One-month Treasury bill rates ended the week at 11 bps, and three-month bills closed at 14 bps. Two-year government yields dropped 14 bps to 0.91%. Five-year T-note yields fell 14 bps to 2.40%. Ten-year yields were down 13 bps to 3.44%. Long bond yields were 18 bps lower to 4.19%. Benchmark Fannie MBS yields fell 7 bps to 4.48%. The spread between 10-year Treasuries and benchmark MBS widened 6 to 104. Agency 10-yr debt spreads widened 2 to 21 bps. The implied yield on December eurodollar futures sank 12.5 bps to 0.465%. The 2-year dollar swap spread declined 7.5 to 36 bps; the 10-year dollar swap spread declined 4 to 22.75 bps; and the 30-year swap spread increased 1 to negative 8.75 bps. Corporate bond spreads were narrower. An index of investment grade bond spreads narrowed 5 bps to 168, and an index of junk spreads narrowed 14 to 694 bps.
Corporate debt issuance has been in late-summer slowdown. Investment grade issuers included WEA Finance $2.0bn, Duke Energy $1.0bn, Procter & Gamble $500 million, Roper Industries $500 million, and Spectra Industries $300 million.
Junk bond funds saw inflows of $275 million (from AMG). Junk issuers included Vector Group $85 million.
I saw no convert issues.
International dollar debt issuers included Westpac Banking $1.5bn.
U.K. 10-year gilt yields dropped 8 bps to 3.55%, and German bund yields declined 6 bps to 3.25%. The German DAX equities index gained 1.0% (up 14.7%). Japanese 10-year "JGB" yields were unchanged at 1.305%. The Nikkei 225 jumped 2.9% (up 18.9%). Emerging markets were mixed to higher. Brazil’s benchmark dollar bond yields declined 2 bps to 5.55%. Brazil’s Bovespa equities index was little changed (up 53.7% y-t-d). The Mexican Bolsa gained 1.0% (up 27.8% y-t-d). Mexico’s 10-year $ yields jumped 17 bps to 5.85%. Russia’s RTS equities index surged 7.2% (up 72.8%). India’s Sensex equities index rallied 4.5% (up 65.0%). China’s Shanghai Exchange fell 3.4%, lowering 2009 gains to 57.1%.
Freddie Mac 30-year fixed mortgage rates increased 2 bps to 5.14% (down 126bps y-o-y). Fifteen-year fixed rates added 2 bps to 4.58% (down 135bps y-o-y). One-year ARMs were unchanged at 4.69% (down 64bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 5 bps to 6.22% (down 118bps y-o-y).
Federal Reserve Credit rose $14.1bn last week to $2.049 TN. Fed Credit has declined $198bn y-t-d, although it expanded $1.165 TN over the past 52 weeks (132%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 8/26) jumped $12.5 to a record $2.825 TN. "Custody holdings" have been expanding at an 18.7% rate y-t-d, and were up $420bn over the past year, or 17.5%.
M2 (narrow) "money" supply declined $5.9bn to $8.312 TN (week of 8/17). Narrow "money" has expanded at a 2.3% rate y-t-d and 8.1% over the past year. For the week, Currency added $1.4bn, while Demand & Checkable Deposits fell $6.9bn. Savings Deposits jumped $19.3bn, while Small Denominated Deposits dropped $8.0bn. Retail Money Funds declined $11.8bn.
Total Money Market Fund assets (from Invest Co Inst) dipped $2.5bn to $3.579 TN. Money fund assets have declined $251bn y-t-d, or 10.0% annualized. Money funds expanded $6.4bn, or 0.2%, over the past year.
Total Commercial Paper outstanding jumped $43.7bn (2-wk gain of $80bn) to $1.154 TN. CP has declined $527bn y-t-d (48% annualized) and $640bn over the past year (36%). Asset-backed CP rose $41.5bn to $458bn, with a 52-wk drop of $301bn (40%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $118bn y-o-y to $7.088 TN. Reserves have increased $323bn year-to-date.
Global Credit Market Watch:
August 27 – Wall Streeet Journal (Craig Karmin, Carrick Mollenkamp and David Roman): “Borrowing in dollars has become cheaper than borrowing in Japanese yen for the first time in 16 years, a sign that fear in the credit markets, which drove borrowing costs sharply higher, has eased significantly… On Wednesday, banks seeking dollars had to pay 0.37188%, which is the three-month dollar Libor, while yen borrowers needed to pay 0.38813%.”
August 25 – Wall Street Journal (Michael Aneiro): “With syndicate desks churning out bond deals all summer, September may be left with little room to produce its customary run-up in new issuance… It has been the busiest August since the record volume seen in August 2006, with 27 ‘junk,’ or high-yield, bond deals valued at $10.1 billion so far, according to Dealogic. That compares with just two deals worth $500 million last August. Similarly, July brought $13.3 billion of new deals, more than three times the amount seen in July 2008.”
August 25 – Bloomberg (Sophie Leung): “China’s economic growth may exceed 10% in the first quarter of next year on a ‘moderately loose’ monetary policy, a government research agency forecast. The policy will stay in place in the short term to ensure a ‘stable recovery,’ Ba Shusong, deputy director of the Development Research Center… said…"
Government Finance Bubble Watch:
August 28 – Bloomberg (Vivien Lou Chen and Steve Matthews): “The Federal Reserve may not need to buy the full $1.25 trillion in mortgage-backed securities the central bank has authorized by year-end, two regional Fed bank chiefs said. The Fed’s program to buy $1.25 trillion in mortgage bonds guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae is aimed at reducing home-finance costs and arresting the housing slump that triggered the recession… Net purchases totaled $25.4 billion in the week ended Aug. 26, compared with a weekly average of $23.3 billion since the Fed began the initiative in January…”
August 28 – Bloomberg (Sandrine Rastello): “The International Monetary Fund said it today pumped about $250 billion into foreign-exchange reserves worldwide, acting on an April call from leaders of the Group of 20 nations to boost global liquidity. Countries will be able to convert the money, to come from so-called Special Drawing Rights, into hard currencies through ‘voluntary trading arrangements’ with other members…”
August 25 – Bloomberg (Alan Crawford): “Germany’s budget swung to a 17.3 billion-euro ($24.7bn) deficit in the first half of this year as the government boosted subsidies for companies to keep workers on the payroll during the recession. Spending by Germany’s federal, state and local governments rose 3.5% and revenue fell 1.1% compared with the first half of 2008, the first decline since 2004…”
Currency Watch:
August 26 – Wall Street Journal (Neil Shah): “The U.S. economy may be showing signs of recovering from the financial crisis, but the jury is still out on the future of the U.S. dollar. While many analysts expect the dollar to strengthen in coming months as the crisis fades and the U.S. economy turns toward growth, a growing chorus of investors is expressing concern about the longer-term outlook for the greenback. In a new twist to an old refrain among economists, who have long worried about the effects of growing U.S. debt, they say that the huge liabilities the U.S. is taking on to dig its way out of crisis could ultimately undermine faith in the dollar."
The dollar index gained 0.3% this week to 78.30 For the week on the upside, the Australian dollar increased 0.8%, the Japanese yen 0.8%, the South African rand 0.8%, the South Korean won 0.5%, and the New Zealand dollar 0.2%. On the downside, the Mexican peso declined 3.1%, the Brazilian real 2.6%, the British pound 1.4%, the Canadian dollar 1.0%, the Swedish krona 0.9%, and the Norwegian krone 0.6%.
Commodities Watch:
Gold ended the week up 0.2% to $956 (up 8.3% y-t-d). Silver rallied 4.2% to $14.80 (up 31% y-t-d). October Crude slipped $1.10 to $72.79 (up 63% y-t-d). September Gasoline gained 3.4% (up 94% y-t-d), while September Natural Gas dropped 6.1% (down 46% y-t-d). December Copper gained 2.6% (up 111% y-t-d). December Wheat rallied 1.6% (down 19% y-t-d), and December Corn increased 0.8% (down 19% y-t-d). The CRB index dipped 0.6% (up 12.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) fell 0.8% (up 33.7% y-t-d).
China Bubble Watch:
August 24 – Reuters: “China will maintain its stimulative policy stance because the economy, far from being on solid footing, is facing fresh difficulties, Premier Wen Jiabao said… In a downbeat statement on the government’s website… Wen said Beijing would ensure a sustainable flow of credit and a ‘reasonably sufficient’ provision of liquidity to support growth… ‘We must clearly see that the foundations of the recovery are not stable, not solidified and not balanced. We cannot be blindly optimistic…Therefore, we must maintain continuity and consistency in macroeconomic policies, and maintaining stable and quite fast economic growth remains our top priority. This means we cannot afford the slightest relaxation or wavering.’”
August 24 – Bloomberg (Sophie Leugn): “Chinese Premier Wen Jiabao said the government will maintain its fiscal and monetary policies as the economic recovery isn’t stable yet and faces many ‘uncertainties.’ Authorities can’t be ‘blindly’ optimistic as a ‘decline in external demand may continue for a longer time’ and excess production capacity may restrain industrial growth, Wen was quoted… China has yet to cement a recovery as factories have too much capacity and exports are weakening, officials said this month.”
August 26 – Bloomberg: “China said it’s studying curbs on overcapacity in industries including steel and cement, adding to concern policy makers may seek to rein in growth fueled by record credit expansion this year. The government will increase ‘guidance’ of industries including steel, cement, coal chemical, plate glass and wind power equipment, the State Council, China’s cabinet, said…”
August 24 – Bloomberg: “China Construction Bank Corp. said excessive banking liquidity has caused bubbles, underscoring concern that lenders will rein in credit after the Shanghai Composite Index rose 64% this year. ‘There are uncertainties in the economy and bubbles in the capital market,’ Guo Shuqing, chairman of the nation’s second-largest bank, told reporters… ‘China’s banking system still has excessive liquidity.’ Chinese banks handed out a record $1.1 trillion of new loans in the first half to support the nation’s $585 billion economic stimulus package.”
August 25 – Bloomberg: “China’s plan to tighten capital requirements for banks by capping cross holdings of subordinated bonds may cut lending by as much as 700 billion yuan ($102 billion), China International Capital Corp. estimated. The nation’s 14 publicly traded banks may have 376.6 billion yuan of subordinated bonds outstanding by the end of this year… The banking regulator sent draft rule changes to banks on Aug. 19 that would require lenders to deduct all existing holdings of subordinated and hybrid debt sold by other lenders from supplementary capital…”
August 24 – Bloomberg (Chris Bourke and Chia-Peck Wong): “China outpaced the U.S. and the U.K. combined in commercial property sales in the first half of the year, Real Capital Analytics Inc. said. China’s transactions totaled $31.2 billion following a surge in land sales after the government eased credit terms… U.S. sales were $16.2 billion in the first half… and the U.K.’s were $13.7 billion.”
August 28 – Bloomberg: “Bank of China Ltd., the nation’s third-largest by assets, plans to slow credit growth in the second half of the year and improve loan quality after posting an unexpected profit gain in the second quarter.”
Japan Reflation Watch:
August 28 – Bloomberg (Toru Fujioka and Mayumi Otsuma): “Japan’s unemployment rate rose to a record 5.7% in July and deflation worsened, dealing a blow to Prime Minister Taro Aso on the eve of an election that polls indicate his ruling Liberal Democratic Party will lose.”
India Watch:
August 27 – Bloomberg (Cherian Thomas and Anoop Agrawal): “India’s central bank indicated it may raise borrowing costs as the ‘accommodative’ policy it started in October threatens to stoke inflation. ‘While the fiscal stance has clearly tilted towards the growth objective, the associated monetary policy, if sustained longer, entails the risk of higher inflation,’ the Reserve Bank of India said…”
August 28 – Bloomberg (Gopal Ratnam and Abhay Singh): “India’s future is threatened by shortages of food, water and energy and these should be addressed on a priority basis, the Prime Minister’s security adviser said. ‘These are part of a broad national security plan, and defense is only one aspect of it,’ Shekhar Dutt, India’s deputy national security adviser, said… ‘We think water is going to be a very severe determinant of prosperity and well-being.’”
Asia Bubble Watch:
August 26 – Wall Streeet Journal (Mark Cranfield): “Asia’s central bankers insist they have no timetable for raising interest rates. Some investors are already placing bets to the contrary. India, the punters think, will go first. China and Korea won’t be far behind. The money’s being put down in the huge, but -- to its outsiders -- opaque world of interest rate swaps, where the yields on two year maturities across much of Asia have risen sharply in the past few months. This market, which had $403 trillion worth of contracts outstanding at the end of 2008, draws a range of investors, from the aggressive -- hedge fund managers -- to the defensive -- companies looking to hedge against a change in monetary policy. About a quarter of its volume is traded in Asia.”
August 26 – Bloomberg (Shinhye Kang): “South Korea needs to maintain its expansionary policy until the economy ‘substantially recovers,’ Finance Minister Yoon Jeung Hyun said. ‘There is a risk that the economy may fall into a double dip if the government shifts the stance of policy too fast,’ Yoon said… ‘It’s premature to discuss the timing of an exit strategy.’”
August 27 – Bloomberg (Karl Lester M. Yap and Cecilia Yap): “Philippine economic growth accelerated in the second quarter… Gross domestic product increased 1.5% from a year earlier…”
Latin America Watch:
August 26 – Bloomberg (Andre Soliani Costa and Heloiza Canassa): “Brazil will get $3.9 billion in special drawing rights from the International Monetary Fund, helping increase the country’s record international reserves… Latin America’s largest economy had $214.9 billion of international reserves on Aug. 24.”
August 27 – Bloomberg (Hugh Collins and Carlos Manuel Rodriguez): “Mexico will get about $4 billion in special drawing rights from the International Monetary Fund, helping increase the country’s international reserves.”
Unbalanced Global Economy Watch:
August 24 – Financial Times (Nicholas Timmins): “Almost 700,000 more people than a year ago are now living in a (UK) household where no-one works, bringing the total to close to one in five households, latest official statistics… show. The number of people of working age living in a household where none of the adults work rose by 500,000 to 4.8m for the period April to June…”
August 25 – Bloomberg (Svenja O’Donnell): “U.K. mortgage approvals rose in July to the highest level since February 2008, the British Bankers’ Association said…”
August 27 – Bloomberg (Jana Randow): “Loans to households and companies in Europe grew at the slowest pace on record in July… Loans to the private sector rose 0.6% from a year earlier…”
August 26 – Bloomberg (Christian Vits): “German business confidence rose for a fifth month in August, suggesting Europe’s largest economy will gather strength after shaking off its worst recession since World War II.”
August 27 – Bloomberg (Milda Seputyte): “Lithuania’s economy contracted a revised 20.2% in the second quarter, the steepest decline in the European Union.”
Central Banker Watch:
August 27 – Bloomberg (Jody Shenn): “The Federal Reserve disclosed that it bought a greater-than-average amount of mortgage bonds for a second straight week… Net purchases totaled $25.4 billion in the week ended yesterday, compared with a weekly average of $23.3 billion since the Fed began the initiative in January…”
Fiscal Watch:
August 26 – Wall Streeet Journal (Jonathan Weisman and Deborah Solomon): “Plunging tax receipts, soaring spending and a sluggish recovery will push the nation’s deficits dramatically higher over the next decade… The Office of Management and Budget revised its May deficit projections to forecast a record, $1.58 trillion deficit for the fiscal year that ends Sept. 30. Spending… will rise by 24% this year, the largest increase since 1952 and the height of the Korean War… Tax revenues will fall 17% from last year’s levels, the largest drop since 1932. Measured against the size of the economy, the deficit will hit 11.2% of the GDP, a level not seen since 1945… The deficit will improve only slightly in fiscal 2010, to $1.5 trillion, worse than the $1.3 trillion forecast in May. And it will stay high, adding $9 trillion onto the federal debt through 2019. Borrowing alone will account for 40% of federal revenues in 2010.”
August 27 – Bloomberg (Alison Vekshin): “The U.S. added 111 lenders to its list of ‘problem banks’ in the second quarter, a 36% increase that pushed the group to a 15-year high. A total of 416 banks with combined assets of $299.8 billion failed the Federal Deposit Insurance Corp.’s grading system for asset quality, liquidity and earnings…”
MBS/ABS/CDO/CP/Money Fund and Derivatives Watch:
August 25 – Wall Street Journal (James R. Hagerty): “Homeowners who fall behind on their mortgage payments have become much less likely to catch up again, a new study shows. The report from Fitch… focuses on a plunge in the ‘cure rate’ for mortgages that were packaged into securities… Fitch found that the cure rate for prime loans dropped to 6.6% as of July from an average of 45% for the years 2000 through 2006. For so-called Alt-A loans… the cure rate has fallen to 4.3% from 30.2%. In the subprime category, the rate has declined to 5.3% from 19.4%.”
California Watch:
August 26 – Wall Streeet Journal (Jim Carlton): “Sales of existing single-family homes in California increased 12% in July from the same time a year ago, as the state’s median price rose for the fifth straight month… The inventory of unsold houses continued to drop, to 3.9 months supply in July from 6.9 months at the same time a year ago. Median prices were off 19.6% from July 2008 at $285,480, but were up 3.9% from June …”
August 29 – Financial Times (Matthew Garranhan): “Arnold Schwarzenegger has come up with a novel way to raise funds for cash-strapped California. He has ordered officials to sell surplus state property, with some of it signed by the movie star-turned governor to increase its value. Under the ‘Great California Garage Sale’, thousands of items including signed cars, bookcases and even dentist chairs are up for grabs on Ebay and Craigslist… ‘This is a win-win for the state and for shoppers,’ said Mr Schwarzenegger. ‘Together we are eliminating waste and providing great deals in this tough economy.”
Crude Liquidity Watch:
August 25 – Bloomberg (Camilla Hall): “Saudi Arabian M2 money supply growth… slowed to 14.2% from 15.8% the previous month, the central bank said…”
Party Like It's 1991:
On CNBC yesterday Richard Bernstein commented on some of the similarities he’s seeing between 2009 and 1991. I have been rambling in our meetings for months now how this year brings back memories of 1991. Going into the first Iraq war, bearish sentiment was extreme. The bears had made a killing in 1990, while the bulls were downtrodden and depressed. The U.S. banking system was a bloody mess, and the economy was sinking fast. As the war approached, the market feared Saddam’s military had the capacity to both put up a fight and strike at Saudi oil fields.
But with the January 17th launch of Operation Desert Storm it became immediately clear that Iraq was no match whatsoever for the highly sophisticated and well-equipped U.S. armed forces. The S&P500 rallied 3.7% on the 17th and didn’t look back.
The 1991 market rally caught the bulls underinvested and the bears highly exposed. Both camps waited anxiously for a pullback to get their positions in order. Not uncharacteristically, Mr. Market was in no mood to accommodate. Mr. Bernstein noted that the riskier stocks gained 90% during 1991, only somewhat ahead of the 85% gain he said this category has gained so far this year. Indeed, a huge short squeeze led the 1991 market rally. This dynamic severely punished the bears, while the generally cautious bulls were for awhile left unsatisfied.
Throughout 1991, there were ample reasons for the bears to maintain bearishness and the bulls to stay cautious. The economic recovery was anemic, with Q2’s 2.7% GDP recovery followed by weak reports in 1991’s Q3 (positive 1.7%) and Q4 (positive 1.6%). Unemployment began the year at 6.3%, only to rise to 7.3% by year end – on its way to the cycle peak of 7.8% posted in June 1992. Personal Income and Spending both lagged. The fiscal situation was dismal ($269bn deficit in 1991) and projected to get even worse ($290bn in 1992). Ten-year bond yields began 1991 at about 8% and were above 8.2% at the year’s midpoint. The thrill of watching the Fed collapse interest rates had yet to be experienced - and wasn't yet even contemplated.
After beginning 1991 at 7.0%, the Fed funds rate was cut repeatedly to an – at that time – extraordinary 3.0% by September 2002. The Greenspan Federal Reserve fashioned a very steep yield curve to ensure the impaired banking system easy profits – a dynamic that also provided easy speculative returns to the Wall Street firms and the fledgling hedge fund industry. It wasn’t long until speculation was running rampant throughout the stock and bond markets.
It is my view that this past year’s unprecedented fiscal and monetary policy response has unleashed powerful speculative forces throughout the global markets. Recalling 1991, a major short squeeze has again propelled the general market higher. The unwind of systemic risk hedges has also surely played a major role in newfound marketplace liquidity abundance – both in equities and fixed income. And there is absolutely nothing like the confluence of extended ultra-cheap “money”, highly liquid markets, and speculative froth to keep the marketplace focused beyond the valley to the hopeful return of prosperity.
It is with this in mind that it is worth mentioning the market’s inattention to terrible budget data released this week. This year’s deficit is now slated at $1.58 TN, or 11.2% of GDP (largest since WWII). Spending will increase 24%, the strongest increase since the Korean War (from the WSJ). The White House increased its estimate for the 2010 shortfall by $200bn to $1.50 TN (40% of federal revenues). Worst of all, the estimate for 10-year deficits was raised $2.0 TN to a staggering $9.0 TN. It was difficult to gauge who cared less – bonds or stocks.
And I understand the fundamental case for disregarding these types of long-term budget forecasts. The Congressional Budget Office (CBO) saw deficits as far as the eye could see back in the early nineties. Actual deficits turned to nice surpluses by the end of the decade. And looking back at year 2000 projections, the CBO penciled in a $400bn surplus for 2009 and better than $3.0 TN of cumulative surplus for this decade. A speculative marketplace easily ignored this week's projections.
I have my own explanation for why the CBO projections were so off in both the early nineties and earlier this decade: the historic expansion of “Wall Street finance.” The Securities Broker/Dealers began the nineties with assets of $237 billion, ended 1999 at $1.0 TN, and peaked at $3.1 TN in 2007. The GSE started 1990 with assets of $454bn, ended the decade at $1.732 TN and concluded 2008 at $3.458 TN. The ABS market began the nineties at $210bn, ended 1999 at $1.313 TN and peaked in 2007 at $4.5 TN. I don’t have data for hedge fund positions, “repos,” or the collateralized debt obligation (CDO) market - but all would have the same Bubble trajectory.
While the U.S. banking system was severely impaired to begin the nineties, this fact did not prove bearish for the economy, the markets or federal government finances. A historic “Wall Street” Credit Bubble was cultivated and then championed by the Greenspan Fed. This massive expansion of Credit created abundant liquidity for spectacular asset Bubbles, a dramatic inflation in government receipts and spending, and a consumption boom like the world had never experienced. And, importantly, the reflationary boom in Wall Street finance worked to repair and rejuvenate the bank Credit-creating mechanism – until last year's collapse left everyone (but the federal government) starved for Credit and liquidity.
So what about today? It’s not difficult for an increasingly speculative stock market to dream it’s 1991 all over again. Many believe the economy’s previous growth trajectory can be reestablished and the great bull market resumed. Others simply see a very fruitful speculative backdrop. Most believe that the recovering markets are a reflection of growth prospects and that the buoyant stock market is discounting the return of the economy to sound footing. The bullish consensus believes economic recovery will work to cure housing and financial sector ills, as it did during the nineties.
I believe the bullish consensus is misguided. First and foremost, it is the Credit system driving the real economy - not vice-versa. Only massive fiscal and monetary stimulus was capable of stabilizing the system. Total non-financial Credit expanded $470 billion 1991. It is my view that the maladjusted U.S. “Bubble” economy will require non-financial Credit growth of at least $2.0 TN this year. With the banking system and Wall Street finance severely impaired, “federal” (Treasury, agency, GSE MBS) Credit will account for the vast majority of system Credit growth this year.
The unprecedented expansion of “federal” Credit has stabilized the system and incited a speculative run in the stock market. But I just don’t see the mechanism for private-sector Credit to recover to the point of carrying the heavy load necessary to sufficiently finance the gluttonous U.S. economy. I don’t see a new boom in Wall Street Credit instruments in the offing, and it’s difficult to see how bank Credit can recover adequately on its own. So, as far as they eye can see, the system is left with “federal” Credit.
I expect this week’s dire deficit projections from the White House and CBO to this time be much more on the mark. I also believe it matters greatly to both the U.S. economy and markets that our government has become the predominant source of system finance. Granted, it may not matter so much right now as artificial recoveries flourish in the markets and economy. But those believing the stock market is forecasting a happy ending to this, the latest stage of the Bubble, will again be disappointed. I haven’t forgotten how the Wall Street boom papered over a lot of problems and structural issues.