Sunday, October 5, 2014

03/23/2010 The Restoration of King Dollar *

For the week, the S&P500 added 0.6% (up 4.6% y-t-d), and the Dow gained 1.0% (up 4.1%). The Banks jumped 2.3%, increasing 2010 gains to 22.5%. The Broker/Dealers declined 1.3% (up 1.4%). The Morgan Stanley Cyclicals rose 2.2% (up 8.7%), and the Transports declined 0.8% (up 5.9%). The Morgan Stanley Consumer index added 0.6% (up 5.1%), and the Utilities fell 1.6% (down 5.0%). The S&P 400 Mid-Caps added 0.2% (up 8.3%), and the small cap Russell 2000 gained 0.8% (up 8.6%). The Nasdaq100 increased 1.0% (up 5.0%), and the Morgan Stanley High Tech index gained 0.9% (up 4.1%). The Semiconductors rallied 2.0% (up 0.8%). The InteractiveWeek Internet index increased 0.8% (up 5.9%). The Biotechs gained 1.9%, increasing 2010 gains to 32.1%. Although bullion added a buck, the HUI gold index fell 3.6% (down 6.6%).

One-month Treasury bill rates ended the week at 10 bps, and three-month bills closed at 13bps. Two-year government yields were unchanged at 0.95%. Five-year T-note yields jumped 9 bps to 2.51%. Ten-year yields surged 16 bps to 3.85%. Long bond yields jumped 17 bps to 4.75%. Benchmark Fannie MBS yields rose 7 bps to 4.44%. The spread between 10-year Treasury and benchmark MBS yields dropped 9 bps to 59 bps. Agency 10-yr debt spreads declined 5 bps to 32 bps. The implied yield on December 2010 eurodollar futures declined 2.5 bps to 0.87%. The 10-year dollar swap spread declined 10 to negative 5.75, and the 30-year swap spread declined 10.5 to negative 24.75. Corporate bond spreads were resilient. An index of investment grade bond spreads widened one to 88 bps, while an index of junk spreads narrowed 4 to 507 bps.

It was another strong week of debt issuance. Investment grade issuers included Wal-Mart $2.0bn, Northwestern Mutual Life $1.75bn, Wells Fargo $1.25bn, Anheuser-Busch $3.25bn, PG&E $950 million, Football Trust $835 million, Florida Power $600 million, Vornado Realty $500 million, Brambles $750 million, Duke Energy $450 million, Endurance Specialty $335 million, and Duke Realty $250 million.

March 22 – Bloomberg (John Glover and Bryan Keogh): “Companies are selling high-yield, high-risk bonds at the fastest pace since credit markets seized up in 2007 amid signs the economic recovery is gaining momentum. Renault SA… and other speculative-grade borrowers issued $24.2 billion of high-yield notes in March through last week, putting this month on course to be the busiest since June 2007…”

March 26 – Bloomberg (Anna-Louise Jackson): “Frontier Communications Corp., the phone company serving rural U.S. markets, sold $3.2 billion of notes in the largest high-yield corporate debt sale of the year.”

Junk flows reported inflows of $954 million (EPFR). Junk issuers included New Communications $3.2bn, Consol Energy $2.75 million, LBI Escrow $2.25bn, Lear $700 million, Coffeyville Resources $500 million, El Paso Pipeline $425 million, ITC Deltacom $325 million, Oversees Shipbuilding Group $300 million, Plains Exploration $300 million, Nationstar Mortgage $250 million, Martin Midstream $200 million, and Wyle Services $175 million.

Convert issues included Cemex SAB $715 million.

International dollar debt sales remain robust. Issuers included America Movil $4.0bn, Svenska Handelsbanken $1.85bn, Santander $1.5bn, Rabobank $1.5bn, Deutsche Bank $1.5bn, Portugal $1.25bn, Eksportanfinans $1.0bn, Votorantim Participacoes $750 million, Rearden $400 million, and Axis Bank $350 million.

U.K. 10-year gilt yields jumped 8 bps to 4.03%, and German bund yields increased 4 bps to 3.15%. Bond yields in Greece dropped 15 bps to 6.19%. The German DAX equities index rose 2.3% (up 2.7% y-t-d). Japanese 10-year "JGB" yields increased 1.5 bps to 1.375%. The Nikkei 225 jumped 2.3% (up 4.3%). Emerging markets were stable. For the week, Brazil's Bovespa equities index slipped 0.2% (up 0.1%), while the Mexico's Bolsa added 0.4% (up 3.2%). Russia’s RTS equities index declined 0.4% (up 5.1%). India’s Sensex equities index rose 0.7% (up 1.0%). China’s Shanghai Exchange dipped 0.3% (down 6.6%). Brazil’s benchmark dollar bond yields rose 12 bps to 4.97%, and Mexico's benchmark bond yields gained 6 bps to 4.84%.

Freddie Mac 30-year fixed mortgage rates increased 3 bps to 4.99% (up 14bps y-o-y). Fifteen-year fixed rates added one basis point to 4.34% (down 24bps y-o-y). One-year ARMs jumped 8 bps to 4.20% (down 65bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up one basis point to 5.82% (down 64bps y-o-y).

Federal Reserve Credit increased $5.3bn last week to a record $2.297 TN. Fed Credit was up $247bn, or 12.0%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 3/24) surged $15.8bn to a record $3.013 TN. "Custody holdings" have increased $57.2bn y-t-d, with a one-year rise of $418bn, or 16.1%.

M2 (narrow) "money" supply dropped $23.3bn to $8.490 TN (week of 3/15). Narrow "money" has declined $22bn y-t-d. Over the past year, M2 expanded 0.9%. For the week, Currency was little changed, while Demand & Checkable Deposits rose $7.7bn. Savings Deposits dropped $12.2bn, and Small Denominated Deposits fell $5.5bn. Retail Money Funds sank $13.5bn.

Total Money Market Fund assets (from Invest Co Inst) declined $4.0bn to $3.013 TN. In the first 12 weeks of the year, money fund assets have dropped $281bn, with a one-year drop of $843bn, or 21.9%.

Total Commercial Paper outstanding declined $7.9bn last week to $1.114 TN. CP has declined $55.6bn, or 20.6% annualized year-to-date, and was down $377bn over the past year (25.3%).

International reserve assets (excluding gold) - as tallied by Bloomberg’s Alex Tanzi – were up $1.189 TN y-o-y, or 17.9%, to a record $7.834 TN.

Global Credit Market Watch:

March 24 – Bloomberg (Matthew Brown): “Portugal’s credit grade was cut by Fitch Ratings, underscoring growing concern that Europe’s weakest economies will struggle to meet their debt commitments as finances deteriorate. The rating was lowered one step to AA- with a ‘negative’ outlook, Fitch said…”

March 25 – Bloomberg (Sarah McDonald and Bryan Keogh): “Ambac Financial Group Inc.’s bond insurance unit will hand control of subprime mortgage-related contracts to a regulator amid concern the second-largest bond insurer’s collapse would trigger losses for municipal noteholders. Ambac Assurance Corp., which guarantees $696 billion of debt payments, will set up a segregated account for insurance contracts linked to credit-default swaps, residential mortgage- backed securities and other structured finance transactions…”

Global Government Finance Bubble Watch:

March 22 – Bloomberg (Joyce Koh): “Advanced economies face ‘acute’ challenges in tackling high public debt, and unwinding existing stimulus measures will not come close to bringing deficits back to prudent levels, said John Lipsky, first deputy managing director of the International Monetary Fund. All G7 countries, except Canada and Germany, will have debt-to-GDP ratios close to or exceeding 100% by 2014, Lipsky said… Already this year, the average ratio in advanced economies is expected to reach the levels seen in 1950, after World War II, he said. The government debt ratio in some emerging-market nations has also reached a ‘worrisome level,’ he said. ‘This surge in government debt is occurring at a time when pressure from rising health and pension spending is building up,’ Lipsky said. Stimulus measures account for about one-tenth of the projected debt increase, and rolling them back won’t be enough to bring deficits and debt ratios back to prudent levels.”

March 21 - New York Times (Keith Bradsher and Sewell Chan): “The global economic crisis has left ‘deep scars’ in the fiscal balances of the world’s advanced economies, which should begin to rein in spending next year as the recovery continues, the No. 2 official at the International Monetary Fund said… In a speech at the China Development Forum in Beijing, the I.M.F. official, John P. Lipsky… offered a grim prognosis for the world’s wealthiest countries, which are at a level of indebtedness not recorded since the aftermath of World War II. For the United States, ‘a higher public savings rate will be required to ensure long-term fiscal sustainability,’ Mr. Lipsky said.”

March 22 – Bloomberg (Daniel Kruger and Bryan Keogh): “The bond market is saying that it’s safer to lend to Warren Buffett than Barack Obama. Two-year notes sold by the billionaire’s Berkshire Hathaway Inc. in February yield 3.5 basis points less than Treasuries of similar maturity… Procter & Gamble Co., Johnson & Johnson and Lowe’s Cos. debt also traded at lower yields in recent weeks… The $2.59 trillion of Treasury Department sales since the start of 2009 have created a glut as the budget deficit swelled to a post-World War II-record 10% of the economy and raised concerns whether the U.S. deserves its AAA credit rating.”

March 26 – MarketNews International (Sheila Mullan): “Paul McCulley… downplayed the odds of a downgrade of the United States’ current ‘AAA’ rating… ‘I tended to look at ratings that they are about default risk… Fiat currencies are not going to default on their debt. Now, could you get inflation? Yes, but the AAA is not a benchmark of whether you are going to have price stability, it is a benchmark of whether you are going to default or not.’ He added, ‘So the notion that the ratings agencies would downgrade America when our debt is denominated in our own currency befuddles me, as an analytical concept.’”

March 22 – Bloomberg (Michael B. Marois): “California boosted the size of a planned taxable bond sale this week by about 25 percent to $2.5 billion, according to the spokesman for Treasurer Bill Lockyer. The state plans to sell $1.61 billion of federally subsidized Build America Bonds and $890 million in other taxable debt…”

March 24 – Bloomberg (Alan Ohnsman and William Selway): “Los Angeles… may win federal support this year that’s required to sell as much as $8.8 billion in bonds to jump-start subway and light-rail expansion, Mayor Antonio Villaraigosa said. The borrowing would be backed by the federal government and repaid with Los Angeles County sales taxes… ‘We can’t actually come to market with it until we know there’s federal participation,’ Villaraigosa said. ‘As soon as we get the federal guarantee we can finance it almost immediately.’”

March 25 – Bloomberg (Arif Sharif and Anthony DiPaola): “Dubai will support Dubai World’s debt restructuring with $9.5 billion as the state-owned holding company asks creditors to wait up to eight years to get all their money back. The additional funds double to $20 billion the amount the government paid to the emirate’s holding company.”

March 25 – Bloomberg (Yusuke Miyazawa and David Yong): “Japanese government guarantees are cutting costs for developing nations to sell Samurai bonds and luring pension funds, prompting Mizuho Securities Co. to forecast the biggest year for the debt since 2001. Sales in Japan by emerging-market countries may climb 27% to 350 billion yen ($3.8 billion) in 2010 as the Japan Bank for International Cooperation widens an Asian guarantee program to all nations…”

March 24 – Bloomberg (Theresa Barraclough and Garfield Reynolds): “Investors are withdrawing from money-market funds at the fastest pace in at least two decades, reducing holdings that peaked at $3.9 trillion in January 2009… ‘The draining of cash from money-market funds shows people are becoming more comfortable taking risk, so equities are going up and bonds are also being well supported and the yield curve is flattening,’ said Christian Carrillo, a senior interest-rate strategist…at Societe Generale SA. ‘Such behavior can give some comfort to the Fed that it’s okay to reduce the size of its balance sheet, which is a pre-requisite for rate hikes.’”

March 23 – Bloomberg (Agnes Lovasz): “Emerging European governments are bringing forward debt sales and investors are lining up to buy it as the region benefits from an anti-Greece sentiment that’s overshadowing the euro area, said analysts at RBC Capital, BNP Paribas S.A. and Societe Generale S.A. Governments from Poland to Romania ‘are trying to issue as much as possible in the first half of the year because the conditions are favorable,’ said Bartosz Pawlowski, a… emerging-market strategist at BNP Paribas… ‘Central and Eastern Europe have been the beneficiaries. They are trying to frontload.’”

March 22 – Bloomberg (John Gittelsohn): “Lennar Corp., the third-largest U.S. homebuilder, is investing in failed bank loans and distressed real estate assets to boost revenue as demand for new houses shows few signs of revival. The… company’s purchase last month of a share of $3.05 billion of delinquent loans seized by the Federal Deposit Insurance Corp. from failed lenders takes the builder into territory so far dominated by private equity firms…”

Currency Watch:

March 22 – Bloomberg: “China warned the U.S. against imposing sanctions over the value of the yuan, arguing that the exchange rate issue has been politicized and that a rise in protectionism threatens the global economic recovery. Pressure on China to strengthen the yuan does ‘no good to anyone,’ China’s Commerce Minister Chen Deming said… Tensions over China’s currency are mounting…”

The dollar index jumped 1.1% this week to 81.63. (up 4.8% y-t-d). For the week on the upside, the Mexican peso increased 0.7% For the week on the downside, the Japanese yen declined 2.1%, the Norwegian krone 2.1%, the South African rand 1.3%, the Australian dollar 1.2%, the Swedish krona 1.2%, the Brazilian real 1.0%, the Danish krone 0.9%, the Canadian dollar 0.9%, and the Euro 0.9%.

Commodities Watch:

March 22 – Bloomberg (Whitney McFerron): “Hog futures rose to a 12-year high on signs that U.S. pork supplies are shrinking after farmers trimmed herds.”

The CRB index declined 1.9% (down 5.7% y-t-d). The Goldman Sachs Commodities Index (GSCI) fell 1.6% (down 2.2% y-t-d). Gold was little changed at $1,108 (up 1% y-t-d). Silver slipped 0.6% to $16.93 (up 0.5% y-t-d). April Crude declined 83 cents to $80.14 (up 1% y-t-d). April Gasoline declined 2.0% (up 7.7% y-t-d), and April Natural Gas sank 7.2% (down 30.6% y-t-d). May Copper gained 1.3% (up 2% y-t-d). May Wheat sank 3.9% (down 14% y-t-d), and May Corn dropped 4.7% (down 14% y-t-d).

China Bubble Watch:

March 25 – Bloomberg: “China central bank Deputy Governor Zhu Min said interest rates are a ‘heavy-duty weapon’ and alternative tools for addressing liquidity are working well, helping to explain why the bank hasn’t raised borrowing costs. ‘We are very careful on the interest rate, because it is a heavy-duty weapon,’ Zhu said… ‘We are very careful managing liquidity’ with other instruments, and it looks like that “works very well,” he said…”

March 24 – Bloomberg: “China’s government needs evidence of a “very certain” recovery before it can roll back stimulus measures adopted during the crisis, central bank Governor Zhou Xiaochuan said. ‘If you can be sure about the recovery, and then some of the extraordinary stimulus policies can gradually fade out,’ Zhou said… ‘On the other hand, you should know that it’s not a W-shaped recovery,’ with a renewed slowdown following the current rebound, he said. China has yet to raise interest rates or allow its exchange rate to appreciate, keeping in place some of the extraordinary measures even as inflation and asset prices accelerate.”

March 23 – Bloomberg: “Bank of China Ltd., the nation’s third-largest lender by market value, posted a more than fourfold increase in fourth-quarter profit, helped by a credit boom and lower impairment losses on assets. Net income climbed to 18.8 billion yuan ($2.8 billion) from 4.42 billion yuan a year earlier…”

Japan Watch:

March 24 – Bloomberg (Keiko Ujikane): “Japan’s exports climbed at the fastest pace in 30 years in February as global trade recovered from the worst postwar recession… Shipments abroad increased 45.3% from a year earlier, helping the trade surplus expand the most since 1982…”

India Watch:

March 22 – Bloomberg (Weiyi Lim): “India is still ‘complacent’ about inflation risks and will need to keep boosting interest rates after the nation’s first increase in almost two years, according to Goldman Sachs… ‘The key point with India is that we looked all around the region; the economy we felt was most in need of raising rates and where the consensus was, we thought most complacent, was India,’ Timothy Moe, the bank’s chief Asian strategist, said… ‘India has the highest inflation of any of the economies currently around Asia.’”

Asia Bubble Watch:

March 24 – Bloomberg (Stephanie Phang and Ranjeetha Pakiam): “Malaysia’s central bank raised the country’s 2010 economic forecast, pledging that its monetary policy will continue to support growth even as it begins to ‘normalize’ interest rates amid an ‘uneven’ global recovery. Southeast Asia’s third-largest economy may expand 4.5% to 5.5% this year…”

March 24 – Bloomberg (Jason Folkmanis): “Vietnamese inflation accelerated to a one-year high in March as a devalued dong pushed up import costs and the government raised power prices… Consumer prices jumped 9.46% from a year earlier…”

Latin America Bubble Watch:

March 22 – Bloomberg (Andre Soliani and Katia Cortes): “Brazil’s current account gap will exceed inflows from foreign direct investment in 2010 for the first time in nine years, according to central bank forecasts… The current account deficit, the broadest measure of trade in goods and services, will widen to a record $49 billion this year, up from an earlier forecast of a $40 billion gap…”

Unbalanced Global Economy Watch:

March 24 – Bloomberg (Maria Levitov): “Russia’s economy will grow faster than previously forecast this year as higher wages and pensions stoke household spending… the World Bank said. Gross domestic product may rise between 5% and 5.5%, the bank said…”

Fiscal Watch:

March 26 – Bloomberg (Rebecca Christie and Kate Andersen Brower): “The Obama administration plans to announce programs to help homeowners avoid foreclosure, including subsidies for borrowers who owe more than their home is worth. The plan… would expand Treasury Department and Federal Housing Administration programs and use funds from the $700 billion Troubled Asset Relief Program… ‘It’s almost like a triage policy,’ said Eric Barden, chief investment officer of Barden Capital Management in Austin, Texas. “It limits the losses of the most overvalued properties and it also limits the losses to the borrowers that are in the most distress.’”

Central Bank Watch:

March 23 – Dow Jones (Michael S. Derby): “In a speech that said there’s no urgency to tighten monetary policy any time soon, a key central bank official also asserted her reputation as an inflation fighter. ‘I don’t believe this is yet the time to be tightening monetary policy," Federal Reserve Bank of San Francisco President Janet Yellen said… The current policy of essentially zero-percent interest rates is ‘accommodative’ and ‘is currently appropriate ... because the economy is operating well below its potential and inflation is subdued.’ Yellen said she is expecting at best a gradual recovery and a slow ebb in high levels of unemployment, all of which argues for supportive monetary policy. But she warned that ‘as recovery takes firm root and economic output moves toward its potential, a time will come when it is appropriate to boost short-term interest rates.’”

March 25 – Bloomberg (Scott Lanman and Joshua Zumbrun): “Federal Reserve Vice Chairman Donald Kohn said he expects the Fed will tighten credit early enough to prevent unprecedented stimulus, including $1 trillion in excess bank reserves, from causing an inflationary surge. ‘I am confident the Federal Reserve can and will tighten policy well in advance of any threat to price stability, and successful execution of this exit will demonstrate that these emergency steps need not lead to higher inflation,’ Kohn said…”

Real Estate Watch:

March 24 – Bloomberg (Hui-yong Yu): “Twelve U.S. cities, including Boulder, Colorado, and Providence, Rhode Island, are showing extended declines in housing values, reversing signs of a sustained recovery last year, according to The number of markets in a ‘double dip’ jumped in January from five in December…”

March 22 – Bloomberg (Brian Louis): “U.S. commercial property values rose for a third month in January as the economy grew, according to Moody’s… The Moody’s/REAL Commercial Property Price Index climbed 1% from December… Values are 40% lower than the peak in October 2007. The index fell 24% from a year earlier.”

March 24 – Wall Street Journal (Josh Barbanel): “A Manhattan condominium owned by a financially troubled Italian film producer was sold in a foreclosure auction for $33.2 million, the highest price paid for Manhattan apartment this year… A Chinese businessman who was not identified purchased the 5,500-square-foot apartment with 20-foot ceilings and views of Central Park… The price in the current deal underscores signs of recovery in luxury housing in Manhattan in the last few months…”

Muni Watch:

March 20 – Wall Street Journal (Mark Gongloff and Ianthe Jeanne Dugan): “At a time of voracious market appetite for traditionally safe municipal bonds, some market watchers are warning municipal-debt investors to be choosy. A still-struggling economy is squeezing municipal budgets across the board, but many larger governments are passing on their pain by choking off the flow of cash to the local level… ‘I prefer large states and cities, as problems within those areas are pushed to local governments,’ Larry Fink, chief executive of BlackRock… ‘The assumption that an investment-grade rating is merited for all municipal debt is less tenable every day,’ said Kenneth Buckfire, CEO…of Miller Buckfire & Co. ‘This is eerily reminiscent of the early days of the subprime crisis, where everybody was comforted by the investment-grade ratings but nobody did any analysis.’”

New York Watch:

March 25 – Bloomberg (Michael Quint): “New York Assembly Democrats proposed narrowing the state’s more than $9 billion deficit with $2 billion of bonds and $4.3 billion of spending reductions, a plan that Governor David Paterson said doesn’t cut enough.”

The Restoration of King Dollar?:

Coming into 2010, there was a prominent view that a dollar rally would spur renewed global market risk aversion and reignite deflationary forces. Year-to-date, the Dollar Index has gained 4.8%. Yet the dollar’s recovery has thus far done little to dampen global risk embracement or impinge the heady flows into risk assets. Emerging equities markets for the most part have retained or even added to 2009’s spectacular gains. Emerging debt markets have been even more impressive, with emerging debt spreads ending today at near 2-year lows. Corporate debt spreads here at home have moved to near 2-year lows. Across the board, risk premiums have contracted further.

Despite the dollar’s rally, crude oil prices have posted a small y-t-d advance. Gold, silver and metals prices are up about a percent. And the Goldman Sachs Commodities Index has declined only 2.2% so far this year. One is hard-pressed to locate indicators pointing to an imminent outbreak of deflation. The so-called commodities currencies have performed well this year, in most cases building on last year’s huge gains. To be sure, this period of dollar strength has nothing in common with the crisis-induced dollar rally and global deleverging fiasco back in 2008.

The resiliency of global risk markets has been especially noteworthy in the face of a confluence of issues including the Greek debt crisis, Chinese tightening fears, and the winding down of Federal Reserve MBS monetization. Even this week, a meaningful jump in global yields had little impact on equities or risk assets generally. Here at home, a series of dismal debt auctions and the worst week in the Treasury market in awhile seemed to go virtually unnoticed in the increasingly ebullient stock market. The S&P Homebuilding index jumped 7.1% this week, increasing y-t-d gains to 25.1%. The regional bank index added 0.4%, increasing 2010 gains to 27.4%. The Morgan Stanley Retail index rose 2.7%, boosting its rise so far this year to 17.0%. The Morgan Stanley Retail index enjoys a one-year gain of 87.4%.

It has been my thesis that the 2008 bursting of the Wall Street/mortgage finance Bubble provided the catalyst for last year’s unleashing of the Global Government Finance Bubble. This Bubble appears to have gained momentum and has become more entrenched. As such, I believe a Credit and Bubble-centric analytical framework is helpful in our efforts to make sense out of today’s extraordinary backdrop. In particular, Bubble and speculative dynamics are at work and playing a prominent role throughout global markets.

It is the nature of Bubbles to expand and broaden as long as they are accommodated by loose financial conditions; speculative forces become increasingly robust. And it is the nature of markets to accommodate Bubbles, with participants enticed by strong returns (asset inflation) and a perceived favorable risk vs. reward backdrop (often with the assumption of some type of governmental backstop underpinning market prices). The longer Bubbles are allowed to progress the more speculation dominates the pricing, issuance and flow of finance. At their core, Bubble dynamics are dictated by a proclivity for nurturing a self-reinforcing mispricing of finance, with resulting distortions to both the flow of finance and the market’s perception of risk.

With the above comments in mind, I’ll briefly address this year’s dollar strength. It is my view that dollar strength is specifically not based on sound fundamentals – it’s a facet of the global Bubble. The markets have gravitated to U.S. financial assets because of the perception that the U.S. enjoys a global competitive advantage in reflationary policymaking.

Let me attempt an explanation: U.S. financial assets – hence the dollar – are perceived to benefit from a relative advantage versus other major currencies based upon, on the one hand, the virtual unlimited capacity for the Treasury to run massive deficits and, on the other, the Fed’s seemingly endless capacity to purchase (monetize) U.S. debt instruments and essentially peg interest-rates (short-term, and only to a lesser extent longer-term market yields). This extraordinary capacity and willingness by U.S. fiscal and monetary policymakers to inflate Credit and meddle (in the markets and economy) today bolsters marketplace confidence in the sustainability of economic recovery. As importantly, it cements the view that the soundness of Credit instruments throughout the entire system – Treasuries, mortgages, financial sector debt, corporates, munis, etc. – is underpinned by current and prospective reflationary policymaking. The markets’ perception of “too big to fail” has inflated U.S. securities pricing – reduced risk premiums - throughout the entire system.

The Greek and, to a much lesser extent, periphery Europe debt crisis has been a major development. Markets are in the process of disciplining politicians and bankers in Greece and elsewhere in Europe (most notably Portugal, Spain, and Italy). In stark contrast to that of the Treasury and the Fed, Greek politicians have lost their ability to attempt to inflate their way out of structural debt problems. The economy in Greece is forced to retrench, as fiscal discipline is imposed upon Athens. A painful period of economic restructuring has commenced. And as much as this is necessary for ensuring long-term stability, the short-term consequences are market unfriendly. Greece’s inability to inflate Credit and monetize its debt has created a situation of great marketplace uncertainty as to the value of its obligations and the soundness of its financial sector more generally.

The downfall of Greece – and, perhaps, European – debt profligacy has, in a way, restored the reign of King Dollar. There might be consternation as to the size of current and prospective U.S. deficits (as well as governmental market and economic intervention), but for the most part the marketplace just loves U.S. debt these days. In contrast to the hamstrung Greeks, the view holds that our policymakers certainly will not let anything stymie economic and financial recovery. If additional stimulus is needed, loads will be immediately forthcoming. Massive deficits are fine, as they ensure sustainable recovery. If zero interest rates are required for years, Drs. Bernanke, Yellen and others will faithfully deliver. The Federal Reserve may be winding down its various emergency programs and Trillion dollar monetization, but the Fed surely wouldn’t hesitate using these incredibly successful tools as needed. No Japan here. In short, dollar securities are underpinned by the markets’ perception of a potent and comprehensive federal backstop.

As I noted above, markets have a dangerous proclivity for accommodating Bubbles. And I see ample evidence of such dynamics throughout currency, debt, and equities markets - at home and abroad. And I would argue that the reinstatement of King Dollar is not, as some had expected, impinging global reflation. Indeed, rather than restraining reflationary forces, dollar strength may today be reinforcing them. I would argue that the dollar’s newfound muscle has not yet impinged Credit systems overseas, especially overheated Credit in the “periphery.” Meanwhile, it has helped underpin “core” U.S. debt markets generally, which has played a prominent role in the ongoing reflation of the world’s largest economy and stock market.

This week, California sold $3.4bn of new debt, including $2.5bn of 30-year Build America Bonds. Heightened demand, especially from international investors, compelled the state to significantly increase the size of this offering. I would argue that without Washington’s massive fiscal and monetary stimulus there would be little demand today for long-term California debt obligations – especially from foreigners. And while many have compared California’s structural debt problems to those of Greece, the markets are doing anything but imposing discipline and restructuring upon our golden state. And in many ways California is a microcosm for our nation’s structural debt and economic issues: reflation is simply postponing the day of reckoning. An increasingly speculative marketplace is happy to focus on the here and now.

The markets are not oblivious to our structural debt problems. Yet a view has taken hold that it’s more of a longer-term issue; nothing imminent to fret too much about. After all, the distressing scope of our federal, state and local, and household debt problems virtually ensures the Fed will maintain extraordinarily loose financial conditions for some years to come. And this view supports asset market reflation, underpins debt market confidence and, most certainly, stokes speculative fervor. It’s textbook Bubble Dynamics, and such a backdrop has been supporting the dollar while also underpinning risk markets globally. Moreover, European debt fragilities are perceived in the markets as one more reason to be confident that the Fed, ECB, People’s Bank of China and the Bank of Japan will cling to extraordinarily loose monetary policies.

Ten-year Treasury yields jumped 16 bps this week to 3.85%. It is my view that a significant jump in Treasury and agency yields would prove problematic for U.S. recovery. But at this point I would tend to view this week backup in yields as more a “normalization” of yields. Bond yields had diverged too much from the reflationary realities evidenced by inflating equities prices. The bond market must look at stocks – and central bank dovishness - with rising apprehension. But at least thus far, rising Treasury yields have not incited a widening of Credit spreads.

I believe U.S. reflation will be in jeopardy when a jump in yields occurs simultaneously with increasing risk premiums and waning Credit availability. And I wouldn’t be surprised if such a scenario unfolds in response to renewed dollar weakness. Considering the backdrop, call me a King Dollar skeptic. I wouldn’t be at all surprised if the prevailing sanguine view regarding U.S. policymaking and structural debt issues proves rather ephemeral. At the end of the day, the soundness of our currency will be determined by the health and sustainability of our economic structure and the size of our debt load. A restoration, albeit temporary, of King Dollar doesn’t appear constructive for either.