Page 1 of
2 CREDIT BUBBLE
BULLETIN US core no longer the
magnet Commentary and weekly watch by Doug
Noland
Last week provided ample
confirmation for the global reflation thesis. The
dollar index dropped another 0.9%. Gold surged
US$22 to $979. Crude oil jumped $4.67 to a
six-month high, posting the largest one-month
percentage gain since 1999 (according to
Bloomberg). The Goldman Sachs Commodities index
rallied 5.5% to an almost seven-month high (up 27%
year-to-date). Emerging markets remain on fire.
And the Baltic Dry Index rose again on Friday,
increasing its streak of consecutive gains to 19.
Leading the "BRIC"
sweepstakes, Russia's RTS equities index jumped
7.3% last week, while India's Sensex rose 5.3%.
Russian stocks are now up 72% year-to-date,
followed by India's 52%, China's 45%, and Brazil's
42%. Elsewhere, stocks in Taiwan are
up
50%, South Korea 24%, Argentina 47%, and Hungary
22%. The "commodity" currencies led the charge
again last week. The South African rand gained
4.1%, the New Zealand dollar 3.3%, the Brazilian
real 3.0%, the Australian dollar 2.4%, and the
Canadian dollar 2.7%.
It was quite a week in US
interest rate markets. Ten-year Treasury yields
jumped 29 basis points (bps) during the shortened
week's first two trading sessions (to 3.74%),
before backing off to end the week up only 2 bps
to 3.47%. The mortgage marketplace turned rather
tumultuous, with benchmark Fannie Mae
mortgage-backed security (MBS) yields spiking 55
bps from last Friday's close before ending the
week 19 bps higher at 4.33%.
Some
interest-rate hedging markets seemed in disarray,
with the dollar swaps market demonstrating price
discontinuity. After closing last week at 14.4
bps, the 10-year dollar swap spread traded as high
as 38.25 before ending the week at 19.50.
Importantly, at least for the
week, mortgage-related market tumult didn't
broaden to other risk markets. Corporate credit
spreads were mostly narrower on the week, even as
the company debt issuance boom ran unabated. The
junk-bond market enjoyed another week of strong
fund inflows more than matched by huge issuance.
It is also worth noting the
resilience of the "emerging" debt markets.
Brazilian benchmark dollar bond yields were down
14 bps to 5.86%. Mexican dollar bond yields fell
14 bps to 5.74%. Brazil's credit default swap
(CDS) prices declined to the lowest level since
early October (197 bps, down from the October high
of 600 bps). It is no longer the case that when
the Treasury market catches a cold others get
really sick.
At this point, the markets'
sanguine attitude toward US dollar and
Treasury/MBS weakness is understandable. From a
global perspective, a weaker dollar bolsters the
inflationary bias that had prior to the credit
meltdown been driving robust economic performance
throughout the energy and commodities-based
economies. Dollar devaluation also works to
reinforce already heady financial flows to
"emerging" markets and non-dollar assets more
generally. There are facets of inflation that
seductively salve recovery.
The
dramatic loosening of financial conditions
globally is supporting an improvement in economic
conditions. The optimists are looking for Asia and
the developing world to lead a global recovery,
and a sinking dollar on a short-term basis would
seem to support such a scenario. Our weak currency
also empowers the global government finance
bubble. Amazingly, most countries today have
unprecedented flexibility to issue debt without
fear of negative market reaction or a run against
their currencies.
I again want to emphasize the
dramatic change in circumstances that is
increasingly in view throughout global markets and
economies. During the 1990s - and stretching
through the "King Dollar" period earlier this
decade - there was an overarching inflationary
bias that worked to direct flows to the "core" (the US
credit system and securities markets). Whether it
was a crisis that initially erupted in Mexico,
Southeast Asia, Russia, Argentine or Brazil, the
immediate market response was an abrupt reversal
of financial flows from the developing countries
to US dollar securities. While there was an
ongoing acceleration in speculative flows
meandering about the globe in search of big
returns, the first sign of trouble would incite a
panic straight to the dollar.
The
"core" absolutely dominated the system, providing
our policymakers (especially the US Federal
Reserve) extraordinary latitude. The
periphery-to-core bias fostered financial crises,
along with general periphery financial and
economic instability. This dynamic worked to keep
global inflationary pressures in check. Or, better
said, the nature of the inflationary flow of
finance kept inflation pressures directed to US
dollar securities markets - as opposed to energy,
commodities and more traditional inflation.
The
global financial and economic backdrop has changed
profoundly. Today, there exists a powerful
inflationary bias working to direct flows away from the core out to the periphery. This
dynamic helps to explain the dramatic change in
the cost and availability of finance for the
developed world over the past several years - the
virtually unlimited cheap finance that funded
historic booms in China and Asia.
Granted, this flow was
abruptly interrupted by last year's global credit
crisis. It is, however, my view that the dynamic
of powerful core-to-periphery flows has resumed.
Moreover, it is the nature of this type of dynamic
that if such a trend recovers it will likely
resume stronger-than-ever (think tech stock
reflation post the Long Term Capital Management
collapse or mortgages reflation post the tech
bubble). This analysis is supported by the
periphery's recent dramatic economic and market
outperformance relative to the core.
So,
is this bullish or bearish? Well, I believe the
core-to-periphery dynamic is supportive of a more
rapid than expected global economic recovery. I
definitely expect global inflation to surprise on
the upside. Adherents to the global deflationary
spiral thesis may be left wondering what the heck
happened. The backdrop seems to be set for
surprising revival in energy and commodities
markets. And I would not be surprised if the
global equities rally has some legs.
Yet
I view the core-to-periphery dynamic as profoundly
bearish for the US. At its core, this historic
redirection of global flows and inflationary
pressures is the consequence of a breakdown in the
dollar standard. Failed policies, a resulting
deeply impaired economic structure, and massive
ongoing devaluation have ended the dollar's reign
as the globe's premier reserve currency and
perceived stable store of value. There is today no
sound currency to replace the dollar, so the
global financial system operates rudderless and
with great uncertainties.
It
is more certain, however, that the great benefits
commanded to our economy and markets over the
decades from governing the world's reserve
currency are drawing to an end. Our policymakers
still believe they can inflate credit and
manipulate interest rates - and not have to pay a
price for it. But the new global reality may be
that currency markets will protest against massive
US fiscal deficits and activist monetary policy,
while global markets come to dictate US market
yields. Over the past two weeks, we have seen the
dollar and US Treasuries/MBS come under
significant pressure. Is this the beginning of
global markets disciplining Washington?
A
robust core-to-periphery dynamic and the
re-emergence of dollar vulnerability are a potent
combination. US markets to this point remain
sanguine with the prospect of an expanding Federal
Reserve balance sheet rectifying any spike in
interest rates. But currency markets are no doubt
increasingly fixated on our propensity to monetize
current and prospective stimulus.
At
some point, increasingly unwieldy flows out of our
currency may force the Fed's hand. The scenario
where the Fed is forced to choose between loose
monetary policy and currency crisis sits out there
as a potential big negative surprise for US
markets.
WEEKLY WATCH For the
week, the S&P500 gained 2.6% (up 1.8% y-t-d),
and the Dow jumped 3.5% (down 3.2% y-t-d).
Economically-sensitive stocks led the charge. The
Morgan Stanley Cyclicals jumped 4.1% (up 15.7%),
and the Transports surged 6.1% (down 9.4%).
Financial stocks were also strong. The Banks rose
4.6% (down 15.6%), and the Broker/Dealers gained
4.0% (up 28.5%). The broader market posted big
gains. The S&P 400 Mid-Caps advanced 4.2% (up
6.9%) and the small cap Russell 2000 rose 4.8% (up
0.4%). The Nasdaq100 surged 5.0% (up 18.5%), and
the Morgan Stanley High Tech index rose 5.3% (up
28.8%). The Semiconductors surged 7.7% (up 27.9%),
and the InteractiveWeek Internet index jumped 5.3%
(up 39.8%). The Biotechs increased 4.4% (up 0.3%).
Somewhat lagging, the Morgan Stanley Consumer
Index gained 2.1% (up 2.2%), and the Utilities
rallied 3.3% (down 9.7%). With Bullion jumping
$22, the HUI gold index gained 4.8% (up 31.6%).
One-month Treasury bill rates
ended the week at 14 bps, and three-month bills
closed at 15 bps. Two-year government yields
declined 3 bps to 0.82%. Five year T-note yields
rose 10 bps to 2.29%. By week's end, ten-year
yields had only increased 2 bps to 3.47%. The
long-bond saw yields end the week down 4 bps to
4.34%. The implied yield on 3-month December '09
Eurodollars slipped 2 bps to 0.935%. Benchmark
Fannie MBS yields jumped 19 bps to 4.33%. The
spread between benchmark MBS and 10-year T-notes
widened 17 bps to 87 bps. Agency 10-yr debt
spreads narrowed 5 bps to 32 bps. Interest-rate
derivative markets were wildly volatile. The
2-year dollar swap spread ended little changed at
40.75 bps; the 10-year dollar swap spread
increased 5 to 19.5 bps; and the 30-year swap
spread declined 1.0 to negative 31.5 bps.
Corporate bond spreads mixed. An index of
investment grade bond spreads tightened 3 to 194
bps, while an index of junk spreads widened 4 to
940 bps.
The
corporate debt issuance boom runs unabated.
Investment grade issuers included Morgan Stanley
$5.5bn, Citigroup $5.0bn, Goldman Sachs $3.0bn,
Bank of America $2.5bn, Metlife $1.25bn, Mass
Mutual $750 million, Travelers $500 million,
Norfolk Southern $500 million, Pride International
$500 million, and Public Service Colorado $400
million.
Junk
bond funds saw inflows of $472 million this past
week (from AMG), 11 straight weeks of positive
flows. Junk issuers included Harrahs $1.375bn,
Cricket Communications $1.1bn, Ford $1.1bn, Virgin
Media $750 million, CBS $600 million, AMC
Entertainment $600 million, Verso Paper $325
million, Allegheny Technologies $350 million,
Terex $300 million, and American Tower $300
million.
I saw no convert issuance
this week.
International dollar debt
issuers included Corp Andina de Fomento $1.0bn and
Westpac Banking $350 million.
UK
10-year gilt yields rose 3 bps to 3.75%, and
German bund yields gained 4 bps to 3.59%. The
German DAX equities index added 0.5% (up 3.6%).
Japanese 10-year "JGB" yields jumped 5 bps to
1.48%. The Nikkei 225 rose 3.2% (up 7.5%).
Emerging markets remain quite strong. Brazil's
benchmark dollar bond yields dropped 14 bps to
5.86%. Brazil's Bovespa equities index jumped 5.2%
(up 41.7% y-t-d). The Mexican Bolsa gained 1.0%
(up 8.7% y-t-d). Mexico's 10-year $ yields dropped
14 bps to 5.74%. Russia's RTS equities index
surged 7.3% (up 72%). India's Sensex equities
index gained 5.3% (up 51.6%). China's Shanghai
Exchange added 1.3% in a shortened week (up
44.6%). Freddie Mac
30-year fixed mortgage rates jumped 9 bps to 4.91%
(down 117bps y-o-y). Fifteen-year fixed rates
gained 3 bps to 4.53% (down 113bps y-o-y).
One-year ARMs dropped 13 bps to 4.69% (down 53 bps
y-o-y). Bankrate's survey of jumbo mortgage
borrowing costs had 30-yr fixed jumbo rates up 26
bps to 6.48% (down 57bps y-o-y).
Federal Reserve Credit
dropped $90.7bn last week to $2.074TN. Fed Credit
has declined $172 y-t-d, although it expanded
$1.196 TN over the past 52 weeks (136%).
Elsewhere, Fed Foreign Holdings of Treasury,
Agency Debt this past week (ended 5/27) jumped
another $14.7bn to a record $2.724 TN. "Custody
holdings" have been expanding at an 20.4% rate
y-t-d, and were up $431bn over the past year, or
18.8%.
Bank Credit increased $7.4bn
to $9.772 TN (week of 5/20). Bank Credit was up
$341bn year-over-year, or 3.6%. Bank Credit was
down $141bn y-t-d (3.7% annualized). For the week,
Securities Credit declined $9.3bn. Loans &
Leases jumped $16.6bn to $7.095 TN (52-wk gain of
$185bn, or 2.7%). C&I loans dropped $7.9bn,
with one-year growth of 2.7%. Real Estate loans
fell $9.1bn (up 6.2% y-o-y). Consumer loans jumped
$15.2bn, and
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
