| Stocks were generally higher for the week. The Dow gained 1%, and the S&P500 added 0.5%. Economically sensitive issues shined. The Transports rose 2%, increasing 2004 gains to 25%. The Morgan Stanley Cyclical index jumped 3%, with y-t-d gains of 14%. The S&P Homebuilding index rose 3%, increasing 2004 gains to 31%. Up 2.4%, the Utilities’ 2004 rise increased to 20%. The Morgan Stanley Consumer index added 1.5%. The broader market performed well. The small cap Russell 2000 (up 15% y-t-d) and S&P400 Mid-cap (up 13% y-t-d) indices increased 1.5%. Technology stocks were mixed and generally unimpressive. The NASDAQ100 dipped 0.5%, while the Morgan Stanley High Tech index added 0.5%. The Semiconductors were about unchanged. The Street.com Internet and NASDAQ Telecommunications indices posted slight declines. The Biotechs declined 1% this week. The Broker/Dealers were about unchanged, while the Banks added 0.5%. Although bullion jumped $7.30 to $441.5, the HUI gold index gained only marginally. Treasury yields moved higher. For the week, two-year Treasury yields jumped 8 basis points to 3.01%. Five-year Treasuries added 6 basis points to 3.58%. Ten-year Treasury yields rose 5 basis points to 4.20%. Long-bond yields ended the week at 4.83%, up 1 basis point for the week. Benchmark Fannie Mae MBS yields rose 7 basis points. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note widened 2.5 basis points to 41, and the spread on Freddie’s 5% 2014 note widened 1 basis point to 34. The 10-year dollar swap spread increased 0.5 to 39.75. Corporate bonds were mixed, with junk spreads widening moderately. The implied yield on 3-month March Eurodollars jumped 6.5 basis points to 2.915%. Corporate bond issuance slowed to a still seasonally-strong $12.1 billion. This week’s investment grade issuers included OMX Timber LLC $1.47 billion, Washington Mutual $850 million, Reliant Energy $750 million, Meridian Funding $630 million, SLM Corp $500 million, American Express $450 million, Inergy LP $425 million, Bellsouth $400 million, Convergys $250 million, Church & Dwight $250 million, Clear Channel $250 million, Duke Realty $250 million, Camden Property Trust $250 million, AGL Capital $200 million, Bio-Rad Labs $200 million, Juniper Generation $200 million, and Stanadyne $100 million. According to Bloomberg, Reliant Energy’s debt was priced at a spread of 262 basis points, down from the 601 basis points in a 10-year deal issued in June 2003. Junk bond funds reported outflows of $148.7 billion (from AMG). Issuers included Magnachip Semi $750 million, WMG Holdings $750 million, Goodman Global $650 million, Cooper Standard $550 million, Levi Strauss $450 million, Landry’s Restaurant $400 million, IWO Escrow $290 million, Tech Olympic $200 million, Venoco $150 million, Spheris $125 million, Citgo Trustees $100 million, and NSP Holdings $92 million. Convert issuers included Bearingpoint $400 million, Ivax $280 million, Gateway $275 million, Seacor Holdings $250 million and Dov Pharmaceutical $65 million. Foreign dollar debt issuance included Asia Aluminum $450 million. December 15 – The Wall Street Journal (Gregory Zuckerma): “Amid an improved economy and climbing stock prices, the long-dormant market for big mergers is showing signs of awakening. So far this month, deals valued at a total of $80 billion have been unveiled around the globe… While the number of transactions is roughly in line with that seen in recent years, the dollar value has soared -- in the U.S. that figure is up about 30% in 2004 compared with last year. Even with several big transactions still in the works, global deals this year already total $1.7 trillion -- up from $1.3 trillion for all of 2003, according to Thomson Financial.” December 16 – Bloomberg (Julia Werdigier): “Johnson & Johnson’s $25.4 billion takeover of Guidant Corp. and 71 other acquisitions announced today made this quarter the busiest for mergers in more than four years. Companies have spent $575 billion on takeovers since the start of October, the most since the second quarter of 2000, when $761 billion of acquisitions were made, data compiled by Bloomberg show. At least 72 purchases worth $59 billion were announced today.” Japanese 10-year JGB yields added one basis point to 1.39%. Brazilian benchmark bond yields sank another 22 basis points to 7.80% (narrowest spreads since 1997). Mexican govt. yields ended the week at 5.12%, down 6 basis points for the week. Russian 10-year dollar Eurobond yields were down 4 basis points to 5.89%. Freddie Mac posted 30-year fixed mortgage rates dipped 3 basis points this week to 5.68%. Fifteen-year fixed mortgage rates were also down 3 basis points, at 5.11%. One-year adjustable-rate mortgages could be had at 4.18%, up 3 basis points for the week. It is worth noting that, with the Fed funds rate up 125 basis points from one year ago, 30-year fixed mortgage rates are actually down 15 basis points, while one-year adjustable mortgages are up only 41 basis points. The Mortgage Bankers Association Purchase application index dipped 0.4% for the week. Purchase applications were up about 13% from one year ago, with dollar volume up 24%. Refi applications fell 2% during the week. The average new Purchase mortgage dipped to $226,800, and the average ARM declined to $304,800. ARMs fell slightly to 34.2% of total applications. Broad money supply (M3) dipped $1.0 billion (week of December 6). Year-to-date (49 weeks), broad money is up $534.4 billion (previous numbers were revised higher by the Fed this week), or 6.4% annualized. For the week, Currency dipped $0.1 billion. Demand & Checkable Deposits sank $51.1 billion. At the same time, Savings Deposits jumped $48.5 billion (y-t-d gain of $358bn, or 12.0% annualized). Small Denominated Deposits added $0.1 billion. Retail Money Fund deposits declined $4.7 billion, and Institutional Money Fund deposits fell $3.6 billion. Large Denominated Deposits rose $7.1 billion. Repurchase Agreements gained $4.3 billion, while Eurodollar deposits dipped $1.4 billion. Bank Credit jumped $23.5 billion (up $101.9bn in 6 weeks!) for the week of December 8 to $6.814 Trillion. Bank Credit has expanded $540 billion during the first 49 weeks of the year, or 9.1% annualized. For the week, Securities holdings dipped $3.7 billion, while Loans & Leases surged $27.2 billion. Commercial & Industrial loans gained $3.2 billion, and Real Estate loans rose $9.8 billion. Real Estate loans are up $300 billion y-t-d, or 14.3% annualized. Consumer loans added $2.3 billion last week, and Securities loans rose $2.8 billion. Other loans jumped $9.0 billion. Elsewhere, Total Commercial Paper rose $4.9 billion to $1.397 Trillion. Financial CP added $1.6 billion to $1.261 Trillion, expanding at a 9.0% rate so far this year. Non-financial CP gained $3.3 billion (up 27.0% annualized y-t-d) to $136.0 billion. Year-to-date, Total CP is up $128.8 billion, or 10.6% annualized. Fed Foreign “Custody” Holdings of Treasury, Agency Debt declined $3.1 billion to $1.329 Trillion for the week ended December 15. Year-to-date, Custody Holdings are up $262.5 billion, or 26.1% annualized. Federal Reserve Credit dipped $1.5 billion for the week to $782.7 billion, with y-t-d gains of $37.6 billion (5.3% annualized). This week’s ABS issuance totaled about $12.5 billion (from JPMorgan). Total year-to-date issuance of $617.4 billion is 37% ahead of comparable 2003. 2004 home equity ABS issuance of $407.7 billion is running 81% ahead of last year’s record pace. Currency Watch: The dollar “rally” stalled, with the dollar index posting a slight decline for the week to 82.23. The Latin American currencies performed well, with the Colombian peso, Chilean peso, and Brazilian real adding just under 2%. On the downside, the South African rand, Iceland krona, and Swedish krona declined less than 1%. Commodities Watch: December 15 – XFN: “China is seeing a gold-buying surge as a hedge against the weakening dollar and negative real interest rates, the South China Morning Post reported, citing figures from the China Gold Society and analysts. The Hong Kong-based newspaper said the gold buying has prompted a booming trade not only in bars, coins and jewelry but also ‘paper gold’, in which the investor does not take possession of the metal, but trades it like other financial instruments.” December 17 – Bloomberg (Xiao Yu): “Bank of China, the country’s oldest lender, became the first bank to win government approval to allow individuals to speculate on gold prices. China Securities Regulatory Commission has given the bank approval to roll out countrywide trading by individuals… Bank of China started trial trading of gold in Shanghai in November last year. Chinese citizens seeking ways to invest their $1.3 trillion in savings may be tempted to buy and sell gold through domestic banks as the precious metal offer higher returns than local stocks. Gold prices have risen 7 percent over the past year, compared with a 13 percent decline in the Shanghai A-share index…” December 13 – Bloomberg (Loretta Ng): “China will complete within three years an emergency oil stockpile to meet 30 days of demand and expand it in stages to 90 days by 2010 to avoid boosting global prices, said an official at a state oil company. China, the world's largest energy consumer after the U.S., may build up a reserve covering six months, though no timeframe has been set…” Energy and commodity prices came back strong this week. Coffee traded today to a 4-year high, while copper jumped 5% for the week. January Crude Oil recovered $5.57 this week to $46.28. The Goldman Sachs Commodities index surged 9.6% for the week, increasing year-to-date gains to 27.6%. The CRB index jumped 3.8%, with 2004 gains of 12.5%. China Watch: December 16 – Bloomberg (Yanping Li): “China’s economic growth next year will probably exceed the government's newly established target, Liu Fuyuan, deputy director of the National Development and Reform Commission’s research arm, said today. Asia’s second-largest economy may grow between 8.5 percent and 9 percent, Liu said… The commission, China’s top economic planning body, this month raised its target to 8 percent annual growth from 7 percent.” December 16 – Bloomberg (Nerys Avery): “Investment in China’s factories, roads and other fixed assets grew at a slower pace in November as the government reined in spending and ordered banks to curb lending. Fixed-asset investment in urban areas rose 24.9 percent in November from a year earlier to 571.8 billion yuan ($69.1 billion) after climbing 26.4 percent in October…” December 14 – Bloomberg (Nerys Avery): “Foreign direct investment in China rose in the first 11 months of the year as companies such as Wal-Mart Stores Inc. and DSM NV expanded to tap rising demand in the world’s most populous nation. Foreign investment increased 22 percent from a year earlier to $58 billion, after gaining 23 percent in the first 10 months of the year, the Beijing-based Ministry of Commerce said…” December 13 – Bloomberg (Philip Lagerkranser): “China’s money supply growth in November stayed within the government's target for a sixth straight month after banks were ordered to limit lending to the steel, auto and real estate industries. M2, which includes cash and all deposits, expanded 14 percent from a year earlier to 24.7 trillion yuan, after growing 13.5 percent in October. December 17 – Bloomberg (Jianguo Jiang): “Chinese property investment growth accelerated, resisting efforts by the central government to rein in what it considers an overheated industry. Real estate prices also rose. Investment in homes, offices and other commercial real estate increased 29.2 percent in the first 11 months of the year, the National Bureau of Statistics reported. That’s up from 29 percent in the first 10 months. Property prices gained 12.5 percent, following 12 percent growth in the January-October period. The gain was close to the eight-year high of 12.9 percent between January and July.” December 13 – Bloomberg (Nerys Avery): “China’s retail sales grew 13.9 percent to the second-highest level on record in November as rising incomes spurred consumers to spend more on eating out and decorating their homes.” Asia Inflationary Boom Watch: December 16 – The Financial Times (Justine Lau): “Asia’s central banks have launched a US$2bn regional bond fund to buy local currency-denominated debt in a further bid to strengthen Asian fixed income markets. East Asia and Pacific Central Banks (Emeap), which comprises 11 central banks, said the Asian Bond Fund 2 would invest in sovereign and quasi-sovereign bonds issued in eight Emeap countries…” December 16 – Bloomberg (Hui-yong Yu): “Morgan Stanley, raising $3 billion for its fifth global real estate fund, got a commitment of as much as $440 million from Washington state’s pension fund to invest in Asia and Europe… Morgan Stanley…is betting on economic recoveries in Asia and Europe to lift property values.” December 13 – Bloomberg (Kartik Goyal): “India set a target of increasing exports by almost a fifth in each of the next two fiscal years, Commerce and Industry Minister Kamal Nath said. Exports may rise 17 percent to $88 billion in the year starting April 1, 2005 and by 18 percent to $104 billion in the following year…” December 15 – Bloomberg (Anand Krishnamoorthy): “India’s vehicle sales rose 22 percent in November after more people bought Maruti Udyog Ltd.’s cars and Hero Honda Motors Ltd.’s motorcycles, taking advantage of loans and discounts during the country’s festival season…” December 15 – Bloomberg (Amit Prakash): “Singapore’s retail sales rose a faster-than-expected 12.5 percent in October from a year earlier as the economy added more jobs and rising tourist arrivals fueled spending on cars, clothes and jewelry.” December 15 – Bloomberg (Laurent Malespine): “Thailand’s new vehicle sales rose to a monthly high this year in November, boosted by record demand for pickup trucks, Toyota Motor (Thailand) Ltd. said. Sales rose 37 percent from a year earlier to 58,577 units…” Global Reflation Watch: December 15 – Bloomberg (Komaki Ito and Mariko Iwasaki): “Personal bankruptcies in Japan fell 20.6 percent in October from the same month a year earlier, according to the Supreme Court of Japan. There were 16,555 cases of personal bankruptcies during the month, the 12th straight monthly decline…” December 14 – Bloomberg (Jeremy van Loon): “Western European car sales rose 9.5 percent in November, the biggest monthly increase this year, as new models such as Volkswagen AG's Golf hatchback and rising rebates attracted buyers. Sales rose to 1.14 million vehicles from 1.04 million units a year earlier, the…European Automobile Manufacturers Association said… Sales in the first 11 months rose 1.7 percent to 13.5 million vehicles.” December 17 – Bloomberg (Christian Baumgaertel): “Business confidence in Germany, Europe’s largest economy, unexpectedly rose to an eight-month high in December after oil prices retreated from a record and signs increased that domestic demand is recovering.” December 15 – Bloomberg (Sam Fleming): “U.K. wages excluding bonuses rose 4.4 percent in the three months through October, the fastest pace since March 2002, as the number at work climbed to the highest since records began. Wage growth climbed from 4.3 percent in the month-earlier period…” December 17 – Bloomberg (Linda Sandler): “Supermodel Kate Moss posed for painter Lucian Freud in 2002 when she was pregnant. ‘Naked Portrait,’ by one of Britain’s top selling artists, may fetch as much as 3.5 million pounds ($6.8 million) at a London auction in February, said Christie’s International.” December 15 – Bloomberg (Marta Srnic and Benjamin Rahr): “Russia, which defaulted on most of its domestic debt in 1998, is in talks to repay as much as $10 billion owed to the Paris Club of creditor governments ahead of schedule next year, Finance Minister Alexei Kudrin said. The government, which is running a budget surplus for a fifth year because of swelling revenue from oil exports, may repay between $7 billion and $10 billion owed to the 19 members of the Paris Club… ‘This way we'll considerably help Western governments lower their budget deficits,’ Kudrin said…” December 16 – The Financial Times (Richard Lapper): “Latin America’s economy is growing at its fastest rate since before the debt crisis of the 1980s, helped by strong commodity prices and buoyant demand from China. The United Nations Economic Commission for Latin America and the Caribbean (Eclac) said on Wednesday that the region would expand by 5.5 per cent in 2004, a result that would “exceed the most optimistic forecasts” and be its best year since 1980… “The region has become less dependent on international capital markets in the last couple of years,” said José Luis Machinea, Eclac’s secretary-general, noting a fall in the level of external debt from 42.8 per cent of GDP in 2003 to 37.2 per cent. The outcome is in sharp contrast to the situation early this decade when Latin America was hit by crippling financial crises and seemed beset by chronic political turmoil... For the first time since 1997 and for only the second time in 20 years growth was faster than 3 per cent in all six of the biggest economies…” December 15 – Bloomberg (Telma Marotto): “Brazilian retail sales rose for an eleventh straight month in October, the government said. Retail, supermarket and grocery store sales, as measured by units sold, rose 8.5 percent from the year-earlier period…” December 16 – Bloomberg (Eliana Raszewski): “Argentina’s economy expanded for a seventh straight quarter in the July-to-September period, led by manufacturing and construction. Gross domestic product, the broadest measure of a country’s output of goods and services, grew 8.3 percent in the third quarter…after expanding 7 percent in the second quarter… The country’s jobless rate fell to 13.2 percent in the third quarter from 14.8 percent in the second quarter…” December 15 – Bloomberg (Robert Willis): “Colombia’s government ordered a halt to the entry of dollars into the country that are declared as an investment of less than one year, daily El Tiempo reported, citing a government decree.” December 13 – Bloomberg (Jason Gale and Fergus Maguire): “Australia, the world’s top supplier of coal, iron ore, alumina and zinc, stuck to its forecast for record commodity exports as soaring prices for coking coal and crude oil buffer miners from a surging local currency. Commodity sales will jump 15 percent to A$95.4 billion ($72 billion) in the year ending June 30…” December 17 – Bloomberg (Tracy Withers): “New Zealand manufacturing surged to a record in November as factories boosted production to meet new orders before the southern hemisphere summer vacation. An index measuring manufacturing rose to 65.9 points from 56.7 in October, according to a statement released today in Wellington by Australia & New Zealand Banking Group…” December 13 – The Wall Street Journal (Craig Karmin and Aaron Lucchetti): “ At a time of growing concern that Asian central banks and other overseas investors are losing their appetite for U.S. securities, rising demand, particularly for bonds, is coming from an unexpected source: oil-producing nations. The 16 major oil-exporting countries -- including Middle Eastern nations, Russia, Mexico and Venezuela -- are net buyers of $50 billion in U.S. bonds and stocks this year through September, according to the latest figures from the U.S. Treasury Department. That number has more than quadrupled from the same period last year…” Dollar Consternation Watch: December 15 – Bloomberg (Christian Baumgaertel): “European Central Bank President Jean-Claude Trichet has proposed asking the world's major official holders of foreign exchange reserves to buy fewer euros, Market News International reported, citing unidentified people. Trichet made the proposal, aimed at slowing the euro’s appreciation, at a meeting of finance ministers last week, Market News said…” December 16 – MarketNews: “The adjustment of the U.S. current account deficit cannot be achieved only by adjusting the dollar exchange rates, ECB Executive Board member Tommaso Padoa-Schioppa said… ‘It’s unthinkable that the rebalancing (of the U.S. current account) should take place just through exchange rates changes. The process must include a correction of the American public deficit and a increased capacity for private savings.’ The American deficit shows ‘the richest country in the world having to borrow wealth and not so much to invest but for consumption. The process to correct this phenomenon will take years,’ he said, noting that the U.S. current account shortfall has risen recently to 5-6% of GDP. “ December 15 – Bloomberg (Christian Baumgaertel): “Following are comments by the European… Central Bank The principal source of the ballooning of the U.S. current account deficit to record levels in 2004, both in absolute and relative terms, was the progressive easing of U.S. fiscal policy after 2000. Indications are that the fiscal deficit is unlikely to contract significantly in the period ahead… Unless households take steps to rein in their debts, current account imbalances could yet expand further… If the recent widening of global imbalances is not corrected over the medium term, important risks would remain…’ On hedge funds: ‘There is a risk that as more financial resources flow into hedge funds and as profit opportunities diminish commensurately, some funds might be encouraged to take on more risk or leverage to achieve targeted returns. In addition, there is the possibility that the positioning of individual hedge funds may become increasingly similar. This can lead to ‘crowded trades’ -- where many funds have the identical investment positions -- which poses risks of market disturbances in case of attempts to exit positions simultaneously.’” Bubble Economy Watch: December 15 – Bloomberg (Greg Wiles): “Sales at U.S. Internet retailers climbed 22 percent last week from a year earlier to $2.67 billion… Online sales, excluding travel and auction transactions, in the week ended Dec. 12 were the most since the start of the holiday-shopping season, ComScore Networks Inc. (said)… That was the most since the start of the holiday-shopping season. Sales for the November-December period to date have risen 25 percent…said ComScore, which is projecting sales will rise between 23 percent and 26 percent during the November-December sales season.” December 13 – Bloomberg (David Altaner): “Whirlpool Corp. and Maytag Inc. are among manufacturers raising prices to cover the increasing cost of raw materials because they can no longer absorb it with productivity improvements and reduced profit margin, the Wall Street Journal said today, citing examples. The appliance makers have said they will raise prices by as much as 10 percent in January…” December 16 – Bloomberg (Martin Z. Braun): “The New York State Thruway’s board of directors authorized a plan to raise tolls on the 641-mile highway for the first time since 1988 to help fund $2 billion in capital improvements. Under the plan, Thruway tolls would increase 25 percent for passenger cars and 35 percent for commercial vehicles starting May 1, 2005.” California Bubble Watch: December 15 Los Angeles Times (Annette Haddad): “Defying some experts’ predictions, home prices in Southern California reached new peaks in November as the pace of sales held steady… The median price in each of the region’s five counties rose at least 23% from the same month in 2003. The number of homes sold dipped 0.6%, to 27,459, but it was the third-strongest November since 1988, according to DataQuick… The median home price — the point at which half sold for more, half for less — for all of Southern California was $415,000, up 23.5%... The Inland Empire,…posted the sharpest increases in November. San Bernardino County led the pack with a 34.6% run-up, followed by Riverside County’s 29.1% gain. In Los Angeles County, which accounts for one-third of the region’s sales, the median rose 22.7% from last year. In Orange County, the region’s priciest, the median climbed 23.8%. Ventura County saw a 25.8% increase; San Diego County, 23.9%. …the stock of homes rose 88% to a 3.5-month supply in the first 11 months of the year compared with the same period a year ago.” December 17 – San Francisco Chronicle (Kelly Zito): “Sometimes it takes a little luck to get a house in the increasingly pricey Bay Area market -- even for those with a head start. Shekeba Hamid, who has owned property in the region for 11 years, got that little boost recently when her name was drawn first from 350 applicants for 12 houses at the new Pacific Pointe development in Union City. The model Hamid selected is roughly 3,700 square feet and will cost about $970,000 when completed next year. Despite the high price tag, the real estate agent and mother of three feels lucky to have the chance to buy a larger home closer to her office. ‘This is an up-and-coming community. I think it will be a great place to live," said Hamid, who already owns a home in Union City… The median price (from DataQuick) for an existing single-family home in the nine-county region hit $560,000 in November, slightly above October’s $552,000 and 18.6 percent above the November 2003… It was the ninth month this year that the resale median hit a new peak… Last month’s tally of 10,897 houses and condos sold was the highest for any November in at least 16 years and 13.6 percent above the year-ago total of 9,594. So far this year, nearly 124,000 properties have changed hands in the Bay Area -- surpassing 2003’s total and ensuring 2004 the top spot in the record books even before December’s sales results come in.” Mortgage Finance Bubble Watch: December 16 – Bloomberg (Catherine Dodge): “U.S. Representative Barney Frank of Massachusetts, the senior Democrat on the House Financial Services Committee, made the following comments about Fannie Mae in an interview and a statement. Fannie Mae, the biggest source of money for U.S. home mortgages, may have to restate earnings by as much as $9 billion after the Securities and Exchange Commission said it broke accounting rules. ‘The SEC's finding that Fannie Mae used incorrect accounting is serious and disturbing…It shows there were deficiencies in the corporate governance… We need to do a very thorough search of how this happened… The whole notion of incentive bonuses is a bad idea… This shows the SEC does a good job.’” Flashback - November 24 – Bloomberg (Michael McKee and Al Yoon): “U.S. Representative Barney Frank, the senior Democrat on the House Financial Services Committee, comments on the Congressional push to overhaul the federal regulator of Fannie Mae and Freddie Mac… the Office of Federal Housing Enterprise Oversight, is a ‘divided’ agency that used leaks to the media to force accounting changes at Fannie Mae and revive its reputation after its failure to uncover bookkeeping mistakes at Freddie Mac. On HUD’s report and Ofheo Director Armando Falcon: The report by HUD’s inspector general shows that Ofheo’s criticisms of Fannie Mae’s accounting were politically motivated, Frank said… ‘When you have the chief accountant overruled by two non-accountants,’ he said ‘then I don’t think they are the right people. These people appear to be rogue cops,’ he said. On Ofheo’s allegations of accounting manipulation at Fannie Mae: The issue ‘is now fortunately out of Ofheo’s hands and into the hands of the SEC, and that’s the appropriate place for that to be.” December 17 - Dow Jones (Danielle Reed): “With prime rates at their highest levels since November 2001, the real estate market is starting to worry aloud about delinquencies and defaults among borrowers with home-equity lines of credit, especially home equity lines of credit as first mortgages. Since home equity loans are typically pegged to the prime rate…more hikes by the Federal Reserve translate ultimately into higher payments by borrowers… With the latest FOMC hike, the prime rate is currently at 5.25%. Until recently, home equity lines of credit were typically for small amounts, with homeowners using them for extra cash to fund, say, a remodel or as a second mortgage - it’s a way to avoid the cost of primary mortgage insurance for borrowers who have less than 20% as a downpayment. But in the last year, home equity lines of credit have begun to be used as first mortgages, said Sue Baxter, branch manager for MortgageIT in Westport, Conn.” Securities Financing Bubble Watch: From Goldman Sachs: “Goldman Sachs achieved record net revenues, net earnings and diluted earnings per share in 2004… Net revenues in Trading and Principal Investments were $13.33 billion for the year, 28% higher than 2003… Fixed Income, Currency and Commodities (FICC) generated record net revenues of $7.32 billion, 31% higher than the previous record set in 2003, reflecting strength across all major businesses and regions... Assets under management increased 21% from a year ago to a record $452 billion, with net asset inflows of $52 billion during the year… Net Revenues in Investment Banking were $3.37 billion for the year, 24% higher than 2003. Net Revenues in Financial Advisory were $1.74 billion for the year, 45% higher than 2003… Compensation and benefit expenses were $9.59 billion for 2004, 30% higher than the prior year.” Interest Income was up 11% for the year to $11.9 billion. The company repurchased 5.6 million shares of stock during the quarter, bringing the full year total to 18.7 million shares. From Lehman Brothers: “For the 2004 full fiscal year, net income increased 39% to a record $2.4 billion… The Firm reported its third highest quarterly net revenues, which rose 25% to $2.9 billion, from $2.3 billion in the fourth quarter of fiscal 2003 and 10% from $2.6 billion in the third quarter of fiscal 2004. Record Investment Banking revenues, which rose 27% to $608 million from $477 million in the prior year’s period, reflected a 95% increase in merger and acquisition advisory fees, to their highest level in almost four years, and record revenues from debt origination activity. Capital Markets net revenues increased 18% to $1.8 billion… A significant increase in foreign exchange business and continued strength in mortgage products contributed to robust fixed Income customer flow activity.” Total Assets expanded at a 21% rate during the quarter to $358.5 billion. Assets were up 15% from one year ago and were up 136% since the beginning of 1998. “Interest and Dividend” revenues increased 43% from the fourth quarter of 2003 and were up 11% for the entire fiscal year to $11.0 billion. The company repurchased 6.0 million shares of stock during the quarter, increasing full year repurchases to 29.0 million. Dilly-Dally Monetary Management Tuesday the Fed continued its “measured” policy stance by raising rates 25 basis points to 2.25%. Almost universally (or, at least, on Wall Street and with the U.S. media), Mr. Greenspan’s “baby-step” approach is heralded as adept (brilliant?) monetary management. The very utmost caution is taken to ensure that rate increases do not disturb the economy or, more importantly, dispirit the financial markets. I find it ironic that a system that is so trumpeted by Mr. Greenspan for its “resiliency” is treated with such delicate kid gloves. The Mighty Credit Bubble scoffs at such timidity (and relishing all the pandering to the markets/speculators). The Fed grossly overreacted in 2002. A bursting dollar Bubble, a mushrooming global leveraged speculating community, and the runaway U.S. Mortgage Finance Bubble had already ensured the emergence of abundant liquidity and heightened pricing pressures both at home and abroad. The potential need for helicopter money – I think not. This was followed by the major error of waiting until the past June to nudge rates up from 1%. And now, years of flawed Fed policies are being capped off with the current course of Dilly-Dally Monetary Management. Why would anyone believe that taking the short-term painless course in monetary policy would yield the most beneficial long-term results? This week provided further evidence that the Fed has not “tightened” at all. And while most would contend that rate increases are “removing accommodation,” such an assertion at this point seems less than accurate. The general financial environment is at least as loose as it has been since the Acute Monetary Disorder of 1999/2000. In many respects – certainly including the Bubbling stock market – the financing environment for business ex-technology has never been as easy. General Credit Availability has not been as easy. Examining some indicators, mortgage Credit growth is currently on record pace; corporate cash flows are booming; the small cap Russell 2000, the Value Line Arithmetic 1650, the S&P 400 Mid-cap, the AMEX Composite, Dow Transports and Utilities, and many financial indices are at all-time highs; M&A activity is approaching tech-Bubble levels; junk bond issuance is at record levels, with Credit spreads at multi-year lows; ABS issuance is at record levels; the securities broker/dealer business is absolutely booming; and it will be a record year in bank Credit growth. Emerging bond spreads have collapsed, with Brazilian bond spreads having narrowed below 400 for the first time since 1997. Evidence abounds that the Greenspan Fed is bringing new meaning to “behind the curve.” This morning’s inflation report had the year-on-year increase for the CPI at 3.5%. This is the highest reading since May 2001. Year-to-date, the 3.7% rate of consumer price inflation is running even above 2000’s 3.4% rate. It is worth noting that the fed funds rate began 2001 at 6.50%. And last month’s 3.5% y-o-y CPI increase compares to November 2003’s 1.8% (last month's Producer Prices were up 5.0% y-o-y). Moreover, a strong case can be made that the CPI currently understates general inflationary pressures. CPI housing costs were up only 3.1% y-o-y, with “owner’s equivalent rent" up 2.2% over the past year. Meanwhile, medical care increased 4.4% from a year earlier. These do not pass the reasonableness test. It is, furthermore, worth recalling that November Import Prices were up 9.5% y-o-y, with U.S. home prices increasing “at the fastest pace in 25 years” during the third quarter (up 13% y-o-y). Inflationary pressures are strong, rising and broadening, and no amount of denial is going to change reality (although abundant liquidity can admittedly work as one heck of a tonic, for awhile). I’m going to go out on a limb (ok, a pretty sturdy one) and predict that going forward we will be hearing much less about the Fed having “won the war on inflation.” Similar talk of a convenient (with a low CPI) “inflation targeting” approach to monetary policy will fade, as will wishful notions of the Fed having its work wrapped up at 2.50%. The inflation genie has been let out of its bottle, and historians will likely look back to the bursting of the dollar Bubble as a key inflection point in U.S. and global inflation dynamics. But for now - awash in and intoxicated by liquidity - global Credit market perceptions remain today far behind the inflation curve – echoing the Fed. While there is no such animal as a single “real inflation rate” in complex contemporary economies (especially with asset inflation, “services” output, and current account deficits providing key outlets for inflationary forces), I would guesstimate a U.S. general consumer price inflation rate for the upcoming year in the range of at least between 4 and 6%. Add another 200 basis points and one might have a short-term rate somewhat less than quite accommodative. Certainly, our base lending rate should today exceed the UK’s (4.75%) and Australia’s (5.25%). Of course, five percent fed funds would today incite quite a ruckus for our highly leveraged Credit system. The Fed knows as much, and the markets know the Fed knows, and all are afforded the opportunity to prolong Bubbles with the delusion they are acting in the system’s best interest. But the Fed should appreciate that there is today a very high cost associated with Dilly-Dallying. Rates should have been increased before the California (and elsewhere) housing mania took firm hold. After all, once feverish speculative impulses take over and price inflation spikes upward, significantly higher rates are required to temper excess. At that point, the risk of “tempering” inflated asset Bubbles includes a crash. Dilly-Dallying guarantees a Big Crash. Rates should have been increased before the world fretted the loss of confidence in the dollar. And, importantly, rates should have been raised to quell the speculative impulses of global financial markets, markets commanded by a massive and inflating pool of speculative finance. The U.S. Credit market, “developing” bond and equity markets, global derivatives and now the U.S. stock market have all become acutely speculative and unsound. A strong inflationary/speculative bias has developed for a wide array of assets – real and financial – across the globe. And, again, once such strong impulses take hold they are not easily quashed. Ten-year Treasury yields are today at about the same level as one year ago (“fundamentals” are not). I would strongly argue that yields have been pressed artificially low by the interplay of global liquidity excess and speculative market dynamics. The bond bears and those hedging against higher rates have faced some ferocious headwinds throughout the year. Repeatedly, market rates appeared to finally commence a decisive move higher, only for “the bears” and hedgers to be forced to scurry for cover (their panic buying forcing prices up and yields down). Massive foreign central bank purchases and general overly abundant marketplace liquidity has provided a strong inflationary bias for Credit market instruments (U.S. and global). And each bout of sinking yields (marketplace “squeeze”) incited self-reinforcing leveraging by the derivatives (hedging their exposure to lower rates) and speculative players. There are also indications that collapsing Credit spreads provoked a self-reinforcing leveraging of corporate debt instruments, as players on the wrong side of spread trades hedged by taking long positions (a recent Grant’s Interest Rate Observer had an excellent piece on this!). These dynamics (endemic leveraging) yielded only greater liquidity excess and stiffer headwinds for the bond bears. And, in true speculative dynamics fashion, these bear headwinds incited animal spirits (“squeeze the shorts!”) and downward pressure on yields that simply overpowered fundamentals. Speculative leveraging in Treasuries, agencies, MBS, ABS, corporates, CDOs, CDS (Credit default swaps), and even equities combined for some kind of financial Bubble unlike anything previously experienced. Unprecedented Dollar liquidity – much emanating from securities leveraging - inundated the world! A lot of things changed, many we surely don’t appreciate today. The bottom line is that the system was in dire need of restraint and received the opposite. To this point, the most conspicuous loser to unrelenting (dollar-denominated) Credit inflation has been the dollar. And the weaker dollar has stoked inflationary pressures at home, while increasing the speculative appeal of non-dollar assets across the globe. Energy and global commodities priced in dollars have experienced major price increases. These price gains and the ultra-easy global financial backdrop have incited a major investment boom – especially throughout the energy sector. The flight to yield and “non-dollars” has afforded “developing” markets extraordinary liquidity. The upshot has been that sectors and economies basically starved of finance for years now have more than they know what to do with (but, rest assured, they will find ways to spend it!) All the while, global inflationary pressures have been building, especially for the U.S. with its faltering currency. It seemed as if all year long there were expectations that the U.S. and global recovery would falter. There were terror and election jitters. More specifically, there were fears that rising rates and reduced fiscal stimulus would restrain the U.S. consumer, while somehow the Chinese boom-time economy was to come crashing down. Indeed, too often the analysis was slimmed down to the vulnerable U.S. consumer and Chinese investment booms. In reality, the “story” has been much more encompassing and all the while evolving: Not only have the powerful U.S. and Chinese Bubbles proved resilient, the global economy is in the midst of an unprecedented financial boom. The U.S. Credit Bubble has sprouted myriad semi-independent Bubbles across the globe, with strong local currencies accommodating lending and speculative excesses in a manner King Dollar would have never tolerated. The faltering dollar, uncontrolled dollar liquidity creation, and resulting global liquidity and speculative excesses have set in motion inflationary processes that are now increasingly difficult to predict, let alone control. Dilly-Dallying and Global Wildcat Finance are a most dangerous mix. It is my sense that very powerful global boom and bust dynamics have taken hold the past year, as the Fed Dilly-Dallied fed funds to a paltry 2.25%. The financial world – of unfettered high-powered leveraging, speculating and derivatives – moves these days at lightning speed. Yet the Fed somehow believes it has no alternative than to adjust in s-l-o-w m-o-t-i-o-n. As history has taught us, the cost of falling behind the curve is that only more aggressive monetary restraint is required down the road. This certainly appears to be the way things are progressing at this time, and it will be fascinating to watch how long the bond market can continue to disregard this reality. |
Monday, September 8, 2014
12/17/2004 Dilly-Dally Monetary Management *
