Saturday, November 1, 2014

02/25/2011 Increasingly Unwieldy. Monetary Disorder *

For the week, the S&P500 declined 1.7% (up 5.0% y-t-d), and the Dow was hit for 2.2% (up 4.8%). The S&P 400 Mid-Caps lost 1.9% (up 6.3%), and the small cap Russell 2000 fell 1.6% (up 4.9%). The Banks dropped 3.0% (up 2.6%), and the Broker/Dealers sank 3.6% (up 3.2%). The Morgan Stanley Cyclicals fell 2.3% (up 2.9%), and the Transports sank 4.7% (down 0.9%). The Morgan Stanley Consumer index declined 2.0% (down 0.6%), and the Utilities slipped 0.3% (up 0.6%). The Nasdaq100 declined 2.0% (up 5.8%), and the Morgan Stanley High Tech index dropped 3.0% (up 5.9%). The Semiconductors gave back 1.7% (up 12.6%). The InteractiveWeek Internet index dropped 3.1% (up 4.7%). The Biotechs lost 3.0% (down 0.9%). While bullion rallied $21, the HUI gold index added only 0.2% (down 3.2%).

One-month Treasury bill rates ended the week at 11 bps and three-month bills closed at 13 bps. Two-year government yields were 3 bps lower at 0.72%. Five-year T-note yields ended the week down 10 bps to 2.17%. Ten-year yields dropped 17 bps to 3.42%. Long bond yields ended the week 19 bps lower to 4.75%. Benchmark Fannie MBS yields were down 11 bps to 4.25%. The spread between 10-year Treasury yields and benchmark MBS yields widened 6 bps to 83 bps. Agency 10-yr debt spreads declined 2 bps to 4 bps. The implied yield on December 2011 eurodollar futures fell 7 bps to 0.63%. The 10-year dollar swap spread increased 2 to 12.5 bps. The 30-year swap spread increased 3.25 bps to negative 21.5 bps. Corporate bond spreads were wider. An index of investment grade bond risk widened 3 bps to 83 bps. An index of junk bond risk widened 22 bps to 405 bps.

Investment grade issuers included McKesson $1.7bn, Kinder Morgan $1.1bn, American Honda $450 million, Caterpillar $285 million, and Wyndham Worldwide $250 million.

Junk bond funds saw inflows of $402 million (from EPFR), the 12th straight week of positive flows. Issuers included United Refining $365 million, Goodrich Petroleum $275 million and Nexeo Solutions $175 million.

I saw no convertible debt issues.

International dollar debt issuers included Australia & New Zealand Bank $1.0bn, Virgin Media $500 million, and Edcon $250 million.

U.K. 10-year gilt yields dropped 19bps this week to 3.61% (up 22bps y-t-d), and German bund yields fell 10bps to 3.15% (up 19bps). Ten-year Portuguese yields gained 5 bps to 7.42%. Spanish yields increased 3 bps to 5.39%, and Irish yields jumped 16 bps to 9.16%. Greek 10-year bond yields rose 17 bps to 11.74%. The German DAX equities index dropped 3.3% (up 3.9% y-t-d). Japanese 10-year "JGB" yields declined 6 bps to 1.24% (up 12bps y-t-d). Japan's Nikkei declined 2.9% (up 2.9%). Emerging markets were mostly lower. For the week, Brazil's Bovespa equities index declined 1.7% (down 3.5%), and Mexico's Bolsa declined 2.7% (down 4.3%). South Korea's Kospi index fell 2.5% (down 4.3%). India’s equities index dropped 2.8% (down 13.7%). China’s Shanghai Exchange slipped 0.7% (up 2.5%). Brazil’s benchmark dollar bond yields dropped 16 bps to 4.66%, and Mexico's benchmark bond yields sank 21 bps to 4.49%.

Freddie Mac 30-year fixed mortgage rates declined 5 bps last week to 4.95% (down 10bps y-o-y). Fifteen-year fixed rates fell 5 bps to 4.22% (down 18bps y-o-y). One-year ARMs were one basis point higher to 3.40% (down 75bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 11 bps to 5.46% (down 46bps y-o-y).

Federal Reserve Credit jumped $13.4bn to a record $2.505 TN (16-wk gain of $224.6bn). Fed Credit was up $97.6bn y-t-d and $236bn from a year ago, or 10.4%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 2/23) gained $4.1bn to a record $3.388 TN. "Custody holdings" were up $424bn from a year ago, or 14.3%.

M2 (narrow) "money" supply gained $8.4bn to a record $8.883 TN. Over the past year, "narrow money" grew 3.8%. For the week, Currency added $1.3bn. Demand and Checkable Deposits declined $9.7bn, while Savings Deposits rose $21.6bn. Small Denominated Deposits declined $2.5bn. Retail Money Funds were down $2.0bn.

Total Money Fund assets declined $5.2bn last week to $2.751 TN. Money Fund assets dropped $415bn over the past year, or 13.1%.

Total Commercial Paper outstanding rose $5.2bn to $1.046 Trillion. CP is now up $77bn y-t-d, although it was down $108bn, or 9.3% from a year ago.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $1.494 TN y-o-y, or 19.1%, to a record $9.309 TN.

Global Credit Market Watch:

February 23 – Bloomberg (Emese Bartha and Patricia Kowsmann): “Some European officials are quietly discussing contingencies for what might be a Portuguese request for financial aid as early as next month, when the highly indebted country begins facing large-scale debt redemptions. Financial pressure on the country's treasury is increasing, a topic that is likely to come up at the March 11 and March 24 meetings of European Union leaders, according to people familiar with the discussions.”

February 25 – Bloomberg (Sapna Maheshwari and Ashley Lutz): “U.S. company bond sales tumbled 74% this week to the lowest in 2011 as growing tensions in the Middle East shook markets. McKesson… led companies selling $5.69 billion of debt, the least since the week ended Dec. 31… That compares with $21.8 billion of issuance in the five days ended Feb. 18.”

Global Bubble Watch:

February 23 – Bloomberg (Glen Carey and Zainab Fattah): “Saudi Arabia’s King Abdullah boosted spending on housing by 40 billion riyals ($10.7bn), and earmarked more funds for education and social welfare amid popular uprisings sweeping the Arab world. The social security budget was raised by 1 billion riyals… King Abdullah also ordered the creation of 1,200 jobs in supervision programs and made permanent a 15% cost-of-living allowance for government employees… ‘They are trying to enlarge the pool of benefits for society given what is happening in the broader Middle East,’ John Sfakianakis, chief economist at Banque Saudi Fransi, said…”

February 25 – Bloomberg (Keith Jenkins): “The European Central Bank’s efforts to stop banks running short of cash are distorting money-market rates as traders try to anticipate when that flow of emergency liquidity might start to dry up. The region’s smaller lenders, ostracized in the interbank market, are reliant on the ECB’s open market operations for funds. Bigger financial institutions, meantime, are parking excess funds back with the… central bank.”

February 24 – Bloomberg (Henry Goldman and Michael J. Moore): “Wall Street bonuses fell 8% last year from 2009, New York state Comptroller Thomas DiNapoli said. Financial firms disbursed $20.8 billion in 2010, compared with $22.5 billion in 2009…”

Currency Watch:

The U.S. dollar index slipped 0.6% to 77.217 (down 2.3% y-t-d). On the upside for the week, the Japanese yen increased 1.8%, the Swiss franc 1.8%, the South African rand 1.7%, the Canadian dollar 1.0%, the Norwegian krone 0.4%, the Australian dollar 0.3%, and the Singapore dollar 0.1%. On the downside, the New Zealand dollar declined 1.3%, the South African rand 1.3%, the Taiwanese dollar 1.2%, the British pound 0.8%, the Mexican peso 0.8%, the Swedish krona 0.6%, and the Brazilian real 0.4%.

Commodities and Food Watch:

February 25 – Bloomberg (Tony C. Dreibus): “Rice, the staple food for half the world, rallied… as governments boosted stockpiles to curb prices that sparked protests across North Africa and the Middle East. Bangladesh, South Asia’s biggest buyer, said it’s seeking supply from India as part of more regular grain purchases to bolster food security. Japan bought 68,000 metric tons of rice from the U.S., Australia and Thailand in a tender two days ago. ‘When we go for international tenders and prices suddenly rise, private suppliers sometimes fail to fulfill their commitments,’ Muhammad Abdur Razzaque, the Bangladeshi food minister, said… ‘They don’t supply us and put us in trouble. It has happened.’”

February 25 – Bloomberg (Thomas Kutty Abraham): “Raw sugar prices that reached their highest level in 30 years this month will cause shortages for consumers in the second half, according to Shree Renuka Sugars Ltd., India’s biggest refiner. Processors are shutting factories because they can’t make enough money… The gain is adding to inflation after global food costs climbed to a record in January…”

The CRB index jumped 2.8% (up 5.6% y-t-d). The Goldman Sachs Commodities Index surged 5.0% (up 9.3%). Spot Gold rallied 1.5% to $1,411 (down 0.7%). Silver rose 2.0% to $32.93 (up 6.4%). April Crude surged $8.17 to $97.88 (up 7.1%). March Gasoline jumped 7.1% (up 12.4%), and March Natural Gas gained 2.5% (down 9.1%). May Copper dipped 0.9% (up 0.2%). May Wheat dropped 5.2% (up 2.1%), while May Corn added 0.2% (up 14.8%).

China Bubble Watch:

February 25 – Bloomberg (Glen Carey and Zainab Fattah): “China’s banking regulator plans to require lenders to set up procedures to allow them to restore their finances in the event of a crisis… Banks deemed systemically important, including Industrial & Commercial Bank of China Ltd., may have to sell debt convertible into equity… Regulators will also be given broader powers to supervise those lenders in an effort to discover risks early… China is seeking to avoid a repeat of its last banking crisis, when the government spent more than $650 billion over a decade to bail out banks after years of state-directed lending.”

February 23 – Associated Press: “China plans to build at least 45 new airports in the next five years to serve booming travel, the top industry regulator said… The plans call for spending 1.5 trillion yuan ($230 billion) to expand air travel… Some 130 of China's 175 existing airports lost money last year but Beijing will support them to boost local economic growth…”

February 25 – Bloomberg (Glen Carey and Zainab Fattah): “China’s cement prices may rise ‘significantly’ in the first quarter from a year ago after the government reiterated its pledge to build 10 million low- income houses this year, according to Citic Securities Co.”

February 24 – Bloomberg: “Drought in northern China may become more severe in March because of less precipitation compared with the same period in previous years, Minister of Water Resources Chen Lei said…”

Asia Bubble Watch:

February 24 – Bloomberg (Shamim Adam): “Accelerating inflation from Singapore to Vietnam is set to spur higher interest rates and currency gains in Asian economies. Singapore’s inflation rate rose to a two-year high of 5.5% in January, while prices in Malaysia climbed at the fastest pace since mid-2009… Vietnam’s consumer prices gained the most in 24 months in February.”

February 24 – Bloomberg (Chinmei Sung): “Taiwan’s industrial production rose for a 17th straight month in January, supporting the case for policy makers to raise borrowing costs further next month. Output advanced 17.19% from a year earlier, after gaining a revised 18.93% in December…”

Latin America Watch:

February 23 – Financial Times (Joe Leahy): “The former central banker who laid the foundation for Brazil’s boom by helping to slay inflation has warned that rapid credit growth in the country needs close scrutiny from policymakers. Arminio Fraga... said... that the quality of some new consumer lending was open to question... The major banks have reported credit growth of more than 20% last year.”

February 24 – Bloomberg (Alexander Ragir): “Brazil’s unemployment in January was at a record low for the month as the economy last year expanded at the fastest pace in more than two decades. Unemployment in January rose to 6.1% on seasonal factors…”

Unbalanced Global Economy Watch:

February 25 – Financial Times (Javier Blas and Gregory Meyer): “The world faces a protracted bout of extremely high food prices, the US government has warned, overwhelming farmers’ ability to cool commodity markets by planting millions of additional hectares with crops… It added that food inflation would surge in the second half of this year as wholesale prices filtered through the supply chain, affecting consumers. The warning at the USDA Outlook Forum… the biggest annual gathering of the agribusiness sector, is likely to fuel global concerns about rising inflation and the potential for destabilizing food riots in developing countries.”

February 25 – Bloomberg (Svenja O’Donnell): “Britain’s economy shrank more than initially estimated in the fourth quarter, complicating the task of the Bank of England as a split deepens among policy makers on whether to withdraw stimulus. Gross domestic product fell 0.6% from the previous three months…”

February 21 – Bloomberg (Christian Vits): “German business confidence unexpectedly rose to a fresh record high in February as booming exports spurred hiring and consumer spending.”

U.S. Bubble Economy Watch:

February 23 – Financial Times (James Politi and Stephanie Kirchgaessner): “The Republican plan to slash government spending by $61bn in 2011 could reduce US economic growth by 1.5 to 2 percentage points in the second and third quarters of the year, a Goldman Sachs economist has warned. The note from Alec Phillips... was seized in the ongoing US budget fight by Democrats as validating their argument that the legislation approved by the Republican-led House of Representatives last Saturday would do significant damage to the US recovery.”

(Increasingly Unwieldy) Monetary Disorder:

The Federal Reserve’s balance sheet has expanded almost $225bn over the past 16 weeks. International (global central bank) “reserve assets” have jumped $1.5 TN in 12 months. In just two years, “reserve assets” have ballooned an incredible $2.6 TN, or about 40%, to $9.3 TN (reserves were about $3.0 TN to begin 2004). There’s been nothing comparable to this in the history of central banking – in the history of “money.” The resulting liquidity onslaught has inflated global securities and commodity prices, distorted market perceptions of risk and liquidity, depressed global yields and fomented speculative excess in any market that trades. I have referred to this backdrop as one of “Monetary Disorder.”

Monetary Disorder can certainly fester for some time under the fa├žade of a seemingly healthy environment. As we have witnessed, global equities prices have been a prime beneficiary of global reflationary dynamics. And there is nothing like the tonic of inflating stock prices to bolster confidence and embolden the risk-takers. Ebullient markets, then, lead economic expansion and provide seeming confirmation of the bullish point of view. Yet there is no escaping the instability lurking just beneath the fragile surface.

It is said that hedge fund assets (and leverage!) have returned to pre-crisis levels. Surely, global sovereign wealth funds have grown only more gigantic. And it is worth noting that China’s “reserve assets” have jumped 46% in only two years to an incredible $2.847 TN. The world is awash in liquidity/”purchasing power” like never before. This is all worth keeping in mind as we contemplate the likelihood of ongoing unrest in the Middle East and potential supply and price shocks. The Goldman Sachs Commodities Index ended the day at the highest level since August 2008.

The global liquidity and speculation backdrop ensures that any important commodity facing potential supply constraint enjoys a propensity for spectacular price inflation – a dynamic now appreciated by companies, speculators and policymakers alike. This inflationary manifestation was really taking hold back in 2008 before the onset of the global Credit crisis. Of late, it has returned with a vengeance throughout the agriculture commodities and food complex. Yet, with stock markets booming and confidence running high, most have been content to disregard this troubling inflation dynamic. The markets this week abruptly turned somewhat less complacent (at least for a few sessions).

The Middle East crisis took a decided turn for the worst this week with the eruption of violence and chaos throughout Libya. The markets now confront great uncertainty as to how developments will unfold throughout the region. Recent events certainly increase the probability for potentially problematic energy supply disruptions and resulting price shocks. A fragile global recovery and inflated markets create a susceptible backdrop, especially with optimism and speculative zeal having become so prominent throughout global markets.

With crude (West Texas Intermediate) surpassing $100 this week – and with prospects high that Middle East instability won’t be dissipating anytime soon – analysts are scurrying to fashion views as to the impact surging energy prices will have on corporate profits, consumer spending, inflation and global growth. To say that unfolding circumstances create extreme uncertainty is no overstatement.

This week, Saudi Arabia’s King Abdullah announced plans to increase social spending by $36bn, including a 15% pay increase for government employees and $10bn for low-income housing. At the top of the list of oil exporters (and with $440bn of international reserves), Saudi Arabia enjoys unusual capacity to ameliorate its underclass. The markets are watching Saudi Arabia with keen interest, at this point confident that the kingdom has the capacity both to hold social unrest at bay and to pump additional barrels.

To be a fly on the wall in Beijing… Chinese policymakers must be intensively analyzing developments throughout the Middle East. I’ll assume they are taking great interest in the House of Saud’s approach to placating the masses. And while China is definitely no Saudi Arabia or Egypt, there is simmering social tension that provides authorities constant worry. China may not have a huge unemployed youth problem, yet inflation and Bubble Economy Dynamics have engendered huge wealth disparities and attendant social instability.

To this point, policymaking has been straddling a fence. There has been a certain determination to dampen home price appreciation and other Bubble effects in urban locations, while at the same time moving to significantly increase minimum wages and boost construction of low-income housing. There has been a focus on addressing real estate excesses, with the expectation that adept economic management will allow this “tightening” to be accomplished without sacrificing ongoing strong growth. This is the type of complex economic management that nurtures a high risk of monetary mismanagement.

Today from Bloomberg News: “China may slow the pace of tightening ‘significantly’ in coming months as policy makers are likely to need time to access the impact of the ‘intensive and aggressive tightening’ measures introduced the past five months, Daiwa Securities Capital Markets Co. said… The political turmoil in some African countries and increased uncertainty about the global economy should make China ‘more cautious’ about implementing further tightening measures, according to the report by Mingchun Sun, analyst at Daiwa.”

First of all, the notion of what amounts to “intensive and aggressive tightening” has evolved considerably since Paul Volcker manned the helm of the Federal Reserve. With borrowing rates about 6% and January bank loan growth of $180bn, China remains some distance away from tight “money.” At the same time, the view that recent events might provide the impetus for Chinese authorities to take a more cautious approach to further “tightening” does resonate.

From the perspective of my analytical framework, China is in the midst of its “terminal phase” of Credit Bubble excess. I have posited that China, with the extraordinary dimensions of its population, its underdeveloped north, and the nation’s $2.8 TN hoard of reserves, has perhaps a unique capacity to prolong its historic boom. I have also noted that it is generally typical for policymakers to turn increasingly timid as the risks of bursting Bubbles compound. China has reached the point where it must move forcefully in order to rein in excess or risk things running completely out of control. I have feared that policymakers would along the way find reason to lose their nerve.

The recent surge in food and energy prices comes at a critical juncture for global policymakers. The inflationary backdrop beckons for meaningful synchronized monetary tightening. The seriousness of unfolding inflationary risks is becoming difficult to downplay. Yet the Federal Reserve, the guardian of the world’s reserve currency, won’t even slow its pace of quantitative easing, let alone reverse course and tighten. Incredibly, global inflationary dynamics do not factor into the Fed’s policy framework. The Europeans have begun to prepare the markets for an increase in rates, although when this does occur it will hardly qualify as monetary restraint. The Bank of Japan won’t be raising rates anytime soon, and I wouldn’t be surprised if other Asian central banks actually step back a bit from their baby-step approach to rate hikes.

The People’s Bank of China - “guardian” of the world’s largest population, most robust economy, most imposing Credit Bubble and most gluttonous appetite for all things food, energy and commodities - was poised to play a pivotal role in global finance; it appeared on the brink of providing a source of monetary restraint. Recent developments could change everything. Instead of potential restraint, China might adjust course and become an even greater source of global demand.

First, if China turns cautious on its tightening program, this will most likely lead to another year of stronger-than-expected economic growth (how long until China reaches 25 million annual vehicle sales?). Second, surging food and energy prices may induce the Chinese (along with others) to move more aggressively toward building “strategic stockpiles” of everything necessary to sustain strong growth and buoy social spirits. Third, the authorities may view the popularity of global protests and the Facebook phenomenon as cause to approach their objective of bolstering incomes and consumption for its enormous poor underclass even more aggressively. The potential to unleash additional purchasing power is enormous.

In a world with some semblance of normality, one would look at surging energy prices as portending restraints on growth. Global bond markets would fret at breathtaking surges in commodities prices – along with the specter of hoarding and inflation psychology becoming firmly entrenched. But these are the most abnormal of times. It is not beyond the realm of possibility that a booming Asia might actually relax and further monetize higher food and energy prices. Global bond markets - that in the past could be counted on to help dampen incipient inflation through the imposition of higher yields – remain these days fixated on the likelihood that the Fed and global central bankers will for an extended period ignore inflation and stick with ultra-loose money.

The current backdrop creates extraordinary uncertainty. From an analytical perspective, things can go in many different directions from here. There is no alternative than to follow developments diligently, keeping an open mind and re-evaluating often. But the makings for a serious inflation problem seem to become more cohesive by the week. Global central bankers are determined to bring new meaning to the term “behind the curve,” which connotes eventual “hard landings.” To be sure, US “CPI” these days provides an especially poor gauge of monetary conditions and the appropriateness of policy. And when writing of an “inflation problem,” I am thinking more in terms of the global market, economic, social and political havoc fomented from an extended period of (increasingly unwieldy) Monetary Disorder.