical maturing of this adolescent Bubble could for some time hold the anxiously-anticipated easing cycle at bay. As an analyst of Bubbles, I am today not all too inclined to proffer the imminent end to such a powerful speculative Bubble (and financial mania) thus far demonstrating intense Inflationary Biases. I certainly don’t expect Wall Street to freely throw in the towel.
When it comes to similarities, I am instead reminded of the marketplace dislocation back in the first-half of 2003. After beginning the year at about 4%, ten-year Treasury yields dropped precipitously to 3.12% by June. Benchmark MBS yields during this period sank 110 basis points to a record low 4.25%. The fledgling Mortgage Finance Bubble was empowered and quickly enveloped the entire Credit system.
Clearly, an atypical relationship developed between the (soaring) demand for mortgage Credit and its (sinking) price. Declining yields then stimulated waves of mortgage borrowing – not to mention the forced unwind of interest-rate and MBS hedges – that created only greater marketplace liquidity and a self-reinforcing bond market (and mortgage finance/housing) moon-shot. Homes sales, having already increased significantly from the nineties, jumped an additional 10% during 2003 and another 10% in 2004. Household mortgage debt growth – having reached 10.1% in 2001 and 12.9% in 2002 – ratcheted up to 14.3% in 2003 and 14.1% in 2004. National home prices jumped almost 20% in 18 months (beginning in 2003), with California prices surging almost 40%.
And while there is today little room for further corporate spread compression, the key issue is actually the sustainability of the current environment of (self-reinforcing) Unlimited Corporate Finance. Faltering housing Bubbles, some slowing in mortgage debt growth, and economic moderation were major factors inciting this year’s bout of heightened financial sector expansion and leveraged securities speculation. The backdrop was obviously highly constructive for the reemergence of a corporate lending Bubble, a multifaceted boom with powerful feedback impulses fueling stock market and asset inflation at home and abroad.
As I’ve explained previously, it is my view that enormous global U.S. Current Account Deficit “recycling” operations (back into Treasuries and agency securities) provided powerful impetus forcing the leveraged speculating community into the corporate arena (certainly including Credit default swaps, CDOs, CPDOs, etc.) in search of profits. The resulting boom in cheap finance (heightened Credit Availability and Marketplace Liquidity) pushed the fledging M&A boom into today’s historic Bubble, not to mention financing unprecedented stock buybacks. Importantly, the prevailing Leveraged Securities Speculation Bubble and the burgeoning Corporate Finance Bubble ended up sustaining the vulnerable U.S. Credit Bubble, in the process perpetuating massive Current Account Deficits and escalating global imbalances overall. The question for today: How might the current bond market melt-up and dollar meltdown impact these Bubbles?
First of all, I have a difficult time buying into “the economy is about to fall off a cliff” viewpoint. I remain skeptical of the bond and interest-rate markets’ histrionic responses to manufacturing data. After all, the U.S. Bubble economy is chiefly dictated by finance and “services.” Financial conditions remain ultra-loose and, as far as I can tell, the services arena maintains an expansionary bias. Global liquidity conditions are unparalleled. As such, I am more inclined to believe that we are witnessing yet another case of derivative and interest-rate hedging-induced market dislocation. In the past, such circumstances incited a boost in lending and market-based finance. It is worth mentioning that the S&P Homebuilding index jumped 4.2% this week (up 30% from July lows). More importantly, however, previous bond market melt-ups pushed those Bubbles and sectors demonstrating the most robust Inflationary Biases to problematic extremes. All eyes on the Global Corporate Finance Bubble and M&A, in particular.
I am still waiting for a faltering dollar to negatively impact U.S. and global liquidity. Outside of Europe, the recent precipitous dollar decline has been greeted by yawns in most global equities markets. I doubt this would be the case if economic weakness was the primary factor behind the dollar and bond market moves. And if the economy was in the process of faltering, we would at the minimum expect widening Credit spreads at home and abroad.
On the other hand, the stubborn global equities boom and narrow risk premiums are reasonable in the circumstance of a U.S. interest-rate market dislocation. If sinking yields help stabilize U.S. mortgage Credit growth at continued strong levels, while spurring only more commanding Securities and Corporate Finance Bubbles, well, the expected upshot would be ongoing massive Current Account Deficits and a continuation of unprecedented global liquidity excess. Recent trading in precious and industrial metals supports the ongoing excess liquidity thesis, as does this week’s jump in crude and energy prices.
Yet market analysis is these days extraordinarily challenging and fraught with unusual risk. Are we in the early stages of the long-simmering dollar crisis, with the marketplace simply hopelessly complacent? Or is it more a case of the dollar bulls and currency derivative players now taking their turn for a market pummeling, with the currencies to reverse once sufficient pain has been inflicted? With global markets now dominated by leveraged speculation and derivatives trading, abrupt and dramatic market lurches have become the norm. We’ve seen as much this year in global equities, the energy and commodities markets, currencies, and interest-rates. The Law of the Jungle rules; and the marketplace goes out of its way to severely punish those that find themselves on the wrong side of a trade.
What is not at all clear is to what extent this escalating Monetary Disorder is acting as a wrecking ball, chipping away at the leveraged players’ returns and risk tolerance, along with market confidence generally. It would be a major bearish development if interest-rate and dollar market dislocations evolved to the point of inciting heightened risk aversion throughout Global Corporate Finance. There just aren’t as yet indications of this unfolding. Conversely, I can envisage the scenario where the sophisticated market players, freed from the fear of actual Fed and global central bank tightening, see recent market gyrations – and specifically dollar weakness and lower global yields - as constructive for ongoing liquidity and speculative excess. Time to gear up for the speculative blow-off. There are indications…
Thus far, dollar weakness and sinking market yields have been constructive for the global equities and commodities booms. There is thus far no indication that market developments are impinging the global M&A boom. Non-dollar assets – from gold and the metals, to energy, to foreign companies and resources – are being revalued higher. And, importantly, this circumstance is quite constructive for Credit growth and speculative excess from a almighty global financial infrastructure that has now had almost five years to get positioned to play this “trade” for all its worth.
And at risk this evening of sounding hopelessly out of touch, I am not ready to jettison the heightened inflation scenario. If this proves yet another case of the ballooning Financial Sphere dictating the Economic Sphere, the current market dislocation and yield collapse could be setting the stage for a 2007 inflation surprise. On a global basis, the faltering dollar will pressure foreign central bankers to tolerate loose financial conditions, while leaving domestic Credit system free to expand at will. A weaker dollar will make it only more difficult for the Chinese to manage their unwieldy Credit and economic booms. Here at home, we surely haven’t seen the last of energy and import price inflation. The booming export sector will be further stimulated.
But I’ll have to label the Corporate Finance Bubble as The Big Wildcard. Considering the liquidity and speculative backdrop, I’d be willing to bet that sinking market yields foster some extraordinary (inflationary) consequences. And it is my view that heightened compensation pressures are today a major Inflationary Bias, nurtured through years of Credit and liquidity excess. Barring financial crisis or some development that restrains Credit expansion or incites de-leveraging, the combination of ballooning corporate liquidity and the worsening skilled labor shortage would appear poised to manifest in continued Income Inflation. All bets are off, however, when the marketplace turns against the Corporate (“Credit arbitrage”) Trade. For now, I’m going to force myself to see it before I believe it. Wall Street and the global leveraged speculating community have become incredibly powerful. I don’t expect they’ll be willing to let go of this pot of gold without a hell of a fight.
November 30 – Market News International (Claudia Hirsh): “U.S. hiring activity firmed in November from October amid rising business confidence, and 2007 could see stronger momentum, according to staffing executives. Personnel specialists said employers in many regions are beginning to shed some of the caution that moderated job growth this year. Low unemployment continues to tighten the talent supply, but has led to wage gains only in some arenas. Accounting and finance personnel are scarcest. Information technology staffing is also accelerating, but is nowhere near the chaotic pace of the tech boom years, recruiters said.”