One-month Treasury bill rates ended the week at 3 bps, and three-month bills closed at 5 bps. Two-year government yields dropped 16 bps to 0.88%. Five-year T-note yields fell 9 bps to 2.52%. Ten-year yields were little changed at 3.84%. Long bond yields jumped 9 bps to 4.72%. Benchmark Fannie MBS yields declined 3 bps to 4.53%. The spread between 10-year Treasury and benchmark MBS yields narrowed 3 to a 17-year low 69 bps. Agency 10-yr debt spreads were unchanged at 30 bps. The implied yield on December 2010 eurodollar futures dropped 30 bps to 1.23%. The 10-year dollar swap spread declined 2.5 to 10.75, while the 30-year swap spread declined 3.0 to negative 14.25. Corporate bond spreads narrowed further to begin the year. An index of investment grade bond spreads narrowed 6 to 79 bps, and an index of junk spreads narrowed 27 to a two-year low 511 bps.
January 8 – Bloomberg (Gabrielle Coppola and Sapna Maheshwari): “General Electric… and Lloyds Banking Group Plc led the busiest week of U.S. corporate bond sales since September as companies rushed to borrow before interest rates rise. Issuance increased to at least $44 billion…”
Investment grade issuers included GE Capital $4.0bn, Met Life $2.5bn, Motiva Enterprises $2.0bn, Crown Castle $1.9bn, and Berkshire Hathaway $1.0bn.
Junk bond funds saw inflows of $288 million. Junk issuers included Qwest Communications $800 million, Level 3 $640 million, Energy Future Holdings $500 million, Paetec Holding $300 million, Kansas City Southern $300 million, and Ply Gem Industries $150 million.
I saw no convert issues.
International dollar-denominated debt issues this week included Turkey $2.0bn, Lloyds Bank $5.0bn, Dexia $4.5bn, Barclays Bank $3.0bn, Deutsche Bank $2.0bn, Banco NAC $2.0bn, National Bank of Australia $1.75bn, Irish Life and Permanent $1.75bn, Rabobank $1.75bn, Philippines $1.5bn, Macquarie Group $1.0bn, ING Bank $1.75bn, and Grupo Posadas $200 million.
U.K. 10-year gilt yields rose 5 bps to 4.06%, while German bund yields were little changed at 3.38%. Bond yields in Greece dropped 19 bps to 5.57%. The German DAX equities index gained 1.3% (52-week gain of 23.7%). Japanese 10-year "JGB" yields increased 7 bps to 1.36%. The Nikkei 225 rose 2.4% (up 21.7%). Emerging markets began the year much as they ended 2009. For the week, Brazil's Bovespa equities index jumped 2.4% (up 67.3%), and Mexico's Bolsa rose 2.4% (up 49.8%). Russia’s RTS equities index was unchanged (up 128.6%). India’s Sensex equities index added 0.4% (up 83.0%). China’s Shanghai Exchange fell 2.5%, reducing 52-week gains to 70.2%. Brazil’s benchmark dollar bond yields fell 8 bps to 5.02%, while Mexico's benchmark bond yields dropped 7 bps to 5.10%.
Freddie Mac 30-year fixed mortgage rates declined 5 bps to 5.09% (up 8bps y-o-y). Fifteen-year fixed rates fell 4 bps to 4.50% (down 12bps y-o-y). One-year ARMs dipped 2 bps to 4.31% (down 64bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 12 bps to 6.08% (down 72bps y-o-y).
Federal Reserve Credit declined $3.6bn last week to $2.216 TN. Fed Credit was up $38.8bn from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 1/6) increased another $6.3bn to a record $2.962 TN. "Custody holdings" expanded $437bn, or 17.3%, over the past year.
M2 (narrow) "money" supply rose $16.4bn to $8.413 TN (week of 12/28). Narrow "money" expanded 2.7% in 2009. For the week, Currency was unchanged, while Demand & Checkable Deposits added $1.4bn. Savings Deposits jumped $22.2bn, while Small Denominated Deposits declined $6.8bn. Retail Money Funds dipped $0.7bn.
Total Money Market Fund assets (from Invest Co Inst) increased $13.8bn to $3.307 TN. Over the past year, money fund assets declined $588bn, or 15.1%.
Total Commercial Paper outstanding sank $94bn last week to $1.076 TN. CP dropped $689bn over the past year (39%). Asset-backed CP fell $66bn last week to $420.8bn, with a 52-wk drop of $360bn (46%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $811bn y-o-y, or 11.9%, to $7.615 TN.
Global Credit Market Watch:
January 6 – Bloomberg (Bryan Keogh and Shannon D. Harrington): “Companies are selling debt with terms last seen before credit markets froze, showing why the world’s biggest bond fund manager says another bubble may be brewing. JohnsonDiversey Holdings Inc., a Sturtevant, Wisconsin, maker of cleaning supplies, and Wind Acquisition Holdings Finance SpA, parent of Italy’s third-largest mobile-phone company, sold bonds that can pay interest in new debt instead of cash, the first such deals since 2007…”
January 6 – Bloomberg (Bryan Keogh and Sapna Maheshwari): “The lowest-rated corporate bonds rallied above so-called distressed trading levels for the first time since January 2008 on optimism the economy is recovering. The average yield on U.S. bonds rated CCC or lower tightened to 9.82 percentage points more than similar-maturity Treasuries, from as much as 36.7 percentage points in March, according to Merrill Lynch & Co. index data. The debt has been distressed, or trading at a spread of at least 10 percentage points, since Jan. 8, 2008, the data show.”
January 6 – Bloomberg (Clarissa Batino and Seda Sezer): “The Philippines received more than $3 billion of orders for a planned bond sale and Turkey got more than triple the $2 billion it offered as confidence in emerging markets drove yields to the lowest in 19 months. Turkey’s government said it received $7.3 billion of orders for its sale of 30-year bonds yesterday. Bids for the Philippine sale were at least twice the $1.5 billion on offer, according to two investors who received notice from underwriters. The extra yield investors demand over U.S. Treasuries to own emerging- market bonds dropped 5 basis points to 2.69 percentage points, the lowest spread since June 2008, according to JPMorgan Chase & Co.’s EMBI+ Emerging Markets Bond Index.”
January 6 – Bloomberg (Shiyin Chen and David Yong): “Emerging-market stocks and bond funds closed 2009 with record annual inflows as a recovery from the global financial crisis boosted demand for riskier assets, according to U.S.-based research company EPFR Global. Emerging-market equity funds received $64.5 billion, while those investing in developing-nation fixed-income securities drew more than $8 billion, EPFR in Cambridge, Massachusetts, said in an e-mailed statement, citing initial figures from funds reporting daily and weekly.”
January 6 – Bloomberg (Lindsay Fortado): “Skadden, Arps, Slate, Meagher & Flom LLP, the top-grossing U.S. law firm, overtook a U.K. competitor to advise on the highest amount of global mergers and acquisitions in 2009, the least-active deal market in six years. The New York-based firm unseated 2008 leader Linklaters LLP, which ranked fifth among legal advisers to buyers and sellers last year, according to data collected by Bloomberg. Total deal value fell about 32 percent to more than $1.7 trillion…”
Global Government Finance Bubble Watch:
January 8 – Wall Street Journal (Christina S.N. Lewis): “The office market in Washington, D.C., is poised to topple New York as the nation’s most expensive, reflecting the declining fortunes of the nation’s financial center and the government expansion under way in the U.S. capital.”
January 7 – Wall Street Journal (Jon Hilsenrath): “Federal Reserve officials squabbled about how to proceed with a program of mortgage-backed-securities purchases at their December meeting, with some saying a weak economy could warrant expansion and at least one arguing for scaling back… The minutes show some officials worried the housing recovery could be cut short next year when the Fed stops buying mortgage debt and when other federal support programs…expire… ‘Some participants remained concerned about the economy's ability to generate a self-sustaining recovery without government support,’ the minutes of the Dec. 15-16 meeting said. Some officials argued the Fed might need to expand its mortgage-purchase program and extend it beyond the first quarter to keep the recovery going… ‘It goes without saying, if this recovery fails for whatever reason, yeah, they’ll ramp up asset purchases,’ said Alan Levenson, chief fixed-income economist at T. Rowe Price…”
January 7 – Bloomberg (Jennifer Ryan): “The Bank of England pledged to spend the rest of its 200 billion-pound ($318bn) bond purchase program as policy makers sought to ensure the economy’s escape from the recession.”
January 4 – Bloomberg (Seyoon Kim): “South Korea’s government said it has allocated more than half of its expenditure to be spent in the first half of this year to help support the economic recovery. The Cabinet agreed to allocate 70% of expenditure to the first six months of this year, the finance ministry said in a statement in Gwacheon today. That would be a total of 178.3 trillion won ($154 billion), the ministry said. ‘The government wants to spur domestic spending and help local demand drive the economic recovery,’ said Kim Jae Eun, economist at Hyundai Securities… ‘It’s trying to show it remains committed to boosting the economy.’”
The dollar index slipped 0.5% this week to 77.456. The "commodities currencies" were out of the blocks quickly. For the week on the upside, the Mexican peso increased 3.0%, the Australian dollar 3.0%, the South Korean won 3.0%, the Norwegian krone 2.3%, the Canadian dollar 2.2%, the New Zealand dollar 1.9%, the Swedish krona 1.2%, the Swiss franc 1.1%, and the Brazilian real 1.1% For the week on the downside, the British pound declined 0.9%.
January 7 – Bloomberg (Jesse Riseborough): “The cash price of iron ore delivered to China, the world’s biggest buyer, rose to the highest in more than a year amid what Goldman Sachs JBWere Pty said was ‘panic buying’ by steel mills… The so-called spot price has surged 24% in four weeks and has more than doubled from its 2009…”
January 6 – Bloomberg (Thomas Kutty Abraham): “A global tea shortage may widen this year and extend into 2011 as a rebound in production in Africa, Sri Lanka and India trails demand growth, the world’s biggest tea-plantation company said… and prices may rise to a record again this year as shortages persist, Aditya Khaitan, managing director, of McLeod Russel India Ltd., said… Prices of top-quality Assam tea have gained almost 50% past year…and may advance further, Khaitan said.”
January 4 – Bloomberg: “Aluminum Corp. of China Ltd., the country’s largest producer of the metal, raised spot alumina prices for the third time in five months as smelters start to stock the material before the Lunar New Year holiday. Prices for the material used to make aluminum increased by 5.7% to 2,800 yuan ($410) a metric ton from Jan. 1, the… company known as Chalco said… Chalco raised prices by 3.9% on Sept. 30, and 6.3% on Sept. 1.”
The CRB index began 2010 with a gain of 2.6% (up 26.5% y-o-y). The Goldman Sachs Commodities Index (GSCI) surged 3.5% (up 55.4% y-o-y). Gold jumped 3.6% to $1,137 (up 33.1% y-o-y). Silver surged 9.8% to $18.495. (up 63.4% y-o-y). February Crude jumped $3.52 to $82.88 (up 103% y-o-y). February Gasoline rose 5.3% (up 95% y-o-y), and January Natural Gas increased 2.7% (up 4% y-o-y). March Copper gained 2.5% (up 120% y-o-y). March Wheat jumped 5.0% (down 10% y-o-y), and March Corn increased 2.1% (up 3% y-o-y).
China Bubble Watch:
January 4 – Bloomberg: “China’s economy may grow 9.5% this year, Hong Kong newspaper Ta Kung Pao reported… citing forecasts by the State Council’s Development Research Center…”
January 8 – Bloomberg: “China’s vehicle sales last year rose to about 13.5 million units, the official Xinhua News Agency reported…”
January 7 – Bloomberg: “China’s central bank said it will target ‘moderate’ loan growth in 2010, adding to signs that policy makers won’t allow a repeat of last year’s record expansion in credit. Policy makers need to support ‘relatively fast’ economic growth while managing inflation expectations, the People’s Bank of China said… China is trying to cement a recovery while preventing excessive liquidity in the financial system from causing resurgent inflation, asset bubbles and bad debts for banks. Property prices are surging in some cities and Liu Mingkang, the top banking regulator, wrote in an opinion piece in Bloomberg News this week that ‘structural bubbles threaten to emerge.’”
January 6 – Bloomberg: “China’s central bank pledged to curb volatility in lending, manage inflation expectations and monitor the property market in 2010 as a credit boom poses risks for the world’s third-biggest economy. The central bank will also ‘stabilize the stock market’s operations,’ the People’s Bank of China said… China’s policy makers are trying to cement an economic rebound while preventing excessive liquidity in the financial system from leading to asset bubbles, resurgent inflation and bad debts for banks.”
January 6 – Bloomberg: “China will limit credit for some home purchases to reduce speculation and rein in surging prices, Housing Minister Jiang Weixin said. The nation will ‘further restrict credit for the purchase of second homes and curb speculative housing investments,’ Jiang said…”
January 7 – AFP: “More regions of China faced power shortages, food prices rose and the government warned of crop damage as a cold front kept its icy grip on the country… A vast swathe of the country… has seen unprecedented spikes in electricity and coal use as residents sought to keep warm, China National Radio reported.”
January 6 – Bloomberg: “China, the world’s second-biggest electricity producer, raised power consumption by 6% in 2009 as the government’s stimulus package bolstered demand and fueled investments in renewable energy… The growth rate is 0.47 percentage point higher than 2008…”
January 4 – Bloomberg: “Companies will raise about 72% more cash through initial public offerings in Shanghai and Shenzhen this year as the IPO market continues to pick up, according to PricewaterhouseCoopers. Funds raised in IPOs will jump to more than 320 billion yuan ($46.9 billion) in 2010 from the 185.6 billion yuan last year, according to…PwC in Shanghai…”
January 8 – Bloomberg (Vipin Nair): “India’s local car sales in December rose 40% to 115,268 units from a year earlier, the Society of Indian Automobile Manufacturers said…”
January 4 – Bloomberg (Rakteem Katakey): “India’s crude oil imports in November rose 6.1% to 10.48 million metric tons, the oil ministry said…”
Asia Bubble Watch:
January 7 – Financial Times (Justine Lau): “A slew of export figures released in Asia on Thursday provided further evidence of the strength of the region’s economic recovery. In Taiwan, the value of exports in December rose 46.9% from the same period a year ago, boosted by a 91.2% jump in shipments to China and Hong Kong… South Korea reported December exports to China jumped 94% and those to the European Union surged 41.7% from a year ago… In Malaysia, exports to China jumped 52.9%... from a year earlier… Driven by China’s strong economic growth in 2009, many export-dependent countries in Asia have seen robust demand for their products in the past few months… ‘Everybody seems to be booming. I think the trend is likely to continue into the first half of 2010. I don’t really see anything stopping it,’ said Tim Condon, Asia chief economist at ING…”
January 7 – Bloomberg (Nguyen Kieu Giang): “Vietnam’s inflation may accelerate to as much as 11% this year due to rising commodity prices and the delayed effects of a stimulus package that stoked credit growth, according to Sacombank Securities Inc.”
Latin America Bubble Watch:
January 4 – Bloomberg (Francisco Marcelino): “Brazil’s domestic vehicle sales rose 51 percent in December to 277,966 units, Reuters reported, citing an unidentified person from auto sector.”
Unbalanced Global Economy Watch:
January 8 – Bloomberg (Simone Meier): “Europe’s unemployment rate unexpectedly increased to 10%, the highest in more than 11 years, as companies cut costs in the wake of the worst recession in more than six decades. November’s euro area jobless rate rose from a revised 9.9% in October…”
January 4 – Bloomberg (Vidya Root): “French car sales jumped 49% in December, the eighth consecutive monthly increase, as demand for small cars was helped by government incentives.”
January 8 – Bloomberg (Frances Robinson): “German exports rose more than economists forecast in November as Europe’s largest economy benefited from the recovery in global trade. Sales abroad… increased 1.6% from October, when they gained 1.9%... Imports fell 5.9% in November from October… The trade surplus widened to 17.4 billion euros ($25bn)… That’s the widest since June 2008, when it was 20.1 billion euros.”
January 8 – Bloomberg (Klaus Wille): “Swiss unemployment increased to the highest in more than 11 years in December as companies continued to trim costs to shore up earnings. The jobless rate rose to 4.2%...”
January 8 – Bloomberg (Jacob Greber and Heidi Couch): “Australia’s economy is heading for its ‘next big boom,’ according to Gerry Harvey, billionaire chairman of the nation’s largest electronics seller, after a report showed retail sales surged by the most in eight months.”
U.S. Bubble Economy Watch:
January 8 – Bloomberg (Dex McLuskey): “The Dallas Cowboys’ first postseason game in their new $1.1 billion stadium has no cheap seats for fans or cheap parking for cars. The Cowboys… are charging as much as $500 for seats along the sidelines at Cowboys Stadium in Arlington, Texas, more than twice the regular-season price. Tickets start at $35 for standing-room that doesn’t guarantee a view of the field. Before they even get into the stadium with a 60-yard-long video screen, $13 Kobe beef burgers and $9 Shiner Bock beers, fans have to fork over as much as $75 to park…”
January 7 – Wall Street Journal (Sara Murray): “Personal bankruptcies soared last year in Western states hit hardest by the real-estate bust. In states such as California, Arizona and Nevada, where housing prices soared and then collapsed during the past decade, consumer bankruptcy filings rose roughly twice as much as the national average increase of 32%... In Arizona and Nevada, where bankruptcies increased most, filings skyrocketed by 79.6% and 59.5%, respectively. Nearly 6.2% of mortgages in Arizona and 9.4% of mortgages in Nevada were in foreclosure by the end of the third quarter… California saw personal bankruptcy filings rise 58.8% last year. At the end of the third quarter, some 5.8% of loans were in foreclosure there.”
January 6 – Bloomberg (Daniel Taub): “Construction spending on hotels, office buildings and retail centers may fall 13% this year, the second straight annual decline amid a drop in property prices, the American Institute of Architects said.”
Central Bank Watch:
January 7 – Bloomberg (Scott Lanman): “Federal Reserve officials discussed whether the economy is strong enough to allow their $1.73 trillion of asset purchases to end in March and differed over the risk of inflation, minutes of their last meeting showed. A few policy makers said it ‘might become desirable at some point’ to boost or extend securities purchases aimed at lowering mortgage rates…”
January 6 – Bloomberg (Zijing Wu and Erik Schatzker): “Morgan Stanley Asia Ltd. Chairman Stephen Roach said U.S. policy makers should start to exit emergency stimulus measures now if the economic recovery is as strong as they say it is. There is never an easy time to do it,’ Roach said… ‘The longer they wait, the greater the chance they sow the seeds for the next bubble. So I’m in favor of an early exit strategy.’”
January 5 – Bloomberg (Steve Matthews): “John Taylor, creator of the so-called Taylor rule for guiding monetary policy, disputed Federal Reserve Chairman Ben S. Bernanke’s argument that low interest rates didn’t cause the U.S. housing bubble. ‘The evidence is overwhelming that those low interest rates were not only unusually low but they logically were a factor in the housing boom and therefore ultimately the bust,’ Taylor, a Stanford University economist, said… Taylor, a former Treasury undersecretary, was responding to a speech by Bernanke two days ago, when he said the Fed’s monetary policy after the 2001 recession ‘appears to have been reasonably appropriate’ and that better regulation would have been more effective than higher rates in curbing the boom.”
January 8 - Financial Times (Krishna Guha): “As the US Federal Reserve pulls back from the mortgage market, will the government and its proxies, Fannie Mae and Freddie Mac, pick up the baton? Many investors are looking to Fannie and Freddie to play an expanded role in the market for mortgage-backed securities (MBS) – helping to keep the market liquid and mortgage rates low – as the Fed completes its $1,250bn purchase programme. This is mitigating concerns, expressed by some Fed officials…that the scheduled winding down of Fed purchases of MBS by March 31 could ‘undercut’ a fragile housing recovery.”
January 6 – Bloomberg (Matt Townsend): “GMAC Inc., the auto and home lender that became majority-owned by the U.S. government last week after a third bailout, may post a loss of more than $10 billion for 2009 as more borrowers defaulted on mortgages. GMAC, based in Detroit, said yesterday that it expects to report a fourth-quarter loss of about $5 billion. Both the quarterly and annual losses would be records for the primary lender for General Motors Co. and Chrysler Group LLC dealers.”
Real Estate Watch:
January 7 – Bloomberg (Dan Levy): “U.S. apartment vacancies rose to a record 8% in the fourth quarter and rents fell the most in three decades… according to Reis Inc. Asking rents dropped 2.3% from a year earlier to an average of $1,026, the biggest decline since Reis began records in 1980… ‘Never before have we observed rental properties in so much distress,’ Victor Canalog, Reis’s research director, said…”
January 8 – Bloomberg (Dan Levy): “Office vacancies in the U.S. surged to a 15-year high in the fourth quarter and rents fell the most on record … according to Reis Inc. The vacancy rate climbed to 17% from 14.5% a year earlier…”
January 6 – Bloomberg (Dan Levy): “Vacancies at the largest U.S. shopping centers reached a record 8.8% in the fourth quarter… Reis Inc. said. Vacancies at smaller neighborhood and community centers increased to 10.6%, the highest level since 1991, from 8.9% a year earlier…”
January 7 – Bloomberg (Brian K. Sullivan): “U.S. state tax collections fell the most in 46 years in the first three quarters of 2009 as the recession shrank revenue from sources including personal income, the Nelson A. Rockefeller Institute of Government said. Revenue dropped 13.3%, or $80 billion, compared with the same nine months of 2008, to $523 billion, the institute said. Collections in the third quarter alone sank 10.9% to about $162 billion… ‘The first three quarters of 2009 were the worst on record for states in terms of the decline in overall state tax collections, as well as the change in personal income and sales tax collections,’ Rockefeller analysts Lucy Dadayan and Donald J. Boyd wrote... Budget gaps have opened in 31 states since fiscal year 2010 began, Dadayan and Boyd wrote… ‘2010 is going to be very difficult for the states and the next year is likely to be significantly worse,” Rockefeller Deputy Director Robert Ward said…”
January 6 – Bloomberg (Jeremy R. Cooke): “New York’s Metropolitan Transportation Authority, the largest mass-transit agency in the U.S., will be one of the first issuers to sell Build America Bonds in a year when such taxable offerings may push municipal issuance to a record $450 billion. The ‘generous ‘35% Treasury rebate on Build America interest costs may entice state and local borrowers to sell as much as $150 billion of the bonds in 2010, more than twice as much as last year, Municipal Market Advisors forecast this week. The MTA, operator of subways, buses, rail lines and river crossings, plans to sell $350 million of so-called BABs…”
January 7 – Bloomberg (Michael B. Marois and William Selway): “California Governor Arnold Schwarzenegger faces a $20 billion deficit in his final budget proposal tomorrow, his last chance to shape the fiscal policies of the most populous U.S. state before he leaves office. Schwarzenegger… has said he won’t raise taxes again to fill gaps of $6.6 billion in the current year and $13.3 billion in the 12 months beginning July 1. Amid warnings of a possible ‘cash crisis,’ he’s also pledged to ease the cost to taxpayers of federally mandated programs such as health care for the poor.”
January 6 – Bloomberg (Dan Levy): “Silicon Valley is beset by the biggest office property glut since the dot-com bust, leaving the U.S. technology hub with empty high-rises and office parks that make it impossible for landlords to sustain average rents. More than 43 million square feet… -- the equivalent of 15 Empire State Buildings -- stood vacant at the end of the third quarter, the most in almost five years, according to CB Richard Ellis Group Inc. San Jose, Sunnyvale and Palo Alto have 11 empty office buildings with about 3 million square feet of the best quality space. ‘There is a bubble bursting in much the same way as the residential market burst,’ said Jon Haveman, principal at Beacon Economics… ‘None of those towers will fill up anytime soon.’”
New York Watch:
January 6 – Bloomberg (Oshrat Carmiel): “Manhattan apartment prices fell for a third consecutive quarter as Wall Street job losses drained demand and the decline in co-op and condominium values reached 21 percent since the market peak. The median price slid 10 percent to $810,000 in the fourth quarter from a year earlier, down from almost $1.03 million in 2008, New York appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate said…”
Crude Liquidity Watch:
January 6 – Bloomberg (Fiona MacDonald): “Kuwait’s parliament approved a bill that would force the government to buy all 6.7 billion dinars ($23.3 billion) of consumer loans, write off the interest and reschedule the payments. The plan, which the government opposes and says is unconstitutional, passed with 35 votes in favor and 22 against in the final round of voting today, speaker Jassim al-Kharafi said.”
Let’s start by setting the backdrop. The world is operating without a stable monetary regime. There is no gold standard. There is no functioning Bretton Woods currency stability regime. There is no longer even an ad hoc dollar reserve “system” that tended – at least on occasion - to discipline foreign Credit systems and restrain excesses. Like never before, Credit systems around the world operate unrestrained. It is my long-held view that pricing mechanisms – and Capitalism generally – function poorly in a backdrop of unrestrained (inherently mis-priced) Credit.
Most importantly, there is today no common understanding that stable international finance is wholly dependent upon individual Credit systems being operated with discipline and restraint. Quite the contrary, as the universal policymaking view these days is that aggressive stimulus and monetary looseness are essential for supporting financial and economic recoveries. The world is devoid of a monetary anchor and operating in a unique monetary environment that foments speculation, financial excess, imbalances, economic maladjustment, and potent bubble dynamics. As we begin 2010, inflationism is still seen as the solution instead of the problem.
The year 2008 marked the collapse of the Wall Street/mortgage finance Bubble. It specifically did not mark the end of the Chinese Bubble, the global Credit Bubble, or even the greater U.S. Credit Bubble. Last year saw the emergence of the Global Government Finance Bubble – quite possibly a monumental development. Accordingly, 2010 should be viewed as a Bubble Year. This implies a bipolar perspective when contemplating probable outcomes: On one end, the Bubble expands and makes it through the year. Or, on the other, the Bubble bursts and financial systems and economies sink right back into crisis. As a long-time analyst of Bubbles, I caution against predicting the timing of their demise.
Last year saw intense speculation reemerge in U.S. and global financial markets. It is the nature of speculation to intensify as long as it is accommodated by loose financial conditions. Similarly, it is the nature of Bubbles to expand and become more robust unless inflation dynamics are quashed through some type of monetary tightening. Excess begets excess… And the more protracted – hence powerful – the Bubble the greater the degree of tightening necessary to eventually rein it in. The more heated and expansive the Bubble the greater the dislocation associated with its bursting. I see no appetite anywhere in the world this year to aggressively suppress Bubbles.
The unfolding Bubble in China is historic, and their policymakers appear poised to tinker. Tinkering doesn’t quell Bubbles – certainly not seasoned ones. I have espoused the view that the Chinese Credit Bubble has entered the dangerous “Terminal Phase” of excess. How this dynamic and the course of policymaking play out is a Major Issue 2010. I expect Chinese authorities to work diligently in an effort to ration the amount of Credit available for real estate speculation. At the same time, the stated goal of stimulating domestic consumption implies huge growth in Chinese household debt.
I am generally skeptical in the efficacy of Credit rationing. This was a focal point of a great debate in the U.S. back in the late-twenties. One (dovish) camp believed that the focus should be on limiting the flow of Credit financing stock market speculation, while at the same time working to maintain ample Credit to fuel the booming economy. The problem is generally that years of expanding Credit create a (financial and economic) system with both a huge Credit appetite and a potent propensity for inflating the quantity of new Credit. Attempts to limit speculative Credit – or even lending to certain sectors – is generally ineffective in itself and fails to address the major issue of runaway total system Credit growth. Indeed, after Bubble dynamics have taken firm hold, attempts to restrict Credit by the nature of its use will tend to distract policymakers and delay efforts to contain systemic excesses. From my point of view, determined, decisive and independent monetary management provides the only hope for reining in “terminal phase” Credit Bubble excess. Such an approach seems in very short supply these days, and I’ll be surprised if much of it emerges in China in 2010.
Here at home, Chairman Bernanke apparently doesn’t discern Bubble risk. Incredibly, in his Sunday morning speech he even argued that Fed rate policy was about right during the 2002-2006 period – and that a low Fed funds rate wasn’t the cause of the U.S. housing Bubble. And we can also assume the he believes his speeches (including his November 2002 - “Helicopter Ben” - “Deflation: Making Sure ‘It’ Doesn’t Happen Here”) did not create a major moral hazard issue.
The markets have no fear that the Fed will tighten in response to financial speculation. I believe the Fed examines today’s real estate markets and fears “deflation.” I would imagine they see a stock market still 25% below all-time highs and worry of “disinflation.” They see stagnant (at best) household debt growth, declining bank Credit, and still impaired securitization markets and see no credible inflation threat. Looking in the rear-view mirror, they just don’t see problematic financial leveraging and lending excesses. They would surely view the reemergence of asset inflation as confirmation of their adept policymaking.
The Fed’s overriding focus is stimulating sustainable recovery. They will err on the side of caution when it comes to removing crisis-period liquidity measures. I will assume that they will not be raising rates meaningfully until they are confident that the markets and economy have first adjusted well to ending quantitative easing operations. Meaningful financial tightening is nowhere in sight. The Bernanke Fed still believes that monetary policy is a “blunt tool” and, as such, is inappropriate for dealing with Bubbles. They prefer stronger “regulation.” So, who is responsible for regulating Washington Credit excesses?
The Fed’s analytical framework and rear-view approach will not serve them well. Today’s domestic Credit excesses are concentrated in the Treasury and agency markets. In a replay of Mortgage Finance Bubble dynamics, Federal Reserve policies today accommodate the Government Finance Bubble. Dr. Bernanke’s talk of helicopter money and the government printing press was fundamental to creating an environment where the markets operated confidently knowing the Fed was there to provide a market liquidity backstop. The Fed’s fingerprints were all over the historic mispricing and over-extension of mortgage Credit. Today, “quantitative ease” and the perception of potentially unlimited Federal Reserve monetization (balance sheet growth) have greatly distorted the pricing mechanisms for government borrowings and debt instruments generally.
Because of the Fed’s words and deeds, the marketplace is dysfunctional when it comes to pricing risk. These days the price of government Credit has no relationship to the interaction of its supply and demand. If Washington seeks to borrow a couple hundred billion - or a few Trillion - it really has little impact on yields. In an ominous replay of the Mortgage Finance Bubble, government intervention has severely distorted the capacity of the marketplace to properly price risk, allocate resources, and discipline market participants (borrowers and speculators).
The Fed should have “leaned in the wind” in response to double-digit mortgage Credit growth in years 2002, 2003, 2004, 2005, and 2006. Instead, the Fed did the exact opposite, believing at least for awhile that the expansion of mortgage Credit was a mechanism to ameliorate deflationary pressures. Furthermore, it had convinced the marketplace that it was there to protect against any potential Credit bust. And then, once the housing/mortgage Bubble really gained a foothold, the Fed was unwilling to rein in the monster it had unleashed. The marketplace had become so dysfunctional that the best “trade” to profit from the inevitable bust was to load up (and further feed the mortgage Bubble) on GSE obligations.
Similar dynamics now promote the Government Finance Bubble. In a more orthodox financial world, our central bank would be expected to “lean against the wind” as our federal government sets course on destroying its (our) creditworthiness. Not these days, as the Fed holds short-term rates steadfastly at near zero, balloons its balance sheet with GSE MBS, and again convinces the marketplace that its balance sheet will always be there as a liquidity backstop.
Despite the prospect of the Fed ending its MBS purchase program in March, GSE MBS spreads to Treasuries ended today near 17-year lows. The marketplace must expect that Fannie and Freddie are to resume their balance sheet growth (and market liquidity-backstop function!); that the Fed will state its intention to provide future support for the MBS market; or a combination of both. There is no end in sight when it comes to the nationalization of mortgage finance. Clearly, the MBS marketplace is rife with government intervention and price distortions. It has, once again, succumbed to dangerous Bubble dynamics and how it functions through the year is a major Issue 2010.
As I mentioned again last week, combined Treasury and GSE MBS debt expanded $2.8 TN in the 15 months ended September 30, 2009. The emergence of the Global Government Finance Bubble was crucial for the stabilization of the U.S. and global economy. U.S. recovery is dependent upon the continuation of this Bubble, and this Bubble is dependent upon massive government fiscal and monetary stimulus. Optimism is now running high. Such a dynamic can be self-fulfilling for awhile, and the U.S. economy could make the bulls look smart in 2010. But this is very unlikely to change the very bearish secular thesis.
The nature of the unfolding economic recovery is an Issue 2010. Will private-sector Credit creation begin to expand sufficiently and, in the process, allocate ample Credit for sound investment and meaningful non-government job growth? Will a self-reinforcing Credit cycle commence, or is the system now trapped in government debt Bubble dynamics?
A respectable December for the retailers has optimism for consumer rejuvenation running high. The S&P Homebuilding index was up 14.6% this week, as the marketplace positions for a traditional economic rebound. But major questions for 2010 remain: How vulnerable is the housing market to higher mortgage yields? How long will the marketplace finance massive deficit spending and GSE debt issuance before demanding significantly higher yields?
My thesis that the unfolding reflation will be altogether different than past reflations may be tested in 2010. So far, massive government stimulus has stabilized both asset markets and national incomes. And some pent up demand throughout the economy is expected. At the same time, savers are receiving about nothing on their savings, while energy and many other prices continue their ascent. Surging financial asset prices have boosted household confidence and Net Worth. Yet a meaningful rise in market yields could easily pressure bond, stock and home prices. To what extent mortgage Credit growth can recover and foster a self-reinforcing housing recovery is a key financial and economic Issue 2010.
Unprecedented market interventions by the government played a decisive role in stabilizing mortgage finance, housing markets, and household spending. It played a similar role in stabilizing the municipal debt market. That cash-strapped state and local government regained access to inexpensive borrowings was instrumental to financial and economic stabilization. If a traditional recovery ensues, perhaps state and local governments can grow out of their debt problems. A more reasonable bet is that municipal finance faces serious and festering structural debt issues. California is an absolute fiscal mess. Do loose financial conditions continue to accommodate what will be enormous 2010 state and local borrowing requirements?
Today, the markets are infatuated with risk assets. From the perspective of Bubble analysis, this is not all too difficult to explain. The first week of the year saw about $45 billion of corporate debt issues. Despite enormous new supply, investment grade debt spreads are at pre-Lehman crisis levels. The same can be said for junk bond and emerging debt spreads. Credit conditions are loose for most creditworthy borrowers, which feeds market demand for these debt instruments - which translates into even greater Credit Availability. In such an environment, even commercial real estate doesn’t look so bad. But is such an accommodating financial landscape sustainable?
It is always impossible to know what developments will surface to upset the applecart: there are any number of festering financial, economic, political, and geopolitical issues that might impede the unfolding Bubble. At the same time, it is not unreasonable to suspect that policymakers might tend to delay dealing with tough issues. The federal deficit is out of control, and monetary policy is outrageously loose. There is an “exit strategy” with assorted doors. There is the looming issue of Fannie and Freddie. The FHA and Ginnie need to be reigned in.
Looking back, policymakers of all stripes missed their opportunities to make tough but necessary decisions in 2009. And now 2010 just doesn’t have the feel of a year that will witness a lot of decisive policymaking. In Washington, the focus will turn to the 2010 elections. The Fed will worry about its reputation and independence. Fearing for their jobs and fearful of mistakes, timid will win over bold. Bubbles treasure timid.
Until proven otherwise, I’ll project 2010 as a year of escalating Monetary Disorder – disorder globally across a broad spectrum of markets. A global Bubble would seem to ensure unsettled currency markets. Dollar optimism runs surprisingly high to begin the New Year. Yet the scenario of a dollar problem leading to a jump in U.S. borrowing costs still doesn’t seem all that nutty to me. Another spike in energy and commodities wouldn’t surprise me, but the best bet is numbing volatility. The emerging markets are poised for a wild year. And, of course, all eyes on interest rates.
As I mentioned above, a Bubble Year suggests the likelihood of bipolar outcomes. I’ll conclude by admitting that I get that uneasy feeling that our central bank is quite determined to avoid learning lessons.