For the week, the S&P500 (up 13.5% y-t-d) and the Dow (up 8.1%) both declined 1.8%. The Morgan Stanley Cyclicals fell 2.5% (up 47.6%), and Transports declined 3.0% (up 4.4%). The Banks dropped 2.8% (up 1.1%), while the Broker/Dealers gained 1.1% (up 50.3%). The Morgan Stanley Consumer index added 0.3% (up 15.1%), while the Utilities were hit for 2.6% (down 3.1%). The broader market gave up some ground. The S&P 400 Mid-Caps dropped 2.2% (up 23.3%), and the small cap Russell 2000 sank 3.1% (up 16.2%). The Nasdaq100 declined 1.9% (up 37.2%) and the Morgan Stanley High Tech index fell 1.6% (up 51.3%). The Semiconductors were slammed for 4.5% (up 44.5%). The InteractiveWeek Internet index dipped 1.6% (up 57.9%). The Biotechs sank 4.1% (up 37.4%). While Bullion advanced $12, the volatile HUI gold index dipped 0.7% (up 30.5%).
One-month Treasury bill rates ended the week at 3 bps, and three-month bills closed at 10 bps. Two-year government yields dropped 11 bps to 0.76%. Five-year T-note yields sank 15 bps to 2.15%. Ten-year yields were 10 bps lower to 3.22%. Long bond yields declined 9 bps to 4.00%. Benchmark Fannie MBS yields sank 15 bps to 4.12%. The spread between 10-year Treasuries and benchmark MBS narrowed 5 to 90. Agency 10-yr debt spreads narrowed 4 to 10 bps. The implied yield on December 2010 eurodollar futures dropped 13 bps to 1.635%. The 2-year dollar swap spread increased 3.5 to 35.25 bps; the 10-year dollar swap spread was unchanged at 16.25 bps; and the 30-year swap spread declined 0.25 to negative 12 bps. Corporate bond spreads were mixed. An index of investment grade bond spreads widened 12 bps to 145, and an index of junk spreads narrowed another 27 to 603 bps.
Corporate debt issuance is booming. Investment grade issuers included Citigroup $5.0bn, L-3 Communications $1.0bn, Tyco $500 million, Penn Electric $500 million, Weyerhaeuser $500 million, Guardian Life $400 million, Entergy Gulf States $300 million, and Alliant Energy $250 million.
Junk issuers included Elan $625 million, Cincinnati Bell $500 million, Transdigm $425 million, Windstream $400 million, Tops $275 million, Gannett $500 million, Stream Global Services $200 million and Venoco $150 million.
I saw no converts issued.
International dollar-denominated debt issuance remained strong. Issuers included Enel Finance $4.5bn, Italy $2.5bn, Brazil $1.5bn, Abu Dhabi Commercial Bank $1.0bn, Arcelormittal $1.0bn, Nordic Investment Bank $1.0bn, Volvo $750 million, Embraer $500 million, Dexus Finance $300 million, Ceva Group $210 million and Caribbean Development Bank $120 million.
U.K. 10-year gilt yields dropped 17 bps to 3.44%, and German bund yields fell 13 bps to 3.12%. The German DAX equities index declined 2.0% (up 13.7% y-t-d). Japanese 10-year "JGB" yields fell 6 bps to 1.25%. The Nikkei 225 sank 5.2% (up 9.8%). Emerging markets were resilient. Russia’s RTS equities index was unchanged (up 93.8%). India’s Sensex equities jumped 2.6% (up 77.6%). China’s Shanghai Exchange declined 2.1%, lowering 2009 gains to 52.6%. Brazil’s benchmark dollar bond yields declined 3 bps to 5.07%. Brazil’s Bovespa equities index gained 1.4% (up 62.9% y-t-d). The Mexican Bolsa slipped 0.3% (up 28.1% y-t-d). Mexico’s 10-year $ yields declined 3 bps to 5.28%.
Freddie Mac 30-year fixed mortgage rates were down 10 bps to an 18-wk low 4.94% (down 106bps y-o-y). Fifteen-year fixed rates dropped 10 bps to 4.36% (down 142bps y-o-y). One-year ARMs declined 3 bps to 4.49% (down 63bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 6 bps to 6.11% (down 107bps y-o-y).
Federal Reserve Credit declined $12.4bn last week to $2.120 TN. Fed Credit has declined $126bn y-t-d, although it expanded $732bn over the past 52 weeks (53%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/30) added $583 million to a record $2.855 TN. "Custody holdings" have expanded at a 17.9% rate y-t-d, and were up $389bn over the past year, or 15.8%.
M2 (narrow) "money" supply declined $8.0bn to $8.310 TN (week of 9/21). Narrow "money" has expanded at a 2.0% rate y-t-d and 5.2% over the past year. For the week, Currency added $1.4bn, while Demand & Checkable Deposits sank $32.4bn. Savings Deposits jumped $40.7bn, while Small Denominated Deposits dropped $9.5bn. Retail Money Funds fell $8.1bn.
Total Money Market Fund assets (from Invest Co Inst) sank $53.5 to $3.429 TN. Money fund assets have declined $401bn y-t-d, or 14.0% annualized. Money funds increased $30bn, or 0.9%, over the past year.
Total Commercial Paper outstanding jumped another $19.7bn (7-wk gain of $158bn) to a 17-wk high $1.232 TN. CP has declined $450bn y-t-d (36% annualized) and $375bn over the past year (23%). Asset-backed CP added $1.5bn to $522bn, with a 52-wk drop of $202bn (28%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $287bn y-o-y to $7.213 TN. Reserves have increased $447bn year-to-date.
Global Credit Market Watch:
September 30 – Bloomberg (Timothy R. Homan and Sandrine Rastello): “The International Monetary Fund cut its projection for global writedowns on loans and investments by 15% to $3.4 trillion, citing improvements in credit markets and initial signs of economic growth.”
September 30 – MarketWatch (Laura Mandaro): “Companies found investors newly receptive to fresh stock and debt offerings in the third quarter… As September winds down, U.S. companies are on track to have issued $39 billion in new stock and convertible debt and $156 billion in bonds, according to Dealogic. The combined capital raising has increased 57% from the same period last year… The total shrank 43% from the second quarter, a period when secondary stock offerings surged as banks sold shares to repay U.S. government bailout funds.”
October 1 – Wall Street Journal (Aaron Lucchetti): “A steady stream of new share and bond issues combined with a stock-market rally to give Wall Street reason to cheer during the third quarter. The three-month period ended Wednesday wasn’t close to setting records for issuance, but traders and bankers welcomed even an average quarter… The volume of third-quarter stock and bond sales, $1.5 trillion, was down 25% from the second quarter but up 69% from the third quarter of 2008..."
October 2 – Bloomberg (John Detrixhe): “Citigroup Inc., ranked third among U.S. lenders by assets, and the finance arm of General Electric Co. issued $8.5 billion of U.S.-guaranteed bonds this week, the most in six months, taking advantage of federal backing from a program the government plans to end.”
Government Finance Bubble Watch:
September 30 – Dow Jones: “The International Monetary Fund needs an appropriate exit strategy from special stimulus measures when the financial crisis ends, the Deutsche Bundesbank said… ‘At the end of the current financial crisis, it should be reviewed whether the increase in special drawing rights...should be withdrawn, either partially or entirely, to limit risks to political stability,’ Hans-Helmut Kotz, a member of the German central bank’s executive board, said…”
September 30 – Bloomberg (Mark Deen and Francois de Beaupuy): “French President Nicolas Sarkozy says that even with a record budget deficit, France needs to spend more borrowed money to kick start economic growth. Promising a ‘grand loan’ to finance spending on everything from Paris’s rail system to new supercomputers, Sarkozy is set to swell a budget shortfall that already is the highest since 1959…”
September 30 – Bloomberg (Gabi Thesing): “The European Central Bank will lend banks less money than economists forecast in its second 12-month auction of unlimited funds, indicating banks’ need for cash has eased for now. Banks bid for 75.2 billion euros ($110bn) at the current benchmark interest rate of 1%... It loaned a record 442 billion euros at the first auction in June…”
Currency Watch:
September 29 – Bloomberg (James Tyson and Michael McKee): “Former Federal Reserve chairman Paul Volcker said the rise of China and other emerging economies has underscored a decline in the comparative economic and intellectual leadership of the U.S. ‘I don’t know how we accommodate ourselves to it,’ Volcker… said… ‘You cannot be dependent upon these countries for three to four trillion dollars of your debt and think that they’re going to be passive observers of whatever you do.’”
The dollar index this week gained 0.3% to 77.03 in continued volatile currency trading. For the week on the upside, the South Korean won increased 1.0%, the Canadian dollar 0.9%, the Brazilian real 0.5% and the Taiwanese dollar 0.4%. On the downside, the South African rand declined 2.9%, the Swedish krona 1.3%, the Danish krone 0.8%, the Euro 0.7%, the Swiss franc 0.7%, and the Mexican peso 0.5%.
Commodities Watch:
September 30 - Bloomberg (John Duce): “China’s sovereign wealth fund bought a stake in the London-traded unit of Kazakhstan’s state-run energy company, taking its spending on resources to at least $3.69 billion this month.”
Gold gained 1.2% to close at $1003 (up 13.7% y-t-d). Silver added 0.7% to $16.18 (up 43% y-t-d). November Crude rallied $3.72 to $69.74 (up 56% y-t-d). November Gasoline jumped 6.1% (up 64% y-t-d), while November Natural Gas fell 4.9% (down 16% y-t-d). December Copper slipped 2.1% (up 90% y-t-d). December Wheat fell 1.9% (down 28% y-t-d), while December Corn was little changed (down 18% y-t-d). The CRB index increased 2.0% (up 11.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) rose 3.0% (up 30.2% y-t-d).
China Bubble Watch:
September 28 – Bloomberg: “China’s government stimulus may risk overheating some parts of the economy as local authorities rush to expand fixed-asset investment, said Qu Hongbin, chief China economist at HSBC… ‘Local governments in China have laid out massive investment plans this year and with an explosion of bank loans funding the construction, overheating in some areas and price increases in raw materials may be on the horizon,” Qu said… ‘How to address the unbalanced recovery will be a test for the government,’ said Qu. Premier Wen Jiabao’s 4 trillion yuan ($586 billion) stimulus package to build airports, power grids, roads and low- cost homes is driving the world’s third-largest economy out of the steepest slump in more than a decade. Still, Wen said this month that his government ‘cannot and will not’ halt stimulus because the nation’s economic rebound isn’t yet solid.”
September 30 – Bloomberg: “Chinese Premier Wen Jiabao pledged his government will further strengthen its economic policies and contribute to a global recovery. China aims to achieve ‘stable and relatively fast’ growth and contribute to a global economic recovery by maintaining the continuity and stability of its policies and improving their effectiveness and sustainability, Wen said… ‘China needs the world and the world needs China,’ Wen said in a nationally televised speech delivered before a banquet in Beijing celebrating the 60th anniversary of the founding of the People’s Republic of China.”
September 29 – Bloomberg (Chia-Peck Wong): “Swire Pacific Ltd., building architect Frank Gehry’s first Asian residential project, said luxury homes in Hong Kong are in short supply as mainland Chinese buyers swooped for apartments. ‘There is relatively short supply at the high end,’ Martin Cubbon, an executive director of the company and chief executive officer of… Swire Properties Ltd., said… There is ‘enormous liquidity and buying’ from Chinese residents… Luxury home prices in Hong Kong have climbed as much as 28% in the first nine months of the year…”
October 2 – Bloomberg (Kelvin Wong and Nipa Piboontanasawat): “Glorious Property Holdings Ltd. fell 15% on its first day of trading in Hong Kong, the fifth straight debut slump for an initial public offering in the city….The developer joins four companies… in falling on the first day in the past two weeks.”
Japan Watch:
October 2 – Bloomberg (Aki Ito and Toru Fujioka): “Japan’s jobless rate unexpectedly retreated in August from a record and household spending rose as the nation emerged from its worst postwar recession. The unemployment rate fell to 5.5% from 5.7% in July…”
September 30 – Bloomberg (Masahiro Hidaka and Mayumi Otsuma): “The Bank of Japan may decide as soon as next month to let its emergency corporate-debt buying programs expire as businesses regain access to private funding, people with direct knowledge of the discussions said. Officials are concerned that maintaining their purchases of corporate bonds and commercial paper beyond the scheduled end in December would distort capital markets…”
India Watch:
September 30 – Bloomberg (Thomas Kutty Abraham): “India’s monsoon rainfall, the main source of irrigation for the country’s 235 million farmers, is the weakest in more than three decades, threatening farm output in the world’s second-biggest producer of rice, wheat and sugar. Falls in the June-September season are 23% below the long-period average…”
Asia Bubble Watch:
October 1 – Bloomberg (Shiyin Chen): “Singapore’s private residential property prices rose last quarter for the first time in more than a year… The price index of private residential property climbed 16% to 154.5 from 133.3 in the previous three months…”
September 29 – Bloomberg (Jason Folkmanis): “Vietnam’s economic growth accelerated this quarter, buoyed by domestic demand and government stimulus spending that has revived bank lending. Gross domestic product expanded 5.8% from a year earlier after gaining 4.5% in the previous three months…”
Latin America Watch:
October 1 – Bloomberg (Helder Marinho and Alex Duff): “Rio de Janeiro easily won the vote to stage the 2016 Olympics, becoming the first South American city to host the event and placing Brazil among what its president said is the elite of the world’s nations. The Brazilian city, which proposed investments of $11.1 billion in preparation for the games, got 66 votes in the final round today, while Madrid received 32 in balloting by the International Olympic Committee…”
Unbalanced Global Economy Watch:
September 30 – Bloomberg (Alexandre Deslongchamps): “Canada’s economy unexpectedly stalled in July… Gross domestic product was unchanged during the month…”
September 30 – Bloomberg (Daryna Krasnolutska): “Ukraine’s economy plunged a revised 17.8% in the second quarter from the same period a year ago, as industrial production and construction plummeted under the weight of the global financial crisis.”
September 30 – Bloomberg (Jacob Greber): “Australian retail sales, approvals to build private homes and bank mortgage lending jumped in August, stoking speculation the central bank will raise borrowing costs from a half-century low in coming weeks.”
U.S. Bubble Economy Watch:
October 1 – American Bankers: “Continued job losses, shorter work weeks and falling incomes are being cited as major factors in another record rate of consumer delinquencies in the second quarter of 2009… Delinquency rates hit record quarterly highs in three key loan categories: home equity loans, home equity lines of credit, and bank cards. The composite ratio, which tracks eight closed-end installment loan categories, also hit a record high at 3.35% of all accounts… compared to 3.23%... the previous quarter.”
October 1 – Bloomberg (Aaron Kuriloff): “Anthony Noto, the National Football League’s chief financial officer hired from Goldman Sachs… last year, dons a hard hat for a tour of what will be the most expensive U.S. sports stadium ever built. On this sunny day in mid-2008 in East Rutherford, New Jersey, workers pour concrete and weld steel girders for the unnamed $1.6 billion venue where both the New York Giants and the New York Jets will play… The stadium epitomizes the NFL’s costly building spree during the past 15 years. Many owners used cheap credit to build and renovate 24 of the league’s 31 venues, more than quadrupling debt held by teams and the league to about $9 billion this year from 1996.”
October 1 – Bloomberg (Michael Buteau): “Tiger Woods is the first athlete to surpass the $1 billion mark in career earnings, Forbes magazine reported on its Web site.”
MBS/ABS/CDO/CP/Money Fund and Derivatives Watch:
September 30 – Bloomberg (Michael J. Moore): “Delinquency rates on U.S. mortgages rose in the second quarter… Mortgages 60 days or more past due climbed to 5.3% of loans through June 30, up from 4.8% on March 31 and 3% a year earlier…”
Real Estate Watch:
September 29 – Bloomberg (Nadja Brandt): “U.S. vacation timeshare sales may fall the most this year since the industry gained popularity in the 1970s… Sales may drop 30% this year from 2008, said Howard Nusbaum, president and chief executive officer of the American Resort Development Association…”
Central Banker Watch:
September 30 – Bloomberg (Tasneem Brogger and Marianne Stigset): “Norway’s policy response to the economic crisis has done its job and left the benchmark interest rate ‘extraordinarily low,’ Governor Svein Gjedrem said, as the bank prepares to reverse an easing cycle.”
September 29 – Bloomberg (Denis Maternovsky): “Russia’s central bank lowered its key interest rates by half a percentage point to help stimulate lending in the world’s biggest energy exporter as it recovers from the biggest economic contraction on record. Bank Rossii cut the refinancing rate to 10% from 10.5%...”
Fiscal Watch:
October 2 – Bloomberg (Jonathan D. Salant): “Applications for Social Security benefits rose almost 50% more than expected this year because of the recession, according to the federal retirement program. ‘We are seeing a significant increase in both retirement and disability applications as a result of the recession,’ said Mark Lassiter, a Social Security spokesman… Agency statistics show that 2.57 million people requested benefits, up from the 2.10 million applications received during the previous 12 months.”
Muni Watch:
October 2 – Bloomberg (Jeremy R. Cooke): “State and local governments sold the most long-term taxable debt in six weeks, led by New York City and the Los Angeles Unified School District, with their first issues under the Build America Bonds stimulus program. Taxable, fixed-rate municipal issues rose to $4 billion this week… Tax-exempt sales were $5.2 billion, little changed from the previous week.”
September 30 – Wall Street Journal (Conor Dougherty): “State tax revenues in the second quarter plunged 17% from a year earlier as rising unemployment and reduced spending hurt sales- and income-tax collections… The decline was the sharpest since at least the 1960s. The biggest drop among major revenue sources was in state income taxes, which were down 28% from a year ago. Sales-tax revenues fell 9%.”
September 30 – Bloomberg (Michael McDonald): “Connecticut, the state with the most tax-supported debt, will borrow $2.25 billion over the next two years to balance its budget amid plunging income tax collections.”
New York Watch:
October 2 – Bloomberg (Oshrat Carmiel): “Manhattan apartment prices fell for a second consecutive quarter, helping drive the biggest gain in sales in more than 13 years… The median price slid 8.4% to $850,000 in the third quarter from a year earlier… appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate said… The number of sales jumped 46% from the second quarter…”
September 30 – Bloomberg (David M. Levitt): “Manhattan office rents fell 5.2% in the third quarter from the previous three months… Asking rents fell to an average of $50.98 a square foot from $53.76… broker Studley Inc. said… Rents for the best offices in Manhattan declined 6.4% to $62.38 a square foot in the period.”
The Governator and the Market Operator:
I’ll begin with an excerpt from Bill Gross’s latest Investment Outlook:
“But California’s problems, while somewhat unique and self-inflicted, are really America’s problems, and not just because the California economy is 15% of national GDP. While California’s $26 billion deficit is not directly comparable to the federal gap of $1 trillion-plus, they both reflect a lack of discipline and indeed vision to perceive that the strong growth in revenues was driven by the same excess leverage and same delusionary asset appreciation that was bound to approach cliff’s edge.”
It’s contagious. Both at the state and local level and in Washington, policymakers “lack discipline and indeed vision…” It is said that “bull markets create genius.” I'll suggest that the downside of the Credit cycle fashions lousy policymaking. I feel for the “Governator” and the California legislature, and I feel for our new President and members of Congress. They confront the harsh post-Bubble reality of no win circumstances – wearing big bullseyes on their backs in an age of slings and arrows.
As much as I respect Bill Gross – and can’t take strong exception with much of what he has been saying and writing of late – I just can’t find it within myself to move on. Newer readers might be unfamiliar with my long-standing - and one-way - debate with the McCulley/Gross view of the financial world. They have over the years been leading proponents for the popular consensus ideology that I have labeled “inflationism.”
It is a basic tenet of Credit Bubble theory that if the system inflates the quantity of Credit it will be spent. Credit Bubbles are fundamentally about a lack of discipline – one could say a confluence of undisciplined behavior. Credit Bubbles evolve specifically because of undisciplined monetary system management, undisciplined lending, undisciplined borrowing, undisciplined investment, undisciplined speculation and, at the end of the day, undisciplined spending throughout. And there are some absolutes: Inflated mortgage Credit, home price gains, and elevated incomes will absolutely inflate the propensity for undisciplined consumption. Inflated tax receipts will absolutely inflate government expenditures – in California, Washington D.C., and all across the country. The discipline problem goes way back but commenced within the bowels of our new age Credit system.
Mr. McCulley, in particular, was a vocal proponent for post-technology Bubble reflation. This reflation doubled total mortgage Credit in about six years and unleashed Monetary Disorder all over the world. In the process, this historic Credit inflation inflated asset prices, incomes, corporate profits, and government receipts. The state of California was at the epicenter of this massive inflation. Going back to fiscal year 2002-2003, California general fund revenues were about $71 billion. By the beginning of the 2007-2008 year, the state was budgeting for general revenues of $101 billion.
In percentage terms, state revenues inflated about 40% during the five-year boom. And with receipts rising each year, of course legislators were going to extrapolate and increasingly inflate state spending. There’s no mystery here. Keep in mind that in typical Bubble economy form, much of the rising expenditure was the result of inflating costs all along the chain of state services. Those campaigning earlier this decade for aggressive monetary ease to fight deflation got, not surprisingly, more than they bargained for.
In hindsight, it is amazing to contemplate the complete and utter lack of vision that afflicted policymakers throughout the golden state and all across the country. How could they not perceive that sophisticated Wall Street financial leveraging and resulting asset Bubbles were only temporarily inflating their coffers? When seemingly everyone bought into the notion of endless prosperity, why couldn’t they have kept their heads? Just because everyone believed the enlightened Federal Reserve had forever mastered the business cycle, why couldn’t they have been more skeptical? And that the economic community, the regulator community, the Federal Reserve and the marketplace all missed this Credit Bubble dynamic is, apparently, no excuse. As I have often written, I sympathize with post-Bubble policymakers.
It is a tenet of Credit Bubble theory that politicians – given the opportunity – will inflate. There is ample history illuminating the dangerous propensity to run the government printing press. Contemporary analysis gets more complex because of the nature of private-sector Credit and the penchant for government (explicit and implicit) guarantees. During the boom, “money” was burning a hole in policymakers’ pockets, but it was Wall Street and the GSEs commanding the electronic printing press 24/7. By far the most precarious absence of discipline and vision belonged to those Operating in and accommodating this historic private-sector Credit Bubble.
I disagree with the policy of massive deficits. Yet the California and U.S. budget quagmires are the direct consequences of the bursting of the Wall Street/mortgage finance Bubble. And as much as greed and leverage have provided easy scapegoats, responsibility lies first and foremost with the nature of contemporary unchecked finance and flawed “activist” monetary management (trumpeted, not coincidently, by our era’s preeminent market Operators). And as much as the consensus view believes that previous financial maladies have been largely rectified, I see a continuation of the same malignant Credit system dynamics. In short, massive government intrusion into the market pricing of Credit continues to fuel economic maladjustment and Bubble dynamics.
Why did Wall Street issue Trillions of ABS, auction-rates securities, CDOs, and private-label MBS? Because they could. Why did the hedge funds and others leverage so egregiously? Because they were making a bloody fortune and the marketplace was more than ok with it. Why did the GSEs increase their MBS guarantees by $400 billion over the past year, and why did the Treasury issue $1.9 Trillion of Treasuries the past twelve months - and will likely do only somewhat less over the next year? And why are cash-strapped state and local governments borrowing so aggressively these days? It’s because the marketplace continues to readily accommodate Credit excess. Who is demonstrating a lack of discipline and vision – the borrower or the lender? The “Governator” or the market Operator? Is this the way the market pricing system is supposed to function?
Why is the marketplace inherently incapable of disciplining the egregious borrower - whether mortgage debt during that Bubble or government debt today? First of all, there are no inherent system restraints on Credit creation. Recalling the mortgage finance Bubble, recent massive increases in the supply of government debt have been met with a collapse in borrowing costs. Second, the marketplace perceived that fiscal and monetary policymakers were backstopping mortgage Credit during the boom. Today, the market is confident that policymakers are firmly behind the Treasury and agency securities markets. Borrowers are undisciplined for one reason: the distorted market mechanism not only fails to discipline them – it accomplishes the exact opposite.
I could ramble on for pages on the myriad costs associated with unchecked, undisciplined and mispriced finance. Mr. Gross touched upon a key cost, noting today’s uncompetitive California and U.S. economies. This is a key aspect of Bubble economy distortions. The dangerous flaw in inflationism dogma is that the Federal Reserve and policymakers can manipulate the cost and quantity of Credit with positive systemic results. In reality, the consequence of increasingly bold policy activism over time include a more distorted and unbalanced economic structure, as witnessed today. And it is my view that a flawed Credit apparatus, ill-advised government intervention, and dysfunctional market dynamics ensure economic maladjustment gets worse before it gets better.
Saturday, October 4, 2014
09/25/2009 From Bear to Bear *
For the week, the S&P500 declined 2.2% (up 15.6% y-t-d), and the Dow gave back 1.6% (up 10.1% y-t-d). The Morgan Stanley Consumer index dipped 1.1% (up 14.8%), and the Utilities declined 1.5% (down 0.5%). The Morgan Stanley Cyclicals sank 4.4% (up 51.4%), and Transports dropped 4.3% (up 7.7%). The Banks fell 3.3% (up 4.1%), and the Broker/Dealers dropped 3.4% (up 48.7%). The broader market pulled back. The S&P 400 Mid-Caps lost 3.3% (up 26.0%), and the small cap Russell 2000 fell 3.1% (up 19.9%). The Nasdaq100 declined 1.8% (up 39.8%) and the Morgan Stanley High Tech index fell 2.8% (up 53.8%). The Semiconductors declined 1.7% (up 51.3%). The InteractiveWeek Internet index declined 1.5% (up 60.5%). The Biotechs dropped 3.1% (up 43.2%). With Bullion down $16.75, the HUI gold index sank 6.2% (up 31.5%).
One-month Treasury bill rates ended the week at 2 bps, and three-month bills closed at 10 bps. Two-year government yields fell 7 bps to 0.87%. Five-year T-note yields sank 12 bps to 2.30%. Ten-year yields were 14 bps lower to 3.32%. Long bond yields dropped 11 bps to 4.10%. Benchmark Fannie MBS yields fell 12 bps to 4.27%. The spread between 10-year Treasuries and benchmark MBS widened 2 to 95. Agency 10-yr debt spreads narrowed 3 to 13 bps. The implied yield on December 2010 eurodollar futures declined 10.5 bps to 1.765%. The 2-year dollar swap spread declined 4.75 to 32 bps; the 10-year dollar swap spread narrowed 4 to 16 bps; and the 30-year swap spread declined 2.25 to negative 11.75 bps. Corporate bond spreads continue their collapse. An index of investment grade bond spreads bps to a 16-month low 133, and an index of junk spreads narrowed 23 to 635 bps.
Corporate debt issuance is booming. Investment grade issuers included Wells Fargo $2.0bn, Enterprise Products $1.1bn, Potash $1.0bn, Burlington Northern $750 million, Jefferies Group $700 million, Allegheny Energy $600 million, Ohio Power $500 million, Niagara Mohawk $500 million, Kroger $500 million, Thomson Reuters $500 million, BB&T $500 million, Private Export Funding $400 million, Unum Group $350 million, Willis North America $300 million, Cabot Corp $300 million, Arrow Electronics $300 million, GATX $300 million and Viacom $250 million.
Junk bond funds enjoyed inflows of $283 million (from AMG). Junk issuers included Delta Airlines $1.35bn, QVC $1.0bn, Acco Brands $460 million, American Airlines $450 million, Dish $400 million, Geoeye $400 million, Spirit Aerosystems $350 million, Developers Diversified $300 million, Seacor Holdings $250 million, Brandywine $250 million, North American Energy $205 million, Nebraska Book $200 million and Inverness Medical $100 million.
Convert issuance included Incyte $350 million.
International dollar-denominated debt issuance remained strong. Issuers included Mexico $5.5bn, EDP Finance $1.0bn, African Development Bank $1.0bn, Total Capital $1.0bn, Finance for Danish Investment $800 million, Banco Bradesco $750 million, Eurasian Development Bank $500 million, Uruguay $500 million, Arcos Dorados $450 million, and Holcim Capital $1.0bn.
U.K. 10-year gilt yields sank 13 bps to 3.61%, and German bund yields fell 12 bps to 3.26%. The German DAX equities index slid 2.3% (up 16.2%). Japanese 10-year "JGB" yields declined 3 bps to 1.31%. The Nikkei 225 fell 1.0% (up 15.9%). Emerging markets were mostly on the defensive. Russia’s RTS equities index declined 1.6% (up 93.9%). India’s Sensex equities was unchanged (up 73.0%). China’s Shanghai Exchange sank 4.2%, lowering 2009 gains to 55.9%. Brazil’s benchmark dollar bond yields rose 6 bps to 5.12%. Brazil’s Bovespa equities index slipped only 0.6% (up 60.7% y-t-d). The Mexican Bolsa sank 3.9% (up 28.5% y-t-d). Mexico’s 10-year $ yields rose 12 bps to 5.28%.
Freddie Mac 30-year fixed mortgage rates were unchanged at 5.04% (down 105bps y-o-y). Fifteen-year fixed rates dipped one basis point to 4.46% (down 131bps y-o-y). One-year ARMs dropped 6 bps to 4.52% (down 64bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down one basis point to 6.17% (down 101bps y-o-y).
Federal Reserve Credit jumped $44.1bn last week to a 17-wk high $2.133 TN. Fed Credit has declined $114bn y-t-d, although it expanded $998bn over the past 52 weeks (88%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/23) increased $11.6bn to a record $2.854 TN. "Custody holdings" have expanded at an 18.4% rate y-t-d, and were up $432bn over the past year, or 17.9%.
M2 (narrow) "money" supply slipped $3.9bn to $8.303 TN (week of 9/14). Narrow "money" has expanded at a 1.9% rate y-t-d and 7.6% over the past year. For the week, Currency added $0.7bn, and Demand & Checkable Deposits increased $1.2bn. Savings Deposits rose $10.3bn, while Small Denominated Deposits fell $13.1bn. Retail Money Funds declined $2.9bn.
Total Money Market Fund assets (from Invest Co Inst) were little changed at $3.483 TN. Money fund assets have declined $350bn y-t-d, or 12.4% annualized. Money funds increased $85bn, or 2.5%, over the past year.
Total Commercial Paper outstanding jumped another $22.5bn (6-wk gain of $138bn) to a 15-wk high $1.212 TN. CP has declined $469bn y-t-d (38% annualized) and $490bn over the past year (29%). Asset-backed CP rose $19.3bn to $521bn, with a 52-wk drop of $233bn (31%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $285bn y-o-y to $7.211 TN. Reserves have increased $446bn year-to-date.
Global Credit Market Watch:
September 25 – Bloomberg (Jody Shenn): “Cash continues to pour into bond funds… according to Bank of America Corp. analysts. About $295 billion has been added this year to funds targeting debt including corporate bonds, bank loans and municipal notes… Net outflows from equity funds have been trimmed to $31 billion, from $77 billion in April.”
September 23 – Dow Jones (Stan Rosenberg): “California… completed its sale of $8.8 billion in revenue anticipation notes meant mainly to help meet the state’s cash flow needs for the balance of its current fiscal year. Pricing terms remained unchanged from levels set Tuesday in an order period for individual investors at yields of 1.25% for notes coming due next May and 1.5% for June securities.”
September 24 – Bloomberg (Katrina Nicholas): “Junk bond sales in Asia will register robust growth as investor appetite for riskier debt increases and companies turn attention toward 2010 financing requirements, according to Nomura Holdings Inc. Issuance of junk, or high yield, securities in the region will follow a resurgence in U.S. and European sales, Glenn Schiffman… said… ‘High yield in Asia is about to come back strongly,’ Schiffman said… Junk bond sales in the U.S. total $99 billion this year, a 63 percent increase on the same period in 2008.”
Government Finance Bubble Watch:
September 25 – Bloomberg (Mark Pittman and Bob Ivry): “The Federal Reserve decided to keep pumping $1.25 trillion of new money into the mortgage market to focus on rescuing the U.S. economy as the financial system revives and banks ask for less help… The U.S. has lent, spent or guaranteed $11.6 trillion to bolster banks and fight the longest recession in 70 years, according to data compiled by Bloomberg.”
September 22 – New York Times (Stephen Labaton): “Tired of the government bailing out banks? Get ready for this: officials may soon ask banks to bail out the government. Senior regulators say they are seriously considering a plan to have the nation’s healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors… The plan, strongly supported by bankers and their lobbyists, would be a major reversal of fortune… ‘It’s a nice irony,’ said Karen Shaw Petrou, managing partner of Federal Financial Analytics… ‘Like so much of this crisis, this is an issue that involves the least worst options.’”
September 23 – Bloomberg (Sandrine Rastello): “International Monetary Fund Managing Director Dominique Strauss-Kahn called on leaders from the Group of 20 nations to maintain efforts to pull the world economy out of a recession, warning that the crisis isn’t over. ‘This recovery will be rather sluggish, at an average lower than growth we had before the crisis,’ Strauss-Kahn said… ‘It’s too early to say the crisis is behind us.’”
September 25 – Bloomberg (Lee J. Miller and Marco Babic): “With China poised to surpass Japan as the second-largest economy, the decision by world leaders to make the Group of 20 nations the main forum for global economic coordination instead of the G-8 reflects the increasing power of emerging markets… ‘The G-8 has long since outlived its purpose,’ said Jim O’Neill, chief economist at Goldman Sachs…”
September 23 – Bloomberg (Alex Nicholson): “The Russian government approved a draft of its 2010 budget, which contains an estimated deficit equivalent to 6.8% of gross domestic product…”
September 25 – Bloomberg (Rebecca Christie and Sandrine Rastello): “European nations are resisting the transfer of more power to emerging markets at the International Monetary Fund..."
September 23 – Bloomberg (Alex Nicholson): “Russia’s government plans to spend 1.9 trillion rubles ($53 billion) next year on infrastructure projects and the ‘modernization’ of the economy, Prime Mininster Vladimir Putin said…”
Currency Watch:
September 24 – Bloomberg (Lori Rothman and Matt Townsend): “The dollar would be facing a lack of confidence over budget deficits if it weren’t the world’s reserve currency, said Robert Sinche, an independent strategist. ‘If the U.S. was an emerging market country, we know there would be a crisis of confidence in the currency,’ Sinche, former head of strategy for global rates, currencies and commodities at Bank of America Corp., said…”
September 23 – Bloomberg (Christopher Anstey): “China’s central bank deputy governor, Hu Xiaolian, proposed setting up a multinational sovereign wealth fund to invest in developing nations and help reduce the danger of another financial crisis. ‘Considerations can be to setting up a ‘supra-sovereign wealth investment fund’ to help channel capital inflow” into developing nations to help them become engines of global growth, Hu said in a paper posted on a Group of 20 Web site… Hu reiterated Chinese calls for greater use of special drawing rights, the International Monetary Fund’s unit of account, instead of the dollar.”
The dollar index this week added 0.4% in a volatile trading week to 76.74. For the week on the upside, the South Korean won increased 1.8%, the Japanese yen 1.8%, the New Zealand dollar 1.1%, the Norwegian krone 1.0%, the Brazilian real 0.7%, and the Swiss franc 0.1%. On the downside, the Mexican peso declined 2.1%, the Canadian dollar 2.1%, the British pound 2.1%, the Swedish krone 1.3%, and the Euro 0.2%.
Commodities Watch:
September 23 – Bloomberg (Lee J. Miller and Jay Wang): “China’s appetite for commodities will increase as the government pushes to add roads, railroads and warehouses, causing bottlenecks in land-locked parts of the world’s most-populous nation, according to Societe General SA. ‘China started stockpiling commodities in February and ran into physical warehousing constraints around May as China simply does not have the infrastructure to distribute these stockpiles quickly,’ Glenn Maguire, SocGen’s chief Asia-Pacific economist, said… ‘That dynamic now appears to be reversing. Freight carried suggests inventories have been cleared and the August data suggest commodity imports are again surging.’”
September 25 – Bloomberg (Yi Tian): “Sugar futures may triple to the highest price since 1974 as a ‘perfect storm’ of technical and fundamental indicators ‘come together in a pretty strong way,’ said Martin Snow at commodity broker PFGBest… The price has gained 94% this year as adverse weather hampered harvests in Brazil and India, the world’s largest producers…”
Gold declined 1.7% to close at $991 (up 12.3% y-t-d). Silver sank 5.9% to $16.05 (up 42% y-t-d). November Crude dropped $6.44 to $66.05 (up 48% y-t-d). October Gasoline sank 11.6% (up 53% y-t-d), while October Natural Gas rose 5.2% (down 29% y-t-d). December Copper declined 1.7% (up 94% y-t-d). December Wheat fell 1.6% (down 26% y-t-d), while December Corn gained 5.0% (down 18% y-t-d). The CRB index sank 3.7% (up 9.1% y-t-d). The Goldman Sachs Commodities Index (GSCI) dropped 6.0% (up 26.3% y-t-d).
China Bubble Watch:
September 22 – Bloomberg: “Ford Motor Co. will build a third car factory in China as the nation’s economic growth spurs auto demand, two people familiar with the plans said… Ford plans to add capacity after China Ford-brand car sales jumped 30% in the first eight months…”
September 23 – Bloomberg: “China’s economic growth has enabled the nation to have a greater voice internationally, the state- run Xinhua News Agency cited central bank Governor Zhou Xiaochuan as saying. China will play a bigger role in representing the interests of developing economies in international issues, Zhou was cited as saying.”
Japan Watch:
September 24 – Bloomberg (Jason Clenfield and Kyoko Shimodoi): “Japan’s exports fell for an 11th month in August as the economic recovery struggled to gain traction. Shipments abroad dropped 36% from a year earlier compared with a 36.5% decline in July…”
India Watch:
September 23 – Bloomberg (Sandrine Rastello): “The World Bank said it approved loans to India totaling $4.3 billion to finance infrastructure projects and to support the government’s economic stimulus. The loans include $2 billion to boost the capital of state banks and maintain credit growth, and $2.2 billion to help improve India’s roads, ports and power supply, the… bank said…”
September 24 – Bloomberg (Kartik Goyal): “India’s merchandise exports dropped 19.7% in August from a year earlier… That compares with an average 30% slide in the six months through July."
Asia Bubble Watch:
September 22 – Bloomberg (Karl Lester M. Yap): “The Asian Development Bank raised its economic growth forecast for the region on strengthening expansions in China, India and Indonesia, and said it’s too early for governments to withdraw stimulus policies. Asia, excluding Japan, will grow 3.9% in 2009, faster than a March estimate of 3.4%... Growth may accelerate in 2010 to 6.4%, it said.”
Unbalanced Global Economy Watch:
September 24 – Bloomberg (Anchalee Worrachate and Brian Parkin): “Germany, Europe’s biggest economy, said it lowered its planned fourth-quarter debt issuance by 22% because of a reduction in funding requirements. The nation will sell 59 billion euros ($87bn) of debt in the period…”
September 23 – Bloomberg (Brad Skillman and Tom Keene): “Iceland President Olafur Ragnar Grimsson said the country’s economy has 'great strength” and that its banks did not violate regulations. Iceland is ‘coming out of crisis,’ Grimsson said…”
September 23 – Bloomberg (Tracy Withers): “New Zealand emerged from its worst recession in three decades, unexpectedly expanding for the first time in six quarters… Gross domestic product increased 0.1% in the three months to June 30 following a 0.8% drop in the first quarter…”
U.S. Bubble Economy Watch:
September 22 – Bloomberg (Timothy R. Homan): “Five U.S. states that were among the hardest hit by job losses and the construction slump also had declines in household incomes during the first year of the recession… Arizona, California, Florida, Indiana and Michigan all saw median household incomes drop in 2008, the Census Bureau said… Only one state had a decline the previous year.”
September 22 – Bloomberg (Peter Woodifield): “The global recession is taking its toll on even the priciest shopping streets, where rents have plunged the most in at least 24 years, according to Cushman & Wakefield… Manhattan’s Fifth Avenue ranked as the world’s most expensive retail address for the eighth straight year, even as annual rents dropped 8.1%... to $1,700 a square foot…”
September 23 – Bloomberg (Cynthia Cotts): “Many students entering their final year at top law schools, including Harvard and New York University, haven’t landed the full-time jobs they would normally have claimed by now, firms and school officials said, a reflection of the shrinking demand for legal services.”
September 25 – Bloomberg (Jeff Plungis): “Stephen Serio, a Waltham, Massachusetts classic-car dealer, expects the 1966 Ferrari 275GTB on his lot to sell for about $810,000. Five years ago, the same car sold for $500,000. ‘When you have something they’re not making any more of, the value goes up,’ said comedian Jay Leno… ‘If you’re knowledgeable, you’ll probably end up making money.’”
MBS/ABS/CDO/CP/Money Fund and Derivatives Watch:
September 24 – Bloomberg (Pierre Paulden and Shannon D. Harrington): “Babson Capital Management LLC and GoldenTree Asset Management LP are among investors bargain- hunting in the $650 billion market for collateralized debt obligations linked to corporate debt as credit markets open. An estimated $11 billion of CDOs backed by high-yield, high-risk loans or linked to corporate bonds using credit derivatives, have exchanged hands this year…”
Real Estate Watch:
September 23 – Bloomberg (John Gittelsohn): “Manhattan apartment rents dropped an average of at least 8% in the year’s most active leasing season as Wall Street job cuts and the recession rippled through the economy, real estate broker Citi Habitats said…”
September 24 – Bloomberg (Nadja Brandt): “Luxury hotel owners risk defaulting on their debt as the recession cuts occupancies and the credit crunch constrains refinancing. Loans secured by more than 1,500 hotels with a total outstanding balance of $24.5 billion may be in danger of default, according to Realpoint LLC…”
September 24 – Bloomberg (Peter Woodifield and Linda Sandler): “Lehman Brothers… owes its London landlord $4.3 billion in rent and charges, according to a claim filed by Canary Wharf Group Plc.”
Central Banker Watch:
September 23 – Bloomberg (Josiane Kremer): “Norway’s central bank kept its benchmark interest rate at a record low and said it considered raising borrowing costs as the economic rebound gained strength… Deputy Governor Jan F. Qvigstad said rate-setters ‘considered the alternative of increasing the key policy rate.’”
September 23 – Bloomberg (Greg Quinn): “Bank of Canada Governor Mark Carney said there are signs of economic growth in all major global regions, and the rebound still lacks signs of ‘self- sustaining’ private demand to underpin it. ‘That growth that we are seeing is largely the result of policy: monetary policy, fiscal policy, the measures to stabilize the financial system, Carney, 44, said… ‘We have a ways to go before we are really going to see true growth, self- sustaining private sector growth.’”
September 24 – Bloomberg (Mike Dorning): “Former Federal Reserve Chairman Paul Volcker called on U.S. lawmakers to give the central bank more authority to oversee the financial system… The Fed has ‘the independence from political pressures, the prestige and the essential qualifications of experience to serve as overseer of the financial system,’ Volcker… said in testimony to the House Financial Services Committee.”
Muni Watch:
September 25 – Bloomberg (Jeremy R. Cooke): “Benchmark borrowing costs for highly rated state and local governments dropped to a 42-year low this week… Net cash flows into municipal bond mutual funds rose to a record four-week moving average of $2.7 billion yesterday…”
New York Watch:
September 23 – Bloomberg (Michael Quint): “New York Governor David Paterson said the state’s budget deficit this year may reach $3 billion, up from $2.1 billion the Division of Budget estimated July 30… Personal income tax collections are down about 35% rather than the projected 15%, Paterson said.”
September 23 – Bloomberg (Michael Quint): “New York Governor David Paterson proposed a 2% cap on spending growth next year on the eve of a meeting with legislative leaders to discuss the state’s current $2.1 billion budget deficit. State agencies were told yesterday to prepare for spending cuts to help close the gap for the fiscal year that ends March 31, according to a letter from Budget Director Robert Megna. Agencies will be told how much to pare later this month, the letter said.”
Speculator Watch:
September 23 – Bloomberg (Tomoko Yamazaki): “Hedge funds assets increased by $21.4 billion in August, rising for a fourth straight month…Eurekahedge Pte said. Net inflows into the industry totaled $12.6 billion, while gains through performance were $8.8 billion, bringing total assets under management to $1.38 trillion…”
From Bear to Bear:
I was inspired to put a few thoughts together after pondering Jim Grant’s interesting op-ed piece in last Saturday’s Wall Street Journal, “From Bear to Bull.”
Along with Mr. Grant, I don’t want to be associated with the term “permabear.” It implies a dogmatic lack of objectivity - the kiss of death for sound analysis. I’ve been bearish for awhile and I remain so. My view is firmly analytically based. Yet it doesn’t mean that I expect the stock market to always go south or the current recession to last indefinitely. Indeed, I am firmly in the global reflation camp, going so far as to posit the emergence of a powerful “Global Government Finance Bubble.”
I remain bearish because, from my analytical framework, deleterious Credit system developments suggest worse yet to come - perhaps much worse. The global Credit boom has not fully run its course, so the depths of the downturn remain indeterminable.
Total U.S. system Credit almost doubled during the nineties to $25.4 Trillion. System Credit has again doubled to end Q2 at $52.8 Trillion. I view this – in conjunction with corresponding global excesses - as history’s greatest Credit Bubble. Over the past 12 months, Treasury debt increased $1.9 TN and GSE MBS jumped $400bn – and counting. I believe unprecedented Credit-related maladjustment over decades continues to manifest itself in a severely impaired U.S. “Bubble” economy.
Such deep structural impairment is rectified only through a long and sobering period of retrenchment and rejuvenation, with adjustment not gaining critical momentum until Bubble-era destabilizing Monetary Processes are discontinued, stable financial flows are established, and significant economic liquidation has transpired. From my analytical perch, I don’t yet see the beginnings of significant structural readjustment. Determined to limit the level of hardship, policymakers have moved aggressively to sustain previous financial and economic structures. Both from a domestic and international standpoint, sound financial and economic footing will not have a chance until some semblance of a disciplined monetary regime supplants the current “system” of synchronized Credit inflation.
There is a popular view that holds that the U.S. economy benefits from an inherent upward trajectory, a dynamic some say ensures a resumption of growth as soon as financial crisis headwinds tail off. And then there is history – always elucidated so eloquently by Mr. Grant – that suggests the worse the economic downturn the more robust the subsequent recovery. I tend to dismiss the “inherent upward trajectory” thesis and believe the historical reliable recovery viewpoint requires important qualifications.
First, the “inherent upward trajectory” thesis does not square well with my analytical framework. First, I believe that the Credit/financial system generally dictates the workings/“trajectory” of economic system activity. This has especially been the case over the past two decades on the back of profound developments throughout contemporary money and Credit. The bursting of the Wall Street/mortgage finance Bubble marked a momentous inflection point in Credit. The “trajectory” of Credit – its type, flow and quantity - going forward will be markedly different from the past twenty years, which will translate into a much altered economic landscape. These days, caution is in order when it comes to extrapolating past economic performance.
I would also caution against using historical parallels. This time is different: History’s greatest Credit Bubble; unmatched changes to the underlying structure of the U.S. “services” and unbalanced global economy; and an unrestrained and rudderless global monetary “system” are just the most conspicuous characteristic that set the current backdrop apart from anything previously experienced.
Jim Grant quoted one of my favorite economic analysts, Michael Darda: “The most important determinant of the strength of an economy recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period.”
It is worth noting that the level of nominal GDP from 1929 was not attained again until 1941 – after bottoming seven years earlier in 1934 (five years after the crash!). Statistically, GDP posted relatively strong growth in 1935, 1936, 1937, 1939, 1940 and 1941 – but in aggregate this period of “strength” only returned output back to the late-twenties level. And anyone turning bullish in 1931 – two years after the financial Bubble burst – would have had to endure a nominal GDP drop of another 25% and even worse percentage declines in the stock market. It was many years after the bursting of the financial Bubble before bullishness had much relevance.
For comparison, Q2 2009 nominal GDP was about 3% below the peak level from last year, with the consensus view holding that this will be almost fully recovered next year. It is hard to read dire expectations from current economic forecasts. And keep in mind that non-financial Credit grew 6.0% last year and expanded about 4.5% annualized during this year’s first half. We have by no means experienced the worst-case scenario from a Credit standpoint.
Today’s Durable Goods report and this week’s housing data confirm sluggish recovery. Considering the double-digit federal deficit and zero interest-rate monetary policy, economic performance remains unimpressive. Expectations have been bolstered by stock market gains, and one would expect ultra-loose monetary conditions to support output. But I’m sticking with the view that the housing and consumption sectors of our economy will lag. Recall that the second quarter saw contractions in both U.S. household Credit and mortgage borrowings.
The consumption-based U.S. economy evolved over many years and is today poorly positioned for the unfolding global reflationary backdrop. Granted, policymakers reversed the downward financial and economic spiral. But stemming a crisis and fostering sound and sustainable recovery is not necessarily the same thing.
In past crises, government reflationary policymaking would help recapitalize the private-sector Credit system. Almost immediately, a Fed-induced manipulation of financial conditions would spur borrowing, lending, and leveraged speculation (not necessarily in that order). Private Credit growth would recover almost immediately, especially in housing related Credit. Indeed, home mortgage debt growth jumped to 9.4% in 1999 (post-LTCM reflation) and 13.4% in 2002 (post-technology Bubble reflation). This rapid increase in mortgage Credit corresponded to strong financial sector expansion – with financial sector borrowings increasing 16.2% in 1999 and 9.6% in 2002.
In my analytical vernacular, for two decades mortgage Credit demonstrated a robust “inflatationary bias.” This Credit characteristic provided the Federal Reserve a powerful mechanism for monetary stimulus. And the results were predictable: in crisis, the Fed would aggressively cuts rates, in the process creating a strong incentive for leveraged speculation in mortgage securities (and other risk assets). Meanwhile, the dramatic loosening in mortgage Credit would incite a refi boom and enormous equity extraction – not to mention a strong upsurge in home sales and construction.
The timely refi, home equity, construction and home transaction booms worked to both increase system Credit and boost economic output. And it was not long before this powerful reflationary dynamic created a self-reinforcing rise in home prices, household financial wealth, household consumption and business investment. It was like clockwork, ensuring virtually uninterrupted Credit expansion, the mildest of economic downturns, deeply ingrained confidence, and the greatest Credit Bubble in the history of mankind. The Fed misused its power to manipulate private Credit expansion, system spending, market psychology and financial speculation.
There is at this point ample confirmation that, with the bursting of the Wall Street/mortgage finance Bubble, this previously steadfast inflationary dynamic has turned impotent. The combination of securitized finance, the proliferation of leveraged speculation, contemporary unconstrained finance, and activist central banking nurtured a financial and economic environment unlike any in recent history. But analysts should no longer extrapolate from this previous boom period. Previous Credit and economic dynamics no longer apply.
And if the nuances of the past twenty years (or more) argue against extrapolation, I contend that the emergence of the Government Finance Bubble argue only further complicates drawing historical inferences. First of all, massive monetary and fiscal stimulus has supported system-wide incomes, spending, and corporate revenues. Policies also incited an unwind of bearish positions and a rather robust, albeit speculative, stock market rebound. Thus far, zero rates and Trillion dollar deficits has created the illusion of normalcy – when it comes to both the markets and real economy. This creates an “analytical” hook that will snare many.
In contrast to previous mortgage-Credit dominated reflations, the evolving global reflation will prove unique for its lack of self-reinforcing dynamics here at home. Before, a Trillion of net additional mortgage Credit would reliably inflate home prices and induce more borrowing, consumption and investment - all of which worked to bolster self-reinforcing confidence in the underlying Credit apparatus and the overall soundness of the general boom-time economy. Today, faith in this private-sector Credit machine is broken, while housing Bubble/consumption psychology is badly shattered.
The $2 Trillion of federal Credit over the past year may have stabilized national income, but it has not reflated home prices or rejuvenated household and mortgage Credit growth. I don’t expect another $2 Trillion to have a much bigger impact, creating a backdrop where the lack of a self-reinforcing private-Credit growth dynamic creates acute systemic vulnerability to any withdrawal of massive federal government spending. Moreover, any backup in market yields – perhaps in anticipation of Federal Reserve “exit strategies” – would weigh heavily on private-sector Credit recovery.
I’ll look to remove the bear from my lapel when a sounder Credit backdrop emerges at home and globally. It’s just not moving in that direction. I don’t see Trillions of federal government Credit as sustainable or constructive – and wouldn’t extrapolate recent system stabilization out to a sustainable economic recovery. I don’t see any semblance of restraint or monetary discipline – the requirements of a sustainable monetary regime – in key domestic Credit systems internationally. And I wouldn’t assume that the worst of Credit dislocation is behind us. And, I’ll add, the worst-case scenario at this point would include a robust global rejuvenation of Credit and asset Bubbles, rapid synchronized economic recovery, and a rebirth of bullish expectations. I do see all the makings for a grinding, debilitating, secular bear market.
One-month Treasury bill rates ended the week at 2 bps, and three-month bills closed at 10 bps. Two-year government yields fell 7 bps to 0.87%. Five-year T-note yields sank 12 bps to 2.30%. Ten-year yields were 14 bps lower to 3.32%. Long bond yields dropped 11 bps to 4.10%. Benchmark Fannie MBS yields fell 12 bps to 4.27%. The spread between 10-year Treasuries and benchmark MBS widened 2 to 95. Agency 10-yr debt spreads narrowed 3 to 13 bps. The implied yield on December 2010 eurodollar futures declined 10.5 bps to 1.765%. The 2-year dollar swap spread declined 4.75 to 32 bps; the 10-year dollar swap spread narrowed 4 to 16 bps; and the 30-year swap spread declined 2.25 to negative 11.75 bps. Corporate bond spreads continue their collapse. An index of investment grade bond spreads bps to a 16-month low 133, and an index of junk spreads narrowed 23 to 635 bps.
Corporate debt issuance is booming. Investment grade issuers included Wells Fargo $2.0bn, Enterprise Products $1.1bn, Potash $1.0bn, Burlington Northern $750 million, Jefferies Group $700 million, Allegheny Energy $600 million, Ohio Power $500 million, Niagara Mohawk $500 million, Kroger $500 million, Thomson Reuters $500 million, BB&T $500 million, Private Export Funding $400 million, Unum Group $350 million, Willis North America $300 million, Cabot Corp $300 million, Arrow Electronics $300 million, GATX $300 million and Viacom $250 million.
Junk bond funds enjoyed inflows of $283 million (from AMG). Junk issuers included Delta Airlines $1.35bn, QVC $1.0bn, Acco Brands $460 million, American Airlines $450 million, Dish $400 million, Geoeye $400 million, Spirit Aerosystems $350 million, Developers Diversified $300 million, Seacor Holdings $250 million, Brandywine $250 million, North American Energy $205 million, Nebraska Book $200 million and Inverness Medical $100 million.
Convert issuance included Incyte $350 million.
International dollar-denominated debt issuance remained strong. Issuers included Mexico $5.5bn, EDP Finance $1.0bn, African Development Bank $1.0bn, Total Capital $1.0bn, Finance for Danish Investment $800 million, Banco Bradesco $750 million, Eurasian Development Bank $500 million, Uruguay $500 million, Arcos Dorados $450 million, and Holcim Capital $1.0bn.
U.K. 10-year gilt yields sank 13 bps to 3.61%, and German bund yields fell 12 bps to 3.26%. The German DAX equities index slid 2.3% (up 16.2%). Japanese 10-year "JGB" yields declined 3 bps to 1.31%. The Nikkei 225 fell 1.0% (up 15.9%). Emerging markets were mostly on the defensive. Russia’s RTS equities index declined 1.6% (up 93.9%). India’s Sensex equities was unchanged (up 73.0%). China’s Shanghai Exchange sank 4.2%, lowering 2009 gains to 55.9%. Brazil’s benchmark dollar bond yields rose 6 bps to 5.12%. Brazil’s Bovespa equities index slipped only 0.6% (up 60.7% y-t-d). The Mexican Bolsa sank 3.9% (up 28.5% y-t-d). Mexico’s 10-year $ yields rose 12 bps to 5.28%.
Freddie Mac 30-year fixed mortgage rates were unchanged at 5.04% (down 105bps y-o-y). Fifteen-year fixed rates dipped one basis point to 4.46% (down 131bps y-o-y). One-year ARMs dropped 6 bps to 4.52% (down 64bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down one basis point to 6.17% (down 101bps y-o-y).
Federal Reserve Credit jumped $44.1bn last week to a 17-wk high $2.133 TN. Fed Credit has declined $114bn y-t-d, although it expanded $998bn over the past 52 weeks (88%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/23) increased $11.6bn to a record $2.854 TN. "Custody holdings" have expanded at an 18.4% rate y-t-d, and were up $432bn over the past year, or 17.9%.
M2 (narrow) "money" supply slipped $3.9bn to $8.303 TN (week of 9/14). Narrow "money" has expanded at a 1.9% rate y-t-d and 7.6% over the past year. For the week, Currency added $0.7bn, and Demand & Checkable Deposits increased $1.2bn. Savings Deposits rose $10.3bn, while Small Denominated Deposits fell $13.1bn. Retail Money Funds declined $2.9bn.
Total Money Market Fund assets (from Invest Co Inst) were little changed at $3.483 TN. Money fund assets have declined $350bn y-t-d, or 12.4% annualized. Money funds increased $85bn, or 2.5%, over the past year.
Total Commercial Paper outstanding jumped another $22.5bn (6-wk gain of $138bn) to a 15-wk high $1.212 TN. CP has declined $469bn y-t-d (38% annualized) and $490bn over the past year (29%). Asset-backed CP rose $19.3bn to $521bn, with a 52-wk drop of $233bn (31%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $285bn y-o-y to $7.211 TN. Reserves have increased $446bn year-to-date.
Global Credit Market Watch:
September 25 – Bloomberg (Jody Shenn): “Cash continues to pour into bond funds… according to Bank of America Corp. analysts. About $295 billion has been added this year to funds targeting debt including corporate bonds, bank loans and municipal notes… Net outflows from equity funds have been trimmed to $31 billion, from $77 billion in April.”
September 23 – Dow Jones (Stan Rosenberg): “California… completed its sale of $8.8 billion in revenue anticipation notes meant mainly to help meet the state’s cash flow needs for the balance of its current fiscal year. Pricing terms remained unchanged from levels set Tuesday in an order period for individual investors at yields of 1.25% for notes coming due next May and 1.5% for June securities.”
September 24 – Bloomberg (Katrina Nicholas): “Junk bond sales in Asia will register robust growth as investor appetite for riskier debt increases and companies turn attention toward 2010 financing requirements, according to Nomura Holdings Inc. Issuance of junk, or high yield, securities in the region will follow a resurgence in U.S. and European sales, Glenn Schiffman… said… ‘High yield in Asia is about to come back strongly,’ Schiffman said… Junk bond sales in the U.S. total $99 billion this year, a 63 percent increase on the same period in 2008.”
Government Finance Bubble Watch:
September 25 – Bloomberg (Mark Pittman and Bob Ivry): “The Federal Reserve decided to keep pumping $1.25 trillion of new money into the mortgage market to focus on rescuing the U.S. economy as the financial system revives and banks ask for less help… The U.S. has lent, spent or guaranteed $11.6 trillion to bolster banks and fight the longest recession in 70 years, according to data compiled by Bloomberg.”
September 22 – New York Times (Stephen Labaton): “Tired of the government bailing out banks? Get ready for this: officials may soon ask banks to bail out the government. Senior regulators say they are seriously considering a plan to have the nation’s healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors… The plan, strongly supported by bankers and their lobbyists, would be a major reversal of fortune… ‘It’s a nice irony,’ said Karen Shaw Petrou, managing partner of Federal Financial Analytics… ‘Like so much of this crisis, this is an issue that involves the least worst options.’”
September 23 – Bloomberg (Sandrine Rastello): “International Monetary Fund Managing Director Dominique Strauss-Kahn called on leaders from the Group of 20 nations to maintain efforts to pull the world economy out of a recession, warning that the crisis isn’t over. ‘This recovery will be rather sluggish, at an average lower than growth we had before the crisis,’ Strauss-Kahn said… ‘It’s too early to say the crisis is behind us.’”
September 25 – Bloomberg (Lee J. Miller and Marco Babic): “With China poised to surpass Japan as the second-largest economy, the decision by world leaders to make the Group of 20 nations the main forum for global economic coordination instead of the G-8 reflects the increasing power of emerging markets… ‘The G-8 has long since outlived its purpose,’ said Jim O’Neill, chief economist at Goldman Sachs…”
September 23 – Bloomberg (Alex Nicholson): “The Russian government approved a draft of its 2010 budget, which contains an estimated deficit equivalent to 6.8% of gross domestic product…”
September 25 – Bloomberg (Rebecca Christie and Sandrine Rastello): “European nations are resisting the transfer of more power to emerging markets at the International Monetary Fund..."
September 23 – Bloomberg (Alex Nicholson): “Russia’s government plans to spend 1.9 trillion rubles ($53 billion) next year on infrastructure projects and the ‘modernization’ of the economy, Prime Mininster Vladimir Putin said…”
Currency Watch:
September 24 – Bloomberg (Lori Rothman and Matt Townsend): “The dollar would be facing a lack of confidence over budget deficits if it weren’t the world’s reserve currency, said Robert Sinche, an independent strategist. ‘If the U.S. was an emerging market country, we know there would be a crisis of confidence in the currency,’ Sinche, former head of strategy for global rates, currencies and commodities at Bank of America Corp., said…”
September 23 – Bloomberg (Christopher Anstey): “China’s central bank deputy governor, Hu Xiaolian, proposed setting up a multinational sovereign wealth fund to invest in developing nations and help reduce the danger of another financial crisis. ‘Considerations can be to setting up a ‘supra-sovereign wealth investment fund’ to help channel capital inflow” into developing nations to help them become engines of global growth, Hu said in a paper posted on a Group of 20 Web site… Hu reiterated Chinese calls for greater use of special drawing rights, the International Monetary Fund’s unit of account, instead of the dollar.”
The dollar index this week added 0.4% in a volatile trading week to 76.74. For the week on the upside, the South Korean won increased 1.8%, the Japanese yen 1.8%, the New Zealand dollar 1.1%, the Norwegian krone 1.0%, the Brazilian real 0.7%, and the Swiss franc 0.1%. On the downside, the Mexican peso declined 2.1%, the Canadian dollar 2.1%, the British pound 2.1%, the Swedish krone 1.3%, and the Euro 0.2%.
Commodities Watch:
September 23 – Bloomberg (Lee J. Miller and Jay Wang): “China’s appetite for commodities will increase as the government pushes to add roads, railroads and warehouses, causing bottlenecks in land-locked parts of the world’s most-populous nation, according to Societe General SA. ‘China started stockpiling commodities in February and ran into physical warehousing constraints around May as China simply does not have the infrastructure to distribute these stockpiles quickly,’ Glenn Maguire, SocGen’s chief Asia-Pacific economist, said… ‘That dynamic now appears to be reversing. Freight carried suggests inventories have been cleared and the August data suggest commodity imports are again surging.’”
September 25 – Bloomberg (Yi Tian): “Sugar futures may triple to the highest price since 1974 as a ‘perfect storm’ of technical and fundamental indicators ‘come together in a pretty strong way,’ said Martin Snow at commodity broker PFGBest… The price has gained 94% this year as adverse weather hampered harvests in Brazil and India, the world’s largest producers…”
Gold declined 1.7% to close at $991 (up 12.3% y-t-d). Silver sank 5.9% to $16.05 (up 42% y-t-d). November Crude dropped $6.44 to $66.05 (up 48% y-t-d). October Gasoline sank 11.6% (up 53% y-t-d), while October Natural Gas rose 5.2% (down 29% y-t-d). December Copper declined 1.7% (up 94% y-t-d). December Wheat fell 1.6% (down 26% y-t-d), while December Corn gained 5.0% (down 18% y-t-d). The CRB index sank 3.7% (up 9.1% y-t-d). The Goldman Sachs Commodities Index (GSCI) dropped 6.0% (up 26.3% y-t-d).
China Bubble Watch:
September 22 – Bloomberg: “Ford Motor Co. will build a third car factory in China as the nation’s economic growth spurs auto demand, two people familiar with the plans said… Ford plans to add capacity after China Ford-brand car sales jumped 30% in the first eight months…”
September 23 – Bloomberg: “China’s economic growth has enabled the nation to have a greater voice internationally, the state- run Xinhua News Agency cited central bank Governor Zhou Xiaochuan as saying. China will play a bigger role in representing the interests of developing economies in international issues, Zhou was cited as saying.”
Japan Watch:
September 24 – Bloomberg (Jason Clenfield and Kyoko Shimodoi): “Japan’s exports fell for an 11th month in August as the economic recovery struggled to gain traction. Shipments abroad dropped 36% from a year earlier compared with a 36.5% decline in July…”
India Watch:
September 23 – Bloomberg (Sandrine Rastello): “The World Bank said it approved loans to India totaling $4.3 billion to finance infrastructure projects and to support the government’s economic stimulus. The loans include $2 billion to boost the capital of state banks and maintain credit growth, and $2.2 billion to help improve India’s roads, ports and power supply, the… bank said…”
September 24 – Bloomberg (Kartik Goyal): “India’s merchandise exports dropped 19.7% in August from a year earlier… That compares with an average 30% slide in the six months through July."
Asia Bubble Watch:
September 22 – Bloomberg (Karl Lester M. Yap): “The Asian Development Bank raised its economic growth forecast for the region on strengthening expansions in China, India and Indonesia, and said it’s too early for governments to withdraw stimulus policies. Asia, excluding Japan, will grow 3.9% in 2009, faster than a March estimate of 3.4%... Growth may accelerate in 2010 to 6.4%, it said.”
Unbalanced Global Economy Watch:
September 24 – Bloomberg (Anchalee Worrachate and Brian Parkin): “Germany, Europe’s biggest economy, said it lowered its planned fourth-quarter debt issuance by 22% because of a reduction in funding requirements. The nation will sell 59 billion euros ($87bn) of debt in the period…”
September 23 – Bloomberg (Brad Skillman and Tom Keene): “Iceland President Olafur Ragnar Grimsson said the country’s economy has 'great strength” and that its banks did not violate regulations. Iceland is ‘coming out of crisis,’ Grimsson said…”
September 23 – Bloomberg (Tracy Withers): “New Zealand emerged from its worst recession in three decades, unexpectedly expanding for the first time in six quarters… Gross domestic product increased 0.1% in the three months to June 30 following a 0.8% drop in the first quarter…”
U.S. Bubble Economy Watch:
September 22 – Bloomberg (Timothy R. Homan): “Five U.S. states that were among the hardest hit by job losses and the construction slump also had declines in household incomes during the first year of the recession… Arizona, California, Florida, Indiana and Michigan all saw median household incomes drop in 2008, the Census Bureau said… Only one state had a decline the previous year.”
September 22 – Bloomberg (Peter Woodifield): “The global recession is taking its toll on even the priciest shopping streets, where rents have plunged the most in at least 24 years, according to Cushman & Wakefield… Manhattan’s Fifth Avenue ranked as the world’s most expensive retail address for the eighth straight year, even as annual rents dropped 8.1%... to $1,700 a square foot…”
September 23 – Bloomberg (Cynthia Cotts): “Many students entering their final year at top law schools, including Harvard and New York University, haven’t landed the full-time jobs they would normally have claimed by now, firms and school officials said, a reflection of the shrinking demand for legal services.”
September 25 – Bloomberg (Jeff Plungis): “Stephen Serio, a Waltham, Massachusetts classic-car dealer, expects the 1966 Ferrari 275GTB on his lot to sell for about $810,000. Five years ago, the same car sold for $500,000. ‘When you have something they’re not making any more of, the value goes up,’ said comedian Jay Leno… ‘If you’re knowledgeable, you’ll probably end up making money.’”
MBS/ABS/CDO/CP/Money Fund and Derivatives Watch:
September 24 – Bloomberg (Pierre Paulden and Shannon D. Harrington): “Babson Capital Management LLC and GoldenTree Asset Management LP are among investors bargain- hunting in the $650 billion market for collateralized debt obligations linked to corporate debt as credit markets open. An estimated $11 billion of CDOs backed by high-yield, high-risk loans or linked to corporate bonds using credit derivatives, have exchanged hands this year…”
Real Estate Watch:
September 23 – Bloomberg (John Gittelsohn): “Manhattan apartment rents dropped an average of at least 8% in the year’s most active leasing season as Wall Street job cuts and the recession rippled through the economy, real estate broker Citi Habitats said…”
September 24 – Bloomberg (Nadja Brandt): “Luxury hotel owners risk defaulting on their debt as the recession cuts occupancies and the credit crunch constrains refinancing. Loans secured by more than 1,500 hotels with a total outstanding balance of $24.5 billion may be in danger of default, according to Realpoint LLC…”
September 24 – Bloomberg (Peter Woodifield and Linda Sandler): “Lehman Brothers… owes its London landlord $4.3 billion in rent and charges, according to a claim filed by Canary Wharf Group Plc.”
Central Banker Watch:
September 23 – Bloomberg (Josiane Kremer): “Norway’s central bank kept its benchmark interest rate at a record low and said it considered raising borrowing costs as the economic rebound gained strength… Deputy Governor Jan F. Qvigstad said rate-setters ‘considered the alternative of increasing the key policy rate.’”
September 23 – Bloomberg (Greg Quinn): “Bank of Canada Governor Mark Carney said there are signs of economic growth in all major global regions, and the rebound still lacks signs of ‘self- sustaining’ private demand to underpin it. ‘That growth that we are seeing is largely the result of policy: monetary policy, fiscal policy, the measures to stabilize the financial system, Carney, 44, said… ‘We have a ways to go before we are really going to see true growth, self- sustaining private sector growth.’”
September 24 – Bloomberg (Mike Dorning): “Former Federal Reserve Chairman Paul Volcker called on U.S. lawmakers to give the central bank more authority to oversee the financial system… The Fed has ‘the independence from political pressures, the prestige and the essential qualifications of experience to serve as overseer of the financial system,’ Volcker… said in testimony to the House Financial Services Committee.”
Muni Watch:
September 25 – Bloomberg (Jeremy R. Cooke): “Benchmark borrowing costs for highly rated state and local governments dropped to a 42-year low this week… Net cash flows into municipal bond mutual funds rose to a record four-week moving average of $2.7 billion yesterday…”
New York Watch:
September 23 – Bloomberg (Michael Quint): “New York Governor David Paterson said the state’s budget deficit this year may reach $3 billion, up from $2.1 billion the Division of Budget estimated July 30… Personal income tax collections are down about 35% rather than the projected 15%, Paterson said.”
September 23 – Bloomberg (Michael Quint): “New York Governor David Paterson proposed a 2% cap on spending growth next year on the eve of a meeting with legislative leaders to discuss the state’s current $2.1 billion budget deficit. State agencies were told yesterday to prepare for spending cuts to help close the gap for the fiscal year that ends March 31, according to a letter from Budget Director Robert Megna. Agencies will be told how much to pare later this month, the letter said.”
Speculator Watch:
September 23 – Bloomberg (Tomoko Yamazaki): “Hedge funds assets increased by $21.4 billion in August, rising for a fourth straight month…Eurekahedge Pte said. Net inflows into the industry totaled $12.6 billion, while gains through performance were $8.8 billion, bringing total assets under management to $1.38 trillion…”
From Bear to Bear:
I was inspired to put a few thoughts together after pondering Jim Grant’s interesting op-ed piece in last Saturday’s Wall Street Journal, “From Bear to Bull.”
Along with Mr. Grant, I don’t want to be associated with the term “permabear.” It implies a dogmatic lack of objectivity - the kiss of death for sound analysis. I’ve been bearish for awhile and I remain so. My view is firmly analytically based. Yet it doesn’t mean that I expect the stock market to always go south or the current recession to last indefinitely. Indeed, I am firmly in the global reflation camp, going so far as to posit the emergence of a powerful “Global Government Finance Bubble.”
I remain bearish because, from my analytical framework, deleterious Credit system developments suggest worse yet to come - perhaps much worse. The global Credit boom has not fully run its course, so the depths of the downturn remain indeterminable.
Total U.S. system Credit almost doubled during the nineties to $25.4 Trillion. System Credit has again doubled to end Q2 at $52.8 Trillion. I view this – in conjunction with corresponding global excesses - as history’s greatest Credit Bubble. Over the past 12 months, Treasury debt increased $1.9 TN and GSE MBS jumped $400bn – and counting. I believe unprecedented Credit-related maladjustment over decades continues to manifest itself in a severely impaired U.S. “Bubble” economy.
Such deep structural impairment is rectified only through a long and sobering period of retrenchment and rejuvenation, with adjustment not gaining critical momentum until Bubble-era destabilizing Monetary Processes are discontinued, stable financial flows are established, and significant economic liquidation has transpired. From my analytical perch, I don’t yet see the beginnings of significant structural readjustment. Determined to limit the level of hardship, policymakers have moved aggressively to sustain previous financial and economic structures. Both from a domestic and international standpoint, sound financial and economic footing will not have a chance until some semblance of a disciplined monetary regime supplants the current “system” of synchronized Credit inflation.
There is a popular view that holds that the U.S. economy benefits from an inherent upward trajectory, a dynamic some say ensures a resumption of growth as soon as financial crisis headwinds tail off. And then there is history – always elucidated so eloquently by Mr. Grant – that suggests the worse the economic downturn the more robust the subsequent recovery. I tend to dismiss the “inherent upward trajectory” thesis and believe the historical reliable recovery viewpoint requires important qualifications.
First, the “inherent upward trajectory” thesis does not square well with my analytical framework. First, I believe that the Credit/financial system generally dictates the workings/“trajectory” of economic system activity. This has especially been the case over the past two decades on the back of profound developments throughout contemporary money and Credit. The bursting of the Wall Street/mortgage finance Bubble marked a momentous inflection point in Credit. The “trajectory” of Credit – its type, flow and quantity - going forward will be markedly different from the past twenty years, which will translate into a much altered economic landscape. These days, caution is in order when it comes to extrapolating past economic performance.
I would also caution against using historical parallels. This time is different: History’s greatest Credit Bubble; unmatched changes to the underlying structure of the U.S. “services” and unbalanced global economy; and an unrestrained and rudderless global monetary “system” are just the most conspicuous characteristic that set the current backdrop apart from anything previously experienced.
Jim Grant quoted one of my favorite economic analysts, Michael Darda: “The most important determinant of the strength of an economy recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period.”
It is worth noting that the level of nominal GDP from 1929 was not attained again until 1941 – after bottoming seven years earlier in 1934 (five years after the crash!). Statistically, GDP posted relatively strong growth in 1935, 1936, 1937, 1939, 1940 and 1941 – but in aggregate this period of “strength” only returned output back to the late-twenties level. And anyone turning bullish in 1931 – two years after the financial Bubble burst – would have had to endure a nominal GDP drop of another 25% and even worse percentage declines in the stock market. It was many years after the bursting of the financial Bubble before bullishness had much relevance.
For comparison, Q2 2009 nominal GDP was about 3% below the peak level from last year, with the consensus view holding that this will be almost fully recovered next year. It is hard to read dire expectations from current economic forecasts. And keep in mind that non-financial Credit grew 6.0% last year and expanded about 4.5% annualized during this year’s first half. We have by no means experienced the worst-case scenario from a Credit standpoint.
Today’s Durable Goods report and this week’s housing data confirm sluggish recovery. Considering the double-digit federal deficit and zero interest-rate monetary policy, economic performance remains unimpressive. Expectations have been bolstered by stock market gains, and one would expect ultra-loose monetary conditions to support output. But I’m sticking with the view that the housing and consumption sectors of our economy will lag. Recall that the second quarter saw contractions in both U.S. household Credit and mortgage borrowings.
The consumption-based U.S. economy evolved over many years and is today poorly positioned for the unfolding global reflationary backdrop. Granted, policymakers reversed the downward financial and economic spiral. But stemming a crisis and fostering sound and sustainable recovery is not necessarily the same thing.
In past crises, government reflationary policymaking would help recapitalize the private-sector Credit system. Almost immediately, a Fed-induced manipulation of financial conditions would spur borrowing, lending, and leveraged speculation (not necessarily in that order). Private Credit growth would recover almost immediately, especially in housing related Credit. Indeed, home mortgage debt growth jumped to 9.4% in 1999 (post-LTCM reflation) and 13.4% in 2002 (post-technology Bubble reflation). This rapid increase in mortgage Credit corresponded to strong financial sector expansion – with financial sector borrowings increasing 16.2% in 1999 and 9.6% in 2002.
In my analytical vernacular, for two decades mortgage Credit demonstrated a robust “inflatationary bias.” This Credit characteristic provided the Federal Reserve a powerful mechanism for monetary stimulus. And the results were predictable: in crisis, the Fed would aggressively cuts rates, in the process creating a strong incentive for leveraged speculation in mortgage securities (and other risk assets). Meanwhile, the dramatic loosening in mortgage Credit would incite a refi boom and enormous equity extraction – not to mention a strong upsurge in home sales and construction.
The timely refi, home equity, construction and home transaction booms worked to both increase system Credit and boost economic output. And it was not long before this powerful reflationary dynamic created a self-reinforcing rise in home prices, household financial wealth, household consumption and business investment. It was like clockwork, ensuring virtually uninterrupted Credit expansion, the mildest of economic downturns, deeply ingrained confidence, and the greatest Credit Bubble in the history of mankind. The Fed misused its power to manipulate private Credit expansion, system spending, market psychology and financial speculation.
There is at this point ample confirmation that, with the bursting of the Wall Street/mortgage finance Bubble, this previously steadfast inflationary dynamic has turned impotent. The combination of securitized finance, the proliferation of leveraged speculation, contemporary unconstrained finance, and activist central banking nurtured a financial and economic environment unlike any in recent history. But analysts should no longer extrapolate from this previous boom period. Previous Credit and economic dynamics no longer apply.
And if the nuances of the past twenty years (or more) argue against extrapolation, I contend that the emergence of the Government Finance Bubble argue only further complicates drawing historical inferences. First of all, massive monetary and fiscal stimulus has supported system-wide incomes, spending, and corporate revenues. Policies also incited an unwind of bearish positions and a rather robust, albeit speculative, stock market rebound. Thus far, zero rates and Trillion dollar deficits has created the illusion of normalcy – when it comes to both the markets and real economy. This creates an “analytical” hook that will snare many.
In contrast to previous mortgage-Credit dominated reflations, the evolving global reflation will prove unique for its lack of self-reinforcing dynamics here at home. Before, a Trillion of net additional mortgage Credit would reliably inflate home prices and induce more borrowing, consumption and investment - all of which worked to bolster self-reinforcing confidence in the underlying Credit apparatus and the overall soundness of the general boom-time economy. Today, faith in this private-sector Credit machine is broken, while housing Bubble/consumption psychology is badly shattered.
The $2 Trillion of federal Credit over the past year may have stabilized national income, but it has not reflated home prices or rejuvenated household and mortgage Credit growth. I don’t expect another $2 Trillion to have a much bigger impact, creating a backdrop where the lack of a self-reinforcing private-Credit growth dynamic creates acute systemic vulnerability to any withdrawal of massive federal government spending. Moreover, any backup in market yields – perhaps in anticipation of Federal Reserve “exit strategies” – would weigh heavily on private-sector Credit recovery.
I’ll look to remove the bear from my lapel when a sounder Credit backdrop emerges at home and globally. It’s just not moving in that direction. I don’t see Trillions of federal government Credit as sustainable or constructive – and wouldn’t extrapolate recent system stabilization out to a sustainable economic recovery. I don’t see any semblance of restraint or monetary discipline – the requirements of a sustainable monetary regime – in key domestic Credit systems internationally. And I wouldn’t assume that the worst of Credit dislocation is behind us. And, I’ll add, the worst-case scenario at this point would include a robust global rejuvenation of Credit and asset Bubbles, rapid synchronized economic recovery, and a rebirth of bullish expectations. I do see all the makings for a grinding, debilitating, secular bear market.
09/18/2009 Q2 2009 Flow of Funds *
For the week, the S&P500 gained 2.5% (up 18.3% y-t-d), and the Dow rose 2.2% (up 11.9% y-t-d). The Banks surged 5.0% (up 7.6%), and the Broker/Dealers jumped 3.9% (up 53.8%). The Morgan Stanley Cyclicals increased 1.5% (up 58.3%), and Transports added 0.1% (up 12.5%). The Morgan Stanley Consumer index added 1.1% (up 16.1%), and the Utilities advanced 3.6% (up 1.0%). The broader market remains quite strong. The S&P 400 Mid-Caps jumped 3.3% (up 30.3%), and the small cap Russell 2000 surged 4.1% (up 23.7%). The Nasdaq100 gained 2.4% (up 42.4%) and the Morgan Stanley High Tech added 1.7% (up 58.2%). The Semiconductors gained 1.6% (up 53.9%). The InteractiveWeek Internet index rose 2.7% (up 62.9%). The Biotechs jumped 3.1% (up 47.9%). Although Bullion gained $2.30, the HUI gold index slipped 0.5% (up 40.2%).
One-month Treasury bill rates ended the week at 3 bps, and three-month bills closed at 8 bps. Two-year government yields rose 8 bps to 0.94%. Five-year T-note yields jumped 15 bps to 2.43%. Ten-year yields were 12 bps higher to 3.47%. Long bond yields gained 4 bps to 4.22%. Benchmark Fannie MBS yields increased 8 bps to 4.38%. The spread between 10-year Treasuries and benchmark MBS narrowed 4 to 91. Agency 10-yr debt spreads narrowed one to 17 bps. The implied yield on December 2010 eurodollar futures jumped 21 bps to 1.875%. The 2-year dollar swap spread increased 4.5 to 36.5 bps; the 10-year dollar swap spread increased 3.5 to 20.75 bps; and the 30-year swap spread increased 6.25 to negative 9.5 bps. Corporate bond spreads narrowed notably to pre-Lehman levels. An index of investment grade bond spreads narrowed 19 bps to 143, while an index of junk spreads narrowed 35 to 657 bps.
Corporate debt issuance was strong. Investment grade issuers included Morgan Stanley $3.0bn, Citigroup $5.0bn, Cenovus Energy $3.5bn, Newmont Mining $2.0bn, DirectTV $2.0bn, GE Capital $600 million, Exelon Generation $1.5bn, PNC $500 million, Markel $350 million, Kimco Realty $300 million, Toll Brothers $250 million, Avista $250 million, National Life Insurance $100 million, and Duke Energy $100 million.
Junk bond funds enjoyed inflows of $339 million (from AMG). Junk issuers included Newpage $1.7bn, Ford Motor Credit $1.0bn, CSN Island $750 million, Blockbuster $675 million, Felcor Lodging $630 million, Frontier Communications $600 million, Textron $600 million, Qwest $550 million, MGM Mirage $475 million, Del Monte Foods $450 million, Country Garden $375 million, Continental Resources $300 million, and Concho Resources $300 million.
I saw no convert issues.
International dollar-denominated debt issuance remained strong. Issuers included SFEF $4.5bn, Shell $4.0bn, Barclays Bank $2.0bn, Export Development Canada $1.0bn, Voto-Votorantim $1.0bn, Central American Bank $500 million, Axtel SAB $300 million and Corporacion GEO $250 million.
U.K. 10-year gilt yields jumped 13 bps to 3.74%, and German bund yields rose 14 bps to 3.37%. The German DAX equities index gained 1.4% (up 18.6%). Japanese 10-year "JGB" yields gained 4 bps to 1.34%. The Nikkei 225 slipped 0.7% (up 17.1%). Emerging markets were mostly strong. Russia’s RTS equities index surged 4.1% (up 97.1%). India’s Sensex equities index gained 2.9% (up 73.5%). China’s Shanghai Exchange declined 0.9%, lowering 2009 gains to 62.7%. Brazil’s benchmark dollar bond yields fell 7 bps to 5.12%. Brazil’s Bovespa equities index jumped 4.0% (up 61.7% y-t-d). The Mexican Bolsa gained 2.1% (up 33.8% y-t-d). Mexico’s 10-year $ yields sank 32bps to 5.16%.
Freddie Mac 30-year fixed mortgage rates declined 3 bps to 5.04% (down 74bps y-o-y). Fifteen-year fixed rates dipped 3 bps to 4.47% (down 88bps y-o-y). One-year ARMs dropped 6 bps to 4.58% (down 45bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates unchanged at 6.18% (down 75bps y-o-y).
Federal Reserve Credit rose $19.0bn last week to a 17-wk high $2.089 TN. Fed Credit has declined $158bn y-t-d, although it expanded $1.157 TN over the past 52 weeks (124%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/16) jumped $15.0bn to a record $2.843 TN. "Custody holdings" have expanded at an 18.2% rate y-t-d, and were up $434bn over the past year, or 18.0%.
M2 (narrow) "money" supply rose $12.6bn to $8.306 TN (week of 9/7). Narrow "money" has expanded at a 2.0% rate y-t-d and 8.0% over the past year. For the week, Currency increased $3.2bn, and Demand & Checkable Deposits rose $28.4bn. Savings Deposits declined $8.0bn, and Small Denominated Deposits fell $6.7bn. Retail Money Funds declined $4.3bn.
Total Money Market Fund assets (from Invest Co Inst) sank $61.0bn to $3.482 TN. Money fund assets have declined $348bn y-t-d, or 12.8% annualized. Money funds increased $70bn, or 2.0%, over the past year.
Total Commercial Paper outstanding increased $16.1bn (5-wk gain of $115bn) to a 13-wk high $1.190 TN. CP has declined $492bn y-t-d (41% annualized) and $574bn over the past year (33%). Asset-backed CP rose $18.0bn to $502bn, with a 52-wk drop of $260bn (34%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $275bn y-o-y to $7.204 TN. Reserves have increased $440bn year-to-date.
Global Credit Market Watch:
September 18 – Bloomberg (John Detrixhe): “Citigroup Inc. and Morgan Stanley led the most U.S. corporate bond sales in four months this week… Borrowers sold at least $39 billion of debt… Including high-yield, high-risk, or junk, debt, companies have borrowed at least $932 billion in bonds this year, a 37% increase from 2008.”
September 15 – Bloomberg (Laura Cochrane and Lester Pimentel): “Emerging-market borrowing costs fell to levels before the collapse of Lehman… The extra yield investors demand to own developing-nations’ bonds instead of U.S. Treasuries dropped 13 bps today to 3.31 percentage points…”
September 17 – Bloomberg (Jeremy R. Cooke): “State and local government bonds returned 14% this year so far, beating their performance during the comparable period in every year since Merrill Lynch & Co.’s Municipal Master Index began in 1989.”
September 17 – Bloomberg (Mary Schlangenstein): “AMR Corp.’s American Airlines, the world’s second-largest carrier, said it raised $2.9 billion in cash and financing and will add flying at four U.S. hubs to focus on the most-profitable parts of its network.”
September 14 – Bloomberg (Mark Deen and David Tweed): “Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc. ‘In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,’ Stiglitz said… ‘The problems are worse than they were in 2007 before the crisis.’ Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker…”
Government Finance Bubble Watch:
September 18 – Bloomberg (Thomas Penny): “Britain posted the biggest budget deficit for any August since modern records began in 1993 as the recession destroyed tax revenue and welfare costs soared. The 16.1 billion-pound ($26.3 billion) shortfall compared with a deficit of 9.9 billion pounds a year earlier…”
September 18 – Bloomberg (Caroline Hyde and Anchalee Worrachate): “Germany and Austria led governments and companies in Europe selling $21.7 billion of bonds in the U.S. currency this week to take advantage of the reduced cost of exchanging the proceeds back into euros. The sales were the most since February…”
September 18 – Bloomberg (Lester Pimentel and Veronica Navarro Espinosa): “Mexico sold $1.75 billion of bonds in its first international issue since it was forced to pull a 21-year debt offer seven months ago… Yields on Mexico’s 2019 bonds have dropped to 5.16% from 6.36% in March…”
Currency Watch:
September 16 – Bloomberg (Dan Levy): “Tom Perkins, the venture capitalist whose firm helped finance Google Inc. and Amazon.com, paid $9.35 million for a penthouse condominium in the Millennium Tower, San Francisco’s tallest residential tower. The 4,806 square-foot apartment is on the top floor of the 60-story building in the city’s South of Market area… ‘It’s a good time to buy things other than paper,’ Perkins, 77, co-founder of… Kleiner Perkins Caufield & Byers, said…”
September 15 – Bloomberg (Paul Abelsky): “Russia’s government sees a handful of regional currencies emerging over the next decade to challenge the dollar, as long as emerging markets continue to grow, President Dmitry Medvedev’s senior economic adviser said. The world will probably have ‘five or six currency unions’ similar to the euro region… Arkady Dvorkovich said…”
The dollar index slipped 0.1% this week to 76.51. For the week on the upside, the Swedish krona increased 2.0%, the Norwegian krone 1.3%, the Brazilian real 1.2%, the South Korean won 1.2%, the Danish krone 1.0%, the Swiss franc 0.8%, the Canadian dollar 0.7%, and the Singapore dollar 0.5%. On the downside, British pound declined 2.4% and the Japanese yen fell 0.7%.
Commodities Watch:
September 16 – Bloomberg: “Commodity demand in China, the largest metals user, ‘is back on track in a very big way,’ and copper and coking coal have the best prospects for price gains… according to CLSA Research Ltd. ‘Commodities that give investors the most upside potential when the rest of the world demand recovers’ are those with supply constraints, Andrew Driscoll…said… ‘In the next twelve months, having exposure to copper is going to be a good investment.’ China’s $586 billion stimulus plan and a record $1.1 trillion of lending in the first half of this year have countered a 10-month slump in the nation’s exports, helping Asia to lead a global rebound from the worst slump since the 1930s. Copper futures have more than doubled this year.”
September 17 – Bloomberg (Glenys Sim): “Private investors in China, the world’s largest metals user, have stockpiled ‘substantial’ quantities of copper as the government ramps up stimulus spending to spur the economy, according to Sucden Financial Ltd. Pig farmers and other speculators may have amassed more than 50,000 metric tons…”
September 16 – Bloomberg (Zijing Wu): “Chinese companies will step up the pace of overseas mergers and acquisitions in a ‘new wave’ of deals, said Xiong Weiping, chairman of Aluminum Corp. of China… ‘Chinese companies will reinforce the going-out strategy and participate in this new wave of M&As,’ Xiong said… There will be more mergers and acquisitions in the mining sector with the end of the financial crisis, he said.”
September 14 – Bloomberg (Bernard Lo and Kim Kyoungwha): “Global banks are engaged in a hiring boom for commodity traders as they add staff to benefit from surging metals and energy prices, offering $1 million packages for top employees, recruiters Robert Walters Plc said. There’s “huge demand for physical traders,’ Gary Lai, manager of financial services at Robert Walters in Singapore, said… ‘For top traders, especially investment bank traders, $1 million is not unexpected, it’s easy to get,’ Lai said…”
Gold added 0.2% to close at $1,008 (up 14.2% y-t-d). Silver gained 1.8% to $17.01 (up 51% y-t-d). October Crude jumped $2.0 to $71.79 (up 61% y-t-d). October Gasoline rallied 3.9% (up 72% y-t-d), and September Natural Gas surged 26.8% (down 33% y-t-d). December Copper declined 2.2% (up 97% y-t-d). December Wheat dropped 2.1% (down 25% y-t-d), and December Corn declined 0.5% (down 22% y-t-d). The CRB index jumped 3.5% (up 13.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) surged 3.9% (up 34.3% y-t-d).
China Bubble Watch:
September 17 – Bloomberg (Chia-Peck Wong and Frank Longid): “Sun Hung Kai Properties Ltd., the world’s largest developer by market value, raised the price of two penthouses in Hong Kong by 50% to a record HK$75,000 ($9,700) a square foot as demand surges for luxury apartments. The units will be offered for HK$300 million ($39 million) each…”
September 15 – Bloomberg (Chia-Peck Wong): “A one-bedroom apartment in Hong Kong’s Kowloon district was bought by a local businessman for HK$30,025 ($3,874) a square foot, a record price for properties of that type in the city… The broker sold the property for HK$24.5 million ($3.2 million).”
September 17 – Bloomberg (Cathy Chan): “Sinopharm Group Co. raised the maximum HK$8.73 billion ($1.13 billion) sought in a Hong Kong initial public offering after investors in the city applied for almost 600 times the stock available to them.”
September 16 – Bloomberg: “China… may have to spend an additional 1.7 trillion yuan ($249 billion) in 2050 to shift the country to a ‘low-carbon’ model of economic growth. ‘China needs between 500 and 600 billion yuan annually to develop energy-conservation and low-carbon technologies, and the capital requirements are even greater in the reduction of carbon dioxide after 2020,’ think-tanks led by the State Council’s Development Research Center said… The cost of cutting China’s emissions may reach $438 billion annually within 20 years, the Financial Times reported…”
India Watch:
September 17 – Bloomberg (Shobhana Chandra): “U.S. pension and private equity firms are ‘excited’ about financing India’s $80 billion program to build roads and expressways, according to Minister for Road Transport and Highways Kamal Nath… ‘The projects are not only viable, but profitable,’ Nath told reporters in New York. U.S. investors ‘are now not looking at real estate, not looking at equities; they’re looking at infrastructure.’ India will need $1.7 trillion to build infrastructure over the next decade to boost economic growth, Goldman Sachs Group Inc. estimated…”
Latin America Bubble Watch:
September 13 – Bloomberg (Andre Soliani and Paulo Winterstein): “Brazil proved to be a ‘success case’ among global economies as growing domestic demand and investments helped buffer that nation during the economic downturn, central bank President Henrique Meirelles said… Brazil is in a ‘very strong position’ now with bank loans being granted at pre-crisis levels, Meirelles said…”
September 15 – Bloomberg (Telma Marotto): “Morgan Stanley, the top adviser on takeovers in Brazil, doubled the investment-banking staff in Latin America’s biggest economy and plans to add more as local capital markets develop, an executive said.”
September 15 – Bloomberg (Joshua Goodman and Adriana Brasileiro): “Brazil’s retail sales accelerated for the second straight month in July, reinforcing bets that domestic demand will power the country’s economic rebound. Retail sales rose 5.9% from the year-ago period…”
September 16 – Bloomberg (Fabiola Moura and Veronica Espinosa): “Brazilian President Luiz Inacio Lula da Silva may reach the target of building 1 million homes for low-income workers by 2011… said the chief executive officer of homebuilder Construtora Tenda SA. ‘The beauty of the government program is that for the first time it has set a goal,’ Carlos Trostli said… ‘It will be very difficult for someone to come and stop a program that’s generating jobs and increasing fiscal revenue.’ Lula announced a plan on March 24 to spend 34 billion reais ($18.8 billion) for low-income housing…”
Unbalanced Global Economy Watch:
September 16 – Bloomberg (Svenja O’Donnell): “U.K. unemployment jumped to the highest level since 1995… The number of people seeking jobs in the three months through July rose by 210,000 to 2.47 million…”
September 15 – Bloomberg (Dara Doyle): “The skeleton of an eight-story Dublin office block lays deserted on the north bank of the River Liffey, just next to the financial district that less than two years ago was the heart of Ireland’s economic boom. Four cranes stand idle at the site, one of at least 35,000 unfinished or empty new offices and homes that dot Ireland’s landscape after the collapse of its real estate market. Finance Minister Brian Lenihan will detail tomorrow how much Ireland will pay for about 90 billion euros ($131 billion) of real estate loans now crippling what as recently as 2006 was one of Europe’s most dynamic economies.”
September 17 – Bloomberg (Emma Ross-Thomas and Simone Meier): “Europe posted the largest trade surplus in five years in July… Exports from the 16-nation euro region rose a seasonally adjusted 4.1% from June…” July imports contracted 0.3% and the trade surplus jumped to 6.8 billion euros ($10bn)…”
U.S. Bubble Economy Watch:
September 17 – Reuters (Lisa Lambert): “The federal government and states are girding themselves for the next foreclosure crisis in the country's housing downturn: payment option adjustable rate mortgages that are beginning to reset. ‘Payment option ARMs are about to explode,’ Iowa Attorney General Tom Miller said… ‘That’s the next round of potential foreclosures in our country.’”
Central Banker Watch:
September 14 – Bloomberg (Frances Robinson): “European Central Bank President Jean-Claude Trichet said saving Lehman Brothers Holdings Inc. or American International Group Inc. from bankruptcy wouldn’t necessarily have prevented the financial crisis from deepening. ‘Lehman was a trigger, but you could have another trigger,’ Trichet told CNBC… ‘Even if Lehman and AIG had been saved, it would be a new entity that had problems… ‘At the end of the weekend we knew it was unfortunately bankruptcy that would be the solution,’ Trichet said… ‘It triggered for us as well as all sister central banks the sentiment that we had to prepare for something that was really big.’”
September 14 – Bloomberg (Theresa Tang and Sophie Leung): “Hong Kong Monetary Authority Chief Executive Joseph Yam said central banks face a dilemma on when to tighten monetary policy. Doing so too soon has the potential to curb an economic recovery, while maintaining loose monetary policy may produce ‘asset bubbles,’ Yam said…”
September 16 – Bloomberg (Tasneem Brogger): “Sweden’s Riksbank should start raising rates earlier than its current outlook indicates as the economy is set to recover faster than the bank’s official forecast, two of the policy board’s six members said. ‘The repo rate might need to be raised during the late spring or summer 2010,’ Riksbank Deputy Governor Barbro Wickman-Parak said…”
September 16 – Bloomberg (Timothy R. Homan): “Former Federal Reserve Chairman Alan Greenspan said he’s worried that lawmakers will hamper U.S. central bank efforts to rein in its monetary stimulus, and that inflation might ‘swamp’ the bond market. ‘It’s the politics in the United States that worries me, whether the Congress will basically feel comfortable” with the Fed withdrawing its stimulus, Greenspan said…‘if inflation rears its head, it will swamp long-term markets,’ referring to bonds.”
Fiscal Watch:
September 18 – Washington Post (Dina El Boghdady): “The Federal Housing Administration has been hit so hard by the mortgage crisis that for the first time, the agency’s cash reserves will drop below the minimum level set by Congress… The FHA guaranteed about a quarter of all U.S. home loans made this year… ‘It’s very serious,’ FHA Commissioner David H. Stevens said… ‘There’s nothing more serious that we're addressing right now, outside the housing crisis in general, than this issue.’ …The agency does not lend money; it insures lenders against losses. It has captured 23% of all new loans made so far this year, up from just 3% in 2006.”
Muni Watch:
September 18 – Bloomberg (Jeremy R. Cooke): “Municipal bond sales rose to $9.7 billion, the highest in five weeks based on data compiled by Bloomberg…”
Speculator Watch:
September 17 – Bloomberg (Saijel Kishan): “The pace of hedge fund liquidations slowed in the second quarter as managers posted a 9.1% gain, according to Hedge Fund Research Inc. About 292 funds shut down, a 22% decline from the first quarter…”
Q2 2009 Flow of Funds:
September 18 – Wall Street Journal (Peter Eavis): “More than half of U.S. residential mortgages are being made by just three large banks. It is a stunning change, but is it good for the housing market, and to what extent will it boost profits over the long term for this elite trio: Wells Fargo, Bank of America, and J.P. Morgan Chase? Right now, housing remains on government life support. Treasury-backed entities are guaranteeing about 85% of new mortgages, while the Fed buys 80% of the securities into which these taxpayer-backed mortgages are packaged.”
The Federal Reserve’s Z.1 “flow of funds” report remains a must “read” when it comes to grasping the happenings of the U.S. Credit system. Granted, the reams of data may not be quite as captivating now as compared to the Wall Street Bubble years. But the report never disappoints.
For the quarter, Non-Financial Credit growth accelerated to 4.9% annualized, up from Q1’s 4.1% and compared to Q2 2008’s 3.3%. In nominal seasonally-adjusted and annualized rate (SAAR) terms, Non-Financial debt expanded $1.646 TN. This was up strongly from Q1’s $1.371 TN SAAR, but still below the $2.0 TN or so I deem necessary to (at least temporarily) stabilize the system. Keep in mind that the economy remained quite weak for much of Q2. I would expect Q3 Credit growth in the neighborhood of $2.0 TN annualized. For perspective, Non-Financial Credit expanded $865bn in 2000, $1.152 TN in 2001, $1.413 TN in 2002, $1.671 TN in 2003, $1.997 TN in 2004, $2.329 TN in 2005, $2.400 TN in 2006, $2.539 TN in 2007 and $1.888 TN in 2008.
And while the recovery in Credit is on the surface encouraging, the composition of this growth is disconcerting. For the quarter, Household debt contracted at a 1.7% rate, with Home Mortgage and Consumer Debt down 1.4% and 6.5% annualized – both worse than Q1 (declines of 0.1% and 3.7%). Corporate borrowings expanded at only 1.0% annualized, down from Q1’s 2.1% and compared to 6.7% back in Q2 2008. Private sector Credit remains stuck in the muck.
Meanwhile, State & Local debt growth accelerated to 8.3% annualized, up from Q1’s 4.9% and Q2 2008’s 0.9%. State & Local governments expanded borrowings $187bn SAAR - a resurgence back to the peak borrowing level from 2007 ($186bn). Federal borrowings expanded at a blistering 28.2% pace, up from Q1’s 22.6% and compared to Q2 2008’s 5.9%. Federal borrowing increased to $1.895 TN SAAR during the quarter. State & Local and Federal combined debt growth reached $2.082 TN SAAR, significantly larger than the total system Non-Financial debt growth of $1.646 TN SAAR (with Household Credit and Mortgage debt contracting).
Over the past four quarters, Non-Financial Credit expanded $1.959 TN, or 6.1%, to $34.320 TN. This was no small amount of debt growth. Treasury borrowings increased $1.893 TN over the past year to $7.143 TN. And during this period Federal Reserve assets ballooned $1.111 TN, or 117%, to $2.063 TN. It is incredible to watch the emerging Government Finance Bubble take such command of U.S. Credit.
On an SAAR basis, the Federal Reserve increased Agency- and GSE-Backed Securities $1.088 TN during Q2 (nominal $272bn). In nominal dollars, Fed holdings of Agency (mostly MBS) securities increased from $20bn at year-end to $559bn by the end of Q2. And keep in mind that Home Mortgage debt actually contracted $53bn during this period (to $10.951 TN).
There is a perception that the Fed’s agency MBS purchase program is specifically targeting stabilization of the conventional mortgage market. Yet, examining the data, one can see that the private-label MBS marketplace is perhaps the greater beneficiary of Federal Reserve largess. For the quarter, Issuers of Asset-Backed Securities (chiefly pools of private-label/non-GSE mortgages) contracted $499bn SAAR, this after a $614bn SAAR contraction in Q1. But this was offset by an increase in GSE MBS of $556bn SAAR in Q2 and $304bn SAAR in Q1.
So, the Fed is amassing quite a stockpile of “conventional” GSE MBS, but often these are “private-label” mortgages recently “refinanced” into GSE securities. And as the Fed buys the new GSE MBS, newly created funds become available to flow back to reliquefy the formerly illiquid ABS marketplace (along with agencies, Treasuries, corporates, and equities). To be sure, placing essentially federal government backing upon previously “private-label” mortgages dramatically changes the market’s perception of these securities’ worth (“moneyness”) – especially with fed funds pegged for an extended period at near zero and the Fed in the midst of a $25bn weekly purchase program in order to fulfill it commitment to purchase $1.25 TN of mortgage securities.
During the quarter, outstanding GSE MBS expanded at a 10.4% rate to $5.173 TN. GSE MBS increased $414bn, or 8.7%, over the past year and $1.098 TN, or 26.9%, over two years. During Q2, the ABS market contracted at a 12.2% rate to $3.817 TN. ABS declined $525bn over the past year, or 12.1%, and $673bn, or 15%, over two years. Here we see confirmation that nationalization of mortgage Credit runs unabated. Not only is the vast majority of new mortgage Credit this year government-backed, Washington guarantees are being slapped on hundreds of billions of existing “nonconventional” mortgages. This intrusion and transfer of (Credit and interest rate) risk has terrible long-term ramifications. Although in the near-term this mechanism provides a powerful stabilizing force for both the Credit system and real economy.
Bank Credit contracted at a 1.4% pace during the quarter to $9.523 TN. Similar to the money supply numbers, I have tended this year to deemphasize private lending data in my analysis. After all, how much can we expect to discern from traditional Credit-related metrics when policymakers are issuing Trillions of Treasuries/agencies Credit and the Fed is monetizing a Trillion or so? It is, however, worth noting that Bank holdings of Government Securities expanded at a 16.2% pace during the quarter to $941bn. Mortgages increased at a respectable 4.6% clip to $3.899 TN. Business loans contracted at a notable 17.8% pace (to $2.031TN), although this may be somewhat explained by the thawing of the corporate debt securities marketplace (companies issuing debt to repay bank borrowings).
On the bank Liability side, total Deposits expanded at a 5.2% rate during the quarter to $7.278 TN (up 7.8% y-o-y). Credit Market borrowings were about flat at $1.720 TN. Fed Funds & Repo expanded ($133bn) for the first time in eight quarters (to $596bn). Meanwhile, Miscellaneous Liabilities contracted at a 24% rate to $2.468 TN.
Posting the strongest growth since Q2 2007, Securities Broker/Dealer assets expanded at a 14.5% pace to $2.00 TN. Broker Dealer assets increased $514bn SAAR during the quarter, although most of this is explained by an increase in Treasuries holdings (up $404bn SAAR). With the Fed’s massive MBS buying program in mind, it’s not surprising to see Broker/Dealer holdings of Agency and MBS declining $179bn SAAR. It is worth noting that, on the Liability side, Security Repos expanded $224bn SAAR, the first increase in repos since Q1 2008. “Other” Miscellaneous Liabilities increased $309bn SAAR.
Examining the miscellaneous categories, Finance Companies contracted 8.6% annualized to $1.777 TN (down 7.9% y-o-y). Credit Unions expanded 9.9% annualized to $877bn (up 9.1% y-o-y). REITs increased 13.3% annualized to $260bn (down 13.5% y-o-y). Money Market contracted at a 16.5% rate during Q2 to $3.584 TN, cutting y-o-y growth to 8.0%. Life Insurance assets grew at an 11.9% pace to $4.552 TN (down 6.6% y-o-y).
Rest of World holdings were down a rather insignificant $134bn SAAR to $14.200 TN. There were, however, some meaningful changes in the composition of foreign holdings of U.S. assets. Net Interbank Assets contracted $692bn SAAR, while Official Treasury holdings jumped $494bn SAAR. U.S. Corporate Bond holdings declined $110bn SAAR, while Miscellaneous Assets expanded $227bn SAAR.
In total, Rest of World purchased $403bn SAAR of Treasuries during Q2, about a quarter of total issuance ($1.896 TN SAAR). Who were the other major purchasers? The Fed monetized $647bn SAAR, the Household Sector bought $343bn SAAR, and Broker/Dealers accumulated $404bn. And while it is positive that American households are buying Treasuries and saving more, this does not change the fact that this so called “savings” was bolstered by income effects from massive government spending increases.
Examining income data, National Income stabilized during the quarter at $12.162 TN. After declining $347bn annualized during Q4 2008 and $225bn annualized during Q1, National Income slipped only $47bn annualized during the quarter. National Income was down 4.0% y-o-y. Total Compensation was down 3.8% y-o-y to $7.726 TN. National Income and Compensation began the decade at $8.358 TN and $5.354 TN. It is my view that, at this point, only massive federal deficits and government intrusions will stabilize system incomes at today’s highly inflated levels.
Federal Q2 Receipts were down 6.6% y-o-y to $2.215 TN SAAR, while Federal Expenditures surged 35.9% to $3.510 TN SAAR. For comparison, federal expenditures were $2.393 TN in 2004, $2.573 TN in 2005, $2.728 TN in 2006, $2.897 TN in 2007 and $3.118 TN in 2008. So current spending levels are running almost 50% above where they were five years ago. Second quarter State & Local receipts were just slightly ahead of the year ago level to $2.004 TN. Spending was slightly down from a year earlier to $2.014 TN.
The media was quick to pick up on the quarter’s $2.0 TN increase in Household Net Worth. For the bad news, Net Worth was still down $7.438 TN over the past year. With Household Liabilities essentially flat (down 1.0% annualized) at about $14.10 TN, changes in Household Assets dictate the increase/decrease in Net Worth. For the quarter, assets were up $1.964 TN, or 12.0%, to $67.208 TN. This jump places asset values back to mid-2005 levels. Real Estate holdings actually rose $157bn (nominal) to $20.026 TN, the first increase in 10 quarters. Yet, reflation’s real impact was felt in the $1.777 TN (17.5%) jump in household holdings of Financial Assets. Over the past year, the value of Real Estate declined $1.759 TN and Financial Assets dropped $6.043 TN. It is worth noting that, despite the crisis, Household Net Worth was up about a third in seven years.
To summarize, there were no surprises in the Q2 2009 Flow of Funds. What I saw was confirmation of the Government Finance Bubble Thesis. “Uncle Sam Bets the House on Mortgages” was the headline for an insightful article in this morning’s Wall Street Journal (Peter Eavis). It would as well make a good title for recent Z.1 Flow of Funds reports. My bet is that this massive government intrusion into mortgage finance eventually backfires. It puts Washington on course for bankrupting the country, while doing little to direct financial and real resources in a manner to spur needed economic restructuring.
One-month Treasury bill rates ended the week at 3 bps, and three-month bills closed at 8 bps. Two-year government yields rose 8 bps to 0.94%. Five-year T-note yields jumped 15 bps to 2.43%. Ten-year yields were 12 bps higher to 3.47%. Long bond yields gained 4 bps to 4.22%. Benchmark Fannie MBS yields increased 8 bps to 4.38%. The spread between 10-year Treasuries and benchmark MBS narrowed 4 to 91. Agency 10-yr debt spreads narrowed one to 17 bps. The implied yield on December 2010 eurodollar futures jumped 21 bps to 1.875%. The 2-year dollar swap spread increased 4.5 to 36.5 bps; the 10-year dollar swap spread increased 3.5 to 20.75 bps; and the 30-year swap spread increased 6.25 to negative 9.5 bps. Corporate bond spreads narrowed notably to pre-Lehman levels. An index of investment grade bond spreads narrowed 19 bps to 143, while an index of junk spreads narrowed 35 to 657 bps.
Corporate debt issuance was strong. Investment grade issuers included Morgan Stanley $3.0bn, Citigroup $5.0bn, Cenovus Energy $3.5bn, Newmont Mining $2.0bn, DirectTV $2.0bn, GE Capital $600 million, Exelon Generation $1.5bn, PNC $500 million, Markel $350 million, Kimco Realty $300 million, Toll Brothers $250 million, Avista $250 million, National Life Insurance $100 million, and Duke Energy $100 million.
Junk bond funds enjoyed inflows of $339 million (from AMG). Junk issuers included Newpage $1.7bn, Ford Motor Credit $1.0bn, CSN Island $750 million, Blockbuster $675 million, Felcor Lodging $630 million, Frontier Communications $600 million, Textron $600 million, Qwest $550 million, MGM Mirage $475 million, Del Monte Foods $450 million, Country Garden $375 million, Continental Resources $300 million, and Concho Resources $300 million.
I saw no convert issues.
International dollar-denominated debt issuance remained strong. Issuers included SFEF $4.5bn, Shell $4.0bn, Barclays Bank $2.0bn, Export Development Canada $1.0bn, Voto-Votorantim $1.0bn, Central American Bank $500 million, Axtel SAB $300 million and Corporacion GEO $250 million.
U.K. 10-year gilt yields jumped 13 bps to 3.74%, and German bund yields rose 14 bps to 3.37%. The German DAX equities index gained 1.4% (up 18.6%). Japanese 10-year "JGB" yields gained 4 bps to 1.34%. The Nikkei 225 slipped 0.7% (up 17.1%). Emerging markets were mostly strong. Russia’s RTS equities index surged 4.1% (up 97.1%). India’s Sensex equities index gained 2.9% (up 73.5%). China’s Shanghai Exchange declined 0.9%, lowering 2009 gains to 62.7%. Brazil’s benchmark dollar bond yields fell 7 bps to 5.12%. Brazil’s Bovespa equities index jumped 4.0% (up 61.7% y-t-d). The Mexican Bolsa gained 2.1% (up 33.8% y-t-d). Mexico’s 10-year $ yields sank 32bps to 5.16%.
Freddie Mac 30-year fixed mortgage rates declined 3 bps to 5.04% (down 74bps y-o-y). Fifteen-year fixed rates dipped 3 bps to 4.47% (down 88bps y-o-y). One-year ARMs dropped 6 bps to 4.58% (down 45bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates unchanged at 6.18% (down 75bps y-o-y).
Federal Reserve Credit rose $19.0bn last week to a 17-wk high $2.089 TN. Fed Credit has declined $158bn y-t-d, although it expanded $1.157 TN over the past 52 weeks (124%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/16) jumped $15.0bn to a record $2.843 TN. "Custody holdings" have expanded at an 18.2% rate y-t-d, and were up $434bn over the past year, or 18.0%.
M2 (narrow) "money" supply rose $12.6bn to $8.306 TN (week of 9/7). Narrow "money" has expanded at a 2.0% rate y-t-d and 8.0% over the past year. For the week, Currency increased $3.2bn, and Demand & Checkable Deposits rose $28.4bn. Savings Deposits declined $8.0bn, and Small Denominated Deposits fell $6.7bn. Retail Money Funds declined $4.3bn.
Total Money Market Fund assets (from Invest Co Inst) sank $61.0bn to $3.482 TN. Money fund assets have declined $348bn y-t-d, or 12.8% annualized. Money funds increased $70bn, or 2.0%, over the past year.
Total Commercial Paper outstanding increased $16.1bn (5-wk gain of $115bn) to a 13-wk high $1.190 TN. CP has declined $492bn y-t-d (41% annualized) and $574bn over the past year (33%). Asset-backed CP rose $18.0bn to $502bn, with a 52-wk drop of $260bn (34%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $275bn y-o-y to $7.204 TN. Reserves have increased $440bn year-to-date.
Global Credit Market Watch:
September 18 – Bloomberg (John Detrixhe): “Citigroup Inc. and Morgan Stanley led the most U.S. corporate bond sales in four months this week… Borrowers sold at least $39 billion of debt… Including high-yield, high-risk, or junk, debt, companies have borrowed at least $932 billion in bonds this year, a 37% increase from 2008.”
September 15 – Bloomberg (Laura Cochrane and Lester Pimentel): “Emerging-market borrowing costs fell to levels before the collapse of Lehman… The extra yield investors demand to own developing-nations’ bonds instead of U.S. Treasuries dropped 13 bps today to 3.31 percentage points…”
September 17 – Bloomberg (Jeremy R. Cooke): “State and local government bonds returned 14% this year so far, beating their performance during the comparable period in every year since Merrill Lynch & Co.’s Municipal Master Index began in 1989.”
September 17 – Bloomberg (Mary Schlangenstein): “AMR Corp.’s American Airlines, the world’s second-largest carrier, said it raised $2.9 billion in cash and financing and will add flying at four U.S. hubs to focus on the most-profitable parts of its network.”
September 14 – Bloomberg (Mark Deen and David Tweed): “Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc. ‘In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,’ Stiglitz said… ‘The problems are worse than they were in 2007 before the crisis.’ Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker…”
Government Finance Bubble Watch:
September 18 – Bloomberg (Thomas Penny): “Britain posted the biggest budget deficit for any August since modern records began in 1993 as the recession destroyed tax revenue and welfare costs soared. The 16.1 billion-pound ($26.3 billion) shortfall compared with a deficit of 9.9 billion pounds a year earlier…”
September 18 – Bloomberg (Caroline Hyde and Anchalee Worrachate): “Germany and Austria led governments and companies in Europe selling $21.7 billion of bonds in the U.S. currency this week to take advantage of the reduced cost of exchanging the proceeds back into euros. The sales were the most since February…”
September 18 – Bloomberg (Lester Pimentel and Veronica Navarro Espinosa): “Mexico sold $1.75 billion of bonds in its first international issue since it was forced to pull a 21-year debt offer seven months ago… Yields on Mexico’s 2019 bonds have dropped to 5.16% from 6.36% in March…”
Currency Watch:
September 16 – Bloomberg (Dan Levy): “Tom Perkins, the venture capitalist whose firm helped finance Google Inc. and Amazon.com, paid $9.35 million for a penthouse condominium in the Millennium Tower, San Francisco’s tallest residential tower. The 4,806 square-foot apartment is on the top floor of the 60-story building in the city’s South of Market area… ‘It’s a good time to buy things other than paper,’ Perkins, 77, co-founder of… Kleiner Perkins Caufield & Byers, said…”
September 15 – Bloomberg (Paul Abelsky): “Russia’s government sees a handful of regional currencies emerging over the next decade to challenge the dollar, as long as emerging markets continue to grow, President Dmitry Medvedev’s senior economic adviser said. The world will probably have ‘five or six currency unions’ similar to the euro region… Arkady Dvorkovich said…”
The dollar index slipped 0.1% this week to 76.51. For the week on the upside, the Swedish krona increased 2.0%, the Norwegian krone 1.3%, the Brazilian real 1.2%, the South Korean won 1.2%, the Danish krone 1.0%, the Swiss franc 0.8%, the Canadian dollar 0.7%, and the Singapore dollar 0.5%. On the downside, British pound declined 2.4% and the Japanese yen fell 0.7%.
Commodities Watch:
September 16 – Bloomberg: “Commodity demand in China, the largest metals user, ‘is back on track in a very big way,’ and copper and coking coal have the best prospects for price gains… according to CLSA Research Ltd. ‘Commodities that give investors the most upside potential when the rest of the world demand recovers’ are those with supply constraints, Andrew Driscoll…said… ‘In the next twelve months, having exposure to copper is going to be a good investment.’ China’s $586 billion stimulus plan and a record $1.1 trillion of lending in the first half of this year have countered a 10-month slump in the nation’s exports, helping Asia to lead a global rebound from the worst slump since the 1930s. Copper futures have more than doubled this year.”
September 17 – Bloomberg (Glenys Sim): “Private investors in China, the world’s largest metals user, have stockpiled ‘substantial’ quantities of copper as the government ramps up stimulus spending to spur the economy, according to Sucden Financial Ltd. Pig farmers and other speculators may have amassed more than 50,000 metric tons…”
September 16 – Bloomberg (Zijing Wu): “Chinese companies will step up the pace of overseas mergers and acquisitions in a ‘new wave’ of deals, said Xiong Weiping, chairman of Aluminum Corp. of China… ‘Chinese companies will reinforce the going-out strategy and participate in this new wave of M&As,’ Xiong said… There will be more mergers and acquisitions in the mining sector with the end of the financial crisis, he said.”
September 14 – Bloomberg (Bernard Lo and Kim Kyoungwha): “Global banks are engaged in a hiring boom for commodity traders as they add staff to benefit from surging metals and energy prices, offering $1 million packages for top employees, recruiters Robert Walters Plc said. There’s “huge demand for physical traders,’ Gary Lai, manager of financial services at Robert Walters in Singapore, said… ‘For top traders, especially investment bank traders, $1 million is not unexpected, it’s easy to get,’ Lai said…”
Gold added 0.2% to close at $1,008 (up 14.2% y-t-d). Silver gained 1.8% to $17.01 (up 51% y-t-d). October Crude jumped $2.0 to $71.79 (up 61% y-t-d). October Gasoline rallied 3.9% (up 72% y-t-d), and September Natural Gas surged 26.8% (down 33% y-t-d). December Copper declined 2.2% (up 97% y-t-d). December Wheat dropped 2.1% (down 25% y-t-d), and December Corn declined 0.5% (down 22% y-t-d). The CRB index jumped 3.5% (up 13.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) surged 3.9% (up 34.3% y-t-d).
China Bubble Watch:
September 17 – Bloomberg (Chia-Peck Wong and Frank Longid): “Sun Hung Kai Properties Ltd., the world’s largest developer by market value, raised the price of two penthouses in Hong Kong by 50% to a record HK$75,000 ($9,700) a square foot as demand surges for luxury apartments. The units will be offered for HK$300 million ($39 million) each…”
September 15 – Bloomberg (Chia-Peck Wong): “A one-bedroom apartment in Hong Kong’s Kowloon district was bought by a local businessman for HK$30,025 ($3,874) a square foot, a record price for properties of that type in the city… The broker sold the property for HK$24.5 million ($3.2 million).”
September 17 – Bloomberg (Cathy Chan): “Sinopharm Group Co. raised the maximum HK$8.73 billion ($1.13 billion) sought in a Hong Kong initial public offering after investors in the city applied for almost 600 times the stock available to them.”
September 16 – Bloomberg: “China… may have to spend an additional 1.7 trillion yuan ($249 billion) in 2050 to shift the country to a ‘low-carbon’ model of economic growth. ‘China needs between 500 and 600 billion yuan annually to develop energy-conservation and low-carbon technologies, and the capital requirements are even greater in the reduction of carbon dioxide after 2020,’ think-tanks led by the State Council’s Development Research Center said… The cost of cutting China’s emissions may reach $438 billion annually within 20 years, the Financial Times reported…”
India Watch:
September 17 – Bloomberg (Shobhana Chandra): “U.S. pension and private equity firms are ‘excited’ about financing India’s $80 billion program to build roads and expressways, according to Minister for Road Transport and Highways Kamal Nath… ‘The projects are not only viable, but profitable,’ Nath told reporters in New York. U.S. investors ‘are now not looking at real estate, not looking at equities; they’re looking at infrastructure.’ India will need $1.7 trillion to build infrastructure over the next decade to boost economic growth, Goldman Sachs Group Inc. estimated…”
Latin America Bubble Watch:
September 13 – Bloomberg (Andre Soliani and Paulo Winterstein): “Brazil proved to be a ‘success case’ among global economies as growing domestic demand and investments helped buffer that nation during the economic downturn, central bank President Henrique Meirelles said… Brazil is in a ‘very strong position’ now with bank loans being granted at pre-crisis levels, Meirelles said…”
September 15 – Bloomberg (Telma Marotto): “Morgan Stanley, the top adviser on takeovers in Brazil, doubled the investment-banking staff in Latin America’s biggest economy and plans to add more as local capital markets develop, an executive said.”
September 15 – Bloomberg (Joshua Goodman and Adriana Brasileiro): “Brazil’s retail sales accelerated for the second straight month in July, reinforcing bets that domestic demand will power the country’s economic rebound. Retail sales rose 5.9% from the year-ago period…”
September 16 – Bloomberg (Fabiola Moura and Veronica Espinosa): “Brazilian President Luiz Inacio Lula da Silva may reach the target of building 1 million homes for low-income workers by 2011… said the chief executive officer of homebuilder Construtora Tenda SA. ‘The beauty of the government program is that for the first time it has set a goal,’ Carlos Trostli said… ‘It will be very difficult for someone to come and stop a program that’s generating jobs and increasing fiscal revenue.’ Lula announced a plan on March 24 to spend 34 billion reais ($18.8 billion) for low-income housing…”
Unbalanced Global Economy Watch:
September 16 – Bloomberg (Svenja O’Donnell): “U.K. unemployment jumped to the highest level since 1995… The number of people seeking jobs in the three months through July rose by 210,000 to 2.47 million…”
September 15 – Bloomberg (Dara Doyle): “The skeleton of an eight-story Dublin office block lays deserted on the north bank of the River Liffey, just next to the financial district that less than two years ago was the heart of Ireland’s economic boom. Four cranes stand idle at the site, one of at least 35,000 unfinished or empty new offices and homes that dot Ireland’s landscape after the collapse of its real estate market. Finance Minister Brian Lenihan will detail tomorrow how much Ireland will pay for about 90 billion euros ($131 billion) of real estate loans now crippling what as recently as 2006 was one of Europe’s most dynamic economies.”
September 17 – Bloomberg (Emma Ross-Thomas and Simone Meier): “Europe posted the largest trade surplus in five years in July… Exports from the 16-nation euro region rose a seasonally adjusted 4.1% from June…” July imports contracted 0.3% and the trade surplus jumped to 6.8 billion euros ($10bn)…”
U.S. Bubble Economy Watch:
September 17 – Reuters (Lisa Lambert): “The federal government and states are girding themselves for the next foreclosure crisis in the country's housing downturn: payment option adjustable rate mortgages that are beginning to reset. ‘Payment option ARMs are about to explode,’ Iowa Attorney General Tom Miller said… ‘That’s the next round of potential foreclosures in our country.’”
Central Banker Watch:
September 14 – Bloomberg (Frances Robinson): “European Central Bank President Jean-Claude Trichet said saving Lehman Brothers Holdings Inc. or American International Group Inc. from bankruptcy wouldn’t necessarily have prevented the financial crisis from deepening. ‘Lehman was a trigger, but you could have another trigger,’ Trichet told CNBC… ‘Even if Lehman and AIG had been saved, it would be a new entity that had problems… ‘At the end of the weekend we knew it was unfortunately bankruptcy that would be the solution,’ Trichet said… ‘It triggered for us as well as all sister central banks the sentiment that we had to prepare for something that was really big.’”
September 14 – Bloomberg (Theresa Tang and Sophie Leung): “Hong Kong Monetary Authority Chief Executive Joseph Yam said central banks face a dilemma on when to tighten monetary policy. Doing so too soon has the potential to curb an economic recovery, while maintaining loose monetary policy may produce ‘asset bubbles,’ Yam said…”
September 16 – Bloomberg (Tasneem Brogger): “Sweden’s Riksbank should start raising rates earlier than its current outlook indicates as the economy is set to recover faster than the bank’s official forecast, two of the policy board’s six members said. ‘The repo rate might need to be raised during the late spring or summer 2010,’ Riksbank Deputy Governor Barbro Wickman-Parak said…”
September 16 – Bloomberg (Timothy R. Homan): “Former Federal Reserve Chairman Alan Greenspan said he’s worried that lawmakers will hamper U.S. central bank efforts to rein in its monetary stimulus, and that inflation might ‘swamp’ the bond market. ‘It’s the politics in the United States that worries me, whether the Congress will basically feel comfortable” with the Fed withdrawing its stimulus, Greenspan said…‘if inflation rears its head, it will swamp long-term markets,’ referring to bonds.”
Fiscal Watch:
September 18 – Washington Post (Dina El Boghdady): “The Federal Housing Administration has been hit so hard by the mortgage crisis that for the first time, the agency’s cash reserves will drop below the minimum level set by Congress… The FHA guaranteed about a quarter of all U.S. home loans made this year… ‘It’s very serious,’ FHA Commissioner David H. Stevens said… ‘There’s nothing more serious that we're addressing right now, outside the housing crisis in general, than this issue.’ …The agency does not lend money; it insures lenders against losses. It has captured 23% of all new loans made so far this year, up from just 3% in 2006.”
Muni Watch:
September 18 – Bloomberg (Jeremy R. Cooke): “Municipal bond sales rose to $9.7 billion, the highest in five weeks based on data compiled by Bloomberg…”
Speculator Watch:
September 17 – Bloomberg (Saijel Kishan): “The pace of hedge fund liquidations slowed in the second quarter as managers posted a 9.1% gain, according to Hedge Fund Research Inc. About 292 funds shut down, a 22% decline from the first quarter…”
Q2 2009 Flow of Funds:
September 18 – Wall Street Journal (Peter Eavis): “More than half of U.S. residential mortgages are being made by just three large banks. It is a stunning change, but is it good for the housing market, and to what extent will it boost profits over the long term for this elite trio: Wells Fargo, Bank of America, and J.P. Morgan Chase? Right now, housing remains on government life support. Treasury-backed entities are guaranteeing about 85% of new mortgages, while the Fed buys 80% of the securities into which these taxpayer-backed mortgages are packaged.”
The Federal Reserve’s Z.1 “flow of funds” report remains a must “read” when it comes to grasping the happenings of the U.S. Credit system. Granted, the reams of data may not be quite as captivating now as compared to the Wall Street Bubble years. But the report never disappoints.
For the quarter, Non-Financial Credit growth accelerated to 4.9% annualized, up from Q1’s 4.1% and compared to Q2 2008’s 3.3%. In nominal seasonally-adjusted and annualized rate (SAAR) terms, Non-Financial debt expanded $1.646 TN. This was up strongly from Q1’s $1.371 TN SAAR, but still below the $2.0 TN or so I deem necessary to (at least temporarily) stabilize the system. Keep in mind that the economy remained quite weak for much of Q2. I would expect Q3 Credit growth in the neighborhood of $2.0 TN annualized. For perspective, Non-Financial Credit expanded $865bn in 2000, $1.152 TN in 2001, $1.413 TN in 2002, $1.671 TN in 2003, $1.997 TN in 2004, $2.329 TN in 2005, $2.400 TN in 2006, $2.539 TN in 2007 and $1.888 TN in 2008.
And while the recovery in Credit is on the surface encouraging, the composition of this growth is disconcerting. For the quarter, Household debt contracted at a 1.7% rate, with Home Mortgage and Consumer Debt down 1.4% and 6.5% annualized – both worse than Q1 (declines of 0.1% and 3.7%). Corporate borrowings expanded at only 1.0% annualized, down from Q1’s 2.1% and compared to 6.7% back in Q2 2008. Private sector Credit remains stuck in the muck.
Meanwhile, State & Local debt growth accelerated to 8.3% annualized, up from Q1’s 4.9% and Q2 2008’s 0.9%. State & Local governments expanded borrowings $187bn SAAR - a resurgence back to the peak borrowing level from 2007 ($186bn). Federal borrowings expanded at a blistering 28.2% pace, up from Q1’s 22.6% and compared to Q2 2008’s 5.9%. Federal borrowing increased to $1.895 TN SAAR during the quarter. State & Local and Federal combined debt growth reached $2.082 TN SAAR, significantly larger than the total system Non-Financial debt growth of $1.646 TN SAAR (with Household Credit and Mortgage debt contracting).
Over the past four quarters, Non-Financial Credit expanded $1.959 TN, or 6.1%, to $34.320 TN. This was no small amount of debt growth. Treasury borrowings increased $1.893 TN over the past year to $7.143 TN. And during this period Federal Reserve assets ballooned $1.111 TN, or 117%, to $2.063 TN. It is incredible to watch the emerging Government Finance Bubble take such command of U.S. Credit.
On an SAAR basis, the Federal Reserve increased Agency- and GSE-Backed Securities $1.088 TN during Q2 (nominal $272bn). In nominal dollars, Fed holdings of Agency (mostly MBS) securities increased from $20bn at year-end to $559bn by the end of Q2. And keep in mind that Home Mortgage debt actually contracted $53bn during this period (to $10.951 TN).
There is a perception that the Fed’s agency MBS purchase program is specifically targeting stabilization of the conventional mortgage market. Yet, examining the data, one can see that the private-label MBS marketplace is perhaps the greater beneficiary of Federal Reserve largess. For the quarter, Issuers of Asset-Backed Securities (chiefly pools of private-label/non-GSE mortgages) contracted $499bn SAAR, this after a $614bn SAAR contraction in Q1. But this was offset by an increase in GSE MBS of $556bn SAAR in Q2 and $304bn SAAR in Q1.
So, the Fed is amassing quite a stockpile of “conventional” GSE MBS, but often these are “private-label” mortgages recently “refinanced” into GSE securities. And as the Fed buys the new GSE MBS, newly created funds become available to flow back to reliquefy the formerly illiquid ABS marketplace (along with agencies, Treasuries, corporates, and equities). To be sure, placing essentially federal government backing upon previously “private-label” mortgages dramatically changes the market’s perception of these securities’ worth (“moneyness”) – especially with fed funds pegged for an extended period at near zero and the Fed in the midst of a $25bn weekly purchase program in order to fulfill it commitment to purchase $1.25 TN of mortgage securities.
During the quarter, outstanding GSE MBS expanded at a 10.4% rate to $5.173 TN. GSE MBS increased $414bn, or 8.7%, over the past year and $1.098 TN, or 26.9%, over two years. During Q2, the ABS market contracted at a 12.2% rate to $3.817 TN. ABS declined $525bn over the past year, or 12.1%, and $673bn, or 15%, over two years. Here we see confirmation that nationalization of mortgage Credit runs unabated. Not only is the vast majority of new mortgage Credit this year government-backed, Washington guarantees are being slapped on hundreds of billions of existing “nonconventional” mortgages. This intrusion and transfer of (Credit and interest rate) risk has terrible long-term ramifications. Although in the near-term this mechanism provides a powerful stabilizing force for both the Credit system and real economy.
Bank Credit contracted at a 1.4% pace during the quarter to $9.523 TN. Similar to the money supply numbers, I have tended this year to deemphasize private lending data in my analysis. After all, how much can we expect to discern from traditional Credit-related metrics when policymakers are issuing Trillions of Treasuries/agencies Credit and the Fed is monetizing a Trillion or so? It is, however, worth noting that Bank holdings of Government Securities expanded at a 16.2% pace during the quarter to $941bn. Mortgages increased at a respectable 4.6% clip to $3.899 TN. Business loans contracted at a notable 17.8% pace (to $2.031TN), although this may be somewhat explained by the thawing of the corporate debt securities marketplace (companies issuing debt to repay bank borrowings).
On the bank Liability side, total Deposits expanded at a 5.2% rate during the quarter to $7.278 TN (up 7.8% y-o-y). Credit Market borrowings were about flat at $1.720 TN. Fed Funds & Repo expanded ($133bn) for the first time in eight quarters (to $596bn). Meanwhile, Miscellaneous Liabilities contracted at a 24% rate to $2.468 TN.
Posting the strongest growth since Q2 2007, Securities Broker/Dealer assets expanded at a 14.5% pace to $2.00 TN. Broker Dealer assets increased $514bn SAAR during the quarter, although most of this is explained by an increase in Treasuries holdings (up $404bn SAAR). With the Fed’s massive MBS buying program in mind, it’s not surprising to see Broker/Dealer holdings of Agency and MBS declining $179bn SAAR. It is worth noting that, on the Liability side, Security Repos expanded $224bn SAAR, the first increase in repos since Q1 2008. “Other” Miscellaneous Liabilities increased $309bn SAAR.
Examining the miscellaneous categories, Finance Companies contracted 8.6% annualized to $1.777 TN (down 7.9% y-o-y). Credit Unions expanded 9.9% annualized to $877bn (up 9.1% y-o-y). REITs increased 13.3% annualized to $260bn (down 13.5% y-o-y). Money Market contracted at a 16.5% rate during Q2 to $3.584 TN, cutting y-o-y growth to 8.0%. Life Insurance assets grew at an 11.9% pace to $4.552 TN (down 6.6% y-o-y).
Rest of World holdings were down a rather insignificant $134bn SAAR to $14.200 TN. There were, however, some meaningful changes in the composition of foreign holdings of U.S. assets. Net Interbank Assets contracted $692bn SAAR, while Official Treasury holdings jumped $494bn SAAR. U.S. Corporate Bond holdings declined $110bn SAAR, while Miscellaneous Assets expanded $227bn SAAR.
In total, Rest of World purchased $403bn SAAR of Treasuries during Q2, about a quarter of total issuance ($1.896 TN SAAR). Who were the other major purchasers? The Fed monetized $647bn SAAR, the Household Sector bought $343bn SAAR, and Broker/Dealers accumulated $404bn. And while it is positive that American households are buying Treasuries and saving more, this does not change the fact that this so called “savings” was bolstered by income effects from massive government spending increases.
Examining income data, National Income stabilized during the quarter at $12.162 TN. After declining $347bn annualized during Q4 2008 and $225bn annualized during Q1, National Income slipped only $47bn annualized during the quarter. National Income was down 4.0% y-o-y. Total Compensation was down 3.8% y-o-y to $7.726 TN. National Income and Compensation began the decade at $8.358 TN and $5.354 TN. It is my view that, at this point, only massive federal deficits and government intrusions will stabilize system incomes at today’s highly inflated levels.
Federal Q2 Receipts were down 6.6% y-o-y to $2.215 TN SAAR, while Federal Expenditures surged 35.9% to $3.510 TN SAAR. For comparison, federal expenditures were $2.393 TN in 2004, $2.573 TN in 2005, $2.728 TN in 2006, $2.897 TN in 2007 and $3.118 TN in 2008. So current spending levels are running almost 50% above where they were five years ago. Second quarter State & Local receipts were just slightly ahead of the year ago level to $2.004 TN. Spending was slightly down from a year earlier to $2.014 TN.
The media was quick to pick up on the quarter’s $2.0 TN increase in Household Net Worth. For the bad news, Net Worth was still down $7.438 TN over the past year. With Household Liabilities essentially flat (down 1.0% annualized) at about $14.10 TN, changes in Household Assets dictate the increase/decrease in Net Worth. For the quarter, assets were up $1.964 TN, or 12.0%, to $67.208 TN. This jump places asset values back to mid-2005 levels. Real Estate holdings actually rose $157bn (nominal) to $20.026 TN, the first increase in 10 quarters. Yet, reflation’s real impact was felt in the $1.777 TN (17.5%) jump in household holdings of Financial Assets. Over the past year, the value of Real Estate declined $1.759 TN and Financial Assets dropped $6.043 TN. It is worth noting that, despite the crisis, Household Net Worth was up about a third in seven years.
To summarize, there were no surprises in the Q2 2009 Flow of Funds. What I saw was confirmation of the Government Finance Bubble Thesis. “Uncle Sam Bets the House on Mortgages” was the headline for an insightful article in this morning’s Wall Street Journal (Peter Eavis). It would as well make a good title for recent Z.1 Flow of Funds reports. My bet is that this massive government intrusion into mortgage finance eventually backfires. It puts Washington on course for bankrupting the country, while doing little to direct financial and real resources in a manner to spur needed economic restructuring.
09/11/2009 And No Dialing Back *
For the shortened week, the S&P500 increased 2.5% (up 15.4% y-t-d), and the Dow gained 1.7% (up 9.5% y-t-d). The Morgan Stanley Cyclicals surged 4.3% (up 56.0%), and Transports jumped 5.3% (up 12.4%). The Morgan Stanley Consumer index increased 2.5% (up 14.8%), while the Utilities slipped 0.5% (down 2.5%). The Banks added 0.4% (up 2.5%), and the Broker/Dealers jumped 3.3% (up 48.0%). The S&P 400 Mid-Caps rose 3.8% (up 26.2%), and the small cap Russell 2000 jumped 3.9% (up 18.8%). The Nasdaq100 gained 2.8% (up 39.1%) and the Morgan Stanley High Tech index jumped 4.0% (up 55.6%). The Semiconductors rose 3.6% (up 51.4%). The InteractiveWeek Internet index advanced 4.1% (up 58.6%). The Biotechs added 0.3% (up 43.4%). With Bullion gaining another $11 to close above $1,000, the HUI gold index rose 4.0% (up 40.9%).
One-month Treasury bill rates ended the week at 8 bps, and three-month bills closed at 14 bps. Two-year government yields dipped 3 bps to 0.80%. Five-year T-note yields fell 6 bps to 2.23%. Ten-year yields were down 10 bps to 3.34%. Long bond yields were 9 bps lower to 4.18%. Benchmark Fannie MBS yields sank 14 bps to 4.29%. The spread between 10-year Treasuries and benchmark MBS narrowed 4 to 95. Agency 10-yr debt spreads narrowed 5 to 19 bps. The implied yield on December 2010 eurodollar futures dropped 13.5 bps to 1.68%. The 2-year dollar swap spread declined 4.0 to 31.75 bps; the 10-year dollar swap spread declined 4.25 to 16.75 bps; and the 30-year swap spread declined 3.25 to negative 16.25 bps. Corporate bond spreads were mostly narrower. An index of investment grade bond spreads narrowed 13 bps to 162, while an index of junk spreads widened 2 to 690 bps.
Corporate debt issuance picked up markedly to begin the month. Investment grade issuers included CVS Caremark $1.5bn, Prudential Financial $1.5bn, Met Life $1.0bn, Kinder Morgan $1.0bn, Midcontinent Express Pipeline $800 million, Agilent Tech $750 million, Avalonbay Communities $500 million, National Rural Utilities $500 million, Airgas $400 million, Puget Sound Energy $350 million, Timken $250 million, and Questar Pipeline $250 million.
Junk bond funds enjoyed inflows of $223 million (from AMG). Junk issuers included Cablevision $900 million, Global Crossing $750 million, Harrahs $720 million, Ferrellgas $300 million, Plains Exploration $400 million, and WR Berkley $300 million.
I saw no convert issues.
International dollar-denominated debt issuance was huge. Issuers included Hutchinson Whampoa $3.0bn, Commercial Bank of Australia $2.75bn, Spain $2.5bn, Svenska Handelsbanken $2.5bn, Iberdrola Ireland $2.0bn, Swedish Export Credit $1.5bn, Taqa Abu Dhabi $1.5bn, Tetroleos Mexica $1.5bn, Vale Overseas $1.0bn, and Petroplus $400 million.
U.K. 10-year gilt yields dipped one basis point to 3.61%, and German bund yields declined one basis point to 3.23%. The German DAX equities index jumped 4.5% (up 16.9%). Japanese 10-year "JGB" yields declined 2 bps to 1.30%. The Nikkei 225 gained 2.5% (up 17.9%). Emerging markets were quite strong. Brazil’s benchmark dollar bond yields sank 26 bps to 5.19%. Brazil’s Bovespa equities index rose 2.9% (up 55.4% y-t-d). The Mexican Bolsa surged 4.0% (up 31.6% y-t-d). Mexico’s 10-year $ yields dropped 21 bps to 5.55%. Russia’s RTS equities index surged 12.5% (up 89.4%). India’s Sensex equities index gained 3.7% (up 68.6%). China’s Shanghai Exchange jumped 4.5%, increasing 2009 gains to 64.2%.
Freddie Mac 30-year fixed mortgage rates dipped one basis point to 5.07% (down 84bps y-o-y). Fifteen-year fixed rates fell 4 bps to 4.50% (down 104bps y-o-y). One-year ARMs increased 2 bps to 4.64% (down 57bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 9 bps to 6.18% (down 75bps y-o-y).
Federal Reserve Credit rose $6.3bn last week to $2.070 TN. Fed Credit has declined $177bn y-t-d, although it expanded $1.181 TN over the past 52 weeks (133%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/7) declined $0.7bn to $2.828 TN. "Custody holdings" have expanded at a 17.9% rate y-t-d, and were up $432bn over the past year, or 18.1%.
M2 (narrow) "money" supply rose $11.3bn to $8.294 TN (week of 8/31). Narrow "money" has expanded at a 1.8% rate y-t-d and 7.6% over the past year. For the week, Currency declined $2.3bn, while Demand & Checkable Deposits slipped $0.9bn. Savings Deposits jumped $28.1bn, while Small Denominated Deposits fell $9.5bn. Retail Money Funds declined $3.9bn.
Total Money Market Fund assets (from Invest Co Inst) fell another $15.4bn to $3.543 TN. Money fund assets have declined $287bn y-t-d, or 10.8% annualized. Money funds fell $38.4bn, or 1.1%, over the past year.
Total Commercial Paper outstanding increased $11.3bn (4-wk gain of $99bn) to $1.174 TN. CP has declined $508bn y-t-d (44% annualized) and $642bn over the past year (35%). Asset-backed CP gained $6.2bn to $484bn, with a 52-wk drop of $297bn (38%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $252bn y-o-y to $7.197 TN. Reserves have increased $432bn year-to-date.
Global Credit Market Watch:
September 8 – Bloomberg (Paul Armstrong and Esteban Duarte): “Corporate bond sales surged in Europe, driving this year’s record issuance above $1.23 trillion… Issuance is now 11% ahead of the total for all of 2008… ‘The market is back on fire after its usual summer lull,’ said Juan Esteban Valencia, a credit analyst at Societe Generale… ‘Appetite for credit remains unabated.’”
September 9 – Bloomberg (Laura Cochrane): “Emerging-market government and state-backed companies will likely sell more than $100 billion of bonds this year, according to Commerzbank AG. ‘Investors are hungry for quasi-sovereign risk,’ said Luis Costa, emerging-market debt strategist at Commerzbank…said…”
September 8 – Bloomberg (Steve Scherer): “Italian Prime Minister Silvio Berlusconi said curbing ‘speculation’ in financial markets is more important to Group of 20 leaders than controlling bonuses for bank executives. G-20 leaders meet in Pittsburgh later this month to discuss measures aimed at making the global financial system more stable after the worst financial collapse since the Great Depression.”
September 10 – Bloomberg (John Glover): “Defaults among speculative-grade companies and issuers of so-called leveraged loans will peak at about 15% this year in Europe, Standard & Poor’s said…”
September 10 – Bloomberg (Doug Alexander): “Stocks sales in Canada surged to the highest in a decade this year after Barrick Gold Corp. and Fairfax Financial Holdings Ltd. led the biggest one-day sale of equity in Canadian history.”
Government Finance Bubble Watch:
September 11 – Bloomberg (Theophilos Argitis and Chris Donville): “Canadian Prime Minister Stephen Harper’s government, which faces defeat in Parliament as early as next week, is delaying the country’s exit from budget deficits... He also projected cumulative deficits of C$164.4 billion ($152.5 billion) by then, doubling his earlier forecasts.”
September 10 – Bloomberg (Christian Vits): “European Central Bank council member Axel Weber said returning to the pre-crisis debt level may take decades. ‘When I look at the longer years it took us to reduce government debt, it’s pretty clear that reaching the same level of economic activity as before the crisis can be done pretty quickly by 2013,’ Weber… said… ‘Reaching the same level of debt to GDP will take at least one to two decades.’”
September 9 – Bloomberg (Rebecca Christie): “The Federal Deposit Insurance Corp. proposed a six-month, emergency-only extension to its debt guarantee program as regulators move to wean companies from federal aid approved at the height of last year’s credit crisis.”
September 10 – Bloomberg (Svenja O’Donnell): “The Bank of England plans to keep buying as much as 175 billion pounds ($290 billion) of assets to cement the economy’s recovery from the worst recession in a generation.”
Currency Watch:
September 7 – Bloomberg (Jonathan Tirone): “The dollar’s role in international trade should be reduced by establishing a new currency to protect emerging markets from the ‘confidence game’ of financial speculation, the United Nations said. UN countries should agree on the creation of a global reserve bank to issue the currency and to monitor the national exchange rates of its members, the Geneva-based UN Conference on Trade and Development said… ‘There’s a much better chance of achieving a stable pattern of exchange rates in a multilaterally-agreed framework for exchange-rate management,’ Heiner Flassbeck, co-author of the report… said… ‘An initiative equivalent to Bretton Woods or the European Monetary System is needed.’ The 1944 Bretton Woods agreement created the modern global economic system and institutions including the IMF and World Bank.”
September 10 – Bloomberg (Jody Shenn): “Yuan deposits offer the largest interest-rate premium over dollar accounts in 17 months, adding to pressure on the Chinese government to end its currency’s fixed-exchange rate… Inflows of hot money, funds that move across borders seeking short-term returns, may swell to more than $160 billion in the second half, compared with $42 billion in the first six months, Zhang Ming, a researcher at the Chinese Academy of Social Sciences, said…”
The dollar index sank 1.9% this week to 76.67. For the week on the upside, the New Zealand dollar increased 2.7%, the Japanese yen 2.6%, the Swedish krona 2.4%, the Swiss franc 2.2%, the South African rand 2.0%, the Danish krone 2.0%, the Euro 2.0%, the British pound 1.7%, the South Korean won 1.6%, the Australian dollar 1.4%, the Singapore dollar 1.2%, the Canadian dollar 1.1%, and the Norwegian krone 1.1%. Losing against the dollar, the Argentine peso declined 0.3% and the Turkish lira fell 0.2%.
Commodities Watch:
September 9 – Bloomberg (Millie Munshi and Veronica Navarro Espinosa): “Gold prices that jumped above $1,000 an ounce this week are signaling that investors are buying metals to hedge against declines in currencies, former Federal Reserve Chairman Alan Greenspan said. The gains are ‘strictly a monetary phenomenon,’ Greenspan said… Rising prices of precious metals and other commodities are ‘an indication of a very early stage of an endeavor to move away from paper currencies,’ he said… ‘What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment,’ Greenspan said… ‘China is turning out to be the 900-pound gorilla in the energy and commodity market,’ Greenspan said. ‘The increase in oil consumption in China has been quite extraordinary.’”
September 9 – Bloomberg (Aya Takada): “Japan, Asia’s second-largest aluminum importer, agreed to increase the fee it pays to producers by at least 53% to the highest in 14 years as surging Chinese demand saps regional supplies.”
September 8 – Bloomberg (Thomas Kutty Abraham): “A global tea shortage may increase by 10% next year as droughts in Kenya, Sri Lanka and India, the top exporters, damage crops and propel prices to a record, the world’s biggest tea plantation company said.”
Gold gained 1.1% to close at $1,006 (up 14.0% y-t-d). Silver jumped 3.1% to $16.79 (up 48.6% y-t-d). October Crude rose a volatile $1.18 to $69.20 (up 55% y-t-d). October Gasoline declined 1.3% (up 65% y-t-d), while September Natural Gas rallied 9.6% (down 47% y-t-d). December Copper declined 1.3% (up 101% y-t-d). December Wheat fell 1.0% (down 24% y-t-d), while December Corn recovered 4.4% (down 21% y-t-d). The CRB index gained 1.2% (up 9.4% y-t-d). The Goldman Sachs Commodities Index (GSCI) jumped 2.8% (up 29.3% y-t-d).
China Bubble Watch:
September 10 – Bloomberg: “China’s Premier Wen Jiabao said the nation ‘cannot and will not’ pull back from economic stimulus measures… ‘China’s economic rebound is unstable, unbalanced and not yet solid,’ Wen said… He cautioned that some stimulus measures will ‘fade’ and others will take time to become effective. Wen’s remarks reflect a commitment last week from the world’s biggest nations to maintain unprecedented fiscal and monetary measures…”
September 10 – Bloomberg: “Bank of China Ltd., which led the nation’s $1.1 trillion lending spree in the first half, said ample liquidity has caused ‘bubbles’ in stocks, commodities and real estate. ‘The potential risk is that a lot of liquidity goes to the asset market,’ Vice President Zhu Min said… ‘So you see asset bubbles in commodities, stocks and real estate, not only in China, but everywhere.’”
September 10 – Bloomberg: “Bankers on Wall Street are suffering from ‘over confidence’ and are ‘myopic’ in the face of a continuing financial crisis, Bank of China Ltd. Vice President Zhu Min said. ‘You go to Wall Street, the people feel the crisis never happened,’ Zhu said… ‘It’s not only over-confidence, it’s over- myopic. This is too much.’ Zhu’s criticism reflects the growing confidence of China…in scolding the U.S. for missteps that led to the financial crisis and mounting federal debt.”
September 10 – Bloomberg: “China’s bank loans will post steady growth in the second half of the year as big fluctuations would hurt the economic recovery, the official Xinhua News Agency reported, citing Bank of China Vice President Zhu Min. Zhu refuted speculation that banks will tighten credit in the second half, saying bank loans will grow steadily in the next six-to-12 months…”
September 10 – Bloomberg: “China’s house prices in the nation’s 70 biggest cities rose at the fastest pace in 11 months on record lending and climbing confidence. House prices increased 2% in August from a year earlier…”
September 8 – Bloomberg (Jacob Greber): “China’s passenger-car sales surged a record 90% last month, as tax cuts and government subsidies spurred demand, bringing the nation closer to overtaking the U.S. as the world’s largest auto market.”
September 11 – Bloomberg: “China’s industrial production grew at a faster pace in August, signaling a strengthening recovery in the world’s third-biggest economy. Output gained 12.3% from a year earlier, after climbing 10.8% in July, the statistics bureau said…”
September 11 – Bloomberg: “China’s power generation rose to a record in August… Power output increased for a third month, gaining 9.3% to 344.3 million megawatt-hours… Power generation had climbed 4.8% in July and 5% in June after contracting for three straight months.”
September 9 – Bloomberg (Andrea Rothman): “China is taking aim at the heart of the global commercial aerospace industry with a jet dubbed ‘The Big Plane,’ seeking to crack the duopoly Boeing Co. and Airbus SAS hold… ‘They have a good mix of technologies and westernized standards,’ Christof Spaeth, senior vice president of Jet Aviation AG…said… ‘So it might find its way from the home also to some international markets. It’s not easy but there’s a chance.’”
September 9 – Bloomberg (Sophie Leung): “Inflation in China may accelerate to at least 4% by the middle of next year, spurring the nation’s central bank to raise interest rates, Deutsche Bank AG economists said. ‘We believe inflation in China will rise faster than in most other major economies and will therefore justify earlier and stronger-than-expected rate hikes,’ Ma Jun, a Hong Kong- based economist for China at Deutsche Bank, said…”
September 8 – Bloomberg: “Commercial Aircraft Corp. of China, the government-controlled planemaker, said its first commercial jet will ‘surely be cheaper’ than comparable Boeing Co. and Airbus SAS models, heightening competition in the world’s fastest-growing aviation market… Comac will initially target Chinese customers for the single-aisle C919 before seeking to challenge Boeing and Airbus overseas…”
India Watch:
September 8 – Wall Street Journal (Nik Hil Gulati and Santanu Choudhury): “Car sales in India rose 26%... Sales climbed to 120,669 cars in August from 96,082 a year earlier, showed data issued Tuesday by industry lobby group Society of Indian Automobile Manufacturers."
September 11 – Bloomberg (Kartik Goyal): “India’s industrial production increased for a seventh straight month as higher government spending and lower borrowing costs stoked demand for cars, motorbikes and other consumer goods. Output at factories, utilities and mines rose 6.8% in July from a year earlier…”
Asia Bubble Watch:
September 9 – Bloomberg (Michael Dwyer): “Asian central banks may find it difficult to tighten monetary policy ‘meaningfully’ due to political constraints caused by high unemployment, UBS AG said. Jobless levels may remain ‘uncomfortably high’ in the region for the next year or two, Duncan Wooldridge, chief Asia economist at UBS…wrote…”
September 9 – Bloomberg (Anil Varma): “Investors are boosting purchases of high-yield Asian debt after dollar money-market rates slid to record lows this year…”
September 11 – Bloomberg (Shamim Adam): “Asia faces greater risks from asset bubbles caused by global stimulus than from threats to economic growth, said Gail Fosler, president of the Conference Board. Governments need to be vigilant of the money flowing into their economies as investors buy assets such as real estate in emerging markets, Fosler…said… ‘There is a tremendous amount of fiscal stimulus that is going into producing the supply response that you see in the global economy today and the growth in assets continues to be stunning… This sets the stage for asset bubbles to move out of the U.S. and into Asia and emerging markets in general.”
Latin America Bubble Watch:
September 8 – Bloomberg (Mike Cohen): “Brazil, the world’s largest producer, may spend $33 billion on new sugar mills and renovating existing plants by 2012, said Fabio Torquato, the international relations director of the Mercosur trading block in Brazil.”
September 9 – Bloomberg (Jens Erik Gould): “Mexican President Felipe Calderon proposed spending cuts and increases in income, corporate and sales taxes as part of ‘unprecedented’ steps to offset diminishing oil revenue and prevent a credit-rating reduction. The 2010 budget proposal cuts spending by 218 billion pesos ($16.3bn), the Finance Ministry said…”
Unbalanced Global Economy Watch:
September 8 – Bloomberg (Jacob Greber): “Australian business confidence jumped in August to its highest level in almost six years…”
U.S. Bubble Economy Watch:
September 10 – Bloomberg (Bob Willis): “The U.S. trade deficit widened in July and imports gained by a record 4.7%, signaling a revival of commerce as the global recession eased. The gap between imports and exports grew 16%, the most in more than a decade, to $32 billion…”
September 9 – Bloomberg (Jeff Plungis): “wealthy individuals’ Chapter 11 bankruptcy filings jumped 73% in the second quarter from a year earlier, according to the National Bankruptcy Research Center… More individuals or families with at least $1,010,650 in secured debt and $336,900 unsecured are using Chapter 11 of the U.S. bankruptcy code typically associated with business reorganizations.”
September 9 – Bloomberg (Gillian Wee): “George Washington University is increasing holdings of commodities such as oil and natural gas out of concern that a return to inflation rates last seen in the 1970s may ravage the value of its $1 billion endowment. U.S. consumer prices may rise 8% annually within three to five years because of unprecedented government spending and deficits, said Donald Lindsey, the Washington school’s chief investment officer… ‘Inflation, once it starts, could get very difficult to stop,’ Lindsey, 50, said… ‘We could see a stagflation environment that’s similar to the 1970s.’”
Central Banker Watch:
September 10 – Reuters (Alister Bull): “Federal Reserve Vice Chairman Donald Kohn said… the U.S. central bank was developing tools to move away from its extremely loose monetary policy, but such an exit would not happen any time soon. ‘Any combination of these tools, in addition to the payment of interest on reserves, may prove very valuable when the time comes to tighten the stance of monetary policy,’ Kohn said… ‘As the FOMC has said, that time is not likely to come for an extended period…’”
September 9 – Bloomberg (Matthew Newman): “European Central Bank President Jean-Claude Trichet said while the financial crisis is not yet over, it’s important for policy makers to consider how they will withdraw economic stimulus measures. ‘It’s not time yet to say that the crisis is over,’ Trichet told reporters…"
September 9 – Bloomberg (Cherian Thomas): “Central banks must maintain low interest rates until consumer and company spending is ‘robust’ enough to support economic growth, said Subir Gokarn, the Standard & Poor’s economist in the running for the deputy governor’s post at the Reserve Bank of India.”
GSE Watch:
September 10 – Bloomberg (Jody Shenn): “‘Credibly’ privatizing Fannie Mae and Freddie Mac… may be too difficult given the precedent set by the Treasury Department’s financial assistance, according to a Government Accountability Office analysis. ‘The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency,’ the GAO said… ‘Consequently, such privatized entities may continue to derive financial benefits, such as lowered borrowing costs, resulting from the markets’ perceptions.’ The Treasury today reiterated that the government intends to make recommendations on Fannie Mae and Freddie Mac next year… ‘Any transition to a new structure would need to consider the enterprises’ still-dominant position in housing finance and be implemented carefully (perhaps in phases) to ensure its success,” the GAO said.”
September 10 – Wall Street Journal (David Enrich): “Banks have been silent partners in the meteoric rise of the Federal Housing Administration. In the past year, the nation’s financial institutions have snapped up securities backed by Ginnie Mae, a government-owned agency that guarantees payments on mortgages backed by the FHA… As of June 30, the roughly 8,500 federally insured banks and thrifts were holding $113.5 billion of Ginnie securities, compared with just $41 billion a year earlier…”
Real Estate Bust Watch:
September 10 – Bloomberg (Daniel Taub): “Foreclosure filings in the U.S. exceeded 300,000 for the sixth straight month… A total of 358,471 properties received a default or auction notice or were seized last month, according to… RealtyTrac Inc. That’s up 18% from a year earlier…”
September 8 – Bloomberg (Jody Shenn): “About $134 billion of securitized ‘option’ adjustable-rate mortgages will reset to higher payments over the next two years…according to Fitch…”
September 9 – Bloomberg (Hui-yong Yu): “The default rate on commercial mortgages held by U.S. banks will rise to 5.4% in 2011, the highest since at least 1992… according to Real Estate Econometrics LLC.”
Speculator Watch:
September 11 – Bloomberg (Gillian Wee): “Harvard University and Yale University, the wealthiest U.S. schools, got about 30% poorer in the past year as their endowments lost more money on investments than less-affluent schools. Harvard’s fund declined to $26 billion in the year ended June 30, led by a 27.3% loss on investments and $1.7 billion in distributions… Yale’s endowment fell to about $16 billion…”
September 8 – Bloomberg (Warren Giles): “Hedge funds lured $4.5 billion in August, double the net inflows the previous month… according to Eurekahedge Pte.”
Crude Liquidity Watch:
September 10 – Bloomberg (Simon Packard): “House prices in Dubai plummeted 47% in the second quarter from a year earlier, the steepest drop of any market, according to Knight Frank LLC, as speculators left the Persian Gulf business hub.”
And No Dialing Back:
CNBC’s Steve Liesman: “Mr. Secretary, how much concern do you have right now - how much pressure are you under right now to dial back on these programs. Dial back spending. Dial back – getting to the audience question right there that I think is critical and that is really indicative of how Americans feel: Get the government out of the private sector. How much pressure are you under right now?”
Treasury Secretary Geithner: “No one is going to be more eager than I am. You’re just not going to care about that more than me. We do not want to be in any of these institutions a day longer than is necessary. And look at what we have already done. We already have $80bn of capital coming back into the Treasury. If you look at what I said today in my testimony on the hill, we’ve seen these emergency programs we put in place already be used at a tiny fraction of their scale in emergency. We designed these things so that they would not be used a day longer than necessary.
But we’re going to be careful not to withdraw too soon. Again, the classic mistake countries make in crisis is that they put on the brakes too early and reignite the recession, ultimately at much greater fiscal cost and much greater damage to the economy. So that’s the balance we’ve got to get right. And we are not now at the point – even though the challenge is shifting – we’re a bit moving now from emergency to the harder challenge, frankly, of repair and recovery. That’s going to change the mix of what we do. We’re going to get out and walk these things back as soon as we are confident we can get out of this thing.”
September 10 – Bloomberg (Jody Shenn): “‘Credibly’ privatizing Fannie Mae and Freddie Mac… may be too difficult given the precedent set by the Treasury Department’s financial assistance, according to a Government Accountability Office analysis. ‘The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency,’ the GAO said… ‘Consequently, such privatized entities may continue to derive financial benefits, such as lowered borrowing costs, resulting from the markets’ perceptions.’ The Treasury today reiterated that the government intends to make recommendations on Fannie Mae and Freddie Mac next year… ‘Any transition to a new structure would need to consider the enterprises’ still-dominant position in housing finance and be implemented carefully (perhaps in phases) to ensure its success,” the GAO said.”
My interest is not in taking shots at today’s policymakers. They have been faced with incredible challenges, and proceed now on a course they hope and believe is best for returning the country to sound footing. And while I disagree strongly with the current path of policymaking, it has been predictable. From a policymaking perspective, the greatest error came with the Greenspan/Bernanke Fed’s failure to act to rein in systemic Credit excess, asset inflation, and financial Bubbles. Many belatedly recognized the Fed’s failings, yet few today appreciate that the costs and risks of flawed analysis and theories only keep mounting.
I retain keen interest in debunking the Fed’s thesis – articulated most clearly by then Fed governor Bernanke – that central banks should avoid the business of popping Bubbles and instead focus on post-Bubble “mopping up” strategies. It was, after all, post-Russia/LTCM “mopping up” that fueled the tech Bubble, and then the post-Tech and 9/11 mopping that fostered the Wall Street/mortgage finance Bubble. And the latest big mop up job sets the stage for perhaps the greatest Bubble of them all – the Global Government Finance Bubble.
They appear as free lunches at the time, but there are myriad financial and economic costs associated with government intrusions into the marketplace. Most are subtle and tend to remain quiescent for years. When (market pricing, resource allocation and economic impairment) distortions do eventually manifest into a crisis, policymaking will have a strong proclivity to treat misdiagnosed ills with only greater government manipulations and intrusions. And the greater the degree of intrusion into the markets, the greater the ongoing costs involved. Huge intrusions ensure open-ended government involvement and increasing governmental command over the economic system.
As much as I believe Secretary Giethner is speaking earnestly, there is no way at this point government influence in the marketplace can be meaningfully Dialed Back. The damage has been done – historic distortions to both the financial system and real economy. The damage began with the activist Greenspan Fed manipulating interest rates, promising market liquidity, and pandering to the leveraged speculators. The damage worsened as the government-sponsored enterprises came to dominate our nation’s market for housing finance. And the damage turned unmanageable when the markets listened back in 2002 to Dr. Bernanke profess the virtues of helicopter money and whatever other unconventional measures the central bank might deem worthwhile.
Federal government finance (Treasuries, agency debt and GSE MBS) has expanded about $2.0 TN over the past year. I expect it to inflate another $2.0 TN over the coming twelve months. The private sector Credit apparatus is simply not up to the task of generating the necessary $2.5 TN (or so) of total system Credit expansion necessary to sustain the current economic structure. In this post-Wall Street Bubble environment, only government and government-related Credit retains sufficient “moneyness” in the marketplace. Systemic reflation today depends on a massive inflation of this government helicopter “money.”
This week’s GAO analysis of the GSE’s was spot on and certainly applies to more than just the government-sponsored enterprises: “The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency.” Over five Trillion – and counting – of GSE securities are valued and traded in the marketplace as (money-like) government-backed obligations. Policymakers would not today risk the negative financial and economic ramifications from Dialing Back from Washington’s explicit and implicit guarantees.
And as much as moral hazard and “too big to fail” are recognized as fundamental facets of previous Bubble excess, our policymakers have nonetheless been compelled to expand only further toward backstopping the entire Credit system (and economy). Obviously, the GSE’s were too big to really fail, while markets appreciate that policymakers now believe it was a mistake to allow Lehman to collapse. The markets – more than ever before - operate with the view that policymakers have no tolerance for a major financial institution failure.
When one contemplates the issue of “getting the government out of the private sector,” these various market liquidity support programs being wound down are an insignificant issue. Fundamentally, for the economy to move toward sounder and sustainable footing would require at least a semblance of a market-based Credit pricing mechanism. Regrettably, the vast majority of system Credit today is “public.” Government intrusion chiefly dictates the cost of finance and the allocation of financial and real resources. Furthermore, I would argue that the limited amount of private sector debt being issued these days is reliant upon the system-stabilizing effects of massive government debt issuance and spending.
As I have stressed repeatedly, in the neighborhood of $2.5 TN of non-financial Credit growth is required to stem systemic implosion – a massive Credit expansion with only our federal government up to the challenge. It is this fundamental facet of Bubble economies – a maladjusted economic structure sustained only through ongoing Credit excess – that prohibits Washington from extricating itself from very public “private sector” intrusions. Fixated on the notion of sustainable recovery, policymakers will not be Dialing Back from massive borrowing, spending, or market backstopping endeavors. And this gets to the core of the unquantifiable costs of failing to rein in Credit and asset Bubbles during the boom.
As I have written over the years, the entire notion of “mopping up” is as flawed as it is dangerous. Clearly, the notion of inflationism remains as seductive as it has throughout history. If, God forbid, deflation ever becomes a risk the central bank must aggressively raise the price level to preclude a downward spiral. We heard this dogma in the early nineties, heard it again earlier this decade, and have had it repeated too often over the past year. The answer is always another bout of Credit inflation.
And the more intense the necessity to reflate - the greater the government’s evolving role throughout both the financial and economic systems. This is a fact of life, human nature and politics. And at the end of the day inflationism tends toward socialism. And there is only one way to reverse this course; it is anything but painless. The economy must be weaned off of Credit and financial excesses and government intrusions – and allowed to proceed through the arduous task of adjustment and rebalancing. Choosing instead a course of sustaining current financial and economic structures implies a huge and ever-expanding role for the government. Efforts to stoke a quick recovery imply massive government intrusion and inherent fragility. There will be no Dialing Back.
Many hope the private-sector can regroup and again rise to the occasion. It is expected that as recovery gains a foothold private sector borrowing and lending will increase, tax receipts will rise, and the government will enjoy the luxury of Dialing Back as the system normalizes. I don’t expect this dynamic to work as it has traditionally because of the confluence of Bubble economy Credit requirements, acute private sector Credit system impairment and market mistrust, and the government’s predominant influence on the recovery.
The dynamic today is one of a shallow recovery induced by a flood of government borrowing and spending and marketplace intrusions. Rampant financial speculation has reemerged, which leaves the marketplace increasingly vulnerable to any serious move to Dial Back. In a normal recovery, the system tends to gain strength and stability over time. Credit requirements are usually manageable, while speculative excesses have been largely wrung out of the system. In stark contrast, today’s combination of huge Credit expansion and a highly speculative financial backdrop ensures only more acute systemic fragilities over time. And the distorted marketplace will simply not function well at even the notion of fiscal and monetary exit strategies.
Conceptually, somewhere along the line there reaches a tipping point where government intrusions no longer act as a stabilizing force. They become invariably destabilizing, as the quantity of government monetary inflation becomes massive and uncontrollable. This is the nature of inflationism, although this dynamic is nowhere to be found in Keynesian doctrine. It is my view that this tipping point was reached some time back. It is with this analysis in mind that I fear the emerging Government Finance Bubble risks destroying the creditworthiness of our entire economy.
One-month Treasury bill rates ended the week at 8 bps, and three-month bills closed at 14 bps. Two-year government yields dipped 3 bps to 0.80%. Five-year T-note yields fell 6 bps to 2.23%. Ten-year yields were down 10 bps to 3.34%. Long bond yields were 9 bps lower to 4.18%. Benchmark Fannie MBS yields sank 14 bps to 4.29%. The spread between 10-year Treasuries and benchmark MBS narrowed 4 to 95. Agency 10-yr debt spreads narrowed 5 to 19 bps. The implied yield on December 2010 eurodollar futures dropped 13.5 bps to 1.68%. The 2-year dollar swap spread declined 4.0 to 31.75 bps; the 10-year dollar swap spread declined 4.25 to 16.75 bps; and the 30-year swap spread declined 3.25 to negative 16.25 bps. Corporate bond spreads were mostly narrower. An index of investment grade bond spreads narrowed 13 bps to 162, while an index of junk spreads widened 2 to 690 bps.
Corporate debt issuance picked up markedly to begin the month. Investment grade issuers included CVS Caremark $1.5bn, Prudential Financial $1.5bn, Met Life $1.0bn, Kinder Morgan $1.0bn, Midcontinent Express Pipeline $800 million, Agilent Tech $750 million, Avalonbay Communities $500 million, National Rural Utilities $500 million, Airgas $400 million, Puget Sound Energy $350 million, Timken $250 million, and Questar Pipeline $250 million.
Junk bond funds enjoyed inflows of $223 million (from AMG). Junk issuers included Cablevision $900 million, Global Crossing $750 million, Harrahs $720 million, Ferrellgas $300 million, Plains Exploration $400 million, and WR Berkley $300 million.
I saw no convert issues.
International dollar-denominated debt issuance was huge. Issuers included Hutchinson Whampoa $3.0bn, Commercial Bank of Australia $2.75bn, Spain $2.5bn, Svenska Handelsbanken $2.5bn, Iberdrola Ireland $2.0bn, Swedish Export Credit $1.5bn, Taqa Abu Dhabi $1.5bn, Tetroleos Mexica $1.5bn, Vale Overseas $1.0bn, and Petroplus $400 million.
U.K. 10-year gilt yields dipped one basis point to 3.61%, and German bund yields declined one basis point to 3.23%. The German DAX equities index jumped 4.5% (up 16.9%). Japanese 10-year "JGB" yields declined 2 bps to 1.30%. The Nikkei 225 gained 2.5% (up 17.9%). Emerging markets were quite strong. Brazil’s benchmark dollar bond yields sank 26 bps to 5.19%. Brazil’s Bovespa equities index rose 2.9% (up 55.4% y-t-d). The Mexican Bolsa surged 4.0% (up 31.6% y-t-d). Mexico’s 10-year $ yields dropped 21 bps to 5.55%. Russia’s RTS equities index surged 12.5% (up 89.4%). India’s Sensex equities index gained 3.7% (up 68.6%). China’s Shanghai Exchange jumped 4.5%, increasing 2009 gains to 64.2%.
Freddie Mac 30-year fixed mortgage rates dipped one basis point to 5.07% (down 84bps y-o-y). Fifteen-year fixed rates fell 4 bps to 4.50% (down 104bps y-o-y). One-year ARMs increased 2 bps to 4.64% (down 57bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 9 bps to 6.18% (down 75bps y-o-y).
Federal Reserve Credit rose $6.3bn last week to $2.070 TN. Fed Credit has declined $177bn y-t-d, although it expanded $1.181 TN over the past 52 weeks (133%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/7) declined $0.7bn to $2.828 TN. "Custody holdings" have expanded at a 17.9% rate y-t-d, and were up $432bn over the past year, or 18.1%.
M2 (narrow) "money" supply rose $11.3bn to $8.294 TN (week of 8/31). Narrow "money" has expanded at a 1.8% rate y-t-d and 7.6% over the past year. For the week, Currency declined $2.3bn, while Demand & Checkable Deposits slipped $0.9bn. Savings Deposits jumped $28.1bn, while Small Denominated Deposits fell $9.5bn. Retail Money Funds declined $3.9bn.
Total Money Market Fund assets (from Invest Co Inst) fell another $15.4bn to $3.543 TN. Money fund assets have declined $287bn y-t-d, or 10.8% annualized. Money funds fell $38.4bn, or 1.1%, over the past year.
Total Commercial Paper outstanding increased $11.3bn (4-wk gain of $99bn) to $1.174 TN. CP has declined $508bn y-t-d (44% annualized) and $642bn over the past year (35%). Asset-backed CP gained $6.2bn to $484bn, with a 52-wk drop of $297bn (38%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $252bn y-o-y to $7.197 TN. Reserves have increased $432bn year-to-date.
Global Credit Market Watch:
September 8 – Bloomberg (Paul Armstrong and Esteban Duarte): “Corporate bond sales surged in Europe, driving this year’s record issuance above $1.23 trillion… Issuance is now 11% ahead of the total for all of 2008… ‘The market is back on fire after its usual summer lull,’ said Juan Esteban Valencia, a credit analyst at Societe Generale… ‘Appetite for credit remains unabated.’”
September 9 – Bloomberg (Laura Cochrane): “Emerging-market government and state-backed companies will likely sell more than $100 billion of bonds this year, according to Commerzbank AG. ‘Investors are hungry for quasi-sovereign risk,’ said Luis Costa, emerging-market debt strategist at Commerzbank…said…”
September 8 – Bloomberg (Steve Scherer): “Italian Prime Minister Silvio Berlusconi said curbing ‘speculation’ in financial markets is more important to Group of 20 leaders than controlling bonuses for bank executives. G-20 leaders meet in Pittsburgh later this month to discuss measures aimed at making the global financial system more stable after the worst financial collapse since the Great Depression.”
September 10 – Bloomberg (John Glover): “Defaults among speculative-grade companies and issuers of so-called leveraged loans will peak at about 15% this year in Europe, Standard & Poor’s said…”
September 10 – Bloomberg (Doug Alexander): “Stocks sales in Canada surged to the highest in a decade this year after Barrick Gold Corp. and Fairfax Financial Holdings Ltd. led the biggest one-day sale of equity in Canadian history.”
Government Finance Bubble Watch:
September 11 – Bloomberg (Theophilos Argitis and Chris Donville): “Canadian Prime Minister Stephen Harper’s government, which faces defeat in Parliament as early as next week, is delaying the country’s exit from budget deficits... He also projected cumulative deficits of C$164.4 billion ($152.5 billion) by then, doubling his earlier forecasts.”
September 10 – Bloomberg (Christian Vits): “European Central Bank council member Axel Weber said returning to the pre-crisis debt level may take decades. ‘When I look at the longer years it took us to reduce government debt, it’s pretty clear that reaching the same level of economic activity as before the crisis can be done pretty quickly by 2013,’ Weber… said… ‘Reaching the same level of debt to GDP will take at least one to two decades.’”
September 9 – Bloomberg (Rebecca Christie): “The Federal Deposit Insurance Corp. proposed a six-month, emergency-only extension to its debt guarantee program as regulators move to wean companies from federal aid approved at the height of last year’s credit crisis.”
September 10 – Bloomberg (Svenja O’Donnell): “The Bank of England plans to keep buying as much as 175 billion pounds ($290 billion) of assets to cement the economy’s recovery from the worst recession in a generation.”
Currency Watch:
September 7 – Bloomberg (Jonathan Tirone): “The dollar’s role in international trade should be reduced by establishing a new currency to protect emerging markets from the ‘confidence game’ of financial speculation, the United Nations said. UN countries should agree on the creation of a global reserve bank to issue the currency and to monitor the national exchange rates of its members, the Geneva-based UN Conference on Trade and Development said… ‘There’s a much better chance of achieving a stable pattern of exchange rates in a multilaterally-agreed framework for exchange-rate management,’ Heiner Flassbeck, co-author of the report… said… ‘An initiative equivalent to Bretton Woods or the European Monetary System is needed.’ The 1944 Bretton Woods agreement created the modern global economic system and institutions including the IMF and World Bank.”
September 10 – Bloomberg (Jody Shenn): “Yuan deposits offer the largest interest-rate premium over dollar accounts in 17 months, adding to pressure on the Chinese government to end its currency’s fixed-exchange rate… Inflows of hot money, funds that move across borders seeking short-term returns, may swell to more than $160 billion in the second half, compared with $42 billion in the first six months, Zhang Ming, a researcher at the Chinese Academy of Social Sciences, said…”
The dollar index sank 1.9% this week to 76.67. For the week on the upside, the New Zealand dollar increased 2.7%, the Japanese yen 2.6%, the Swedish krona 2.4%, the Swiss franc 2.2%, the South African rand 2.0%, the Danish krone 2.0%, the Euro 2.0%, the British pound 1.7%, the South Korean won 1.6%, the Australian dollar 1.4%, the Singapore dollar 1.2%, the Canadian dollar 1.1%, and the Norwegian krone 1.1%. Losing against the dollar, the Argentine peso declined 0.3% and the Turkish lira fell 0.2%.
Commodities Watch:
September 9 – Bloomberg (Millie Munshi and Veronica Navarro Espinosa): “Gold prices that jumped above $1,000 an ounce this week are signaling that investors are buying metals to hedge against declines in currencies, former Federal Reserve Chairman Alan Greenspan said. The gains are ‘strictly a monetary phenomenon,’ Greenspan said… Rising prices of precious metals and other commodities are ‘an indication of a very early stage of an endeavor to move away from paper currencies,’ he said… ‘What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment,’ Greenspan said… ‘China is turning out to be the 900-pound gorilla in the energy and commodity market,’ Greenspan said. ‘The increase in oil consumption in China has been quite extraordinary.’”
September 9 – Bloomberg (Aya Takada): “Japan, Asia’s second-largest aluminum importer, agreed to increase the fee it pays to producers by at least 53% to the highest in 14 years as surging Chinese demand saps regional supplies.”
September 8 – Bloomberg (Thomas Kutty Abraham): “A global tea shortage may increase by 10% next year as droughts in Kenya, Sri Lanka and India, the top exporters, damage crops and propel prices to a record, the world’s biggest tea plantation company said.”
Gold gained 1.1% to close at $1,006 (up 14.0% y-t-d). Silver jumped 3.1% to $16.79 (up 48.6% y-t-d). October Crude rose a volatile $1.18 to $69.20 (up 55% y-t-d). October Gasoline declined 1.3% (up 65% y-t-d), while September Natural Gas rallied 9.6% (down 47% y-t-d). December Copper declined 1.3% (up 101% y-t-d). December Wheat fell 1.0% (down 24% y-t-d), while December Corn recovered 4.4% (down 21% y-t-d). The CRB index gained 1.2% (up 9.4% y-t-d). The Goldman Sachs Commodities Index (GSCI) jumped 2.8% (up 29.3% y-t-d).
China Bubble Watch:
September 10 – Bloomberg: “China’s Premier Wen Jiabao said the nation ‘cannot and will not’ pull back from economic stimulus measures… ‘China’s economic rebound is unstable, unbalanced and not yet solid,’ Wen said… He cautioned that some stimulus measures will ‘fade’ and others will take time to become effective. Wen’s remarks reflect a commitment last week from the world’s biggest nations to maintain unprecedented fiscal and monetary measures…”
September 10 – Bloomberg: “Bank of China Ltd., which led the nation’s $1.1 trillion lending spree in the first half, said ample liquidity has caused ‘bubbles’ in stocks, commodities and real estate. ‘The potential risk is that a lot of liquidity goes to the asset market,’ Vice President Zhu Min said… ‘So you see asset bubbles in commodities, stocks and real estate, not only in China, but everywhere.’”
September 10 – Bloomberg: “Bankers on Wall Street are suffering from ‘over confidence’ and are ‘myopic’ in the face of a continuing financial crisis, Bank of China Ltd. Vice President Zhu Min said. ‘You go to Wall Street, the people feel the crisis never happened,’ Zhu said… ‘It’s not only over-confidence, it’s over- myopic. This is too much.’ Zhu’s criticism reflects the growing confidence of China…in scolding the U.S. for missteps that led to the financial crisis and mounting federal debt.”
September 10 – Bloomberg: “China’s bank loans will post steady growth in the second half of the year as big fluctuations would hurt the economic recovery, the official Xinhua News Agency reported, citing Bank of China Vice President Zhu Min. Zhu refuted speculation that banks will tighten credit in the second half, saying bank loans will grow steadily in the next six-to-12 months…”
September 10 – Bloomberg: “China’s house prices in the nation’s 70 biggest cities rose at the fastest pace in 11 months on record lending and climbing confidence. House prices increased 2% in August from a year earlier…”
September 8 – Bloomberg (Jacob Greber): “China’s passenger-car sales surged a record 90% last month, as tax cuts and government subsidies spurred demand, bringing the nation closer to overtaking the U.S. as the world’s largest auto market.”
September 11 – Bloomberg: “China’s industrial production grew at a faster pace in August, signaling a strengthening recovery in the world’s third-biggest economy. Output gained 12.3% from a year earlier, after climbing 10.8% in July, the statistics bureau said…”
September 11 – Bloomberg: “China’s power generation rose to a record in August… Power output increased for a third month, gaining 9.3% to 344.3 million megawatt-hours… Power generation had climbed 4.8% in July and 5% in June after contracting for three straight months.”
September 9 – Bloomberg (Andrea Rothman): “China is taking aim at the heart of the global commercial aerospace industry with a jet dubbed ‘The Big Plane,’ seeking to crack the duopoly Boeing Co. and Airbus SAS hold… ‘They have a good mix of technologies and westernized standards,’ Christof Spaeth, senior vice president of Jet Aviation AG…said… ‘So it might find its way from the home also to some international markets. It’s not easy but there’s a chance.’”
September 9 – Bloomberg (Sophie Leung): “Inflation in China may accelerate to at least 4% by the middle of next year, spurring the nation’s central bank to raise interest rates, Deutsche Bank AG economists said. ‘We believe inflation in China will rise faster than in most other major economies and will therefore justify earlier and stronger-than-expected rate hikes,’ Ma Jun, a Hong Kong- based economist for China at Deutsche Bank, said…”
September 8 – Bloomberg: “Commercial Aircraft Corp. of China, the government-controlled planemaker, said its first commercial jet will ‘surely be cheaper’ than comparable Boeing Co. and Airbus SAS models, heightening competition in the world’s fastest-growing aviation market… Comac will initially target Chinese customers for the single-aisle C919 before seeking to challenge Boeing and Airbus overseas…”
India Watch:
September 8 – Wall Street Journal (Nik Hil Gulati and Santanu Choudhury): “Car sales in India rose 26%... Sales climbed to 120,669 cars in August from 96,082 a year earlier, showed data issued Tuesday by industry lobby group Society of Indian Automobile Manufacturers."
September 11 – Bloomberg (Kartik Goyal): “India’s industrial production increased for a seventh straight month as higher government spending and lower borrowing costs stoked demand for cars, motorbikes and other consumer goods. Output at factories, utilities and mines rose 6.8% in July from a year earlier…”
Asia Bubble Watch:
September 9 – Bloomberg (Michael Dwyer): “Asian central banks may find it difficult to tighten monetary policy ‘meaningfully’ due to political constraints caused by high unemployment, UBS AG said. Jobless levels may remain ‘uncomfortably high’ in the region for the next year or two, Duncan Wooldridge, chief Asia economist at UBS…wrote…”
September 9 – Bloomberg (Anil Varma): “Investors are boosting purchases of high-yield Asian debt after dollar money-market rates slid to record lows this year…”
September 11 – Bloomberg (Shamim Adam): “Asia faces greater risks from asset bubbles caused by global stimulus than from threats to economic growth, said Gail Fosler, president of the Conference Board. Governments need to be vigilant of the money flowing into their economies as investors buy assets such as real estate in emerging markets, Fosler…said… ‘There is a tremendous amount of fiscal stimulus that is going into producing the supply response that you see in the global economy today and the growth in assets continues to be stunning… This sets the stage for asset bubbles to move out of the U.S. and into Asia and emerging markets in general.”
Latin America Bubble Watch:
September 8 – Bloomberg (Mike Cohen): “Brazil, the world’s largest producer, may spend $33 billion on new sugar mills and renovating existing plants by 2012, said Fabio Torquato, the international relations director of the Mercosur trading block in Brazil.”
September 9 – Bloomberg (Jens Erik Gould): “Mexican President Felipe Calderon proposed spending cuts and increases in income, corporate and sales taxes as part of ‘unprecedented’ steps to offset diminishing oil revenue and prevent a credit-rating reduction. The 2010 budget proposal cuts spending by 218 billion pesos ($16.3bn), the Finance Ministry said…”
Unbalanced Global Economy Watch:
September 8 – Bloomberg (Jacob Greber): “Australian business confidence jumped in August to its highest level in almost six years…”
U.S. Bubble Economy Watch:
September 10 – Bloomberg (Bob Willis): “The U.S. trade deficit widened in July and imports gained by a record 4.7%, signaling a revival of commerce as the global recession eased. The gap between imports and exports grew 16%, the most in more than a decade, to $32 billion…”
September 9 – Bloomberg (Jeff Plungis): “wealthy individuals’ Chapter 11 bankruptcy filings jumped 73% in the second quarter from a year earlier, according to the National Bankruptcy Research Center… More individuals or families with at least $1,010,650 in secured debt and $336,900 unsecured are using Chapter 11 of the U.S. bankruptcy code typically associated with business reorganizations.”
September 9 – Bloomberg (Gillian Wee): “George Washington University is increasing holdings of commodities such as oil and natural gas out of concern that a return to inflation rates last seen in the 1970s may ravage the value of its $1 billion endowment. U.S. consumer prices may rise 8% annually within three to five years because of unprecedented government spending and deficits, said Donald Lindsey, the Washington school’s chief investment officer… ‘Inflation, once it starts, could get very difficult to stop,’ Lindsey, 50, said… ‘We could see a stagflation environment that’s similar to the 1970s.’”
Central Banker Watch:
September 10 – Reuters (Alister Bull): “Federal Reserve Vice Chairman Donald Kohn said… the U.S. central bank was developing tools to move away from its extremely loose monetary policy, but such an exit would not happen any time soon. ‘Any combination of these tools, in addition to the payment of interest on reserves, may prove very valuable when the time comes to tighten the stance of monetary policy,’ Kohn said… ‘As the FOMC has said, that time is not likely to come for an extended period…’”
September 9 – Bloomberg (Matthew Newman): “European Central Bank President Jean-Claude Trichet said while the financial crisis is not yet over, it’s important for policy makers to consider how they will withdraw economic stimulus measures. ‘It’s not time yet to say that the crisis is over,’ Trichet told reporters…"
September 9 – Bloomberg (Cherian Thomas): “Central banks must maintain low interest rates until consumer and company spending is ‘robust’ enough to support economic growth, said Subir Gokarn, the Standard & Poor’s economist in the running for the deputy governor’s post at the Reserve Bank of India.”
GSE Watch:
September 10 – Bloomberg (Jody Shenn): “‘Credibly’ privatizing Fannie Mae and Freddie Mac… may be too difficult given the precedent set by the Treasury Department’s financial assistance, according to a Government Accountability Office analysis. ‘The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency,’ the GAO said… ‘Consequently, such privatized entities may continue to derive financial benefits, such as lowered borrowing costs, resulting from the markets’ perceptions.’ The Treasury today reiterated that the government intends to make recommendations on Fannie Mae and Freddie Mac next year… ‘Any transition to a new structure would need to consider the enterprises’ still-dominant position in housing finance and be implemented carefully (perhaps in phases) to ensure its success,” the GAO said.”
September 10 – Wall Street Journal (David Enrich): “Banks have been silent partners in the meteoric rise of the Federal Housing Administration. In the past year, the nation’s financial institutions have snapped up securities backed by Ginnie Mae, a government-owned agency that guarantees payments on mortgages backed by the FHA… As of June 30, the roughly 8,500 federally insured banks and thrifts were holding $113.5 billion of Ginnie securities, compared with just $41 billion a year earlier…”
Real Estate Bust Watch:
September 10 – Bloomberg (Daniel Taub): “Foreclosure filings in the U.S. exceeded 300,000 for the sixth straight month… A total of 358,471 properties received a default or auction notice or were seized last month, according to… RealtyTrac Inc. That’s up 18% from a year earlier…”
September 8 – Bloomberg (Jody Shenn): “About $134 billion of securitized ‘option’ adjustable-rate mortgages will reset to higher payments over the next two years…according to Fitch…”
September 9 – Bloomberg (Hui-yong Yu): “The default rate on commercial mortgages held by U.S. banks will rise to 5.4% in 2011, the highest since at least 1992… according to Real Estate Econometrics LLC.”
Speculator Watch:
September 11 – Bloomberg (Gillian Wee): “Harvard University and Yale University, the wealthiest U.S. schools, got about 30% poorer in the past year as their endowments lost more money on investments than less-affluent schools. Harvard’s fund declined to $26 billion in the year ended June 30, led by a 27.3% loss on investments and $1.7 billion in distributions… Yale’s endowment fell to about $16 billion…”
September 8 – Bloomberg (Warren Giles): “Hedge funds lured $4.5 billion in August, double the net inflows the previous month… according to Eurekahedge Pte.”
Crude Liquidity Watch:
September 10 – Bloomberg (Simon Packard): “House prices in Dubai plummeted 47% in the second quarter from a year earlier, the steepest drop of any market, according to Knight Frank LLC, as speculators left the Persian Gulf business hub.”
And No Dialing Back:
CNBC’s Steve Liesman: “Mr. Secretary, how much concern do you have right now - how much pressure are you under right now to dial back on these programs. Dial back spending. Dial back – getting to the audience question right there that I think is critical and that is really indicative of how Americans feel: Get the government out of the private sector. How much pressure are you under right now?”
Treasury Secretary Geithner: “No one is going to be more eager than I am. You’re just not going to care about that more than me. We do not want to be in any of these institutions a day longer than is necessary. And look at what we have already done. We already have $80bn of capital coming back into the Treasury. If you look at what I said today in my testimony on the hill, we’ve seen these emergency programs we put in place already be used at a tiny fraction of their scale in emergency. We designed these things so that they would not be used a day longer than necessary.
But we’re going to be careful not to withdraw too soon. Again, the classic mistake countries make in crisis is that they put on the brakes too early and reignite the recession, ultimately at much greater fiscal cost and much greater damage to the economy. So that’s the balance we’ve got to get right. And we are not now at the point – even though the challenge is shifting – we’re a bit moving now from emergency to the harder challenge, frankly, of repair and recovery. That’s going to change the mix of what we do. We’re going to get out and walk these things back as soon as we are confident we can get out of this thing.”
September 10 – Bloomberg (Jody Shenn): “‘Credibly’ privatizing Fannie Mae and Freddie Mac… may be too difficult given the precedent set by the Treasury Department’s financial assistance, according to a Government Accountability Office analysis. ‘The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency,’ the GAO said… ‘Consequently, such privatized entities may continue to derive financial benefits, such as lowered borrowing costs, resulting from the markets’ perceptions.’ The Treasury today reiterated that the government intends to make recommendations on Fannie Mae and Freddie Mac next year… ‘Any transition to a new structure would need to consider the enterprises’ still-dominant position in housing finance and be implemented carefully (perhaps in phases) to ensure its success,” the GAO said.”
My interest is not in taking shots at today’s policymakers. They have been faced with incredible challenges, and proceed now on a course they hope and believe is best for returning the country to sound footing. And while I disagree strongly with the current path of policymaking, it has been predictable. From a policymaking perspective, the greatest error came with the Greenspan/Bernanke Fed’s failure to act to rein in systemic Credit excess, asset inflation, and financial Bubbles. Many belatedly recognized the Fed’s failings, yet few today appreciate that the costs and risks of flawed analysis and theories only keep mounting.
I retain keen interest in debunking the Fed’s thesis – articulated most clearly by then Fed governor Bernanke – that central banks should avoid the business of popping Bubbles and instead focus on post-Bubble “mopping up” strategies. It was, after all, post-Russia/LTCM “mopping up” that fueled the tech Bubble, and then the post-Tech and 9/11 mopping that fostered the Wall Street/mortgage finance Bubble. And the latest big mop up job sets the stage for perhaps the greatest Bubble of them all – the Global Government Finance Bubble.
They appear as free lunches at the time, but there are myriad financial and economic costs associated with government intrusions into the marketplace. Most are subtle and tend to remain quiescent for years. When (market pricing, resource allocation and economic impairment) distortions do eventually manifest into a crisis, policymaking will have a strong proclivity to treat misdiagnosed ills with only greater government manipulations and intrusions. And the greater the degree of intrusion into the markets, the greater the ongoing costs involved. Huge intrusions ensure open-ended government involvement and increasing governmental command over the economic system.
As much as I believe Secretary Giethner is speaking earnestly, there is no way at this point government influence in the marketplace can be meaningfully Dialed Back. The damage has been done – historic distortions to both the financial system and real economy. The damage began with the activist Greenspan Fed manipulating interest rates, promising market liquidity, and pandering to the leveraged speculators. The damage worsened as the government-sponsored enterprises came to dominate our nation’s market for housing finance. And the damage turned unmanageable when the markets listened back in 2002 to Dr. Bernanke profess the virtues of helicopter money and whatever other unconventional measures the central bank might deem worthwhile.
Federal government finance (Treasuries, agency debt and GSE MBS) has expanded about $2.0 TN over the past year. I expect it to inflate another $2.0 TN over the coming twelve months. The private sector Credit apparatus is simply not up to the task of generating the necessary $2.5 TN (or so) of total system Credit expansion necessary to sustain the current economic structure. In this post-Wall Street Bubble environment, only government and government-related Credit retains sufficient “moneyness” in the marketplace. Systemic reflation today depends on a massive inflation of this government helicopter “money.”
This week’s GAO analysis of the GSE’s was spot on and certainly applies to more than just the government-sponsored enterprises: “The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency.” Over five Trillion – and counting – of GSE securities are valued and traded in the marketplace as (money-like) government-backed obligations. Policymakers would not today risk the negative financial and economic ramifications from Dialing Back from Washington’s explicit and implicit guarantees.
And as much as moral hazard and “too big to fail” are recognized as fundamental facets of previous Bubble excess, our policymakers have nonetheless been compelled to expand only further toward backstopping the entire Credit system (and economy). Obviously, the GSE’s were too big to really fail, while markets appreciate that policymakers now believe it was a mistake to allow Lehman to collapse. The markets – more than ever before - operate with the view that policymakers have no tolerance for a major financial institution failure.
When one contemplates the issue of “getting the government out of the private sector,” these various market liquidity support programs being wound down are an insignificant issue. Fundamentally, for the economy to move toward sounder and sustainable footing would require at least a semblance of a market-based Credit pricing mechanism. Regrettably, the vast majority of system Credit today is “public.” Government intrusion chiefly dictates the cost of finance and the allocation of financial and real resources. Furthermore, I would argue that the limited amount of private sector debt being issued these days is reliant upon the system-stabilizing effects of massive government debt issuance and spending.
As I have stressed repeatedly, in the neighborhood of $2.5 TN of non-financial Credit growth is required to stem systemic implosion – a massive Credit expansion with only our federal government up to the challenge. It is this fundamental facet of Bubble economies – a maladjusted economic structure sustained only through ongoing Credit excess – that prohibits Washington from extricating itself from very public “private sector” intrusions. Fixated on the notion of sustainable recovery, policymakers will not be Dialing Back from massive borrowing, spending, or market backstopping endeavors. And this gets to the core of the unquantifiable costs of failing to rein in Credit and asset Bubbles during the boom.
As I have written over the years, the entire notion of “mopping up” is as flawed as it is dangerous. Clearly, the notion of inflationism remains as seductive as it has throughout history. If, God forbid, deflation ever becomes a risk the central bank must aggressively raise the price level to preclude a downward spiral. We heard this dogma in the early nineties, heard it again earlier this decade, and have had it repeated too often over the past year. The answer is always another bout of Credit inflation.
And the more intense the necessity to reflate - the greater the government’s evolving role throughout both the financial and economic systems. This is a fact of life, human nature and politics. And at the end of the day inflationism tends toward socialism. And there is only one way to reverse this course; it is anything but painless. The economy must be weaned off of Credit and financial excesses and government intrusions – and allowed to proceed through the arduous task of adjustment and rebalancing. Choosing instead a course of sustaining current financial and economic structures implies a huge and ever-expanding role for the government. Efforts to stoke a quick recovery imply massive government intrusion and inherent fragility. There will be no Dialing Back.
Many hope the private-sector can regroup and again rise to the occasion. It is expected that as recovery gains a foothold private sector borrowing and lending will increase, tax receipts will rise, and the government will enjoy the luxury of Dialing Back as the system normalizes. I don’t expect this dynamic to work as it has traditionally because of the confluence of Bubble economy Credit requirements, acute private sector Credit system impairment and market mistrust, and the government’s predominant influence on the recovery.
The dynamic today is one of a shallow recovery induced by a flood of government borrowing and spending and marketplace intrusions. Rampant financial speculation has reemerged, which leaves the marketplace increasingly vulnerable to any serious move to Dial Back. In a normal recovery, the system tends to gain strength and stability over time. Credit requirements are usually manageable, while speculative excesses have been largely wrung out of the system. In stark contrast, today’s combination of huge Credit expansion and a highly speculative financial backdrop ensures only more acute systemic fragilities over time. And the distorted marketplace will simply not function well at even the notion of fiscal and monetary exit strategies.
Conceptually, somewhere along the line there reaches a tipping point where government intrusions no longer act as a stabilizing force. They become invariably destabilizing, as the quantity of government monetary inflation becomes massive and uncontrollable. This is the nature of inflationism, although this dynamic is nowhere to be found in Keynesian doctrine. It is my view that this tipping point was reached some time back. It is with this analysis in mind that I fear the emerging Government Finance Bubble risks destroying the creditworthiness of our entire economy.
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