07/12/2007 Worse Than Irrelevant *

For the volatile week, the Dow gained 2.2% (up 11.6% y-t-d) and the S&P500 1.4% (up 9.5%).  The Morgan Stanley Cyclical index rose another 2.0%, increasing y-t-d gains to 25.9%.  The Transports jumped 2.6% (up 17.8%).  The Utilities gained 2.0% (up 9.5%) and the Morgan Stanley Consumer index 1.2% (up 7.1%).  The small cap Russell 2000 added 0.4% (up 8.6%), and the S&P400 Mid-Caps increased 1.1% (up 15.2%).  The highflying NASDAQ100 rose 2.2%, increasing 2007 gains to 15.7%.  The Morgan Stanley High Tech index gained 1.9% (up 14.3%).  The Semiconductors jumped 3.0% (up 13.2%).  The Street.com Internet Index rose 1.8% (14.0%).  The NASDAQ Telecommunications index jumped 3.6%, increasing y-t-d gains to 18.9%.  The Biotechs advanced 1.5% (up 5.4% y-t-d).  The (wild) Broker/Dealers ended the week up 0.4% (up 8.3%) and the Banks gained 0.6% (down 2.1%).  With Bullion rising $10.80, the HUI Gold index rallied 1.2%. Two-year U.S. government yields this week declined 6 bps to 4.92%.  Five-year yields fell 8.5 bps to 5.00%.  Ten-year Treasury yields dropped 9 bps to 5.10%.  Long-bond yields ended the week 8 bps lower at 5.19%.  The 2yr/10yr spread ended the week at a positive 12 bps.  The implied yield on 3-month December ’07 Eurodollars declined 2.5 bps to 5.335%.  Benchmark Fannie Mae MBS yields declined 5 bps to 6.32%, this week underperforming Treasuries.  The spread on Fannie’s 5% 2017 note widened one to 45, and the spread on Freddie’s 5% 2017 note widened one to 46.  The 10-year dollar swap spread increased 0.6 to 64.8.  Corporate bond spreads widened further, with the spread on a junk index this week increasing a notable 17 bps.     July 9 – Financial Times (Paul J Davies):  “The price of junk-rated loans in the US and European markets has tumbled in the past couple of weeks as investors begin to turn away from the asset class, according to new data from S&P LCD, the market information service.  US leveraged loan prices have fallen to their lowest level in more than four years, while in the derivatives markets a sell-off has pushed the prices of both US and European loan risk to less than the face value of the loans themselves.  The fall in prices is significant for banks and private equity firms preparing to launch new debt deals after recent buy-outs because it implies a rise in loan yields, which means higher borrowing costs… Growing concerns about the level of borrowings employed by private equity and the aggressiveness of debt structures, coupled with the problems in the US subprime mortgage market, have sparked a crisis of confidence in debt markets.” Investment grade debt issuers included Lehman Brothers $5.0bn, XTO Energy $1.25bn, Disney $1.1bn, Limited Brands $1.0bn, Tennessee Valley Authority $1.0bn, John Deere $500 million, PepsiAmericas $300 million, Commercial Metal $400 million and Rochester G&E $100 million.    Junk issuers included Bruce Mansfield $1.135bn, and American Capital Strategies $500 million.  Convert issuers included Newmont Mining $1.0bn, Live Nation $200 million, Sonosite $200 million, and Kendle Intl $175 million. International dollar bond issuers included Merna Nationwide Building Society $2.0bn, Bancaja $1.3bn, Turanalem Finance $1.0bn, and Neo-China Group $400 million. July 11 – Bloomberg (Hamish Risk):  “Corporate bond risk soared in Europe by the most in at least three years as debt rating downgrades on U.S. subprime securities triggered a worldwide sell-off, according to traders of credit-default swaps.” German 10-year bund yields declined 6 bps to 4.62%, while the DAX equities index added 0.6% (up 22.7% y-t-d).  Japanese 10-year “JGB” yields were unchanged at 1.93%.  The Nikkei 225 gained 0.5% (up 5.9% y-t-d).  Emerging equity markets were strong, and debt markets generally rallied.  Brazil’s benchmark dollar bond yields declined 2 bps this week to 6.10%.  Brazil’s Bovespa equities index surged 3.1% to a new record high (up 29.6% y-t-d).  The Mexican Bolsa was little changed (up 22.5% y-t-d).  Mexico’s 10-year $ yields dropped 6 bps to 5.92%.  Russia’s RTS equities index jumped 4.4% (up 7.3% y-t-d).  India’s Sensex equities index gained 2.1% (up 10.8% y-t-d).  China’s Shanghai Composite index ended the week 3.5% higher (up 46.3% y-t-d and 136% over the past year). Freddie Mac posted 30-year fixed mortgage rates jumped 10 bps to a four-week high 6.73% (down one basis point y-o-y).  Fifteen-year fixed rates gained 9 bps to 6.39% (up 2bps y-o-y).  One-year adjustable rates were unchanged at 5.71% (down 4 bps y-o-y).  The Mortgage Bankers Association Purchase Applications Index increased 3.8% this week.  Purchase Applications were up 21.1% from one year ago, with dollar volume 27.5% higher (likely distorted by the holiday week).  Refi applications fell 3% for the week, although dollar volume was up 40.4% from a year earlier.  The average new Purchase mortgage declined to $233,100 (up 5.3% y-o-y), and the average ARM fell to $392,400 (up 20.3% y-o-y).  Bank Credit jumped $24.9bn (week of 7/4) to a record $8.603 TN.  For the week, Securities Credit rose $13.6bn.  Loans & Leases expanded $11.3bn to $6.296 TN.  C&I loans increased $6.8bn, while Real Estate loans fell $10.6bn.  Consumer loans jumped $10.9bn.  Securities loans added $1.3bn, and Other loans gained $3.0bn.  On the liability side, (previous M3) Large Time Deposits increased $5.3bn.      M2 (narrow) “money” increased $4.5bn to a record $7.264 TN (week of 7/2).  Narrow “money” has expanded $220bn y-t-d, or 6.0% annualized, and $438bn, or 6.4%, over the past year.  For the week, Currency increased $0.9bn, and Demand & Checkable Deposits increased $15.4bn.  Savings Deposits fell $14.6bn, and Small Denominated Deposits increased $0.8bn.  Retail Money Fund assets added $2.1bn.        Total Money Market Fund Assets (from Invest. Co Inst) jumped another $19.5bn last week to a record $2.579 TN.  Money Fund Assets have increased $197bn y-t-d, a 15.4% rate, and $440bn over 52 weeks, or 20.6%.      Total Commercial Paper jumped $11.2bn last week to a record $2.179 TN, with a y-t-d gain of $204.6bn (19.2% annualized).  CP has increased $393bn, or 22%, over the past 52 weeks.  Asset-backed Securities (ABS) issuance was a slow $6.5bn.  Year-to-date total US ABS issuance of $411bn (tallied by JPMorgan) is now running about 10% behind comparable 2006.  At $199bn, y-t-d Home Equity ABS sales are about a third below last year’s pace.  Meanwhile, y-t-d US CDO issuance of $191 billion is running 13% ahead of record 2006 sales.  Fed Foreign Holdings of Treasury, Agency Debt last week (ended 7/11) increased $6.8bn to a record $1.989 TN.  “Custody holdings” were up $237bn y-t-d (25% annualized) and $356bn during the past year, or 21.8%.  Federal Reserve Credit last week declined $3.0bn to $854.3bn.  Fed Credit has expanded $2.1bn y-t-d, with one-year growth of $24.4bn (2.9%).     International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $776bn y-t-d (30% annualized) and $1.04 TN y-o-y (22.9%) to a record $5.587 TN.  Currency Watch: July 13 – Bloomberg (Megumi Yamanaka):  “Iran asked Japanese refiners to switch to the yen to pay for all crude oil purchases, to counter the risk that U.S. dollar transfers may be frozen by increased sanctions.  Iran wants yen-based transactions ‘for any/all of your forthcoming Iranian crude oil liftings,’ according to a letter sent to Japanese refiners… The request is for all shipments ‘effective immediately,’…” July 12 – Financial Times (Michael Mackenzie):  “The dollar’s slide this week to multi-year lows against a number of currencies has come amid a fresh wave of concerns about US economic growth and the sustainability of foreign investor appetite for US assets… The catalyst for this latest dollar weakness is concern that the US consumer, for years the mainstay of the economy, could be flagging. Such worries followed evidence that the US housing market still does not appear to be finding a bottom along with news that retailers are suffering.” July 11 – Market News International:  “China’s large and growing trade surplus helped drive Chinese foreign exchange reserves up another $130.6 bln in the second quarter of this year, though unwinding financial transactions between the central bank and domestic lenders also played decisive parts… China’s foreign exchange reserves at the end of June were $1.3326 trln, reflecting growth of $130.6 bln in reserves in the second quarter of 2007… Adding in the first quarter’s $135.7 bln increase, and China has accumulated a total $266.3 bln in foreign exchange reserves so far this year, exceeding total foreign exchange reserve accumulation over the whole of 2006.” July 11 – Bloomberg (Shigeki Nozawa):  “Japan, the largest overseas holder of U.S. Treasuries, should invest $700 billion of its currency reserves in higher-yielding assets such as stocks and corporate bonds, said Takatoshi Ito, an adviser to the prime minister.  The reserves should be managed by a special fund that will gradually diversify into euros, Australian dollars and emerging market currencies… Central banks in South Korea, China and Taiwan have announced plans to buy assets with higher returns than U.S. debt…” The dollar index sank 1.1% to a multi-year low 80.39.  On the upside, the Thai baht gained 3.0%, the Czech koruna 2.7%, The Brazilian real 2.2% (to a 7-yr high), the Australian dollar 1.5%, the Swiss franc 1.3%, the Swedish krona 1.3%, the British pound 1.2%, the Norwegian krone 1.2%, the Japanese yen 1.2%, and the Euro 1.1%.   On the downside, the dollar made headway against the Ugandan shilling (down 2.5%), the Gambian dalasi (down 1.9%), the Somali shilling (down 1.8%) and the Zambian kwacha (down 1.4%).   Commodities Watch July 11 – Financial Times (Daina Lawrence):  “A rule of thumb for the price of oil in the past five years has been to take the last digit of the year and add a zero: 2002 saw prices in the $20s; 2003 in the $30s; now oil is hovering around $70 a barrel. These high prices are desirable for steering the economy away from oil, but in the meantime they could also spell trouble. Oil companies need to adjust to this new reality and rethink their business model.  The latest report by the International Energy Agency warns of an oil supply crunch in five years. Demand is expected to rise at more than 2% annually. Supply, the IEA calculates, will not be able to keep pace.” July 10 – Bloomberg (Wang Ying):  “China’s crude oil imports jumped 20% in June from a year earlier as production from domestic fields failed to keep pace with energy demand in the world’s fastest-growing major economy.  Imports climbed to 14.12 million metric tons (3.45 million barrels a day)…” July 10 – Financial Times (Jenny Wiggins):  “Toast at breakfast may soon be more of a treat than a staple after Premier Foods, the owner of Hovis bread, yesterday said it was preparing to raise bread prices for the second time in six months.  The pending increase - which the company attributed to rising wheat costs - is merely the latest in a series of price increases food and drink companies have been trying to pass on to consumers this year.  The series has seen costs of making bread, beer, yoghurt and chocolate as well as dozens of others packaged food products become increasingly expensive. In the first half of the year, Lehman Brothers’ ingredients cost index - which covers cocoa, coffee, oats, tea, soyabeans and milk, among other commodities and which is based on spot rates - rose 14.9%. That follows a 16.5% increase in the second half of 2006.  The biggest increase has occurred in powdered milk prices. These have nearly doubled compared with the same period a year ago. Barley prices have also shot up 53%, while corn prices are up 68%.” July 11 – Bloomberg (Chanyaporn Chanjaroen):  “Lead rose to a record $3,000 a metric ton in London as stockpiles shrank and demand increased from China, the largest consumer of the metal…. Demand for the metal used in car batteries will exceed production by 74,000 tons this year, according to Macquarie Bank… Stockpiles tracked by the London Metal Exchange fell 125 tons to 42,925 tons… They have declined 61% in the past 12 months.” July 10 – The Wall Street Journal (John J. Fialka):  “Government efforts to reduce U.S. reliance on imported oil are forcing up prices for another indispensable commodity: soap.   Soap and detergent makers say they are being hurt by a double whammy of federal subsidies and mandates that has reduced the supply and pushed up the costs of a key ingredient, beef tallow. The steeply rising price of corn, driven by a federal requirement to use more ethanol, has pushed up corn prices, making animal feed more expensive and prompting farmers to blend the less-expensive tallow and other fats into their feed.  The upshot: In the past year, beef-tallow prices have doubled.” For the week, Gold rose 1.6% to $666.70 and Silver 2.8% to $13.11.  Copper was little changed.  August crude gained $1.12 to an 11-month high $73.93.  August gasoline fell 3.7%, while August Natural Gas rallied 3.4%.  For the week, the CRB index rose 1.3% (up 5.8% y-t-d), and the Goldman Sachs Commodities Index (GSCI) gained 1.8%  to a near record high (up 17.4% y-t-d).  Japan Watch: July 11 – Bloomberg (Toru Fujioka):  “Japan’s current account surplus widened in May as a weaker yen increased the value of overseas investment income and exports.  The surplus expanded 31% to 2.13 trillion yen ($17.5 billion) from a year earlier…” July 11 – Bloomberg (Mayumi Otsuma):  “Japan’s wholesale inflation accelerated in June as oil and other commodity prices rose, prompting food and packaging companies to pass on costs to clients.  An index of prices companies pay for energy and raw materials climbed 2.3% from a year earlier…” China Watch: July 11 – Bloomberg (Nipa Piboontanasawat):  “China’s economy expanded more than the government initially estimated in 2006, taking the pace of growth to the fastest in 12 years.  Gross domestic product rose 11.1% from a year earlier to 21.09 trillion yuan ($2.79 trillion)…” July 10 – Financial Times (Richard McGregor and George Parker):  “China’s swelling monthly trade surplus hit a new high in June of $26.9bn, an 85.5% increase on the same month last year… The surplus for the first half of the year has now reached $113bn, more than for the whole of 2005…  ‘This level of trade surplus is unprecedented for China or any other major economy in the world,’ said Hong Liang, of Goldman Sachs.  Exports of some products jumped dramatically in the first half, such as steel, which was up by 97%, and containers, up by 55%.” July 11 – Bloomberg (Nipa Piboontanasawat and Lee Spears):  “China’s money supply growth topped the central bank’s target for a fifth straight month… M2…rose 17.1% in June from a year earlier to 37.8 trillion yuan ($5 trillion)…” July 11 – Bloomberg (Li Yanping):  “China’s 2007 retail sales may rise 15.8% to 8.8 trillion yuan ($1.16 trillion), the fastest annual growth pace in a decade, according to…the country’s top planning agency.” July 11 – Bloomberg (Nipa Piboontanasawat):  “China’s tax revenue rose 29% in the first six months of 2007 from a year earlier, the official Xinhua News Agency reported.” July 10 – Bloomberg (Tian Ying):  “China’s first-half vehicles sales rose 23% as economic growth spurred demand for passenger cars and commercial vehicles.” July 10 – Bloomberg (Maria Levitov):  “China’s government must pursue tougher monetary policies to ensure the world’s fast-growing major economy doesn’t overheat, Finance Minister Jin Renqing said.” India Watch: July 9 – Financial Times (Joe Leahy):  “A sign of how quickly the private equity industry has grown in India is the location of many of the firms’ offices.  Such has been the industry’s haste to tap Asia’s newest private equity market that many firms have not had time to find proper premises and still work out of five-star hotel rooms.  ‘When I started looking at India in 2004, there were fewer than 15 private equity fund managers we could have looked at. Now there are [perhaps] 150 trying to put money to work there,’ says Anne-Maree Byworth, India portfolio director with CDC Group… India is the latest Asian country to attract the attention of the world’s leading buy-out funds. They are estimated to have a total of $25bn intended for the region, which with leverage provides a war chest for deals in excess of $100bn.” Asia Boom Watch: July 9 – Financial Times (Joe Leahy):  “The volume of initial public offerings in Asia is set to increase sharply in the second half of this year driven by deals from China and India.  Companies in Asia excluding Japan are planning to launch IPOs with a total value of $47bn in the six months ending December, up 37.8% compared with the first half…” July 9 – Bloomberg (Perris Lee):  “Taiwan’s export growth accelerated more than expected in June on increased shipments to China, where manufacturing was the strongest in more than two years.  Exports rose 11% from a year earlier…” July 11 – Bloomberg (Kim Kyoungwha):  “South Korea’s government increased its 2007 economic growth forecast because of a rebound in consumer spending and surging exports…  The economy will advance 4.6% this year…” July 10 – Bloomberg (Hui-yong Yu):  “Morgan Stanley set a record for real estate purchases in South Korea with its agreement to buy Daewoo Engineering & Construction Co.’s Seoul head office for 960 billion won ($1 billion), brokers said.” July 10 – Bloomberg (Shamim Adam):  “Singapore’s economy grew at the fastest pace in two years as soaring demand for apartments and offices spurred construction… Gross domestic product expanded an annualized 12.8% in the three months ended June, up from a revised 8.5% in the first quarter…” Unbalanced Global Economy Watch: July 13 – Bloomberg (Simon Packard):  “Luxury home prices in London rose at the fastest monthly rate since real estate broker Knight Frank LLC began tracking them 31 years ago… The average price of the costliest houses and apartments in the British capital gained 3.1% in June…” July 10 – Financial Times (Leslie Crawford and Mark Mulligan):  “Spanish companies face much tougher credit conditions as a result of a dramatic change in perceptions of country risk, brought on by fear that Spain’s house price bubble is about to burst.   According to rating agency Standard & Poor’s, Spanish corporate debt is at an historic high point, totalling 106% of gross domestic product last year compared with a Eurozone average of 70%.   The surge follows a credit-driven acquisition spree at home and abroad. But banks that extended credit freely into the boom are now encountering problems in syndicating some of the riskier loans. Spanish real estate groups have been locked in negotiations with their creditors, who are having difficulties syndicating loans.” July 10 – Bloomberg (Jonas Bergman):  “Swedish unemployment fell to the lowest in at least 15 years in June as companies increased hiring amid the fastest economic growth since the turn of the decade.  The…rate fell to 3.7%...” July 11 – Bloomberg (Maria Levitov):  “Russia’s trade surplus expanded 13% in May from the previous month, as imports continued to grow faster than exports, the central bank said.  The surplus rose to $12.7 billion, compared with $11.2 billion in April, the Moscow-based central bank said… Imports totaled $17.6 billion in May, while exports reached $30.3 billion…  Sales of imported cars jumped 60% to 510,000 units in the first half…” July 11 – Bloomberg (Maria Levitov):  “The Russian government’s budget surplus probably reached 1.07 trillion rubles ($40 billion) in the first half of the year, the Finance Ministry said.” July 11 – Bloomberg (Maria Kolesnikova):  “Wheat prices in Russia rose by 10% on the week, prompting Russian bakers to demand that the government limit prices and exports, Vremya Novostei reported.  Bread prices in Russia could rise by 40% by the end of 2007…” Latin American Boom Watch: July 12 – Financial Times (Richard Lapper and Adam Thomson):  “President Martín Torrijos of Panama yesterday unveiled what could become one of the biggest investment projects in the country’s history, with a value of up to $10bn.  The creation of an urban centre the size of central London on the outskirts of Panama City is the latest sign of an economic boom that has invited comparisons between Panama and bigger international business centres, such as Dubai.” Central Banker Watch: July 10 – Financial Times (Daina Lawrence):  “Canada’s central bank raised its key interest rate on Tuesday amid growing concern about inflationary pressures and a soaring Canadian dollar… The Bank of Canada raised the overnight rate to 4.5%, up one quarter of a percentage point, the highest in six years… ‘Some modest further increase in the overnight rate may be required to bring inflation back to the target over the medium term,” reported the bank.’” Bubble Economy Watch: May’s Trade Deficit increased from April’s $58.7bn to $60.0bn.  Goods Exports were up 11.2% from May ’06 to a record $93.3bn.  Goods Imports were up 4.1% y-o-y to $162.3bn. July 13 – Bloomberg (Linda Sandler):  “Christie’s International, the world’s largest art seller, said auctions and private sales rose almost 30% on premium prices for Warhols and an influx of new buyers.” Financial Sphere Bubble Watch: July 10 – Financial Times (Michiyo Nakamoto and David Wighton):  “Chuck Prince yesterday dismissed fears that the music was about to stop for the cheap credit-fuelled buy-out boom, declaring that Citigroup was ‘still dancing’.  The Citigroup chief executive told the Financial Times that the party would end at some point but there was so much liquidity at the moment it would not be disrupted by the turmoil in the US subprime mortgage market.  He also denied that Citigroup, one of the biggest providers of finance to private equity deals, was pulling back, in spite of problems with some financings. ‘When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,’ he said… ‘The depth of the pools of liquidity is so much larger than it used to be that a disruptive event now needs to be much more disruptive than it used to be.  At some point, the disruptive event will be so significant that instead of liquidity filling in, the liquidity will go the other way. I don’t think we’re at that point.’” July 12 – Bloomberg (Le-Min Lim):  “Judy Carline helps expatriates settle in after they've transferred to Hong Kong. These days, she spends most of her time helping anxious parents who are trying to get their kids into international schools.  ‘This year is particularly bad,’ says Carline, a real estate agent at Savills Plc. There are more of ‘these bankers, between 35 and 42, with young children. These days, people think their 3-year-olds are going to Harvard. The Manhattan ladies, they are the worst. They work themselves into a state.’  Hong Kong’s booming economy and increased demand for English-language instruction from local Chinese parents have filled the city’s international schools to the bursting point.” Mortgage Finance Bubble Watch: July 11 – Bloomberg (Bernard Lo and Debra Mao):  “Alphonso Jackson, U.S. Secretary of Housing and Urban Development, said the mortgage default crisis in the U.S. may involve 20% of subprime loans… ‘Remember that the subprime loans made in ‘04, ‘05, ‘06, were probably, most of them were stable and good – 80% of them. But we’re going to have a problem: 20% of the loans are pretty bad. We believe the Federal Housing Administration, under HUD, can save a number of those buyers who went to the subprime market and did not go to the prime market.’” July 13 – Bloomberg (Josephine Lau):  “The U.S. is urging China’s central bank to buy more mortgage-backed securities after a surge in defaults by risky borrowers in the world’s largest economy eroded demand for such instruments.  ‘It’s not a matter whether they're going to do more business in mortgage-backed securities, it’s who they’re going to business with,’ U.S. Department of Housing and Urban Development Secretary Alphonso Jackson told reporters in Beijing.  He met with central bank Governor Zhou Xiaochuan and Minister of Construction Wang Guangtao in the nation’s capital this week.  The U.S. housing regulator is seeking to tap China’s $1.33 trillion of foreign-currency reserves after surging defaults on subprime mortgages caused the near-collapse last month of two hedge funds run by Bear Stearns Cos.” July 13 – Bloomberg (Rachel Layne):  “General Electric Co. plans to sell WMC Mortgage, the company’s three-year-old U.S. subprime mortgage unit, following a surge in defaults by borrowers.  ‘The mortgage industry has greatly changed since the purchase of WMC,’ Laurent Bossard, chief executive officer of the division, said… ‘The current subprime market environment has made a significant negative impact on the business.’” Foreclosure Watch: July 12 – Bloomberg (Dan Levy and Brian Louis):  “Mortgage foreclosures in the U.S. jumped to a record in the first half… Almost 926,000 foreclosure notices were filed, 56% more than a year earlier and the most since…RealtyTrac started tracking the data in 2005. Foreclosures were the highest last month in California and Florida, where some home prices have fallen as much as 25%, and Ohio and Michigan, where the automotive industry fired more than 50,000 people in the past 10 years.” MBS/ABS/CDO/Derivatives Watch: July 11 – Bloomberg (Caroline Salas and Mark Pittman):  “On Wall Street, where the $800 billion market for mortgage securities backed by subprime loans is coming unhinged, traders are belatedly acknowledging what they see isn’t what they get.  As delinquencies on home loans to people with poor or meager credit surged to a 10-year high this year, no one buying, selling or rating the bonds collateralized by these bad debts bothered to quantify the losses.  Now the bubble is bursting and there is no agreement on how much money has vanished: $52 billion, according to an estimate from…Credit Suisse… earlier this week that followed a $90 billion assessment from…Deutsche Bank AG.” July 11 – Dow Jones (Anusha Shrivastava):  “Standard & Poor’s said… it is reviewing the credit ratings of some collateralized debt obligations - complex securities that have been under the spotlight… The ratings firm said that this review is based on the outcome of reviews for possible downgrade it is currently conducting of 612 classes of residential mortgage-backed securities backed by subprime collateral.  The affected classes total approximately $12 billion in rated securities, roughly 2.13% of the $565.3 billion in U.S. residential mortgage bonds rated by S&P between the fourth quarter of 2005 and fourth quarter of 2006.” July 12 – Bloomberg (Mark Pittman and Jody Shenn):  “Standard & Poor’s cut credit ratings on $6.39 billion of bonds backed by subprime mortgages and Fitch Ratings said it may cut $7.1 billion on expectations home-loan defaults will increase.  S&P lowered ratings on 562 securities, including 64 that were under scrutiny before this week. Fitch put 170 subprime transactions ‘under analysis,’ indicating that they may be cut.  Ratings of 19 collateralized debt obligations were placed on review for a downgrade…” Real Estate Bubbles Watch: July 11 – UPI:  “While the subprime U.S. real estate market is in the dirt, high-end U.S. homes are in clover, an analysis of nationwide home sales published Wednesday showed. The national trend has gone largely unnoticed because Washington and the National Association of Realtors…don’t report statistics for different price segments, The New York Times said.  The newspaper and DataQuick…found sales of homes in the top 5% of the market have been rising in many cities -- often selling at above-asking prices - while sales have fallen in the market’s middle and bottom sectors.” July 12 – Bloomberg (Sharon L. Crenson):  “Manhattan apartment rents jumped by as much as 36% in the past five years, driven higher by a scarcity of space and rising prices for condominiums and co-operatives… ‘Rents increased dramatically,’ Citi Habitats Chief Operating Officer Gary Malin said… ‘New York is a renter-based city, with approximately 75% of its overall housing comprised of rental properties.’” July 10 – Bloomberg (Sharon L. Crenson):  “Rents for Manhattan’s prime offices surged 38% in the second quarter to a record as financial services companies sought more space, according to… Cushman & Wakefield.  Average asking rents rose to $69.58 a square foot for Class A properties…  Average rents on all classes of office space climbed 36% to $59.17 a square foot…” July 9 – Bloomberg (Hui-yong Yu):  “The vacancy rate in neighborhood and community shopping centers in the U.S. climbed to 7.3% in the second quarter to the highest in almost four years as weakness in Ohio offset strength in California, according to Reis Inc.” M&A and Private-Equity Bubble Watch: July 12 – Financial Times (Gillian Tett and Joanna Chung):  “A year ago, some analysts at Deutsche Bank made a striking call: at a big financial industry conference in Barcelona, they predicted that the subprime sector was heading for problems - even though most large banks were relatively upbeat about the sector at the time.  A year later, senior Deutsche Bank officials are keen to avoid seeming too smug about the call… As befits a man [Anshu Jain, co-head of its investment bank] who is renowned as one of the City’s canniest operators…Mr Jain is keen to avoid sounding alarmist about market woes.  However, he accepts that there is now a rising danger of so-called ‘event risk’, not simply in the subprime sector, but also in leveraged finance… ‘The question is whether what has happened in subprime could now be repeated in leveraged lending, given that leverage ratios continue to ratchet up… [It is] likely not - at least for as long as the world economy keeps growing in line with our analysts’ projections. [But] if growth slows down, there could be consequences.’” Energy Boom and Crude Liquidity Watch: July 12 – Bloomberg (Jim Kennett):  “Exxon Mobil Corp., the oil company John D. Rockefeller formed in 1882, became the only publicly traded company valued above half a trillion dollars.” July 11 – Bloomberg (Tarek Al-Issawi):  “Saudi Arabia led the Middle East in spending on telecommunications services with $10.6 billion spent last year, Asharq al-Awsat reported…” July 10 – Bloomberg (A. Craig Copetas):  “The luxury-submarine business is sometimes hard to fathom.  ‘If you can find my submarine, it’s yours,’ says Russian oil billionaire Roman Abramovich.  And that’s all the reclusive owner of the Chelsea Football Club has to say.  The ocean floor is the final spending frontier for the world’s richest people…  Journeying to see what’s on the bottom aboard a personal submersible is a wretched excess guaranteed to trump the average mogul’s stable of vintage Bugattis or a $38 million round-trip ticket to the International Space Station… Luxury-submarine makers and salesmen from the Pacific Ocean to the Persian Gulf say fantasy and secrecy are the foundations of this nautical niche industry built on madcap multibillionaires.”    Fiscal Watch: After nine months of the fiscal year, total federal receipts are running 7.5% ahead of lasts years pace.  Year-to-date spending is running 2.5% above a year ago.   July 10 – Bloomberg (James Kraus):  “The cost of the wars in Iraq and Afghanistan has increased to $12 billion a month, from $8 billion two years ago, after an increase in troop levels, the Wall Street Journal reported.  So far, Congress has allocated $610 billion in war-related money since the Sept. 11, 2001…” Speculator Watch: July 10 – Financial Times (Anuj Gangahar):  “Hedge fund launches in the United States are up sharply for the year to date, with 72 new funds with a combined $14bn in assets beginning to trade, according to a survey.  Over the same period last year, 51 new funds were launched, raising $11.7bn, according to latest figures from Absolute Return Magazine…” Worse Than Irrelevant: For lack of a better adjective, I’ll say it was a rather “idiosyncratic” week for the markets and otherwise.  Monday, Citigroup’s CEO Chuck Prince made curious comments regarding the boom in M&A finance (quoted by the FT – see above):  “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.  We’re still dancing… The depth of the pools of liquidity is so much larger than it used to be that a disruptive event now needs to be much more disruptive than it used to be.  At some point, the disruptive event will be so significant that instead of liquidity filling in, the liquidity will go the other way. I don’t think we’re at that point.” Not all that comforting.  I could only chuckle when a journalist from the Wall Street Journal, appearing on CNBC, compared Mr. Prince to a ticket scalper outside a concert venue imploring potential buyers with assurances that the show was going to be so good they wouldn’t want to miss out.  On Wednesday, Alphonso Jackson, the Secretary of Housing and Urban Development (HUD), was on Bloomberg television warning that the U.S. mortgage default crisis may impact one-fifth of all subprime loans.  This is no small sum considering that there are $800bn of outstanding subprime MBS (from Bloomberg).  And what do you know, on Friday a Bloomberg article had Secretary Jackson meeting with Bank of China officials in Beijing urging the Chinese to “buy more mortgage-backed securities after a surge in defaults by risky borrowers in the world’s largest economy eroded demand for such instruments.”  Another ticket scalper in an age of scalpers, though one apparently forced to admit something like this:  “Ok, I know you know this show isn’t going to be pretty but, please my friend, I really need you to help me out on this one.”   And when it comes to “selling a bill of goods,” I refuse to let Dr. Bernanke’s Tuesday speech, Inflation Expectations and Inflation Forecasting, before the Monetary Economics Workshop of the National Bureau of Economic Research, go unanswered.  For starters, I don’t recommend reading it.  It is academic, written specifically for so-called monetary economists, and basically propounds doctrine that is Worse Than Irrelevant with respect to current inflation dynamics.  I found it disturbingly detached from reality. I’ll plead once again that the issues of “money”, Credit, and inflation are much too vital to the long-term health of free-market democracies to be left to a select group of policymakers and “ivory tower” dogma.  I would instead argue that it is imperative that citizens become sufficiently educated on the perils of Credit inflation, financial excess, and unsound “money.”  This would provide our only hope against the inflationary tendencies of politicians, the Fed, and the Financial Sphere – tendencies that turn highly toxic when mixed with high octane contemporary “money.”  Whether by design or, perhaps more likely, his theoretical indoctrination, Dr. Bernanke’s inflation discussion continues to evade and obfuscate when it comes to the central monetary issues of our day. Dr. Bernanke:  “As you know, the control of inflation is central to good monetary policy. Price stability, which is one leg of the Federal Reserve’s dual mandate from the Congress, is a good thing in itself, for reasons that economists understand much better today than they did a few decades ago.” That’s all well and good, but to commence fruitful discussion and debate first requires up-to-date, understandable, and reality-based definitions of “inflation” and “price stability.”  It should be clear by now that sticking with Milton Friedman’s “too much money chasing too few goods” over-simplification does more analytical harm than good.  “Money” was already too much of an unclear, amorphous and indefinite concept during Dr. Friedman’s heyday.  The ongoing “evolution” of contemporary “money” only lunged ahead madly over the past decade or so.  Moreover, adherence to a Friedmanite monetary perspective leads one to an ill-advised focus on “narrow money” and confined “core” consumer price inflation, along with a false notion of the government’s capacity to manage both.  Today, “good monetary policy” and “price stability” are erroneously associated with perpetual - if perhaps only moderate - inflation in a narrow index of aggregate of consumer goods and services prices that represents such a small (and shrinking) part of total economy- and market-wide expenditures. It’s more productive to start with “inflation” as a multitude of potential effects emanating from the creation of Excess Purchasing Power (Credit).  These may include various price effects, although excess purchasing power also typically engenders elevated real investment, imports, and/or market speculation.  Inflation’s price influences may develop in “core” consumer prices, or perhaps become more prevalent in energy and food prices – depending on many factors including supply/demand dynamics and the nature of the flow of funds/purchasing power.  Especially if a Credit system is heavily focused on real (i.e. real estate, commodities, sport franchises, art, collectables, etc.) and financial (bonds, stock, “structured” instruments, commodities-related, etc.) assets, asset prices will be a prevailing Inflationary Manifestation.  Contemporary “price stability” must be examined in the context of system-wide price levels, Credit growth by sector and in aggregate, and the scope and nature of speculation – and to be reality-based it should begin with the asset markets.   We have today a unique finance-driven economy that becomes more finance-dominated each passing year (month).  Analytically, it is important to conceptualize the evolving nature of finance generally and appreciate that a finance economy will be an atypically mutating economic animal.  The pool of available finance grows ever larger; the flows of finance become all the more powerful; the speculative impulses more intense and diffuse; the inflationary impacts more dramatic; and the real economy effects more pernicious - yet almost by design effects upon the general (“core” CPI) price level are nominal and lagging.   In particular, incredible amounts of financial “wealth” (financial sector inflation) are being generated, distributed and expended quite unequally (a key Credit Bubble-induced inflationary dynamic).  At the same time, highly-populated emerging economies are engulfed in Credit Bubble dynamics, with obvious inflationary consequences for global food and energy prices.  It is not hyperbole to suggest that financial, economic and inflationary dynamics have been radically transformed over recent years to the point of leaving policymakers and conventional economic doctrine in the dark.   Today, the U.S. and global economies are buffeted by powerful inflationary forces unlike anything experienced in decades - if ever.  Years of unrelenting Credit and speculative excess have created a vast global pool of enterprising “purchasing power” (including hedge funds and other leveraged speculators, sovereign wealth funds, pension funds, mutual funds, insurance companies, etc.) searching high and low for robust returns.  At the same time, the perception that the U.S. dollar is now a perpetually devaluing currency has created a powerful inflationary bias in myriad “non-dollar” asset classes (and economies) across the globe.  Dr. Bernanke and the Fed would be better off disposing of their old academic articles and notions of inflation and starting from scratch. In a week when Dr. Bernanke applauded a tradition of “good monetary policy” and “price stability,” U.S. financial markets were notable for demonstrating acute instability.   Dr. Bernanke states that, “undoubtedly, the state of inflation expectations greatly influences actual inflation and thus the central bank’s ability to achieve price stability.”  He then reiterates the commonly accepted view that - because of the Fed’s ongoing commitment and success in fighting inflation - inflation expectations “have become much better anchored over the past thirty years.”  Well, this may have been somewhat the case for a period of time, but it is foolhardy to believe it holds true these days.  After all, seemingly the entire world prescribes to the view of ongoing asset and commodities inflation.  And these expectations - in conjunction with liquidity and Credit abundance – provide one of the more highly charged inflationary backdrops imaginable. I don’t recall Dr. Bernanke’s mentioning asset inflation in his speech, although he does sanguinely address the inflationary (non-) ramifications from the surge in oil prices.  “…A one-off change in energy prices can translate into persistent inflation only if it leads to higher expected inflation and a consequent ‘wage-price spiral.’  With inflation expectations well anchored, a one-time increase in energy prices should not lead to a permanent increase in inflation but only to a change in relative prices.” And, “the long-run effect on inflation of ‘supply shocks,’ such as changes in the price of oil, also appears to be lower than in the past,” along with “inflation is less responsive than it used to be to changes in oil prices and other supply shocks.” The major issue I have with such conjecture is that it blindly disregards the key issues and prevailing dynamics of contemporary finance.  Oil has always been the most important commodity in the world, yet it has never been as economically and financially critical across the globe as it is today.  The huge inflation in oil and energy prices has had much to do with the massive expanding global pool of dollar balances (mostly emanating from our Current Account Deficits), the depreciating value of the dollar, and the associated massive liquidity over-abundance throughout Asia.  Energy and related inflation has had and will, going forward, have only greater geopolitical consequences.  It is nonsensical today to concentrate on oil inflation’s (to date) impact on “core” U.S. consumer prices.    Liquidity-induced oil price inflation has been exacerbated by the interplay of boom-time global demand increases (especially in Asia).  Knock-on effects then included the liquidity/purchasing power accumulated by OPEC and other exporters, as well as liquidity created in the process of leveraged speculation internationally.  Importantly, inflating energy prices have fostered Credit creation through myriad channels.  For one, U.S. companies, governments, individuals and the economy overall have borrowed more for energy purchases, in the process working to sustain destabilizing Current Account Deficits in the face of a weakening dollar.  There has been no “supply shock” specifically because easily accessed cheap Credit has provided sufficient added purchasing power to ensure uninterrupted robust energy demand (“monetization”). Across the globe, more borrowed finance has been needed to acquire energy resources and companies; more has been borrowed to explore, develop and extract oil and to pursue sources of alternative energy.  The rising values of energy assets (including oil company stock prices and energy derivatives) have created additional collateral to borrow against.  And, more recently, the surge in energy prices has led to more broad-based secondary effects, including the large transportation and food sectors – which will work to encourage additional borrowing and broadening price effects.  It would be a huge analytical blunder to expect that “energy prices should not lead to a permanent increase in inflation but only to a change in relative prices.” Importantly, rising oil prices were initially an inflationary effect which, accommodated by easy “money,” then spurred greater Credit creation and increasingly potent inflationary forces.  Inflation begets inflation, and the Fed can continue to downplay asset and commodities inflation at our currency’s peril.  Both may be exerting only modest pressure on “core” consumer price indices these days, but such a narrow-minded focus completely misses the point. The Fed is forever fond of gauging “long-run inflation expectations” by measuring the difference in yields between nominal and inflation-indexed bonds.  In the current financial backdrop, this is comforting but flawed analysis.  It may illuminate the markets’ best guesswork with respect to prospective CPI levels, but when it comes to actual “inflation expectations” I would suggest the Fed monitor a “basket” of indicators including the price of gold, oil, energy, and general commodities indices, the relative value of “commodity” currencies, global equities and real estate prices and, importantly, the global demand for Credit.  Furthermore, a reasonable view of “inflation expectations” could be gleaned through the study of speculative leveraging throughout global financial and asset markets.  The key inflationary focus today should be on factors and dynamics driving Credit growth and speculative excess. While on the subject, it’s worth noting that speculative excess in the U.S. stock market has reached the greatest intensity since early-2000.  The nature of current synchronized global market speculation is extraordinary to say the least; virtually all markets everywhere.  Here at home, all the fun and games, squeezes and intoxication should have the Fed alarmed.  Surely, a destabilizing market “melt-up” is the last thing our vulnerable system needs right now.  And when I commented above that Dr. Bernanke’s (and the Fed’s) inflation doctrine was “Worse Than Irrelevant,” I had today’s global financial backdrop in mind.  To be sure, a policy of pegging short-term rates with promises of fixating two eyes on “core” CPI and no eyes on asset prices/Credit/or speculative excess has been fundamental in nurturing history’s greatest Credit Bubble.  Or, from another angle, relatively stable consumer prices have ensured runaway Credit inflation and speculative asset Bubbles.  And the marketplace’s inability to orderly adjust to rising global bond yields, surging energy prices and mounting inflationary pressures, and unfolding Credit market tumult portend problematic market dislocations at a future date.

07/05/2007 Monopoly *

For the week, the Dow gained 1.5% (up 9.2% y-t-d) and the S&P500 1.8% (up 7.9%).  The Transports jumped 2.5% (up 14.7%), as the Morgan Stanley Cyclical index closed the week up 2.2% to a new record high (up 23.2%).  The Utilities rallied 0.7% (up 7.3% y-t-d), and the Morgan Stanley Consumer index increased 0.9% (up 5.8%).  The broader market rallied sharply.  The small cap Russell 2000 jumped 2.2% (up 8.2%), and the S&P400 Mid-Caps rose 2.3% (up 13.9%).  Strong technology performance continued.  The NASDAQ 100 jumped 2.7%, increasing y-t-d gains to 13.2%.  The Morgan Stanley High Tech index advanced 2.3%, increasing 2007 gains to 12.1%.  The Semiconductors surged 2.6% (up 10%).  The Street.com Internet Index rose 1.8% (up 12%) and the NASDAQ Telecommunications index 3.3% (up 14.7%).  The Biotechs added 0.7% (up 3.8%).  The Broker/Dealers rallied 3.5% (up 7.9%), and the Banks gained 1.2% (down 2.7%).  With bullion rising $6.15, the HUI index rallied 6.6%. Trade interest-rates and the yield curve at your peril.  Two-year U.S. government yields this week rose 12 bps to 4.98%.  Five-year yields surged 16 bps to 5.09%.  Ten-year Treasury yields jumped 16 bps to 5.18%.  Long-bond yields ended the week 15 bps higher at 5.27%.  The 2yr/10yr spread ended the week at 20 bps.  The implied yield on 3-month December ’07 Eurodollars increased 7.5 bps to 5.36%.  Benchmark Fannie Mae MBS yields rose 11 bps to 6.37%, this week outperforming Treasuries.  The spread on Fannie’s 5% 2017 note was little changed at 44, and the spread on Freddie’s 5% 2017 note little changed at about 45.  The 10-year dollar swap spread increased 0.4 to a multi-year high 64.2.  Corporate bond spreads were volatile, with the spread on a junk index narrowing slightly this week.     There was little debt issuance this holiday week.  July 5 – Bloomberg (Cecile Gutscher and Caroline Salas):  “The world’s biggest bondholders have had their fill of leveraged buyouts, convinced that increasing mortgage delinquencies will drag down the U.S. economy and drive debt-laden companies into default.  TIAA-CREF, which oversees $414 billion in retirement funds for teachers and college professors, is boycotting some debt offerings used to finance LBOs. Fidelity International…and Lehman Brothers Asset Management LLC…say they’re avoiding debt from buyouts.  Investors are getting skittish just as private-equity firms led by Kohlberg Kravis Roberts & Co. and Blackstone Group Inc. prepare to sell $300 billion of bonds and loans to finance LBOs, according to Bear Stearns Cos. In the past two weeks alone, more than a dozen companies were forced to postpone or restructure debt sales.” International dollar bond issuers included Merna Reinsurance $1.1bn, million. German 10-year bund yields jumped 10.5 bps to 5-year high 4.675%, while the DAX equities index added 0.5% (up 22% y-t-d).  Japanese 10-year “JGB” yields rose 6 bps to 1.93%.  The Nikkei 225 was little changed (up 5.3% y-t-d).  Emerging equity markets were on fire, while debt markets were under only moderate pressure.  Brazil’s benchmark dollar bond yields rose 2.5 bps this week to 6.12%.  Brazil’s Bovespa equities index surged 3.8% to a record high (up 26.9% y-t-d).  The Mexican Bolsa jumped 4.0% to an all-time closing high (up 22.5% y-t-d).  Mexico’s 10-year $ yields rose 6 bps to 5.97%.  Russia’s RTS equities index rallied 4.1% (up 2.7% y-t-d).  India’s Sensex equities index gained 2.1% (up 8.5% y-t-d).  China’s Shanghai Composite index swung back and forth, ending the week 1.0% lower (up 41.3% y-t-d and 117% the past year). Freddie Mac posted 30-year fixed mortgage rates declined 4 bps to 6.63% (down 16bps y-o-y).  Fifteen-year fixed rates fell 4 bps to 6.30% (down 14bps y-o-y).  One-year adjustable rates rose 6 bps to 5.71% (down 12bps y-o-y).  The Mortgage Bankers Association Purchase Applications Index increased 2% this week.  Purchase Applications were up 5% from one year ago, with dollar volume 11.4% higher.  Refi applications fell 2.6% for the week, although dollar volume was up 21.3% from a year earlier.  The average new Purchase mortgage declined to $236,400 (up 6.1% y-o-y), and the average ARM slipped to $396,600 (up 16.9% y-o-y).  Bank Credit declined $19.9bn (week of 6/27) to $8.567 TN.  For the week, Securities Credit fell $12.5bn ($24.3bn 2-wk decline).  Loans & Leases declined $7.5bn to $6.273 TN.  C&I loans dropped $8.3bn, and Real Estate loans dipped $0.8bn.  Consumer loans declined $4.2bn.  Securities loans rose $8.7bn, while Other loans fell $2.8bn.  On the liability side, (previous M3) Large Time Deposits expanded $5.5bn.      M2 (narrow) “money” rose $10.5bn to a record $7.262 TN (week of 6/25).  Narrow “money” has expanded $218bn y-t-d, or 6.2% annualized, and $430bn, or 6.3%, over the past year.  For the week, Currency added $0.2bn, while Demand & Checkable Deposits declined $6.7bn.  Savings Deposits gained $8.7bn, and Small Denominated Deposits increased $2.6bn.  Retail Money Fund assets increased $5.5bn.        Total Money Market Fund Assets (from Invest. Co. Inst.) surged $23bn last week to a record $2.560 TN.  Money Fund Assets have increased $178bn y-t-d, a 14.4% rate, and $422bn over 52 weeks, or 19.7%.      Total Commercial Paper surged $25.4bn last week to a record $2.168 TN, with a y-t-d gain of $193bn (18.9% annualized).  CP has increased $384bn, or 21.5%, over the past 52 weeks.  Fed Foreign Holdings of Treasury, Agency Debt last week (ended 7/4) increased $7.0bn to a record $1.982 TN.  “Custody holdings” were up $230bn y-t-d (25.3% annualized) and $346bn during the past year, or 21.1%.  Federal Reserve Credit last week jumped $9.7bn to $857.3bn.  Fed Credit has expanded $5.1bn y-t-d, with one-year growth of $21.1bn (2.5%).     International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $636bn y-t-d (25.4% annualized) and $993bn y-o-y (22.3%) to a record $5.446 TN.  July 6 – Bloomberg (Anoop Agrawal):  “India’s foreign-exchange reserves increased $937 million to $213.49 billion in the week ended June 29…” Currency Watch: July 3 – Bloomberg (Kosuke Goto):  “Japanese housewives are helping to moderate currency swings by betting against professional investors, Bank of Japan board member Kiyohiko Nishimura said.  ‘The arrival of Japanese households as major investors seems to have affected foreign-exchange markets,’ Nishimura, 54, said… ‘The gnomes of Zurich were accused in their day of destabilizing markets. The housewives of Tokyo are apparently acting to stabilize them.’  Nishimura is the first policy maker to comment on increasing foreign-exchange margin trading, which last month helped push implied volatility on one-month yen options to the lowest since the Bank of Japan began compiling data in August 1992.” The dollar index declined 0.5% to 81.26.  On the upside, the Iceland krona gained 1.9%, the Czech koruna 1.6%, the Thai baht 1.3%, the Chilean peso 1.1%, and the Swedish krona 1.0%.  On the downside, the Japanese yen declined 0.8%, the Swiss franc 0.6%, the South African rand 0.5%, and the Philippines peso 0.5%.   Commodities Watch July 4 – Financial Times (Javier Blas):  “Food prices will rise by between 20 and 50% over the next decade from average levels over the last ten years, supported by the growth of the biofuel industry and increased food demand in emerging countries, a study warned yesterday.  The report by the United Nation’s Food and Agriculture Organization (FAO) and the OECD, added that long-term prices would be up to 30% higher than previously estimated.” July 6 – Financial Times (Geoff Dyer):  “Food prices are set for a period of ‘significant and long-lasting’ inflation because of demand from China and India and the use of crops for biofuels, according to the head of Nestlé.  Peter Brabeck, chairman of the world’s largest food company, said rises in food prices reflected not only temporary factors but also long-term and structural changes in supply and demand.  ‘They will have a long-lasting impact on food prices,’ he told the Financial Times… Several food companies have warned about the short-term outlook for prices, but Mr. Brabeck’s comments are among the starkest warnings that a long period of rising food prices could stoke broader inflationary pressures… Corn prices have risen about 60% and wheat about 50% over the last 12 months. Sugar, milk and cocoa prices have also surged, prompting the biggest increase in retail food prices in three decades in some countries.” July 5 – Bloomberg (Yoshifumi Takemoto):  “Japanese steel company costs may rise more than expected this year as raw material prices gain, said Shoji Muneoka, executive vice president of Nippon Steel Corp., the world’s second-largest steelmaker.  Costs may increase as much as 1 trillion yen ($8 billion), 43% more than an industry forecast, as prices rose for iron ore, coking coal, molybdenum, nickel, tin, scrap metal and shipping, Muneoka said…” For the week, Gold gained 0.9% to $655.80, and Silver jumped 2.3% to $12.76.  Copper surged 4.4%.  August crude rose $2.13 to a 10-month high $72.81.  August gasoline gained 3.2%, while August Natural Gas sank an additional 4.9%.  For the week, the CRB index increased 1.6% (up 4.4% y-t-d), and the Goldman Sachs Commodities Index (GSCI) jumped 2.4% (up 15.4% y-t-d).  Japan Watch: July 3 – Financial Times (Michiyo Nakamoto):  “Big foreign investment banks achieved record revenues in Japan last year largely because of the strength of their brokerage operations, despite a lacklustre stock market.  Morgan Stanley posted a 21% rise in revenues to a record Y238.6bn for the year to March, followed by Goldman Sachs, which saw record revenues of Y231.3bn, up 4%.  Merrill Lynch, Deutsche Securities and UBS also posted record revenues in Japan…  This has prompted UBS to increase its Tokyo headcount by 20% this year, while Morgan Stanley and Deutsche increased their staffs by 14% and Goldman Sachs by 10%.” China Watch: July 4 – Financial Times (Robin Kwong, Sundeep Tucker and Anuj Gangahar):  “Capital raised by new listings in China is set to exceed $52bn this year, twice the figure forecast in January, putting the mainland on track to become the world’s leading centre for share offerings this year… The flood of offerings is being driven by mainland companies’ rush to benefit from valuations on the soaring stock market. The main Shanghai index has trebled in the past 18 months.  ‘This latest forecast is scary,’ said a senior Hong Kong banker…” July 5 – Bloomberg (Li Yanping):  “China’s trade surplus may have widened by more than 60% to $110 billion in the first half of 2007, state-run Xinhua News Agency reported…” July 5 – Bloomberg (Kelvin Wong):  “Hong Kong’s retail rents will surge 19% in the 12 months through May 2008 on increased local consumer spending and an influx of overseas retailers, according to…Colliers International…” July 5 – Bloomberg (Nipa Piboontanasawat):  “Hong Kong’s property sales rose 32% to HK$213.7 billion ($27 billion) in the first six months of 2007 from the same period a year earlier… The number of transactions climbed 33%...” India Watch: July 2 – Financial Times (Joe Leahy):  “In India, barely a week goes by without a company announcing another major fund-raising exercise.  In the latest such move, government-controlled State Bank of India, the country’s largest bank, said last week it needs Rs500bn ($12.3bn) of capital over the next three years and will raise part of it through share offerings.  ‘We need capital, all banks in India need capital, because the Indian economy is growing at a fantastic pace and bank lending is growing 25% plus,’ SBI chairman Om Prakash Bhatt said.  All of this is music to the ears of international investment banks. They have been scrambling to boost their presence in India to ride the boom…” July 3 – Bloomberg (Anil Varma):  “India’s central bank faces ‘severe policy challenges’ in managing capital inflows attracted by the nation’s record economic growth, Governor Yaga Venugopal Reddy said.  ‘We have several significant economic strengths but we also have twin deficits - current and fiscal; have a higher component of more volatile portfolio flows on capital account and severe policy challenges in managing capital flows.’” July 2 – Bloomberg (Kartik Goyal):  “India’s trade deficit widened in May as companies imported more machinery and other goods, taking advantage of a record rise in the nation’s currency.  The trade deficit was $6.22 billion in May compared with $4.26 billion a year earlier…” Asia Boom Watch: July 2 – Bloomberg (Seyoon Kim):  “South Korea’s export growth accelerated and the nation’s finance minister said improving overseas sales will help drive a faster expansion of Asia’s third-largest economy in the next six months.  Exports climbed 15.9% in June from a year earlier…” Unbalanced Global Economy Watch: July 5 – The Wall Street Journal (Deborah Solomon):  “Governments from Canada to China are considering or implementing restrictions on foreign purchases of companies, factories, real estate and natural resources in their countries, moves that U.S. officials fear could harm global economic growth if they proliferate.   ‘Perhaps the greatest challenge is rising investment protectionism, and we’ve got to work very hard to keep investment barriers low,’ says U.S. Deputy Treasury Secretary Robert Kimmitt, who recently visited Moscow and Beijing to urge officials to minimize restrictions on foreign investment.” July 5 – Bloomberg (Greg Quinn):  “Canadian building permits rose 21% in May to a record, a pace almost four times faster than economists forecast, led by commercial office space in the western cities of Calgary and Vancouver.” July 6 – Bloomberg (Alexandre Deslongchamps):  “Canada’s economy added 34,800 jobs in June, twice as many as expected, and the unemployment rate stayed at a 33-year low for a fifth month, giving the Bank of Canada more reason to raise interest rates next week.” July 3 – Bloomberg (Fergal O’Brien):  “European unemployment fell to a record in May as companies added jobs to meet strengthening demand, a sign wage claims may rise and inflationary pressures increase.  The jobless rate in the 13-nation euro area declined for a seventh month, dropping to 7% from 7.1% in April…” July 3 – Bloomberg (Fergal O’Brien):  “Ireland’s economic growth quickened in the first quarter, as companies invested more and exports rose.  Gross domestic product increased an annual 7.5%, the fastest pace since the third quarter of 2006…” July 6 – Bloomberg (Simone Meier):  “Swiss unemployment declined in June, pushing the jobless rate to the lowest in almost five years as companies step up spending and hiring to meet orders… The jobless rate fell to 2.7%...” July 5 – Bloomberg (Andreas Cremer):  “German Economy Minister Michael Glos comments on prospects for growth in Europe’s largest economy… ‘The shortage of skilled labor in Germany is giving us reason for concern. Business is desperately looking for qualified staff even though 20,000 engineers are registered as unemployed. That doesn’t make sense and slows the economic upswing. We need more investment in education… Our economy is running at full steam, Germany has again become the engine of growth in Europe.’” July 2 – Bloomberg (Robin Wigglesworth):  “Norway’s domestic credit growth accelerated to 14.8% in May, adding to expectations the central bank will keep raising interest rates to curb spending and inflation.” July 4 – Bloomberg (Maria Levitov):  “Russia’s money supply expanded 19% in the first quarter and will probably expand as much as 39% by the end of the year, central bank Chairman Sergei Ignatiev said.  ‘The money supply has so far been growing too quickly,’ Ignatiev told lawmakers at the parliament…” July 4 – Bloomberg (Maria Levitov):  “Russia’s annual inflation rate accelerated to 8.5% in June on higher prices of fruits and vegetables, central bank chairman Sergey Ignatiev said.  Inflation increased from 7.8% in May…” July 2 – Bloomberg (Mark Bentley and Steve Bryant):  “Turkey’s economic growth accelerated in the first three months… Gross domestic product in the EU candidate expanded an annual 6.8%, compared with 5.2% in the previous three months…” Latin American Boom Watch: July 2 – Bloomberg (Bill Faries):  “Argentina’s June tax revenue rose as exports and consumer spending in South America’s second-largest economy heads into its fifth straight year of growth.  Tax revenue in June rose 30.4% from a year earlier to 18 billion pesos ($5.8 billion)…” Central Banker Watch: July 5 – Bloomberg (Svenja O’Donnell):  “The Bank of England raised its benchmark interest rate for the fifth time in a year as accelerating economic growth and surging house prices kept inflation above target.  The nine-member Monetary Policy Committee…increased the bank rate by a quarter-point to 5.75%, the highest since April 2001… Inflation has held above the bank’s 2% target for more than a year as a boom in London’s financial services industry and rising home values powered the fastest economic growth in three years.” Bubble Economy Watch: July 5 – Financial Times (Daniel Pimlott):  “Amid crowds of cranes, rumbling concrete trucks and grand schemes for its future, New York is experiencing one of the greatest eras of development in its history.  A series of dramatic skyscrapers, including the new World Trade Center, is set to transform the city as financial giants such as Goldman Sachs and Bank of America cash in on the strength of the US economy… The New York Building Congress expects ‘unprecedented construction levels’ this year and next, with total construction spending for the city likely to breach $25bn this year…” Financial Sphere Bubble Watch: July 2 – Financial Times (Richard Beales and Francesco Guerrera):  “Some US companies are starting to take on more debt in order to pay it out to shareholders – a response to rampant leveraged buy-outs and activist investors.  The moves, while still unusual, could herald a gradual shift among publicly listed companies towards more aggressive capital structures.  Recent announcements include…Home Depot’s intention to borrow $12bn to help finance a $22.5bn share buy-back and plans at Expedia…to spend $3.5bn buying back 42% of its shares – funding part of the buy-back with debt.” Mortgage Finance Bubble Watch: July 5 – The Wall Street Journal (Rex Nutting):  “More Americans fell behind on debt payments in the first quarter than at any time since the 2001 recession, despite fewer delinquencies on credit-card debts, the American Bankers Association reported…   Delinquencies of all types of consumer loans rose to 2.42% in the first quarter from 2.23% in the fourth quarter, led by higher rates of late payments for real-estate loans.” Foreclosure Watch: MBS/ABS/CDO/Derivatives Watch: July 6 – Financial Times (James Mackintosh and Paul J Davies):  “Investment banks are demanding more capital to back loans to hedge funds investing in US subprime mortgage-linked debt, as they try to head off a repeat of the near-collapse of two Bear Stearns hedge funds. The ‘haircut’, or margin requirement, on financing provided to buy collateralised debt obligations (CDOs) backed by subprime mortgage bonds has been increasing sharply, in many cases doubling, according to hedge funds, bank executives and prime brokers.” July 6 – Financial Times (Paul J Davies):  “The fallout from the crisis at two Bear Stearns hedge funds in the broader market for the complex securities they hold is likely to worsen, as investment banks cut their credit exposure to funds involved in the field. It is far from certain how significant the direct impact of these cuts will be and even more uncertain are the knock-on effects to other areas of structured credit and debt markets beyond.  But some in the market say that whatever the outcomes, the current troubles in collateralised debt obligations of asset-backed securities are a sneak preview of what the next broad-based downturn in markets might look like.” Real Estate Bubbles Watch: July 5 – The Wall Street Journal (Jennifer S. Forsyth):  “Office rents are skyrocketing across the nation, driving up costs for businesses large and small, thanks to a dearth of space in some major markets and a new breed of deep-pocketed landlords who can afford to hold out for premium tenants.  Nationwide, effective rents on office properties… jumped an average of 3.1% during this year’s second quarter, up from gains of 2.8% in the first quarter and 2.1% in the year-earlier period, according to a report…by Reis Inc.   That was the sharpest quarterly increase since the third quarter of 2000…” July 5 – Financial Times (Jim Pickard, David Turner and Dan Pimlott):  “All the best parties tend to conclude with painful hangovers.  In real estate, the celebrations have been going on for nearly five years against the heady backdrop of strong investor demand, rising prices, cheap debt and a benign occupier market.  Some canny investors have made a killing from highly geared bets on rising property markets from Mumbai to Madrid. And global real estate stocks are up 341% since March 2003.  Now, however, someone appears to have turned off the music. Share prices of some real estate companies have taken a battering in recent months. In the UK, some of the biggest groups are down 20 to 30% from their new year highs.” July 3 – Bloomberg (Sharon L. Crenson):  “Manhattan co-operative apartment prices fell in the second quarter, the first decline in four years, as buyers favored condominiums that are free of resale and sublet restrictions.  The median price of a co-op declined 3.7% to $695,000 in the period ending June 30, according to…Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate. The median price for a condo climbed 5.1% to $1.04 million.” M&A and Private-Equity Bubble Watch: July 3 – Financial Times (Paul J Davies ):  “At the height of the first junk-rated debt crisis in 1989, RJR Nabisco sold what remained until very recently the biggest ever slug of high-yield bonds.  But what is less well remembered is that the company and its buy-out backers, Kohlberg Kravis Roberts, raised only about $4bn from its $6.1bn bond issue as market turmoil forced it to offer much of the debt at a hefty discount.  For many people, the parallels between then and now are striking. With plenty of leveraged buyout-related loans and bonds due to hit the markets in coming months, the massed ranks of private equity groups and investment banks will be hoping they do not suffer the same fate.  But with US and European companies…all bringing or expected to bring huge junk-rated bond or loan deals in coming weeks and months, investor sentiment and appetite is likely to be well tested.  Nowhere is this more true than in the US, where a record $215bn of loans is expected to be sold into the markets over the second half of the year, according to data from S&P… Crucial to the success of these loan sales and others in Europe is the health of a highly complex and still young market for collateralised loan obligations (CLOs)… The big problem facing sponsors of leveraged buy-outs in particular is that in modern credit markets, sentiment in CLOs and thus in underlying loan markets has become far more closely inter-linked with that in a far broader range of other markets…” July 5 – Financial Times (Ben White and James Politi):  “Kohlberg Kravis Roberts, which filed for a $1.25bn initial public offering late on Tuesday, expects to trade at a valuation multiple equal to, or higher, than rival Blackstone.  Insiders said KKR’s belief is based on the fact that it is a pure-play buy-out firm, without Blackstone’s exposure to other asset management businesses.  If the expectation is justified then KKR would be valued at more than $15.5bn… KKR’s move continued a wave of alternative asset managers - including Blackstone, Fortress and Och-Ziff Capital Management - that are seeking to raise permanent capital to expand operations, attract talent and offer founders a way to cash in on the boom in the private equity and hedge fund industries.” Energy Boom and Crude Liquidity Watch: July 5 – Bloomberg (Will McSheehy):  “The Kuwait Investment Authority, which oversees as much as $400 billion for the Persian Gulf state, made a fiscal year profit of $28.5 billion from investments in companies… Kuwait’s Future Generation Fund and General Reserve Fund, both managed by the authority…made a combined profit of 8.2 billion dinars ($28.5bn) in the year to March 31, a 23% increase on the previous year…” July 6 – New York Times (Leslie Wayne):  “The chairman of Emirates airline —Sheik Ahmed bin Saeed al-Maktoum of the ruling family of Dubai — has grand ambitions and a bankroll to match.  He has a huge pot of money to spend: $82 billion from his government, the airline and other financiers. He loves large planes, and he has ordered 55 superjumbo A380s, to create the biggest fleet of these double-decker planes in the world. And he wants to make Dubai, a sheikdom by the sea, the busiest airline hub in the world, overtaking London, New York and Singapore… Emirates is the world’s fastest-growing airline — it will take delivery of one new Boeing or Airbus plane a month for the next five years…  ‘We’ve never seen anything like it before,’ said Robert Cullemore, a consultant at Aviation Economics, an advisory firm in London. ‘We’ve never seen growth at this rate.’” July 3 – Bloomberg (James Brooke):  “The Ritz-Carlton Moscow threw open its neo-imperial doors near the Kremlin this week. The cheapest room for the summer tourist season is $1,036 with tax.  That rate reflects how Moscow hotel openings are lagging behind room demand fueled by soaring tourism, exports and investor interest in the world’s largest energy producer.” July 3 – Bloomberg (Shanthy Nambiar and Matthew Brown):  “Nasser David Khalili, catapulted into the top five of the U.K. rich list by the soaring value of his Islamic art, said the jump in prices for old works by Muslim artists has barely begun.  ‘Anyone who says Islamic art is expensive is dreaming,’ said Khalili…  ‘The Muslim world is not short of money, but the world is short of objects. This is only the beginning.’   Governments and millionaires in nations from Saudi Arabia to Malaysia, enriched by a doubling of crude oil prices in four years, are bidding for a dwindling supply of surviving artifacts from 1,400 years of Islamic culture. Khalili said his seven-century-old ‘Jami’ al-Tawarikh, one of the world’s earliest histories, is now worth 15 to 20 times the $12 million he paid for it in 1990.” Monopoly: Is an attempt to make some sense out of recent crosscurrents even plausible?  One would have expected rising global yields, mounting U.S. consumer debt issues, and serious festering problems within Wall Street “structured finance” to have by now at least somewhat impinged marketplace liquidity.  And, actually, the vast majority of Credit spreads have widened meaningfully over the past few weeks.  Deteriorating market conditions have forced an increasing number of debt deals to be re-priced, postponed, or cancelled altogether.  M&A Bubble vulnerability has become palpable.  Yet over-liquefied global equities markets are at or near record highs; crude is rapidly approaching $73; gold is back above $650; major commodities indices are rallying back toward all-time highs; and international debt issuance is running at a record pace.  Buyout announcements are unrelenting.  And despite the housing downturn and subprime implosion, the U.S. Bubble economy chugs right along.  Non-farm payrolls have increased 871,000 year-to-date, only moderately below the pace of job generation during the preceding two years.  The Morgan Stanley Cyclical index enjoys a 23% 2007 gain.  The NASDAQ Composite sits today on a one-year gain of 23.7% (up 10.4% y-t-d).    Let’s first delve briefly into the (Bubble) economy and then return to the markets.  June’s 132,000 and May’s revised 190,000 (from 157,000) jobs created confirm ongoing economic expansion.  This should not be surprising considering continuing Credit excess and the strong inflationary biases that persist in many sectors (certainly including the stock market/M&A/general finance, exports, energy, commodities, agriculture, healthcare, the military and government).  Healthcare employment increased 42,000 during June, while Government jobs were up 40,000 and “Leisure” 39,000.  Year-to-date, Service Producing jobs have gained 943,000, with Education & Health Services up 291,000, Leisure 194,000, Trade & Transport 107,000, and Business Services 80,000.  Goods Producing employment has declined 72,000 y-t-d, with 84,000 jobs lost in Manufacturing and (only) 3,000 in Construction. June Hourly Earnings were up 3.9% y-o-y, now hovering near 4% annual increases for 14 straight months.  Keep in mind that y-o-y Hourly Earnings growth peaked at 4.3% during 2000 and then fell below 4% during the five-year period July 2001 through June 2006.  Upward wage pressures certainly appear more pervasive today than they were during the technology/telecom Bubble period.  Skilled workers remain in short supply in most industries - a dynamic one would not expect to play well with bond managers. The schizophrenic Treasury market was hit head-on this week by a strong ISM Manufacturing report (up one to 56), a booming ISM Non-Manufacturing number (up one to 60.7), and today’s robust jobs data.  Rather abruptly, last week’s fear of impending Credit tumult was - at least for top-tier fixed income - temporarily displaced by angst associated with an overheated global economy, heightened inflationary pressures, and rising global rates.  Visions of impending Fed easing were overcome by the menacing view of a Fed forced down the road into additional rate hikes.   On the one hand, there is significant stress in the U.S. CDO marketplace with the very real potential to expand into a serious liquidity event.  On the other, energized Credit systems across the globe are today firing on virtually all cylinders.  The debt markets are caught confounded and indecisive with respect to the nuances of this newfound global Credit and liquidity juggernaut, as well as to the scope of the liquidity-creating function undertaken by the CDO marketplace over the past couple years.  There is today an unusually fine line between an unwieldy global liquidity Bubble and the mounting risk of a liquidity dislocation in the market for financing risky securities.  Such uncertainty has become a distinguishing feature of the today’s Credit and speculation-induced Monetary Disorder. The risks of a flight away from the CDO market are very real and won’t likely dissipate anytime soon.  “Ponzi Finance” dynamics have created acute fragility.  A run on these illiquid instruments would be immediately problematic, requiring re-pricing throughout.  Since a large amount of these securities are financed through the Wall Street “repo” machine, lower prices would instigate margin calls and forced liquidation.  The risk of a problematic deleveraging and marketplace dislocation is today quite high. By their nature, prolonged Credit Bubbles concentrate incredible financial power in fewer and fewer bigger hands.  Those most successful at financial innovation exploit their capacity to intermediate Credit and issue the debt instruments sought by the marketplace.  The natural inclination is to capitalize fully on one’s financial prowess – to consolidate power and influence by outgrowing, acquiring, merging or linking with a dwindling cadre of “competitors.”  This dynamics melds well with the progressively arduous task of creating and distributing the ever-larger quantities of Credit instruments necessary to sustain the Bubble.  Wall Street’s astounding “success” with electronic “money” owes much to its ability to have made a Monopoly out of the business of “structured finance” (i.e. contemporary "money" and money-like Credit).  When this Credit Bubble inevitably bursts, the large financial operators (the Wall Street firms, “money center” banks, hedge funds, financial guarantors, and rating agencies) will be anathema to the general public (and legislators!) as they were in the post-1929 crash environment.  In the meantime, however, we should expect the “money” changers to go to great lengths to sustain the boom.  Not only do Wall Street investment bankers today control the creation of debt instruments (contemporary “money” and Credit), these firms also dominate the entire risk intermediation (i.e. derivatives) and financial asset management business.  I mention this only to remind readers that – as one should expect at this stage of a historic financial Bubble – we are not these days dealing with “free” or “efficient” markets.  It doesn’t work that way. At the same time, I don’t believe the Fed, Wall Street, or any group has much control over developments other that to work diligently to ensure sufficient Credit creation.  Command over how this created purchasing power flows through the global economy and markets is becoming a different story altogether.  And that, loyal readers, is the age old dilemma of inflationary booms.  I may believe we are on the precipice for one heck of a problem associated with the reversal of speculative flows to risky and illiquid debt instruments.  But what this means in the near-term for the U.S. and global equities Game is anything but clear. I’ve written in the past how markets can go haywire near inflection points.  In reality, these days they have a strong propensity for doing it.  The NASDAQ Bubble is the poster child.  Increasingly evident fundamental problems – a faltering telecom debt Bubble, rapidly weakening industry profit trends, and acute “Ponzi Finance” dynamics – surely played an instrumental role in the final melt-up and resulting subsequent collapse.  Huge short positions and derivatives bets created the backdrop for destabilized market conditions and unavoidable dislocation. Witnessing recent market dynamics, I'm increasingly of the view that we are experiencing oddities reminiscent of the 1999/early-2000 market dislocation.  To be sure, there are eerie fundamental parallels along with abundant “technical” fodder.  The number of outstanding NASDAQ shares sold short in June was up 37% from a year earlier and were 28% higher at the NYSE.  Over the past six months, short interest has expanded at a 65% rate at NASDAQ and 58% at the NYSE.  We also know that derivative positions and trading activity have surged. I’ll assume that so-called “market neutral” strategies are responsible for much of the increased shorting, especially the more recent proliferation of “130/30” (130% long and 30% short) strategies.  Having lived through all the squeezes and nonsense orchestrated against bearish positions during the nineties, I’ll cynically suggest that we shouldn’t be all too surprised if this current bout of speculative excess runs its course only after wreaking some bloody havoc on this popular strategy.  For sure, there is a plethora of players new to shorting.  Actually, this dynamic already may help explain the strong gains posted by stocks with oversized dollar value shorts positions (i.e. Amazon, Research in Motion, Apple, Google, Intel, GM, etc.)    Short squeezes create market liquidity, albeit temporarily.  I would also argue that rising stock markets (and asset markets generally) generate their own liquidity, especially when derivatives strategies proliferate.  Writing out-of-the-money call options to finance the purchase of out-of-the money put options was a popular hedging strategy in the late nineties.  Such trades have little impact as long as the market trades in a narrow range.  But, and as we saw with NASDAQ, these strategies can be destabilizing in rapidly rising markets, adding additional marketplace leverage and the forced unwind of hedges as prices surge higher.  Moreover, I see no reason why we should not expect today’s unfathomable derivatives markets to run amuck. How far we are today into an upside market dislocation is impossible to discern.  Yet I certainly suspect that speculative dynamics have reemerged as an integral aspect of market behavior, at home and likely abroad.  The specter of a synchronized global market “melt-up” and the acute susceptibility to breakdown such a scenario would entail is one aspect of the unfolding “worst-case scenario.”  As I expounded above, today’s global Credit apparatus has extraordinary command over the liquidity-creation process.  It’s just losing more and more control over inflationary effects in an asset manic world.  Wall Street is immersed in a dangerous Game.