One-month Treasury bill rates ended the week at 14 bps, and three-month bills closed at 18 bps. Two-year government yields added one basis point to 0.96%. Five-year T-note yields added 3 bps to 2.51%. Ten-year yields added one basis point to 3.66%. Long bond yields were one basis point higher at 4.54%. Benchmark Fannie MBS yields were 3 bps lower at 4.60%. The spread between 10-year Treasuries and benchmark MBS narrowed 4 to 94. Agency 10-yr debt spreads were little changed at 11 bps. The implied yield on December eurodollar futures declined 2.5 bps to 0.745%. The 2-year dollar swap spread declined 3.5 to 44 bps; the 10-year dollar swap spread declined 1.5 to 22.5 bps; and the 30-year swap spread declined 2.25 to negative 21 bps. Corporate bond spreads were tighter. An index of investment grade bond spreads narrowed a notable 15 bps to 171 (2009 low), and an index of junk spreads narrowed 12 to 855 bps.
Investment grade issuers included Citigroup $2.5bn, Bank of America $2.5bn, Wal-Mart $2.0bn, BB&T $1.0bn, Bemis $800 million, Plains All American Pipeline $500 million, TJX $400 million, and Heinz $250 million.
Junk bond fund inflows rose to $567 million (from AMG). The list of junk issuers included SBA Telecommunications $750 million, CapitalSource $300 million, Greif Inc. $250 million, MTR Gaming $250 million, Reliance Intermediate $250 million, and Prospect Medical $160 million.
Intel issued a $1.75bn convert issue this week.
International dollar debt issuers included Poland $3.5bn, Dolphin Energy $1.25bn, GAZ Capital $1.25bn, Westpac $1.0bn, Korea National Oil $1.0bn, Cent Elet Brasileiras $1.0bn, Celulosa Arauco $500 million, and Empresas Public Medellin $500 million.
July 24 – Bloomberg (Allen Wan and Catarina Saraiva): “The world’s two biggest initial public offerings this year are from China and Brazil, reflecting the ‘growing power’ of the so-called BRIC nations, said Barton Biggs… China State Construction Engineering Corp…. yesterday raised 16 billion yuan ($7.3 billion)… The Brazilian affiliate of Visa Inc., known as VisaNet, took in 8.4 billion reais ($4.3 billion) in its Sao Paulo offering in June. ‘No question, it shows the growing power of the BRICs,’ Barton Biggs…said… ‘Clearly the BRICs are the big growth areas of the world and will need a lot of foreign capital.’”
U.K. 10-year gilt yields jumped 15 bps to 3.96%, and German bund yields rose 8 bps to 3.48%. The German DAX equities index jumped 5.0% (up 8.7%). Japanese 10-year "JGB" yields rose 6 bps to 1.37%. The Nikkei 225 surged 6.4% (up 12.2%). Emerging markets were, again, strong. Brazil’s benchmark dollar bond yields dipped 2 bps to 5.80%. Brazil’s Bovespa equities index jumped 4.6% (up 45.0% y-t-d). The Mexican Bolsa rose 3.5% (up 19.1% y-t-d). Mexico’s 10-year $ yields sank 13 bps to 5.66%. Russia’s RTS equities index jumped 9.5% (up 60.3%). India’s Sensex equities index rallied 4.3% (up 59.4%). China’s Shanghai Exchange gained 5.7%, increasing 2009 gains to 85.2%.
Freddie Mac 30-year fixed mortgage rates jumped 7 bps to 5.20% (down 143bps y-o-y). Fifteen-year fixed rates gained 5 bps to 4.68% (down 150bps y-o-y). One-year ARMs added one basis point to 4.77% (down 72bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 6 bps to 6.38% (down 90bps y-o-y).
Federal Reserve Credit dipped $1.1bn last week to $2.011 TN. Fed Credit has declined $236bn y-t-d, although it expanded $1.128 TN over the past 52 weeks (128%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 7/22) rose $4.8bn to a record $2.787 TN. "Custody holdings" have been expanding at a 19.3% rate y-t-d, and were up $433bn over the past year, or 18.4%.
M2 (narrow) "money" supply fell $15.0bn to $8.334 TN (week of 7/13). Narrow "money" has expanded at a 3.1% rate y-t-d and 8.5% over the past year. For the week, Currency dipped $0.2bn, while Demand & Checkable Deposits gained $3.9bn. Savings Deposits declined $6.1bn, and Small Denominated Deposits fell $4.9bn. Retail Money Funds dropped $7.9bn.
Total Money Market Fund assets (from Invest Co Inst) increased $8.9bn to $3.656 TN. Money fund assets have declined $174bn y-t-d, or 8.2% annualized. Money funds expanded $149bn, or 4.2%, over the past year.
Total Commercial Paper outstanding declined $3.4bn to $1.093 TN. CP has declined $588bn y-t-d (63% annualized) and $651bn over the past year (37%). Asset-backed CP decreased $4.5bn to $437bn, with a 52-wk drop of $313bn (42%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $30bn y-o-y to a record $7.017 TN. Reserves have now increased $253bn year-to-date.
Global Credit Market Watch:
July 24 – Bloomberg (Bryan Keogh, Morwenna Coniam and Abigail Moses): “Corporate credit in the U.S. and Europe rallied this week to levels last seen more than a year ago…”
July 22 – Bloomberg (Robert Schmidt): “Most investors are shaking off the world economic crisis and many are willing to take on more risk as they hunt for opportunities, especially in China and India, according to a survey by Bloomberg…”
Government Finance Bubble Watch:
July 20 – Bloomberg (Dawn Kopecki and Catherine Dodge): “U.S. taxpayers may be on the hook for as much as $23.7 trillion to bolster the economy and bail out financial companies, said Neil Barofsky, special inspector general for the Treasury’s Troubled Asset Relief Program. The Treasury’s $700 billion bank-investment program represents a fraction of all federal support to resuscitate the U.S. financial system, including $6.8 trillion in aid offered by the Federal Reserve, Barofsky said in a report… Costs include $2.3 trillion in programs offered by the Federal Deposit Insurance Corp., $7.4 trillion in TARP and other aid from the Treasury and $7.2 trillion in federal money for Fannie Mae, Freddie Mac, credit unions, Veterans Affairs and other federal programs, he said.”
July 24 – Bloomberg (Dawn Kopecki): “Fannie Mae and Freddie Mac grew to the point where they posed ‘enormous risk’ to the financial system, an error that will shape how policy makers restructure the companies, Treasury Secretary Timothy Geithner said. ‘It would have been good had we figured out a way to avoid that out earlier,’ Geithner told the House Financial Services Committee… ‘That mistake should underpin much of what we do in thinking about how to create a more stable system.’ …The Obama administration has yet to figure out what to do with Fannie Mae and Freddie Mac, which regulators seized in September… Geithner reiterated that a restructuring is being put off until next year because of the companies’ size and as officials tackle other economic issues. ‘We cannot credibly think of that right now, because they are the entire mortgage market in the country… But that time will come and it will come relatively quickly.’”
July 21 – Bloomberg (Gonzalo Vina): “Britain had a 13 billion-pound ($21.4 billion) budget deficit in June, the most for the month since records began in 1993…”
July 23 – Bloomberg (Paul Abelsky): “Russia will transfer 1.36 trillion rubles ($43.7 billion) from the Reserve Fund, one of its two sovereign wealth funds, in the third quarter as the government tries to plug its first budget shortfall in a decade.”
July 21 – Financial Times (David Oakley, Ralph Atkins and Gillian Tett): “Central banks have pumped a vast amount of money into the financial system this year – but so far there is little evidence that this liquidity has found its way into the broader economy. What is happening could be likened to the pattern that develops when a household drain is partly blocked as the central banks frantically pour money into the financial system, with the commercial banks supposedly acting as a pipe, in an effort to stabilise the economies. But many commercial banks are reluctant to pass this liquidity on to their customers, in the form of loans, because they are scrambling to repair their own balance sheets and are afraid to lend because of fears of potential losses. The banking pipe is, thus, partly blocked.”
July 20 – Bloomberg (Agnes Lovasz): “Iceland will spend 270 billion kronur ($2.1 billion) to rebuild its banking system following the failure of the industry last year. The government will issue bonds to the three new banks that emerged from the collapse of its biggest lenders in October, the Finance Ministry said…”
Currency Watch:
July 21 – Financial Times (Jamil Anderlini): “Beijing will use its foreign exchange reserves, the largest in the world, to support and accelerate overseas expansion and acquisitions by Chinese companies, Wen Jiabao, the country’s premier, said… ‘We should hasten the implementation of our ‘going out’ strategy and combine the utilisation of foreign exchange reserves with the ‘going out’ of our enterprises,” he told Chinese diplomats… The ‘going out’ strategy is a slogan for encouraging investment and acquisitions abroad, particularly by big state-owned industrial groups… Qu Hongbin, chief China economist at HSBC, said: “This is the first time we have heard an official articulation of this policy ... to directly support corporations to buy offshore assets… This is reserve diversification in a broader sense. Instead of accumulating foreign exchange reserves and short-term financial assets, the government wants the nation to accumulate more long-term corporate real assets.’ …In an interview published in state-controlled media, the chairman of China Development Bank said Chinese outbound investment would accelerate but should focus on resource-rich developing economies. ‘Everyone is saying we should go to the western markets to scoop up [underpriced assets]… I think we should not go to America’s Wall Street, but should look more to places with natural and energy resources.’”
The dollar index declined 0.7% this week to 78.77. For the week on the upside, the Swedish krona increased 4.6%, the South African rand 4.0%, the Canadian dollar 2.7%, the Norwegian krone 2.5%, the Australian dollar 1.8%, the New Zealand dollar 1.7%, the Brazilian real 1.6%, and the Euro 0.8%. On the downside, the Japanese yen declined 0.6%.
Commodities Watch:
July 22 – Bloomberg: “China, the world’s largest coal user, increased imports of the fuel to a record last month after demand recovered and global prices fell. Overseas coal purchases jumped to 16 million metric tons in June, a sixfold increase from a year earlier…”
July 24 – Bloomberg (Sophie Leung): “China may overtake India to become the world’s top gold consumer this year, the World Gold Council said, as the nation became the first of the major economies to rebound from the global recession.”
July 22 – Bloomberg: “China, the world’s largest steel producing nation, should curtail ‘reckless investments’ in the industry by withholding project approvals. China’s demand for steel is about 500 million metric tons, less than the annual output capacity of 660 million tons, Zhu Hongren, spokesman for the Ministry of Industry & Information Technology, said…”
Gold ended the week up 1.5% to $952 (up 7.9% y-t-d). Silver rallied 3.5% to $13.875 (up 22.8% y-t-d). August Crude surged $3.46 to $68.04 (up 53% y-t-d). August Gasoline jumped 8.3% (up 80.4% y-t-d), while August Natural Gas was little changed (down 35% y-t-d). September Copper gained 4.4% (up 79% y-t-d). September Wheat sank 4.7% (down 15% y-t-d), and August Corn declined 1.9% (down 22% y-t-d). The CRB index jumped 2.8% (up 9.7% y-t-d). The Goldman Sachs Commodities Index (GSCI) surged 4.1% (up 28.4% y-t-d).
China Reflation Watch:
July 22 – China Knowledge: “The financial institutions in China extended a total of RMB 466.18 billion in home mortgage loans in the first half of this year, up 150% from the same period of last year… In the first half, the home mortgage loans issued by state-owned banks accounted for 71.79% of the country’s total…”
July 20 – Bloomberg: “New home prices in 36 medium- and large-sized Chinese cities rose 6.3% in June from a year earlier as bank lending tripled in the first half. The average price of new homes rose to 6,554 yuan ($959) per square meter…”
July 22 – Bloomberg: “Chinese investors are rushing to buy into the world’s second best-performing stock market following the end of a ban on initial public offerings and a rebound in economic growth. Individual investors opened 484,799 stock accounts last week… the most since the five days ended Jan. 25, 2008, and almost five times this year’s low in January.”
July 23 – Bloomberg (Bei Hu): “China State Construction Engineering Corp. attracted more than 1.8 trillion yuan ($263.5 billion) of orders for the world’s largest initial public offering since March 2008… The number represents about 36 times the maximum amount the company is seeking…”
Asia Bubble Watch:
July 24 – Financial Times (Christian Oliver and Tim Johnston): “ South Korea posted its strongest growth in five and a half years during the second quarter… South Korea’s economy grew 2.3% in the second quarter compared with the first… echoing positive gross domestic product trends reported by China, Singapore, Vietnam and Kazakhstan.”
Latin America Watch:
July 21 – Bloomberg (Iuri Dantas): “Brazilian antitrust agency chief Arthur Badin said a move by state-owned banks to cut interest rates in a bid to force others to match lower borrowing costs threatens to hurt the banking industry. Public banks fulfill an important role in helping the economy recover,’ Badin said… ‘It’s also important that, under the pretext of increasing competition, you don’t achieve the opposite in the long term, with irrational pricing of interest rates when there exists the possibility for effective competition.’”
July 20 – Bloomberg (Bill Faries): “Argentina will have a budget deficit this year for the first time since 2002, increasing the risk of a default as tax revenue lags behind spending increases, Morgan Stanley economist Daniel Volberg wrote…”
Unbalanced Global Economy Watch:
July 22 – Bloomberg (Alexandre Deslongchamps): “Canadian retail sales rose more than expected in May, posting the fourth gain in five months…”
July 23 – Bloomberg (Jennifer Ryan): “U.K. mortgage approvals rose in June to the highest level since March 2008 as the property slump showed sign of easing and banks became more willing to lend.”
July 23 – Bloomberg (Svenja O’Donnell): “U.K. retail sales jumped four times as much as economists forecast in June… Sales climbed 1.2% from May… From a year earlier, sales rose 2.9%.”
July 21 – Bloomberg (Steve Scherer): “Italian research institute Isae said the nation’s economy will contract 5.3% this year, twice as it previously forecast…”
July 23 – Bloomberg (Kim McLaughlin): “Sweden’s unemployment rate rose for a second month in June… The non-seasonally adjusted jobless rate… was 9.8%...”
Bursting Bubble Economy Watch:
July 23 – Wall Street Journal (Jon Hilsenrath and Deborah Solomon): “The job market is doing even worse than the overall economy, prompting concern inside and outside the government that deeper-than-expected joblessness could persist once the recession ends. Breaking from historical patterns, the unemployment rate -- currently at 9.5% is one to 1.5 percentage points higher than would be expected under one economic rule of thumb, says Lawrence Summers… Since the recession began in December 2007, the economy has lost 6.5 million jobs, 4.7% of total employment. The unemployment rate has jumped five percentage points, while the economy has contracted by roughly 2.5%.”
July 21 – Bloomberg (Caroline Salas and Michael McKee): “For the first time since Harry S. Truman was in the White House, Americans are paying back their debts, a phenomenon that just might help keep interest rates low as the Treasury sells a record $2 trillion of bonds and rising unemployment increases U.S. savings. … household borrowing fell to 128% of the average family’s after-tax income in the first quarter from a record 133% in the same period a year earlier…”
July 22 – Bloomberg (Gillian Wee): “Harvard University and Yale University are preparing for an extended period of austerity as U.S. colleges are forced to cut spending next year and beyond to offset the biggest investment losses since 1974.”
Central Banker Watch:
July 22 – Bloomberg (Mayumi Otsuma): “Bank of Japan Deputy Governor Hirohide Yamaguchi said the central bank will end its unprecedented credit programs in a way that is least disruptive to investors. ‘The bank will, without any predetermined view, carefully assess developments in corporate financing and financial markets,’ Yamaguchi said… ‘It is important to plan an exit in a way that market participants can anticipate and not bring about unnecessary market disturbances.’”
Real Estate Bust Watch:
July 22 – Bloomberg (Kathleen M. Howley): “Home prices fell 5.6% in May from a year earlier as job losses and record foreclosures deterred buyers during the spring selling season when the bulk of U.S. real estate sales typically occur. The average price rose 0.9% from April, the Federal Housing Finance Agency…said...”
July 22 – Los Angeles Times (W.J. Hennigan): “The slump in the hospitality business… has led to dramatic increases in the number of hotels that can’t pay their bills. About 250 hotels are in default or foreclosure in California, according to…Atlas Hospitality Group… With the trend expected to continue throughout 2009, as many as 500 properties could be in default by year’s end, Atlas President Alan X. Reay said.”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
July 21 – Bloomberg (Sarah Mulholland): “Standard & Poor’s raised the ratings on commercial mortgage-backed debt from three bonds sold in 2007, restoring the top-ranked status of the securities. The debt had been cut as recently as last week, rendering the securities ineligible for the Federal Reserve’s Term Asset- Backed Securities Loan Facility to jumpstart lending.”
GSE Watch:
July 22 – Bloomberg (Jody Shenn): “Mortgage bonds guaranteed by U.S. agency Ginnie Mae will probably swell to $1 trillion by the end of 2010 because borrowers with low down payments or credit scores can only qualify for government-insured loans, Bank of America Corp. analysts said. The Federal Housing Administration, which insures loans with down payments as low as 3.5% and has no credit-score requirements, is ‘the only source of funding for these leveraged borrowers,’ Ankur Mehta and Ohmsatya Ravi…wrote… Debt explicitly backed by the U.S. through Ginnie Mae, formally known as the Government National Mortgage Association, climbed to $680 billion as of June 30 from $360 billion two years earlier… Lenders package those mortgages into bonds backed by Ginnie Mae.”
New York Watch:
July 20 – Bloomberg (Michael Quint): “New York state tax collections were $486.9 million less than projected for the three months ended June 30… The shortage was mostly in collections of personal income taxes…”
Muni Watch:
July 21 – Financial Times (Nicole Bullock): “Sharply falling tax revenues across the US have left states facing fresh budget shortfalls and threatening further painful spending and service cuts following previous multiple rounds of belt-tightening. In the first quarter of the calendar year, tax collections dropped by 11.7%, the largest fall on record, according to the Rockerfeller Institute of Government. Of 50 states, some 45 reported declines."
Speculator Watch:
July 21 – Bloomberg (Michael B. Marois): “The California Public Employees’ Retirement System, the largest U.S. defined-benefit public pension, lost 23.4% last year… Assets totaled $183.7 billion…”
July 22 – Bloomberg (Tomoko Yamazaki): “Hedge funds had net inflows of $6.2 billion and returned an average 0.2% in June, rounding off a record three-month rally, Eurekahedge Pte said.”
July 21 – Financial Times (Sam Jones): “Hedge fund managers forecast that a wave of investor cash would flow into the industry in coming months after evidence of the best quarterly performance by many funds in a decade. Total assets under management by the world’s hedge funds rose more than $142bn in the second quarter of 2009, reflecting the strong performance of the industry as a whole, according… to Hedge Fund Research. Outflows from clients slowed to $42bn, from a peak of $152bn in the quarter following last September’s collapse of Lehman Brothers… A leading hedge fund manager, who declined to be named, said ‘This is the best time for generating alpha in 10 years.’”
July 22 – Wall Street Journal (Gregory Zuckerman): “Hedge funds are enjoying their best period in a decade. One reason: Wall Street firms are pulling back from their own ‘proprietary’ trading, meaning less competition. For years, hedge funds grumbled that their biggest rivals weren’t other funds, but groups within banks trading their firms’ own cash. These proprietary trading desks, usually focused on similar opportunities to hedgies, could use higher leverage to make bets… The prop traders were assigned to other trading desks and given less cash to work with. That is making life easier for hedgies.”
Tug-of-War:
I had limited time to write today. Rather than go with a “Just the Facts,” I leave you instead with brief comments.
Chairman Bernanke committed another mistake this week. Removing monetary stimulus before inflation takes root was the focus of both his Wall Street Journal op-ed piece and this week’s congressional testimony. While I consider inflation to be a risk, it is definitely not the dominant systemic risk in play these days. Continuing its now traditional approach, the Federal Reserve is content to disregard unfolding asset Bubble risk. Today’s Bubble inflates rapidly throughout government finance – more specifically the enormous Treasury, agency debt and GSE MBS marketplace.
Actually, Dr. Bernanke did worse than ignore Bubble risk. The markets were promised the Fed would maintain its current ultra-loose monetary policy stance for an “extended period.” This is the same type of policy commitment that fostered speculative Bubbles in mortgages, housing, private-label MBS and CDOs. The Fed today is determined to peg short rates and market yields. Sure, there are obvious short-term reflationary benefits to such an approach. But such an endeavor also nurtures speculation and leveraging, especially in the Bubbling Treasury, agency and MBS markets. From my perspective, this is the most dangerous Bubble yet. It is addressed by no one.
I do appreciate that the Bernanke Fed has spent considerable time contemplating how to remove the past year’s unprecedented monetization. In a normal environment it would matter. But extraordinary circumstances would seem to completely rule out the possibility of Federal Reserve tightening. The risk of bursting the government finance Bubble is too great - and will become only greater. With Treasury, agency and GSE MBS now accounting for the vast majority of system Credit creation, economic and Credit system “recovery” would be stopped dead in its tracks by a surprising jump in market yields. The Fed has, once again, delegated itself to the role of Bubble enabler.
Tuesday, Bloomberg News went with the headline “Treasuries Rise as Bernanke Sees Limited Inflation…” The Sydney Morning Herald captured the true underpinnings of the Treasuries’ big gain: “Bernanke to Keep Easy US Credit Policy.” Dr. Bernanke did a nice job showcasing his inflation-fighting toolkit, although the markets really just needed reassurance he’s not going to back away from aggressive reflation anytime soon. And, here we are again, with Fed actions becoming a significant factor shaping/distorting market perceptions – hence the pricing and flow of finance throughout the economy. This becomes a critical dynamic with respect to the unfolding “government finance Bubble” because this Credit dynamic is capital markets driven (market perceptions of returns on securities dictating Credit expansion).
With U.S. inflation well in check, a strong bullish consensus sees prolonged loose monetary policymaking ensuring low and stable bond yields indefinitely. There is today a tremendous amount riding on this market view. At the same time, it is difficult to envisage a financial system and economy more acutely vulnerable to a spike in yields. How could the sanguine consensus view on rates be wrong?
First of all, it appears that global reflationary forces have reached critical mass. China and Asia are bouncing back. Loose financial conditions throughout the developing markets appear poised to spur robust economic recovery. Two important unknowns are how quickly inflationary pressures will reemerge and how soon foreign central bankers will begin feeling the heat. All eyes on China.
I am struck by a market disconnect. Each passing year finds market and economic forces increasingly globalized. Yet the view regarding favorable prospects for the U.S. fixed income market seems to be driven by favorable expectations of U.S. inflation and U.S. monetary policy. For the markets, Bernanke trumps international forces. The dollar hardly matters. And globally, the view seems to be that low U.S. market yields will continue to anchor global yields. But with financial and economic power having shifted markedly overseas, will there come a point in time when global factors play a much more significant role in determining our market yields. Has the Fed commenced a game of tug-of-war?
Listening to Chairman Bernanke this week, I couldn’t help but contemplate the prospect of waning Federal Reserve power. And I am not referring to regulatory power over our financial institutions. As I see it, the Fed is now locked into permanent monetary ease; they’ve let another Bubble get away from them. Resulting dollar devaluation traps the U.S. economy into a more inflationary backdrop. Meanwhile, the dynamic of massive flows of outbound dollar liquidity, coupled with unconstrained developing-economy Credit systems create powerful inflationary dynamics globally.
It would make sense to me that global forces increasingly tug U.S. yields upward. And we’ll have to wait and see how much the Fed is willing to use its balance sheet to try to tug them back down. Bernanke would clearly prefer to talk rates lower. It will be interesting to see how long talk suffices.