Page 1 of 3 CREDIT BUBBLE BULLETIN An off-limits bubble
Commentary and weekly watch by Doug Noland
Last week marked the first anniversary of a historic stock market rally. The
S&P 500 enjoys a one-year gain of 66.8%. The broader market has fared even
better. The small cap Russell 2000 and S&P400 mid-caps sport 12-month gains
of 90.6% and 87.4%. The past year also witnessed record junk debt issuance and
an amazing turnabout in financial conditions. Housing markets may be stuck in
the mud, but government-induced reflation has worked wonders for equities,
corporate debt and global risk assets more generally.
Long-time readers may have noticed that awhile back I stopped the weekly
presentation of bank credit and asset data. For the record, bank credit
declined US$470 billion over the past year, or about 5%. I specifically have
not emphasized this bank
contraction, believing it had become a deceptive indicator of financial
conditions. Also luring in those anticipating deflationary conditions, M2
"money supply" expanded just under 2% over the past year. There has been no
reason to fret over a substandard $200 billion one-year expansion of narrow
"money", not with Treasury and agency securities inflating a couple trillion
and the Federal Reserve monetizing a trillion of mortgage-backed securities
One year ago, the Federal Reserve held $69 billion of mortgage-backed
securities. Their hoard now surpasses $1.027 trillion. Over the past year,
Treasury has run deficits of about $1.5 TN. The United States government's
"electronic printing press" has dispersed unprecedented purchasing power to
households and businesses throughout the economy. The Fed's trillion dollar
monetization has unleashed unmatched liquidity throughout the financial
March 5 - Bloomberg (Wes Goodman): "Investors plowed a record $2.6 billion into
global bond funds in the week ended March 3, moving out of money markets to
seek higher returns because of the threat of quickening inflation, EPFR Global
said ... US bond funds drew in $2 billion, attracting cash for a 61st straight
week ... 'Flows into these funds remained incredibly robust in early March,'
EPFR said. 'Cash continues to flee the safe havens of 2006-08.'"
Brazil's Bovespa gained 84.2% in 12 months, Mexico's Bolsa 86.8%, and
Argentina's Merval 140.8%. In Asia, China's Shanghai Composite gained 36.5%,
Hong Kong's Hang Seng 70.2%, Taiwan's Taiex 65.3%, South Korea's Kospi 54.4%,
Australia's S&P/ASX 200 49.5%, the Thai index 73.6%, the Jakarta Composite
100.2%, and the Ho Chi Minh index 108.1%. In Europe, the Prague stock index has
gained 80.8%, Budapest 131.3%, and Russia's RTS index 170.1%. Emerging market
debt spreads (EMBI) were above 730 a year earlier, yet closed this week below
300 basis points. Mexican bond yields traded to a record low on Friday (4.80%).
Over the past year, the South African rand has gained 43%, the Australian
dollar 42%, the New Zealand dollar 39.5%, the South Korean won 37.5%, the
Brazilian real 34.5%, the Swedish krona 30.8%, and the Canadian dollar 25.6%.
The price of crude oil has almost doubled in 12 months, and the CRB Commodities
index has gained 35%.
Over the past six weeks of Greek and European debt consternation, emerging debt
markets remained notably resilient. Brazil's 10-year dollar bond yields barely
traded above 5.3%, while Mexico's yields stayed below 5.2%. Around the world,
debt markets hardly flinched. It is also worth mentioning that Greece's bond
offering on Thursday was three times oversubscribed. They had to pay up
somewhat (6.385%), but there was no shortage of bids.
At this point, global reflationary forces appear well entrenched. There is
little indicating that the dollar's rally is forcing the unwind of the
so-called "dollar carry trade". It is difficult to identify signs of
deleveraging and fading liquidity. There are instead indicators pointing to
unrelenting liquidity overabundance. If this were an environment with tight
global financial conditions, Greece would likely be in a heap of trouble. In a
backdrop of risk aversion and deleveraging, Greek contagion would likely be a
serious global issue. In some ways, the Greece debt crisis is providing a
litmus test for the global risk and liquidity backdrop. At least so far, there
is ample confirmation of extraordinarily loose global financial conditions.
After the bursting of the technology bubble, the Federal Reserve was content to
live with mortgage excesses as it worked toward its objective of systemic
reflation. The post-bubble focus was to make sure the bad guys were punished
(Enron, Worldcom, Arthur Anderson, and so on) and that accounting rules were
significantly tightened up. The causes behind the system's proclivity toward
dangerous financial excess - the root of the problem - were so easily
disregarded. The Alan Greenspan / Ben Bernanke Fed's overriding objectives were
to ensure abundant cheap liquidity and foment reflationary forces. I am
unsympathetic to Federal Reserve president Jeffrey Lacker's assertion last week
that the Fed is "being made a scapegoat".
On Friday, the Fed's overriding objective - understood in the markets more
clearly than ever - remains ensuring abundantly cheap liquidity. This period's
bad guys - the bankers - are under the spotlight, as the focus for this round
of reform turns to ensuring that the banks are not the instigators of future
crises. And I expect the "Volcker rule" to be about as successful as the
Sarbanes-Oxley Act when it comes to protecting the system from financial excess
and devastating bubbles.
March 4 - Bloomberg (Rebecca Christie and Phil Mattingly): "The Obama
administration's legislative draft of the so-called Volcker Rule incorporated
exemptions that may ease the impact on financial markets should it be enacted.
President Barack Obama ... sent Congress the five-page proposal to ban
proprietary trading and block mergers that give banks more than a 10% market
share ... It also would bar banks from owning or investing in hedge funds and
private equity firms. The rule, which is aimed at reducing the risk of another
financial crisis, exempts mergers that exceed the market-share limit in cases
when a firm acquires a failing bank with regulators' approval. Also left out
are trading in Treasury and agency securities, including debt issued by Ginnie
Mae, Fannie Mae and Freddie Mac."
Throughout the post-tech bubble reflationary period, mortgage credit expansion
was viewed as integral to the solution. Mortgage finance was basically off
limits from a regulatory standpoint, with this dynamic providing major impetus
for historic credit and speculative excess. Rather than recognizing an
unfolding mortgage finance bubble as a systemic risk, policymakers were content
to feed the excess and look the other way. Of course, a speculative marketplace
figured this all out and took full advantage. The government's multifaceted
support (the Fed, government-sponsored enterprises, Treasury, etc.) of mortgage
finance fanned speculative excess and directly fueled the bubble.
These days, the administration's watered-down "Volcker rule" - which will
likely be diluted to water-like reform legislation in congress - excludes the
government debt markets from proprietary trading restrictions. Government
finance is today's unfolding bubble and, not surprisingly, this bubble is off
limits for regulatory reform. Government deficits are integral to the bubble,
and there will be no serious effort to rein them in. The Fed's balance sheet is
a serious bubble issue, but it also remains untouchable. Treasury, GSEs, and
Federal Reserve Credit are viewed as the solution, and a historic bubble is
emboldened and builds momentum.
The markets' perception of "too big to fail" has for years been an integral
facet of bubble dynamics. And despite all the talk of trying to rid the
marketplace of this notion, the markets remain more persuaded than ever: the
unfolding global government finance bubble is much too gigantic for
policymakers to risk letting it come anywhere close to failing. Massive US
deficits and near-zero interest rates ensure a steady flow of finance (newly
created as well as an ongoing exodus out of low-yielding instruments) to debt
markets around the world. Confidence runs high that ultra-loose US financial
conditions will continue to underpin credit expansions globally. Politicians
may talk tough, and they do put on a good show. Meanwhile, markets function
with reticent aplomb, knowing they've got policymakers right where they want
For the week, the S&P500 jumped 3.1% (up 2.1% y-t-d), and the Dow gained
2.3% (up 1.3%). The broader market has been exceptionally strong. The S&P
400 Mid-Caps surged 4.3% (up 6.0%), and the small cap Russell 2000 jumped 6.0%
(up 6.5%). The Banks jumped another 2.4% (up 13.8%), and the Broker/Dealers
rose 3.0% (up 2.2%). The Morgan Stanley Cyclicals surged 4.8% (up 4.4%), and
the Transports increased 1.5% (up 2.3%). The Morgan Stanley Consumer index
gained 2.7% (up 2.8%), and the Utilities rose 2.8% (down 4.6%). The Nasdaq100
jumped 3.8% (up 1.5%), and the Morgan Stanley High Tech index gained 3.6% (up
0.3%). The Semiconductors rose 3.7% (down 2.3%). The InteractiveWeek Internet
index jumped 4.8% (up 2.2%). The Biotechs surged 12.7%, increasing 2010 gains
to 24.5%. With bullion up almost $15, the HUI gold index jumped 6.1% (down
One-month Treasury bill rates ended the week at 9 bps, and three-month bills
closed at 13 bps. Two-year government yields jumped 8 bps to 0.81%. Five-year
T-note yields gained 4 bps to 2.26%. Ten-year yields increased 7 bps to 3.68%.
Long bond yields jumped 9 bps to 4.64%. Benchmark Fannie MBS yields were little
changed at 4.33%. The spread between 10-year Treasury and benchmark MBS yields
narrowed 7 to 65 bps. Agency 10-yr debt spreads increased 2 to 36 bps. The
implied yield on December 2010 eurodollar futures rose 7 bps to 0.875%. The
10-year dollar swap spread was cut in half to 4.25, and the 30-year swap spread
declined 2 to negative 16. Corporate bond spreads narrowed. An index of
investment grade bond spreads narrowed 3 to 89 bps, and an index of junk
spreads narrowed 2 to 520 bps.
Debt issuance picked up to a respectable $20.0bn (from Bloomberg). Investment
grade issuers included Dexia Credit $4.0bn, Goldman Sachs $2.0bn, Time Warner
$2.0bn, Republic Services $1.5bn, Baxter International $600 million, John Deere
$500 million, US Bancorp $500 million, Johnson Controls $500 million,
Southwestern Electric Power $350 million, Puget Sound Energy $325 million, Teco
Finance $550 million, Public Service E&G $300 million, and Western
Massachusetts Electric $95 million.
Junk bond funds saw inflows of $314 million. Junk issuers included HCA $1.4bn,
Masco $500 million, Avis Budget Car Rental $450 million, TW Telecom $430
million, Alliance Oil $350 million, Solutia $300 million, Reddy Ice $300
million, Pioneer Drill $250 million, Zayo Group $250 million, Conexant Systems
$175 million, Express $250 million, and Holly Energy $150 million.
I saw no converts issued.
International dollar debt sales remain robust. Issuers included Mexico $2.0bn,
South Africa $2.0bn, Export-Import Bank of Korea $1.0bn, Rabobank $1.0bn, and
Bank of Moscow $750 million.