Page 1 of
5 Tight
'money' Commentary and weekly
review by Doug Noland
COMMENTARY
Between June 30, 2004, and June 29, 2006,
the US Federal Reserve raised rates from 1% to
5.25%. During this period of significant Fed
"tightening", "money" became progressively looser.
More accurately, credit and financial conditions
loosened in the face of rising short-term interest
rates. Today, the Fed is in the midst of another
of its aggressive loosening cycles. Credit
conditions are today tight, and there is the
distinct possibility that
they
will remain taut or possibly tighten further.
The Fed receives too much credit for the
"efficacy" of past easing cycles. Going all the
way back to the then extraordinary rate slashing
from the early-1990s (23 straight cuts!), it was
actually the burgeoning power of Wall Street
finance providing the brute force behind Fed
"reliquefications" and "reflations". The evolving
securitization markets and government-sponsored
enterprises were the key mechanisms driving system
credit expansion when the banking system was
severely impaired back in 1991/92. By 1993, the
blossoming leveraged speculating community had
become a major force, taking highly leveraged
positions in US (and Mexican!) debt securities, in
the process significantly augmenting system credit
availability and marketplace liquidity. By the
time of the "Asian Contagion" and the Russian/Long
Term Capital Management crisis, leveraged
speculation throughout the (global) debt markets
had become a prevailing source of system credit
and liquidity creation.
Having first
nurtured "Wall Street finance" to buck the banking
system "headwinds" early in the '90s, by the end
of the decade Fed accommodation had fashioned the
most powerful "reflationary" tool in the history
of central banking. Simply tinker with rates or
signal lower prospective market yields and the
enterprising speculators would quickly lever up on
risky debt instruments on demand. Never had it
been so easy for a central bank to incite "animal
spirits" and stimulate credit and liquidity. The
hedge funds, Wall Street firms and, increasingly
over time, myriad global financial players forged
the maestro’s "genius", the American economic
"miracle", and synchronized global asset and
economic booms. In any case, the leveraged
speculating community has been the force behind US
bubble economy dynamics including $800 billion
current account deficits, negative savings rates,
destabilizing asset bubbles, and so-called
economic "resiliency".
I’ll be quite
surprised if this easing cycle lives up to market
expectations. Most importantly, Wall Street
Finance self-destructed over the past few years.
Trust will not be returning anytime soon to
"structured credit products", meaning the
securitization and derivatives markets are for
quite some time impotent to play their usual
"reflationary" role. This has been a momentous
development, one certainly compounded by the role
our major financial institutions came to play in
structured finance and their resulting problematic
credit and market exposures.
It is also
worth noting that 10-year Treasury yields are
today below 4%. This compares to the 6% or so when
the economy headed toward recession in 2000 and
the 8% or so yields when the economy succumbed to
tightened credit conditions back in 1991. There is
simply not much room for further "easing" of most
market yields today. The Wall Street firms and the
hedge funds are already dangerously distended
after several years of reckless speculation. Wall
Street is today in an extraordinarily poor
position to expand and bolster system credit. More
likely, there is today years' worth of overhang of
risk securities that will eventually be liquidated
by impaired leveraged players.
The
unfolding credit crisis has necessitated the
sequel, "Committee to Save the World, Part Two".
Especially after the credit system took a turn for
the worse the week before last, I can understand
Treasury Secretary Henry Paulson’s urgency to have
institutions renegotiate mortgage terms with
troubled borrowers. But not only are we too far
into the mortgage bust for such efforts to pay
much in the way of dividends, I am skeptical that
our securitization markets have the necessary
infrastructure and legal structure to equitably
adjust mortgage terms on millions of loans. And it
is becoming increasingly clear that a large
segment of troubled loans today involved some
degree of fraud at origination. Besides, there is
simply not much time to sort through all the
various details. Examining the startling almost
$92,000 two-month drop in Californian median home
prices, it's apparent that momentum generated by
the The Great Housing Bust is not to be impeded by
a program to check subprime mortgage resets.
Such efforts, however, obviously have
major impacts on the markets. I can’t imagine more
challenging market conditions or ones more
fascinating to try to analyze. It was quite a
"squeeze" last week in stocks, credit instruments,
currencies and commodities. The way I see it,
there is today a great and destabilizing
dichotomy. On the one hand, the credit crisis and
severe impairment of key sectors in the credit
system ensure major liquidity constraints,
faltering asset markets, and an arduous economic
adjustment period. On the other hand, years of
egregious credit inflation have created an
incredibly bloated financial apparatus
(domestically and internationally) determined to
disregard new realities.
This "system",
importantly, is especially indisposed to
succumbing to boom-turned-bust dynamics. Or,
stated another way, our Wall Street dominated
financial apparatus is keen on "Inflate or Die"
dynamics and has no intention of relinquishing the
tremendous power it has gathered over the years.
This is understandable, although it certainly
creates a very serious problem when it comes to
the stock market refusing to adjust to rapidly
deteriorating underlying fundamentals. And if
market dynamics preclude an orderly stock market
revaluation, expect it to come at some point
violently and with great hardship. This is one
aspect of the great costs associated with the Fed
moving aggressively again to "reflate". It won’t
work, its further subverts the market process, and
only worsens an already perilous situation.
WEEK IN REVIEW
Things get
only wilder ... For the week, the Dow gained 3.0%
(up 7.3% y-t-d) and the S&P500 2.8% (up 4.4%).
The Transports surged 4.7% (up 2.2%), and the
Morgan Stanley Cyclical index rose 3.9% (up
11.1%). The Morgan Stanley Consumer index rose
2.2% (up 8.5%), and the Utilities gained 1.5% (up
15.5%). The small cap Russell 2000 increased 1.7%
(down 2.5%), and the S&P400 Mid-Cap index
jumped 3.1% (up 7.0). The NASDAQ100 rose 3.0%,
increasing 2007 gains to 18.9%. The Morgan Stanley
High Tech index advanced 1.9% (up 8.5%), and the
Semiconductors added 0.3% (down 11.4%). The
Street.com Internet Index rose 2.8% (up 16.2%),
and the NASDAQ Telecommunications index added 0.1%
(up 11.9%). The Biotechs gained 3.8% (up 9.9%).
The financials rallied strongly. The
Broker/Dealers jumped 4.1% (down 12.6%), and the
Banks surged 5.3% (down 17.3%). With Bullion down
$40, the HUI Gold index dropped 5.5% (up 20.1%).
Three-month Treasury bill rates fell an
additional 8 bps this week to 3.15%. Two-year
government yields dropped 8 bps to 3.0%. Five-year
T-Note yields were down 2 bps to 3.39%, and
ten-year yields fell 6 bps to 3.94%. Long-bond
yields declined 4.5 bps to 4.38%. The 2yr/10yr
spread ended the week at 94 bps. The implied yield
on 3-month December ’08 Eurodollars sank 15 bps to
3.435%. Benchmark Fannie Mae MBS yields collapsed
26 bps to 5.39%, this week remarkably
outperforming Treasuries. The spread on Fannie’s
5% 2017 note narrowed 14 to 60, and the spread on
Freddie’s 5% 2017 note narrowed 13 to 60. The
10-year dollar swap declined 10.9 bps to 65.4.
Corporate bond spreads were mixed to narrower,
although the spread on an index of junk bonds
ended the week 14 bps wider.
Investment
grade debt issuers included GE $4.0bn, Bank of
America $3.5bn, CIT Group $2.0bn, Encana $1.5bn,
Virginia E&P $1.05bn, Pepsico $1.0bn,
Nordstrom $1.0bn, Nucor $1.0bn, Dupont $750
million, Kellogg $750 million, Disney $750
million, Aetna $700 million, Rockwell Auto $500
million, Anheuser Busch $500 million, M&T Bank
$400 million, Harris Corp $400 million, Dominion
Resources $350 million, Textron $350 million,
Southwestern Electric Power $300 million, New York
State E&G $200 million and Georgia Power $100
million.
Junk issuers included Texas
Competitive Electric Holdings $3.75bn,
Constellation $500 million, and Alliance Imaging
$150 million.
Foreign dollar bond issuance
included Barclays $1.25bn and Marks & Spencer
$800 million.
November 29 – Bloomberg
(Lester Pimentel): "Emerging-market bonds fell…as
soaring international bank lending rates pared
demand for higher-yielding assets. The cost of
borrowing euros for a month rose by a record
amount and loans in dollars climbed the most in
more than a decade as financial institutions
grapple with losses from subprime mortgage
investments."
German 10-year bund yields
jumped 12 bps to 4.12%, while the DAX equities
index rose 3.4% for the week (up 19.3% y-t-d).
Japanese "JGB" yields gained 5.5 bps to 1.47%. The
Nikkei 225 rallied 5.3%, reducing 2007 losses to
9.0%. Emerging debt and equities markets rallied
sharply. Brazil’s benchmark dollar bond yields
sank a notable 29 bps to 5.63%. Brazil’s Bovespa
equities index jumped 3.3% (up 41.6% y-t-d). The
Mexican Bolsa rallied 3.7% (up 12.6% y-t-d).
Mexico’s 10-year $ yields fell 6 bps to 5.39%.
Russia’s RTS equities index advanced 3.2% (up
15.5% y-t-d). India’s Sensex equities index gained
2.7% (up 40.5% y-t-d). China’s Shanghai Exchange
fell 3.2%, reducing y-t-d gains to 82% and 52-week
gains to 132%.
Freddie Mac posted 30-year
fixed mortgage rates dropped 10 bps this week to
6.10% (down 4bps y-o-y), the low since January
2006. Fifteen-year fixed rates fell 10 bps to
5.73% (down 14bps y-o-y). One-year adjustable
rates added one basis point to 5.43% (down 3bps
y-o-y).
Bank Credit surged $73.1bn during
the week (11/21) to a record $9.219 TN. Bank
Credit has posted an 18-week gain of $575bn (19.2
annualized) and a y-t-d rise of $922bn, a 12.3%
pace. For the week, Securities Credit jumped
$39.9bn. Loans & Leases rose $33.2bn to $6.731
TN (18-wk gain of $406bn). C&I loans surged
$21.9bn (2007 growth rate 21.8%). Real Estate
loans gained $13bn. Consumer loans added $2.3bn.
Securities loans declined $16.4bn, while Other
loans increased $12.4bn. On the liability side,
(previous M3) Large Time Deposits fell $23bn.
M2 (narrow) "money" supply rose $17.3bn to
$7.420 TN (week of 11/19). Narrow "money" has
expanded $377bn y-t-d, or 5.9% annualized, and
$449bn, or 6.4%, over the past year. For the
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
