One-month Treasury bill rates ended the week at 9 bps, and three-month bills closed at 13 bps. Two-year government yields dropped 8 bps to 0.84%. Five-year T-note yields fell 10 bps to 2.29%. Ten-year yields were down one basis point to 3.44%. Long bond yields were 7 bps higher to 4.27%. Benchmark Fannie MBS yields fell 5 bps to 4.43%. The spread between 10-year Treasuries and benchmark MBS narrowed 4 to 99. Agency 10-yr debt spreads widened 2 to 24 bps. The implied yield on December eurodollar futures declined 2 bps to 0.455%. The 2-year dollar swap spread was little changed at 36 bps; the 10-year dollar swap spread declined 2.25 to 20.5 bps; and the 30-year swap spread declined 4.75 to negative 13 bps. Corporate bond spreads were mixed. An index of investment grade bond spreads widened 7 bps to 175, and an index of junk spreads narrowed 7 to 677 bps.
Corporate debt issuance will begin to pick up next week. Investment grade issuers included Republic Services $650 million, Plains All American Pipeline $500 million, and US Bancorp $350 million.
Junk bond funds saw inflows of $216 million (from AMG). Junk issuers included Beazer Homes $250 million.
I saw no convert issues.
International dollar debt issuers included Canada $3.0bn, Westpac Banking $5.3bn, and Country Garden $300 million.
U.K. 10-year gilt yields rose 7 bps to 3.62%, while German bund yields dipped one basis point to 3.24%. The German DAX equities index fell 2.4% (up 11.9%). Japanese 10-year "JGB" yields were about one basis point higher at 1.32%. The Nikkei 225 dropped 3.3% (up 15.0%). Emerging markets were mostly lower. Brazil’s benchmark dollar bond yields sank 12 bps to 5.47%. Brazil’s Bovespa equities index declined 1.8% (up 50.9% y-t-d). The Mexican Bolsa dipped 1.0% (up 26.5% y-t-d). Mexico’s 10-year $ yields declined 4 bps to 5.78%. Russia’s RTS equities index declined 2.4% (up 68.3%). India’s Sensex equities index gave back 1.5% (up 62.6%). China’s Shanghai Exchange was about unchanged, with 2009 gains to 57.2%.
Freddie Mac 30-year fixed mortgage rates dropped 6 bps to 5.08% (down 127bps y-o-y). Fifteen-year fixed rates declined 4 bps to 4.54% (down 136bps y-o-y). One-year ARMs fell 7 bps to 4.62% (down 53bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 13 bps to 6.09% (down 127bps y-o-y).
Federal Reserve Credit expanded $14.4bn last week to $2.063 TN. Fed Credit has declined $183bn y-t-d, although it expanded $1.169 TN over the past 52 weeks (131%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/2) rose $3.9bn to a record $2.829 TN. "Custody holdings" have been expanding at an 18.4% rate y-t-d, and were up $425bn over the past year, or 17.7%.
M2 (narrow) "money" supply dropped $28.1bn to $8.282 TN (week of 8/24). Narrow "money" has expanded at a 1.7% rate y-t-d and 7.6% over the past year. For the week, Currency added $1.0bn, while Demand & Checkable Deposits fell $18.3bn. Savings Deposits rose $9.7bn, while Small Denominated Deposits declined $7.3bn. Retail Money Funds dropped $13.3bn.
Total Money Market Fund assets (from Invest Co Inst) fell $20.2bn to $3.559 TN. Money fund assets have declined $272bn y-t-d, or 10.5% annualized. Money funds declined $27bn, or 0.7%, over the past year.
Total Commercial Paper outstanding increased $8.0bn (3-wk gain of $87.6bn) to $1.162 TN. CP has declined $519bn y-t-d (46% annualized) and $642bn over the past year (36%). Asset-backed CP jumped $19.5bn to $477bn, with a 52-wk drop of $300bn (39%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $310bn y-o-y to a record $7.268 TN. Reserves have increased $504bn year-to-date.
Global Credit Market Watch:
September 4 – Bloomberg (Lester Pimentel): “Developing-nation junk bonds are gaining at the slowest pace in six months after the lowest-rated companies sold more international debt in seven weeks than during the whole previous year. Companies issued $6.5 billion of below investment-grade debt since July 16…”
Government Finance Bubble Watch:
September 3 – Bloomberg (Rebecca Christie): “U.S. Treasury Secretary Timothy Geithner said the Group of 20 nations has been ‘very successful’ in helping to end the global recession and cautioned that it’s too early to remove policies aimed at boosting growth. ‘You’re seeing the first signs of positive growth now in this country and countries around the world… We’ve come a very long way but I think we have to be realistic, we’ve got a long way to go still.’”
September 4 – Bloomberg: “China’s banking regulator said it will take years to implement stricter capital requirements for banks, seeking to assuage concerns the rules will cause a plunge in new lending.”
The dollar index slipped 0.3% this week to 78.14. For the week on the upside, the Brazilian real increased 2.2%, the South African rand 2.1%, the Australian dollar 1.2%, the British pound 0.8%, the Japanese yen 0.6%, the Canadian dollar 0.6%, the Norwegian krone 0.5%, and the New Zealand dollar 0.5%. On the downside, Mexican peso declined 0.9%, the Swedish krona 0.7%, and the Swiss franc 0.1%.
September 2 – Bloomberg: “China, holder of the world’s largest rare-earths deposits, may build a strategic reserve in Inner Mongolia, strengthening its control over materials used in technology ranging from iPods to guided missiles. Inner Mongolia, which contains 75% of China’s deposits, is in talks with the central government to build stockpiles to support prices… China, which imports most of its iron ore, oil and copper, is tightening control over supplies of rare earths, a range of more than 15 elements such as scandium and lanthanum… ‘The plan of building a national reserve stockpile is part of a government-level strategy to protect the resources of rare earths and prevent it from being sold cheaply,’ Liu Minda, analyst at Huatai Securities Co., said…”
September 1 – New York Times (Keith Bradsher): “China is set to tighten its hammerlock on the market for some of the world’s most obscure but valuable minerals. China currently accounts for 93% of production of so-called rare earth elements — and more than 99% of the output for two of these elements, dysprosium and terbium, vital for a wide range of green energy technologies and military applications like missiles. Deng Xiaoping once observed that the Mideast had oil, but China had rare earth elements...”
September 2 – Bloomberg (Aya Takada and Yasumasa Song): “Rubber prices are expected to climb as much as 19% by the end of next year as rising vehicle sales in China increase demand, said Marubeni Corp., the largest Japanese trader of the commodity.”
Gold surged 4.1% to $994 (up 12.7% y-t-d). Silver jumped 9.8% to $16.27 (up 44% y-t-d). October Crude dropped $6.94 to $67.80 (up 52% y-t-d). October Gasoline dropped 7.1% (up 66% y-t-d), while September Natural Gas sank 9.4% (down 51% y-t-d). December Copper declined 3.2% (up 103% y-t-d). December Wheat fell 4.7% (down 23% y-t-d), and December Corn dropped 6.9% (down 15% y-t-d). The CRB index dropped 4.0% (up 7.9% y-t-d). The Goldman Sachs Commodities Index (GSCI) sank 5.9% (up 25.8% y-t-d).
China Bubble Watch:
September 4 – Bloomberg (Heather Burke): “Toyota Motor Corp. plans to more than double the amount of Chinese dealerships offering car loans in the next two years by expanding into inland areas of the nation, Nikkei English News reported…”
Japan Reflation Watch:
September 1 – Bloomberg (Keiko Ujikane): “Democratic Party of Japan leader Yukio Hatoyama, fresh from a sweeping election victory, may have limited options to address record unemployment and deflation that threaten the nation’s economic recovery. The DPJ won power for the first time yesterday on a pledge to support households battered by two decades of economic stagnation. Hatoyama has also said he’ll avoid more bond sales, so new spending will depend on his success in shrinking the bureaucracy and public works programs…”
August 31 – Bloomberg (Cherian Thomas): “India’s economic growth accelerated for the first time since 2007… Gross domestic product expanded 6.1% last quarter from a year earlier after a 5.8% rise in the previous quarter…”
September 3 – Bloomberg (Anil Varma): “India will raise the ratio of cash banks need to set aside against deposits as early as next quarter to help curb the fastest consumer-price inflation in 11 years, Nomura Securities Co. said. The… consumer-price index for industrial workers jumped 11.89% in July, the most since November 1998…”
Asia Bubble Watch:
September 3 – Bloomberg (Saeromi Shin): “South Korea’s economy expanded in the second quarter at a faster pace than initially estimated… Gross domestic product grew 2.6% from the previous three months...”
Unbalanced Global Economy Watch:
September 4 – Bloomberg (Greg Quinn): “Canada recorded a surprise job gain in August, the first in four months… The jobless rate increased to 8.7% from July’s 8.6%, the highest since January 1998…”
August 31 – Bloomberg (Alexandre Deslongchamps): “Canada’s economy shrank faster than expected in the second quarter and the country’s first recession since 1991 is proving deeper than thought, even as growth in June indicates the contraction is nearing an end. Gross domestic product shrank at a 3.4% annualized rate in the April-through-June period…”
September 1 – Bloomberg (Jennifer Ryan and Svenja O’Donnell): “U.K. consumers repaid debt by the most on record in July and manufacturing unexpectedly contracted, indicating the economy’s path out of the worst recession in a generation will be uneven.”
September 1 – Bloomberg (Simone Meier): “Europe’s unemployment rate rose to the highest in more than 10 years in July… Unemployment in the 16-member euro region increased to 9.5% from 9.4% in June.”
September 3 – Bloomberg (Simone Meier): “Europe’s manufacturing and service industries unexpectedly returned to growth in August for the first time in over a year… A composite index of both industries rose to 50.4 from 47 in July…”
September 3 – Bloomberg (Mark Deen): “France’s unemployment rate climbed to the highest in at least three years… The jobless rate rose to 9.5% from a revised 8.9% in the first quarter…”
September 2 – Bloomberg (Jacob Greber): “Australia’s economic growth unexpectedly accelerated in the second quarter… Gross domestic product rose 0.6%, the biggest gain in more than a year…”
U.S. Bubble Economy Watch:
September 2 – Bloomberg (Alan Bjerga): “A record 35.1 million people received food stamps in June as unemployment reached a 26-year high… The 22% increase from a year earlier marked the seventh straight month of record participation… Spending on benefits also reached a monthly record at $4.68 billion…”
September 2 – Wall Street Journal (Anne Marie Chaker): “Students are borrowing dramatically more to pay for college, accelerating a trend that has wide-ranging implications for a generation of young people. New numbers from the U.S. Education Department show that federal student-loan disbursements -- the total amount borrowed by students and received by schools in the 2008-09 academic year grew about 25% over the previous year, to $75.1 billion.”
September 2 – Bloomberg (Christopher Scinta): “U.S. consumer bankruptcy filings rose 24% in August from the previous year to 119,874, according to the American Bankruptcy Institute and National Bankruptcy Research Center. ‘Consumers continue to turn to bankruptcy as a shield from the sustained financial pressures of today’s economy,’ said Samuel Gerdano, the executive director of the American Bankruptcy Institute.”
September 4 – Bloomberg (Joe Mysak): “Life on top means not having to lower your prices. …the cost of a year as an undergraduate at Harvard and Princeton has risen through boom and bust. Tuition and fees at Harvard jumped 67.8% over the decade; at Princeton, they increased 43.4%.”
Central Banker Watch:
September 2 – Bloomberg (Craig Torres): “Federal Reserve officials in their August meeting discussed extending the end-date for purchases of mortgage bonds to minimize any market disruptions, and expressed concern about the pace of a likely economic recovery. A number of policy makers judged that a ‘tapering of agency debt and MBS purchases could be helpful in the future as those programs approach completion,’… The central bank boosted its mortgage- backed securities and agency-debt programs in March and they are currently scheduled to end in December.”
September 4 – Bloomberg (Gabi Thesing): “European Central Bank President Jean-Claude Trichet said the bank won’t necessarily raise interest rates when the time comes for it to start withdrawing other emergency stimulus measures. ‘The term ‘exit strategy’ should be understood as the framework and set of principles guiding our approach to unwinding the various non-standard measures,’ Trichet said… ‘It does not include considerations about interest policy.’”
September 3 – Bloomberg (Kim McLaughlin): “Sweden’s Riksbank left the key interest rate at a record low and repeated its plan to keep borrowing costs on hold for another year as policy makers in the largest Nordic economy gauge the strength of its recovery.”
September 3 – Bloomberg (Jacob Greber): “Pressure is mounting on (Australian) central bank Governor Glenn Stevens to raise interest rates from a half-century low as soon as next month after a report yesterday showed the economy strengthened on surging consumer spending.”
August 31 – Bloomberg (Greg Quinn): “Canadian Finance Minister Jim Flaherty said central banks should consider widening the use of monetary policy from controlling inflation to checking financial-market bubbles. Policy makers have assumed that keeping inflation low would ensure financial stability, something that needed a more ‘critical eye,’ Flaherty said… ‘Central banks, including Canada’s, can and should look for ways to improve the implementation of monetary policy in the interest of financial stability,’ Flaherty said.”
September 2 – Bloomberg (Dawn Kopecki): “Mortgage bankers are pushing Congress to expand the U.S. government’s support of the market by guaranteeing private-industry home-loan securities and replacing finance companies Fannie Mae and Freddie Mac. The first step builds off the model for Ginnie Mae, the agency that guarantees payments on bonds backed by government- insured mortgages… The second part involves winding down government-seized mortgage buyers Fannie Mae and Freddie Mac and creating ‘two or three’ new privately funded, government-chartered companies to back individual loans… Putting the ‘full faith and credit’ of the U.S. Treasury behind a portion of the $1.8 trillion non-agency mortgage market would help boost a once-dominant form of home-loan financing that almost collapsed in 2007… The infrastructure of Fannie Mae and Freddie Mac should be used as a foundation for the new initiative, the association said… The Mortgage Bankers Association said it advocates a ‘good bank/bad bank resolution’ for the companies. Two or three mortgage credit-guarantor entities should be created to replace the companies… The entities would own and guarantee loans that they then package into bonds. A new agency similar to Ginnie Mae would then guarantee those securities, according to the association’s plan.”
Real Estate Bust Watch:
September 2 – Wall Street Journal (John Jannarone): “The U.S. housing market was unified by the bust. After peaking in 2006, home prices across the country joined the march downward. Are investors prepared for a return to more normal times? It wasn’t long ago that a nationwide price decline was considered almost impossible by many, not having been observed since the Great Depression… But a look on a regional level shows a different story. The likes of overbuilt Las Vegas and Miami have yet to see prices turn. There, distressed sales now make up around two-thirds of transactions…”
September 1 – Bloomberg (Sarah McDonald): “Australian property trusts are unloading failed overseas investments from Munich to Michigan after piling up losses equal to almost a third of their market value in the last 12 months.”
September 4 – Bloomberg (Jeremy R. Cooke): “The gap in yields between the highest- and lowest-rated investment-grade municipal bonds narrowed to the tightest since late October 2008…. The yield spread between Merrill Lynch & Co. indexes that track municipal securities rated AAA and BBB reached about 250 bps, down almost two percentage points for the year.”
September 1 – Bloomberg (William Selway): “U.S. city officials say they expect to face further financial strains because tax collections won’t recover until after the economy emerges from the deepest recession since the Great Depression, a national survey found. Eighty-eight percent of city finance officers said they are less able to cover the cost of running their governments than a year ago, up from 64% a year earlier…”
September 1 – Wall Street Journal (Leslie Eaton): “The recession is finally hitting city budgets, with overall city revenues inching down in fiscal 2009 for the first time since 2002… Overall city revenues declined by 0.4%, even as expenses rose 2.5%, and city officials expect steep drops in tax collections in the next two years…”
September 4 – Bloomberg (Tom Cahill): “Fund of hedge fund assets tumbled by $95 billion, or 14%, in the first six months of 2009, according to a survey by InvestHedge…”
September 2 – Financial Times (Francesco Guerrera and Sam Jones): “Cerberus, the investment group, is barring investors in two new hedge funds from withdrawing money for three years in an effort to avoid a repeat of the large outflows that followed its lossmaking purchases of Chrysler and GMAC…The move to introduce a three-year ‘lock-up’ is rare among hedge funds…”
ECB President Jean-Claude Trichet penned an op-ed in today’s Financial Times, “Europe has Mapped its Monetary Exit.” Following the path of Chairman Bernanke, Mr. Trichet explains in some detail the ECB’s plan for exiting its program of “enhanced Credit support.” And further tracing the Fed’s footprints, Mr. Trichet is keen not to spook the markets: “Stressing the importance of the exit strategy should not be confused with its activation: it is premature to declare the financial crisis over. Today is not the time to exit.”
President of the New York Fed, William Dudley, stated clearly in Monday’s interview with CNBC’s Steve Liesman that he believes it is too early for the Fed to begin its monetary stimulus exit. “…The economy isn’t growing very fast and we do have a very high unemployment rate.” Deep structural impairment ensures that there will be no agreeable time for policymakers to reverse course.
Ahead of the Group of 20 meeting, UK Chancellor of the Exchequer Alistair Darling commented today that nations should “abandon measures” when recovery takes hold. If it were only that easy. The Fed has already promised markets an extended period of ultra-loose monetary conditions. And I would expect dollar vulnerability (strong euro) coupled with more general systemic fragilities will keep ECB “exit” policy stalled or, at best, restricted to tiny Greenspan-style baby steps.
I’m rather skeptical with respect to central banker “exit” chatter. As markets have recovered and economies stabilized, they have been compelled to articulate somewhat coherent plans for returning to a more stable monetary backdrop. On the one hand, central bankers are keen to reassure the markets that inflation fighting remains a top priority. At the same time, central banks go to great pains to ensure the markets that no meaningful monetary tightening is in the offing anytime soon. On the surface this appears an act of walking a fine line. In reality, markets these days fret only monetary tightening.
In response to Mr. Liesman’s question on the Fed’s commitment to purchase $1.25 TN of agency MBS, Mr. Dudley made telling comments. “Market expectations are very, very important. And the market expects us to complete these programs, to do the full amount. So to contradict that market expectation, I think, is a pretty high hurdle.”
When I contemplate “exit” strategies, I think specifically in terms of policymakers eliminating government market intrusions that distort the price and flow of finance throughout the financial system and real economy. Today – and over the years – one can certainly look to the (activist) Federal Reserve’s (and other central banks’) manipulations of the targeted “Fed funds” rate as a fundamental government intrusion. For years now, artificially low “pegged” borrowing costs have distorted pricing and price relationships for financial instruments and risk more generally. Over time the Fed became only more comfortable – and encroaching - with its capacity to influence market behavior (i.e. lending, speculating, leveraging, investing in risk assets, etc).
Yet, as I’ve argued over the years, the government’s intrusion into our nation’s mortgage market has likely been as consequential in distorting both market pricing and the allocation of financial and real resources as loose monetary policy. The GSE’s used the market’s perception of implicit government backing to balloon their books of business to $5 Trillion. Today, more explicit Washington guarantees will empower Fannie, Freddie, the FHLB, the FHA, VA, Ginnie Mae and others to accumulate Trillions more risk exposure. I can’t take any talk of an exit strategy seriously until I see some coherent plan for disengaging the federal government from our nation’s mortgage industry.
From this morning’s Wall Street Journal (Nick Timiraos and Deborah Solomon):
“In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006… FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year… Before the boom, the FHA wasn’t a big player in the housing business because it didn’t follow private lenders in loosening its standards. Borrowers had to fully document incomes and insured loans were capped at $362,000. Congress increased those limits last year to as high as $729,750 in the most expensive markets. In August, the FHA and the U.S. Department of Veterans Affairs backed 40% of loans for all home sales.”
It is as well worth noting that Fannie Mae increased its book of business (retained mortgages and MBS guaranteed) by $70bn in the past two months (to $3.22 TN). And, according to Bloomberg data, y-t-d issuance of agency (Fannie, Freddie, and Ginnie) MBS is already approaching $1.3 TN, compared to full year 2008’s $1.153 TN, 2007’s $1.148 TN, 2006’s $903bn, and 2005’s $958bn.
So, it has reached the point where Washington is underwriting the majority of existing mortgage debt throughout the system and is now backing essentially the entire amount of net new mortgage Credit. Meanwhile, the Federal Reserve is purchasing/monetizing about $25bn of agency MBS - on a weekly basis. As Mr. Dudley stated, “Part of the whole point of the agency mortgage-backed securities purchase program was to drive mortgage rates down to therefore make housing more affordable - to cushion the decline in the housing market. So I think it has been very effective.”
Effective perhaps, but what about an exit strategy? Well, I see a “No Exit” sign. These distortions have been going on for too many years and become too systemic. Indeed, government interventions are at the core of systemic fragilities that ensure Washington will continue to meddle. Exiting government intervention would entail the Fed normalizing rates and ending its massive program of monetization, while an exit by the federal government would entail an end to its expansive program of guaranteeing Trillions of mortgages and mortgage-backed securities. Understandably, the markets spend little time fretting the possibility of Washington getting cold feet on mortgages (or rates).
The Mortgage Bankers Association was out this week with a proposal for revamping the GSEs. From The Wall Street Journal (Nick Timiraos): “A mortgage-industry trade group is calling for Congress to transform Fannie Mae and Freddie Mac into several smaller privately held companies that would issue mortgage securities carrying an explicit government guarantee.” With the help of a government-directed “bad bank,” Fannie and Freddie could be restructured and, apparently, have another go at it. The federal government’s explicit backing of MBS was the key facet to the proposal, a feature seen as necessary for the market’s acceptance of the mortgage securities.
The Administration is to issue its own recommendations for mortgage overhaul next year. We can only hope that this scheme of breaking the GSEs into a group of new “private” companies – benefitting from explicit government debt guarantees - is not adopted. The last thing the system needs going forward is a bunch of little Fannies running around – with hot stocks – trumpeting a seductive story of a new and improved risk models that can promote mortgage lending, housing recovery, and economic growth – with the taxpayer on the hook for only more losses.
As I have written previously, the number one policy priorty these days should be to ensure the course of policymaking does not bankrupt the country. The Federal Reserve must do its part first and foremost by protecting our currency. The Fed must in a timely manner exit its crisis management regime of zero interest-rates and massive monetization – especially of MBS. To avoid “bankruptcy,” the federal government must move aggressively to exit massive deficit spending and the accumulation of systemic mortgage risk.
Regrettably, signs read No Exit on all fronts. And it is this mortgage issue that worries me the most, as few seem to appreciate the mounting risks. Conventional thinking has it that the governent can step in temporarily and stabilze the housing markets. And when home prices reflate and the economy recovers, the private Credit system will take over as the federal government gracefully exits.
The more likely scenario is that federal government market intervention further distorts the marketplace – creating a dyamic whereby only government-guaranteed mortgages attract market demand. Any move by the government to retreat from its backing of the mortgage market would risk acute instability. And, at some point, the government’s accumulation of debt and mortgage obligations would begin to impact the market’s view of creditworthiness.
There is the appearance that government intervention throughout the mortgage marketplace provides a free lunch: Households, once again, enjoy access to plentiful cheap mortgage Credit, while there’s no impact to the cost of federal borrowings. Why would anyone in their right mind even contemplate an Exit – especially when things remain so fragile? Why not wait a year or two or a few…
Yet I would argue that there is a huge and festering (latent) cost to Washington’s mortgage operations. At some point along the way – and you can count on it being a rather inconvenient juncture for the markets and economy - creditworthiness will become a hot issue. The market will finally demand higher yields for Treasuries, agencies, and GSE MBS – and will surely be less than enamored with our currency. MBS backed by today’s artificially low mortgages will come back to bite. And when the market turns against “federal” debt obligations, you can count on the market really, really turning sour on mortgage risk. That will mark the point when years of government market interventions and distortions come home to roost.