Page 2 of 5 CREDIT BUBBLE BULLETIN
A new inflationary epoch
Commentary and weekly watch by
Doug Noland
was met by a massive increase in technology production capacity. The incredible
growth in semiconductor and technology output was known as a "productivity
miracle". It was, however, industry idiosyncratic. The buyers of these
relatively inexpensive new products benefited, while fortunes were made (and
many then lost) in the Internet and technology stock bubble.
The next Fed-instigated round of credit and asset bubble dynamics then invaded
mortgage and housing markets. Wall Street simply created trillions of new
higher-yielding securities, while the homebuilding industry constructed
millions of new homes. Most American relished the wealth effects from inflating
home and stock prices. The economy enjoyed a credit-induced boom. Corporate
cash-flows boomed, while government receipts swelled. Similar to the technology
bubble, few felt or thought they were suffering from the ill-effects of
inflation.
I am now referring to a new inflationary epoch because today's unfolding
inflationary dynamics are different in kind. For one, prevailing inflationary
pressures are global in nature. Wall Street finance is not the source fueling
the boom, and it's running outside the Fed's control.
American asset inflation and resulting wealth effects are minimal, while price
effects for food, energy, and commodities are extreme. In contrast to previous
inflationary booms, while some selected groups benefit, the vast majority of
people today recognize they are being hurt by rising prices. This pain comes
concurrently with atypical housing price declines.
Today's price effects pummel already weakened consumer sentiment, as opposed to
previous effects that tended (through asset inflation) to bolster confidence.
Furthermore, current inflationary forces are destabilizing and even destructive
to many businesses, while playing havoc with the fiscal standing of federal,
state and municipal governments.
Revolving around booming Wall Street finance, previous inflationary booms
naturally fueled surges in securities issuance and speculation. These bubble
effects worked as powerful magnets in attracting foreign financial
institutions, foreign-sourced speculators, and cheap foreign-sourced borrowings
(such as yen borrowings financing higher-yielding US securities) that all
worked in concert to "recycle" our current account deficits ("bubble dollars")
directly back to our securities markets.
In contrast, inflationary forces these days largely bypass US securities to
play global energy, commodities, and hard assets. Foreign financial
institutions are fleeing the US risk intermediation business, while bubble
dollars are chiefly recycled back into Treasury and agency securities (where
they now have minimal effect on US home and asset prices). Meanwhile, the
massive global pool of speculative finance is today focused on energy,
commodities and the emerging economies.
Unlike with tech stocks/junk bonds, and US mortgages/houses, it is today
extremely difficult to meaningfully increase the supply of energy, agricultural
commodities, and many natural resources. Moreover, the longer this boom is
sustained the greater the demand for energy and commodities from the likes of
China, India, greater Asia and the Middle East. And the higher prices rise, the
greater the tendency for hoarding and problematic supply disruptions - only
aggravating supply/demand imbalances and emboldening aggressive speculation.
Wall Street can't fix this demand imbalance.
Importantly, surging prices for vital necessities such as energy and food by
their nature elicit expanded credit creation - albeit our consumers using
credit cards at the gas pump; our Congress deficit financing economic stimulus
packages; our state and federal deficits expanding to pay for generally rising
costs; corporate America borrowing to finance surging energy and other
expenses; aggressive borrowing by US and global energy/commodities-related
industries expanding operations; by the alternative energy bubble; by
speculation-related leveraging; by governments around the globe that will
expand deficit spending programs implemented in an effort to placate outraged
citizenry; and by OPEC, Brazil, Russia, Australia, Norway and other economies
directly prospering from the boom.
Or, stated differently, through various mechanisms, processes, dynamics, and
rationalizations there will be overriding tendencies to "monetize" today’s
inflationary effects. And unlike previous inflation manifestations that tended
to remain largely contained within asset markets, today’s virulent energy and
commodities inflation will spawn broad-based secondary price effects. As recent
trends corroborate, inflation begets only greater inflation.
The reality that powerful inflationary psychology has taken hold - and that the
world's leading central banks show no inclination to confront this worsening
problem - motivates this week’s title, "A New Inflationary Epoch."
WEEKLY WATCH
For yet another extraordinary week in global markets, the Dow declined 2.4%
(down 3.9% y-t-d) and the S&P500 fell 1.8% (down 5.5%). The Transports were
hit for 2.2% (up 13.6%), and the Morgan Stanley Cyclicals dipped 0.9% (down
1.8%). The Utilities sank 2.6% (down 6.4%), and the Morgan Stanley Consumer
index declined 2.1% (down 7.0%). The broader market was stronger. The
S&P400 Mid-Caps added 0.4% (down 0.5%), while the small cap Russell 2000
slipped only 0.8% (down 6.0%). The NASDAQ100 declined 1.1% (down 6.0%), and the
Morgan Stanley High Tech index fell 1.3% (down 6.2%). The Semiconductors dipped
0.3% (down 2.3%), the Street.com Internet Index lost 1.3% (down 4.0%), and the
NASDAQ Telecommunications index fell 1.9% (down 2.2%). The Biotechs declined
1.3% (down 4.9%). The wildly volatile financial stocks were sold this week. The
Broker/Dealers sank 6.2% (down 17.5%), and the Banks lost 6.0% (down 8.5%).
With Bullion rallying $29.20, the HUI Gold index recovered 5.9% (up 3.3%).
One-month Treasury bill rates surged 25 bps this week to 1.59%, and 3-month
yields rose 15 bps to 1.68%. At the same time, two-year government yields sank
21 bps 2.24%. Five-year T-note yields fell 22 bps to 2.96%, and ten-year yields
declined 9 bps to 3.72%. Long-bond yields fell 5 bps to 4.52%. The 2yr/10yr
spread ended the week at 153 bps. The implied yield on 3-month December ’08
Eurodollars dropped 14.5 bps to 2.80%. Benchmark Fannie MBS yields declined 5
bps to 5.37%. The spread between benchmark MBS and 10-year Treasuries widened 4
to 160 bps. The spread on Fannie’s 5% 2017 note widened 6 to 60 bps, and the
spread on Freddie’s 5% 2017 note widened 5 to 59 bps. The 10-year dollar swap
spread declined one to 60.0. Corporate bond spreads were mostly wider this
week. An index of investment grade bond spreads widened 15 to 103 bps, while an
index of junk bond spreads narrowed 16 to 624 bps.
According to Bloomberg, this week's $38.2 billion corporate debt sales were the
third highest on record (four straight weeks of $30 billion+ issuance)
Investment grade issuance included Glaxosmithkline $9.0 billion, Citigroup
$3.55 billion, Berkshire Hathaway $2.0 billion, Merrill Lynch $1.75 billion,
ConocoPhillips $1.5 billion, Transalta $500 million, Travelers $500 million,
Duke Realty $325 million, and Alabama Power $300 million.
In what Bloomberg is describing as the "busiest week since November," junk
issuers included Newfield Exploration $600 million, Petrohawk Energy $500
million, Atlas Energy $400 million, Ace Hardware $300 million, and Newport TV
$200 million.
Convert issuance this week included TTM Technologies $155 million and Synnex
$125 million, .
International dollar bond issuance included GTL Trade Finance $1.5bn, Nordic
Investment Bank $1.0bn, Quebec $1.0bn, Grupo Televisa $500 million, and
Independencia International $300 million.
May 7 - Dow Jones (Rogerio Jelmayer and Tom Murphy): "Taking advantage of a
recent credit rating upgrade to investment grade, Brazil Wednesday re-opened
its Global 2017 bond for $500 million, pricing it at 104.816 to yield 5.299%,
the lowest yield ever for a Brazilian overseas sovereign bond. Demand was
considerable… The bonds were issued at a spread over comparable US Treasurys of
140 basis points…"
German 10-year bund yields dropped 20 bps to 3.99%, as the DAX equities index
slipped 0.6% (down 13.2% y-t-d). Japanese 10-year "JGB" yields fell 9 bps to
1.55%. The Nikkei 225 declined 1.4% (down 10.8% y-t-d and 23.1% y-o-y).
Emerging debt markets were mostly quiet, while equities were mixed to down.
Brazil’s benchmark dollar bond yields added 3 bps to 6.02%. Brazil’s Bovespa
equities index increased 0.4% (up 9.0% y-t-d). The Mexican Bolsa added 0.4% (up
3.9% y-t-d). Mexico’s 10-year $ yields slipped 4 bps to 4.79%. Russia’s RTS
equities jumped 7.6% (down 0.3% y-t-d). India’s Sensex equities index sank
4.9%, boosting y-t-d losses to 17.5%. China’s Shanghai Exchange declined 2.2%,
raising 2008 losses to 31.3%.
Mortgage rates were little changed again this week. Freddie Mac 30-year fixed
mortgage rates dipped one basis point to 6.05% (down 10bps y-o-y). Fifteen-year
fixed rates added one basis point to 5.60% (down 27bps y-o-y). One-year
adjustable rates were unchanged at 5.29% (down 17bps y-o-y).
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