Friday, October 24, 2014

05/28/2010 Unwitting Beneficiary *

For the week, the S&P500 added 0.2% (down 2.3% y-t-d), while the Dow dipped 0.6% (down 2.8% y-t-d). The Banks declined 0.9% (up 16.9%), while the Broker/Dealers increased 0.2% (down 5.6%). The Morgan Stanley Cyclicals rallied 1.7% (up 2.7%), and the Transports gained 2.2% (up 5.8%). The Morgan Stanley Consumer index slipped 0.5% (down 0.6%), and the Utilities lost 0.1% (down 8.2%). The broader market outperformed. The S&P 400 Mid-Caps rallied 1.7% (up 5.0%), and the small cap Russell 2000 rose 1.9% (up 5.8%). The Nasdaq100 gained 1.6% (down 0.4%), and the Morgan Stanley High Tech index rose 1.2% (down 4.6%). The Semiconductors rallied 1.9% (down 1.2%). The InteractiveWeek Internet index rose 1.7% (up 1.4%). The Biotechs increased 1.1%, increasing 2010 gains to 11.7%. With bullion rallying $37, the HUI gold index recovered 5.0% (up 5.5%).

One-month Treasury bill rates ended the week at 14 bps and three-month bills closed at 16 bps. Two-year government yields dipped one basis point to 0.75%. Five-year T-note yields increased 5 bps to 2.06%. Ten-year yields rose 5 bps to 3.30%. Long bond yields jumped 11 bps to 4.22%. Benchmark Fannie MBS yields rose 5 bps to 4.14%. The spread between 10-year Treasury and benchmark MBS yields was little changed at 84 bps. Agency 10-yr debt spreads narrowed 5 bps to 35 bps. The implied yield on December 2010 eurodollar futures was little changed at 0.995%. The 10-year dollar swap spread increased 3.5 to 8.25. The 30-year swap spread declined 1.5 to negative 18.5. Corporate bond spreads were mixed. An index of investment grade spreads narrowed 3 to 116, while and index of junk bond spreads widened 20 to 547 bps.

Debt issuance remained slow. Investment grade issuers included Abbott Labs $3.0bn, Discovery Communications $3.0bn, Goldman Sachs $1.25bn, Georgia Power $600 million, General Mills $500 million, Regency Centers $150 million, and Empire District Electric $100 million.

Junk issuers included DriveTime Auto and Acceptance $200 million.

Converts issues included Salix Pharmaceuticals $300 million.

International dollar debt sales included Nordic Investment Bank $1.25bn, Malaysia $1.0bn, International Bank of Reconstruction & Development $1.0bn, and Trans-Canada Pipeline $1.25bn.

U.K. 10-year gilt yields rose 3 bps to 3.58%, and German bund yields increased 2 bps to 2.68%. Greek 10-year bond yields dropped 16 bps to 7.66%, while 10-year Portuguese yields rose 6 bps to 4.69%. The German DAX equities index rallied 2.0% (down 0.2% y-t-d). Japanese 10-year "JGB" yields added one basis point to 1.25%. The Nikkei 225 slipped 0.2% (down 7.4%). Emerging markets were mostly higher. For the week, Brazil's Bovespa equities index jumped 2.8% (down 9.7%), and Mexico's Bolsa rallied 3.0% (down 1.8%). Russia’s RTS equities index rose 3.9% (down 5.7%). India’s Sensex equities index increased 2.5% (down 3.4%). China’s Shanghai Exchange recovered 2.8% (down 18.9%). Brazil’s benchmark dollar bond yields jumped 8 bps to 4.98%, while Mexico's benchmark bond yields dipped one basis point to 4.94%.

Freddie Mac 30-year fixed mortgage rates declined 6 bps last week to 4.78% (down 13bps y-o-y). Fifteen-year fixed rates dipped 3 bps to 4.21% (down 32bps y-o-y). One-year ARMs fell 5 bps to 3.95% (down 84bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 5 bps to 5.64% (down 68bps y-o-y).

Federal Reserve Credit dropped $15.3bn last week to $2.324 TN. Fed Credit was up $103.8bn y-t-d (11.6% annualized) and $249bn, or 12.0%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 5/26) jumped $9.6bn to $3.066 TN. "Custody holdings" have increased $111bn y-t-d (9.3% annualized), with a one-year rise of $342bn, or 12.6%.

M2 (narrow) "money" supply was up $43.9bn to $8.573 TN (week of 5/17). Narrow "money" has increased $60.8bn y-t-d. Over the past year, M2 grew 1.9%. For the week, Currency added $1.1bn, while Demand & Checkable Deposits dropped $18.3bn. Savings Deposits surged $50.6bn, while Small Denominated Deposits declined $3.1bn. Retail Money Fund assets jumped $13.7bn.

Total Money Market Fund assets (from Invest Co Inst) increased $5.2bn to $2.849 TN. In the first 21 weeks of the year, money fund assets have dropped $444bn, with a one-year decline of $940bn, or 24.8%.

Total Commercial Paper outstanding declined $2.6bn last week to $1.073 TN. CP has declined $97bn, or 20.4% annualized, year-to-date, and was down $175bn from a year ago.

International reserve assets (excluding gold) - as tallied by Bloomberg’s Alex Tanzi – were up $1.644 TN y-o-y, or 24.5%, to a record $8.352 TN.

Global Credit Market Watch:

May 28 – Bloomberg (Bryan Keogh and Sonja Cheung): “Companies sold the least amount of bonds in a decade this month as concern Europe’s sovereign debt crisis will slow the global economy drove up relative borrowing costs by the most since the aftermath of Lehman Brothers Holdings Inc.’s collapse. Borrowers issued $66.1 billion of debt in currencies from dollars to yen, a third of April’s tally and the least since December 2000…”

May 26 – Bloomberg (Pierre Paulden and Shannon D. Harrington): “Yields on junk bonds rose to the highest since December relative to Treasuries… Spreads widened 27 bps yesterday to 724 bps… the highest since Dec. 9… That’s up from a low this year of 542 basis points on April 26. High-yield debt has lost 4.6% in May, on pace for the first drop in 15 months… ‘We’re seeing high yield under a lot of pressure here,’ said Nicholas Pappas, the co-head of flow credit trading in the Americas at Deutsche Bank… ‘There is a flight to quality to solid investment-grade companies.’”

May 27 – Bloomberg (Jason Corcoran and Michael Patterson): “Europe’s debt crisis is intensifying fear among investors and making strategies that use leverage and derivatives to increase returns less attractive, said Hans-Joerg Rudloff, the chairman of Barclays Capital. ‘All of this creates a climate which does not lend itself for investment, particularly not for so-called sophisticated trading strategies with all of their derivatives and leverage,’ Rudloff, the chairman of Barclays Plc’s securities unit who pioneered the Eurobond market in the 1980s, said…”

May 25 – Bloomberg (Jody Shenn): “Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates widened to a seven-month high relative to Treasuries… Fannie Mae’s current-coupon 30-year fixed-rate mortgage bonds increased less than 0.01 percentage point to 0.93 percentage point more than 10-year Treasuries… up from 0.69 percentage point on April 26 and the biggest gap since Oct. 21…”

May 24 – Bloomberg (John Glover and Caroline Hyde): “Corporate bond sales are poised for their worst month in a decade, while relative yields are rising the most since Lehman Brothers Holdings Inc.’s collapse… Companies have issued $47 billion of debt in May, down from $183 billion in April and the least since December 1999… The extra yield investors demand to hold company debt rather than benchmark government securities is headed for the biggest monthly increase since October 2008… The rate banks say they charge each other for three-month loans in dollars has almost doubled since February.”

May 27 – Bloomberg (Bryan Keogh and Kate Haywood): “The percentage of corporate bonds considered in distress surged this week to the highest since 2009 as investors dumped debt of the neediest borrowers… Some 17% of junk bonds yield at least 10 percentage points more than Treasuries, up from 9.2% last month…The jump is the biggest since the distress ratio rose 11 percentage points in November 2008…”

May 27 – Bloomberg (Esteban Duarte): “Spanish lenders need to refinance 125 billion euros ($153bn) of bonds by the end of next year, putting the nation’s savings banks in a ‘very weak and risky position,’ according to analysts at Deutsche Bank AG. The so-called cajas have to repay about half the 46 billion euros falling due for banks this year and the 79 billion euros maturing 2011, according to Carlos Berastain… The remainder is owed by commercial lenders such as Banco Santander SA.”

Global Government Finance Bubble Watch:

May 24 – Bloomberg (Candice Zachariahs): “The U.S., Spain and Greece are among developed nations whose borrowings put them in a ‘ring of fire’ amid sovereign debt concerns, said Pacific Investment Management Co….

Currency Watch:

May 27 – Bloomberg: “China denied as ‘groundless’ a report that it’s reviewing foreign-exchange holdings of euro assets, and the nation’s sovereign wealth fund said it’s maintaining its European investments. ‘Europe has been, and will be one of the major markets for investing China’s exchange reserves,’ the State Administration of Foreign Exchange said in a statement on its website today. The official Xinhua News Agency reported China Investment Corp. President Gao Xiqing said… Europe’s turmoil ‘hasn’t had too big of an impact’ on CIC’s investment decisions.”

The dollar index jumped 1.7% to 86.78 (up 11.5% y-t-d). For the week on the upside, the South African rand increased 2.9%, the South Korean won 2.8%, the Brazilian real 2.0%, the Australian dollar 1.9%, the Taiwanese dollar 0.5%, and the Canadian dollar 0.5%. For the week on the downside, the Euro declined 2.4%, the Danish krone 2.35, the Japanese yen 1.2%, and the Swiss franc 0.8%.

Commodities Watch:

May 24 – Bloomberg (Asjylyn Loder): “Hedge funds sold oil at the fastest pace in almost eight months, cutting their bullish bets by 32% as crude prices plunged on concern Europe’s debt crisis will hurt energy demand."

The CRB index rallied 1.3% (down 10.1% y-t-d). The Goldman Sachs Commodities Index (GSCI) jumped 3.0% (down 6.9% y-t-d). Spot Gold rallied 3.2% to $1,214 (up 10.7% y-t-d). Silver rose 4.4% to $18.42 (up 9.3% y-t-d). July Crude recovered $3.93 to $73.97 (down 7% y-t-d). July Gasoline increased 3.8% (down 1% y-t-d), and June Natural Gas gained 5.7% (down 22% y-t-d). July Copper increased 1.4% (down 7% y-t-d). July Wheat declined 3.0% (down 16% y-t-d), and July Corn fell 2.7% (down 13.4% y-t-d).

Japan Watch:

May 27 – Bloomberg (Keiko Ujikane): “Japan’s exports rose more than economists estimated in April… Shipments abroad advanced 40.4% from a year earlier, the fifth straight increase, compared with 43.5% in March…

May 28 – Bloomberg (Aki Ito): “Japan’s unemployment rate unexpectedly increased in April, household spending fell and deflation deepened, signaling domestic demand is restraining the nation’s recovery from its worst postwar recession. The jobless rate rose to 5.1% from 5%...”

Asia Bubble Watch:

May 28 – Bloomberg (Eunkyung Seo): “South Korean manufacturers’ confidence held near a seven-year high as the nation’s economic growth accelerates.”

May 24 – Bloomberg (Weiyi Lim): “Taiwan’s jobless rate fell to 5.43% in April, the statistics bureau said…”

Latin America Watch:

May 28 – Bloomberg (Matthew Bristow): “Brazil’s broadest measure of inflation rose at a the fastest pace in 22 months in May, boosting pressure on policy makers to raise their benchmark interest rate… Prices… rose 1.19% in May after a 0.77% climb in April…”

Unbalanced Global Economy Watch:

May 27 – Bloomberg (William Selway and Terrence Dopp): “From Athens to Olympia, Washington, governments made poorer by the recession are looking to higher taxes on the rich for cash. Spain’s wealthiest should be tapped to help close the euro region’s third-largest budget deficit, Prime Minister Jose Luis Rodriguez Zapatero said… The U.K. has boosted taxes on high earners and French and Swedish politicians are calling for the same. The top U.S. tax rate is set to rise in 2011, while at least 14 states have lifted rates or are considering increases. ‘There’s a real move to get at whatever revenue you can get at without being so broad as to get the populace all up in arms,’ said Scott Pattison, executive director of the National Association of State Budget Officers… ‘You go where the money is.’”

May 27 – Bloomberg (Vernon Silver): “ ‘The crisis is over.’ So says Emeric Challier, a money manager at Avenir Finance Investment Managers in Paris. Rather than being alarmed by the plunging euro -- down 4.1% against the dollar in the week before the European Union’s nearly trillion-dollar bailout for debt-saddled members and 3.1% the week after -- he cites the economic boost a weaker currency provides. ‘The advantage of the euro drop is it will continue to support the recovery,’ says Challier, who is betting that Spanish, Portuguese and Italian government bonds will rise. German exports and Spanish and Greek vacations become cheaper for Americans and Asians…”

May 28 – Bloomberg (Johan Carlstrom): “Sweden’s economy grew in the first quarter and revised figures showed gross domestic product rose in the last three quarters of 2009…Gross domestic product…rose 1.4% from the previous quarter…”

May 28 – Bloomberg (Josiane Kremer): “Norway’s unemployment rate was unchanged in the March quarter as companies held on to staff amid signs the global recovery was gaining momentum. The seasonally-adjusted rate was 3.5%…”

U.S. Bubble Economy Watch:

May 25 – Bloomberg (Sara Gay Forden and Doron Levin): “Trader Craig Poler couldn’t hold out any longer. Browsing at the Miller Motorcars dealership in Greenwich, Connecticut, he spotted the $130,000 Aston Martin Vantage Coupe he had been dreaming about for months. ‘The second I saw it I knew I was going to buy it,’ said Poler, 48, who trades oil and petroleum products. ‘I’ve wanted one for a long time, since I started seeing them in London when I went on business.’ Super-luxury cars, whose sales plunged after Lehman Brothers Inc.’s collapse and the ensuing financial crisis, are making a comeback… U.S. sales this year of cars priced at more than $100,000 may jump 42% after falling 30% in 2009, according to… IHS Global Insight."

Central Bank Watch:

May 27 – Bloomberg (Scott Lanman and Joshua Zumbrun): “Federal Reserve Bank of Richmond President Jeffrey Lacker said proposed U.S. laws to overhaul financial rules keep too much of a safety net in place for firms and probably won’t break a ‘vicious circle’ of crises. ‘My early assessment is that the House legislation -- and to some extent even the Senate version -- creates enough discretionary rescue powers to dampen market discipline and sustain the vicious circle that brought us an expansive financial safety net,’ Lacker said…”

GSE Watch:

May 27 – Bloomberg (Jody Shenn): “Mortgage lenders are seeking relief from Fannie Mae and Freddie Mac as the government-supported companies force them to buy back more soured debt, said John Courson, president of the industry’s largest trade group. While his members ‘certainly understand’ their contracts require repurchases of defaulted loans when faulty appraisals, inflated borrower incomes or missing documentation are discovered, the Mortgage Bankers Association has started to ‘aggressively’ push the two companies and their regulator to ease up, he said. Fannie Mae and Freddie Mac, propped up by unlimited taxpayer capital, should acknowledge lenders are unfairly absorbing too many losses… Courson said… ‘We’re trying to see if we can’t reach some type of a system that says there is a bright line out there, if this loan has been making payments and defaulted for a reason that is neither fraud nor related to the underwriting of the loan, it shouldn’t be subject to a repurchase,’ he said.”

Fiscal Watch:

May 24 – Bloomberg (Jody Shenn and John Gittelsohn): “Loans guaranteed by the Federal Housing Administration, the U.S.-owned mortgage insurer, may be involved in more home-purchase transactions than borrowing financed by Fannie Mae and Freddie Mac. FHA lending last quarter may have topped the combined volume of government-supported Fannie Mae and Freddie Mac in a home-lending market that’s still a ‘government-financed market,’ David Stevens, the agency’s head, said… ‘This is a market purely on life support, sustained by the federal government,’ he said… ‘Having FHA do this much volume is a sign of a very sick system.’ The FHA, which backs loans with down payments as low as 3.5%, insured $52.5 billion of home-purchase mortgages in the first quarter, compared with $46 billion of purchases of the debt by Fannie Mae and Freddie Mac… The FHA and Fannie Mae and Freddie Mac… have been financing more than 90% of U.S. home lending after a retreat by banks and the collapse of the market for mortgage bonds without government-backed guarantees.”

May 25 – Bloomberg (Mary Childs): “The U.S. government’s Aaa bond rating will come under pressure in the future unless additional measures are taken to reduce projected record budget deficits, according to Moody’s… The U.S. retains its top rating for now because of a ‘high degree of economic and institutional strength,’ the… ratings company said… The government’s finances have been ‘substantially worsened by the credit crisis, recession, and government spending to address these shocks,’ Moody’s analysts lead by Steven A. Hess wrote. ‘The ratios of general government debt to GDP and to revenue are deteriorating sharply, and after the crisis they are likely to be higher than the ratios of other Aaa-rated countries.’ Debt to revenue has more than doubled over the past three years and is now over 400%, which could lead to ‘potential stress’ on finances, the report said.”

Muni Watch:

May 27 – Bloomberg (Darrell Preston): “U.S. states, which avoided borrowing because $135 billion of economic stimulus funds helped them balance budgets, may become more indebted as the flow of federal money ends, Standard & Poor’s said… Stimulus funds under the American Recovery and Reinvestment Act of 2009 helped states limit borrowing to $15 billion nationwide to help balance budgets… During the last recession that began in 2001 states borrowed $30 billion. With an estimated $100 billion of deficits they may have to borrow when stimulus money stops flowing this year, said Robin Prunty, one of the analysts… ‘A difficult budget environment translates into more debt issuance,’ said Prunty, who is a managing director at the ratings company in New York. States face another 12 to 24 months of budget pressure because the rebound of tax revenue lags behind any economic recovery, said S&P, which rates the credit quality of municipal bonds.”

May 27 – Bloomberg (Dunstan McNichol): “The U.S. Internal Revenue Service plans to examine as many as half of all Build America Bond sales in connection with rules that limit how the subsidized issues can be used and how much they cost. The reviews follow a questionnaire the tax service began distributing to issuers in February, seeking information on recordkeeping and the steps borrowers took to ensure they got proper rates, Steven Chamberlin, compliance manager in the agency’s tax-exempt bond unit, said…”

New York Watch:

May 27 – Wall Street Journal (Betsy McCaughey): “Guess how long it is before the state of New York runs out of cash? Less than a week, according to the state’s comptroller. On June 1, New York is due to send $3.8 billion in aid to local school districts, including $2.1 billion that was supposed to be paid in March but not sent for lack of funds. Yet New York is still $1 billion short. This could affect school operations, the solvency of any business that sells goods or services to the state, the paychecks of state workers, and ultimately home values.”

Unwitting Beneficiary?:

How about a brief review of “where we’ve been; where we are; and where we might be heading”?

The year 2008 witnessed the collapse of the Wall Street/mortgage finance Bubble. This historic Bubble was the latest of a long series of Bubbles going back at least to the late-eighties’ (“decade of greed”) excesses emboldened by Alan Greenspan’s 1987 post-market crash liquidity injections and assurances. This serial Bubble episode saw each Bubble emerge bigger than its predecessor – which required ever-increasing policymaker post-Bubble market interventions resulting in only deeper market distortions.

I have posited that unprecedented policymaker response to the 2008 Bubble collapse inflated a Global Government Finance Bubble. Arguably, this Bubble has the potential to be the biggest and most dangerous yet. It’s certainly complex and poses analytical challenges. At least here at home, Credit excesses have gravitated to the heart of the monetary system (government and Federal Reserve Credit).

Many scoff at the notion of yet another huge Bubble. With a focus on asset valuation, they would argue that stock and real estate prices are nowhere near Bubble territory. They would likewise dismiss the notions of a “Bubble economy” and attendant Credit addiction and systemic fragilities. The conventional view holds that the U.S. economy enjoys long-term growth dynamics that will over time hold sway over cyclical setbacks. Aggressive fiscal and monetary stimulus was, from their perspective, necessary to counteract extraordinary Credit system stress and to shove the economy back toward its sustainable growth track.

Bubbles are not obvious while they are inflating, and the Global Government Finance Bubble is no exception. The key characteristics of Credit Bubbles are various forms of Credit excesses, distortions to the price and flow of finance, and heightened speculation. While the massive issuance of government debt is readily apparent, pricing distortions have been more subtle.

Fundamentally, this Bubble’s main price distortions emanate from the market perception that synchronized global fiscal and monetary policies will sustain global financial and economic recoveries. This creates a dynamic where massive issuance of sovereign debt is generally priced in the marketplace with meager little risk premiums. Similarly, the perception that markets and economies are underpinned by government policies ensures that debt instruments throughout – certainly including U.S. corporates, municipal debt, agencies, and mortgages – trade at narrow risk spreads to sovereigns. It’s the ultimate “too big to fail.”

It has been fundamental to my Bubble thesis that the finance underpinning global recoveries has been unsound, unstable and unsustainable. In particular, extraordinary stimulus measures incited a move by the speculators aggressively back into global risk assets. The massive pool of global speculative finance – having been reined in during the 2008 crisis – quickly returned to near full force and power. Leverage that had been taken down during the crisis was ratcheted right back up. Carry trades that had unwound during the crisis were wound right back up. Unprecedented policy stimulus and market intervention had again made it too easy to garner speculative profits.

The influx of speculator finance upon global risk markets inflated prices and stoked returns, while zero interest rates here at home incited a massive flow of finance from relative safety out to inflating global securities markets. Money market fund assets peaked the second week of January, 2009, at $3.922 TN. In the past 15 months, over $1.0 TN has flowed from the money fund complex out to global risk markets.

As a proxy for financial conditions, junk bond spreads peaked at over 1,300 bps in January, 2009. At last month’s (April 23rd) trough, junk spreads had contracted 835 bps all the way down to 478 bps. Similar risk premium collapses occurred in investment grade corporates, agency debt, mortgage-backed securities, and municipal bonds. It was one of history’s great reversals in market perceptions/financial conditions.

This dramatic loosening of financial conditions inflated global securities prices. Huge rallies in the risk markets played a significant role in bolstering confidence. This combination of loose finance and improved confidence was instrumental in fostering economic recovery. The bounce back in economic activity then supported the bubbling markets and emboldened the speculators. That’s where we’ve been.

Over the past month, markets have gone from close to euphoria to near panic. The global financial Bubble ran smack up against an expanding Greek debt crisis, a tightening of Chinese mortgage Credit, and a tightening regulatory noose around the U.S. financial sector and speculative finance more generally. Complacent, highly speculative and over-liquefied securities markets were bludgeoned by losses, contagion effects, de-leveraging, and general mayhem.

The speculator world was positioned for the Global Government Finance Bubble. Led by the U.S. Treasury, massive synchronized fiscal stimulus was expected to support worldwide economic recovery. Led by the U.S. Federal Reserve, massive synchronized monetary stimulus was to ensure liquid and accommodative global securities markets. And as the currency of the leading reflationist nation, the dollar was viewed in the markets as fundamentally weak and vulnerable. Markets anticipated an unsound dollar would continue to bolster global reflationary forces. With such a strong inflationary bias throughout the global risk markets, borrowing at near zero rates in dollars or yen to leverage in any assortment of risk trades appeared an unusually compelling bet.

The Greek debt crisis blew a lot of expectations – and leveraged trades - out of the water. As Eurozone policymakers bumbled, susceptible markets buckled. The belief that assertive policymakers would move quickly to avert financial crisis proved too optimistic. Soon, the specter of Greek debt default or reorganization fomented dislocation in the Credit default swap (CDS) market. Contagion effects were transmitted quickly through the CDS markets to Portugal, Spain, Italy and Ireland. With European debt markets in disarray, the euro came under heavy selling pressure. Yen and dollar strength gained momentum, with global leveraged players suddenly finding themselves on the wrong side of quickly changing marketplace. The unwind of leveraged trades led to a contraction of marketplace liquidity and increasingly problematic contagion effects throughout the system. And Credit system de-leveraging, faltering liquidity, and sinking markets provoked a panicked reassessment of global commodities pricing and growth dynamics.

This week from St. Louis Federal Reserve Bank President James Bullard (quoted by MarketNews International’s Steven K. Beckner): “The U.S. may actually be an unwitting beneficiary of the crisis in Europe, much as it was during the Asian currency crisis of the late 1990s. This is because of the flight to safety effect that pushes yields lower in the U.S…. Of course the U.S. also has its own fiscal problems that must be directly addressed in a timely manner if the nation is to maintain credibility in international financial markets.”

So far, I guess one could make the “unwitting beneficiary” case. Treasuries have rallied strongly along with the dollar. As someone who has managed short positions for over two decades, I don’t necessarily equate dramatic price spikes with sound underpinnings. Indeed, it is so often the case that stocks/markets rally sharply right as weak fundamentals are about to emerge; one final short squeeze and price dislocation before the fall. The experience of technology stocks in early-March 2000 quickly comes to mind. Clearly, many were caught short the dollar and Treasuries. Especially considering the massive ongoing supply of Treasuries and the Fed’s zero rate policy, the upside for Treasuries and our currency had seemed rather limited.

Thus far, the bulls are not dissuaded. And I’ll be the first to admit that over the years (including during the Asian crisis) the U.S. economy was on the receiving end of stimulus benefits emanating from global crises. A safe-haven bid to the dollar and Treasuries would lead immediately to lower mortgage borrowing costs (and ballooning GSE balance sheets!). In short order, homeowners would extract equity while refinancing mortgages. A jump in home transactions would boost both prices and the amount of mortgage Credit slushing around the economy. Those dynamics, however, are dead and buried in the post-housing mania era. With such fragile underpinnings, I see no real U.S. benefits from global financial tumult.

In my “Issues 2010” piece from early January, I argued the case for 2010 being a “Bubble year” with “bi-polar outcome possibilities.” It was my view that, as long as Bubble Dynamics were accommodated by loose financial conditions, Bubble effects would be free to strengthen and broaden. At the same time, fragile underpinnings and an exceptionally speculative financial backdrop left the system vulnerable to any tightening of Credit conditions.

So, where might we be heading? Likely, prospects will be determined by developments in financial conditions. Will they remain loose and render ongoing support to the Bubble? Will markets regain their composure to the point of ensuring sufficient liquidity and Credit expansion? Or will finance tighten – has Credit Availability already tightened? Did the Greek debt crisis pierce the Global Government Finance Bubble – akin to the subprime collapse dooming the Wall Street/mortgage finance Bubble? I don’t believe there’s room for a middle ground here – no “muddle through” – it's boom or back to bust.

Well, I believe finance has tightened and this tightening will not prove fleeting. The global Bubble has been pierced, a result of Greece – although the catalyst could have as easily been developments in the U.S. or China. But since crisis erupted initially in the Eurozone, the dollar/Treasuries have benefited thus far from de-leveraging and some safehaven perceptions. Many are programmed to interpret this as good news for U.S. recovery, although the important news is that market perceptions have changed; markets have become hyper-volatile; and the backdrop is so uncertain that speculators and investors will choose - or be forced to - rein in risk-taking.

The waves of liquidity unleashed through speculator leveraging and the flight out of safehaven assets has run its course. As we’ve seen over the past few weeks, markets can go from seemingly over-liquefied to illiquid the moment speculators reverse course and head for the exits. The markets have been reminded of this harsh reality and behavior will change. Others would argue that there is no crisis in the U.S. Credit system and, with Treasury yields so low, financial conditions have actually loosened. I would counter that it’s a global financial Bubble and destabilizing contagion effects were unleashed with the big rally in Treasuries.

The collapse in yields must have caused havoc for those hedging interest-rate risk in the multi-Trillions market for mortgage-backed securities. With our mortgage market essentially nationalized, there is little attention paid to MBS these days. Yet interest-rate hedging continues to play a crucial role throughout the Credit markets. I’ll assume that huge hedging programs helped push Treasury yields to recent depths. It’s exactly this type of volatility and uncertainty that forces players to pare back risk. And it’s rising risk aversion that will pressure financial conditions and fuel liquidity concerns. The markets have passed an important inflection point, and faltering markets are certainly not good for fragile confidence.