Page 2 of 4 CREDIT BUBBLE BULLETIN Weak links
Commentary and weekly watch by Doug Noland
I am increasingly focused on municipal debt market developments. Muni funds suffered another week of significant redemptions (14 straight weekly outflows). Fed policies helped spur enormous inflows into municipal finance. I suspect, as well, that high-yielding tax-exempt muni bonds provided a too enticing venue for hedge fund, ''structured products'' and other derivative-related leveraging. It's also a big market where most underlying issues trade with little liquidity. And unlike Treasurys and MBS, muni debt doesn't enjoy the benefits of the Fed's QE backstop. So it has all the characteristics of a marketplace susceptible to
risk aversion and a deteriorating general fixed income liquidity backdrop.
Benchmark Puerto Rico bond yields jumped another 8 bps last week to 6.24%, having increased 60 bps in three weeks. Andrew Bary's ''Troubling Winds'' analysis of ''Puerto Rico's huge debt load'' was the cover story for last week's Barron's magazine. Reading Bary's informative piece, I immediately recalled the Greek debt fiasco. Over-liquefied and complacent markets were content to continue lending to Greece despite increasingly obvious issues. In November 2009, Greece could tap the markets for two-year paper at just over 2% - and the marketplace could presume a eurozone backstop and ignore fundamentals. Six months later, with market yields at 16%, Greece was hopelessly insolvent.
I don't know enough to compare Puerto Rican fundamentals to those of Greece. But from a marketplace standpoint, I would expect Puerto Rico to play a similar role as the marginal borrower, first to lose access to cheap finance in a faltering bubble environment. With muni yields shooting higher, with an abrupt reversal of finance out of the municipal debt complex, and with Detroit and other municipalities in trouble, the tightening of muni finance could evolve into an important transmission mechanism for an unfolding global crisis to the US economy.
The S&P500 fell 1.8% (up 14.5% y-t-d), and the Dow declined 1.3% (up 13.0%). The Morgan Stanley Consumer index dropped 2.0% (up 18.5%), and the Utilities declined 1.1% (up 4.7%). The Banks were hit for 4.2% (up 21.3%), and the Broker/Dealers fell 2.7% (up 38.9%). The Morgan Stanley Cyclicals were down 2.1% (up 17.5%), and the Transports sank 3.6% (up 17.8%). The S&P 400 MidCaps dropped 2.8% (up 16.0%), and the small cap Russell 2000 fell 2.6% (up 19.0%). The Nasdaq100 declined 1.6% (up 15.5%), and the Morgan Stanley High Tech index lost 1.8% (up 12.6%). The Semiconductors declined 1.3% (up 19.2%). The InteractiveWeek Internet index fell 2.4% (up 20.0%). The Biotechs slipped 0.9% (up 33.0%). Although bullion was down only $3, the HUI gold index was hit for 6.9% (down 42.9%).
One-month Treasury bill rates ended the week at two bps and three-month bill rates closed at two bps. Two-year government yields rose two bps to 0.40%. Five-year T-note yields ended the week up two bps to 1.64%. Ten-year yields slipped 3 bps to 2.79%. Long bond yields fell 9 bps to 3.70%. Benchmark Fannie MBS yields declined 3 bps to 3.57%. The spread between benchmark MBS and 10-year Treasury yields was little changed at 78 bps. The implied yield on December 2014 eurodollar futures declined 1.5 bps to 0.695%. The two-year dollar swap spread declined 2 to 16 bps, while the 10-year swap spread was little changed at 20 bps. Corporate bond spreads widened. An index of investment grade bond risk rose 5 to 84 bps. An index of junk bond risk jumped 14 to 406 bps. An index of emerging market (EM) debt risk gained 12 to 358 bps.
Debt issuance slowed to a crawl. Investment grade issuers included Overseas Private Investment Corp $250 million.
I saw no junk issues in the week.
Convertible debt issuers included Qihoo 360 $550 million.
International dollar debt issuers included International Finance Corp $3.5bn, European Investment Bank $3.0bn, Export-Import Bank of Korea $1.0bn and Kommuninvest $600 million.
Ten-year Portuguese yields jumped 16 bps to 6.59% (down 16bps y-t-d). Italian 10-yr yields rose 7 bps to 4.40% (down 11bps). Spain's 10-year yields gained 8 bps to 4.52% (down 75bps). Pressuring eurozone bond spreads, German bund yields fell 8 bps to 1.86% (up 6bps). French yields were little changed at 2.47% (up 47bps). The French to German 10-year bond spread widened 8 to 61 bps. Greek 10-year note yields jumped 24 bps to 10.02% (down 45bps). U.K. 10-year gilt yields increased 6 bps to 2.77% (up 95bps).
Japan's Nikkei equities index ended the week down 1.9% (up 28.8% y-t-d). Japanese 10-year "JGB" yields dropped 5 bps to 0.71% (down 7bps). The German DAX equities index sank 3.7% for the week (up 6.5%). Spain's IBEX 35 equities index was hit for 4.6% (up 1.5%). Italy's FTSE MIB dropped 3.8% (up 2.5%). Emerging markets were wildly mixed. Brazil's Bovespa index sank 4.2% (down 18.0%), and Mexico's Bolsa fell 3.5% (down 9.6%). South Korea's Kospi index rallied 3.0% (down 3.5%). India's Sensex equities index gained 0.5% (down 4.2%). China's Shanghai Exchange jumped 2.0% (down 7.5%).
Freddie Mac 30-year fixed mortgage rates declined 7 bps to 4.51% (up 92bps y-o-y). Fifteen-year fixed rates fell 6 bps to 3.54% (up 68bps). One-year ARM rates were down 3 bps to 2.64% (up one bp). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates 6 bps lower at 4.69% (up 46bps).
Federal Reserve credit jumped $12.0bn to a record $3.602 TN. Over the past year, Fed credit was up $798bn, or 29%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $635bn y-o-y, or 6.0%, to a record $11.168 TN. Over two years, reserves were $1.015 TN higher, for 10% growth.
M2 (narrow) "money" supply dropped $18.3bn to $10.742 TN. "Narrow money" expanded 7.1% ($714bn) over the past year. For the week, Currency increased $1.4bn. Total Checkable Deposits slipped $2.7bn, and Savings Deposits dropped $13.0bn. Small Time Deposits declined $1.8bn. Retail Money Funds fell $2.2bn.
Money market fund assets gained $6.5bn to $2.644 TN. Money Fund assets were up $73bn from a year ago, or 2.8%.
Total Commercial Paper outstanding was little changed at $1.020 TN. CP has declined $46bn y-t-d and $12bn, or 1.1%, over the past year.
Currency and 'Currency War' Watch
The US dollar index gained 0.9% to 82.087 (up 2.9% y-t-d). For the week on the upside, the South Korean won increased 0.6%, the Japanese yen 0.6%, the Singapore dollar 0.3% and the Taiwanese dollar 0.2%. For the week on the downside, the Mexican peso declined 3.2%, the Swedish krona 2.1%, the Norwegian krone 1.6%, the Brazilian real 1.5%, the Australian dollar 1.4%, the Danish krone 1.2%, the euro 1.2%, the New Zealand dollar 1.0%, the Swiss franc 0.8%, the British pound 0.4%, the Canadian dollar 0.4% and the South African rand 0.4%.
The CRB index added 0.1% last week (down 1.3% y-t-d). The Goldman Sachs Commodities Index rose 1.2% (up 1.6%). Spot Gold slipped 0.2% to $1,395 (down 16.7%). Silver declined 1.1% to $23.51 (down 22%). October Crude gained $1.23 to $107.65 (up 17%). October Gasoline added 0.7% (up 5%), and October Natural Gas jumped 1.7% (up 7%). December Copper sank 3.7% (down 12%). September Wheat gained 1.4% (down 17%), while September Corn slipped 0.1% (down 29%).
US Fixed Income Bubble Watch
August 30 - Bloomberg (Michelle Kaske): ''Municipal debt from Puerto Rico is poised for its worst year since at least 2000 as demand for state and local securities wanes with yields at two-year highs. Bonds of Puerto Rico and its localities have lost 14.9% this year through Aug. 28, about three times more than the rest of the $3.7 trillion municipal market, according to Standard & Poor's data. The commonwealth's borrowings haven't had an annual loss this steep since at least 2000. Investors demand 2.76 percentage points of additional yield to buy 30-year Puerto Rico general-obligation bonds rather than top-rated munis, the most since January ... The island's general-obligation debt is rated one level above junk amid recurring budget deficits and a pension system that has a lower funding level than any US state.''
August 26 - Bloomberg (Charles Mead and Sridhar Natarajan): ''It took three decades for the amount of speculative-grade debt to reach $1 trillion. It took about seven years to reach $2 trillion as investors sought relief from the financial repression brought on by near-zero interest rates. The market for dollar-denominated junk-rated debt has expanded more than eightfold since the end of 1997 from $243 billion, according to Morgan Stanley. That compares with a quadrupling of the investment-grade market to $4.2 trillion ... While Federal Reserve policies have pushed investors toward riskier investments to generate high yields, allowing even the neediest companies that might otherwise default to access capital markets, concern is rising that missed payments may soar when benchmark rates begin to increase.''
August 28 - Bloomberg (Charles Stein): ''US bond mutual funds last week suffered their biggest redemptions since June as yields reached a two-year high amid speculation that the Federal Reserve will begin cutting back asset purchases. Bond funds had withdrawals of $11.1 billion in the week ended Aug. 21 ... It was the largest move out of bond funds since the week ended June 26, when $28.2 billion was withdrawn.''
August 30 - Bloomberg (Jody Shenn): ''US government-backed mortgage bonds are heading toward their longest monthly slump since 1999 as concern mounts that the Federal Reserve will begin paring its debt purchases even as the steepest rise in home-loan rates in at least 40 years slows the housing rebound. Securities guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae lost 0.53% through Aug. 28, heading for their fourth month of declines and bringing losses since April to 2.97% ... For almost a year, the Fed has been adding $40 billion of bonds to its balance sheet each month from the more than $5 trillion market. It expanded the purchases in January to include $45 billion of Treasurys.''
US Bubble Economy Watch
August 26 - Bloomberg (Michelle Jamrisko and Ilan Kolet): ''The cost of higher education has surged more than 500% since 1985, illustrating why there have been renewed calls for change from both political parties. …Tuition expenses have increased 538% in the 28-year period, compared with a 286% jump in medical costs and a 121% gain in the consumer price index. The ballooning charges have generated swelling demand for educational loans while threatening to make college unaffordable for domestic and international students. The 'skyrocketing' increases exacerbate income inequality by depriving those of less means of the schooling they need to advance and may also derail the 'prestige and status' of US higher education, said Michelle Cooper, president of the ... Institute for Higher Education Policy.''
August 30 - Bloomberg (Prashant Gopal and Heather Perlberg): ''Amy and Ted Wilder lost out in the bidding for several Seattle-area homes during the past six months, even with offers well above the asking price. After May's sudden spike in mortgage rates, the Microsoft Corp. consultants put their search on hold. 'We fell in love with a house for about $400,000 and thought we could afford it, and then we discovered it was $300 more a month than what we would have paid in February when we started looking,' Amy Wilder, 42, said. 'The mortgage rates just pushed it too far.' A surge in borrowing costs to a two-year high is starting to cool demand from homebuyers as higher rates combine with surging prices to reduce affordability ... The biggest pinch is being felt in expensive markets such as Seattle and New York, where budgets already were stretched, leading to a more uneven national recovery.''
August 28 - Bloomberg (Charles Mead): ''Company debt loads in the US are approaching the highest level since the aftermath of the financial crisis as borrowing to finance mergers and shareholder payouts exceeds earnings growth. Debt levels have increased faster than cash flow for six straight quarters, boosting the obligations of investment-grade companies in the second quarter to 2.09 times earnings before interest, taxes, depreciation and amortization, according to JPMorgan ... That's up from 2.07 times in the first three months of 2013 and compares with 2.13 in the third quarter of 2009, when it peaked after the deepest recession since the Great Depression.''