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.

03/19/2010 Greenspan on the Crisis *

For the week, the S&P500 gained 0.9% (up 4.0% y-t-d), and the Dow rose 1.1% (up 3.0%). The Banks increased another 1.3% (up 19.7%), while the Broker/Dealers slipped 0.6% (down 2.7%). The Morgan Stanley Cyclicals added 0.6% (up 6.3%), and the Transports gained 1.1% (up 6.7%). The Morgan Stanley Consumer index rose 0.9% (up 4.5%), and the Utilities jumped 1.6% (down 3.6%). The S&P 400 Mid-Caps increased 0.2% (up 8.0%), while the small cap Russell 2000 declined 0.4% (up 7.8%). The Nasdaq100 increased 0.4% (up 3.9%), and the Morgan Stanley High Tech index gained 0.7% (up 3.2%). The Semiconductors were little changed (down 1.2%). The InteractiveWeek Internet index was unchanged (up 5.1%). The Biotechs slipped 0.5%, yet 2010 gains were at 29.6%. Although bullion was up $5.0, the HUI gold index was unchanged for the week (down 3.1%).

One-month Treasury bill rates ended the week at 13 bps, and three-month bills closed at 15 bps. Two-year government yields rose 4 bps to 0.995%. Five-year T-note yields increased 5 bps to 2.46%. Ten-year yields declined one basis point to 3.69%. Long bond yields fell 5 bps to 4.58%. Benchmark Fannie MBS yields increased 2 bps to 4.37%. The spread between 10-year Treasury and benchmark MBS yields widened 3 bps to 68 bps. Agency 10-yr debt spreads widened 2 bps to 37 bps. The implied yield on December 2010 eurodollar futures declined one basis point to 0.895%. The 10-year dollar swap spread declined 0.5 to 4.25, while the 30-year swap spread increased 0.5 to negative 13.5. Corporate bond spreads were mixed. An index of investment grade bond spreads widened 2 to 86 bps, while an index of junk spreads declined 9 to 511 bps.

It was a decent week of debt issuance. Investment grade issuers included Goldman Sachs $2.75bn, International Lease Finance $2.0bn, Rockies Express Pipeline $1.7bn, Hartford Financial $1.1bn, Axis Specialty Finance $500 million, First Niagara $300 million.

Junk flows reported inflows of $597 million (Lipper). Junk issuers included US Steel $600 million, Narragansett Electric $550 million, Ball Corp $500 million, Developers Diversified $300 million, Sitel $300 million, Coleman Cable $275 million, Bioscrip $225 million, and Da-Lite Screen $105 million.

Convert issues included Knight Capital $325 million.

International dollar debt sales remain robust. Issuers included Shell $4.25bn, Commonwealth Bank of Australia $3.5bn, European Investment Bank $3.0bn, Bombardier $1.5bn, Credit Suisse $1.5bn, Digicel Group $775 million, Banco Brades $750 million, BES Investimento Brazil $500 million, and QVC $1.0bn.

U.K. 10-year gilt yields dropped 14 bps to 3.95%, and German bund yields fell 6 bps to 3.11%. Bond yields in Greece jumped 12 bps to 6.34%. The German DAX equities index added 0.6% (up 0.4% y-t-d). Japanese 10-year "JGB" yields increased 2 bps to 1.36%. The Nikkei 225 rose 0.7% (up 2.6%). Emerging markets were mostly higher. For the week, Brazil's Bovespa equities index slipped 0.7% (up 0.4%), while the Mexico's Bolsa rose 1.3% (up 2.8%). Russia’s RTS equities index jumped 1.9% (up 6.9%). India’s Sensex equities index rose 2.4% (up 0.6%). China’s Shanghai Exchange gained 1.8% (down 6.4%). Brazil’s benchmark dollar bond yields rose 4 bps to 4.85%, and Mexico's benchmark bond yields rose 4 bps to 4.78%.

Freddie Mac 30-year fixed mortgage rates added one basis point to 4.96% (down 2bps y-o-y). Fifteen-year fixed rates gained one basis point to 4.33% (down 28bps y-o-y). One-year ARMs dropped 10 bps to 4.12% (down 79bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down one basis point to 5.81% (down 108bps y-o-y).

Federal Reserve Credit surged $30.0bn last week to $2.292 TN. Fed Credit was up $251bn, or 12.3%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 3/17) jumped $14.9bn to a record $2.997 TN. "Custody holdings" expanded $406bn, or 15.7%, over the past year.

M2 (narrow) "money" supply declined $13.3bn to $8.513 TN (week of 3/8). Narrow "money" has increased $1.0bn y-t-d. Over the past year, M2 expanded 1.5%. For the week, Currency added $1.0bn, while Demand & Checkable Deposits fell $13.5bn. Savings Deposits rose $15.6bn, while Small Denominated Deposits declined $5.5bn. Retail Money Funds sank $10.8bn.

Total Money Market Fund assets (from Invest Co Inst) sank $73.6bn to $3.170 TN. In the first 11 weeks of the year, money fund assets have dropped $277bn, with a one-year drop of $847bn, or 21.9%.

Total Commercial Paper outstanding fell $22.5bn last week to $1.122 TN. CP has declined $47.7bn, or 19.3% annualized year-to-date, and was down $354bn over the past year (24%).

International reserve assets (excluding gold) - as tallied by Bloomberg’s Alex Tanzi – were up $1.185 TN y-o-y, or 17.9%, to $7.818 TN.

Global Credit Market Watch:

March 17 – Bloomberg (Jonathan Stearns and James G. Neuger): “Greek Prime Minister George Papandreou kept alive the possibility of requesting International Monetary Fund aid as German Chancellor Angela Merkel cautioned against ‘hasty’ decisions on European Union assistance for the country. As long as ‘Greece is still borrowing at an unreasonably high interest rate, over 6%,’ the country will keep ‘all options open’ while preferring an EU solution, Papandreou said…”

March 18 – Bloomberg (John Glover): “Company borrowing costs have fallen to the lowest levels since the credit crisis started to roil markets in 2007, as investors seek alternatives to sovereign securities tainted by governments’ deteriorating finances. The extra yield investors demand to hold corporate debt rather than U.S. Treasuries tumbled to 156 bps… less than a third of the gap a year ago… Companies responded to the drop in borrowing costs by pushing issuance to a record. Corporate bond sales worldwide climbed to an all-time high of $3.2 trillion in 2009 and totalled at least $612 billion so far this year…”

March 19 – Bloomberg (Bradley Keoun): “Citigroup Inc., the bank 27% owned by the U.S. government, will ramp up purchases of mortgages underwritten by other firms and keep more loans on its balance sheet after reversing a plan to scale back home lending. Citigroup has decided mortgages are a ‘core’ product alongside consumer-banking staples savings accounts and credit cards, Sanjiv Das, who heads the… lender’s U.S. mortgage business, said... ‘In order to be full-service consumer bank we had to be able to offer mortgages to our customers’ Das said. ‘Then, we said, let’s now start to rebuild this business.’”

March 18 – Bloomberg (Tal Barak Harif and Ye Xie): “Japanese housewives and retirees are buying record amounts of Brazilian real-denominated bonds in international markets… Japanese mutual funds’ holdings of Brazilian bonds surged to a record 1.34 trillion yen ($14.8bn) in February from 431 billion yen a year earlier, according to the Investment Trusts Association.”

March 17 – Bloomberg (Michael Patterson): “The combination of record mutual fund inflows and the fastest economic growth are failing to lift shares in the largest developing nations with valuations at the highest level versus advanced countries since at least 1995. Emerging-market stock funds lured $86.6 billion in the year through January, the most in 14 years of data, according… EPFR Global.”

Global Government Finance Bubble Watch:

March 19 – Dow Jones (Luca Di Leo and Jeff Bater): “The U.S. Federal Reserve’s balance sheet expanded… in the latest week as the central bank’s huge holdings of mortgage-backed securities continued to grow. …the Fed said its asset holdings in the week ended March 17 grew to $2.311 trillion from $2.286 trillion a week earlier. Holdings of mortgage-backed securities rose to $1.066 trillion from $1.029 trillion a week earlier.”

March 16 – Bloomberg (Craig Torres and Scott Lanman): “Federal Reserve officials repeated their pledge to keep the main interest rate near zero for an ‘extended period’ and confirmed that emergency measures to prop up the housing market will end as planned this month. While the economy has ‘continued to strengthen,’ policy makers noted that ‘housing starts have been flat at depressed levels’ and ‘employers remain reluctant to add to payrolls.’”

March 19 – Bloomberg (Bryan Keogh): “Financial company bonds are beating industrial debt by the most this year after lagging behind in February… Bond sales…by JPMorgan, the second-largest U.S. bank by assets, and… Credit Suisse drove global financial debt issuance this month to at least $121 billion, surpassing February’s total by 22%...”

March 19 – Bloomberg (Nariman Gizitdinov): “The Development Bank of Kazakhstan, a state-owned bank that promotes industry, may cancel plans to sell $500 million of bonds to international investors this year after it received a $5 billion line of credit from China.”

Currency Watch:

The dollar index was 1.2% higher this week to 80.758 (up 3.7% y-t-d). For the week on the upside, the New Zealand dollar increased 0.8%, the South African rand 0.8%, and the Canadian dollar 0.2% For the week on the downside, the Brazilian real declined 2.1%, the Swedish krona 1.8%, the Euro 1.7%, the Danish krone 1.7%, the Norwegian krone 1.5%, the British pound 1.3%, the Mexican peso 0.4%, and the Swiss franc 0.3%.

Commodities Watch:

The CRB index slipped 0.2% (down 3.8% y-t-d). The Goldman Sachs Commodities Index (GSCI) declined 0.4% (down 0.6% y-t-d). Gold rose 0.5% to $1,107 (up 0.9% y-t-d). Silver was little changed at $17.032 (up 1.1% y-t-d). April Crude declined 56 cents to $80.68 (up 1.7% y-t-d). April Gasoline was unchanged (up 10% y-t-d), while April Natural Gas sank 5.3% (down 25% y-t-d). May Copper slipped 0.2% (up 0.8% y-t-d). May Wheat declined 0.3% (down 11% y-t-d), while May Corn gained 2.8% (down 10% y-t-d).

China Bubble Watch:

March 17 – Bloomberg (Sophie Leung): “The World Bank indicated that China… should raise interest rates to help contain the risk of a property bubble and allow a stronger yuan to help damp inflation expectations. The nation’s ‘massive monetary stimulus’ risks triggering large asset-price increases, a housing bubble, and bad debts from the financing of local-government projects, the… World Bank said… The group raised its economic growth forecast for this year to 9.5% from 9% in January.”

March 17 – Bloomberg (Bei Hu): “China is in the midst of ‘the greatest bubble in history,’ said James Rickards, former general counsel of hedge fund Long-Term Capital Management LP. The Chinese central bank’s balance sheet resembles that of a hedge fund buying dollars and short-selling the yuan, said Rickards, now the senior managing director for… Omnis Inc. ‘As I see it, it is the greatest bubble in history with the most massive misallocation of wealth,’ Rickards said…”

March 17 – Bloomberg (Jeremy van Loon): “China replaced the U.S. as the biggest investor in renewable energy for the first time in five years as the Asian nation raced to meet rising demand for power and reduce carbon emissions. China invested $34.5 billion in wind turbines, solar panels and other low-carbon energy technologies in 2009… The U.S. spent about half as much last year…”

Japan Watch:

March 18 – Bloomberg (Mayumi Otsuma and Aki Ito): “The Bank of Japan’s decision to double the size of a liquidity program for banks may prove more effective in placating the government than stemming deflation. The bank yesterday increased its three-month lending facility for banks to 20 trillion yen ($221bn), a ‘monetary easing’ that may help reduce borrowing costs and bolster corporate sentiment, Governor Masaaki Shirakawa said…”

India Watch:

March 20 – Bloomberg (Cherian Thomas and Anil Varma): “India’s central bank will probably raise interest rates again next month as the first increase in two years is only the initial step in the battle against inflation, BNP Paribas SA and Standard Chartered Plc said. The Reserve Bank of India yesterday increased the benchmark reverse repurchase rate to 3.5% from a record-low 3.25%... saying containing inflation has become ‘imperative.’ Governor Duvvuri Subbarao’s move comes after Australia and Malaysia increased rates this month, while Norway and Israel did so at the end of last year…”

March 17 – Bloomberg (Rakteem Katakey): “India, with $254 billion of foreign-exchange reserves, may create a sovereign wealth fund to help state companies compete for overseas energy assets with China, a government official said. The oil ministry has formally asked the finance ministry to set up a fund using a part of the reserves…”

Latin America Bubble Watch:

March 17 – Bloomberg (Iuri Dantas): “Brazil’s economy added a record number of jobs for the month of February as Latin America’s biggest economy expands at the fastest pace in two years. The Labor Ministry said… registered 209,425 jobs in February… Brazil will generate more than 2 million jobs this year…”

Bubble Economy Watch:

March 18 – Bloomberg (John Lauerman): “Harvard College, the undergraduate division of Harvard University, raised the cost of tuition, room, board and other fees 3.8% to $50,724 for the 2010- 2011 academic year.”

Central Bank Watch:

March 17 – Bloomberg (Craig Torres and Joshua Zumbrun): “Federal Reserve Chairman Ben S. Bernanke said the central bank shouldn’t be relegated to the role of regulating only the largest financial firms, as proposed by a draft bill in the Senate. ‘We are quite concerned by proposals to make the Fed a regulator only of the biggest banks,’ Bernanke told the House Financial Services Committee… ‘It makes us essentially the too-big-to-fail regulator. We don’t want that responsibility.’”

Central Bank Watch:

March 13 – Wall Street Journal (Sudeep Reddy and Jon Hilsenrath): “Janet Yellen's expected nomination as Federal Reserve vice chairman would bring a strong advocate of low interest rates into the central bank’s leadership just as the Fed weighs how to unwind its extraordinary intervention in the economy. For two other vacancies on the Fed’s board, the White House says it is considering Sarah Raskin, Maryland’s commissioner of financial regulation, and Massachusetts Institute of Technology economist Peter Diamond, an expert on Social Security, pensions and taxation… Fed Chairman Ben Bernanke, seeking to pick the appropriate time to tighten policy, is likely to get a set of new governors who support keeping interest rates low to help the economy recover. The likely nominees are expected to be a key counterweight to the Fed's most ‘hawkish’ policy makers…”

Real Estate Watch:

March 13 – Wall Street Journal (James R. Hagerty): “The number of U.S. households benefiting from lower mortgage payments under a government rescue program rose 6% last month to one million…”

Muni Watch:

March 17 – Bloomberg (Michael McDonald and Jerry Hart): “Florida temporarily suspended sales of Build America Bonds on concern that the Internal Revenue Service may block federal interest-cost subsidies, said Ben Watkins, who oversees the state’s debt sales. The… state… halted issuance after a recent conference call in which the IRS said it may offset the 35% subsidy payments if an issuer owes the federal government for other programs, such as Medicaid, Watkins said…”

March 18 – Bloomberg (Michael B. Marois and Catarina Saraiva): “California, the largest U.S. issuer of municipal debt, is pursuing its next sale of Build America Bonds, even as Florida suspended its offerings on concern that the Internal Revenue Service may block interest-cost subsidies. ‘We plan to go full speed ahead with our BABs,’ Tom Dresslar, spokesman for California Treasurer Bill Lockyer, said…”

Speculation Watch:

March 13 - Financial Times (Francesco Guerrera, Henny Sender and Patrick Jenkins): “The fallout from the report into the collapse of Lehman Brothers shook Wall Street and London on Friday as US officials grilled banks about off balance-sheet trades and questions were raised over the City’s role in the company’s attempts to cover up its problems. The 2,200-page report by Anton Valukas, appointed by a US court to probe the reasons for Lehman’s failure in September 2008, paints a damning picture of the bank’s top management…”

Greenspan on The Crisis:

“The house price bubble, the most prominent global bubble in generations, was engendered by lower interest rates, but it was long term mortgage rates that galvanized prices, not the overnight rates of central banks, as has become the seeming conventional wisdom.” Alan Greenspan, March 19, 2010

The net annual increase in U.S. Total Mortgage Debt (TMD) averaged $265bn during the decade of the nineties. Implementing its post-tech Bubble reflation, the Fed continued to aggressively slash interest rates late into 2002. This was despite a rapid acceleration in mortgage debt growth. TMD expanded a record $901bn in 2002, a heady 12.1% pace. The Fed cut rates from 1.25% to 1% one final time for that cycle in June, 2003. Not surprisingly, already hot mortgage finance turned white-hot. TMD expanded a record $1.004 TN in 2003 (12.0%), boosting six-year growth to 83% (and almost four-times the annual rate from the nineties!). It should have been clear to the Fed by 2003 that it was dealing with a major financial Bubble. It was apparently at the time focused on deflationary risks.

TMD growth accelerated further during 2004, increasing $1.263 TN (13.5%). Fed funds were finally adjusted 25 bps higher at mid-year, yet ended 2004 at only 2.25%. TMD growth surged further into uncharted territory, increasing $1.439 TN in 2005. By mid-year, rates had been raised to 3.25% before ending the year at 4.25%. Home prices around much of the country were inflating at double-digit rates. Baby-step rate increases continued throughout 2006. By year-end, fed funds were at 5.25%, with 2006 TMD growth of another $1.40 TN. By the end of 2007, TMD had doubled in only six years and was up 185% over 10 years.

The growth trajectory of our Current Account Deficits followed that of mortgage debt. The deficit jumped to $215bn in 1998 (from $141bn); then to $302bn in 1999 and to $417bn in 2000. Atypically of a recessionary backdrop, the Current Account Deficit remained at an enormous $400bn in 2001. Specifically, consumption had been boosted by the huge Fed-induced growth in mortgage debt, home price inflation, and equity extraction. The deficit then jumped to $459bn in 2002, $522bn in 2003, $631bn in 2004, $749bn in 2005, and a record $804bn in 2006 – closely paralleling ballooning mortgage debt growth.

Alan Greenspan presented a paper today at a Brookings Institution conference titled “The Crisis.” His paper is 45 pages, and I haven’t yet had a chance to dive fully into it. But what I’ve read thus far is deserving of some Friday afternoon comments.

Mr. Greenspan: “In short, geopolitical events ultimately led to a fall in long-term mortgage interest rates that in turn led, with a lag, to the unsustainable boom in house prices globally.”

The historical fact of the matter is that the Greenspan Fed mistakenly accommodated both the Bubble in U.S. mortgage Credit and the resulting unprecedented Current Account Deficits. Somehow, Mr. Greenspan, Dr. Bernanke and others will still argue that the massive outflow of dollar liquidity to the world – that was largely monetized by foreign central banks – was not the primary catalyst for the destabilizing decline in global market yields. And perhaps they would argue that Federal Reserve policy – including rapid rate cuts and telegraphed baby-step increases and talk of “helicopter money” and “unconventional measures” - didn’t entice speculative leveraging throughout the market for GSE and “private-label” MBS. And I doubt Greenspan will concede that his position as the leading proponent for derivatives, hedge funds and contemporary Wall Street finance, more generally, was a major factor promoting their fateful runaway expansion. Cllearly, Greenspan and Bernanke refuse to acknowledge that they looked the other way as the GSEs ran completely out of control.

It’s just hard for me these days to stomach the same flawed dogma that the financial crisis was caused by some nefarious “global saving glut.” It was caused by a Credit Bubble whose epicenter was in Washington and New York. The crisis was all about the consequences from a historic government-induced mispricing and inflation of Credit. At its core, the crisis manifested from a massive inflation of financial obligations by the Credit system commanding the world’s reserve currency. There is plenty of blame to go around, but the ongoing saga will surely be viewed as a case of monumental central banking mismanagement.

Mr. Greenspan: “We had been lulled into a sense of complacency by the only modestly negative economic aftermaths of the stock market crash of 1987 and the dot-com boom. Given history, we believed that any declines in home prices would be gradual. Destabilizing debt problems were not perceived to arise under those conditions.”

I don’t buy it. After the 1987 stock market crash, the 1994 bond market crisis, the 1995 Mexican meltdown, the 1996/97 Asian crisis, the 1998 Russian collapse and LTCM debacle, Brazil, the Y2K scare, Argentina, the technology stock collapse, the corporate debt crisis, and the 9/11 disaster – how on earth could there have been a shred of complacency anywhere within the Federal Reserve system? Clearly, major changes in the nature of contemporary finance had increased risk-taking and systemic fragilities. I believe the opposite of complacency was likely at work. Fragile underpinnings and Bubble dynamics throughout mortgage finance had the Fed hamstrung to baby-step timidity – and it was this submissive approach to financial regulation that really fed the U.S. and global Credit Bubble.

I do agree with Mr. Greenspan when he writes that pricking Bubbles does not come without economic pain. But the key to monetary management – certainly not recognized by Greenspan - is to ensure that Bubble risk doesn’t inflate to the point where policymakers are afraid to employ restraint and discipline the instigators of excess. There must be rules of the road that work to restrain excessive risk-taking rather than promote it.

It appears Mr. Greenspan has, again, missed his opportunity to come clean and admit that the Greenspan/Bernanke doctrine of ignoring Bubbles and focusing instead on “mopping up” strategies was fundamentally flawed and a historic disaster in monetary management. Don’t blame complacency. The issue was flawed central banking doctrine and a dogmatic hands-off approach to monetary (mis)management.

Mr. Greenspan: “The primary imperative going forward has to be (1) increased regulatory capital and liquidity requirements on banks and (2) significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutions making the trades…”

It is not clear to me how increased capital standards coupled with liquidity and collateral requirements is going to restrain global central bank balance sheets and contain fiscal deficits. I don’t see how these measures will counteract the deep distortions in the market pricing and allocation of finance today throughout the global financial system. This “primary objective” will have no meaningful impact on the unfolding government finance Bubble or upon structural economic imbalances. A focus on private-sector Credit is fighting the last war.

Mr. Greenspan: “Unless there is a societal choice to abandon dynamic markets and leverage for some form of central planning, I fear that preventing bubbles will in the end turn out to be infeasible. Assuaging their aftermath seems the best we can hope for.”

This is the best we can hope for? As we have witnessed for (at least) the past 18 months now, there is not a more powerful apostle for central planning than the hardship and confusion associated with the bursting of a major Credit Bubble. Cannot Mr. Greenspan today at least question the danger to free markets occasioned by central banks’ manipulation of market interest rates and their repeated market interventions?

I wish we could implement a gold standard. Global Credit systems and economies are in dire need of a mechanism that would work to promote at least a semblance of stability. Regrettably, at this stage of massive global debt and synchronized global inflationism, a gold-based monetary regime is implausible. As such, I am a proponent of sound central banking – the kind that doesn’t exist today. It’s our last resort. And it’s in this vein that I am so frustrated with Mr. Greenspan. He just refuses to address the dangerous flaws of contemporary central banking.

So we learn so little from the past and set course for another historic Bubble – The Global Government Finance Bubble. Flawed central banking doctrine leads to mistake after bigger mistake. The consequences of previous government market interventions ensure only more intrusive interference. And Alan Greenspan, the seeming free-market ideologue, works to ensure he goes down in history as the father of modern inflationism.

03/05/2010 A Year in Reflation *

For the week, the S&P500 jumped 3.1% (up 2.1% y-t-d), and the Dow gained 2.3% (up 1.3%). The broader market has been exceptionally strong. The S&P 400 Mid-Caps surged 4.3% (up 6.0%), and the small cap Russell 2000 jumped 6.0% (up 6.5%). The Banks jumped another 2.4% (up 13.8%), and the Broker/Dealers rose 3.0% (up 2.2%). The Morgan Stanley Cyclicals surged 4.8% (up 4.4%), and the Transports increased 1.5% (up 2.3%). The Morgan Stanley Consumer index gained 2.7% (up 2.8%), and the Utilities rose 2.8% (down 4.6%). The Nasdaq100 jumped 3.8% (up 1.5%), and the Morgan Stanley High Tech index gained 3.6% (up 0.3%). The Semiconductors rose 3.7% (down 2.3%). The InteractiveWeek Internet index jumped 4.8% (up 2.2%). The Biotechs surged 12.7%, increasing 2010 gains to 24.5%. With bullion up almost $15, the HUI gold index jumped 6.1% (down 0.3%).

One-month Treasury bill rates ended the week at 9 bps, and three-month bills closed at 13 bps. Two-year government yields jumped 8 bps to 0.81%. Five-year T-note yields gained 4 bps to 2.26%. Ten-year yields increased 7 bps to 3.68%. Long bond yields jumped 9 bps to 4.64%. Benchmark Fannie MBS yields were little changed at 4.33%. The spread between 10-year Treasury and benchmark MBS yields narrowed 7 to 65 bps. Agency 10-yr debt spreads increased 2 to 36 bps. The implied yield on December 2010 eurodollar futures rose 7 bps to 0.875%. The 10-year dollar swap spread was cut in half to 4.25, and the 30-year swap spread declined 2 to negative 16. Corporate bond spreads narrowed. An index of investment grade bond spreads narrowed 3 to 89 bps, and an index of junk spreads narrowed 2 to 520 bps.

Debt issuance picked up to a respectable $20.0bn (from Bloomberg). Investment grade issuers included Dexia Credit $4.0bn, Goldman Sachs $2.0bn, Time Warner $2.0bn, Republic Services $1.5bn, Baxter International $600 million, John Deere $500 million, US Bancorp $500 million, Johnson Controls $500 million, Southwestern Electric Power $350 million, Puget Sound Energy $325 million, Teco Finance $550 million, Public Service E&G $300 million, and Western Massachusetts Electric $95 million.

Junk bond funds saw inflows of $314 million. Junk issuers included HCA $1.4bn, Masco $500 million, Avis Budget Car Rental $450 million, TW Telecom $430 million, Alliance Oil $350 million, Solutia $300 million, Reddy Ice $300 million, Pioneer Drill $250 million, Zayo Group $250 million, Conexant Systems $175 million, Express $250 million, and Holly Energy $150 million.

I saw no converts issued.

International dollar debt sales remain robust. Issuers included Mexico $2.0bn, South Africa $2.0bn, Export-Import Bank of Korea $1.0bn, Rabobank $1.0bn, and Bank of Moscow $750 million.

U.K. 10-year gilt yields added 3 bps to 4.06%, and German bund yields increased 5 bps to 3.15%. Bond yields in Greece dropped 30 bps to 6.06%. The German DAX equities index surged 5.0% (down 1.3% y-t-d). Japanese 10-year "JGB" yields were little changed at 1.30%. The Nikkei 225 was up 2.4% (down 1.7%). Emerging markets were mostly strong. For the week, Brazil's Bovespa equities index jumped 3.5% (up 0.4%), and Mexico's Bolsa increased 2.5% (up 1.0%). Russia’s RTS equities index surged 5.7% (up 4.6%). India’s Sensex equities index rallied 3.3% (down 2.7%). China’s Shanghai Exchange slipped 0.7% (down 7.5%). Brazil’s benchmark dollar bond yields sank 14 bps to a 2010 low 4.84%, and Mexico's benchmark bond yields dropped 20 bps to a record low 4.80%.

Freddie Mac 30-year fixed mortgage rates dropped 8 bps to 4.97% (down 18bps y-o-y). Fifteen-year fixed rates fell 7 bps to 4.33% (down 39bps y-o-y). One-year ARMs jumped 12 bps to 4.27% (down 59bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down a basis point to 5.87% (down 101bps y-o-y).

Federal Reserve Credit declined $6.7bn last week to $2.263 TN. Fed Credit is up $371bn, or 19.6%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 3/3) rose $4.4bn to a record $2.969 TN. "Custody holdings" expanded $372bn, or 14.3%, over the past year.

M2 (narrow) "money" supply rose $10.3bn to $8.537 TN (week of 2/22). Narrow "money" has increased $25.3bn y-t-d. Over the past year, M2 expanded 1.9%. For the week, Currency increased $2.2bn, while Demand & Checkable Deposits slipped $0.6bn. Savings Deposits increased $13.9bn, while Small Denominated Deposits declined $4.2bn. Retail Money Funds fell $2.2bn.

Total Money Market Fund assets (from Invest Co Inst) increased $1.7bn to $3.168 TN. In the first nine weeks of the year, money fund assets dropped $126bn, with a one-year drop of $738bn, or 18.9%.

Total Commercial Paper outstanding dropped $20.3bn last week to $1.134 TN. CP has declined $36.4bn, or 18.0% annualized year-to-date, and was down $347bn over the past year (23.4%).

International reserve assets (excluding gold) - as tallied by Bloomberg’s Alex Tanzi – were up $1.160 TN y-o-y, or 17.4%, to a record $7.821 TN.

Global Credit Market Watch:

March 3 – New York Times (Landon Thomas Jr.): “As Greece’s debt troubles batter the euro, Britain has done its utmost to stay above the fray. Until now, that is. Suddenly, investors are asking if Britain may soon face its own sovereign debt crisis if the government fails to slash its growing budget deficits quickly enough to escape the contagious fears of financial markets… Without a strong political majority to tackle Britain’s lumbering fiscal problems, investors could start to make it greatly more expensive for the government to raise funds, setting the stage for a potential double-dip recession, if not worse. ‘If you really want a fiscal problem, look at the U.K.,’ said Mark Schofield, a fixed-income strategist at Citigroup. ‘In Europe, the average deficit is about 6% of G.D.P. and in the U.K. it’s 12%. It is only just beginning.’”

March 4 – Bloomberg (Caroline Salas): “The thawing of the credit markets in 2009 spawned record debt sales as companies sought to ensure they had enough capital to run their businesses and meet their debt obligations. Corporate bond sales worldwide climbed 31% to $3.04 trillion and issuance of high-yield, high-risk securities -- the most lucrative market for underwriters -- ballooned by 181% to $207 billion… Both set records. The new bond issues earned bankers $18.8 billion in fees from debt underwriting, a 31% increase over 2008 and equal to the record set in 2007.”

March 4 – Bloomberg (Rebecca Christie and Phil Mattingly): “The Obama administration’s legislative draft of the so-called Volcker Rule incorporated exemptions that may ease the impact on financial markets should it be enacted. President Barack Obama… sent Congress the five-page proposal to ban proprietary trading and block mergers that give banks more than a 10% market share… It also would bar banks from owning or investing in hedge funds and private equity firms… left out are trading in Treasury and agency securities, including debt issued by Ginnie Mae, Fannie Mae and Freddie Mac. Such exemptions may help to avoid market disruptions that could affect small investors, said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ…”

March 1 – Bloomberg (Joel Schectman and Sapna Maheshwari): “The 8.8-magnitude earthquake that struck Chile last week may cost insurers more than $2 billion, according to catastrophe-modeling firm AIR Worldwide. The earthquake killed more than 700 people, cut off the nation’s main highway, knocked out power lines and damaged 1.5 million homes, officials said. Economic losses may exceed $15 billion…”

Global Government Finance Bubble Watch:

March 5 – Bloomberg (Caroline Salas and Jody Shenn): “The Federal Deposit Insurance Corp. sold $1.81 billion of debt backed by mortgage securities, as it seeks to raise cash after the worst financial crisis since the Great Depression.”

March 5 – Bloomberg: “China will sell 200 billion yuan ($29.3bn) of bonds for a second year to help local governments fund infrastructure projects, Premier Wen Jiabao told today’s annual meeting of the National People’s Congress… The central government’s role in local debt sales has reduced the cost of building roads and railways as part of a two-year $586 billion spending package…”

March 4 – Bloomberg (Andres R. Martinez and Jens Erik Gould): “Mexico’s sale of $1 billion in 10-year international bonds today was 2.5 times oversubscribed, said Gerardo Rodriguez, head of the public debt unit at the Finance Ministry. They sold at the lowest yield ever… The government sold 60% of the debt to investors in the U.S., 28% to Europe, 10% to Mexico and 2% to Asia, Rodriguez said… Favorable market conditions for the debt sale were present for the past eight to 10 days, he said. ‘This was a very interesting opportunity to access the market,’ Rodriguez said. ‘We saw a very clear window of opportunity.’”

Currency Watch:

March 3 – Reuters: “Chinese commercial banks absorbed about $170 billion in foreign exchange from the financial system last year, mainly through yuan-dollar swaps, state media…cited a former official as saying. …the State Administration of Foreign Exchange (SAFE), the foreign exchange regulator, absorbed about 1 trillion yuan through the swaps in 2009. SAFE is an arm of the central bank and is in charge of foreign exchange policy and managing the country’s $2.4 trillion in foreign reserves. Authorities have been struggling to absorb a massive amount of yuan liquidity that has flowed into the interbank market as a result of inflows of foreign exchange from the trade surplus, foreign investment and speculative capital.”

February 28 – Bloomberg (Bo Nielsen): “The rise of carry trades, in which investors take advantage of interest-rate differences between countries, may signal bigger swings in currencies during crises, the Bank for International Settlements said. Variations in interest rates played a larger role in the latest financial turmoil than in either the Asian financial crisis of 1997-1998, or following the Russian debt default in 1998… That may reflect the ‘increasing role carry trades play in exchange rate movements,’ it said. ‘This factor may have changed the dynamics of exchange rates around crises more generally, affecting a broader set of currencies and leading to more pronounced swings in exchange rates during and after crisis episodes,’ the BIS said.”

The dollar index was little changed this week at 80.46 (up 3.3% y-t-d). For the week on the upside, the South African rand increased 4.2%, the Canadian dollar 2.1%, the South Korean won 1.7%, the Brazilian real 1.7%, the Australian dollar 1.4%, the Mexican peso 1.1%, the Singapore dollar 0.5%, and the Taiwanese dollar 0.5% For the week on the downside, the Japanese yen declined 1.5%, the British pound 0.7%, and the New Zealand dollar 0.2%.

Commodities Watch:

March 1 – Bloomberg (David Wilson): “Rising commodity costs threaten an anticipated resurgence in U.S. corporate profits, according to Adam S. Parker, a Sanford C. Bernstein & Co. strategist. The… year-to-year percentage changes in U.S. producer prices for crude goods, primarily commodities, on an overall basis and excluding food and energy. Both gauges surged from record lows, set last year, and Parker cited the overall index in a report today. ‘Headwinds on commodity costs’ are likely to hold back earnings growth by the second half, Parker wrote. Makers of consumer staples, including food and beverages, and capital- equipment producers are most at risk, in his view.”

The CRB index gained 0.8% (down 2.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) rallied 1.7% (up 0.3% y-t-d). Gold gained 1.3% to $1,132 (up 3.2% y-t-d). Silver jumped 5.1% to $17.37 (up 3.1% y-t-d). April Crude rose $2.08 to $81.74 (up 3.0% y-t-d). April Gasoline rallied 4.1% (up 11% y-t-d), while April Natural Gas dropped 4.5% (down 17.5% y-t-d). May Copper jumped 4.2% (up 2.3% y-t-d). March Wheat dropped 5.0% (down 8.9% y-t-d), and March Corn declined 3.5% (down 9.4% y-t-d).

China Bubble Watch:

March 3 – Bloomberg: “China’s hidden borrowing may push government debt to 96% of gross domestic product next year… Professor Victor Shih said. ‘The worst case is a pretty large-scale financial crisis around 2012,’ said Shih, a political economist at Northwestern University… who spent months researching borrowing transactions by about 8,000 local-government entities…Surging borrowing by local-government entities, uncounted in official estimates of China’s debt-to-GDP ratio, is the key reason for Shih’s concern… By Shih’s count, China’s debt may reach 39.838 trillion yuan ($5.8 trillion) next year. His forecast for debt-to-GDP compares with an International Monetary Fund estimate for China of 22% this year, which excludes local-government liabilities. The IMF sees Spain at 69.6%, the U.S. at 94%, Greece at 115% and Japan at 227%.”

March 3 – Bloomberg (Simon Packard): “China overtook the U.S. as the world’s biggest property investment market last year and will probably keep the lead in 2010 on economic growth and a lower reliance on debt, Cushman & Wakefield LLP said. Real estate investment in China more than doubled to $156.2 billion last year, while the total for the U.S. slumped 64% to $38.3 billion… Excluding residential investments, the U.S. came third after China and the U.K.”

March 3 – Bloomberg: “China’s economy, the world’s third biggest, will top last year’s 8.7% growth in 2010, said Su Ning, a central bank deputy governor. ‘China’s economy will perform better than last year,’ Su said… He said that he was referring to the ‘pace, structure and growth quality.’”

March 4 – Bloomberg (Joji Mochida): “China’s sharpest import increase on record in January signals an export surge through at least this quarter, reducing the impact of monetary tightening on economic growth, Nomura Institute of Capital Markets Research said… ‘The latest data portends that exports will increase sharply in the first quarter of this year. A surge in overseas shipments would allow China to consider revaluation of the yuan.’ Imports rose 56% in December and 86% in January from the same periods a year earlier, driven by shipments of metals including copper and aluminum.”

March 3 – China Knowledge: “China’s exports of electronics and information technology products jumped 38.5% in January, according to… the Ministry of Industry and Information Technology. The export value of Chinese electronics and IT products reached US$37.35 billion in the period, accounting for 34.1% of the country's total exports.”

March 3 – Bloomberg: “China’s airlines flew 59% more passengers internationally in February compared with last year, the country’s civil aviation director Li Jiaxiang said…”

Japan Watch:

March 1 – Bloomberg (Makiko Kitamura): “Toyota Motor Corp. and Honda Motor Co., Japan’s two biggest automakers, led the seventh straight increase in the nation’s monthly auto sales… Sales of cars, trucks and buses, excluding minicars, rose 35% to 294,887 vehicles in February from a year earlier…”

India Watch:

March 4 – Bloomberg (Kartik Goyal): “India’s food-price inflation rate stayed above 17% for a sixth week and may accelerate after truckers raised freight rates citing higher fuel costs.”

Asia Bubble Watch:

March 3 – Bloomberg (Nguyen Kieu Giang): “Vietnam’s banking credit rose 1.14% in February from a month earlier, raising concerns that the government may fail to achieve its 25% loan growth target for the year.”

Latin America Bubble Watch:

March 4 – Bloomberg (Laura Price and Juan Pablo Spinetto): “Brazil’s economy may overheat as too much foreign investment flows into the country, said Luciano Coutinho, president of state development bank BNDES. ‘We are worried about excessive inflow or excessive growth this year,’ Coutinho said…He added that the government is seeking economic growth of 5% to 5.5% in 2010.”

March 5 – Bloomberg (Adriana Brasileiro and Andre Soliani): “Brazil’s inflation quickened in February to the fastest pace in 21 months, cementing expectations the central bank will raise interest rates no later than April. Consumer prices, as measured by the benchmark IPCA price index, jumped 0.78% in February…”

March 1 – Bloomberg (Alexander Ragir and Tal Barak Harif): “Buyout firms are poised to spend $9 billion in Brazil on everything from infrastructure to oil exploration as the economy recovers from a recession, the nation’s private equity and venture capital association said.”

March 1 – Bloomberg (Eliana Raszewski): “Argentine inflation is poised to accelerate as President Cristina Fernandez de Kirchner gains access to as much as 24.7 billion pesos ($6.4 billion) in central bank profits to help her avoid cutting spending.”

March 2 – Bloomberg (Daniel Cancel): “Venezuela will raise prices on some food goods 11% to 47% following the devaluation of the bolivar and a drought that has cut production, El Nacional said…”

Unbalanced Global Economy Watch:

March 1 – Bloomberg (Greg Quinn): “Canada’s economy expanded at a 5% annualized rate in the fourth quarter, faster than predicted by the Bank of Canada, raising pressure on policy makers to increase interest rates later this year. Gross domestic product grew at the fastest pace since the third quarter of 2000…”

March 5 – Bloomberg (Theophilos Argitis and Greg Quinn): “Canadian Prime Minister Stephen Harper’s five-year plan to cut defense spending, foreign aid and government operations won’t be rejected by opposition lawmakers, putting the country on course to be the first in the Group of Seven to erase its deficit.”

March 1 – Bloomberg (Scott Hamilton): “U.K. mortgage approvals dropped in January by more than economists forecast to an eight-month low, adding to evidence that the housing-market recovery may be losing momentum.”

March 3 – Bloomberg (Steve Bryant): “Turkey’s inflation rate rose in February to 10.1% from 8.2% a month earlier…”

Central Bank Watch:

March 4 – Bloomberg (Christian Vits): “The European Central Bank may have to decide just how much it’s prepared to allow Greece dictate monetary policy for the euro region as a whole... ‘With a Greek roadblock on the exit lane, the ECB will have to drive carefully,’ said Carsten Brzeski, an economist at ING Group… ‘The one-size-fits-all approach isn’t functioning when there are divergent trends in the member states.’”

March 1 – Bloomberg (Craig Torres and Peter Cook): “Federal Reserve Bank of Richmond President Jeffrey Lacker said the central bank is ‘being made a scapegoat’ to satisfy anger over bailouts as Congress seeks to limit its consumer-protection and bank-supervision powers. ‘People are mad at us,’ Lacker said… ‘I can understand the ire after what happened in 2008. It was so unexpected, and it seemed to over- step boundaries that everyone thought we were going to obey.’ Lacker said he wouldn’t ‘second guess’ moves by Federal Reserve Chairman Ben S. Bernanke to backstop non-bank financial institutions… He said proposals to curtail the Fed’s supervision authority would weaken its ability to lend to banks.”

March 1 – Wall Street Journal (David Wessel and Jon Hilsenrath): “Donald L. Kohn, the 67-year-old vice chairman of the Federal Reserve Board who has been a close adviser to Fed chairmen Ben Bernanke and Alan Greenspan, said he will step down from the post when his term ends in June. The retirement gives President Barack Obama a third seat to fill on the seven-member Fed board… ‘At no time since the Great Depression have this ability and dedication been tested as they have been over the past several years,’ Kohn said in a letter to Mr. Obama. ‘I am confident that history will judge the Federal Reserve, under the leadership of Chairman Ben Bernanke, to have met these challenges with great speed, imagination, and effectiveness.’”

Real Estate Watch:

March 4 – Bloomberg (Courtney Schlisserman): “Fewer Americans than expected signed contracts to purchase previously owned homes in January, indicating the extension of a tax credit is doing little to lure buyers… The drop in contract signings adds to evidence the housing market at the center of the worst recession since the 1930s is struggling to rebound…”

GSE Watch:

March 5 – Bloomberg (Dawn Kopecki): “Fannie Mae and Freddie Mac bondholders shouldn’t assume the government will make them whole on their investments as Congress retools the companies, House Financial Services Committee Chairman Barney Frank said. ‘Please don’t think this is federally guaranteed, I don’t think it is, I don’t think it should be, I don’t feel any obligation to bail you out,’ Frank told reporters… Congress will ‘certainly not’ extend any new protections to bond and mortgage-security investors beyond what exists, Frank said. A ‘whole range’ of options is being considered for investors in the two government-seized companies, ‘from paying nothing to a haircut to whatever,’ Frank said.”

March 4 – MarketNews International (Yali N'Diaye): “Amid reports that government-sponsored enterprises are preparing to ask lenders to repurchase over $20 billion of loans that they originated, a Freddie Mac spokesman said… his company is simply being responsible with taxpayers’ money. He added that loan repurchase requests are the result of an aggressive quality control policy, although rising delinquencies are also a driver of the increasing amounts of repurchase requests.”

New York Watch:

March 3 – New York Times (Patrick McGeehan): “In fall 2008, after Lehman Brothers collapsed and other Wall Street firms seemed ready to topple, New York appeared to be headed for a brutal recession, one that would rival the worst downturns in the city’s history. Now city officials and private economists are revising their forecasts with a drastic change in tone. The gathering consensus is that the recession is nearly over in the city and, largely because of the enormous amount of federal aid poured into the big banks, the toll on New York will be much less severe than most had feared.”

Muni Watch:

March 5 – Bloomberg (Terrence Dopp): “New Jersey Transit proposed raising fares by a record 25 percent system-wide and reducing service to help close a $300 million budget deficit.”

Speculation Watch:

March 3 – Bloomberg (Ben Moshinsky): “Banks and regulators across Europe were summoned by the European Commission to discuss regulation of the market for sovereign credit default swaps in the wake of the Greek debt crisis. The European Union’s executive agency will hold a meeting in Brussels ‘shortly,’ Chantal Hughes, a commission spokeswoman, said…”

March 3 – Bloomberg (Katherine Burton and David Scheer): “The U.S. is asking hedge funds not to destroy trading records on euro bets, according to a person with knowledge of the requests, as Europe and the U.S. step up scrutiny of the funds’ role in the Greek debt crisis.”

March 5 – Bloomberg (Netty Ismail): “Singapore is planning to create its own hedge-fund capital modeled after Greenwich, Connecticut, in a cluster of ex-British army homes called Nepal Hill, a 15-minute cab-ride from the city-state’s main banking district.”

A Year in Reflation:

This week marked the one-year anniversary of a historic stock market rally. The S&P500 enjoys a one-year gain of 66.8%. The broader market has fared even better. The small cap Russell 2000 and S&P400 Mid-Caps sport 12-month gains of 90.6% and 87.4%. The past year also witnessed record junk debt issuance and an amazing turnabout in financial conditions. Housing markets may be stuck in the mud, but government-induced reflation has worked wonders for equities, corporate debt and global risk assets more generally.

Long-time readers may have noticed that awhile back I stopped the weekly presentation of bank Credit and asset data. For the record, bank Credit declined $470bn over the past year, or about 5%. I specifically have not emphasized this bank contraction, believing it had become a deceptive indicator of financial conditions. Also luring in those anticipating deflationary conditions, M2 “money supply” expanded just under 2% over the past year. There has been no reason to fret a substandard $200bn one-year expansion of narrow “money,” not with Treasury and agency securities inflating a couple Trillion and the Fed monetizing a Trillion of MBS.

One year ago, the Federal Reserve held $69bn of mortgage-backed securities. Their hoard now surpasses $1.027 TN. Over the past year, Treasury has run deficits of about $1.5 TN. Our government’s “electronic printing press” has dispersed unprecedented purchasing power to households and businesses throughout the economy. The Fed’s Trillion dollar monetization has unleashed unmatched liquidity throughout the financial markets.

March 5 – Bloomberg (Wes Goodman): “Investors plowed a record $2.6 billion into global bond funds in the week ended March 3, moving out of money markets to seek higher returns because of the threat of quickening inflation, EPFR Global said… U.S. bond funds drew in $2 billion, attracting cash for a 61st straight week… ‘Flows into these funds remained incredibly robust in early March,’ EPFR said. ’Cash continues to flee the safe havens of 2006-08.’”

Brazil’s Bovespa gained 84.2% in 12 months, Mexico’s Bolsa 86.8%, and Argentina’s Merval 140.8%. In Asia, China’s Shanghai Composite gained 36.5%, Hong Kong’s Hang Seng 70.2%, Taiwan’s Taiex 65.3%, South Korea’s Kospi 54.4%, Australia’s S&P/ASX 200 49.5%, the Thai index 73.6%, the Jakarta Composite 100.2%, and the Ho Chi Minh index 108.1%. In Europe, the Prague stock index has gained 80.8%, Budapest 131.3%, and Russia’s RTS index 170.1%. Emerging Market debt spreads (EMBI) were above 730 a year earlier, yet closed this week below 300 bps. Mexican bond yields traded to a record low today (4.80%). Over the past year, the South African rand has gained 43%, the Australian dollar 42%, the New Zealand dollar 39.5%, the South Korean won 37.5%, the Brazilian real 34.5%, the Swedish krona 30.8%, and the Canadian dollar 25.6%. The price of crude oil has almost doubled in 12 months, and the CRB Commodities index has gained 35%.

Over the past six weeks of Greek and European debt consternation, emerging debt markets remained notably resilient. Brazil’s 10-year dollar bond yields barely traded above 5.3%, while Mexico’s yields stayed below 5.2%. Around the world, debt markets hardly flinched. It is also worth mentioning that Greece’s bond offering yesterday was three times oversubscribed. They had to pay up somewhat (6.385%), but there was no shortage of bids.

At this point, global reflationary forces appear well entrenched. There is little indicating that the dollar’s rally is forcing the unwind of the so-called “dollar carry trade.” It is difficult to identify signs of deleveraging and fading liquidity. There are instead indicators pointing to unrelenting liquidity overabundance. If this were an environment with tight global financial conditions, Greece would likely be in a heap of trouble. In a backdrop of risk aversion and deleveraging, Greek contagion would likely be a serious global issue. In some ways, the Greece debt crisis is providing a litmus test for the global risk and liquidity backdrop. At least so far, there is ample confirmation of extraordinarily loose global financial conditions.

After the bursting of the technology Bubble, the Federal Reserve was content to live with mortgage excesses as it worked toward its objective of systemic reflation. The post-Bubble focus was to make sure the bad guys were punished (Enron, Worldcom, Arthur Anderson, etc.) and that accounting rules were significantly tightened up. The causes behind the system’s proclivity toward dangerous financial excess – the root of the problem – were so easily disregarded. The Greenspan/Bernanke Fed’s overriding objectives were to ensure abundant cheap liquidity and foment reflationary forces. I am unsympathetic to Federal Reserve President Jeffrey Lacker’s assertion this week that the Fed is “being made a scapegoat.”

Today, the Fed’s overriding objective – understood in the markets more clearly than ever - remains ensuring abundantly cheap liquidity. This period’s bad guys – the bankers – are under the spotlight, as the focus for this round of reform turns to ensuring that the banks are not the instigators of future crises. And I expect the “Volcker rule” to be about as successful as the Sarbanes-Oxley Act when it comes to protecting the system from financial excess and devastating Bubbles.

March 4 – Bloomberg (Rebecca Christie and Phil Mattingly): “The Obama administration’s legislative draft of the so-called Volcker Rule incorporated exemptions that may ease the impact on financial markets should it be enacted. President Barack Obama… sent Congress the five-page proposal to ban proprietary trading and block mergers that give banks more than a 10% market share… It also would bar banks from owning or investing in hedge funds and private equity firms. The rule, which is aimed at reducing the risk of another financial crisis, exempts mergers that exceed the market-share limit in cases when a firm acquires a failing bank with regulators’ approval. Also left out are trading in Treasury and agency securities, including debt issued by Ginnie Mae, Fannie Mae and Freddie Mac.”

Throughout the post-tech Bubble reflationary period, mortgage Credit expansion was viewed as integral to the solution. Mortgage finance was basically off limits from a regulatory standpoint, with this dynamic providing major impetus for historic Credit and speculative excess. Rather than recognizing an unfolding mortgage finance Bubble as a systemic risk, policymakers were content to feed the excess and look the other way. Of course, a speculative marketplace figured this all out and took full advantage. The government’s multifaceted (Fed, GSEs, Treasury, etc.) support of mortgage finance fanned speculative excess and directly fueled the Bubble.

These days, the Administration’s watered-down “Volcker rule” – which will likely be diluted to water-like reform legislation in Congress – excludes the government debt markets from proprietary trading restrictions. Government finance is today’s unfolding Bubble and, not surprisingly, this Bubble is off limits for regulatory reform. Government deficits are integral to the Bubble, and there will be no serious effort to rein them in. The Fed’s balance sheet is a serious Bubble issue, but it also remains untouchable. Treasury, GSEs, and Federal Reserve Credit are viewed as the solution, and a historic Bubble is emboldened and builds momentum.

The markets’ perception of “too big to fail” has for years been an integral facet of Bubble dynamics. And despite all the talk of trying to rid the marketplace of this notion, the markets remain more persuaded than ever: the unfolding global government finance Bubble is much too gigantic for policymakers to risk letting it come anywhere close to failing. Massive U.S. deficits and near-zero interest rates ensure a steady flow of finance (newly created as well as an ongoing exodus out of low-yielding instruments) to debt markets around the world. Confidence runs high that ultra-loose U.S. financial conditions will continue to underpin Credit expansions globally. Politicians may talk tough, and they do put on a good show. Meanwhile, markets function with reticent aplomb, knowing they’ve got policymakers right where they want them.

03/12/2010 Q4 2009 Flow of Funds *

For the week, the S&P500 gained 1.0% (up 3.1% y-t-d), and the Dow added 0.6% (up 1.9% y-t-d). The Banks surged 3.8% (up 18.1%), while the Broker/Dealers increased 1.1% (up 3.3%). The S&P500 Regional Bank index jumped 5.5%, increasing y-t-d gains to 24.1%. The Morgan Stanley Cyclicals added 1.3% (up 5.7%), and the Transports jumped 3.1% (up 5.5%). The Morgan Stanley Consumer index increased 0.8% (up 3.6%), while the Utilities slipped 0.6% (down 5.1%). The Morgan Stanley Retail index rose 2.3%, increasing 2010 gains to 12.6%. The S&P Supercomposite Restaurant index jumped 4.0% this week, boosting y-t-d gains to 8.5%. The broader market posted another solid week. The S&P 400 Mid-Caps gained 1.7% (up 7.9%), and the small cap Russell 2000 rose 1.6% (up 8.2%). The Nasdaq100 gained 1.9% (up 3.4%), and the Morgan Stanley High Tech index increased 2.2% (up 2.5%). The Semiconductors increased 1.1% (down 1.3%). The InteractiveWeek Internet index jumped 2.8% (up 5.0%). The Biotechs rose another 4.7%, increasing 2010 gains to 30.3%. With bullion down $32, the HUI gold index dropped 2.9% (down 3.1%).

One-month Treasury bill rates ended the week at 9 bps, and three-month bills closed at 14 bps. Two-year government yields rose 6 bps to 0.88%. Five-year T-note yields increased 8 bps to 2.34%. Ten-year yields gained 2 bps to 3.70%. Long bond yields slipped 2 bps to 4.63%. Benchmark Fannie MBS yields rose 2 bps to 4.34%. The spread between 10-year Treasury and benchmark MBS yields was little changed at 64 bps. Agency 10-yr debt spreads narrowed one to 35 bps. The implied yield on December 2010 eurodollar futures gained 2.5 bps to 0.90%. The 10-year dollar swap spread was little changed at 4.75, while the 30-year swap spread increased 1.75 to negative 15. Corporate bond spreads were narrower. An index of investment grade bond spreads narrowed 3 to 82 bps, and an index of junk spreads narrowed 14 to 522 bps.

It was a huge week for debt issuance. Investment grade issuers included Novartis $5.0bn, Medtronic $3.0bn, Directv $3.0bn, Bank of America $2.5bn, Prologis $1.1bn, Amgen $1.0bn, American Honda Finance $1.0bn, Anadarko Petroleum $750 million, Ameriprise Financial $750 million, CME Group $612 million, Partnerre Finance $500 million, Southern California Edison $500 million, Hasbro $500 million, St. Jude Medical $450 million, Cliffs Natural $400 million, Georgia Power $350 million, Airgas $300 million, Premier Aircraft Leasing $300 million, Nstar Electric $300 million, Renre North America $250 million, and Columbus Southern Power $150 million.

Junk issuers included GMAC $1.5bn, MGM Mirage $845 million, Cincinnati Bell $625 million, Amsted Industries $500 million, Steel Dynamics $350 million, Huntsman International $350 million, Building Materials Corp $325 million, Alion Science and Tech $310 million, Parker Drilling $300 million, Boise Paper $300 million, Reckson $250 million, Suburban Propane $250 million, Sonic Automotive $210 million, International Coal Group $200 million, and Prestige Brands $150 million.

The convert market even came to life. Issues included Rovi Corp $400 million, Ciena $375 million, Health Care REIT $340 million and International Coal Group $100 million.

International dollar debt sales remain robust. Issuers included Bank of England $2.0bn, Royal Bank of Scotland $2.0bn, Turkey $1.0bn, BNP Paribas $750 million, Danske Bank $750 million, Shinhan Bank $700 million, Ceva Group $625 million, Axtel SAB $490 million, Transalta $300 million and Garda World Security $250 million.

U.K. 10-year gilt yields increased 3 bps to 4.09%, and German bund yields added one basis point to 3.17%. Bond yields in Greece declined 8 bps to 6.22%. The German DAX equities index gained 1.2% (down 0.2% y-t-d). Japanese 10-year "JGB" yields rose 3.5 bps to 1.34%. The Nikkei 225 surged 3.7% (up 1.9%). Emerging markets were mostly stronger. For the week, Brazil's Bovespa equities index increased 0.7% (up 1.1%), and Mexico's Bolsa added 0.4% (up 1.4%). Russia’s RTS equities index gained 1.7% (up 6.2%). India’s Sensex equities index increased 1.0% (down 1.7%). China’s Shanghai Exchange slipped 0.6% (down 8.0%). Brazil’s benchmark dollar bond yields dropped 13 bps to 4.76%, and Mexico's benchmark bond yields sank 23 bps to 4.68%.

Freddie Mac 30-year fixed mortgage rates dipped 2 bps to 4.95% (down 8bps y-o-y). Fifteen-year fixed rates declined one basis point to 4.32% (down 32bps y-o-y). One-year ARMs fell 5 bps to 4.22% (down 58bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 5 bps to 5.82% (down 110bps y-o-y).

Federal Reserve Credit was little changed last week at $2.263 TN. Fed Credit is up $385bn, or 20.5%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 3/10) jumped $12.9bn to a record $2.982 TN. "Custody holdings" expanded $390bn, or 15.1%, over the past year.

M2 (narrow) "money" supply declined $11.2bn to $8.527 TN (week of 3/1). Narrow "money" has increased $14.3bn y-t-d. Over the past year, M2 expanded 1.9%. For the week, Currency added $1.4bn, while Demand & Checkable Deposits declined $6.8bn. Savings Deposits rose $6.5bn, while Small Denominated Deposits fell $4.7bn. Retail Money Funds dropped $7.5bn.

Total Money Market Fund assets (from Invest Co Inst) sank $77.4bn to $3.090 TN. In the first ten weeks of the year, money fund assets have dropped $203bn, with a one-year drop of $816bn, or 20.9%.

Total Commercial Paper outstanding increased $11.2bn last week to $1.145 TN. CP has declined $25.2bn, or 11.2% annualized year-to-date, and was down $339bn over the past year (22.9%).

International reserve assets (excluding gold) - as tallied by Bloomberg’s Alex Tanzi – were up $1.180 TN y-o-y, or 17.8%, to $7.820 TN.

Global Credit Market Watch:

March 12 – Bloomberg (James Regan and David Yong): “Emerging-market and high-yield bond funds each took in more than $1 billion in the week ended March 10, EPFR Global said, the most since the research firm began publishing weekly data… a decade ago.”

March 12 – Bloomberg (Emre Peker): “CF Industries Holdings Inc., the second-largest producer of nitrogenous fertilizer, cut the interest rates and almost doubled the size of bank debt it may use to finance a takeover of Terra Industries Inc.”

March 11 – Wall Street Journal (Michael Aneiro): “Companies are aggressively borrowing in the debt markets once again… In the U.S., bond sales by companies such as Bank of America Corp. and GMAC Financial Services are on pace to conclude their busiest week since the beginning of the year. In Europe, borrowing by companies so far in March is already more than 60% of February’s totals... So far in 2010, U.S. corporations have issued $195.2 billion of debt, excluding government-guaranteed bonds, according to… Dealogic, up from $166.8 billion during the same period in 2009… Some $375.4 billion flowed into bond mutual funds last year, compared with an $8.7 billion outflow from equity funds, according to data compiled by the Investment Company Institute.”

March 12 – Bloomberg (Chris Fournier): “Canadian corporations are on a pace to issue the most debt during a first quarter in four years…”

March 10 – Bloomberg (Katrina Nicholas): “The lowest relative borrowing costs in more than two years and demand from international investors is driving Asian companies to sell record amounts of dollar- denominated bonds. BOC Hong Kong (Holdings) Ltd., the Hong Kong unit of Bank of China Ltd.,and Chinese developer Evergrande Real Estate Group Ltd. led Asia-Pacific borrowers selling $38.4 billion of dollar debt this year, the fastest start on record…”

March 10 – Bloomberg (Denis Maternovsky): “Yields on Russian dollar bonds fell to less than 5% for the first time as oil rallied and investors’ appetite for riskier assets increased ahead of the country’s first foreign-currency bond sale in 12 years.”

March 12 – Bloomberg (Steve Bryant): “Turkey sold $1 billion of 11-year dollar bonds at the lowest yield on record after the government decided it didn’t need International Monetary Fund help to meet the country’s financing needs… Turkey sold the securities to yield 2.03 percentage points above 10-year U.S. Treasuries.”

March 8 – Bloomberg (Tasneem Brogger): “Icelanders’ rejection of a foreign depositor bill complicates the prospect of a settlement and may leave the government unable to resolve a dispute with the U.K. and the Dutch for another year, Moody’s… said. ‘Potentially we could see this dragging on until the middle of 2011,’ Moody’s Senior Credit Analyst Kenneth Orchard said… ‘The voting down of the referendum is going to complicate getting a deal.’”

Global Government Finance Bubble Watch:

March 8 – Bloomberg (Dakin Campbell): “U.S. regulators are encouraging public pension funds that control more than $2 trillion to inject capital directly into the banking system by buying failed lenders… The Federal Deposit Insurance Corp. is trying to attract pension funds that want to buy stakes or assets of distressed bank-holding companies, according to two of the people.”

March 12 – Bloomberg (John Fraher): “European Union finance ministers will discuss next week whether any Greek bailout should be funded by EU bonds guaranteed by euro region governments, said… people briefed on preparations for March 15-16 meetings.”

March 12 – Bloomberg (Caroline Hyde and Sonja Cheung): “Portuguese, Italian and Spanish companies are rushing to sell bonds, taking advantage of investors’ demand for corporate debt after Greece’s budget crisis froze issuance… ‘There’s pure naked demand for corporate bonds as investors need new paper,’ said Suki Mann, head of credit strategy at Societe Generale…”

Currency Watch:

The dollar index was down 0.8% this week to 79.80 (up 2.5% y-t-d). For the week on the upside, the Swiss franc increased 1.5%, the Norwegian krone 1.1%, the South Korean won 1.1%, the Canadian dollar 1.1%, the Danish krone 1.0%, the Euro 1.0%, the Swedish krona 0.9%, the Brazilian real 0.9%, the Australian dollar 0.8%, the Mexican peso 0.7%, and the New Zealand dollar 0.6% For the week on the downside, the Japanese yen dipped 0.2%.

Commodities Watch:

March 10 – Bloomberg (Jesse Riseborough): “Iron ore contract prices may surge 60% to a record this year as demand from China increases and steel production recovers in developed economies, Goldman Sachs JBWere Pty said.”

The CRB index declined 1.3% (down 3.6% y-t-d). The Goldman Sachs Commodities Index (GSCI) slipped 0.5% (down 0.2% y-t-d). Gold dropped 2.8% to $1,102 (up 0.5% y-t-d). Silver declined 1.6% to $17.10 (up 1.5% y-t-d). April Crude fell 28 cents to $81.22 (up 2.3% y-t-d). April Gasoline dipped 0.6% (up 9.9% y-t-d), and April Natural Gas lost 4.6% (down 21.3% y-t-d). May Copper declined 0.8% (up 1.3% y-t-d). May Wheat fell 1.7% (down 10% y-t-d), and May Corn dropped 3.0% (down 12% y-t-d).

China Bubble Watch:

March 8 – Bloomberg: “China plans to nullify all guarantees local governments have provided for loans taken by their financing vehicles as concerns about credit risks on such debt increases. The Ministry of Finance will also ban all future guarantees by local governments and legislatures in rules that may be issued as early as this month… A crackdown on such loans, estimated at about 11.4 trillion yuan ($1.7 trillion) at the end of 2009 by Northwestern University Professor Victor Shih, could trigger a ‘gigantic wave’ of bad debts as projects are left without funding, Shih said… ‘By striking the fear of God into lenders, regulators hope to get them to turn off the tap,” said Patrick Chovanec, a professor at Tsinghua University in Beijing. ‘Banks have lent on the assumption that a lot of these infrastructure projects are risk-free, but many had no creditworthiness beside the guarantees.’”

March 11 – Bloomberg: “China’s lending fell in February after the government told banks to limit credit growth… Banks extended 700.1 billion yuan ($103 billion) of local-currency loans, down from 1.39 trillion yuan in January and 1.07 trillion yuan a year earlier… M2… rose 25.5%.”

March 11 – Bloomberg: “China’s inflation reached a 16-month high, industrial output climbed and new loans exceeded forecasts, adding to the case for the government to pare back stimulus measures. Consumer prices rose 2.7% in February from a year earlier… Production rose 20.7% in the first two months of 2010, the most in more than five years… ‘Inflation may top the 3% policy target by April, which is bound to trigger further monetary tightening,’ said Dariusz Kowalczyk, chief investment strategist at SJS Markets…”

March 10 – Bloomberg: “China’s exports rose more than forecast in February and property prices jumped the most in almost two years, adding pressure on policy makers to pare stimulus measures adopted during the global recession. Shipments abroad gained 46 percent in February from a year before after a 21% advance in January…”

March 10 – Bloomberg (Chia-Peck Wong): “China’s property prices rose at the fastest pace in almost two years in February… Residential and commercial real-estate prices in 70 cities climbed 10.7% from a year earlier… That topped a gain of 9.5% in January. Chinese officials are trying to reduce the risk of asset bubbles, resurgent inflation and bad loans for banks after flooding the world’s fastest-growing economy with cash to drive a recovery.”

March 9 – Bloomberg (Chinmei Sung): “Office rents in China will rise as much as 20% this year as the global economy recovers and the supply of new buildings slows, Jones Lang LaSalle Inc. said.”

March 10 – Bloomberg: “China’s trade surplus shrank to the lowest level in a year in February as a surge in imports signaled the nation may start to outshine the U.S. as a destination for the world’s goods. Imports rose a more-than-estimated 44.7% from a year ago… The surplus was $7.61 billion, and exports gained 45.7%.”

March 10 – Bloomberg (Mark Lee): “China Mobile Ltd., the world’s biggest phone company by market value, agreed to buy 20% of Shanghai Pudong Development Bank Co. for 39.8 billion yuan ($5.8bn) to expand its electronic-payment business.”

March 8 – Bloomberg (Stanley James): “China is in talks to extend its high-speed rail network to about 17 countries, the South China Morning Post reported… China is negotiating with the countries, most of which are in southeast and central Asia, about trading resources for the high-speed rail technology and equipment…”

Japan Watch:

March 12 - Bloomberg (Masahiro Hidaka and Mayumi Otsuma): “Japan’s central bank may seek next week to counter a contraction of its balance sheet caused by the month-end expiration of an emergency-credit program as deflation persists in the world’s second-largest economy. The Bank of Japan’s options include expanding a 10 trillion yen ($111 billion) fund providing loans to banks, according to two central bank officials…”

India Watch:

March 12 – Bloomberg (Kartik Goyal): “India’s industrial production rose 16.7% in January, diminishing spare capacity and contributing to inflationary pressures that may spur the central bank to raise interest rates within weeks.”

March 10 – Bloomberg (Madelene Pearson and Natalie Obiko Pearson): “Indian companies are stepping up interest to secure coal resources in Indonesia and Australia to meet the power needs of the world’s second-most populous country, Australia & New Zealand Banking Group Ltd. said. ‘We are seeing a lot of flow in terms of merger and acquisition interest or off-take interest from India into both Indonesia and Australia,’ Glenn Porritt, executive director… said…”

Asia Bubble Watch:

March 8 – Bloomberg (Bomi Lim): “South Korea will propose a global safety net to shield emerging economies from the risks triggered by external crises when the leaders of Asia’s fourth-biggest economy host the Group of 20 Nations summit in November. South Korea’s government was forced to guarantee banks’ foreign-currency debt and sign bilateral currency swap agreements to fend off fallout from the collapse of the U.S. housing market and the contagion that then spread through global credit and financial markets.”

March 12 – Bloomberg (Aloysius Unditu): “Indonesia’s sovereign debt rating was raised to the highest level in 12 years by Standard & Poor’s after the central bank increased the country’s economic growth forecasts…”

March 10 – Bloomberg (Karl Lester M. Yap and Cecilia Yap): “Philippine exports rose at the fastest pace in more than 14 years in January as demand for electronics goods gained amid the global economic recovery. The peso climbed to an eight-week high. Shipments abroad increased 42.5% from a year earlier to $3.58 billion…”

Latin America Bubble Watch:

March 10 – Bloomberg (Andre Soliani): “Brazil’s gross domestic product may grow as much as 6% this year as the economy creates 2 million government-registered jobs, Budget Minister Paulo Bernardo said.”

March 12 – Bloomberg (Eliana Raszewski): “Argentine consumer prices rose in February at the fastest pace in almost four years… Prices rose 1.2% from January… Annual inflation was 9.1%, the fastest pace since July 2008.”

Unbalanced Global Economy Watch:

March 12 – Bloomberg (Alexandre Deslongchamps): “Canada created more jobs than expected in February and the jobless rate fell to a 10-month low… The jobless rate fell to 8.2%...”

March 9 – Bloomberg (Scott Hamilton): “The U.K. trade deficit unexpectedly swelled in January to the widest in 17 months… The goods-trade gap was 8 billion pounds ($12bn), the most since August 2008…”

March 12 – Bloomberg (Simone Meier): “European industrial output rose the most in more than two decades in January… Output in the economy of the 16 nations using the euro jumped 1.7% from December…”

Bubble Economy Watch:

March 8 – Bloomberg (Anthony Feld and Courtney Schlisserman): “U.S. state and local governments are likely to keep cutting jobs even as the broader labor market shows signs of emerging from the worst slump since World War II, economists said. … combined employment by state and local governments fell for eight straight months through February. The streak of losses was the longest since two years of declines ending in 1983. State and local governments, which account for about 13% of gross domestic product, have so far cut a total of 192,000 jobs since August 2008...”

March 8 – Bloomberg (Dan Levy): “In California’s Napa Valley, producer of the most expensive U.S. wines, 2010 may be a vintage year for foreclosures… As many as 10 wineries and vineyards in Napa will change hands in distressed sales or foreclosures this year and next, up from none in 2008…‘We have 250 vintner clients saying this downturn is the worst in 20 years,” Bill Stevens, manager of [Silicon Valley Bank’s] wine division in St. Helena, California, said… ‘Anybody who was late to the party won’t have staying power.’”

Central Bank Watch:

March 10 – Bloomberg (Steve Matthews and Scott Lanman): “The Federal Reserve’s pledge to keep interest rates close to zero for an ‘extended period’ has come under criticism from policy makers who say it’s restricting their room to maneuver as the economy recovers. Kansas City Fed President Thomas Hoenig voted against repeating the statement on Jan. 27… Since then, Dallas Fed President Richard Fisher, James Bullard of St. Louis and the Philadelphia Fed’s Charles Plosser have also expressed reservations. The Fed presidents have said the phrase… might reduce the central bank’s flexibility to raise interest rates or mislead investors into believing the Fed has a specific date in mind.”

Fiscal Watch:

March 11 – Bloomberg (Vincent Del Giudice): “The U.S. budget deficit widened to a record in February… The excess of spending over revenue increased to $221 billion last month, compared with a shortfall of $194 billion in February 2009… The figures show the deficit this year will likely surpass the record $1.4 trillion in the fiscal year that ended in September… Spending for February increased 17% from the same month a year ago, to $328.4 billion. Revenue and other income rose 23% to $107.5 billion, marking the first increase in receipts since April 2008…”

Real Estate Watch:

March 12 – Bloomberg (Scott Hamilton): “U.K. house prices increased in February at the fastest pace in more than seven years… The average cost of a home in England and Wales was 222,008 pounds ($334,033), up 1.9% from January…”

GSE Watch:

March 12 - Dow Jones (Prabha Natarajan): “As the Federal Reserve wraps up its $1.25 trillion mortgage-purchase program, risk premiums on mortgage-backed securities backed by Fannie Mae and Freddie Mac have improved unexpectedly… In the past week, the market prices of these securities, also called pass-throughs, have improved so much that risk premiums, or differences in spreads over comparable Treasury yields, are at the narrowest level of the year and pretty close to the firmest level last year.”

Muni Watch:

March 10 – Bloomberg (Margaret Collins): “Investors in search of better returns poured $7.8 billion into high-yield municipal bond funds last year, pushing assets to a two-year high… ‘People are starving for yield because rates are at zero,’ said Paul Tramontano, co-chief executive officer of… Constellation Wealth Advisors… ‘They’re taking more risk than they think.’”

Speculation Watch:

March 10 – Bloomberg (Emily Thornton, Cristina Alesci and Jason Kelly): “Buyout funds sitting on half a trillion dollars committed by investors may need more than a decade to put the money to work if mergers and acquisitions continue at the current pace. Firms… announced $87 billion in deals over the past 12 months…”

March 11 – Bloomberg (Ben Moshinsky and Aaron Kirchfeld): “European politicians and regulators could initiate a continent-wide ban on speculative trading of sovereign credit-default swaps tomorrow. Making it stick without the Americans won’t work. New York and London dominate swaps trading, and both have resisted greater regulation. Last year, U.S. regulators and Congress rejected a proposed ban on buying credit-default swaps without owning the underlying debt. Adair Turner, chairman of the U.K. Financial Services Authority, said yesterday that these so-called naked swaps weren’t the ‘key driver’ of the Greek debt crisis and it would be wrong to rush to ban them.”

Q4 2009 "Flow of Funds":

For all of 2009, U.S. Non-Financial Debt (NFD) expanded 3.3%, down from 2008’s 5.9%. In nominal dollars, NFD expanded $1.116 TN, the smallest expansion since year 2000 ($865bn). There has been much discussion about the ongoing Credit contraction. For the year, Household Home Mortgage debt contracted $165bn, Consumer Credit contracted $113bn, and total Business borrowings contracted $200bn. I have tried to highlight the massive counterbalancing inflation of “federal” Credit. Federal Government (Treasury) Credit expanded a record $1.444 TN last year (2-yr gain of $2.683 TN) and GSE-Mortgage-Backed Securities grew $422bn (2-yr $920bn).

In the Domestic Financial Sector, borrowings fell an unprecedented $1.753 TN for the year. Bank Credit declined $467bn, GSE Assets dropped $371bn, and the Asset-Backed Securities (ABS) market shrank $675bn. At the same time, the Fed’s holdings of Agency and GSE-Backed Securities ballooned $979bn.

It was another extraordinary year in Credit and financial flow analysis. There are numerous complexities that make this a challenging endeavor. There were gigantic charge-offs (banks and GSEs) that reduced outstanding mortgage and consumer debt. Near zero interest rates also worked to reduce the amount of financial sector debt expansion created in the process of paying interest on outstanding liabilities (i.e. deposit liabilities increasing as interest is accrued to depositor accounts). It is also difficult to ascertain the various Credit impacts from the Fed’s $1.0 TN monetization of MBS. Many factors make it difficult to gauge the true scope and nature of the Credit creation flowing to the real economy. It’s my view that the $1.1 TN net increase of NFD likely understates the real expansion of system Credit/purchasing power for 2009.

I have asserted that the monetary and fiscal policy response to the 2008 bursting of the Wall Street/Mortgage Finance Bubble fostered the emergence of the Global Government Finance Bubble. Over the past 6 quarters, Treasury debt has jumped $2.531 TN, or 48%, to $7.782 TN. During the same period, federally-backed GSE-MBS expanded $624bn, or 13%, to $5.383 TN. Combined “federal” finance ballooned an incredible $3.155 TN in just 18 months. At the same time, the Federal Reserve’s balance sheet jumped $1.315 TN, or 138%, to $2.267 TN.

Unprecedented policy responses sent a clear message: the securities markets are too big to fail. Sure, the massive fiscal stimulus mobilized purchasing power throughout the economy. And, yes, the Trillion monetized by the Bernanke Federal Reserve unleashed a wall of liquidity upon the markets. Yet there’s another critically important facet of system stabilization: The historic collapse of risk premiums – especially in mortgage and corporate debt – can be at least partially explained by the market’s perception that Washington will respond to future crises with the Powell Doctrine of overwhelming fiscal and monetary force.

The market today perceives that essentially no amount of stimulus or monetization is out of bounds. The Fed is there as a backstop bid for debt securities, while the Treasury and Federal Reserve have teamed to establish a floor under GDP/national income. Market malformations now lie at the heart of the unfolding Bubble and go a long way toward explaining the market’s complacency when it comes to the simultaneous contraction in private-sector Credit and the explosion of federal debt and obligations.

During Q4, Total System Credit (TSC) declined $132bn to $52.417 TN. TSC has declined for three consecutive quarters. Yet it has still increased 52% during the past six years, increasing from just over 300% of GDP to over 360% today. Over the past six years, Non-Financial Credit has inflated 57% and Financial Sector Credit has gained 42%.

Total Mortgage Debt (TMD) declined 2.1% during 2009 to $14.307 TN. TMD is flat over two years but is still up 72% over seven years. TMD contracted at a 3.2% rate during Q4, the same pace as Q3. Household Mortgage borrowings contracted at a 2.1% rate during Q4 (to $10.786 TN), an improvement from Q3’s 3.4%. Commercial Mortgage Borrowings contracted at a 7.4% pace (to $2.486 TN), accelerating from Q3’s 4.0% pace of decline.

The ABS market contracted another $186bn during Q4 to $3.394 TN. ABS was down $702bn, or 17.1%, for the year. Much of this decline is explained by the ongoing contraction in “private-label” MBS. There have been huge write-downs in this space. Yet there’s an ever bigger factor. Low interest rates and myriad government programs have encouraged millions of borrowers to replace their old mortgages with new ones enjoying government (Fannie, Freddie and FHA) guarantees and much lower yields. Placing a government stamp on hundreds of billions of mortgages has been a major stabilizing force.

Lower debt service costs were not the only factor bolstering household consumption. Importantly, Household Assets rose $657bn during Q4 to $68.188 TN. For the year, Assets jumped $2.579 TN – recovering a chunk of 2008’s $13.226 TN drop. Household Liabilities contracted $26bn during Q4 and were down $194bn for the year (1.4%) to $14.0 TN. Accordingly, Household Net Worth gained $682bn during Q4 to $54.176 TN. For the year, Net Worth jumped $2.772 TN. Net Worth has now returned to 2005 levels. For the year, Household Real Estate holdings were down $905bn (to $18.207 TN), while Financial Assets were up $3.407 TN (to $45.115 TN).

National Income posted strong Q4 gains ($152bn). For the year, National Income was down only $22bn, or 0.2%, to $12.412 TN. Total Compensation declined slightly ($17bn) during Q4 to $7.735 TN. For the year, Total Comp was down $296bn, or 3.7%. There is no doubt that massive fiscal stimulus was instrumental in stabilizing system incomes at, arguably, rather inflated levels. National Income ended 2009 51% above where it began the decade, with Total Compensation 44% higher.

Q4 Federal Expenditures were up 15.1% y-o-y to an annualized $3.595 TN. Expenditures jumped to $3.466 TN for all of 2009. For comparison, expenditures were $2.573 TN in 2005, $2.728 TN in 2006, $2.897 TN in 2007 and $3.118 TN in 2008. Q4 Federal Receipts were down 8.8% y-o-y to $2.232 TN annualized. For the year, Receipts were down 10%.

State & Local government Q4 borrowings expanded at a 4.7% rate, up from Q4 2008’s 0.2% but down from Q3 2009’s 5.5%. For all of 2009, State & Local government debt expanded 4.8%, up from 2008’s 2.5%. Q4 State & Local Receipts were up 3.5% y-o-y, while Expenditures gained 1.0%.

Returning to the financial sector, Bank Assets were little changed for the quarter at $14.137 TN. For the year, Assets were up $136.3bn, or 1% (largely explained by the acquisition of broker/dealer assets). Bank Credit, on the other hand, was down $371bn y-o-y to $9.301 TN. Down only 0.7% during Q4, Bank Credit stabilized going into year end. For the year, Bank holdings of government securities jumped 15.6% to $1.462 TN. Bank Mortgage loans were little changed for the year at $3.819 TN. Miscellaneous Bank Assets were up $417bn, or 12.1%, for the year to $3.868 TN. On the Bank Liability side, Deposits were up $466bn y-o-y to $7.642 TN.

Rest of World (ROW) Holdings of US assets jumped $290bn last year to $15.423 TN. ROW is up $3.90 TN over four years (despite 2008’s $960bn decline). For 2009, total Treasury holdings jumped $503bn to $3.713 TN. Agency holdings dropped $130bn y-o-y to $1.315 TN. Corporate bond holdings declined $100bn to $2.357 TN.

Securities Broker/Dealer Assets expanded slightly during Q4 to $2.080 TN (down 6.2% y-o-y). Finance Company Assets contracted at a 9.9% rate during the quarter to $1.691 TN (down 8.7% y-o-y). Credit Unions expanded 5.9% annualized during Q4 to $885bn (up 8.9% y-o-y). REITs declined 5.9% (down 27% y-o-y). Life Insurance company Assets expanded 5.7% annualized to $4.819 TN (up 6.7% y-o-y). Money Market funds contracted $104bn during Q4 (to $3.59TN), with a 2009 decline of $499bn.

There were few surprises in the Z.1 report. The gains in Household Net Worth and National Income do help explain the decent recovery in consumption. The ongoing expansion of Treasury, GSE MBS and Federal Reserve Credit supports the Government Finance Bubble thesis. As we look forward to 2010 data, I would expect a meaningful uptick in the rate of system Credit expansion. It is my view that, in a more normal rate/liquidity environment, it will take in the neighborhood of $2.0 TN of system Credit growth to sustain our current economic structure. I expect that – until the debt markets say otherwise – the majority of this will be “federal” Credit.