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5 CREDIT BUBBLE
BULLETIN Not so benign
neglect By Doug Noland
trade back above 2000 for more than
seven years. Post-tech Bubble liquidity
(characteristically) avoided the technology sector
like the plague. After all, a much more enticing
Inflationary Bias was gaining momentum with
fledgling Mortgage Finance and Housing Bubbles
(“Liquidity Loves Inflation”). The Fed may have
believed it was conducting appropriate “mopping
up” policies, but commanding Financial Structures
ensured that it was more a
case
of Bubble accommodation.
The serious
issues associated with the current “reflation” are
many. For one, the dollar is structurally quite
fragile while the most robust Inflationary Biases
are in non-Dollar Asset Classes. Previously, Fed
reflationary policies provided a competitive
advantage for U.S. risk assets that worked to
incite sufficient financial flows to support or
even boost the greenback. This proved a huge
ongoing advantage for our expansionary Credit
system. Today, the negative ramifications
associated with dollar weakness more than offset
the Fed’s capacity to inflate U.S. securities
prices. The Fed’s recent rate cut proved a bonanza
for most foreign markets (currencies, commodities,
equities, bonds, etc.), especially relative to
dollar-denominated mortgage securities (the
previous Bubble asset class of choice).
The Flow of Finance will now pose
extraordinary challenges and risks. The unfolding
mortgage crisis (especially in “private-label” and
jumbo) will prove stubbornly immune to
“reliquefication” benefits. This dynamic places
home prices, the consumer balance sheet, and the
general U.S. economy in harm’s way. At the same
time, there are the stock market Bubble and an
acutely vulnerable dollar. I will presuppose that
the Fed is hopeful to ignore equities and
currencies, while operating monetary policy with a
focus on the Credit market and real economy. Such
a policy course, however, implies at this point
much greater currency, market instability, and
inflationary risks than our central bankers seem
to appreciate.
I would furthermore contend
that the nature of current Risk Intermediation is
seductively problematic. On a short-term basis,
enormous bank and money-fund led financial sector
expansion has been sufficient to over-inflate
non-mortgage Credit. It’s been too easy - and
Credit to sustain the boom too risky. Meantime,
post-Bubble risk aversion festers in
mortgage-related finance that will creep
ever-closer to spilling over into an economic
downturn and a reemergence of financial
turbulence. We can expect foreign demand for our
risk assets to remain tepid at best.
Despite current market euphoria, these
processes are significantly elevating the systemic
risks associated with today’s ballooning financial
sector balance sheet. A stock market Bubble beset
by destabilizing speculative dynamics only
compounds systemic vulnerabilities. Such a
backdrop seems to beckon for a currency crisis, a
risk that leaves our Federal Reserve policymakers
with much less flexibility than they or the
markets today appreciate. There are major costs
associated with Not So Benign Neglect. The Fed had
better at least start sounding like they’ve
thought through some of the issues.
For the week, the Dow added 0.2% (up 13.1%
y-t-d) and the S&P500 0.3% (up 10.1%). The
Transports were hit for 1.1% (up 8.3%), while the
Morgan Stanley Cyclical index increased 0.3% (up
21.9%). The Utilities gained 0.9% (up 11.9%),
while the Morgan Stanley Consumer index was little
changed (up 8.5%). The small cap Russell 2000
slipped 0.4% (up 6.8% y-t-d) and the S&P400
Mid-Cap index 0.2% (up 13.4%). The NASDAQ100
gained 1.3%, increasing 2007 gains to 24%. The
Morgan Stanley High Tech index rose 1.4% (up
21.2%). The Semiconductors dropped 2.3% (up 4.2%).
The Street.com Internet Index jumped 1.8% (up
23.7%), and the NASDAQ Telecommunications index
rose 1.0% (up 26.1%). The Broker/Dealers dipped
0.5% (up 0.3%), while the Banks gave back 2.3%
(down 8.1%). With Bullion gaining $6.40 and
trading intraday above $750, the HUI Gold index
jumped 4.9% (up 22.2%).
Interest rates are
back on the rise. Three-month Treasury bill rates
jumped 21 bps this week to 4.18%, the high since
Sept. 6th. Two-year government yields rose 14 bps
to 4.21%. Five-year yields ended the week 7.5 bps
higher at 4.41%. Ten-year Treasury yields
increased 4 bps to 4.68%, and long-bond yields
added 4 bps to 4.90%. The 2yr/10yr spread narrowed
this week to 47 bps. The implied yield on 3-month
December ’08 Eurodollars rose 11 bps to 4.585%.
Benchmark Fannie Mae MBS yields were unchanged at
5.98%, this week again outperforming Treasuries.
The spread on Fannie’s 5% 2017 note widened 2 to
42, and the spread on Freddie’s 5% 2017 note
widened 2 to 42. The 10-year dollar swap spread
declined 1 to 62, the low going back to mid-June.
Corporate bond spreads continued to narrow. The
spread on an index of junk bonds ended the week
sharply narrower.
Junk issuers included AES Corp $2.0bn and
Allison Transmission $550 million.
Convert
issuers included Istar Financial $800 million,
Rayonier $250 million and Morgans Hotel $150
million.
Foreign dollar bond issuance
included Deutsche Bank $3.0bn, Oester Kontrolbank
$1.75bn, Export-Import Bank of Korea $1.5bn,
Midori LTD $260 million, Industrias Metal $225
million, and Grupo Juo Sab $200 million.
German 10-year bund yields rose 7 bps to a
two-month high 4.42%, while the DAX equities index
ended the week unchanged (up 21.3% y-t-d).
Japanese 10-year “JGB” yields added 0.5 bps to
1.70%. The Nikkei 225 advanced 1.4%, increasing
2007 gains to 3.25%. Most emerging equities
markets built on recent gains, while debt markets
were mostly quiet. Brazil’s benchmark dollar bond
yields increased 4 bps to 5.83%. Brazil’s Bovespa
equities index surged 3.4% to a record high (up
40.4% y-t-d). The Mexican Bolsa jumped 3% (up
22.8% y-t-d). Mexico’s 10-year $ yields increased
2 bps to 5.60%. Russia’s RTS equities index gained
2.3% (up 12.5% y-t-d). India’s Sensex equities
index increased 3.6% to another record (up 33.6%
y-t-d and 46.9 y-o-y). China’s Shanghai Exchange
jumped 6.3% to a record high (up 121% y-t-d and
232% y-o-y).
Freddie Mac posted 30-year
fixed mortgage rates gained 3 bps this week to
6.40% (up 3bps y-o-y). Fifteen-year fixed rates
rose 3 bps to 6.06% (unchanged y-o-y). Curiously,
one-year adjustable rates surged 15 bps to 5.73%
(up 17 bps y-o-y).
Bank Credit surged
$54.5bn for the week (10/3) to a record $8.982 TN.
Bank Credit has now posted an 11-week gain of
$339bn (18.5% annualized) and y-t-d rise of
$686bn, a 10.7% pace. For the week, Securities
Credit surged $42bn. Loans & Leases increased
$12.5bn to a record $6.595 TN (11-wk gain of
$271bn). C&I loans jumped $16.8bn, increasing
the y-t-d growth rate to 21.3%. Real Estate loans
declined $4.9bn. Consumer loans dipped $3.4bn.
Securities loans added $1.9bn, and Other loans
increased $2.3bn. On the liability side, (previous
M3) Large Time Deposits rose $7.9bn (4-wk gain of
$78.1bn).
M2 (narrow) “money” added $2.1bn
to a record $7.384 TN (week of 10/1). Narrow
“money” has expanded $340bn y-t-d, or 6.3%
annualized, and $470bn, or 6.8%, over the past
year. For the week, Currency gained $1.8bn, and
Demand & Checkable Deposits increased $4.9bn.
Savings Deposits fell $10.5bn, and Small
Denominated Deposits increased $1.7bn. Retail
Money Fund assets rose $4.3bn.
Total Money
Market Fund Assets (from Invest. Co Inst)
increased $16.8bn last week to a record $2.909 TN.
Money Fund Assets have now posted an 11-week gain
of $335bn (60% annualized) and a y-t-d increase of
$527bn (28% annualized). Money fund asset have
surged $644bn over 52 weeks, or 28.5%.
Total Commercial Paper rose $5.0bn to
$1.865 TN. CP is down $359 bn over the past nine
weeks. Asset-backed CP declined an additional
$6.3bn (9-wk drop of $256bn) to $918bn.
Year-to-date, total CP has declined $109bn, with
ABCP down $166bn. Over the past year, Total CP has
contracted $49bn, or 2.6%.
Asset-backed
Securities (ABS) issuance increased to $11bn this
week. Year-to-date total US ABS issuance of $481bn
(tallied by JPMorgan) is running 30% behind
comparable 2006. At $213bn, y-t-d Home Equity ABS
sales are 51% off last year’s pace. Year-to-date
US CDO issuance of $274 billion is running 2%
below 2006.
Fed Foreign Holdings of
Treasury, Agency Debt last week (ended 10/10)
increased $5.5bn, surpassing $2.0 TN for the first
time. “Custody holdings” were up $252bn y-t-d
(18.2% annualized) and
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