In an especially quiet final week of the year, the S&P500 was about unchanged (2010 gain of 12.8%), and the Dow was slightly positive (up 11.0%). The S&P 400 Mid-Caps gave back 0.4%, but finished the year up 24.9%. The small cap Russell 2000 slipped 0.7%, while ending 2010 with a gain of 25.3%. The Banks advanced 0.85% (up 22.2%), and the Broker/Dealers added 0.1% (up 5.6%). The Morgan Stanley Cyclicals increased 0.5% (up 25.6%), and the Transports gained 0.5% (up 24.6%). The Morgan Stanley Consumer index was little changed (up 12.4%), while the Utilities slipped 0.2% (up 0.9%). The Nasdaq100 dipped 0.6% (up 19.2%), while the Morgan Stanley High Tech index posted a small advance (up 14.9%). The Semiconductor index was unchanged (up 14.4%). The InteractiveWeek Internet index declined 1.1%, yet ended the year up 31.6%. The Biotechs fell 1.2%, reducing 2010 gains to 37.7%. With bullion jumping $39, the HUI gold index gained 2.4% (up 33.4%).
One-month Treasury bill rates ended the year at 5 bps and three-month bills closed at 12 bps. Two-year government yields dropped 10 bps to 0.54%. Five-year T-note yields ended the week down 7 bps to 1.95%. Ten-year yields dropped 10 bps to 3.30%. Long bond yields ended the week 13 bps lower at 4.34%. Benchmark Fannie MBS yields were 10 bps lower to 4.13%. The spread between 10-year Treasury yields and benchmark MBS yields was little changed at 83 bps. Agency 10-yr debt spreads narrowed 7 bps to 8 bps. The implied yield on December 2011 eurodollar futures sank 16 bps to 0.73%. The 10-year dollar swap spread was little changed at 8.5 bps. The 30-year swap spread increased 4.5 to negative 22.75 bps. Corporate bond spreads were mixed. An index of investment grade bond risk was little changed at 85 bps. An index of junk bond risk declined 7 to 430 bps.
There were no debt issues this week.
Junk bond funds saw inflows of $335 million (from EPFR).
U.K. 10-year gilt yields dropped 11 bps this week to 3.39%, and German bund yields dipped 2 bps to 2.96%. Ireland yields rose 5 bps to 9.05%. Greek 10-year bond yields jumped 27 bps to 12.46%. Ten-year Portuguese yields declined 2 bps to 6.58%, and Spanish yields dipped 2 bps to 5.44%. The German DAX equities index dropped 2.1% (up 16.1%). Japanese 10-year "JGB" yields declined 3 bps to 1.12%. The Nikkei 225 declined 0.5% (down 3.0%). Emerging markets were mostly higher. For the week, Brazil's Bovespa equities index gained 1.2% (up 1.0%), and Mexico's Bolsa rose 1.2% to close the year at a 2010 high (up 20%). South Korea's Kospi index gained 1.0% (up 21.9%). India’s equities index jumped 2.2% (up 17.4%). China’s Shanghai Exchange declined 1.0% (down 14.3%). Brazil’s benchmark dollar bond yields were little changed at 4.62%, while Mexico's benchmark bond yields declined 7 bps to 4.48%.
Freddie Mac 30-year fixed mortgage rates rose 5 bps last week to a 7-month high 4.86% (down 28bps y-o-y). Fifteen-year fixed rates increased 5 bps to 4.20% (down 34bps y-o-y). One-year ARMs sank 14 bps to 3.26% (down 107bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 9 bps to 5.60% (down 60bps y-o-y).
Federal Reserve Credit jumped $19.2bn to a record $2.408 TN (8-wk gain of $127bn). Fed Credit was up $188bn for the year, or 8.5%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 12/29) declined $0.7bn to $3.350 TN. "Custody holdings" increased $395bn in 2010, or 13.4%.
M2 (narrow) "money" supply increased $4.9bn to a record $8.834 TN. Narrow "money" has increased $301bn y-t-d, or 3.6% annualized. Over the past year, M2 grew 3.3%. For the week, Currency slipped $0.5bn. Demand and Checkable Deposits jumped $14.2bn, while Savings Deposits declined $5.8bn. Small Denominated Deposits fell $3.9bn. Retail Money Funds added $1.0bn.
Total Money Market Fund assets (from Invest Co Inst) jumped $22.4bn to $2.810 TN. For the year, money fund assets dropped $483bn.
Total Commercial Paper outstanding declined $5.0bn to $969 billion. CP declined $201bn this year, or 17.2%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg’s Alex Tanzi – were up $1.392 TN y-o-y, or 18.2%, to $9.024 TN.
Global Credit Market Watch:
December 29 – Bloomberg (Brendan A. McGrail and Ashley Lutz): “Tax-exempt municipal bonds are heading for their worst quarterly performance in more than 16 years as yields soared amid a U.S. Treasury selloff and the looming expiration of Build America Bonds. Municipal investments have lost 4.5% this quarter through Dec. 27…”
December 30 – Bloomberg (Tim Catts and Sapna Maheshwari): “Corporate bond sales worldwide topped $3 trillion for a second straight year, led by the highest-ever issuance of junk-rated debt… Ally Financial Inc., Ford Motor Credit Co. and 509 other speculative-grade companies sold $287 billion of debt in the U.S., smashing the previous record of $162.7 billion in 2009… Yields on investment-grade corporate bonds worldwide fell to an average of 3.36% on Oct. 11, the lowest ever level for the daily data that began in 1996… Companies in the U.S. sold $844 billion of investment-grade bonds denominated in dollars this year, a 21% decline from 2009, as borrowers built a $1.17 trillion cash hoard, the most on record…”
December 29 – Bloomberg (Tim Catts): “Companies sold almost twice as much debt with the lowest ratings this year as they took advantage of plunging yields to refinance looming maturities at lower costs. Sales of notes ranked Caa1 or less by Moody’s… accounted for 16% of all junk-rated sales this year, versus 8.5% in 2009… Junk issuance climbed to a record $289 billion this year, including $46.4 billion ranked in the CCC tier or lower… That compares with $162.7 billion sold last year, of which $13.9 billion had the lowest grades.”
December 29 – Bloomberg (Kristen Haunss): “Leveraged-loan issuance in the U.S. more than doubled this year… More than $369 billion of loans were raised as of Dec. 28… up from $170 billion in 2009… Interest rates fell to 3.91 percentage points more than the London interbank offered rate on average, from 10.28 percentage points at the end of 2009…”
December 27 – Bloomberg (Sarah Mulholland): “Bond offerings tied to automobile loans and leases are poised to dominate sales of asset-backed debt for a third straight year in 2011 after issuance of all types of the securities plunged 31% in 2009. Vehicle debt bundled into securities will likely total from $70 billion to $75 billion, up as much as 23% from 2010… according to Barclays Capital. Bond sales linked to auto and education loans, and credit cards may reach $115 billion in 2011… Total issuance fell to $92 billion this year from $134 billion as banks relied more heavily on deposits to fund credit card lending and the Federal Reserve ended its Term Asset-Backed Securities Loan Facility…”
Global Government Finance Bubble Watch:
December 31 – Financial Times (Kevin Brown and Toni O’Loughlin): “Emerging Asia’s central banks are imposing fresh administrative controls on local banks as fears rise of volatile currency movements and asset price bubbles caused by the knock-on effects of loose US monetary policy. In the latest sign of growing nervousness about the scale of financial inflows from the west, Indonesia announced more than 20 technical measures designed to minimise inflationary pressures and the risk of a sudden reversal of fund flows. The announcement followed moves by Taiwan to tighten curbs on exchange rate derivatives and rising expectations in Seoul that South Korea will significantly reduce limits on banks’ holdings of exchange derivatives in January. Thailand imposed a 15% withholding tax on capital gains and interest payments relating to government and state-owned company bonds, signalling that it was prepared to take tough measures to curb inflows of ‘hot money’.”
December 31 – Wall Street Journal (Arran Scott, Aries Poon, and Ditas Lopez): “Central banks in South Korea, Malaysia and Thailand are believed to have intervened in foreign-exchange markets Thursday as Asian currencies surged against the dollar on optimism about the region's economic outlook, underscored by strong economic data from China and signals that the yuan will continue to strengthen.”
December 30 – Bloomberg (Rita Nazareth): “Marc Faber… said U.S. Treasuries are a ‘suicidal’ investment. Government bonds are likely to decline, said Faber, who publishes the Gloom, Boom and Doom report… ‘This is a suicidal investment,’ Faber said… ‘Over time, interest rates on U.S. Treasuries will go up. Investors will gradually understand that the Federal Reserve wants to have negative real interest rates. The worst investment is in U.S. long-term bonds.’”
December 30 – Bloomberg (Emma Charlton): “Switzerland’s franc jumped to a record against the euro and the dollar as investors bet its economy is set to outperform the euro zone and U.S. next year.”
December 30 – Bloomberg (Monami Yui): “The Australian dollar traded near the highest level since 1982 as signs the U.S. economic recovery is gaining momentum spurred demand for higher-yielding assets.”
December 29 – Bloomberg: “Chinese executives are reducing support for a stronger yuan as they criticize U.S. monetary easing for weakening the dollar and fueling asset bubbles in emerging-market economies. Shen Wenrong, chairman of Jiangsu Shagang Group Co., the nation’s biggest private steelmaker, said China should only allow a ‘token’ appreciation while the U.S. is ‘printing money to stoke inflation.’ Ma Weihua, chief executive officer of China Merchants Bank Co., said the yuan shouldn’t climb ‘too fast’ and the Federal Reserve must show more restraint after announcing plans to buy $600 billion of Treasuries.”
The dollar index dropped 1.9% in 2010's final week to 78.968, reducing the year's gain to 1.4%. On the upside for the week, the New Zealand dollar increased 4.1%, the Swiss franc 2.9%, the Norwegian krone 2.5%, the South Korean won 2.5%, the Japanese yen 2.2%, the Swedish krona 2.1%, the Euro 2.0%, the Danish krone 2.0%, the Australian dollar 1.9%, the Brazilian real 1.8%, the South African rand 1.6%, the Taiwanese dollar 1.3%, the Singapore dollar 1.2%, the British pound 1.1%, the Canadian dollar 1.0%, and the Mexican peso 0.2%.
December 30 – Financial Times (Javier Blas): “Cereals, iron ore and oil. The three commodities, the most important for the day-to-day working of economies around the world, could derail the recovery next year. The cost of cereals, oil and iron ore has surged already to two-year highs, up between 40 and 150 per cent from the lows of 2009 at the height of the global financial crisis, and analysts and traders generally anticipate further increases into next year. The three are critical for the world – both in economic and political terms. For example, high prices for cereals… not only push up food inflation, but could also trigger food riots. The cost of iron ore, used to make steel, is critical to the global economy as it filters into steel prices and, ultimately, into the cost of everyday goods… The same is true for oil prices, which add inflation at the petrol station, but also along the supply chain due to higher power and transport costs.”
December 29 – Bloomberg (Claudia Carpenter): “Sugar extended gains to a 30-year high in New York, and climbed to a 21-year high in London, on speculation floods will prevent a bigger crop in Australia, the world’s third-largest exporter.”
December 29 – Bloomberg (Jeff Wilson): “Rice futures rose the most allowed by the Chicago Board of Trade after flooding reduced production in Thailand, the world’s biggest exporter… ‘Asian destinations are more aggressive buyers of U.S. rice,’ said Roy Huckabay, an executive vice president for the Linn group in Chicago.”
The CRB index gained 1.0%, increasing 2010 gains to 17.4%. The Goldman Sachs Commodities Index (GSCI) added 0.6% (up 20.4%). Spot Gold rallied 2.8% to a record $1,421 (up 29.5%). Silver surged 5.5% to $30.93 (up 84%). February Crude slipped 11 cents to $91.40 (up 15%). February Gasoline added 0.3% (up 19%), and February Natural Gas jumped 6.3% (down 21%). March Copper rose 4.1% to a new record high (up 33%). March Wheat gained 1.4% (up 47%), and March Corn rose 2.4% (up 52%).
China Bubble Watch:
December 27 – Bloomberg: “China continues to face an ‘arduous task’ in managing credit and liquidity next year, while containing financial risks, the central bank said today… The People’s Bank of China will ‘seriously’ implement prudent monetary policy and prioritize stabilizing overall price levels in 2011, it said in a statement posted… Premier Wen Jiabao said… that inflation expectations were ‘more dire’ than inflation and that government measures to curb the nation’s property market weren’t well implemented. The central bank will deploy various monetary instruments to manage liquidity and steer credit growth to normal levels, it said… Credit should grow in a ‘reasonable and moderate’ manner, the central bank said.”
December 27 – Bloomberg: “China’s Premier Wen Jiabao said measures to curb the country’s property market weren’t well implemented and reiterated his goal for home prices to return to a ‘reasonable level’ during his term that ends in 2012. The government will also increase the supply of affordable housing and introduce more measures to curb speculation, he said… China’s land sales are expected to top 2 trillion yuan ($302 billion) this year from 1.5 trillion yuan in 2009…”
December 27 – Bloomberg: “Chinese industrial companies’ profits rose 49.4% in the 11 months through November from a year earlier, putting pressure on the central bank to add to this year’s two interest-rate increases. Net income climbed to 3.88 trillion yuan ($585 billion)…”
December 28 – Bloomberg: “Beijing will raise the minimum wage by 20.8% in 2011, becoming the latest local government to lift pay in a country where inflation is running at the fastest clip in more than two years. The increase to 1,160 yuan ($175) a month… the second boost this year, will take effect on Jan. 1… The city will also raise pension and unemployment benefits… Local governments are augmenting wages to head off worker unrest and help households cope with accelerating inflation, which reached a 28-month high of 5.1% in November.”
December 28 – Bloomberg (Toru Fujioka and Keiko Ujikane): “Japanese Finance Minister Yoshihiko Noda renewed his warning to take “bold” action against the yen’s advance if needed, a sign of concern among policy makers about the currency’s climb slowing the recovery. The yen’s recent appreciation has been “one-sided,” Noda told reporters in Tokyo today, adding that the government will take “bold action when moves are excessive.” Economy Minister Banri Kaieda said “abrupt yen moves must be avoided.”
December 30 – Bloomberg (Kartik Goyal): “India’s inflation remains at ‘elevated levels,’ the central bank said, signaling it may resume raising interest rates after keeping them unchanged this month because of a cash crunch in the banking system.”
December 30 – Bloomberg (Tushar Dhara): “India’s Finance Minister Pranab Mukherjee raised his inflation forecast for the current year after an index of food prices surged to a 10-week high. The benchmark wholesale-price inflation rate may be ‘around’ 6.5% by March 31… more than the 6% prediction he made on Dec. 14. Food inflation rose 14.44% in the week to Dec. 18 from a year earlier…”
Asia Bubble Watch:
December 30 – Bloomberg (Eunkyung Seo and William Sim): “South Korea’s industrial production increased 10.4 percent in November from a year earlier…”
December 29 – Bloomberg: “Vietnam’s economic expansion accelerated in the fourth quarter, adding pressure on the central bank to curb credit growth to prevent overheating. Gross domestic product grew 7.34% in the three months through December from a year earlier…”
December 27 – Bloomberg (Joel Guinto): “The Philippine economy grew around 6.5% in the fourth quarter, driven by consumption, Economic Planning Secretary Cayetano Paderanga told reporters…”
December 29 – Bloomberg (Clarissa Batino and Francisco Alcuaz Jr.): “The Philippines plans to boost debt sales by 52% in the coming quarter, taking advantage of record-low borrowing costs to finance its budget deficit.”
Unbalanced Global Economy Watch:
December 29 – Bloomberg (Katya Kazakina and Scott Reyburn): “The value of the world’s most expensive items sold at auction more than doubled in 2010 as the top end of the market bounced back from the financial crisis. The priciest 10 lots amounted to $698.6 million, compared with the combined $326.1 million of 2009… Buyers around the globe snapped up works by trophy-name 20th-century artists, and historic Chinese art ousted European Old Masters as the other main contributor.”
December 30 – Bloomberg (Jones Hayden): “European retail sales increased at the fastest pace in 2 1/2 years in December, signaling consumer spending is gaining strength in the 16 nations using the euro.”
December 30 – Bloomberg (Charles Penty): “Spain has between 700,000 and 1.1 million unsold homes, an amount that will drag on a recovery in the housing market as prices will probably keep falling in 2011, the Bank of Spain said.”
December 30 – Bloomberg (Lorenzo Totaro): “Italian business confidence rose for a third month to the highest in almost three years as executives shared consumers’ optimism about the economic recovery.”
December 27 – Bloomberg (Paul Abelsky): “Russia’s manufacturing growth jumped in December, accelerating at the fastest pace since March 2008, as companies benefited from demand for exports and employers boosted hiring at the highest rate in more than four years.”
U.S. Bubble Economy Watch:
December 27 – Bloomberg (David Altaner): “U.S. health-insurance costs are rising more quickly than the ability of U.S. families to pay and the gap is widening, according to the Commonwealth Fund. …private-insurance premiums for families rose three times faster than median household income over six years… Deductibles… rose almost five times faster, the fund said. ‘Families are being priced out of the market,’ said Cathy Schoen, an economist with the fund… ‘The consequences are less adequate insurance coverage, costlier insurance coverage, higher rates of no coverage and growing stress on the family.’”
Central Bank Watch:
December 27 – Bloomberg (Toru Fujioka): “A Bank of Japan board member said there’s uncertainty about the U.S. Federal Reserve’s quantitative easing policy, minutes from the bank’s policy- setting meeting showed. One ‘member was of the view that the effects of the measure taken’ by the Fed ‘were highly uncertain and growth in the U.S. economy was still likely to remain low for some time…’”
New York Watch:
December 30 – Associated Press: “New York commuters are facing a double-whammy: a blizzard that paralyzed the transit system and fare increases that have left some riders fuming. The Metropolitan Transportation Authority fare hike for riding the city's subways, buses and commuter rails is increasing for the third time in three years. It comes just months after severe cuts to service.”
December 30 – Bloomberg (Michael Quint and Martin Z. Braun): “A state authority may decide today whether to assert control over Nassau County’s finances, moving beyond an oversight role because elected officials haven’t closed next year’s $343 million budget gap.”
December 28 – Bloomberg (Darrell Preston): “The cost of insuring Illinois’s bonds against default rose to the highest level in five months as the state headed for the new year without a plan to finance a $3.7 billion pension-fund contribution. The cost of credit-default swap insurance on the lowest-rated state after California has risen 16% to $330,000 to protect $10 million of debt…”
December 28 – Bloomberg (Tim Jones and Darrell Preston): “Illinois Governor Pat Quinn is considering borrowing $15 billion to pay overdue bills and balance the biggest budget deficit in the state’s history. The plan is among a range of proposals that Quinn is discussing with state lawmakers as they prepare to return to Springfield Jan. 3 for the final days of the legislative session… Illinois faces a budget shortfall of at least $13 billion because of declining tax revenue.”
December 30 – Bond Buyer (Caitlin Devitt): “Indiana cities would be allowed to file for Chapter 9 bankruptcy protection under a bill touted by Republican Gov. Mitch Daniels. Daniels this week called the measure - Senate Bill 150 - a ‘useful mechanism’ for helping fiscally stressed cities that would help provide clarity on the topic of municipal bankruptcy.”
December 28 - Bond Buyer (Caitlin Devitt): “Detroit has filed its annual audit on time for the first time in five years. The 237-page financial report… warns that the city faced a total deficit of $1.6 billion as of June 30… The deficit grew by $692 million over the previous year, the bulk of which was due to a change in accounting rules that requires governments to now report expected future costs of derivatives.”
Real Estate Watch:
December 28 – Bloomberg (Bob Willis): “Home prices dropped more than forecast in October, a sign housing will remain a weak link as the U.S. recovery accelerates into the new year. The S&P/Case-Shiller index of property values fell 0.8% from October 2009, the biggest year-over-year decline since December 2009… A wave of foreclosures waiting to reach the market means home prices will remain under pressure in 2011, representing a risk to household finances. Federal Reserve policy makers this month said ‘depressed’ housing and high unemployment remained constraints on consumer spending, reasons why they reiterated a plan to expand record monetary stimulus.”
Year in Review:
The return of Bubble Dynamics was the overriding thesis coming into 2010. The extraordinary global fiscal and monetary response to the 2008 bursting of the mortgage/Wall Street finance Bubble had unleashed the “global government finance Bubble.” This Bubble analysis implied bi-polar outcome possibilities: the Bubble would gain further momentum - or it would burst. “Muddling through” is simply not a Bubble earmark. And we’re not witnessing some “new normal” at work, but rather “The Latest Abnormal” in a prolonged cycle of policy-induced boom and bust dynamics. For this phase of the cycle, the Bubble has invaded the very heart of the Credit system. Normal does not apply.
It is the nature of Bubbles that, if accommodated by loose finance, they expand, broaden and gain increasing momentum. In a world of loose “money,” unchecked speculation will have a propensity for evolving into intense speculative excess. Yet fragile underpinnings - for global economies, Credit systems and markets - ensured acute vulnerability and the return to crisis conditions in the event of faltering confidence in marketplace liquidity conditions or waning faith in government stimulus measures.
Bullish optimism was running high to begin the New Year. Coming off of a spectacular stock market rally and 5.0% GDP growth in Q4 2009, the consensus view was calling for the type of typically robust recovery that would follow a steep economic pullback. Financial conditions were abnormally loose and mortgage rates unusually low, seemingly implying a strong recovery for our nation’s battered housing markets. Home sales had gained a head of steam into year-end 2009, and it appeared the worst of the storm had passed. A housing recovery was expected to work wonders on the financial sector and real economy.
The bears saw things differently. The most popular bearish view focused on ongoing mortgage troubles and “deleveraging.” Some of the more vocal bears spoke of persistent Credit contraction. Indeed, contracting household mortgage debt and stagnant corporate borrowings were leading to a highly unusual decline in private-sector Credit. Emboldening this line of analysis, bank Credit was continuing to contract and “money” supply growth remained tepid.
Yet the conventional bearish view tended to downplay the impact from the massive expansion of government debt. From my analytical perspective, a debt expansion of such magnitude should be the analytical centerpiece. Total Non-financial debt actually expanded 3.0% in 2009 and then accelerated to 4.3% annualized in Q1 2010 and 4.7% in Q2. On the back of unprecedented (double-digit to GDP) peacetime federal borrowings, total system Credit was expanding – not contracting. The bearish Credit collapse thesis was flawed.
Massive government borrowing and spending stabilized incomes, home prices, securities markets, household net worth, consumption and corporate earnings. And the unprecedented expansion of the Fed’s (and global central banks’) balance sheet ensured the type of liquidity overabundance necessary for the marketplace to accommodate our government’s insatiable borrowing appetite.
There was a lingering problem, however, in that the Federal Reserve expected to actually begin unwinding its crisis-period liquidity operations. I don't believe policymakers had any plans for ongoing market intervention and liquidity support mechanisms. Chairman Bernanke went to some lengths to explain the Fed’s so-called “exit strategy.” It was not to be.
Global markets were hit with another ill-timed shock when the Greek debt crisis became a systemic issue in late-April. Prior to the Greek crisis, the markets (especially within the global leveraged speculating community) presumed that policymakers had things well under control. Concerted global fiscal and monetary stimulus was supposed to have ensured highly-liquid markets and a sustainable recovery. “Risk on” was back on.
Suddenly, the market convulsed and the leveraged players were again caught on the wrong side of faltering markets. The Credit default swap (CDS) market for European sovereign debt dislocated and the entire debt marketplace was hit with another destabilizing bout of illiquidity. This wasn't supposed to happen; governments couldn't actually be shut out of the debt market and, perhaps, even default - could they? Deleveraging and de-risking returned with vengeance. Risk aversion and liquidity issues quickly resurfaced in the U.S. debt markets – jeopardizing the stock market and economic recoveries. Cracks were again forming in the foundation of the entire global Credit system.
What happened next will be debated for decades. The Federal Reserve began discussing – and later implementing – a second massive monetization of U.S. debt securities (in this case, $600bn of U.S. Treasurys). And I would add that, in this matter, size didn’t really matter all that much. What was critical, though, was that the Federal Reserve had completely scrapped the notion of removing crisis-period stimulus - and was instead content to solidify the markets’ premise that the Fed had become a steadfast backstop for marketplace liquidity. The Fed’s dramatic move – along with various market support measures by the ECB, BOJ and others – provided the missing piece for the unfolding global government finance Bubble.
The prospect of QE2 weakened the dollar and supported price inflation for risk assets the world over. And the weaker the dollar – the more required buying and “recycling” of surfeit global dollar balances right back into the Treasury market. The Treasury marketplace was pushed to even greater Bubble excess – in the process emboldening the analysts that had been trumpeting deflation risk. "Money" flooded out of money fund and deposits and into U.S. and global bond funds. Like tech stocks that could never go down and home prices that could only go up, the view took hold that bond yields would only go lower.
Meanwhile, dollar weakness and attendant global liquidity excess set off a major run in commodities markets (certainly not unlike the policy-induce reflation after the subprime eruption in the autumn of 2007). Both the precious and industrial metals went on a record run, although some of the biggest gains were posted by the agriculture commodities. Energy prices lagged somewhat but crude ended the year above $91. The CRB commodities index closed the year at the high since 2008. And by the end of the year it was clear that China, India and greater Asia had serious inflation and “hot money” issues. Cautious little baby step policy moves aren’t going to get the job done.
QE2 was met with rebuke at home and from abroad. As global equities surged higher, these protests mostly subsided. Looking at Treasury yields and commodities prices, a decent case can be made that QE2 was counterproductive. The last thing the U.S. household sector needs right now is higher mortgage rates and gas prices. But these issues were trumped by the stunning fourth quarter gains posted by U.S. stocks. And there’s nothing like a surging stock market to incite optimistic analysis and embolden the bulls.
From my bearish perspective, the marketplace has been disregarding some important developments. For starters, despite the massive $4 trillion increase in government liabilities in just nine quarters, an extended period of near zero interest rates, and unprecedented Federal Reserve quantitative easing, the unemployment rate will end the year near 9.8%. And despite extremely low mortgage yields, our nation’s housing market is barely treading water. Developments – or lack of them – in the real economy are disconcerting and supportive of the secular bear thesis.
There is also the important issue of rising global yields. Moreover, the debt markets have become increasingly discriminating. A few months back – in the heat of the euphoric “endless liquidity for everybody forever” backdrop – the markets were content to readily finance just about any borrower. More recently, in somewhat of a return to sobriety, the marketplace has looked increasingly askance at borrowers such as Ireland, Spain and U.S. municipalities. This is a serious development for the global government finance Bubble – but perhaps not as serious in the short-term.
The U.S. financial system these days is being completely dominated by the expansion of federal borrowings. This creates different financial and economic dynamics than we’re used to analyzing. In contrast to when mortgage Credit was playing a predominate role during that Bubble period, a rise in market yields today will have virtually no near-term impact on the quantity of (government) Credit being issued. And especially with the extension of Bush era tax cuts along with additional stimulus measures – the speculative U.S. stock market has taken great comfort from the seeming sustainability of the tepid (government-dominated) U.S. economic recovery.
I have written that policymakers were more than content in 2010 to Kick the Can Down the Road. In fact, it was a year where policymaking became completely unbounded. The 26% gain in the small cap Russell 2000 and 26% advance in the S&P400 Mid-Cap index support our contention that Bubble dynamics more than persevered through year 2010. The Bernanke Fed certainly ensured that financial speculation gained at the expense of savers. And the municipal debt market now confronts the dilemma resulting from Bubble-related risk distortions, misperceptions and investor disappointment – and a problematic flow reversal out of the sector. Was year-end dollar weakness a harbinger of things to come?