05/25/2006 Inflection point or Respite *

For the week, the Dow gained 1.2%, and the S&P500 added 1.0%. The Transports rose 1.1%, and the Morgan Stanley Cyclical index gained 1.0%. The Utilities jumped 1.9%, and the Morgan Stanley Consumer index rose 1.0%. The small cap Russell 2000 rallied 1%, and the S&P400 Mid-cap index increased 0.4%. Technology stocks were mixed but generally unimpressive. The NASDAQ100 mustered only a 0.3% gain, and the Morgan Stanley High Tech index rose 1.0%. The Semiconductors fell 4.7%, and the NASDAQ Telecommunications index declined 1.3%. The Biotechs jumped 3.6%. The Broker/Dealers gained 1.2%, and the Banks added 0.8%. Although bullion was down $6.20, the HUI Gold index rallied 2.3%.   For the week, two-year Treasury yields dipped one basis point to 4.94%, and five-year yields declined 2 bps to 4.94%. Bellwether 10-year yields added one basis point to 5.05%. Long-bond yields actually rose 2 bps to 5.16%. The 2yr/10yr spread ended the week at a positive 11 bps. Benchmark Fannie Mae MBS yields rose 2 bps to 6.24%, this week underperforming Treasuries. The spread on Fannie’s 4 5/8% 2014 note ended the week one bp wider at 26, and the spread on Freddie’s 5% 2014 note was one bp wider to 28. The 10-year dollar swap spread increased one to 54.75. Corporate bond spreads generally stabilized this week, although junk again somewhat underperformed. The implied yield on 3-month December ’06 Eurodollars fell 3 bps to 5.335%.           Investment grade issuers included Lehman Brothers $2.5 billion, Merrill Lynch $2.35 billion, Gannett $1.2 billion, United Technologies $1.1 billion, Hewlett-Packard $1.0 billion, HSBC $1.5 billion, Humana $500 million, Keycorp $500 million, Ameriprise Financial $500 million, Marshall & Ilsley $400 million, Noble Corp $300 million, DTE Energy $300 million, PepsiAmericas $250 million, and Belo Corp $250 million.  Junk issuers included Hanger Orthopedic $175 million, MTR Gaming $125 million and Midway Games $75 million.  Convert issuers included Global Crossing $125 million, and CBIZ $100 million. May 24 – Bloomberg (Harris Rubinroit): “Sales of U.S. collateralized debt obligations rose about 66 percent to $43.9 billion in the first quarter from the same period a year earlier, Moody’s…said… The number of first quarter rated CDO transactions, which package assets such as corporate bonds and loans into securities, rose about 60 percent from the first three months of last year… ‘We are confident that the first half of the year will be a record breaker for U.S. CDOs,’ Moody’s analyst Richard Michalek said…” May 26 – Financial Times (Louisa Mitchell ): “Two companies have successfully issued PIK, payment in kind, loans this week, taking advantage of a quiet new issue market and the ongoing cash available for high yield instruments. On Wednesday, Italian telecommunications operator Windraised €555m at a spread of 800 basis points over Euribor.” May 25 – Bloomberg (Sebastian Boyd): “Banks in the Persian Gulf are selling bonds in Europe for the first time, reducing their dependence on U.S. investors and taking advantage of lower borrowing costs.” Foreign dollar debt issuers included DNB Nor Bank $2.75 billion, and Canadian National $700 million.  Japanese 10-year JGB yields dropped 5.5 bps this week to 1.85%. The Nikkei 225 index declined 1% (down 0.9% y-t-d).  German 10-year bund yields fell 10 bps to 3.88%. Emerging markets generally regained their composure. Brazil’s benchmark dollar bond yield declined 3 bps to 7.16%. Brazil’s Bovespa equity index jumped 2.4%, increasing 2006 gains to 15.5%. Despite a late-week rally, the Mexican Bolsa was down 3% for the week (up 10% y-t-d). Mexico’s 10-year $ yields jumped 10 bps to 6.37%. Russian 10-year dollar Eurobond yields were unchanged at 6.84%. The Russian RTS equities index was up 3%, increasing 2006 gains to 33% and 52-week gains to 123%. India’s Sensex equities index gained 1.2%, increasing 2006 gains to 15%.  Freddie Mac posted 30-year fixed mortgage rates added 2 bps to 6.62%, up 97 basis points from one year ago. Fifteen-year fixed mortgage rates rose 3 bps to 6.23%, 102 bps higher than a year ago. One-year adjustable rates slipped one basis point to 5.61%, an increase of 140 bps over the past year. The Mortgage Bankers Association Purchase Applications Index dropped 7.1% last week. Purchase Applications were down 17% from one year ago, with dollar volume down 15%. Refi applications fell 4.3% last week. The average new Purchase mortgage dropped almost $10,000 to $228,400, while the average ARM declined $6,000 to $340,800. Bank Credit rose $11.9 billion last week to a record $7.901 Trillion, with a y-t-d gain of $395 billion, or 13.7% annualized. Bank Credit inflated $783 billion, or 11.0% over 52 weeks. For the week, Securities Credit added $3.6 billion. Loans & Leases rose $8.3 billion for the week, with a y-t-d gain of $229 billion (10.9% annualized). Commercial & Industrial (C&I) Loans have expanded at a 16.4% rate y-t-d and 14.2% over the past year. For the week, C&I loans jumped $5.8 billion, and Real Estate loans added $0.9 billion. Real Estate loans have expanded at a 10.3% rate y-t-d and were up 12.9% during the past 52 weeks. For the week, Consumer loans gained $5.1 billion, and Securities loans increased $6.8 billion. Other loans were down $10.1 billion. On the liability side, (previous M3 component) Large Time Deposits added $0.9 billion.  M2 (narrow) “money” supply rose $8.4 billion to $6.780 Trillion (week of May 15). Year-to-date, narrow “money” has expanded $90 billion, or 3.5% annualized. Over 52 weeks, M2 has inflated $290 billion, or 4.5%. For the week, Currency added $0.7 billion. Demand & Checkable Deposits gained $3.1 billion. Savings Deposits increased $2.6 billion, while Small Denominated Deposits rose $3.4 billion. Retail Money Fund assets dipped $1.4 billion. Total Money Market Fund Assets, as reported by the Investment Company Institute, jumped $16.5 billion last week to $2.074 Trillion. Money Fund Assets have increased $17.3 billion y-t-d, with a one-year gain of $180 billion (9.5%).  Total Commercial Paper added $2.1 billion last week to $1.769 Trillion. Total CP is up $120 billion y-t-d, or 18.1% annualized, while having expanded $250 billion over the past 52 weeks, or 16.5%.  Asset-backed Securities (ABS) issuance surged to $32 billion. Year-to-date total ABS issuance of $289 billion (tallied by JPMorgan) is running 2% ahead of 2005’s record pace, with y-t-d Home Equity Loan ABS sales of $203 billion 10% above last year. Fed Foreign Holdings of Treasury, Agency Debt (“US marketable securities held by the NY Fed in custody for foreign official and international accounts”) declined $7.8 billion to $1.617 Trillion for the week ended May 24th. “Custody” holdings are up $97.5 billion y-t-d, or 15.9% annualized, and $206 billion (14.6%) over the past 52 weeks. Federal Reserve Credit declined $1.8 billion to $822.8 billion. Fed Credit has declined $3.6 billion y-t-d, or 1.1% annualized. Fed Credit increased 4.6% ($36.2bn) during the past year.  International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – are up $358 billion y-t-d (21% annualized) and $551 billion (14.3%) in the past year to $4.38 Trillion. Currency Watch: The dollar index mustered a 0.5% gain this week. On the upside, the New Zealand dollar gained 2.4%, the Canadian dollar 1.8%, the Hungarian forint 0.9%, the Polish zloty 0.8%, and the Mexican peso 0.7%. On the downside, the Turkish lira declined 1.9%, the Iceland krona 1.7%, the Brazilian real 1.5%, and the British pound 1.1%. Commodities Watch: Don’t count the commodities out yet… For the week, Gold declined 0.9% to $653.20, while Silver rose 3% to $12.73. Copper surged 10%. July crude rose $2.08 to $71.37. June Unleaded Gasoline gained 4.8%, while June Natural Gas fell 0.6%. Wheat futures traded at a 9-year high this week and have gained almost 50% over the past year. For the week, the CRB index rose 2.7% (y-t-d up 4.8%). The Goldman Sachs Commodities Index (GSCI) gained 2.7%, increasing y-t-d gains to 10.6%.      Japan Watch: May 24 – Bloomberg (Lily Nonomiya): “Japan’s economic growth will remain robust as domestic demand fuels expansion, the International Monetary Fund said in its annual report on the country. The economy will expand 2.75 percent this year and 2 percent in 2007, the fund said…” China Watch: May 23 – MarketNewsInternational: “The Chinese economy grew at a 10.3% annualized rate in the first quarter, a slight upward revision from  the initial 10.2% estimate, the National Bureau of Statistics said…” May 22 – Bloomberg (Yanping Li and Nerys Avery): “China will take measures such as raising the percentage of deposits banks must set aside as reserves to rein in lending in the world’s fastest-growing major economy, the central bank said…” May 25 - China Knowledge: “China’s hotel and restaurant retailing sales amounted to RMB 329.9 billion in the first four months this year, 14.5%...more than the previous year, according to Xinjin News.” May 23 – Bloomberg (Nerys Avery): “Beijing raised per-kilometer taxi fares by 25 percent to 2 yuan ($0.25) on May 20, the first increase in charges since 2000, to offset an increase in fuel costs…” May 24 – Bloomberg (Cathy Chan): “Hong Kong individual investors ordered at least HK$268 billion ($35 billion) of shares in Bank of China Ltd.’s initial public offering, 70 times the amount available to them, people involved in the sale said.” Asia Boom Watch: May 25 – Bloomberg (Denise Kee): “Asia-Pacific companies will get a record $200 billion of loans this year as borrowing costs drop to levels before the region's financial crisis nine years ago. Asian companies outside of Japan will boost loans by 60 percent from 2005, John Corrin, chairman of the Asia Pacific Loan Market Association, said at a conference in Singapore yesterday. ‘The performance in the first quarter is already very strong and we certainly expect this to continue into 2007. The loan market is virtually four times the size of the bond market and will remain a reliable source of funding for our clients in Asia.’” May 22 – Bloomberg (Kartik Goyal): “India’s economic expansion in the year to March 31 will match last year’s estimated growth of 8.1 percent, Economic Affairs Secretary Ashok Jha said today…” May 25 – Bloomberg (Cherian Thomas and Kartik Goyal): “India’s exports rose 27 percent in April from a year earlier, faster than the 21 percent gain in the previous month, the government said.” May 23 – Bloomberg (Kim Kyoungwha): “South Korea’s economic growth may accelerate to 5.2 percent this year, powered by rising consumer spending and exports, the Organization for Economic Cooperation and Development said. Expansion may quicken from 4 percent in 2005…” May 26 – XFN: “South Korea posted its biggest current account deficit in nine years in April because of a smaller merchandise trade surplus and larger income account deficit, the Bank of Korea said… The current account deficit widened to $1.53 bln…” May 23 – Bloomberg (Theresa Tang): “Taiwan’s export orders rose at the slowest pace in nine months in April… Orders, indicative of actual shipments in one to three months, rose 18.6 percent to $24.7 billion…” May 22 – Bloomberg (Theresa Tang): “Taiwan’s jobless rate fell for a fourth straight month to the lowest in five years in April… The unemployment rate dropped to a seasonally adjusted 3.93 percent…” May 25 – Bloomberg (Theresa Tang): “Taiwan’s money supply growth picked up in April as bank lending and investment rose and stock market trading increased. M2, the broadest measure of money supply, rose 6.5 percent from a year ago after gaining 6.2 percent in March…” Unbalanced Global Economy Watch: May 22 – Bloomberg (Gabi Thesing): “The Bundesbank said accelerating money supply growth, rising energy costs and higher value-added tax in Germany pose ‘serious’ threats to inflation in the dozen nations sharing the euro. ‘There are immediate inflationary risks emerging,’ the German central bank said… Money supply growth ‘is a serious warning sign,’ it said…” May 24 – Bloomberg (Chris Malpass and Gabi Thesing): “Import prices in Germany, Europe’s largest economy, increased the most in almost six years in April, driven by higher energy costs and metals prices. The cost of foreign goods rose 6.9 percent from a year earlier, compared with a 5.5 percent gain in March…” May 25 – Bloomberg (Sheyam Ghieth): “Italian business confidence unexpectedly rose in May to the highest in more than five years, indicating companies reckon they can withstand the impact of rising oil prices and an appreciating euro.” May 24 – Bloomberg (Ben Sills): “Spanish exports grew the most in almost six years in the first quarter, suggesting gains in spending by its main trading partners will help growth in Europe’s fifth-biggest economy outpace the European Union for an 12th year. Exports rose 9.1 percent from a year earlier…” May 24 – Bloomberg (Jonas Bergman): “The prices charged by Swedish manufacturers rose a more-than-expected 0.6 percent last month, led by higher costs for metals products. Prices charged for goods ranging from food to textiles climbed an annual 4.7 percent…” May 24 – Bloomberg (Bunny Nooryani): “Norwegian oil-rig workers won a pay increase from employers, as soaring crude prices boost demand for rigs and skilled staff. The…labor unions agreed with the Norwegian Shipowners’ Association on a general pay increase of 45,000 kroner ($7,341) this year and 3,000 kroner next year…” May 22 – Bloomberg (Ayla Jean Yackley): “Turkey’s current account deficit will probably widen to 7 percent of gross domestic product this year, surpassing the government’s initial…forecast…” May 25 – Bloomberg (Nasreen Seria): “The cost of goods leaving South African factories and mines rose an annual 5.5 percent in April, more than expected, fueling speculation the central bank will raise its benchmark lending rate this year.” Latin America Watch: May 25 – Bloomberg (Gerald Jeffris): “Brazil’s government posted a record primary budget surplus in April of 19.43 billion Brazilian reals ($8.27 billion), up from BRL13.19 billion in March, on large surpluses accumulated by federal government agencies… The central bank said it was the highest budget surplus on record since it began its current accounting methodology in 1991…” May 26 – Bloomberg (Carlos Caminada and Fabio Alves): “Brazil’s annual inflation rate declined to a seven-year low in the first half of May as ethanol fuel prices dropped and food price increases were held in check. Inflation…slowed to 4.3 percent in the 12 months through May 15…” May 19 -Bloomberg (Patrick Harrington): “Mexico may receive as much as $20 billion in foreign direct investment this year, helping sustain the country’s economic expansion, Economy Minister Sergio Garcia de Alba said. Direct investment is poised to rise from last year’s $17.8 billion…” May 24 – Dow Jones: “Improved sales of gold, copper and zinc helped lift Peru’s exports to $1.68 billion in April, 35% higher than in the same month a year earlier, government agency Prompex said…” May 25 – Bloomberg (Andrea Jaramillo): “Colombia’s retail sales in March rose 15.3 percent from a year earlier, led by purchases of furniture, office equipment, vehicles and motorcycles…” Central Bank Watch: May 25 – AFX: “A deputy governor of Sweden's Riksbank, Lars Nyberg, said it will soon be time to take the next step towards a less expansionary monetary policy. He said the expansionary monetary policy can still be seen in, for example, growing credit facilities as well as rising house prices, which now appears to have spread to the commercial property market.” Bubble Economy Watch: May 26 – Bloomberg (Julia Werdigier): “Companies announced a record $1.42 trillion of mergers and acquisitions this year, surpassing the pace of 2000, as rising profits give executives more money to pay for takeovers.  The last time so many mergers were announced the global stock market was at the start of a three-year decline.” First quarter annualized nominal GDP growth jumped to 8.8%, the strongest since Q3 2003’s 9.3%. Real GDP rose from the fourth-quarter’s 4.8% to 5.3%. Gross Private Investment expanded at an 8.3% pace, led by 13.1% growth in Nonresidential Fixed Investment (Equipment & Software up 13.8%). Goods Exports grew at a 20.8% rate during the quarter, outpacing Goods Imports that expanded at a 13.9% pace. Federal Government Consumption increased at a 10.5% rate.  Personal Income increased 0.5% during April, with a notable 0.8% rise in the Compensation component. Over the past five months, Compensation has been up 0.8%, 0.5%, 0.5%, 0.8%, and 0.4%. Personal Income was up 5.4% from April 2005, with Compensation up 5.6%. As incomes grow, spending grows faster. April Personal Spending was up 0.6%, with a y-o-y gain of 6.2%.  Real Estate Bubble Watch: April Existing Homes Sales were reported at an annualized 6.76 million pace. While this is down from 2005’s record 7.07 million sales, is still compares quite favorably to the nineties annual average of 3.99 million. While Sales were down 5.7% y-o-y and Average Prices up 3.8% (to $270,800), Total Annualized Calculated Transaction Value slipped only 2.1% from April 2005. April New Home Sales were a stronger-than-expected annualized 1.198 million (compare to 2005’s record 1.282 million sales or the nineties average 698,000). Sales were down 5.7% from one year ago, with Average Prices up 3.2% to $298,300. Year-to-date Total Home Sales are running 4.1% below last year’s record level. And with average prices (New and Existing) prices up about 4% y-o-y, Total Calculated Transaction dollars are about even with last year’s pace. If the sales pace from the first four months is sustained (likely a “big if”), 2006 Total Sales will rival 2004 for the second strongest year of home sales. May 23 – Bloomberg (Brian K. Sullivan): “Massachusetts single-family home sales in April fell to their lowest point in more than 10 years while prices remained steady, according to a real estate report issued today, the Boston Globe reported. Single-family homes sales for April were 4,142, down 16.5 percent from the 4,961 sold in April 2005…” May 23 – Bloomberg (Pham-Duy Nguyen): “An 81-year-old casket factory on the shore northeast of Seattle may get a new lease on life – as residential space. While the real estate market is cooling in some parts of the U.S., demand continues to surge in the Seattle area. That has prompted developers to step up their search for properties, even old, abandoned addresses. The North Coast Casket Factory, a red timber building used to assemble and store caskets for 71 years, was scheduled for demolition until the Port of Everett decided to seek bids from developers. Now the factory may become meeting space or artists’ living-and-working lofts as part of a $300 million, 600-condominium redevelopment of the Everett waterfront, 29 miles from Seattle.” Mortgage Finance and Real Estate Bubble Watch: May 23 – Bloomberg (Janice Kirkel): “Armando Falcon, the former director of the Office of Federal Housing Enterprise Oversight, comments on a report put out today by the regulator saying Fannie Mae needs stricter regulation that will limit growth after its board of directors failed to prevent $11 billion of accounting errors. Falcon was director of Ofheo from 1999 to May 2005. On the culture of Fannie Mae: ‘It’s been allowed to happen because the company’s political influence allowed it to avoid any kind of fully empowered, fully resourced oversight… The length to which the company and executives would go in order to try to manage earnings and thereby maximize their bonuses is just stunning. The company seemed to employ every trick in the book to try to manage earnings and maximize the money they received as bonuses.’” Energy and Crude Liquidity Watch: May 23 – Bloomberg (Hannah Gardner): “The Russian government is considering investing 10 percent of its windfall oil revenue in foreign shares, creating a ‘fund for future generations,’ Vedomosti reported, citing Deputy Prime Minister Alexander Zhukov.” May 23 – Bloomberg (Bunny Nooryani and Beate Evensen): “Norway’s international pension fund, made up of oil revenue to pay for future pensions, swelled to $243 billion in the first quarter as rising oil prices boosted revenue for the world’s third-largest oil exporter.” Fiscal Watch: May 24 – Bloomberg (Henry Goldman): “The Independent Budget Office, a public agency monitoring New York City’s finances, said it expects a $3.5 billion surplus by the end of fiscal 2006 on June 30, $100 million more than Mayor Michael Bloomberg estimated. The agency also predicted the city would end fiscal 2007 with a $400 million surplus beyond the $57.5 billion budget the mayor proposed May 4.” Speculator Watch: May 24 – Financial Times (Anuj Gangahar): “Volatility is becoming an asset class in its own right. A range of structured derivative products, particularly those known as variance swaps, are now the preferred route for many hedge fund managers and proprietary traders to make bets on market volatility... When volatility rises like this, it is not long before people begin asking if hedge funds and proprietary traders, using complex trading strategies, are profiting from the falls, or in some mysterious way, driving them. Variance swaps are at the centre of their current activity… A hedge fund manager added: ‘As volatility, in the form of options or variance swaps are sold into the market, volatility drops. We invariably take more risk and the price of risky assets goes up. The introduction of these derivatives in the market then creates a situation that when volatility begins to rise, these trades must be rehedged and/or unwound. This makes volatility rise again.’ So what exactly are variance swaps? They are derivative instruments, traded over the counter. They are among the most intimidatingly complex financial instruments that have yet been designed, requiring a grasp of advanced mathematics, and so there is no trading of them by retail investors.” May 25 – Financial Times (Stephen Schurr): “James Simons of Renaissance Technologies and T. Boone Pickens Jr. of BP Capital Management raked in $1.5bn and $1.4bn in 2005, putting them at the top of the Institutional Investor’s Alpha magazine list of the Top 25 highest paid hedge fund managers… This year’s list…markets the first time two fund managers have earned more than $1bn. The 26 hedge fund managers on the list earned $363m on average – up 45 per cent from the $251m average in 2004.” May 26 – New York Times (Jenny Anderson): “Talk about minting money. In 2001 and 2002, hedge fund managers had to make $30 million to gain entry to a survey of the best paid in hedge funds that is closely followed by people in the business. In 2004, the threshold had soared to $100 million. Last year, managers had to take home — yes, take home — $130 million to make it into the ranks of the top 25.” May 25 – Financial Times (Gillian Tett, Louisa Mitchell and Peter Smith ): “Private equity groups operating in Europe are loading the companies they buy with record levels of debt, new data show. In particular, the so-called ‘leveraged ratio’ - or the ratio of debt to core earnings - has risen sharply, suggesting that some companies could struggle to repay debt if their performance deteriorated suddenly… One measure of this trend is the ratio between a company’s debt and its core earnings - earnings before interest, tax, depreciation and amortization… In March, companies raising finance that had a rating below investment grade had debt that was 5.73 times ebitda… This is the highest figure since the leveraged loan market started to be tracked in Europe in the late 1990s.” Inflection point or Respite? Can we make any sense out of recent global market gyrations? Brazil’s Bovespa equities index traded to an all-time high of 42,062 during the May 11th session, at the time sporting a y-t-d gain of almost 26%. Today, 11 sessions later, the Bovespa is 8% off its high. The Mexican Bolsa has declined 10% from record highs, and the Argentine Merval 14%. The highflying India Sensex has dropped 15% from highs and Russia’s RTS 17%. Equities have suffered meaningful setbacks across the globe, although most markets remain positive for the year. Brazil’s Bovespa is up 15.5% y-t-d, Mexico’s Bolsa 10%, Argentina’s Merval 9%, India’s Sensex 15%, and Russia’s RTS 33%. For 12 months, the Bovespa is up 58%, the Bolsa 49%, Merval 16%, Sensex 62%, and the RTS 122%. The major index in the UK is up 3% y-t-d, France 7%, Germany 7%, Spain 6%, and Italy 3%. Iceland’s ICEX is unchanged. Many of the periphery European markets, while suffering recent steep falls, are still firmly in the black for the year. The major index in Portugal is up 11%, Ireland 4%, Belgium 6%, Finland 9%, Norway 15%, Sweden 1%, Austria 4%, Poland 14%, Hungary 6%, Romania 9%, and the Ukraine 13%. Canada’s TSX index is up 4%, Australia’s ASX 6% and New Zealand’s NZX 7%. And while Japan’s Nikkei is down slightly (0.9%) for 2006, most markets in Asia have posted advances. China’s Shanghai A index is up 39% and Shanghai B 54%. The major index in Hong Kong is up 7%, Taiwan 5%, Singapore 4%, Indonesia 14%, Philippines 10%, and Thailand 1%. South Korea’s KRX is down 2% y-t-d.  So, the question of the evening is how much has the financial world changed since May 11? I am aware that some view the recent market retrenchment as indicating a key inflection point for the market’s assessment and acceptance of risk. Yes, the hedge funds were caught in the downdraft, but industry returns remain solidly on the plus side for the year. And sure, derivatives trading strategies likely played a major role in recent market swoons, as it certainly did in exacerbating the preceding hasty advances. We’ll have to get used to it. There is a lengthy list of reasons why 2006’s wild ups and downs are now par for the course, including 9,000 hedge funds, scores of well-capitalized proprietary trading desks, a plethora of new financial instruments and investment vehicles, $900 billion U.S. Current Account Deficits as far as the eye can see, global Credit systems firing on all cylinders, and resulting unprecedented global marketplace liquidity. Have global financial conditions really tightened meaningfully from the ultra-easy conditions of two weeks ago? Perhaps, but I’ll need more convincing.    Returning back to May 11th, recall that global markets at the time were in “melt-up” mode, crude had surged above $75, gold $725, Silver $15, and copper $400. The CRB and Goldman Sachs Commodities indices both went to all-time highs on Thursday, May 11th. Global risk premiums, including emerging market and junk bond Credit spreads, were at multi-year lows. And, importantly, the dollar index fell below 84 on May 11 to a 14-month low. The yen, swissy and Euro were all rising rapidly against our currency. The dollar traded as low as 83.41 on May 12th, the same day (not coincidently) that 10-year Treasury yields jumped to a 4-year high 5.20%. It is my view that markets were earlier this month commencing a move toward a highly unusual liquidity-induced dislocation, with an increasingly panicky liquidation out of dollar balances into commodities and foreign markets – exacerbated surely by trend-following derivatives (“dynamic” hedging/trading) strategies. Such a marketplace development would have major implications for marketplace perceptions, inflation expectations, monetary policy, and interest-rates. Understandably, the Fat Cat U.S. bond market was beginning to shudder. The (fortuitous) sharp reversal in commodities and foreign markets did somewhat chasten global speculators. Yet the fundamental question is whether the past two weeks have done much to alter underlying liquidity dynamics, marketplace perceptions and, to this point, steadfast financial flow biases. First of all, when it comes to analyzing the global backdrop there are some intriguing crosscurrents. It is a statement of fact that global markets have never been subject to the degree of (unwieldy) foreign flows, speculation, leveraging, and derivatives activity as they are these days. Certainly, this infers extraordinary uncertainty along with uncommon fragility. Credit spreads have widened somewhat, although they remain narrow from a historical perspective and a far cry from levels during previous crises. There are as well other key dynamics that must play into our analysis.  Importantly, there is not today a legion of Pegged Currencies biding time to play Catalyst for Domino Credit System Collapses. This dynamic had for awhile held market participants, particularly foreigners and derivative-hedgers, hostage to bouts of intense fear and loathing.  Indeed, the acute vulnerability to discontinuous currency and debt markets hastened previous emerging market crises. It reached the point where any time the flinching herd moved abruptly to outflank a lurking market dislocation, the local central bank’s only hope was to fight (till “death”) to protect their currency peg (hence the entire Credit system) with sharply higher rates. Central banks were also forced to liquidate their generally meager foreign reserve holdings, efforts amounting to nothing more than futile attempts to stave off financial Armageddon. Local lenders and economies were left hopelessly vulnerable to sudden and catastrophic Credit withdrawals and collapses in financial market liquidity. For the global system generally, with each regional financial crisis came a more vehement (“King Dollar”) bias toward the safe haven dollar and U.S. markets generally. The global backdrop and Greenspan safeguards ensured that U.S. markets became virtually the only game in town for the burgeoning global leveraged speculating community. Today’s global environment and market dynamics are radically transformed in so many respects. Not only do emerging markets and economies appear much less vulnerable to abrupt marketplace dislocations, the pro-dollar bias is very much a fad from the past. Instead of facing only the ever-present “stick” of emerging currency/debt market fragilities, investors in these markets nowadays have sound rationale to focus more keenly on the potential “carrot” of dollar weakness/commodities inflation/potential dollar dislocation. It is worth noting how unimpressively the dollar has performed during recent emerging market unrest, along with how well commodity prices have hung in there. So far, local Credit systems and economies remain robust and, clearly, less susceptible to the vagaries of international speculative flows. Of course, the nature of today’s marketplace dynamics guarantees that these markets are prone to eye-opening volatility and occasional heart-stopping downdrafts. But these days I believe we must be cognizant of the possibility that domestic Credit systems are significantly more resilient than they have been in the recent past. Even major stock market declines do not necessarily entail systemic liquidity crises.  Many emerging economies are these days enjoying trade surpluses, buoyed by robust global demand and high commodities prices. Central banks have built significant foreign reserve war chests, and even after recent setbacks most global markets continue to outperform their U.S. counterparts. The amount of Middle Eastern and Asian finance waiting anxiously on the sidelines for emerging market “bargains” is an issue worth contemplating. Notably, 10-year Brazilian (dollar) government yields ended the day at 7.16%, up just 26 basis points so far this year – and nowhere near the 9% yields posted in March 2005, in the midst of last year’s bout of (GM/derivatives/risk asset) market tumult. Considering the backdrop, it is not all too surprising that crude closed today at $71.37, up 17% so far this year. Commodities have thus far held much of their gains, with the Goldman Sachs Commodities Index up 10% year-to-date and 35% over the past year. Gold is up 26% y-t-d, silver 41%, and copper 98%. A rather strong case can be made that the global inflationary backdrop is deteriorating and increasingly problematic - overheated Credit systems and marketplace liquidity overabundance ensuring that boom economies remain largely impervious to rising prices and the occasional bout of financial turbulence.    I am less alarmed by recent global developments than the average bear, although I am anything but sanguine about prospects for U.S. markets. I may not at this point see a high probability for a full-blown emerging market crisis in the near-term. Yet I don’t necessarily view this as the best of news for our markets. Global financial tumult would not only give the Bernanke Fed the impetus to do what it wants (stop raising rates). It might also assuage inflationary pressures and take the heat off our bond market. I am still convinced that sharply higher rates pose the greatest systemic risk here at home. Markets seem to have a different focus – positioning for the Fed’s imminent end to the “tightening” cycle. It may not be so simple. A scenario where the Bernanke Fed is forced to actually tighten financial conditions is not as far fetched as it sounds. The possibility certainly exists for heightened inflation concerns – perhaps even a “scare”, especially when factoring in the poor performance of the dollar. If oil prices remain high or go even higher, expectations that energy inflation need not be pushed through the entire economy will be proved little more than wishful thinking. The weak dollar (and the attendant propensity to trade depreciating dollars for capital goods and other U.S. exports) also supports the goods producing and export sectors.  To what extent the massive surplus of dollars in the world returns to U.S. property markets is another interesting issue. Yes, real estate markets are slowing and, in some cases, slowing rapidly, but there remain myriad factors supporting ongoing mortgage Credit excess. For one, at least for now much of the economy is booming. The jobs market is tight and wage pressures continue to build. Strong income growth remains at the top of my list of surprises to the consensus view. And if the solidifying view that the U.S. economy is softening is again proved premature, the Fed may find itself under the gun. I am left pondering whether the past two weeks mark an important inflection point in global financial conditions, or perhaps only a respite from the unfolding dynamics taking shape earlier this month. There appear to be two quite divergent courses to analyze and ruminate. I will continue to closely monitor global Credit systems for indications of more measured Credit Availability, reduced Credit growth and/or waning marketplace liquidity. But the benefit of the doubt will remain with the strong proclivity toward global Credit excess, mounting inflationary pressures, and dollar vulnerability.  Here at home, a key issue is the clashing and highly unsettled crosscurrents between weakening housing markets and a system commanded by Credit and economic Bubbles. For now, the benefit of the doubt goes to ongoing Credit excess, income growth, inflationary pressures, and higher rates. It’s obviously a highly fluid environment. I’ll re-evaluate every Friday and am ready to admit I’m wrong and switch course when the time comes. As always, Thanks for Reading!