Page 2 of 3 CREDIT BUBBLE BULLETIN Government quasi-capitalism
Commentary and weekly watch by Doug Noland
After much contemplation, I've decided it's again appropriate to update Minsky's "Stages of development of capitalist finance". A couple decades of financial arbitrage capitalism left deep scares in the financial system. The federal government was compelled to essentially nationalize mortgage credit. To sustain market confidence in the massive overhang of private-sector credit has required ongoing unprecedented fiscal and monetary stimulus.
Financial arbitrage capitalism has also left a deeply maladjusted economic system. It's an economic structure that requires enormous ongoing credit expansion (neighborhood of $2 trillion annually). The economy is highly unbalanced, with ultra-loose
"money" spurring record securities prices and the return of bidding wars in some housing markets - while Detroit files for bankruptcy and 47 million receive food stamps. It's an economy that runs perpetual trade and current account deficits. The financial backdrop incentivizes stock buybacks, special dividends and cost cutting - as opposed to investment in productive plant and equipment.
I'll posit that evolution to a consumption and services-based economic structure is an evolution to credit gluttony. With households highly leveraged and the private sector unable to expand credit sufficiently to power our structurally deficient economic structure, credit expansion/inflation it is left to the federal government and the Federal Reserve.
This backdrop has spurred massive federal deficits, zero interest rates, and unprecedented central bank monetization. Washington policies spur further wealth redistribution and, I would argue, wealth destruction. I'm going to call the new "Minsky Stage" - "government finance quasi-capitalism" (GFQC).
The government now essentially determines market yields throughout the entire credit system. The government now basically insures system mortgage credit and sets mortgage borrowing costs. Massive federal deficits and low Fed-dictated borrowing costs sustain inflated corporate earnings and cash-flows. The Fed has come to believe it is within its mandate to inflate securities and asset prices. It has crushed returns on saving instruments. Amazingly, the Fed believes it is within its mandate to dictate that savers flee the safety of deposits and other "money" for the risk markets.
Government finance quasi-capitalism exacerbates fragilities. It fosters ongoing credit excesses including a historic expansion of non-productive government debt. GFQC and the resulting flow of finance exacerbate imbalances and economic maladjustment. Accordingly, resulting financial and economic fragilities ensure an even bigger role for Washington in the real economy and for the Federal Reserve in the financial markets.
With securities markets near record highs, it has become popular to refer to "enlightened" policymaking. As a student of monetary history, I see the seductive workings of the monetary inflation expedient. And once commenced, it always assumes increasing control. The expansion of government finance ensures dependency on fiscal deficits and central bank "money printing". Inflating securities prices, highly speculative and distorted financial markets, and economic maladjustment ensure ongoing fragilities. Government finance quasi-capitalism" ensures the over-issuance of mis-priced finance, the misallocation of resources and a resulting deficient real economy.
The widening gulf between weak fundamentals and monetary inflation-induced market bubbles creates a highly unstable, uncertain and precarious backdrop. All seem to ensure only greater government intrusion, control and stagnation. And I'll conclude, as I often do, by stating that I hope my analysis is flawed.
The S&P500 fell 2.1% (up 16.1% y-t-d), and the Dow declined 2.2% (up 15.1%). The Morgan Stanley Consumer index dropped 2.7% (up 21.1%), and the Utilities sank 4.4% (up 5.6%). The Banks declined 1.0% (up 26.2%), and the Broker/Dealers fell 1.1% (up 40.9%). The Morgan Stanley Cyclicals were 1.4% lower (up 20.5%), and the Transports were down 1.6% (up 20.1%). The S&P 400 MidCaps dropped 2.6% (up 18.2%), and the small cap Russell 2000 fell 2.3% (up 20.6%). The Nasdaq100 declined 1.4% (up 15.5%), and the Morgan Stanley High Tech index lost 1.3% (up 14.9%). The Semiconductors dropped 2.0% (up 20.4%). The InteractiveWeek Internet index fell 2.3% (up 22.0%). The Biotechs sank 4.7% (up 29.6%). With bullion gaining $62, the HUI gold index surged 12.9% (down 39%).
One-month Treasury bill rates ended the week at 3 bps and three-month bill rates closed at 4 bps. Two-year government yields gained 4 bps to 0.34%. Five-year T-note yields ended the week up 21 bps to 1.56%. Ten-year yields surged 25 bps to a two-year high 2.83%. Long bond yields jumped 22 bps to 3.85%. Benchmark Fannie MBS yields rose 27 bps to 3.63%. The spread between benchmark MBS and 10-year Treasury yields widened 2 to 80 bps. The implied yield on December 2014 eurodollar futures increased 7 bps to 0.66%. The two-year dollar swap spread increased 2 to 19 bps, while the 10-year swap spread was little changed at 17 bps. Corporate bond spreads widened. An index of investment grade bond risk increased 6 bps to a six-week high 81 bps. An index of junk bond risk jumped 26 to a six-week high 406 bps. An index of emerging market debt risk declined 6 to 323 bps.
Debt issuance was strong. Investment grade issues included Burlington Northern $1.5bn, Viacom $3.0bn, Cenovus Energy $800 million, Virginia E&P $585 million, JPMorgan $750 million, Jersey Central P&L $500 million, CA Inc $500 million, Paccar $500 million, Broadridge Financial $400 million, Southwestern Public Services $400 million, Prudential $1.0bn, Commonwealth Edison $350 million, Lincoln National $350 million, Westar Energy $250 million, Sierra Pacific Power $250 million, Amtrust Financial $250 million, McCormick $250 million, Georgia Power $200 million, and Kayne Anderson MLP $175 million.
Junk bond funds saw outflows of $388 million (from Lipper). Junk issuers this week included American Tower $1.25bn, Access Midstream Partners $750 million, Foresight Energy $600 million, T-Mobile $500 million, Windstream $500 million, TW Telecom $450 million, RR Donnelley $400 million, Crestview $350 million, ACI Worldwide $300 million, Flexi-Van Leasing $265 million, Nustar Logistics $200 million, Shingle Springs Casinos $260 million, Cogent Communications $240 million, and Medical Properties Trust $550 million.
Convertible debt issuers included JDS Uniphase $575 million and Rambus $120 million.
International dollar debt issuers included BNP Paribas $1.25bn, Kommunivest $500 million, Bolivia $500 million, International Finance Corp $500 million, Korea Finance $500 million, Life Finance $187 million and Korea Development Bank $110 million.
Ten-year Portuguese yields fell 20 bps to 6.37% (down 38bps y-t-d). Italian 10-yr yields were unchanged at 4.19% (down 32bps). Spain's 10-year yields dropped 14 bps to 4.36% (down 91bps). German bund yields jumped 20 bps to 1.88% (up 56bps), and French yields rose 16 bps to 2.39% (up 39bps). The French to German 10-year bond spread narrowed 4 to 51 bps. Greek 10-year note yields declined 10 bps to 9.62% (85bps). U.K. 10-year gilt yields surged 24 bps to 2.70% (up 88bps).
Japan's volatile Nikkei equities index added 0.3% (up 31.3% y-t-d). Japanese 10-year "JGB" yields ended the week unchanged at 0.76% (down 2bps). The German DAX equities index increased 0.6% for the week (up 10.2%). Spain's IBEX 35 equities index gained 1.0% (up 8.0%). Italy's FTSE MIB jumped 2.9% (up 8.6%). Emerging markets were mixed. Brazil's Bovespa index jumped 3.3% (down 15.4%), while Mexico's Bolsa fell 1.4% (down 3.8%). South Korea's Kospi index rallied 2.1% (down 3.9%). India's Sensex equities index declined 1.0% (down 4.3%). China's Shanghai Exchange gained 0.8% (down 8.8%).
Freddie Mac 30-year fixed mortgage rates were unchanged at 4.40% (up 78bps y-o-y). Fifteen-year fixed rates added a basis point to 3.44% (up 59bps). One-year ARM rates jumped 5 bps to 2.67% (down 2bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 4 bps to 4.64% (up 42bps).
Federal Reserve Credit jumped $31.0bn to a record $3.566 trillion. Fed Credit expanded $780bn during the past 45 weeks. Over the past year, Fed Credit was up $672bn, or 23.6%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $717bn y-o-y, or 6.9%, to a record $11.183 trillion. Over two years, reserves were $1.047 trillion higher, for 10% growth.
M2 (narrow) "money" supply expanded $21.9bn to a record $10.784 trillion. "Narrow money" expanded 7.8% ($782bn) over the past year. For the week, Currency increased $0.7bn. Total Checkable deposits slipped $2.3bn, while Savings Deposits jumped $26.7bn. Small Time Deposits declined $2.2bn. Retail Money Funds dipped $0.9bn.
Money market fund assets dropped $44.6bn to $2.622 trillion. Money Fund assets were up $49bn from a year ago, or 1.9%.
Total Commercial Paper outstanding rose $15.9bn this week to $1.004 trillion. CP has declined $62bn y-t-d and $7bn, or 0.7%, over the past year.
Currency and 'Currency War' Watch
August 16 - Bloomberg (Jeanette Rodrigues): "India's rupee sank to a record on concern recent steps to steady the currency will prompt foreigners to rethink investment plans amid speculation the US will pare stimulus next month. Bonds and stocks plunged."
August 16 - Bloomberg (Gabrielle Coppola and Josue Leonel): "Brazil's real tumbled the most in 15 months after Finance Minister Guido Mantega said a weaker currency was good for local industry, deepening a selloff sparked by concern the US will curb monetary stimulus. The real depreciated 2.2% to 2.3925 per dollar at the close of trading in Sao Paulo, the worst performance among all currencies tracked by Bloomberg. The real lost 5% this week. Swap rates on the contract due in January 2015 rose 27 bps ... to 10.33%. Brazil's currency has lost 15% in the past three months, boosting the cost of imports and adding to inflation that already exceeds central bank targets."
The US dollar index added 0.2% to 81.257 (up 1.9% y-t-d). For the week on the upside, the British pound increased 0.8%, the New Zealand dollar 0.8%, and the Taiwanese dollar 0.1%. For the week on the downside, the Brazilian real declined 5.0%, the South African rand 2.7%, the Mexican peso 2.3%, the Japanese yen 1.4%, the Norwegian krone 1.1%, the Singapore dollar 1.0%, the Canadian dollar 0.5%, the Swiss franc 0.4%, the Australian dollar 0.2%, the Swedish krona 0.2%, the South Korean won 0.1%, the euro 0.1% and the Danish krone 0.1%.
The CRB index jumped 2.5% this week (down 0.9% y-t-d). The Goldman Sachs Commodities Index rose 2.4% (up 0.5%). Spot Gold rallied 4.8% to $1,377 (down 17%). Silver surged 14.2% to $23.37 (down 23%). September Crude gained $1.49 to $107.46 (up 17%). September Gasoline rose 2.0% (up 8%), and September Natural Gas advanced 4.3% (up 1%). December Copper gained 1.6% (down 8%). September Wheat slipped 0.4% (down 19%), while September Corn gained 1.7% (down 32%).
US Fixed Income Bubble Watch
August 16 - Bloomberg (Daniel Kruger): "Holdings of Treasuries in China, the largest foreign lender to the US, fell in June for the first time in five months amid discussion by Federal Reserve officials about slowing the pace their bond purchases. China's stake dropped by $21.5 billion in June, or 1.7%, to $1.276 trillion ... The pullback by China comes as overseas holdings of Treasuries have grown $26.8 billion, or 0.5% this year, the slowest pace since a 2.8% decline in the first six months of 2006. Treasuries have lost 3.1% this year ... , headed for the worst performance since 2009."
August 16 - Bloomberg (Brian Chappatta): "Cook County, home to Chicago, had the rating on $3.7 billion of general-obligation bonds cut one level to A1 by Moody's ... because it faces 'formidable hurdles' in fixing its pension system. The county of 5.2 million, the second-most-populous in the US, is the latest issuer in Illinois to have its rating cut by Moody's."
Global Bubble Watch
August 15 - Financial Times (Tracy Alloway and Arash Massoudi): "Parts of the booming market for exchange traded funds risk worsening broader market sell-offs or triggering crashes, according to two studies released this week. The reports, from the Federal Reserve and Fitch Ratings, come weeks after a sharp sell-off in fixed income sparked scrutiny of certain ETFs and the structure of the industry, which has grown to a market worth more than $2tn. ETFs allow investors quick and easy exposure to a range of assets that might otherwise be difficult to access. But the two reports warn that certain of the investment tools - corporate bond ETFs and so-called 'leveraged ETFs' - could destabilise broader markets. ETFs that seek to replicate the performance of corporate bonds risk intensifying a sell-off in the underlying debt, according to ... Fitch. Increased ETF trading volumes might 'amplify overall bond market volatility, as redemptions of ETFs can, in turn, drive selling in the underlying bonds', Fitch analysts including Robert Grossman and Martin Hansen wrote ... "
Bursting EM Bubble Watch
August 14 - Wall Street Journal (Rogerio Jelmayer and Matthew Cowley): "Brazil's government-run Banco do Brasil SA is pressing ahead with its rapid increase in lending, urged on by the government, even as the economy slows and its private-sector rivals hold back. President Dilma Rousseff and her administration have pressed government lenders including Banco do Brasil to lend more to help jump-start weak economic growth. Low unemployment, rising salaries and ample credit have fueled strong consumer demand, while industry has contracted. Some investors fear that Banco do Brasil, Latin America's largest bank by assets, could be storing up trouble for the future. The economy is showing little sign of a strong recovery, and unemployment levels have started to lift off their recent historical lows. That could lead to more defaults on the new loans Banco do Brasil made during the slowdown."