Page 1 of 2 CREDIT BUBBLE BULLETIN The official start of QE2
Commentary and weekly watch by Doug Noland
There are a couple key facets of my thesis worthy of some extra focus in this
column - the official start of the second round of quantitative easing (QE2) by
the United States. First, in the post-Greek crisis world - with parallels to
the subprime eruption in the spring of 2007 - the markets are increasingly keen
to look hard at structural debt issues. Second, inflationary pressures have
gained significant momentum in China, Asia and the "emerging" economies more
In the world of structural debt problems, the European debt crisis turned more
acute last week. Ireland's 10-year yields surged to almost 9% on Thursday (from
about 5% in early-August), before declining 76 bps on Friday on more
conciliatory talk from European officials. Prior to Friday's bond rally,
were up another 50bps (to 7.0%) this week and Greece yields were another 15 bps
higher (to 11.60%). Recalling the 2007-08 experience in US mortgage finance,
the initial policy response to the European peripheral debt crisis may have
bought some time but has had little effect on underlying structural debt
On the inflation front, Chinese stocks (Shanghai Composite) were hit for 5.2%
on Friday on fears of more aggressive monetary tightening by the People's Bank
of China. Chinese authorities have warned of the heightened inflation risk
related to QE2. The markets are taking this talk seriously.
Earlier this week, gold and cotton surged to new record highs. Silver, sugar
and rubber jumped to near 30-year highs. Copper, corn and crude traded to
two-year highs. From the beginning of September, the CRB Commodities Index
rallied about 20%. Indicative of increasingly unstable global markets, the CRB
index sank 3.7% on Friday after trading to a 2-year high earlier in the week.
On Thursday, China reported a larger-than-expected 4.4% year-on-year jump in
consumer prices. Also last week, China reported its October money supply (up
19.3% y-o-y) and bank loan growth ($89 billion) surprised on the upside.
Reports on China's retail sales (up 18.6% y-o-y) and auto sales (up 27% y-o-y)
were strong. And to the chagrin of Chinese authorities, real estate prices
remain resilient at elevated levels. These days, China's policymakers face an
overheated bubble economy, a dilemma compounded by the prospects for surging
commodity costs and destabilizing "hot money" inflows. Patience is wearing
thin. Prospects are not favorable for monetary "tinkering" to be effective.
For the past couple of months, the world has been enamored with QE2 and
prospects for concerted global central bank monetization/liquidity creation.
European peripheral debt problems were viewed as ensuring European Central Bank
(ECB) market intervention/support. Deflation had the Bank of Japan poised for
aggressive action. In the US, structural problems were sure to support multiple
QEs and a feeble dollar. A faltering greenback equated to ongoing Asian central
bank dollar purchases and the "recycling" of these balances back to the US
Treasury market. Ultra-low Treasury yields would then remain a steadfast anchor
on market yields for the vast spectrum of global borrowers.
Global markets - stocks, bonds, commodities, and currencies - have been
luxuriating in visions of endless liquidity over-abundance - for all. It's been
a backdrop where fundamental factors and issues were relegated to the
Last week, it seemed like the focus may have shifted toward fundamentals. Risk
is returning to the equation. For starters, the markets' disregard for global
inflation risks has begun to wane. And despite all the focus on global
liquidity abundance, systemic risks remain quite elevated. As the week wore on,
the liquidity backdrop suddenly looked a lot less certain. Perhaps the future
does not guarantee ultra-loose "money" for all - but rather an increasingly
discriminating market environment of "the haves" and "have nots".
Global yields were on the rise. German bund yields gained 9 bps to 2.51% and
Japan's JGBs rose 7 bps to 0.99%. Notably, UK 10-year yields jumped 24 bps
(3.21%), Spain 17 bps (4.53%), and Italy 18 bps (4.15%). Our 30-year Treasury
yields rose 17 bps to 4.29%, the high since mid-May. Benchmark US municipal
yields jumped 24 bps to 3.70% (from Bloomberg).
If the markets are indeed beginning to reevaluate the global inflation backdrop
and the prospects for China/Asian monetary tightening, the marketplace would
also be expected to become more discriminating based on respective borrower
fundamentals. After all, the potential for rising global yields and a less
accommodating liquidity backdrop would more severely impact the most heavily
indebted. As such, I take particular interest in last week's jump in yields for
the UK, Spain, Italy, the US long bond, and American municipal bonds.
And if the market has in fact begun to shift from "endless liquidity for all"
to a more fundamentally driven focus, don't expect such a transition to go
smoothly. After all, ultra-loose financial conditions tend to most benefit the
weakest borrowers. That has certainly been the case in the US credit market,
with junk bonds, leveraged loans, and municipal debt having enjoyed such
stellar performance. In our stock market, many of the most fundamentally
challenged stocks and sectors have posted tremendous gains. An extraordinary
liquidity backdrop has nurtured speculative excess - in the process creating
acute vulnerability to changing market perceptions.
On a global macro basis, few governments have benefited more from global
liquidity excess than the US Treasury. It is worth noting that in the face of
this week's global risk markets drubbing - Treasury yields rose and the dollar
index barely treaded water.
Has quantitative easing - on this, the initial trading day of QE2 - turned
counterproductive? Have markets reached an inflection point, with concern
shifting away from perceived liquidity benefits to the heightened risks
associated with additional Federal Reserve liquidity creation (ie inflation,
Chinese/Asian tightening, unwieldy global liquidity flows, heightened market
instability, worsening structural problems, etc)? Did global policymaking and
the markets' euphoric perception of endless liquidity set the stage for
disappointment and liquidity issues? Last week felt different; highly
speculative global markets are overdue for a bout of "soul searching".
For the week, the S&P500 dropped 2.2% (up 7.5% y-t-d), and the Dow fell
2.2% (up 7.3%). The Banks sank 3.3% (up 10.2%), and the Broker/Dealers declined
2.7% (down 1.9%). The Morgan Stanley Cyclicals fell 2.4% (up 14.7%), and the
Transports declined 2.4% (up 17.3%). The Morgan Stanley Consumer index declined
2.3% (up 7.5%), and the Utilities fell 2.5% (up 0.6%). The S&P 400 Mid-Caps
declined 2.0% (up 16.1%), and the small cap Russell 2000 fell 2.4% (up 15.0%).
The Nasdaq100 declined 2.2% (up 14.9%), and the Morgan Stanley High Tech index
lost 2.2% (up 8.7%). The Semiconductors dropped 2.4% (up 6.3%). The
InteractiveWeek Internet index lost 2.1% (up 29.5%). The Biotechs gave back
1.3%, reducing 2010 gains to 22.8%. Although bullion declined $25 for the week,
the hyper-volatile HUI gold index added 0.4% (up 28.4%).
One-month Treasury bill rates ended the week at 10 bps and three-month bills
closed at 13 bps. Two-year government yields jumped 13 bps to 0.50%. Five-year
T-note yields ended the week 26 bps higher at 1.31%. Ten-year yields jumped 25
bps to 2.79%. Long bond yields jumped 17 bps to a 5-month high 4.28%. Benchmark
Fannie MBS yields were 32 bps higher at 3.63%. The spread between 10-year
Treasury yields and benchmark MBS yields widened 7 bps to 84 bps. Agency 10-yr
debt spreads were 3.5 bps wider to 13.5 bps. The implied yield on December 2011
eurodollar futures jumped 25 bps to 0.815%. The 10-year dollar swap spread
increased 0.75 bps to 14.0. The 30-year swap spread was little changed at
negative 37. Corporate bond spreads widened. An index of investment grade bond
risk jumped 8 bps to 94 bps. An index of junk bond risk jumped 50 to 486 bps.
Investment grade issuers included United Parcel $2.0 billion, Time Warner Cable
$1.9 billion, JPMorgan $1.75 billion, PPG Industries $1.0 billion, Becton
Dickinson $1.0 billion, LG & E Energy $875 million, Boston Properties $850
million, Talisman Energy $600 million, Plum Creek Timber $575 million,
Louisville G&E $535 million, Autozone $500 million, Ventas Realty $400
million, Public Service Colorado $400 million, Coca-Cola Enterprises $400
million, Entergy Arkansas $350 million, American Honda $350 million,
Continental Trust $350 million, Hubbell Inc. $300 million, Cleco Power $250
million, Integrys Energy $250 million, Avalonbay Communities $250 million,
Kentucky Utilities $1.5 billion, and AMB Property $175 million.
Junk bond funds attracted inflows of $382 million (from Lipper), the tenth
straight week of positive flows. Junk issuers included HCA Holdings $1.525
billion, Berry Plastics $800 million, Mylan $800 million, West Corp $650
million, Omega Healthcare $575 million, Univision Communications $500 million,
Ferrellgas $500 million, Affinion Group $475 million, Health Care REIT $450
million, Calfrac Holdings $450 million, Checkout Holdings $440 million,
Polypore International $365 million, Seneca Gaming $325 million, Icahn
Enterprises $500 million, Medassets $325 million, Allen Systems $300 million,
Mercer Intl $350 million, Roofing Supply $225 million, Beazer Homes $250
million, Mobile Mini $200 million, Frontier Oil $150 million and Star Gas $125
Converts issues included Radian Group $450 million.
The list of international dollar debt sales included IPIC $2.5 billion,
Odebrecht Drill $1.5 billion, Peru $1.0 billion, ICICI Bank $1.0 billion,
Precision Drilling $650 million, Vnesheconombank $1.6 billion, Renhe Commercial
$600 million, MBPS $320 million, China Oriental $300 million, China Forestry
$300 million, Allied World Assurance $300 million, Aerospace Satellite $165
million, Global Crossing $150 million, and International Bank of Reconstruction
and Development $100 million.
U.K. 10-year gilt yields rose 24 bps to 3.21%, and German bund yields gained 9
bps to 2.51%. Greek 10-year bond yields declined 5 bps to 11.39%. Ten-year
Portuguese yields jumped 23 bps to 6.725%. Ireland yields rose 70 bps to 7.62%.
The German DAX equities index slipped 0.3% (up 13.0% y-t-d). Japanese 10-year
"JGB" yields jumped 7 bps to 0.99%. The Nikkei 225 gained 1.0% (down 7.8%).
Emerging equity markets were under pressure. For the week, Brazil's Bovespa
equities index dropped 3.1% (up 2.6%), and Mexico's Bolsa slipped 0.7% (up
12.3%). South Korea's Kospi index declined 1.3% (up 13.7%). India's Sensex
equities index fell 4.0% (up 15.4%). After today's steep decline, China's
Shanghai Exchange ended the week down 4.6% (down 8.9%). Brazil's benchmark
dollar bond yields jumped 32 bps to 3.90%, and Mexico's benchmark bond yields
rose 36 bps to 3.82%.
Freddie Mac 30-year fixed mortgage rates dropped 7 bps last week to a record
low 4.17% (down 74bps year-over-year). Fifteen-year fixed rates fell 6 bps to
3.57% (down 79bps y-o-y). One-year ARMs were unchanged at 3.26% (down 120bps
y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed
jumbo rates up 5 bps to 5.16% (down 75bps y-o-y).
Federal Reserve Credit expanded $8.4 billion to $2.289 TN. Fed Credit was up
$69.3 billion y-t-d (3.6% annualized) and $173.5 billion, or 8.2%, from a year
ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week
(ended 11/10) surged $20.4 billion (22-wk gain of $260 billion) to a record
$3.336 TN. "Custody holdings" have increased $380.7 billion y-t-d (14.9%
annualized), with a one-year rise of $419 billion, or 14.4%.
M2 (narrow) "money" supply jumped $22.4 billion to $8.786 TN. Narrow "money"
has increased $253 billion y-t-d, or 3.5% annualized. Over the past year, M2
grew 3.2%. For the week, Currency added $1.9 billion, and Demand &
Checkable Deposits gained $6.1 billion. Savings Deposits jumped $22.0 billion,
while Small Denominated Deposits declined $6.1 billion. Retail Money Fund
assets slipped $1.6 billion.
Total Money Market Fund assets (from Invest Co Inst) increased $2.0 billion to
$2.802 TN. Year-do-date, money fund assets have dropped $492 billion, with a
one-year decline of $533 billion, or 16.0%.
Total Commercial Paper outstanding declined $11.7 billion (8-wk gain of $97.6
billion) to $1.134 TN. CP has declined $36.4 billion year-to-date, and was down
$105 billion from a year ago.
Global central bank "international reserve assets" (excluding gold) - as
tallied by Bloomberg's Alex Tanzi - were up $1.516 TN y-o-y, or 20.2%, to a
record $9.033 TN.
Global Credit Market Watch
November 8 - Bloomberg: "Chinese Vice Finance Minister Zhu Guangyao said the US
Federal Reserve's decision to pump $600 billion into the economy might ‘shock'
emerging markets by flooding them with capital. The first round of quantitative
easing, as the Fed policy is termed, in 2009 was justified because the global
economy lacked liquidity, Zhu told reporters ... With a recovery now under way,
new purchases of Treasuries to inject funds into the financial system may be
destabilizing, he said. ‘Around the world we have $10 trillion of hot money
flowing around, more than the $9 trillion in hot money at the beginning of the
global financial crisis,' Zhu said. The US ‘has not fully taken into
consideration the shock of excessive capital flows to the financial stability
of emerging markets.'"
November 8 - Bloomberg (Jonathan Stearns): "Luxembourg's Jean-Claude Juncker,
who heads the panel of euro-area finance ministers, said he agreed with German
Finance Minister Wolfgang Schaeuble's criticism of the Federal Reserve's
decision to pump more money into the US economy. ‘I am in full agreement with
Mr. Schaeuble when it comes to the way he was criticizing the US,' Juncker told
reporters ... Schaeuble on Nov. 5 described the Fed's move as ‘clueless.'"
November 10 - Bloomberg: "President Barack Obama finds himself on the defensive
as world leaders gather in Seoul for the Group of 20 summit, with members
disparaging US economic policies they say weaken the dollar and stoke hot-money
flows. The US Federal Reserve decision last week to pump $600 billion into
world's biggest economy has stolen the spotlight away from China's currency.
Brazilian Finance Minister Guido Mantega said ... that the Fed's move may
inflate commodities prices and proposed the world move away from using the
dollar as the main reserve currency. Former Chinese central bank governor Dai
Xianglong this week faulted the US for adopting policies without regard for the
dollar's global role."
November 8 - Bloomberg: "China's middle-income and affluent consumers will
probably almost triple in 10 years with the bulk of the increase coming from
smaller cities, Boston Consulting Group Inc. said ... There will be 270 million
more consumers whose annual household incomes exceed 60,000 yuan ($9,000) in
the world's most populous country by 2020, said Carol Liao ... That would lift
the total number of middle-class and affluent Chinese to 415 million from 148
million now, she said."
November 11 - Bloomberg (Veronica Navarro Espinosa and Gabrielle Coppola): "The
best year for Brazilian bank bond sales may be over as a probe into accounting
irregularities at Banco Panamericano SA increases investor scrutiny and drives
up borrowing costs for lenders. Yields on dollar debt ... jumped yesterday to
the highest level since they were issued this year ... Panamericano is being
investigated by the central bank after the controlling shareholder, Grupo
Silvio Santos, borrowed 2.5 billion reais ($1.5 billion) from the deposit
insurance fund to cover potential losses at the bank that it said were caused
by accounting ‘inconsistencies.' Brazil's banks have sold a record $15.2
billion of debt this year, up from $4.3 billion in all of 2009, to help finance