Saturday, November 8, 2014

Weekly Commentary, September 28, 2012: It's all Greek to Me

The focus of analysis this week shifts back to Europe. My thesis remains that the unfolding European debt and economic crises provide a potential catalyst for a bout of problematic global de-risking/de-leveraging. An argument can be made that the recent rally and short squeeze throughout global risk markets actually heightens market vulnerability. 

I have expected that policy would have little success in halting the bad debt cancer spreading methodically from Europe’s periphery to its core. I have also posited that with core country Spain enveloped in Credit tumult, crisis momentum had passed a critical juncture. It is worth recalling that Spanish 10-yr yields reached 7.5% in late-July, as Italian yields surged to 6.6%. An important part of the thesis, as well, has been that the European crisis would expose Bubble fragilities fermenting in the “developing” economies, especially in China, Brazil and India. There has been important confirmation in the thesis, both from financial and economic perspectives.

Not unexpectedly, global policymakers have responded to heightened systemic risk with extraordinary vigor. In Europe and the U.S., central bankers have introduced the world to the idea of open-ended liquidity creation and market intervention. Global risk markets have responded strongly to the latest iteration in New Age monetary management, only widening the gulf between securities prices and fundamental prospects. Markets now anxiously anticipate the implementation of the Draghi Plan and Bernanke’s big monetization. At the same time, there is justified caution with respect to the impact all this liquidity is going to have on already problematic economic imbalances. 

Last week’s CBB focused on the premise that “economic structure matters – and it matters tremendously.” This is one of those “master of the obvious” comments, yet these days one sees essentially no attention paid to such analysis. The evolving European crisis has provided important confirmation of this analysis. We’ve watched how Greece’s tiny little economy evolved into a formidable financial black hole. Why? Well, years of Credit excess fomented deep structural maladjustment – maladjustment that remained largely concealed so long as ample Credit/spending power was forthcoming. Post-Bubble, the Greek economy is just not capable of creating sufficient real economic wealth to support its population – not to mention its debt load. Greece’s economy remains in a steep downward spiral – and in desperate need for bailout #3 and ongoing outside assistance. Meanwhile, the social fabric badly frays or worse.

A critical question today – for Europe, for international markets and for the global economy - is whether Spain is following in Greece’s footsteps. According to IMF (2011) data, Greece ranks just below Venezuela as the world’s 35th largest economy (GDP of $303bn). About five times the size of Greece, the Spanish economy ranks #12 in the world at $1.494 TN. While not as debt-ridden as Greece, Spanish federal and regional government debt now exceeds 100% of GDP – and is rising rapidly.

Spain will require enormous financial support. It has both a substantial economy and substantial banking system – both today in serious trouble. Similar to Greece, a prolonged Credit boom has resulted in a terribly maladjusted economic structure. Literally hundreds of billions of euros will be required – and I fully expect the bailout tab will, in Greek fashion, expand on an annual basis. Fear for Spain and Italy was the impetus behind the creation of large bailout facilities (ESM joining the EFSF) and, more recently, commitments for open-ended bond purchases from the Draghi ECB – Outright Monetary Transactions (OMT). In a sign of the times, global markets to this point have viewed Spain largely in a positive light, as a likely catalyst for hundreds of billions of governmental and central bank market interventions/liquidity operations.

Developments this week provided a hint that complacency might be unjustified. With an unemployment rate of almost 25%, social tensions have reached the boiling point. Public protests that had been peaceful turned violent this week – recalling a critical crisis inflection point in Athens. At least Greece has not had to deal with regional governments calling for independence.

This week, Artur Mas, President of Catalonia, called early elections for November 25. Catalonia is the wealthiest of Spain’s 17 regions, accounting for about one-fifth of Spanish GDP. From the Financial Times: “Catalonia has a proud tradition of self-rule dating from the Middle Ages… In recent times a decisive moment came in 2010 when Spain’s constitutional court largely rejected a new statute of autonomy for Catalonia approved by the national parliament in 2006. The statute was favored by Spain’s former Socialist government but opposed by the centre-right Partido Popular, which now holds power in Madrid.”

There’s no love lost between Mr. Mas and Prime Minister Rajoy. In recent meetings, Rajoy rejected Mas’ request for more financial independence (including control of local tax receipts) from Madrid. Catalonia’s economy has faltered badly, and the heavily indebted region was forced to seek bailout assistance from the federal government. The Rajoy government has been seen as using the crisis backdrop to wrest control from the regions, something that has inflamed latent animosities – especially in independent-minded Catalonia. Catalonians resent paying significantly more to Madrid than they received in services, essentially subsidizing other regions. They blame Madrid for their problems. Catalonian officials have been determined to take control of their own purse strings, a right enjoyed by the nationalistic Basques region. On September 11, an estimated 1.5 million protested in support of “Catalonia, a new European state” in the streets of Barcelona.

There has been some concern that Spain’s military may be forced to respond to Catalonia’s move to independence. This further complicates an already complex economic, social, political and historical backdrop. Spain on Friday afternoon announced the results of an “independent audit” of the country’s 14 largest banks. As expected, the government reported a $76bn (euro 62bn) short-fall in bank capital. While the EU would like to believe these stress tests are a “major step” in restoring confidence, few analysts believe the results accurately reflect the size of the rapidly expanding hole in Spain’s banking system. It takes a major leap of faith to believe that half of the banks tested are today adequately capitalized. And from the UK Telegraph: “The audit was based on an assumption that the economy would shrink 0.3% in 2012, but this already looks outdated as conditions quickly deteriorate.”

And while we’re on the subject of economic deterioration and incredulous assumptions, Spain Thursday released its 2013 budget. The Rajoy government plans to use spending cuts, tax increases and $3.9bn of pension reserves to reduce its budget deficit to the agreed upon 4.5% for 2013 (in the face of an expected 30% increase in debt service costs). This budget assumes economic contraction of 0.5% next year, when some forecasts now call for deepening recession and GDP contraction of at least 3%. Tuesday, Spain reported that its deficit for the first eight months of 2012 had already increased to 4.77% of GDP (vs. year ago 3.81%), with spending rising 8.9% and receipts declining 4.6%. It’s all Greek to me. 

And while Spain’s budget and “stress test” results have limited credibility, it hasn’t much mattered. Some go so far as to recommend holding Spanish debt on the view that it’s good to own what governments are about to buy (holds true, as well, for U.S. Treasuries and MBS). It’s now a matter of ironing out the timing and details of an ESM bailout and, presumably, ECB purchases in the secondary market. And, to this point, it is a case where the more rapidly things deteriorate the more confident market operators become in the imminent arrival of the liquidity onslaught. 

Here’s where things get more interesting. The original plan calling for Spain to tap the ESM for funds to recapitalize its banks has hit road blocks. Earlier in the week, ministers from Germany, the Netherlands and Finland (the Northern AAAs) argued against direct bank recapitalization, while also stating their view that problem bank assets must remain the responsibility of the sovereign. Besides, there is supposed to be a European-wide bank regulator in place before recapitalization fundings are considered. The whole scope of a single bank supervisor has become a source of heated debate, with Germany strongly opposed to the idea of the ECB attempting to supervise all 6,000 European banks. 

And it is worth noting that the Bundesbank’s Jens Weidmann was out in force again this week, in one instance speaking in support of the Northern AAAs: “In order to keep liability and control in balance, only risks that have arisen after common supervision is established can be taken under joint liability. The legacy burdens on bank balance sheets have to be underwritten by the countries under whose supervision they have arisen… Mutualization of risks can’t be the primary purpose of a banking union.” Spain has made a disastrous mess of their banking system – and market hopes that they were about to offload some of this risk to the EU/ESM is at this point little more than wishful thinking.

Europe remains an unfolding disaster, although the region’s bonds and stocks remain speculating vehicles of choice under the assumptions that Draghi is about to lend hundreds of billions of support and, at the end of the day, the Germans will backstop the European debt markets. As for the Draghi Plan, I’ll presume many on the governing council hope that the ECB is never called upon to use its bazooka. Indeed, the true capacity of the Draghi Plan is much in doubt. The Bundesbank is adamantly opposed to the OMT, while questions remain as to its legality. And in Germany, it appears there is mounting political opposition to the ECB and other transfer mechanisms. 

I know, when faltering markets place the barrel of a gun to Ms. Merkel and others’ heads, mouths open and market-friendly utterances pop out. Yet, once again, we’re witnessing how it is incredibly difficult to go from talk to actual bailout program implementation. Meanwhile, the politics seem to only get more difficult by the week – if that’s even possible. Right now, markets are focused on the inevitability of a Spain bailout and the unleashing of the vaunted ESM and OMT programs. I’m not sure whether it will be weeks or months, but I do expect we’re heading in a direction where the markets will turn attention to sinking Italian and French economies and worry that these bailout programs are not going to be up to the task. 

For the Week:

The S&P500 declined 1.3% (up 14.5% y-t-d), and the Dow lost 1.1% (up 10.0%). The Morgan Stanley Cyclicals sank 3.0% (up 10.8%), and the Transports slipped 0.4% (down 2.5%). The Morgan Stanley Consumer index declined 0.6% (up 10.1%), while the Utilities gained 1.0% (unchanged). The Banks were down 1.3% (up 25.9%), and the Broker/Dealers were hit for 3.2% (down 0.8%). The S&P 400 Mid-Caps fell 1.7% (up 12.5%), and the small cap Russell 2000 dropped 2.1% (up 13.0%). The Nasdaq100 was down 2.2% (up 22.9%), and the Morgan Stanley High Tech index dropped 2.0% (up 16.2%). The Semiconductors were slammed for 3.3% (up 4.9%). The InteractiveWeek Internet index declined 0.8% (up 14.0%). The Biotechs fell 2.6% (up 42.8%). Although bullion was little changed, the HUI gold index dropped 2.2% (up 3.0%). 

One-month Treasury bill rates ended the week at 6 bps and three-month bills closed at 9 bps. Two-year government yields were down 3 bps to 0.23%. Five-year T-note yields ended the week down 4 bps to 0.63%. Ten-year yields sank 12 bps to 1.63%. Long bond yields dropped 12 bps to 2.82%. Benchmark Fannie MBS yields rose two bps to 1.84%. The spread between benchmark MBS and 10-year Treasury yields widened 14 bps to 21 bps. The implied yield on December 2013 eurodollar futures declined 3 bps to 0.375%. The two-year dollar swap spread was little changed at 13 bps, while the 10-year dollar swap spread jumped 5 to 7 bps. Corporate bond spreads widened. An index of investment grade bond risk rose 3 to 99 bps. An index of junk bond risk surged 46 to 504 bps. 

Debt issuance remained exceptionally strong. Investment grade issuers this week included Watson Pharmaceuticals $2.9bn, NBCUniversal Media $2.0bn, UPS $1.75bn, Penske $1.5bn, MetLife $1.0bn, Hyundai Capital $1.0bn, WEA Finance $500 million, and Commonwealth Edison $350 million. 

Junk bond funds saw outflows of $310 million (from Lipper). Another long list of junk issuers included Ryerson $900 million, Frontier Communications $850 million, Regency Energy $700 million, Lender Process Services $600 million, ADS Waste $550 million, International Wire Group $500 million, Alpha Natural Resources $500 million, Sinclair Television Group $500 million, PDC Energy $500 million, TW Telecom $480 million, Bristow Group $450 million, Breitburn Energy $450 million, CDRT $450 million, RBS Citizens Financial Group $350 million, Wolverine World Wide $325 million, Atlas Pipeline $325 million, Viasat $300 million, Gray Television $300 million, Ply Gem Industries $160 million, and Casella Waste Systems $125 million.

Convertible debt issuers included GT Advanced Technologies $205 million. 

International dollar bond issuers included KFW $3.0bn, Serbia $2.0bn, BBVA Bancomer $1.5bn, Stadshypotek $1.5bn, Network Rail $1.25bn, Newcrest Finance $1.25bn, Credit Agricole $1.0bn, Swedbank $1.0bn, Canadian Imperial Bank $1.0bn, Nufarm Australia $325 million, ENA Norte $600 million, Elan $600 million, Agrium $500 million, Kommunekredit $500 million, Banco ABC-Brasil $400 million, Agrokor $300 million, Industrial Bank of Korea $300 million, and Global Bank Corp $200 million.

Spain's 10-year yields jumped 17 bps to 5.87% (up 83bps y-t-d). Italian 10-yr yields rose 4 bps to 5.07% (down 196bps). German bund yields dropped 15 bps to 1.44% (down 38bps), and French yields declined 9 bps to 2.17% (down 97bps). The French to German 10-year bond spread widened 6 bps to 73 bps. Ten-year Portuguese yields surged 49 bps to 8.75% (down 403bps). The new Greek 10-year note yield dropped another 43 bps to 19.04%. U.K. 10-year gilt yields fell 11bps to 1.72% (down 25bps). Irish yields were 12 bps higher to 4.89% (down 337bps). 

The German DAX equities index was hit for 3.2% (up 22.3% y-t-d). Spain's IBEX 35 equities index sank 6.3% (down 10%), and Italy's FTSE MIB dropped 5.6% (unchanged). Japanese 10-year "JGB" yields declined 3 bps to 0.77% (down 22bps). Japan's Nikkei fell 2.6% (up 4.9%). Emerging markets were mixed. Brazil's Bovespa equities index dropped 3.5% (up 4.3%), while Mexico's Bolsa gained 1.3% (up 10.2%). South Korea's Kospi index slipped 0.3% (up 9.3%). India’s Sensex equities index added 0.1% (up 21.4%). China’s Shanghai Exchange rallied 2.9% (down 5.2%).

Freddie Mac 30-year fixed mortgage rates dropped 9 bps to 3.40% (down 61bps y-o-y). Fifteen-year fixed rates declined 4 bps to 2.73% (down 55bps). One-year ARMs were down a basis point to 2.60% (down 23bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 7 bps to 4.08% (down 73bps).

Federal Reserve Credit declined $10.8bn to $2.797 TN. Fed Credit was down $42bn from a year ago, or 1.5%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/26) rose $9.0bn to a record $3.593 TN. "Custody holdings" were up $173bn y-t-d and $157bn year-over-year, or 4.6%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $422bn y-o-y, or 4.1% to a record $10.640 TN. Over two years, reserves were $2.032 TN higher, for 24% growth.

M2 (narrow) "money" supply increased $13.8bn to a record $10.138 TN. "Narrow money" has expanded 7.1% annualized year-to-date and was up 6.9% from a year ago. For the week, Currency increased $3.2bn. Demand and Checkable Deposits sank $47bn, while Savings Deposits surged $59.4bn. Small Denominated Deposits declined $2.5bn. Retail Money Funds added about $1.0bn. 

Total Money Fund assets rose $8.5bn to $2.576 TN. Money Fund assets were down $119bn y-t-d and $58bn over the past year, or down 2.2% y-o-y. 

Total Commercial Paper outstanding dropped $18.1bn to a nine-week low $990 million CP was up $31bn y-t-d, while having declined $18bn from a year ago, or down 1.7%. 

Currency Watch:

September 27 – Wall Street Journal (Aaron Back and In-Soo Nam): “Officials from the central banks of China and South Korea sharply criticized the U.S. Federal Reserve's latest round of quantitative easing… and advocated reducing Asia's dependence on the U.S. dollar. The comments, aired at a joint seminar in Beijing held by the two central banks, are the clearest indication yet of a rising backlash in Asia against U.S. monetary policy, suggesting it could have the unintended consequence of accelerating efforts to find alternatives to the U.S. dollar as the main global currency. ‘The rise in global liquidity could lead to rapid capital inflows into emerging markets including South Korea and China and push up global raw-material prices,’ said Bank of Korea Gov. Kim Choong-soo. ‘Therefore, Korea and China need to make concerted efforts to minimize the negative spillover effect arising from the monetary policies of advanced nations.’” 

The U.S. dollar index increased 0.7% to 79.885 (down 0.4% y-t-d). For the week on the upside, the South Korean won increased 0.7%, the Japanese yen 0.3%, the Norwegian krone 0.3% and the Taiwanese dollar 0.1%. For the week on the downside, the euro declined 0.9%, the Danish krone 0.9%, the Australian dollar 0.8%, the Swiss franc 0.7%, the Canadian dollar 0.7%, the South African rand 0.4%, the British pound 0.4%, the Singapore dollar 0.2%, the Brazilian real 0.2% and the Swedish krona 0.1%.

Commodities Watch:

The CRB index added 0.1% this week (up 1.3% y-t-d). The Goldman Sachs Commodities Index increased 0.3% (up 3.2%). Spot Gold was little changed at $1,772 (up 13.3%). Silver slipped 0.2% to $34.58 (up 24%). November Crude declined 70 cents to $92.19 (down 7%). November Gasoline jumped 3.6% (up 10%), and November Natural Gas jumped 8.1% (up 11%). December Copper declined 0.8% (up 9%). December Wheat added 0.6% (up 38%), and December Corn gained 1.1% (up 17%). 

Global Credit Watch:

September 26 – Bloomberg (Emma Ross-Thomas and David Tweed): “Spanish Prime Minister Mariano Rajoy’s dispute with the leader of his country’s richest region became the newest front in Europe’s effort to quell the debt crisis while tension over street protests escalated in Madrid. Spanish bond yields rose the most since Aug. 31 after Catalan President Artur Mas called early elections. His bid for greater autonomy came five days after Rajoy rejected his demand for increased control of the region’s revenue. Mas yesterday set the vote for Nov. 25, saying the time has come to seek ‘self- determination.’ Mas’s gambit risks plunging Rajoy into a constitutional crisis amid a recession that has sent unemployment to 25%. He’s struggling to persuade Spaniards to accept the deepest austerity measures on record and stoking frustration in Germany over his foot-dragging on whether to seek a bailout. As police clashed with protesters in Madrid yesterday, Rajoy didn’t respond to their demands or to Mas’s defiance. ‘It’s the very last thing Rajoy needed right now, and the last thing Europe needed,’ said Ken Dubin, a political scientist who teaches at Carlos III University…” 

September 25 – Bloomberg (Jana Randow and Rainer Buergin): “European Central Bank President Mario Draghi defended his bond-purchase plan and took a swipe at Germany’s Bundesbank, saying choosing to do nothing would have been dangerous. ‘Either you do nothing -- nein zu Allem,’ or no to everything, and ‘allow the singleness of monetary policy to be undermined, or you take action,’ Draghi told an audience of German business people… ‘The greatest risk to stability is not action, it’s inaction.’ The comments risk widening the rift between the ECB and the Bundesbank, which says bond purchases are tantamount to printing money to finance profligate governments. Draghi on Aug. 2 named Bundesbank President Jens Weidmann as the only ECB policy maker to vote against his bond-buying plan, breaching the established practice of keeping ECB deliberations confidential. Since then, Weidmann has sharpened his criticism of ECB policy, warning that central bank funding can ‘become addictive like a drug’ and eventually hurt the currency through inflation.” 

September 25 – Bloomberg (Angeline Benoit and Ben Sills): “Spain said it needs to know how much the European Central Bank intends to spend buying its debt to decide if it should seek outside help as its borrowing costs rose at a bill auction in Madrid… Prime Minister Mariano Rajoy has held off seeking aid since ECB President Mario Draghi last month said he’ll buy Spanish debt if Rajoy accepts conditions. ‘There are many fronts we have to tackle,’ Deputy Prime Minister Soraya Saenz de Santamaria told radio station Cadena Ser… ‘We need to know to what extent the ECB will intervene in the secondary market. To take decisions you need to have all the elements on the table.’” 

September 26 – Bloomberg (James G. Neuger): “European governments are still debating the role of the planned permanent rescue fund in recapitalizing banks, the European Commission said. ‘It will be for the member states to come to an agreement on this future design,’ commission spokesman Olivier Bailly told reporters… Bailly said Germany, the Netherlands and Finland made a ‘contribution’ to the discussions yesterday by calling for national governments to take care of ‘legacy’ debts of their banks before they come under European oversight. ‘Some elements” of the bank-aid system were laid out by euro government leaders in a June 29 statement and ‘the rest is indeed to be defined,’ Bailly said. He called on the governments to ‘implement quickly” those promises.’” 

September 26 – Bloomberg (Jana Randow and Stefan Riecher): “Bundesbank President Jens Weidmann rejected European Central Bank President Mario Draghi’s jibe that he says ‘no to everything’ on the ECB council. ‘This is certainly not my impression, that I’m saying no to everything,’ Weidmann said… ‘The central bank has acted in the crisis’ and ‘taken a lot of measures to prevent an escalation of the crisis with the support of the Bundesbank… I don’t relate this comment to me, despite it being said in German.’” 

September 28 – Dow Jones: “It’s too soon to judge Spain’s raft of new austerity measures announced Thursday in Madrid, a European Union spokesman said… ‘We will not be immediately commenting [on the Spanish budget],’ Simon O'Connor, spokesman for EU economics chief Olli Rehn, told reporters… ‘We will be issuing our forecasts on November 7 and in that context we will assess the various budgetary measures in all member states and in this case, Spain’s too,’ he added… But it will be the assessment of the new Spanish budget that will determine whether the country--increasingly under market pressure to request a sovereign bailout after being granted a banking-sector rescue package--can meet agree deficit targets in 2013.” 

September 27 – Financial Times (David Gardner): “Spain has entered a constitutional crisis. The decision of Catalonia’s nationalist government to call a snap election in November – which in practice will amount to a referendum on independence – has opened the way to Catalan secession. That decision, in turn, may give a lift to Basque separatists, now running neck and neck with mainstream nationalists in regional government elections due next month, after winning the largest number of Basque Country seats last year in local and general elections. As a Spain trapped in the eurozone crisis tries to battle its way through a wrenching recession, it must now contemplate the real possibility that its plurinational state, which replaced the suffocatingly centralist Franco dictatorship with highly devolved regional government, may break up.” 

September 28 – Bloomberg (Emma Ross-Thomas and Ben Sills): “Spanish Prime Minister Mariano Rajoy’s unprecedented raid on a decade-old pension reserve fund to finance increased benefits comes less than a month before before regional elections as his popularity slumps. As the Cabinet approved a 2013 austerity budget demanded by the European Union, Rajoy’s ministers also agreed to use 3 billion euros ($3.9bn) from the 67 billion-euro reserve for the first time. It approved a 1% rise in pensions for 2013, the same as in 2012, and said retirees may also be compensated for inflation above that rate.” 

September 27 – Dow Jones (Tom Fairless): “Consumers and companies continued to pull money out of banks in Spain, Greece and Cyprus in August, and even French banks saw sizeable outflows, despite a pledge by European Central Bank President Mario Draghi to do ‘everything it takes’ to defend the euro zone. In Spain… private bank deposits fell 1.1% from the previous month… That marks the fifth straight month of outflows and takes Spanish bank deposits to their lowest level since April 2008. Still, the exodus moderated from a whopping 4.7% drop in July. Deposits in Greek banks also fell 0.3% on the month, while deposits at Cypriot banks fell by 0.9%, the data showed." 

September 26 – UK Telegraph: “The European Central Bank will not fill potential financing gaps in Greece's budget, Governing Council member Jens Weidmann said… Asked about whether Greece might need another bail-out, the president of Germany's Bundesbank told reporters after a meeting with Italian Finance Minister Vittorio Grilli that he did not want to comment on rumours and would rather wait for a formal assessment of Greece's financial state. ‘This is a question we should ask finance ministers. They are responsible for setting up the programmes and also for deciding on potential financial gaps. Those are not to be filled by central banks. This is a clear position I have,’ Weidmann, who also heads the German Bundesbank, said.” 

September 28 – Bloomberg (Stefan Riecher): “European Central Bank Executive Board member Joerg Asmussen said Greece may need more aid, joining the International Monetary Fund in expressing doubt that the two existing bailouts will suffice. Even if Greece meets its budget goals, ‘there could be additional need for external financing because, for example, growth is worse than was initially anticipated,’ Asmussen said… Such financial aid can only come ‘from the member states of the euro zone,’ he said, ruling out ECB involvement because that would be ‘prohibited monetary state financing.’” 

September 25 – Wall Street Journal: “Bundesbank President Jens Weidmann said he isn't the only member of the European Central Bank Council to doubt the wisdom of its bond-purchasing plans and that others also share his concerns, according to an interview to be published in the Neue Zuercher Zeitung Wednesday. ‘Despite broad support for the (bond-buying program) I have the impression others share my concerns,’ Mr. Weidmann told the Swiss daily newspaper. Mr. Weidmann has repeatedly argued the ECB is acting beyond its mandate to keep bond yields stable by effectively printing money to finance government deficits in the crisis-plagued euro zone. By contrast, ECB President Mario Draghi said earlier this month the plan is ‘strictly within our mandate.’ Mr. Weidmann, who is also a key member of the ECB's rate-setting governing council, said the central bank's financing ‘cannot be seen as a comprehensive problem solver’ for the region, the NZZ reported. ‘If the ECB measures relieve the pressures on the euro-region politicians to solve their problems, then they are not advancing the reform process in the region,’ Mr. Weidmann said.” 

September 28 – Bloomberg (Andrew Davis and Andrew Frye): “The European Central Bank should not impose extra economic conditions on nations using its bond- buying mechanism, and the International Monetary Fund shouldn’t have an oversight role, said Italian Prime Minister Mario Monti. Countries such as Italy and Spain are reluctant to request the bond buying they championed because of uncertainty about what conditions the central bank would seek to impose, he said. The program is only available to countries that are already taming public finances and conditions should not go beyond European Union recommendations made in June, Monti said. Oversight should be limited to establishing ‘checks so the countries continue to behave in that positive way,’ Monti said… ‘If this is the conditionality that will be finally delivered, should a country be in a market situation suggesting its use, there would be nothing dishonorable.’” 

September 28 – Reuters (Steve Scherer): “Two of Italy’s biggest unions marched through Rome on Friday to protest against Prime Minister Mario Monti's cuts in public spending as opposition grows to austerity policies aimed at steering the country out of its economic crisis. The strike followed clashes between anti-austerity protesters and police in Madrid and Athens this week and coincided with labor unrest at the ILVA steel plant in southern Italy.”

September 28 – Bloomberg (Mark Deen and Helene Fouquet): “President Francois Hollande’s first annual budget raised taxes on the rich and big companies and included a minimum of spending cuts to reduce the deficit. The 2013 blueprint relies on 20 billion euros ($26bn) in tax increases, including a levy of 75% on incomes over 1 million euros… Hollande aims to reduce spending by 10 billion euros, bringing the deficit to 3% of output from 4.5% in 2012. The budget predicts growth of 0.8%.” 

September 28 – Bloomberg (Joao Lima): “Portugal’s budget deficit will reach 5% of gross domestic product this year after it narrowed to 4.4% in 2011… Portugal’s debt will increase to 119.1% of GDP this year from 108.1% in 2011… Prime Minister Pedro Passos Coelho is battling rising joblessness and a deepening recession as he cuts spending and raises taxes to meet the terms of a 78 billion-euro ($100bn) aid plan from the European Union and the International Monetary Fund.”

September 26 – Bloomberg (Stephen Morris): “Corporate defaults have risen in Europe and may climb further because of economic and political uncertainty, deteriorating growth and looming debt maturities, Standard & Poor’s said… S&P’s speculative-grade default rate rose to 5.3% at the end of the second quarter, from 4.7% at the end of March… The trailing 12-month default rate will increase to 6.3% by the end of June 2013 and could surge to more than 8% if Europe’s recession is worse than expected…” 

Global Bubble Watch:

September 27 – Bloomberg (Charles Mead and Sarika Gangar): “Anheuser-Busch InBev NV to BHP Billiton Ltd. are leading the busiest third quarter of corporate bond sales ever as unprecedented investor demand allows issuers to refinance debt with borrowing costs at all-time-lows. Worldwide corporate issuance of $949 billion since June 30 brings the total for the year to $2.9 trillion, the second-fastest pace on record…” 

September 25 – Bloomberg (Vidya Root): “The Swiss National Bank purchased about 80 billion euros of sovereign debt in the euro area’s so- called core countries in the first seven months of the year, driving down yields, Standard & Poor’s said in a report today. The decision by Switzerland’s central bank to stem the appreciation in the Swiss franc has led to a ‘de facto recycling’ of funds to the euro area’s core countries of Germany, France, the Netherlands, Finland and Austria, the credit-rating company said. S&P said the SNB’s euro-area bond buying in the period amounted to about 48% of the estimated combined full-year deficits for the euro-area’s core for 2012, up from 9% in 2011. The Swiss central bank’s action has ‘significantly contributed’ to declining yields on bonds issued by these countries, S&P said.” 

September 28 – Bloomberg (Jody Shenn): “Relative yields on mortgage securities that guide U.S. home-loan rates are poised for their biggest monthly drop ever after the Federal Reserve began buying more of the bonds… The gap between yields on Fannie Mae mortgage bonds trading closest to face value and an average of rates on five- and 10-year Treasuries narrowed 58 bps this month… The decline exceeded the previous record from the past decade by 45%, with the spread reaching an all-time low of 55 bps on Sept. 25…”

September 28 – Bloomberg (Craig Stirling): “The U.K. faces an increased risk of a downgrade to its top credit rating after Fitch Ratings said that government debt will peak at a higher level and later than it previously predicted.”

September 27 – Bloomberg (Zachary R. Mider, Matthew Campbell and Cathy Chan): “Global mergers and acquisitions slumped this quarter to a level not seen since the aftermath of the financial crisis amid increasing concern the economic recovery is deteriorating. Companies have announced $446 billion of takeovers since June 30, the smallest amount since the third quarter of 2009… Acquisitions are now on pace to drop 15% in 2012 to $2 trillion, the lowest in three years.” 

September 26 – Bloomberg (Brian Parkin): “Germany’s sale today of a 10-year bund that fell short of its maximum target highlights ‘weakening investor interest -- in a volatile market -- in bonds with a maturity longer than five years,’ said Finance Agency spokesman Joerg Mueller… after the auction.” 

Germany Watch: 

September 27 – Bloomberg (Jeff Black): “European Central Bank Governing Council member Jens Weidmann said the proposed banking union can’t take responsibility for existing bad debts. ‘In order to keep liability and control in balance, only risks that have arisen after common supervision is established can be taken under joint liability,’ Weidmann, who heads Germany’s Bundesbank, said… ‘The legacy burdens on bank balance sheets have to be underwritten by the countries under whose supervision they have arisen.’ Weidmann’s comments come after finance chiefs from Germany, the Netherlands and Finland said this week that direct recapitalization of banks by the euro area’s permanent bailout fund should be a last resort and that legacy debts should remain the responsibility of national authorities. European leaders agreed in June that, as part of a prospective banking union, banks would qualify for direct aid once an ECB-led supranational supervisory mechanism has been established. ‘Mutualization of risks can’t be the primary purpose of a banking union,’ Weidmann said. Allowing the euro-area bailout fund to help ease the existing debts of banks would amount to ‘financial transfers,’ he said… Weidmann, in a speech titled “Trust -- Prerequisite for Success of a Stable Currency,” also made veiled criticisms of ECB President Mario Draghi’s bond-purchase plan. Speaking of how the Chinese invented paper money around 1,000 A.D., he said the emperors of the time ‘knew the importance of this invention and used it richly.’ ‘They produced more and more banknotes, but unfortunately without withdrawing the old ones. The result wasn’t surprising: Inflation.’ Weidmann said central banks mustn’t take on fiscal tasks, and voiced concern about the side-effects of ‘ultra-expansive monetary policy.’”

September 27 – Dow Jones (Tom Fairless and Todd Buell): “National authorities should bear the cost of losses in their banking industry suffered prior to the establishment of a European banking regulator, Bundesbank President Jens Weidmann said…, weighing into a debate about the extent to which Europe's rescue fund should pay for legacy bank debts. ‘To maintain a balance of liability and control, only risks acquired after the establishment of a common [banking] supervisor can fall under shared liability,’ Mr. Weidmann… said… ‘For legacy debts in banks' balance sheets, those countries under whose supervision the liabilities were generated’ must still vouch for them, he said. ‘Anything else would be financial transfers.’ With the comments, Mr. Weidmann appears to be throwing his weight behind… the finance ministers of Germany, the Netherlands and Finland, in which they said the region's permanent bailout fund, the European Stability Mechanism, should assume only a limited burden in bank recapitalizations. National governments should retain responsibility for issues arising from banks' bad lending decisions before they fall under a common supervisor, the ministers said. Mr. Weidmann stressed that the Bundesbank ‘fundamentally welcomes a European banking regulator,’ and that a banking union can be an ‘important building block’ for a stable currency union. However, creating a banking union will take time…, adding that its primary purpose mustn't be to mutualize risks. Mr. Weidmann also warned that it will be ‘difficult’ for the ECB to separate monetary policy from banking supervision if it becomes Europe's single banking regulator. The ECB has pledged to keep its monetary policy responsibilities strictly separate from its future regulatory role.”

September 27 – Bloomberg (Rainer Buergin): “German coalition lawmakers called on Chancellor Angela Merkel’s government to ensure that big euro-region banks are compelled to pass checks before coming under European supervision, with any restructuring needed carried out at the home country’s expense. ‘Banks that pose systemic risks are to be subjected to a stress test and restructured or liquidated at the expense of the national restructuring fund before they are included in the direct supervision mechanism,’ said the motion sponsored by Merkel’s Christian Democratic Union and their Free Democratic Party coalition partner.”

September 26 – Bloomberg (Rainer Buergin): “Former ECB Chief Economist Otmar Issing tells German newspaper Die Welt the bank risks losing its credibility after Draghi’s announced bond-buying program. Issing doubts ECB will soak up liquidity in time… says ‘unthinkable’ ECB would stop bond-buying if troubled states fail to meet conditions… says ECB is trapped between politics and markets… says ECB is prescribing more of the wrong medicine…” 

September 26 – Bloomberg (Rainer Buergin): “German Deputy Finance Minister Thomas Steffen says euro region government bond spreads are close to a ‘normality’ that existed before the year 2000. While the euro region is returning toward a more realistic pricing of risks, there are ‘exaggerations’ euro region governments have to fight together, Steffen says in a speech in Berlin…” 

China Watch:

September 27 – Financial Times (Simon Rabinovitch): “The Chinese central bank has injected a record amount of money into the financial system this week to alleviate a cash crunch that had driven up borrowing costs. The People’s Bank of China has poured Rmb365bn ($58bn) into money markets over the past three days through reverse repurchase agreements, the largest weekly amount in history.’” 

September 27 – Bloomberg: “China’s Foreign Ministry described as ‘outrageous’ and ‘self-deceiving’ Japanese Prime Minister Yoshihiko Noda’s remark that his country would never budge on its ownership over East China Sea islands claimed by both sides. While Japan isn’t seeking a military confrontation with China and wants to keep talking ‘calmly,’ the disputed islands ‘are an inherent part of our territory in light of history and also under international law… There can’t be any compromise that would be a step back from this basic position.’” 

Japan Watch:

September 26 – Bloomberg (Ma Jie and Yuki Hagiwara): “Toyota Motor Corp., Nissan Motor Co. and Honda Motor Co. signaled Chinese production cuts may deepen this month after anti-Japanese protests flared in the world’s largest vehicle market. Nissan lowered August output in China, its largest market by volume, 8.9% from a year earlier… Chinese production fell 18% to 67,625 vehicles at Toyota, Asia’s biggest automaker, and declined 10% at Honda.” 

India Watch:

September 28 – Reuters (Bibhudatta Pradhan and Abhijit Roy Chowdhury): “The Indian government left the target for debt sales in the second half of the fiscal year unchanged after stepping up efforts to pare its budget deficit… India’s budget deficit is the widest among major emerging nations as slower growth hurts tax receipts and subsidies fan spending, imperiling the government’s goal of narrowing the gap to 5.1% of gross domestic product from 5.8% last year.” 

European Economy Watch:

September 26 – Reuters (Daniel Flynn and Brian Love): “The number of unemployed in France topped the 3 million mark in August for the first time since 1999, its labor minister said…, adding to President Francois Hollande’s woes as he seeks to revive a stalled economy and his tumbling poll ratings. Michel Sapin said August's unemployment data… would show a 16th consecutive monthly rise… ‘It’s bad. It's clearly bad,’ Sapin told France 2 television.” 

September 24 – Bloomberg (Stefan Riecher): “German business confidence unexpectedly fell to the lowest in more than two and a half years in September as the sovereign debt crisis clouded the economic outlook.” 

September 28 – Bloomberg (Svenja O’Donnell): “Euro-area inflation unexpectedly accelerated in September… Consumer prices in the 17-nation euro region increased 2.7% from a year earlier after a 2.6% gain in August…”

September 28 – Bloomberg (Emma Ross-Thomas): “Spanish consumer prices rose the most in 17 months in September after the government increased the sales tax to help plug the budget deficit. Prices rose 3.5% from a year earlier…, accelerating from 2.7% the prior month…”

September 27 – Bloomberg (Neil Callanan and Sharon Smyth): “Angel Fernandez used to travel to the Netherlands to buy equipment for Spanish homebuilders when they were powering Europe’s third-biggest construction market. Now he watches as buyers come to take diggers, excavators and trucks to countries where they won’t just gather dust. Standing in a sunburned field in Ocana, a 90-minute drive south of Madrid, 41-year-old Fernandez looks on as never-used construction equipment is sold at discounts of as much as 20% through Ritchie Bros. Auctioneers Inc. Business is brisk for the world’s largest industrial-equipment auctioneer, a sign that time has run out for Spanish builders that were propped up by banks for years after the machines fell silent… Almost half of Spain’s 67,000 developers are insolvent but not bankrupt after getting additional financing from banks, according to R.R. de Acuna & Asociados, a property consulting firm. Extending the lives of companies is becoming harder for banks…” 

September 26 – Bloomberg (Johan Carlstrom): “Swedish consumer confidence fell more than predicted for a second month in September after unemployment rose as Europe’s debt crisis weighs on export demand in the largest Nordic economy.” 

U.S. Bubble Economy Watch:

September 28 – Bloomberg (John Hechinger and Janet Lorin): “More than one in 10 borrowers defaulted on their federal student loans, intensifying concern about a generation hobbled by $1 trillion in debt and the role of colleges in jacking up costs. The default rate, for the first three years that students are required to make payments, was 13.4%, with for-profit colleges reporting the worst results, the U.S. Education Department said… ‘Default rates are the tip of the iceberg of borrower distress,’ said Pauline Abernathy, vice president of The Institute for College Access & Success, a nonprofit…” 

Central Bank Watch:

September 25 – Bloomberg (Jeff Kearns and Aki Ito): “Federal Reserve Bank of Philadelphia President Charles Plosser said new bond buying announced by the Fed this month probably won’t boost growth or hiring and may jeopardize the central bank’s credibility. ‘We are unlikely to see much benefit to growth or to employment from further asset purchases,’ Plosser said… ‘Conveying the idea that such action will have a substantive impact on labor markets and the speed of the recovery risks the Fed’s credibility.’ ... ‘I opposed the Committee’s actions in September because I believe that increasing monetary policy accommodation is neither appropriate nor likely to be effective in the current environment,’ Plosser said. ‘Every monetary policy action has costs and benefits, and my assessment is that the potential costs and risks associated with these actions outweigh the potential meager benefits… The Fed’s most recent actions carry with them significant risks… I am not forecasting that those risks will necessarily materialize and I hope they will not. But if they do, they could prove quite costly to the economy.” 

September 28 – Bond Buyer: “Chicago Federal Reserve Bank President Charles Evans… said he expects the Fed to continue asset purchases at current levels once the current maturity extension program, also known as ‘Operation Twist,’ ends. ‘By the end of this year, we (the Fed) have a decision to make due to Operation Twist ending. We have to decide how much additional asset purchases to do. I expect to do something on the same magnitude we are doing now,’ Evans told reporters… To stop the asset purchases, Evans said he would like to see 200,000 -- or probably more like 250,000 -- additions in non-farm payrolls ‘for a couple of quarters,’ coupled with above trend growth, increases in labor market participation, and unemployment well below 8%.”

Weekly Commentary, September 21, 2012: Z1 QE3 and Deleveraging

As you read my opening summary of the Fed’s latest quarterly Z.1 “flow of funds” report, keep in mind the Fed’s recent decision to move to an altogether more aggressive monetary policy stance.

For the second quarter, Total Non-financial Credit market debt expanded at a 5.0% rate, the strongest expansion since Q4 2008 (14 quarters ago). Debt growth increased from Q1’s 4.4% rate and was almost double Q2 2011’s 2.6%. Corporate Credit market borrowings expanded at a 6.9% pace, up from Q1’s 4.7%. Total Household debt expanded at a 1.2% pace, the strongest growth since Q1 2008. Consumer Credit grew at a robust 6.2% rate, the strongest in 19 quarters (Q3 ’07). Home mortgage Credit contracted at a 2.1% pace, an improvement from Q1’s 3.3% pace of decline. State & Local borrowings increased at a 0.8% pace, compared to Q1’s 1.2% rate of contraction.

For the quarter, Total Non-Financial Credit expanded at a seasonally-adjusted and annualized (SAAR) $1.946 TN. This was the strongest debt expansion since Q4 2008’s SAAR $2.082 TN. And for comparison, the current pace of debt growth compares to 2008’s total growth of $1.906 TN, ‘09’s $1.063 TN, 2010’s $1.437 TN and 2011’s $1.326 TN. In the past, I’ve posited that our maladjusted Bubble economic structured requires in the neighborhood of $2.0 TN annualized Credit growth to retain reflationary momentum throughout the economy and asset markets.

And while Corporate and Consumer Credit (non-mortgage: i.e. credit cards, student loans, auto and installment debt, etc.) are now expanding robustly, the Credit system remains largely dominated by the historic expansion of federal debt. Federal borrowings expanded SAAR $1.183 TN during the quarter, down from Q1’s SAAR $1.428 TN, but up notably from Q2 2011’s $792bn pace. Federal borrowings expanded at a 10.9% pace during the quarter, up from the 8.2% rate from a year ago. In 16 quarters, Treasury debt has expanded a historic $5.775 TN, or 110%, to $11.026 TN. Outstanding Treasury debt expanded 24.2% in ’08, 22.7% in ’09, 20.2% in ’10 and 11.4% in ’11.

Consensus thinking has it that our system is progressing through a difficult “deleveraging” process. In contrast, I see much more system reflation than actual deleveraging. Sure, Household debt has declined $800bn since the end of 2007 to $13.456 TN. Meanwhile, federal debt has expanded more than seven times the decline in household borrowings. Indeed, Total Non-Financial debt ended Q2 at a record $38.924 TN, having expanded $6.550 TN, or 20.2%, in 16 reflationary quarters. As a percentage of GDP, total Non-financial debt has increased from 124% of GDP in June of 2008 to 249.4% to end 2012’s second quarter.

The ongoing inflation of system incomes made possible by the historic expansion of federal debt has been the key dynamic of this latest reflationary cycle. For the five Bubble years 2003 through 2007, National Incomes jumped 32% to $12.396 TN, with Compensation rising 29% to $7.856 TN. National Income and Compensation dropped 3.8% and 3.3%, respectively, during the recessionary year 2009. Importantly, however, over the past 12 quarters National Income has jumped 13.7% ($1.662 TN) to a record $13.791 TN, while Compensation has risen 9.5% ($743bn) to a record $8.563 TN. Q2 National Incomes were up 3.7% y-o-y, with Compensation 3.3% higher.

Income gains have supported spending growth, corporate profits and renewed asset inflation. This reflationary cycle has seen Household Net Worth bounce back strongly. Household assets ended Q2 at $76.127 TN, up $1.423 TN y-o-y and are now only about 3% below the late-2007 peak. At $62.668 TN, Household Net Worth (assets minus liabilities) has inflated $9.335 TN, or 17.5%, over the past eight quarters to less than 3% below Bubble period highs. And while Real Estate values remain significantly below Bubble highs, the value of Household sector Financial Asset holdings has reached new records at about $52 TN. Household Financial Asset holdings have inflated $8.505 TN in 24 months, or 19.6%.

“De-leveraging” discussions have been intriguing. Hedge fund manager Ray Dalio has been public with his framework. According to Mr. Dalio, deleveraging can be broken down into three processes: Austerity, debt restructuring and money printing. He has even referred to the ongoing “beautiful deleveraging” here in the U.S. that has supposedly found the right mix of austerity, restructuring and printing appropriate to ward of deflation while promoting slow growth.

As one would expect, most financial market operators focus their analysis on the financial aspects of so-called “deleveraging.” And, no doubt about it, the titans of today’s gigantic global leverage speculating community are precisely those players that have most adroitly played the ongoing cycle of global central bank reflationary policymaking. Their astounding financial success provides them a public forum in which to shape both the analytical debate and general viewpoints.

I tend to believe that conventional thinking – albeit from central bankers, bond and hedge fund kings, or FT and WSJ columnists - is wrong on deleveraging. Deleveraging is not predominantly a financial issue. Economic structure matters – and it matters tremendously. Importantly, true deleveraging requires that system debt loads are reduced to a level supportable by the capacity of an economy to produce real wealth. A system can achieve stability and robustness only when a sound economy supports a manageable amount of system financial assets. Yet with a highly unsound economy, ongoing rampant inflation of non-productive debt and highly unstable financial markets, from my framework our system remains very much in a financial leveraging Credit Bubble Cycle.

Today, a consensus view holds that money printing will inflate incomes and prices to levels that reduce the overall burden of system debt. The belief is that a doubling of federal debt in four years has supported private-sector deleveraging – in the process creating a more robust system. Higher risk asset prices are viewed as confirmation of the adeptness of this policy course.

And while it’s widely recognized that we are witnessing experimental monetary management, few seem to appreciate that we are similarly watching a historic experiment in economic structure. Never before has a world-leading economy been so dominated by consumption and services. This is especially noteworthy in terms of historical comparisons of deleveraging cycles. I would strongly argue that if policymakers throw Trillions of fiscal and monetary stimulus at a maladjusted consumption and asset inflation-based economy – the end result will be an only more distended maladjusted economy.

“Inflationists” have again come to Dr. Bernanke’s defense, and it’s worth noting that some don’t hesitate taking shots at the “liquidationist” naysayers. And if I were writing my CBB back in the late-twenties, I would be categorized as one of those dreadful liquidationists - and one of Dr. Bernanke’s “Bubble poppers.” My argument is along the same lines as those economic thinkers that believed that either a Bubble economy and associated price levels be allowed to settle back to sustainable levels - or a runaway inflation of Credit would risk systemic collapse. Historical revisionism notwithstanding, those knucklehead “Bubble poppers” had the analysis right.

Historic Bubbles require a spectacular backdrop. The ongoing Bubble period and the “Roaring Twenties” share important similarities, especially in the realm of extraordinary technological advancement. Epic periods of innovation significantly impact the evolution of economic structures, while they also tend to stoke optimism as well as policy mistakes. Resulting booms spur Credit, economic and speculative excesses. And while such environments beckon for tighter monetary management regimes, during the twenties and throughout this prolonged Bubble policymakers administered the opposite. The confluence of economic and financial complexities was beyond the grasp of policymakers.

Contemporary economies have an unprecedented capacity to absorb inflating Credit/purchasing power. Apple expects to sell 10 million iPhone 5’s this weekend. Throw more Credit and higher incomes at our economy, and folks can acquire more cool technology products, enjoy more downloads, do more laser treatments or dine at more upscale restaurants. Literally Trillions of deficits and Fed monetization can be readily absorbed with hardly an impact on CPI. A services and consumption-based economy is – at least during a Credit cycle’s upside - something to behold – and confound.

Our economic structure certainly enjoys unmatched capacity to absorb Credit excess without engendering traditional consumer price inflation. Yet there is indeed a huge problem that no one seems to want to recognize: Our system also has an unprecedented capacity to expand Credit that is backed by little in the way of wealth-creating capacity. Our government literally injects Trillions into the economy – Credit that inflates incomes and sustains consumption and elevates asset prices. The downside of this economic miracle is that, at the end of the day, there’s little left to show for the whole exercise except for an ever-expanding mountain of suspect financial claims. Moreover, market values of these claims are sustained only by the unrelenting expansion of additional claims/Credit concurrent with increasingly radical monetary management. This is Minsky’s “Ponzi Finance” at a systemic level.

A real deleveraging would see the economy and financial markets weaned off of rampant Credit growth. Non-financial Credit growth averaged about $700bn annually during the nineties. This inflated to about $2.4 TN at the Mortgage Finance Bubble pinnacle in 2007. As I noted above, we’re currently running at an annualized Credit growth rate of nearly $2.0 TN. This is posing great unappreciated risk to system stability.

A real deleveraging would see price levels (and market-based incentives) adjust throughout the economy in a manner that would spur business investment – in the process incentivizing sound investment-based lending and resulting job growth. Real deleveraging would see a shift in the economic structure from Credit-fueled consumption to savings and productive investment. Real deleveraging would give rise to our endemic trade deficits shifting to surplus. Real deleveraging would see a meaningful reduction in non-productive debt. Real deleveraging would see market prices dictated by fundamentals rather than governmental intervention, manipulation and inflationism.

The “raging” debate is whether recent elevated unemployment is a “cyclical” or “structural” phenomenon. Academic “white papers” not required. After all, find a system that doubles mortgage Credit in about six years and then proceeds to double federal debt in four - and you'll no doubt locate a deeply maladjusted economic structure. Such gross financial imbalance ensures economic imbalance. And, importantly, the longer such imbalances are accommodated/incentivized by loose fiscal and monetary policies the deeper the structural impairment. Throw massive fiscal stimulus and monetize Trillions and such a structure will surely demonstrate historic deficiencies and fragilities.

Deleveraging – the process of unwinding the economic damage wrought from years of excess - will be a quite arduous economic process; one that will commence at some unknown date in the future. Oh, I guess I failed to mention that total (financial and non-financial) Credit ended Q2 at a record $55.031 TN, or 353% of GDP. And Rest of World holdings of our financial assets ended the quarter at a record $19.100 TN, a $3.860 TN increase from the end of 2008.

For the Week:

The S&P500 slipped 0.4% (up 16.1% y-t-d), and the Dow dipped 0.1% (up 11.2%). The Morgan Stanley Cyclicals fell 1.9% (up 14.1%), and the Transports sank 5.9% (down 2.2%). The Morgan Stanley Consumer index rose 0.7% (up 10.7%), while the Utilities declined 0.2% (down 0.9%). The Banks were down 2.8% (up 27.5%), and the Broker/Dealers were 4.9% lower (up 2.4%). The broader market gave back some of recent outperformance. The S&P 400 Mid-Caps fell 2.0% (up 14.4%), and the small cap Russell 2000 declined 1.1% (up 15.5%). The Nasdaq100 was up 0.2% (up 25.6%), while the Morgan Stanley High Tech index declined 1.0% (up 18.6%). The Semiconductors dropped 2.8% (up 8.4%). The InteractiveWeek Internet index lost 1.1% (up 15.0%). The Biotechs jumped 3.6% (up 46.6%). With bullion little changed, the HUI gold index gained 1.6% (up 5.4%).

One-month Treasury bill rates ended the week at 4 bps and three-month bills closed at 10 bps. Two-year government yields were up a basis point to 0.26%. Five-year T-note yields ended the week down 3 bps to 0.67%. Ten-year yields fell 11 bps to 1.75%. Long bond yields dropped 15 bps to 2.94%. Benchmark Fannie MBS yields declined 31 bps to 1.82%. The spread between benchmark MBS and 10-year Treasury yields narrowed 20 to a record low 7 bps. The implied yield on December 2013 eurodollar futures rose 2 bps to 0.40%. The two-year dollar swap spread was little changed at 13 bps, and the 10-year dollar swap spread declined 2 to one basis point. Corporate bond spreads widened from last week's multi-month lows. An index of investment grade bond risk jumped 13 to 96 bps. An index of junk bond risk rose 14 to 458 bps.

Debt issuance remained exceptionally strong. Investment grade issuers this week included JPMorgan $3.0bn, Novartis $2.0bn, Ford Motor Credit $1.0bn, Duke Energy Carolinas $650 million, Franklin Resources $600 million, Sempra Energy $500 million, Nextera Energy $500 million, New York Life $500 million, Church & Dwight $400 million, Southern Cal Gas $350 million, Digital Realty Trust $300 million, Torchmark $300 million, Ingredion $300 million, Tampa Electric $250 million, System Energy Resources $250 million, and North Shore Long Island $135 million.

Junk bond funds saw inflows jump to $1.3bn (from Lipper). The long list of junk issuers included Biomet $2.6bn, VPI $1.75bn, Rockwood Specialties $1.25bn, Nielsen $800 million, Continental Airlines $800 million, Hovnanian Enterprises $800 million, Sabre $800 million, FMC Technologies $800 million, Fiserv $700 million, Harley-Davidson $600 million, General Cable $600 million, Serta Simmons $650 million, Valeant Pharmaceuticals $500 million, SBA Communications $500 million, Sky Growth $490 million, Jones Group $400 million, Air Lease Corp $400 million, Kohl's $350 million, Amkor Technology $300 million, Sotheby's $300 million, CNO Financial Group $275 million, Ryland Group $250 million, P.H. Glatfelter $250 million, Michaels Stores $200 million and Baker & Taylor $145 million.

I saw no convertible debt issued.

International dollar bond issuers included Ukraine $2.6bn, National Bank Australia $2.5bn, Bank Nederlandse Gemeenten $2.25bn, ING Bank $2.0bn, Corp Andina de Fomento $1.5bn, Hazine Mustesarligi $1.5bn, Total Capital International $1.5bn, Banco Santander $1.35bn, Vodafone $2.0bn, Kommunalbanken $1.25bn, Ontario $1.25bn, Westpac Banking $2.25bn, Grupo Aval $1.0bn, PKO Finance $1.0bn, Nordea Bank $1.0bn, Bangkok Bank $1.2bn, Korea Finance $800 million, Schneider Electric $800 million, Banko Pactual $800 million, Colombia Telecom $750 million, Alpha Bank $750 million, Banco del Peru $650 million, Intelsat Jackson $640 million, Anglo American $1.35bn, Development Bank of Japan $500 million, Novolipetsk Steel $500 million, Rentenbank $250 million and Maestro Peru $200 million.

Spain's 10-year yields declined 3 bps to 5.70% (up 66bps y-t-d). Italian 10-yr yields added 3 bps to 5.03% (down 200bps). German bund yields fell 11 bps to 1.60% (down 23bps), and French yields added a basis point to 2.26% (down 88bps). The French to German 10-year bond spread widened 12 bps to 66 bps. Ten-year Portuguese yields jumped 49 bps to 8.26% (down 451bps). The new Greek 10-year note yield sank 80 bps to 19.46%. U.K. 10-year gilt yields fell 13 bps to 1.83% (down 14bps). Irish yields were 31 bps lower to 4.77% (down 349bps).

The German DAX equities index added 0.5% (up 26.3% y-t-d). Spain's IBEX 35 equities index gained 0.9% (down 3.9%), while Italy's FTSE MIB fell 3.8% (up 6.0%). Japanese 10-year "JGB" yields were unchanged at 0.79% (down 19bps). Japan's Nikkei declined 0.6% (up 7.7%). Emerging markets were mostly lower. Brazil's Bovespa equities index declined 1.3% (up 8.1%), and Mexico's Bolsa fell 0.9% (up 8.8%). South Korea's Kospi index slipped 0.3% (up 9.7%). India’s Sensex equities index rose 1.6% (up 21.3%). China’s Shanghai Exchange sank 4.6% (down 7.9%).

Freddie Mac 30-year fixed mortgage rates dropped 6 bps to 3.49% (down 60bps y-o-y). Fifteen-year fixed rates fell 8 bps to 2.77% (down 52bps). One-year ARMs were unchanged at 2.61% (down 21bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 4 bps to 4.15% (down 62bps).

Federal Reserve Credit added $1.0bn to $2.807 TN. Fed Credit was down $33bn from a year ago, or 1.2%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/19) rose $7.4bn to $3.584 TN. "Custody holdings" were up $164bn y-t-d and $116bn year-over-year, or 3.4%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $387bn y-o-y, or 3.8% to a record $10.611 TN. Over two years, reserves were $2.032 TN higher, for 24% growth.

M2 (narrow) "money" supply jumped $34.6bn to a record $10.124 TN. "Narrow money" has expanded 7.1% annualized year-to-date and was up 6.7% from a year ago. For the week, Currency increased $1.6bn. Demand and Checkable Deposits fell $16.4bn, while Savings Deposits surged $53.6bn. Small Denominated Deposits declined $1.8bn. Retail Money Funds fell $2.8bn.

Total Money Fund assets declined $10bn to $2.568 TN. Money Fund assets were down $127bn y-t-d and $53bn over the past year, or down 2.0% y-o-y.

Total Commercial Paper outstanding fell $7.2bn to $1.008 TN. CP was up $49bn y-t-d, while having declined $22bn from a year ago, or down 2.1%.

Currency Watch:

The U.S. dollar index recovered 0.6% to 79.328 (down 1.1% y-t-d). For the week on the upside, the Japanese yen increased 0.3%, the Taiwanese dollar 0.3%, and the British pound 0.1%. For the week on the downside, the Danish krone declined 1.2%, the euro 1.1%, the Mexican peso 1.1%, the Norwegian krone 1.0%, the Australian dollar 0.9%, the South African rand 0.9%, the Swiss franc 0.7%, the Brazilian real 0.5%, the Canadian dollar 0.5%, the South Korean won 0.2%, and the Swedish krona 0.1%.

Commodities Watch:

September 20 – Bloomberg: “China passed the U.S. last year for the first time to become the biggest importer of agricultural products and also increased its exports… Imports, including food and beverages, rose 34% to $144.7 billion in 2011 from $108.3 billion in 2010… Exports gained 25% to $64.6 billion, beating Canada to become the sixth largest...”

The CRB index dropped 3.7% this week (up 1.2% y-t-d). The Goldman Sachs Commodities Index sank 4.4% (up 3.0%). Spot Gold added 0.2% to $1,773 (up 13.4%). Silver was little changed at $34.64 (up 24%). November Crude dropped $6.44 to $92.89 (down 6%). October Gasoline declined 2.4% (up 11%), and October Natural Gas fell 2.0% (down 4%). December Copper declined 1.1% (up 10%). December Wheat fell 2.9% (up 37%), and December Corn dropped 4.3% (up 16%).

Global Credit Watch:

September 21 – Wall Street Journal (Marcus Walker and Matina Stevis): “A confrontation is brewing among Greece's international creditors over who will provide the financing needed to keep the country afloat. A report by international inspectors, due in October, will state how big the funding shortfall is in Greece's bailout program, but European officials say the deficit is far too big for Greece to close on its own. That means the International Monetary Fund, the European Central Bank, and euro-zone governments such as Germany will have to negotiate over which of them will make painful concessions to ease Greece's debt-service burden. That is intended to avoid a Greek bankruptcy that could force the country out of the euro and reignite financial panic across the currency bloc.”

September 21 – Bloomberg (Anchalee Worrachate): “The European Central Bank’s plan to buy bonds is proving more successful at keeping borrowing costs for France and Belgium near record lows than persuading investors to lend to Spain and Italy for less. Spain’s three-year yield is back up to 3.83% after dipping to 3.37% on Sept. 7… The cost of insuring French debt against default has declined 24%, almost twice the 13% drop in Italian default-swap costs.”

September 21 – New York Times (Raphael Minder): “Prime Minister Mariano Rajoy, already under pressure from his European counterparts to clean up Spain's banks and public finances, failed on Thursday to ease what has recently turned into his biggest domestic challenge: a separatist push by the nation’s most economically powerful region, Catalonia. Instead, Catalonia's leader, Artur Mas, accused Mr. Rajoy of losing a ‘historic opportunity’ to safeguard the relationship between his region and the rest of Spain, after Mr. Mas was unable to persuade Mr. Rajoy to change the tax rules for Catalonia. Mr. Mas warned that Mr. Rajoy's refusal to negotiate any fiscal changes was likely to increase resentment toward the Madrid government among Catalans, after hundreds of thousands of people in the region held the largest-ever pro-independence rally, on Sept. 11 in Barcelona. ‘The people and society of Catalonia are on the move, as we have seen on Sept. 11, and not willing to accept that our future will be gray when it could be more brilliant,’ Mr. Mas said… after a two-hour meeting with Mr. Rajoy.”

September 21 – Bloomberg (Chiara Vasarri and Lorenzo Totaro): “Italy and Spain won’t request bailouts unless a new surge in bond yields leaves them shut out of markets as no government will voluntarily accept conditions imposed for the aid, a senior Italian government official said. ‘There won’t be any nation that voluntarily, with a preemptive move, even if rationally justified, would go to an international body and say -- ‘I give up my national sovereignty,’” Gianfranco Polillo, undersecretary of finance, said… ‘I rule it out for Italy and for any other country.’”

September 18 – Bloomberg (Anne-Sylvaine Chassany): “European banks pledged last year to cut more than $1.2 trillion of assets to help them weather the sovereign-debt crisis. Since then they’ve grown only fatter. Lenders in the euro area increased assets by 7% to 34.4 trillion euros ($45 trillion) in the year ended July 31… BNP Paribas SA, Banco Santander SA, and UniCredit SpA, the biggest banks in France, Spain and Italy, all expanded their balance sheets in the 12 months through the end of June. They have Mario Draghi to thank. The ECB president’s decision nine months ago to provide more than 1 trillion euros of three-year loans to banks eased the pressure to sell assets at depressed prices… ‘Deleveraging isn’t taking place, especially in Spain and Italy,’ said Simon Maughan, a bank analyst at Olivetree Securities… ‘The fact that we haven’t got on with it, or very slowly, suggests that when the time comes we’ll need another ECB injection to roll over the first one, just to keep the balance sheets of Italian banks in business.’”

September 21 – Financial Times (Peter Spiegel and Miles Johnson): “EU authorities are working behind the scenes to pave the way for a new Spanish rescue programme and unlimited bond buying by the European Central Bank, by helping Madrid craft an economic reform programme that will be unveiled next week. According to officials involved in the discussions, talks between the Spanish government and the European Commission are focusing on measures that would be demanded by international lenders as part of a new rescue programme, ensuring they are in place before a bailout is formally requested.”

September 17 – Bloomberg (Charles Penty): “Spanish banks, already hooked on cheap European Central Bank loans, are haemorrhaging deposits as the government debates whether to seek a bailout. Households and companies drained 26 billion euros ($34bn) from Spanish bank accounts in July, driving the ratio of loans to deposits among lenders to 187% from 183% in December and 182% a year earlier… Shrinking deposits undermine the ability of banks to support economic growth by lending to companies and consumers. ‘There are significant outflows of deposits now in Spain and they won’t start coming back until people are sure they’re safe and that Spain is secure,’ said Simon Maughan, a financial strategist at Olivetree Securities…”

September 20 – Reuters (Jesús Aguado and Julien Toyer): “An independent stress test of Spain's banking sector will likely reveal capital needs of 50 billion to 60 billion euros (47.9 billion pounds)… Spain became the latest focus point earlier this year of the euro zone debt crisis after it became clear its banks would need financial support to clean up their balance sheets of around 185 billion euros of toxic real estate assets. Sources told Reuters the Bank of Spain had started to communicate to the banks the results of the stress tests earlier on Thursday and that all of them would be informed by Monday.”

September 17 – MarketNews International: “European Central Bank Governing Council Member Luc Coene thinks it is unlikely that the central bank will engage in outright bond purchases. Coene told an audience… that Spain and other countries would have to request a program with the euro zone's bailout fund in order for the ECB to buy its bonds: ‘I think it's very unlikely - given the mandate we have and the treaty we have - that the ECB will engage in outright bond purchases. Of course, never say never as they say. It's clear that if Spain decides not to demand a program with the EFSF we will not buy Spanish bonds, the same is valid for the other countries ... Whatever country wants us to buy its bonds has to submit to the program with appropriate conditionality and then only on that condition will we buy bonds and only on the short part of the maturity.’”

Global Bubble Watch:

September 19 – Bloomberg (Toru Fujioka): “The Bank of Japan unexpectedly expanded its asset-purchase fund by 10 trillion yen ($126bn), seeking to counter an increasing danger of contraction in the world’s third-largest economy. The BOJ’s program, in which it buys mainly government debt, or JGBs, was enlarged to 55 trillion yen…”

September 18 – Reuters (Sudip Roy): “Emerging markets sovereigns, corporates and financial institutions could raise nearly $400bn of external debt this year as they seek to take advantage of benign issuance conditions, according to ING. Borrowers have already raised a record $314bn year-to-date, one-third more than the amount they issued over the same period last year.”

September 21 – Bloomberg (Jody Shenn): “A measure of relative yields on mortgage securities that guide U.S. home-loan rates is poised for its biggest weekly drop in almost four years on speculation that the Federal Reserve will find a shortage of the bonds as it expands purchases… This week’s drop of 34 bps, the largest since December 2008, exceeds the decline of 19 seen in the final two days of last week after the Fed’s Sept. 13 announcement that it would expand its balance sheet with monthly purchases of $40 billion of government-backed housing debt until the economic recovery strengthens.”

September 18 – Bloomberg (Lisa Abramowicz): “Investors are so attracted to junk bonds that they’re accepting less compensation than holders of loans, which get paid first in bankruptcies. Yields on U.S. speculative-grade notes have fallen to 6.2%, 1 basis point less than a measure of what’s being paid by senior secured loans, according to JPMorgan Chase & Co. That’s the first time the gap has vanished, with junk bonds paying an average 103 basis points, or 1.03 percentage points, more than loans over the past three years… Junk-bond buyers are demanding lower yields to take on greater risk as they seek alternatives to Treasuries paying the least ever. Investors have unleashed an unprecedented flood of cash into the junk-bond market this year that’s almost 18 times the deposits into funds that buy floating-rate loans…”

September 18 – IFR (Sudip Roy): “Emerging markets sovereigns, corporates and financial institutions could raise nearly USD400bn of external debt this year as they seek to take advantage of benign issuance conditions, according to ING. Borrowers have already raised a record USD314bn year-to-date, one-third more than the amount they issued over the same period last year. And the Dutch Bank foresees a further USD78.4bn of issuance this year…”

September 17 – Bloomberg (Mary Childs): “Exchange-traded funds are poised to overtake credit derivatives by year-end as a way to speculate on junk bonds. The value of corporate securities held by the five-largest junk ETFs almost doubled in the past year to a record $31.4 billion, while the net amount of protection bought or sold on the debt using the two current credit-default swaps indexes declined 3% to $35 billion… The ETFs are growing at an average 5.2% monthly pace this year, which would put assets at more than $36.5 billion by Dec. 31.”

September 15 – Bloomberg: “China’s former banking chief called the Federal Reserve’s third round of quantitative easing ‘irresponsible,’ while an official at the regulator said the stimulus won’t provide sustained support to the U.S. economy. ‘It’s irresponsible to the U.S., and also irresponsible to us,’ Liu Mingkang, former chairman of the China Banking Regulatory Commission, told Bloomberg… Liu’s comments were the latest from China warning of risks from the U.S. stimulus program, which drove commodities higher and spurred stocks to the highest levels since 2007.”

September 20 – Financial Times (John Paul Rathbone and Jonathan Wheatley): “Guido Mantega, Brazil’s finance minister, has warned that the US Federal Reserve’s ‘protectionist’ move to roll out more quantitative easing will reignite the currency wars with potentially drastic consequences for the rest of the world. ‘It has to be understood that there are consequences,’ Mr Mantega told the Financial Times… The Fed’s QE3 programme would only have a marginal benefit [in the US] as there is already no lack of liquidity . . . and that liquidity is not going into production.”

Germany Watch:

September 18 – MarketNews International): “The sister party of German Chancellor Angela Merkel's CDU, the Bavarian CSU, is arguing that Germany’s share in the European Central Bank’s new bond-buying program must be part of the E190 billion that parliament approved as the country's contribution to Europe's permanent bailout fund, the European Stability Mechanism (ESM). CSU party leader Horst Seehofer told German weekly Der Spiegel… that the agreed E190 billion for the ESM must also include the ECB bond purchases. ‘The E190 billion is what counts - including the ECB,’ he said. According to Der Spiegel, the ECB leadership is worried about the announcement by the CSU and has called for a meeting with Seehofer.”

September 19 – Bloomberg (Annette Weisbach): “Offenbach, a city of about 120,000 people neighboring Germany’s financial capital Frankfurt, is so mired in debt it had to ask the state of Hesse for a 211 million-euro ($277 million) bailout in June. In so doing, it became one of the largest of 102 municipalities to tap 3.2 billion euros of aid Hesse is making available as the first of Germany’s 16 federal states to introduce a formal rescue fund for struggling towns and cities.”

China Watch:

September 18 – Bloomberg: “A Chinese manufacturing survey pointed to an 11th month of contraction and Japan’s exports fell in August… The preliminary reading was 47.8 for a China purchasing managers’ index… by HSBC Holdings Plc and Markit Economics, compared with a final level of 47.6 last month… Japan’s overseas shipments slid 5.8% on weakness in demand from Europe and China.”

September 18 – Bloomberg: “Net sales of foreign currency by China’s central bank and financial institutions accelerated last month, suggesting capital outflows picked up as the nation’s economic slowdown deepened… The report follows data showing foreign investment in China fell in July to the lowest level in two years amid signs economic expansion may decelerate for a seventh quarter.”

September 18 – Bloomberg: “Three Chinese bond issuers have delayed or canceled bonds in the past week, as concerns grow that the U.S. Federal Reserve’s monetary easing will stoke accelerating inflation in China. Sichuan Expressway Construction & Development Co…. will delay 3 billion yuan ($475 million) of notes that had been planned for sale by the end of this month… That follows cancellation of a debt sale by China Development Bank, the country’s biggest lender to government projects, and the postponement of an offering by Xinao China Gas Investment Co. last week.”

September 18 – Bloomberg: “Prices for newly constructed homes in China rose in fewer cities in August than the previous month, reducing the likelihood that policy makers will strengthen steps designed to constrain property prices. Thirty-five of 70 cities covered by the statistics bureau’s monthly report had price gains, compared 49 in July…”

September 18 – Bloomberg (Joshua Fellman): “619-sq.m. unit in Cofco’s Ocean One development in ‘Little Lujiazui’ area sold for record total price [$18.4 million]…”

Japan Watch:

September 18 – Bloomberg: “Japan's Fast Retailing Co. and Aeon Co. shuttered stores in China, the world’s second-biggest economy, as a territorial dispute and the anniversary of the Japanese invasion prompted thousands to protest in Beijing, Shanghai and other cities… Nissan Motor Co., the largest Japanese carmaker in China, halted production at two factories in the country. Japan’s purchase last week of uninhabited islands claimed by both countries is threatening trade ties of more than $340 billion and complicating efforts to fortify growth in both countries as the European debt crisis saps demand for exports. Protesters in China have ransacked retailers, smashed store fronts and overturned cars, with fires having damaged a Panasonic Corp. plant and a Toyota Motor Corp. dealership.”

India Watch:

September 18 Wall Street Journal (Prasanta Sahu and Mukesh Jagota): “India will overshoot its fiscal deficit target for this financial year as economic growth has fallen short of initial estimates, the head of a top government think tank said… The fiscal deficit target--5.1% of gross domestic product--was set when the government was expecting the economy to grow around 7.5% in the current financial year through March, said Montek Singh Ahluwalia, deputy chairman of the Planning Commission. ‘But we know growth rate is going to be less than that, may be 6.5%,’ Mr. Ahluwalia said. ‘For that reason alone, fiscal deficit will widen.’ Many Economists expect the deficit could widen to as much as 6.0% of GDP this fiscal year, from 5.75% last year…”

European Economy Watch:

September 20 – Reuters (Daniel Flynn): “French business activity took a sharp turn for the worse in September, shrinking at its fastest pace since April 2009 as weak domestic demand and a deepening slowdown in southern Europe dragged the euro zone's No. 2 economy towards contraction. Economists suggested that the downbeat picture from France… showed that unemployment running a 13-year high and a raft of tax rises announced by Socialist President Francois Hollande may be weighing on activity. The Markit/CDAF flash composite purchasing manager's index (PMI), a preliminary estimate of firms' activity that covers both manufacturing and services, slid to 44.1 in September, its lowest level in 41 months, from 48.0 in August.”

September 18 - UK Guardian (Henry MacDonald): “Economists have long tried to perfect the art of forecasting recessions, but others believe there are straightforward warning signs that have nothing to do with algebra or computerised modelling. For Jonnie and Derek Keys, two Irish brothers who run a vehicle and machinery auction company in Co Tyrone, Northern Ireland, the canary in the coal mine is the spike in construction equipment leaving a country at knockdown prices. ...Jonnie Keys has noticed a recent increase in the purchase of diggers, loaders, lorries and other mechanical equipment from Italy. ‘We are already familiar with a surplus of vehicles, diggers, trucks and generators in Spain. Now we have noticed a large amount of kit for sale coming out of Italy at low prices. It's a sure sign of a slowdown, a warning light that things are about to get much worse, especially in the country's construction industry. That is what is now happening in Italy,’ Keys says as he surveys his enormous auction yard.”

September 21 – Bloomberg (Svenja O’Donnell): “Euro-area services and manufacturing output fell to a 39-month low in September as European leaders struggled to reverse the single-currency bloc’s slide into recession.”

September 18 – Bloomberg (Ola Kinnander): “Ford… led the steepest decline in European car sales in six months as the region’s economic woes hurt demand in Germany. Industrywide car registrations fell 8.5% from a year earlier to 722,483 vehicles in August… The European car market has shrunk for 11 consecutive months as governments grapple with a sovereign-debt crisis, and the ACEA is forecasting a 17-year low for full-year sales.”

September 21 – Bloomberg (Gonzalo Vina): “Britain posted its biggest August budget deficit on record, heaping pressure on Chancellor of the Exchequer George Osborne as the recession hits tax revenue and pushes up spending on welfare. The shortfall excluding government support for banks was 14.4 billion pounds ($23.5bn)… Tax revenue rose 1.8% and government spending climbed 2.5%.”

September 21 – Bloomberg (Stefan Riecher): “The European Central Bank said the cost of its new Frankfurt headquarters will jump by as much as 41% due to higher prices for construction materials and ‘a number of unforeseen challenges.’ The 185-meter twin-towered skyscraper will now cost as much as 1.2 billion euros ($1.6bn), up to 350 million euros more than the initial price of 850 million euros… The central bank’s relocation to the new premises remains scheduled for 2014… The cost blowout comes as the ECB castigates profligate European governments for failing to control their own spending.”

Global Economy Watch:

September 18 – Bloomberg (Ilan Kolet and Theophilos Argitis): “Canadian existing home sales fell the most in more than two years in August as a market slump in Toronto deepened, a realtor group said. The sale of homes fell 5.8% in August to 35,869… Home sales were down 8.9% from the same month last year. The average national price for existing homes rose 1.1% from July and 0.3% from a year earlier.”

U.S. Bubble Economy Watch:

September 20 – Bloomberg (Liz Capo McCormick): “The Federal Reserve’s decision to hold borrowing costs steady into 2015 and buy mortgage debt each month is reducing bond market volatility and demand for options that hedge against changes in interest rates. Mortgage bond holders often use swaptions, or options on interest-rate swaps, to guard against swings in rates… Bond market volatility is already approaching the lowest levels since just before the global financial crisis.”

September 21 – Dow Jones (Patrick McGee): “Weekly high-grade corporate-bond issuance is on its way to hit $30 billion for a third straight week, as more companies capitalize on a voracious appetite for fixed-income assets. Just more than $25 billion had priced as of Wednesday, and six deals are in the market Thursday for a combined $4 billion. The high-grade market has only seen a trifecta of consecutive $30 billion weeks three times in the past 17 years, most recently in early 2011, data provider Dealogic shows.”

Central Bank Watch:

September 19 – UK Telegraph (Jeremy Warner): “Forget QE3 in the US, or whatever round of quantitative easing we are now up to here in the UK; in Japan they are about to embark on QE7, or is that QE8 – it’s hard to keep up. In the land of the setting sun, QE is now such an everyday part of the economic landscape that it would barely have warranted a mention, let alone an entire column, but for the fact that the latest dollop of ‘unconventional’ policy action appears to be part of a co-ordinated, global response to the economic slowdown. Like big deficits and mountainous public debt, in Japan, QE no longer generates the same agonised debate it does in the West. It just is. For Japan, the ‘unconventional’ is now very much the conventional. And little good does it seem to have done either. The Japanese economy remains firmly frozen in time, having barely grown for more than 20 years now….”

September 16 – Bloomberg (Joshua Zumbrun): “Richmond Federal Reserve President Jeffrey Lacker said that he opposed the central bank’s third round of quantitative easing in mortgage-backed securities because allocating credit should be the province of fiscal authorities such as the U.S. Treasury or Congress. ‘I strongly opposed purchasing additional agency mortgage- backed securities,’ Lacker said… ‘Such purchases, as compared to purchases of an equivalent amount of U.S. Treasury securities, distort investment allocations and raise interest rates for other borrowers.’ Lacker said that ‘channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve.’”

September 18 – Bloomberg (Joshua Zumbrun and Mark Clothier): “Federal Reserve Bank of Chicago President Charles Evans said the central bank’s third round of quantitative easing will help the economy keep growing despite headwinds from Europe’s debt crisis as well as potential U.S. tax increases and spending cuts. ‘Given the slow and fragile recovery, the large resource gaps that still exist, and the large risks we face, it remains clear that we needed a more resilient economy,’ Evans said…”

September 20 – Bond Buyer: “QE3 is battling, as intended, the threat of decades of a ‘Great Stagnation,’ accelerating recovery but still in need of reinforcing fiscal policy, Boston Federal Reserve Bank President Eric Rosengren said… In an extended defense of the Fed’s latest unconventional policy stimulus, Rosengren framed the effort as the Fed's refusal to accept high unemployment and low resource utilization as the status quo. The FOMC's ‘forceful’ actions, an example to ‘policymakers of all sorts,’ are in contrast, he said, to Japan's ‘muted’ response that helped prolong that country's stagnation into two decades.”

California Watch:

September 21 – New York Times (Mary Williams Walsh): “Gov. Jerry Brown of California announced when he came into office last year that he had found an alarming $28 billion ‘wall of debt’ looming over the state, which had to be dismantled. Since then, he has slowed the issuance of municipal bonds, called for spending cuts and tried to persuade the state's famously antitax voters to approve a tax increase this fall. On Thursday, an independent group of fiscal experts said… the ‘wall of debt’ was several times as big as the governor thought. Directors of the State Budget Crisis Task Force said their researchers had found a lot of other debts that did not turn up in California's official tally. Much of it involved irrevocable promises to provide pensions to public workers, health care for retirees, the cost of delayed highway maintenance and an estimated $40 billion bill to bring drinking water up to federal standards. They also pointed out many of the same unpaid bills from previous years that the governor had brought to light, like $8 billion in delayed payments to schools and community colleges… The task force estimated that the burden of debt totaled at least $167 billion and as much as $335 billion. Its members warned that the off-the-books debts tended to grow over time…”

Muni Watch:

September 17 – Bloomberg (Michelle Kaske): “U.S. tax-exempt debt is poised to cheapen relative to Treasuries as issuance in the $3.7 trillion municipal market leaps by the most in two years. New York’s Metropolitan Transportation Authority… is scheduled to lead about $8.6 billion of borrowing this week, up 87% from the previous five days… It would be the biggest jump in consecutive non-holiday weeks since May 2010. The surge may extend into October, the busiest month of issuance for the past three years.”