One-month Treasury bill rates ended the week at 22 bps, and three-month bills ended the week at 28 bps. Two-year government yields jumped 8.5 bps to 0.93%. Five-year T-note yields rose 12 bps this week to 1.92%. Ten-year yields jumped 14 bps to 2.97%. Long-bond yields gained another 10 bps to 3.73% (up 120bps from Dec. lows). The implied yield on 3-month December ’09 Eurodollars declined 11.5 bps to 1.435%. Benchmark Fannie MBS yields rose 8 bps to 4.35%. The spread between benchmark MBS and 10-year T-notes narrowed 6 to 136 bps. Agency 10-yr debt spreads narrowed a notable 13 to 76 bps. The 2-year dollar swap spread declined 8.75 to 61 bps; the 10-year dollar swap spread declined 0.25 to 23 bps, and the 30-year swap spread declined 2.25 to negative 23.5 bps. Corporate bond spreads were narrower. An index of investment grade bond spreads narrowed 5 to 194 bps, and an index of junk bond spreads narrowed 43 to 1,235 bps (8-wk low).
Investment grade issuance included Fannie Mae $7.0bn, Novartis $5.0bn, Altria $4.5bn, Procter & Gamble $3.0bn, Morgan Stanley $3.0bn, Caterpillar $3.0bn, CME Group $750 milliion, Goldman Sachs $600 million, Wellpoint $1.0bn, Georgia Power $500 million, and Sunoco Logistics $175 million.
Junk issuers included El Paso Corp $500 million, Landry's Restaurant $295 million, and American Media Operation $300 million.
International issuers included Petrobras $1.5bn and Swedbank $1.45bn.
U.K. 10-year gilt yields added 3 bps to 3.73%, and German bund yields jumped 7 bps to 3.37%. The German DAX equities index surged 7.1% (down 3.4%). Japanese 10-year "JGB" yields ended the week up 4 bps at 1.33%. The Nikkei 225 rallied 1.0% (down 8.8%). Emerging markets were mixed to higher. Brazil’s benchmark dollar bond yields jumped 20 bps to 6.83%. Brazil’s Bovespa equities index surged 8.8% (up 13.9% y-t-d). The Mexican Bolsa rallied 4.6% (down 8.7% y-t-d). Mexico’s 10-year $ yields rose 37 bps to 6.68%. Russia’s RTS equities index declined 2.6% (down 17.6%). India’s Sensex equities index fell 1.3% (down 3.6%). China’s Shanghai Exchange surged 9.6% (up 19.8%).
Freddie Mac 30-year fixed mortgage rates jumped 15 bps to 5.25% (down 42bps y-o-y). Fifteen-year fixed rates rose 12 bps to 4.92% (down 23bps y-o-y). One-year ARMs dipped two bps to 4.92% (down 13bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 8 bps this week to 6.95% (up 37bps y-o-y).
Federal Reserve Credit dropped $149bn to $1.841 TN. Fed Credit expanded $979bn over the past 52 weeks (114%). Liquidity swaps with foreign central bank counterparts fell $78bn this past week to $387bn. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt last week (ended 2/4) increased $6.4bn to a record $2.555 TN. "Custody holdings" were up $437bn over the past year, or 20.6%.
Bank Credit dropped $54.8bn to $9.749 TN (week of 1/28). Bank Credit expanded $459bn year-over-year, or 4.9%. Bank Credit jumped $356bn over the past 21 weeks. For the week, Securities Credit sank $42bn. Loans & Leases declined $12.8bn to $7.057 TN (52-wk gain of $179bn, or 2.6%). C&I loans dipped $2.7bn, with 52-wk growth of 7.9%. Real Estate loans gained $6.3bn (up 4.7% y-o-y). Consumer loans added $2.4bn, while Securities loans fell $13.2bn. Other loans declined $5.5bn.
M2 (narrow) "money" supply rose $19.8bn to a record $8.277 TN (week of 1/26). Narrow "money" has now inflated at a 20.3% rate over the past 19 weeks and has jumped $771bn over the past year, or 10.3%. For the week, Currency jumped $5.9bn, while Demand & Checkable Deposits declined $7.4bn. Savings Deposits jumped $33.8bn, while Small Denominated Deposits declined $3.6bn. Retail Money Funds dropped $8.9bn.
Total Money Market Fund assets (from Invest Co Inst) increased $2.4bn to $3.906 TN, with a 52-wk expansion of $545bn, or 16.2% annualized.
Total Commercial Paper outstanding slipped $4.3bn this week to $1.585 TN. CP has declined $263bn over the past year (14.2%). Asset-backed CP dropped $7.8bn to $734bn, with a 52-wk decline of $89bn (10.8%).
The Asset-Backed Securities (ABS) market remains quiet. Year-to-date total US ABS issuance of $1.8bn (tallied by JPMorgan's Christopher Flanagan) is a fraction of 2008's comparable $24.6bn. There has been no home equity ABS issuance in months. Year-to-date CDO issuance is less than $300 million.
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $405bn y-o-y, or 6.4%, to $6.735 TN. International reserves have declined $212bn over the past 16 weeks.
Global Credit Market Dislocation Watch:
February 4 – Associated Press (Andrew Taylor): “The cost of President Barack Obama’s economic recovery plan now exceeds $900 billion after the Senate added money for medical research and tax breaks for car purchases. It could go higher Wednesday if a tax break for homebuyers is made more generous, even as centrists in both parties promise to clear away spending items that won’t jump-start the economy immediately… In a victory for auto manufacturers and dealers, Sen. Barbara Mikulski, D-Md., won a 71-26 vote to allow most car buyers to claim an income tax deduction for sales taxes paid on new autos and interest payments on car loans. The break would cost $11 billion over the coming decade… ‘Just as we need to get the housing market going, we need to get auto sales going,’ said Sen. Debbie Stabenow, D-Mich.”
February 6 – Bloomberg (Rebecca Christie and Alison Vekshin): “U.S. Treasury Secretary Timothy Geithner’s strategy to aid the nation’s banks will likely emphasize guarantees of toxic assets over proposals to create a so-called aggregator bank that would remove them from balance sheets, according to people familiar… The government guarantees, which might be modeled on those already given to Citigroup Inc. and Bank of America Corp., may be coupled with the purchase of preferred shares in the banks that would be later convertible into common stock, some of the people said. The aggregator bank or ‘bad bank,’ has lost favor, in part because the potential costs involved, they added.”
February 4 – Bloomberg (Jeremy R. Cooke): “Top-rated U.S. state and local governments’ borrowing costs are falling… Yields on tax-exempt general obligation bonds due in 10 years have dropped almost one percentage point in eight weeks to 3.36%, according to Municipal Market Advisors.”
February 2 – Bloomberg (Bryan Keogh): “The percentage of high-yield corporate bonds trading at distressed levels fell to the lowest since September… according to Merrill Lynch… The percentage of so-called junk bond issues with yields at least 1,000 basis points more than Treasuries of similar maturity dropped to 69% from 82% at the end of December and a record 84% in November… The ratio was about 40% at the end of September.”
February 2 – Bloomberg (Jody Shenn): “The first increase in four months in foreign central banks’ holdings of so-called U.S. agency debt and mortgage bonds was ‘extremely noteworthy,’ showing those investors can be wooed back to the market, according to a Morgan Stanley analyst. Foreign central banks’ investments in the debt, including Fannie Mae and Freddie Mac securities, climbed $5 billion to $811.3 billion…”
February 2 – Bloomberg (Sarah Mulholland): “Yields on bonds backed by credit card payments and automobile loans fell in January from record highs relative to benchmark interest rates… The gap, or spread, on top-rated credit card-backed debt maturing in three years fell 260 bps to 290 bps more than the one-month… Libor, in January, according to JPMorgan Chase… The spread on similar bonds backed by auto loans fell 175 bps to 425 bps more than Libor…”
February 3 – Bloomberg (Caroline Salas and Neil Unmack): “Bond investors’ bets on bank nationalizations are hindering already reduced lending by the world’s biggest financial institutions. The market for securities with characteristics of both debt and equity that Citigroup Inc., Bank of America Corp. and other financial companies used to bolster their capital is in freefall… The hybrids… fell 11% last month in the U.S., more than they did in all of 2008, according to Merrill Lynch…”
February 2 – Bloomberg (John Glover): “Investors in subordinated bonds sold by European banks had their worst month on record in January. So-called Tier 1 bonds posted a decline of more than 22% during the month…”
February 3 – Bloomberg (Adriana Brasileiro): “Brazil’s local bond yields fell to the lowest since October 2007 and the real weakened after industrial output plunged the most in 17 years in December, prompting traders to step up bets on interest-rate cuts.”
February 3 – Financial Times (Paul J Davies): “UK banks and building societies borrowed £185bn through the Bank of England’s emergency support facility… The special liquidity scheme was designed as a temporary crutch for banks while credit markets were seized up leaving them unable to offload assets they had created before 2008. Initially, demand was expected to reach about £50bn and the scheme was to be open for six months from April last year.”
February 3 – Bloomberg (Niklas Magnusson and Johan Carlstrom): “Sweden’s government will inject as much as 50 billion kronor ($6 billion) in the country’s banks to make it easier for them to lend to companies in a fresh attempt to pull the economy out of its first recession in 15 years.”
February 4 – Bloomberg (Brad Cook and William Mauldin): “Russia had its debt rating cut by Fitch Ratings for the first time in more than a decade as falling oil prices contributed to dwindling foreign currency reserves and record capital flight. The rating was lowered to BBB, the second-lowest investment grade…”
February 2 – Bloomberg (Neil Unmack): “Catastrophe bonds sold by Allstate…face ‘imminent’ default because of losses caused by the failure of Lehman Brothers Holdings Inc., according to S&P. S&P downgraded $250 million of debt sold by Allstate’s Willow Re Ltd. to D, the lowest grade… Allstate sold the bonds in 2007 to protect against losses caused by U.S. hurricanes.”
The dollar index declined 1.1% this week to 85.54. For the week on the upside, the South African rand increased 6.6%, the Australian dollar 5.9%, the New Zealand dollar 4.5%, the Brazilian real 3.5%, the Swedish krona 3.0%, the Norwegian krone 2.0%, the British pound 1.7%, the Danish krone 1.0%, the Singapore dollar 1.0%, and the Euro 1.0%. On the downside, the Japanese yen declined 2.1% and the South Korean won 0.3%.
February 5 – Bloomberg (William Bi and Feiwen Rong): “China, the world’s largest grain grower, said a three-month drought has hurt nearly 46% of the winter wheat crop in its major growing provinces and may slow the planting of other crops in spring. Dry conditions ‘rarely seen in history’ threaten about 139 million mu (23 million acres) of wheat in eight provinces including Henan and Anhui, the Office of State Flood Control and Drought Relief Headquarters said…”
Gold declined 1.7% this week to $912 (up 3.4% y-t-d), while silver rose 3.9% to $13.05 (up 15.5% y-t-d). March Crude dropped $1.65 to $40.0 (down 10% y-t-d). March Gasoline slipped 0.8% (up 17% y-t-d), while March Natural Gas rallied 9.1% (down 14% y-t-d). March Copper surged 10.5% (up 15% y-t-d). March Wheat declined 1.9% (down 8.8% y-t-d), and Corn slipped 0.5% (down 7.3% y-t-d). The CRB index gained 1.8% (down 2.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) increased 0.5% (down 3.2% y-t-d).
February 2 – Bloomberg (Robert Hutton): “Chinese Premier Wen Jiabao said the worldwide economic crisis shows ‘how dangerous a totally unregulated market can be.’ ‘It brings disastrous consequences,’ Wen said… ‘The main causes are for some economies, they have imbalances in their economic structure. For a long period of time they’ve had dual deficits, trade deficits and fiscal deficits.’”
February 4 – Bloomberg (Luo Jun): “Chinese banks may have offered a record 1.2 trillion yuan ($175 billion) of new loans in January, the China Securities Journal reported… The four biggest state-owned banks completed 20% of their full-year target, with majority of the loans lent for railways, highways, electricity grids and the infrastructure, report said.”
February 3 – Bloomberg (Wang Ying): “China’s oil refineries posted a loss of 149.3 billion yuan ($22 billion) in the first 11 months of last year because of higher raw material costs… China faced an energy shortage in the first half though supplies became ample in the second half as the economy slowed, the Ministry of Industry and Information Technology said…”
February 1 – Bloomberg (Dune Lawrence): “China’s retail sales during the week- long Lunar New Year holiday climbed to 290 billion yuan ($42.4 billion), 14% higher than last year’s holiday period, the Ministry of Commerce reported yesterday.”
February 3 – Bloomberg (Chia-Peck Wong): “Hong Kong’s home sales fell for a seventh month in January… The number of residential units changing hands last month slumped 67% from January 2008…”
February 3 – Bloomberg (Toru Fujioka and Keiko Ujikane): “The Bank of Japan will buy 1 trillion yen ($11.1 billion) of shares owned by financial institutions to shore up their capital, which has been ravaged by the global stock-market rout.”
February 2 – Bloomberg (Makiko Kitamura): “Toyota Motor Corp. and Honda Motor Co., Japan’s two largest carmakers, led the biggest drop in the country’s auto sales in 35 years last month as a recession cut wages and jobs and crippled consumer demand. Sales of cars, trucks and buses fell 28 percent to 174,281 vehicles in January…”
February 5 – Bloomberg (Cherian Thomas): “India’s budget deficit may triple this year from the planned target as the government steps up spending to arrest an economic slowdown, said Suresh Tendulkar, the top economic adviser to Prime Minister Manmohan Singh. The deficit may widen to 7.5% of gross domestic product in the year ending March 31 from a target of 2.5% of GDP…”
Asia Bubble Watch:
February 2 – Bloomberg (William Sim): “South Korea’s exports tumbled by a record 32.8 percent in January, foreshadowing a deepening slump in Asia’s export-driven economies.”
Latin America Watch:
February 3 – Bloomberg (Andre Soliani and Jeb Blount): “Brazil’s industrial output fell the most in 17 years… Total goods produced by factories declined 14.5% in December from the month a year earlier…”
February 2 – Bloomberg (Iuri Dantas): “Brazil had its first monthly trade deficit in almost eight years in January as exports plunged by a record amount on falling prices for the country’s commodities. The $518 million deficit in January compares with a $2.3 billion surplus in December, the Trade Ministry said today. It was the first monthly deficit since March 2001 and the largest gap since November 2000, the ministry said.”
January 30 – Bloomberg (Diana Kinch and Andre Soliani): “Brazilian President Luiz Inacio Lula da Silva raised the minimum wage by 12% starting next month, a move the government said will increase incomes of more than 20% of the population.”
Central Banker Watch:
February 5 – Bloomberg (Brian Swint): “The Bank of England cut the benchmark interest rate to the lowest since the bank was founded in 1694 to help drag the British economy out of the deepening recession. The nine-member Monetary Policy Committee, led by Governor Mervyn King, reduced the bank rate to 1% from 1.5%.”
February 3 – Bloomberg (Brian Swint): “The Bank of England said it accepted collateral with a nominal value of 287 billion pounds ($409 billion) in its emergency lending program for banks.”
February 3 – Bloomberg (Jacob Greber): “Australia’s central bank cut its benchmark interest rate to the lowest level in 45 years and the government announced it will spend a further A$42 billion ($27 billion) to ward off a recession. Governor Glenn Stevens lowered the overnight cash rate target to 3.25%...”
February 6 – Dow Jones (Patrick Yoest): “The nonpartisan Congressional Budget Office said Thursday that it estimates that the U.S. has so far recorded a $355 billion deficit for the current fiscal year. The projection applies to the first four months of fiscal year 2009, which began Oct. 1, 2008.”
February 2 – Bloomberg (Rebecca Christie): “The U.S. Treasury said it would borrow 34% more this quarter than initially projected… Borrowing needs in the three months to March 31 will be $493 billion, compared with $368 billion predicted in November…”
February 4 – Bloomberg (Darrell Preston): “U.S. Representative Barney Frank says he plans to seek federal guarantees for municipal debt that may eliminate the need for private bond insurance. Such a guarantee, similar to what the Federal Deposit Insurance Corp. provides banks, may insure repayment of state and local government general obligation bonds backed by the jurisdictions’ full taxing power, Frank, chairman of the House Financial Services Committee, said…”
Unbalanced Global Economy Watch:
February 3 – Bloomberg (Keith Naughton): “Canadian auto sales, after hitting their second highest annual level in 2008, fell 25% in January as the weakening Canadian dollar pushed up prices.”
February 5 – Bloomberg (Thomas Penny and Robert Hutton): “Spreading strikes, reduced workweeks and tens of thousands of job cuts are throwing British Prime Minister Gordon Brown back to the 1970s. With 16 months before he has to call an election, Brown is facing the toughest test of a Labour premier since James Callaghan’s so-called Winter of Discontent in 1979, after which the party was cast out of office for almost two decades.”
February 2 – Bloomberg (Alan Purkiss): “U.K. home prices might decline by more than 40% unless the government succeeds in bringing about an increase in lending, according to… the Centre for Economics and Business Research, the Independent said. Prices this year could drop by 25%, after falling 16% in 2008…”
February 4 – Bloomberg (Colm Heatley): “Irish unemployment rose to a record in January as the country slipped further into a recession and builders, banks and manufacturers cut jobs. Benefit applications, adjusted for seasonal swings, increased to 326,100, the highest since records began in 1967…”
February 6 – Bloomberg (Jana Randow): “Industrial production in Germany, Europe’s largest economy, dropped the most in at least 18 years in December as demand for plant and machinery faltered. Output fell a seasonally adjusted 4.6% from November…”
February 5 – Bloomberg (Emma Ross-Thomas): “Spanish industrial production fell by a record 20% and bankruptcy proceedings almost quadrupled as the credit squeeze pushed the country’s debt-laden economy toward its worst recession in half a century.”
February 3 – Bloomberg (Emma Ross-Thomas): “Registered unemployment in Spain, which has the highest jobless rate in the European Union, rose the most in at least 13 years in January… The number of people registering as unemployed rose 6.4%...”
February 3 – Bloomberg (Garth Theunissen): “South African vehicle sales fell by the most in 25 years last month as interest rates near the highest since 2003 and slowing economic growth curbed consumer spending. Sales dropped 35%...”
Bursting Bubble Economy Watch:
February 3 – Bloomberg (Dan Levy): “The U.S. housing market lost $3.3 trillion in value last year and almost one in six owners with mortgages owed more than their homes were worth as the economy went into recession, Zillow.com said… ‘It’s like a runaway train gaining momentum,’ Stan Humphries, Zillow’s vice president of data and analytics, said… ‘It’s difficult to say when we’ll see a bottom to the housing market.’”
February 6 – Dow Jones (Shobhana Chandra): “The unemployment rate reached the highest level since 1992 and payrolls tumbled in January, with millions more likely to lose their jobs before a stimulus and emergency-lending programs temper the U.S. economy’s freefall. The jobless rate rose to 7.6% from 7.2% in December… Payrolls fell by 598,000, the biggest monthly decline since December 1974. Losses spanned almost all industries…”
February 2 – Bloomberg (Craig Torres): “A majority of U.S. banks made it tougher for consumers and businesses to get credit in the past three months even as lenders received infusions of taxpayer funds… ‘About 65% of domestic banks reported having tightened lending standards on commercial and industrial loans to large and middle-market firms,” the Fed said in its quarterly Senior Loan Officer survey. ‘Large fractions of domestic banks continued to report a tightening of policies on both credit-card and other consumer loans.’”
February 4 – Dow Jones: “U.S. auto sales plunged in January to their lowest level in nearly 27 years… Total sales of light vehicles in the U.S. fell 37% last month from January 2008, putting the annual sales rate at 9.57 million units, the lowest level since June 1982… The declines were particularly steep for General Motors Corp. and Chrysler LLC, which… announced that their sales fell 49% and 55%... in January.”
February 3 – Bloomberg (Josh Fineman): “Citigroup Inc. plans to use $36.5 billion to lend to consumers and companies and to fund U.S. mortgage loans after receiving $45 billion as part of the government’s bailout… The… bank will use $25.7 billion for mortgages, $2.5 billion for consumer loans, $1 billion for student loans, $5.8 billion for credit card lending and $1.5 billion for corporate loans… ‘The government, on behalf of the American taxpayer, has invested in Citigroup,’ Chief Executive Officer Vikram Pandit said… ‘We have an obligation to repay in ways that go well beyond the $3.41 billion Citigroup will pay the government each year in dividends associated with its TARP investment, and a separate loss-sharing agreement.’”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
February 5 – Bloomberg (Jeff Kearns and Edgar Ortega): “The U.S. options market is shrinking for the first time in at least seven years as investors curb the use of borrowed money, making it more expensive to insure stocks against losses. The number of outstanding calls and puts sank as much as 46% in January to 153 million… Record volatility reduced the reliability of mathematical models for pricing options and helped spur declines that shut down about 9% of all hedge funds last year… ‘The big firms don’t have the money or they’re not willing to commit the capital,’ said Al Greenberg, the head of trading… for BNY Convergex Group LLC. “Brokers that do a lot of institutional business are not nearly as busy, and the orders they’re getting don’t seem as large as they were a year ago.’”
February 3 – Bloomberg (Hui-yong Yu): “Securitized loans on U.S. offices, apartments and commercial properties are at greater risk of default after rents fell in 43% of buildings of all types in the fourth quarter, up from an average 25% in the first nine months of 2008, research firm Reis Inc. said. ‘This alarming trend is magnified’ in cities such as New York that depend on the financial-services industry, said Victor Calanog, director of research at Reis. Rents fell in 75% of apartment buildings in New York last quarter… “We haven’t seen this speed of decline before. Reis expects default rates to worsen considerably over the next two years.’”
Real Estate Bust Watch:
February 3 – Bloomberg (Kathleen M. Howley): “A record 19 million U.S. houses stood empty at the end of 2008 as banks seized homes faster than they could sell them and prices continued to fall. Vacant homes in the fourth quarter increased by 6.7% from the same period a year ago… The vacancy rate… rose to 2.9% in the quarter, the most in data that goes back to 1956.”
February 4 – Bloomberg (Andrew Frye and Jamie McGee): “MetLife Inc., the largest U.S. life insurer, said investors in private-equity funds face writedowns in the first half of this year, with the ‘harshest’ losses coming from the biggest buyout firms. Markdowns on holdings in large buyout firms may range from 10% to 20%, said MetLife Chief Investment Officer Steve Kandarian… Funds that purchased businesses with the intent of reselling them or holding public share sales are facing a ‘lack of exit opportunities right now,’ Kandarian said.”
February 2 – Bloomberg (Saijel Kishan): “Citadel Investment Group LLC, the Chicago-based hedge-fund firm whose largest funds lost about 55% last year, in January posted its first gain in seven months, according to an investor.”
February 6 – Wall Street Journal (Valerie Bauerlein): “A growing number of states are running out of cash to pay unemployment benefits, a sign of how far social-welfare systems are being stretched by the swelling ranks of the jobless… Unemployment filings have soared so high in recent months that seven states have already emptied their unemployment-insurance trust funds… Another 11 states are in jeopardy of depleting reserves by year’s end, according to the National Conference of State Legislatures… So far, states have borrowed more than $2.3 billion in emergency funds from the federal government, money they are required to pay back."
February 3 – Bloomberg (Michael McDonald): “Philip Duff, Morgan Stanley’s former chief financial officer, last month fired 80 of the 100 people at his 11-month-old hedge fund, and now he’s looking to sublet excess office space in Greenwich, Connecticut. Record losses and terminations at hedge funds like Duff Capital Advisors have reduced Connecticut’s tax revenue… Facing an anticipated $12 million drop in state aid, Superintendent John Ramos says he may close some of his 35 schools.”
February 6 – Bloomberg (William Selway and Michael B. Marois): “California government offices were closed throughout the most-populous U.S. state today as about 200,000 workers were forced to take unpaid days off because the worsening recession is threatening to drain the state of money.”
New York Watch:
February 5 – Bloomberg (Martin Z. Braun): “New York City’s economic decline is likely in its early stages and the unemployment rate may reach 10.5%, a level not seen since the mid-1970s administration of Mayor Abraham Beame, a UBS AG report said.”
February 3 – Bloomberg (Michael Quint): “New York state may run out of money if lawmakers and Governor David Paterson don’t agree on a plan to close a $1.6 billion deficit… budget director Laura Anglin said. ‘We would not have enough cash to meet all our spending needs,” Anglin said…”
Crude Liquidity Watch:
February 3 – Bloomberg (Ayesha Daya): “Dubai rents for apartments and villas dropped by as much as a third in the last eight weeks as homeowners flooded the market with properties amid falling demand, Arabian Business reported…”
February 2 – Bloomberg (Zainab Fattah): “United Arab Emirates property prices have fallen “off a cliff” as banks reduced lending and speculators exited the market because of the global economic crisis, Morgan Stanley said.”
The Government Finance Bubble:
What are we really dealing with here? First of all, the system is suffering through the breakdown in contemporary “Wall Street finance.” As wrenching and destabilizing as it continues to be, this process should be differentiated from outright financial collapse. Confidence in Wall Street “money” (their previously perceived safe and liquid securities/instruments) has been shattered. Myriad sophisticated Credit instruments have been discredited and thus will no longer provide a viable mechanism for system Credit expansion. Importantly, however, confidence has been sustained for system “money” more generally.
As I’ve noted in previous writings, analysts made a momentous blunder earlier this decade when they mistook the collapse of the technology Bubble (and attendant recession and corporate debt problems) for the onset of “deflation.” Reflationary policymaking without regard to the nature of inflationary consequences proved disastrous. We’re about to repeat this error.
Ignoring the Acute Inflationary Bias unfolding in mortgage finance was the greatest mistake in both analysis and policymaking from the ill-fated 2001-2004 period. It should have been clear at the time that rates were way too low and mortgage finance way too loose. This was especially the case when compared to the rapid pace of home price inflation. Most regrettably, the strong inflationary biases that had taken hold in the mortgage and housing marketplaces (“Bubbles”) were too easily exploited as a monetary policy expedient for systemic reflation. Excess in some local housing markets was viewed as a small price to pay for thwarting systemic deflationary pressures.
Despite today’s histrionic fixation on “deflation,” current dynamics have some similarities to the post-tech Bubble period. Granted, the collapse of Wall Street finance is of much greater scope and consequence than the bursting of the tech Bubble. Yet I would counter that The Burgeoning Bubble in Government Finance is poised to make the Mortgage Finance Bubble appear tiny in comparison.
There has been no run on bank deposit “money;” not with the FDIC, Treasury, and Federal Reserve there to backstop confidence. The marketplace’s love affair with agency debt runs unabated – compliments of federal government receivership and guarantees. Money market fund assets are right at record levels, confidence bolstered by Fed and Treasury assurances. And despite the prospect of a $1 TN borrowing requirement this year, the Treasury can still tap liquid markets for short-term funds at about 20 bps. The Fed’s balance sheet has ballooned, although nothing to compare to the unfolding explosion of Trillions of Treasury borrowings, obligations and guarantees (both implied and explicit).
The Government Finance Bubble is enormous and powerful - and should be anything but underestimated. Akin to the previous Bubble in Wall Street finance, the epicenter of this Bubble is here in the U.S. But I would argue that this unfolding Bubble dynamic has greater potential to engulf the entire world than even U.S.-style mortgages and derivatives did starting back around 2002. Welcome to the new world of synchronized stimulus, deficits, and reflationary policymaking. I don’t believe true systemic deflation (as opposed to collapsing asset Bubbles) is a high probability scenarios as long as the Government Finance Bubble is rapidly inflating. All bets are off, however, if confidence in government debt falters. The worst case scenario – that should be avoided at all costs – is a massive inflation of government claims that sets the stage for a devastating bust.
It is imperative for policymakers to ensure that the Government Finance Bubble does not follow in the footsteps of the runaway excess associated with Wall Street/mortgage finance. Yet it’s clear that policymaking (monetary and fiscal) is setting a course to guarantee just such an outcome. And, as has been the case for some time now, markets are keen to fall in love with – and aggressively accommodate – whatever might be the Bubble of the Day.
The Wall Street/Mortgage Finance Bubble ran to such incredible extremes that its subsequent implosion has created the near ideal backdrop for the explosion of Government Finance (as the tech implosion did for mortgage finance). Some notable pundits espouse throwing “Trillions” at the problem in hopes of finding a solution. They fail to be appreciated that Trillions today will only create the need for ongoing Trillions. But this is the nature of vulnerable inflationary booms. The solution is always incorrectly gauged as a shortage of money, Credit and spending.
There is hope that massive government reflation will reinvigorate the asset markets and resuscitate Wall Street finance. I view this as highly unlikely - and these lofty goals incredibly dangerous. It is more likely that the historic Bubble in private-sector Credit creation – with its focus on myriad sophisticated instruments, structures and leveraging – will recover little of its former power and glory. In past episodes of financial turmoil, our policymakers would simply entice private sector financial operators (notably the Wall Street firms, hedge funds and bond fund managers) with alluring borrowing costs, spreads and speculative profits. Strong inflationary biases permeated Wall Street finance, the leveraged speculating community, and U.S. asset prices more generally. Accordingly, almost on demand, private-sector Credit creation would quickly evolve into the main source for fueling system (i.e. asset) reflation. Moreover, asset price inflation was the focal point for perceived wealth creation and economic stimulus.
Today's Post-Credit Bubble Backdrop and The Nature of the Government Finance Bubble ensure quite atypical dynamics (and analytical surprises). For one, the flow of finance to the asset markets will be insufficient to reinvigorate asset inflation (post-Bubble realities of burst confidence, altered market psychology, impaired Credit mechanisms and economic angst/dislocation). This is critical analysis. It was the strong inflationary biases throughout the asset markets that fostered the self-reinforcing Bubble in private-sector Credit. And private-sector Credit was behind past inflationary financial and economic Bubbles - that have left the system today so fragile (and pundits clamoring for more inflation!). Structural realities dictate that Government Finance cannot simply enter the fray and miraculously make things right. A moderate amount of stimulus would be expected to assist the post-Bubble economic adjustment, while inordinate government Credit inflation and market intervention will only work to compound systemic fragility.
The public sector is now essentially on its own when it comes to stoking this bout of reflation. Moreover, it is being called upon after a couple of decades where private-sector Credit grossly inflated home prices, securities values, various other asset prices, household incomes, consumer borrowing and spending, corporate profits, and government receipts and expenditures. The Government Finance Bubble is being called upon to reflate with little assistance from private Credit, while at the same time it is faced with a Deeply Maladjusted Economic Structure still overly dependent upon inflationary Credit expansion. Throwing mega-Trillions at our distorted economy is just asking for trouble.
It is in this context that I fear that the Trillions of Government Finance spent to save the world from “deflation” will, in the end, require perpetual needs for Trillions more. There will be no kick-starting asset Bubbles or a return of private-sector Credit excess. Instead, it will be a case of throwing repeated doses of government-directed finance/purchasing power at the system. Temporary but fleeting economic boosts will then require only stronger doses of artificial stimulus.
We’ve commenced a new cycle dominated by government electronic printing presses in all their various forms. The inflationary consequences will be a different variety than we’ve grown accustomed to from previous reflations. But the bottom line is – and there’s ample history to support this view – that once the “printing presses” get humming along it’s going to be darn difficult to slow them down.