Page 1 of 3 CREDIT BUBBLE BULLETIN So much for an exit strategy
Commentary and weekly watch by Doug Noland
Ten-year Treasury yields dropped another 14 basis points (bps) last week to
2.68%. Yields on benchmark Fannie Mae mortgage-backed securities (MBS) sank 13
bps to a record low 3.43%. Tuesday's announcement from the Federal Open Market
Committee (FOMC) further emboldened a highly speculative fixed-income
Some analysts argue that the Fed's move to reinvest cash receipts from its MBS
portfolio into Treasuryies is no big deal; the decision will not involve sums
of Treasury purchases sufficient to move market and economic needles. A former
Federal Reserve governor - and noted "Fed watcher" - commented on CNBC that
this amounts to "neutral" monetary policy. It is his view that it would be a
case of "tight" policy if the Fed's balance sheet were
allowed to shrink with a drawing down of its MBS portfolio. Conversely, Federal
Reserve holdings would need to expand for monetary policy to remain loose. The
size of the Fed's balance sheet is now viewed as a key policy tool.
I see things differently - and view last week's decision by the Ben Bernanke
Federal Reserve as yet another dangerous leap into experimental monetary
management. Market perceptions remain the key facet of bubble analysis - and
not week-to-week changes in Fed holdings.
Not many weeks ago the focus was on the Fed's "exit strategy". Apparently,
policymakers now recognize that there is no way out. It was supposed to have
been a case of the Federal Reserve having used its balance sheet as an
extraordinary policy tool in response to the 2008 credit seizure, with the Fed
dedicated to unwinding this unprecedented stimulus as the system stabilized.
Today, not only is the Fed unwilling to normalize its securities holdings, it
has signaled to the markets that it is able and willing to expand its balance
sheet on an as-needed basis. At least that's the way the markets will see
things: the Fed is there ready to act quickly and forcefully as a reliable
system backstop. No more worries about "exit" issues; and as the debt markets
turn increasingly overheated, it's sure comforting the markets know the Fed is
there to ensure marketplace liquidity. This is a very big deal.
There were many crosscurrents in the markets this week. The dollar rallied
sharply, immediately reinstituting pressure on various global risk markets.
Euro weakness quickly translated into widening risk premiums in periphery
European debt markets - that then tend to feed further euro vulnerability. The
dollar pop also slammed crude prices and pressured some of the other
commodities. Reminiscent of the Greek debt crisis period, dollar strength
pressured global equities markets more generally. The global "reflation trade"
seems these days to hinge day-to-day on the direction of the dollar -
especially versus the euro.
Market pundits pointed to the Federal Reserve's downbeat economic assessment as
the main reason behind the equity sell-off, although the currency markets
continue to be the driving force behind wildly volatile global markets. Perhaps
the Fed's downbeat assessment and announcement of Treasury purchases was
somehow behind the dollar's rally; or perhaps it was instead that traders had
become sufficiently bearish on the dollar to ensure that Mr Market did an about
face - with a "rip their faces off!" rally.
Stocks were weak and the dollar was generally strong. But the real show was
provided - once again - in fixed income. Prices continued their melt-up - yield
meltdown - with bubble dynamics becoming only more conspicuous each passing
week. And I know that most dismiss the bubble thesis and view prices as
reflecting poor economic prospects and the deflationary backdrop. I would
respond that the environment remains extraordinarily conducive to bubble
Barron's Jonathan R Laing captured the current mood with his article, "Time to
Print, Print, Print". With inflation risks so low and the scourge of deflation
so potentially devastating, many believe it would be a dereliction of the
Federal Reserve's duty not to aggressively expand its securities holdings
("print money"). Similar reasoning was used to justify the ultra-loose monetary
policies earlier this decade that inflated the mortgage/Wall Street finance
Today, extreme activist fiscal and monetary policies inflate the global
government finance bubble. After the 2008 fiasco, I have a difficult time
comprehending how analysts can remain dismissive of bubble risks. And with an
increasingly conspicuous bubble at the heart of our monetary system, our
central bank should not be reinforcing the market perception that the Fed is
there to backstop the markets and economic recovery with open-ended Treasury
Instead of a well-functioning marketplace (and central bank) working to
discipline a profligate Washington, dysfunctional monetary and market
environments continue to accommodate perilous credit excess.
For the week, the S&P500 dropped 3.8% (down 3.2% y-t-d), and the Dow fell
3.3% (down 1.2%). The Banks sank 5.1% (up 7.6%), and the Broker/Dealers fell
5.7% (down 9.9%). The Morgan Stanley Cyclicals were hit for 5.6% (down 0.4%),
and the Transports dropped 5.7% (up 2.5%). The Morgan Stanley Consumer index
declined 2.5% (down 0.1%), and the Utilities dipped 1.1% (down 1.7%). The
S&P 400 Mid-Caps dropped 4.8% (up 1.1%), and the small cap Russell 2000
sank 6.3% (down 2.5%). The Nasdaq100 fell 4.4% (down 2.3%), and the Morgan
Stanley High Tech index sank 5.9% (down 8.4%). The Semiconductors were pounded
for 8.2% (down 10.3%). The InteractiveWeek Internet index fell 3.9% (up 3.7%).
The Biotechs declined 3.4%, reducing 2010 gains to 14.5%. Although bullion
gained $10, the HUI gold index declined 1.3% (up 5.6%).
One-month Treasury bill rates ended the week at 13 bps and three-month bills
closed at 15 bps. Two-year government yields were little changed at 0.51%.
Five-year T-note yields declined 4 bps to 1.39%. Ten-year yields dropped 14 bps
to 2.68%. Long bond yields sank 14 bps to 3.86%. Benchmark Fannie MBS yields
fell 13 bps to 3.43%. The spread between 10-year Treasury yields and benchmark
MBS yields widened one basis point to 75 bps. Agency 10-yr debt spreads were 3
wider at 21 bps. The implied yield on December 2010 eurodollar futures
increased 2.5 bps to 0.47%. The 10-year dollar swap spread declined 3 to
negative 2.25. The 30-year swap spread declined 13.5 to negative 43. Corporate
bond spreads widened. An index of investment grade spreads rose 5 to 108 bps.
An index of junk bond spreads jumped 29 to 573 bps.
It was another strong week of debt issuance. Investment grade issuers included
Direct TV $3.0bn, International Lease Finance $4.0bn, Anadarko Petroleum
$2.0bn, Toyota Motor Credit $1.0bn, Simon Properties $900 million, Keycorp $750
million, Wellpoint $1.0bn, Nustar Logistics $450 million, Cott Beverages $375
million, Great Plains Energy $250 million, and Orange & Rockland $160
A record week of junk issuers included Ally Financial $1.75bn, Goodyear Tire
$900 million, SPX Corp $600 million, Chesapeake Energy $2.0bn, American Tower
$700 million, Peabody Energy $650 million, Rite Aid $650 million, QEP Resources
$625 million, First Data $510 million, International Lease Finance $500
million, Building Materials Corp $450 million, Diamond Resorts $425 million,
Pinnacle Food $400 million, Gentiva Health Services $325 million, Developers
Diversified $300 million, Regal Entertainment $275 million, and Targa Resources
I saw no converts issued.
International dollar debt sales included Statoil $2.0bn, Banco Bradesco $1.1bn,
Opti Canada $825 million, Tembec Industries $255 million, KWG Property $250
million, Elan $200 million and Barclays Bank $100 million.
U.K. 10-year gilt yields sank 10 bps to 3.12%, and German bund yields dropped
13 bps to 2.39%. Greek 10-year bond yields jumped 33 bps to 10.48%, and 10-year
Portuguese yields rose 22 bps to 5.21%. The German DAX equities index declined
2.4% (up 2.6% y-t-d). Japanese 10-year "JGB" yields fell 7 bps to 0.98%. The
Nikkei 225 was hit for 4.0% (down 12.3%). Emerging equity markets were under
some pressure. For the week, Brazil's Bovespa equities index dropped 2.7% (down
3.4%), and Mexico's Bolsa fell 2.5% (down 0.1%). Russia's RTS equities index
sank 5.1% (down 0.1%). India's Sensex equities index was little changed (up
4.0%). China's Shanghai Exchange declined 1.9% (down 20.5%). Brazil's benchmark
dollar bond yields fell 10 bps to 4.00%, and Mexico's benchmark bond yields
dropped 12 bps to 3.88%.
Freddie Mac 30-year fixed mortgage rates declined another 5 bps last week to
4.44% (down 85bps y-o-y). Fifteen-year fixed rates fell 3 bps to 3.92% (down
77bps y-o-y). One-year ARMs dipped 2 bps to 3.53% (down 119bps y-o-y).
Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates
down 8 bps to 5.37% (down 105bps y-o-y).
Federal Reserve Credit declined $142 million last week to $2.309 TN. Fed Credit
was up $89bn y-t-d (6.5% annualized) and $320bn, or 16.1%, from a year ago.
Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended
8/11) jumped another $10.6bn (8-wk gain of $84.6bn) to a record $3.164 TN.
"Custody holdings" have increased $209bn y-t-d (11.5% annualized), with a
one-year rise of $349bn, or 12.4%.