Page 1 of
3 CREDIT BUBBLE
BULLETIN Free cash to the
exits Commentary and weekly
watch by Doug Noland
Global systemic stress
has been gaining critical momentum, and markets
last week were heartened that global policymakers
were in the process of mustering meaningful
responses. Scores of headlines offered
encouragement that European officials were working
diligently on a plan to help Spain resolve its
banking crisis.
While reports were
conflicting - and often contradictory - there was
a general sense that circumstances had forced the
Germans into a softer approach. And as global
markets rallied, the fallback view again held sway
that when global policymakers recognize the
seriousness of a situation they will surely act
accordingly - and, as such, "risk on" is alive if
not well. Pavlovian.
Confidence in
politicians may be rather shallow, yet there remains
deep faith in the
capacity of central bankers to rise to the
occasion and bolster global risk markets. First
came comments from European Central Bank (ECB)
president Mario Draghi: "We monitor all
developments closely and we stand ready to act."
Federal Reserve vice chair Janet Yellen
made it clear the Fed was poised to do more:
"There are a number of significant downside risks
to the economic outlook, and hence it may well be
appropriate to insure against adverse shocks that
could push the economy into territory where
self-reinforcing downward spiral of economic
weakness would be difficult to arrest. ... I am
convinced that scope remains for [the Federal
Reserve] to provide further policy accommodation
either through its forward guidance or through
additional balance-sheet actions."
Yet on
the policy response front, the biggest surprise of
the week arrived courtesy of Beijing. The People's
Bank of China reduced lending and deposit rates by
25 basis points (bps), the first cut in official
rates since 2008. China's central bank also took
measures to loosen lending standards, allowing
banks additional flexibility to both discount
loans and attract deposits.
There were
also reports that Chinese bank regulators had
delayed the implementation of more onerous bank
capital requirements. From Bloomberg: "New draft
rules from the China Banking Regulatory Commission
aim to set 'reasonable' schedules for banks to
meet capital targets in a way that helps 'maintain
appropriate credit growth'."
Beijing
confirmed the bullish consensus view that China's
policymakers will ensure strong economic growth.
Meanwhile, data continue to support the thesis
that China's economic and credit engines are
really sputtering.
In Europe, there were
reports of special weekend meetings - and perhaps
even Spain requesting emergency financial
assistance. There are important French
parliamentary elections Sunday. And, of course,
there is the final countdown to Greece's June 17
national election, which may be disrupted by a
municipal workers strike. Markets confront a
minefield of issues, although attention for now
seems fixated on renewed policymaker largesse.
In
studying past monetary fiascos, I've often been
struck by the predictable nature of credit
inflations. Credit booms would be followed by
busts - and the arduous downside of the credit
cycle would invariably provoke aggressive policy
responses. Historically, governments would resort
to printing larger amounts of currency (or simply
incorporate more zeros), in increasingly desperate
attempts to support post-bubble faltering economic
output, rising unemployment and sinking prices
levels (goods and asset prices). Often it
would come down to a critical dynamic:
policymakers would eventually recognize (admit)
that their money printing operations were having
deleterious effects. A consensus view would even
develop that inflationary policies had to be wound
down - if not scuttled altogether.
Throughout history, there have been many
derivations of the typical pronouncement, "Be on
notice, this will be the last time this government
resorts to the printing press." And rarely would
it ever work out that way. Indeed, not only would
monetary inflations continue, the scope of the
money printing would too often escalate to the
point of being completely out of control. Once
unleashed, monetary inflations take on a life of
their own - and turn unwieldy on many levels. And
this complex dynamic explains why monetary history
is littered with worthless currencies.
Years of "activist" central banking have
conditioned markets to envisage eager-to-please
policymakers with flasks in hands at the fountain
of everlasting market vigor. Meanwhile,
policymakers at this point (four years into crisis
management mode) more clearly appreciate both the
limits of their monetary tools and the costs
associated with ultra-loose monetary conditions
and sure-fire market interventions. Markets were
nonetheless content last week to cling firmly to
the view that markets and policymakers remain on
the same page.
Curiously, ECB president
Draghi and Fed chairman Ben Bernanke last week
seemed to be reading from similar scripts. While
both, of course, assured market participants of
their respective central banks' commitment to
providing market backstops in times of crisis,
each also seemed determined to try to signal to
the markets that monetary policy has done about
all it can do. Both seemed to recognize that
ultra-loose monetary policy has played an integral
role in political foot-dragging when it comes to
implementing fiscal reform/responsibility. Both
were measured in their comments, as if reluctant
to incite market animal spirits (ie destabilizing
speculation).
There is also a view that
Drs Draghi and Bernanke are keen to save some of
their central banks' depleted arsenals in the
event of destabilizing fallout post the Greek
election. And there is certainly the possibility
that the Spanish debt crisis rapidly spirals out
of control.
When I read a Reuter's report
with sources claiming that Spain would request
bailout aid on Saturday, I immediately assumed
that capital flight must be turning unmanageable.
But then a Financial Times article (Peter Spiegel)
quoted "a senior European official": "It is
essential that the other euro-area member states
are pre-emptively and effectively ringfenced and
protected from any possible Greek fallout, before
the elections."
This explanation for why
Spain would do an about face on European Union
financial assistance - even before the completion
of International Monetary Fund (IMF) and private
audits of its banking system - seems as reasonable
as problematic capital flight.
Spain and
the EU face a serious dilemma. Several analysts
have gone so far as to state that the euro will be
made or lost in Spain. And while the markets
seemed to welcome leaks of an imminent Spanish
bailout, it might be one of those "be careful what
you wish for" moments.
Spain - it's
sovereign, banks, regional governments,
corporations and economy - today suffers a market
crisis of confidence. Estimates place (guess) the
banking system's capital shortfall in the wide
range of between 40 billion (US$50.5 billion) to
250 billion euros. A full-scale Spain IMF/EU
bailout program could tally in the hundreds of
billions. The chatter is of some "bailout light"
strategy that would tide Spain over - at least
through the Greek election and its immediate
aftermath. Do too little and the plan lacks
credibility; promise too much and the markets will
question where the money is to come from.
The Telegraph's Ambrose Evans-Pritchard
("Spain too big for EU rescue fund as China
recoils") reminded readers of potential problems
associated with the EU's "firewall" facilities.
The European Financial Stability Facility
(EFSF), for example, is backed by euro zone
member/creditors. But once a country taps
emergency funds it can longer back EFSF
borrowings. So the firewall shrinks or the
additional liabilities accrue to the other member
states. There is also the issue of prospective
market appetite for EFSF/ESM (European Stability
Mechanism) debt. Mr Evans-Pritchard's article
noted that China's sovereign wealth fund is
backing away from European debt. Quoting the
chairman of China Investment Corporation: "The
risk is too big, and the return too low."
I have written previously that Europe's
"firewall" was created with the hope/intention
that it would never be deployed - a big bazooka
that sits there with everyone just kind of
assuming it's loaded and operational. Well, it's
likely to be called upon in a big way and in a
hurry. And when the headline crosses that Spain
has requested aid, it might very well be seen as
good news ("resolves uncertainty") in the
marketplace.
I don't expect it to be long,
however, before serious questions arise as to the
credibility of the bailout structure. Is the
bazooka legit? Will global investors be willing to
buy hundreds of billions of euros of EFSF/ESM debt
in an environment where the marketplace surely
will have serious questions as to the
sustainability of the euro currency regime? Can
bailout bond and the euro credibility persevere
through the failure of a "core" euro zone country?
There were reports that Greek government
revenues during May were down 20-25% year on year.
No matter the outcome of the Greek election - or
even whether Greece stays or exits the euro -
there is little to suggest that this deeply
troubled little economy will anytime soon end its
status as a quite formidable financial
"blackhole".
This post-bubble dynamic
makes one really fear for Spain - and the euro.
I've believed that a preferred strategy - and
perhaps the only hope for salvaging the euro -
would have been to push the Greeks out of the euro
to ensure that the full weight of policymaker
attention and European resources could be deployed
to "ring-fence" the euro zone's vulnerable "core."
Over the coming days and weeks we'll
instead be faced with the spectacle of a failed
periphery (Greece) and a failing core (Spain)
perhaps working in concert to pull the fabric of
the euro apart at the seams.
The view that
last week provided only the opening policy
response salvo is anything but unjustified. If
things proceed in Europe (and globally) as I fear,
we can expect the ECB to cut rates and implement
additional liquidity measures, as the Fed moves
forward with additional quantitative easing. The
Chinese, Indians, Brazilians and others will
stimulate in hope of sustaining faltering booms.
And I expect all of these measures to have little,
if any, constructive impact on deepening global
credit and economic crises.
At the same
time, the impact on financial markets is less
clear. Even New York City taxi drivers are
confident that policy measures are sure to bolster
the markets. To what extent will the sophisticated
operators now use generous market accommodation to
head for the exits? It's traditionally been
referred to as "distribution". Think Facebook IPO.
WEEKLY WATCH The S&P500
rallied 3.7% (up 5.4% y-t-d), and the Dow gained
3.6% (up 2.8%). The S&P 400 Mid-Caps increased
3.3% (up 5.3%), and the small cap Russell 2000
surged 4.3% (up 3.8%). The Morgan Stanley
Cyclicals jumped 4.4% (up 3.9%), and the
Transports rose 3.1% (up 0.8%). The Morgan Stanley
Consumer index increased 3.1% (up 2.4%), and the
Utilities rose 3.1% (up 1.5%). The Banks rallied
4.0% (up 10.7%), and the Broker/Dealers gained
3.5% (up 3.1%). The Nasdaq100 was 4.1% higher (up
12.4%), and the Morgan Stanley High Tech index
jumped 4.8% (up 7.6%). The Semiconductors surged
5.5% (up 2.3%). The InteractiveWeek Internet index
jumped 4.8% (up 6.3%). The Biotechs increased 2.5%
(up 29.8%). With bullion declining $31, the HUI
gold index slipped 0.4% (down 11.3%).
One-month Treasury bill rates ended the
week at 3 bps and three-month bills closed at 8
bps. Two-year government yields were up 2 bps to
0.27%. Five-year T-note yields ended the week 9
bps higher at 0.71%. Ten-year yields rose 18 bps
to 1.64%. Long bond yields jumped 23 bps to 2.75%.
Benchmark Fannie MBS yields increased 9 bps to
2.61%. The spread between benchmark MBS and
10-year Treasury yields narrowed 9 to 97 bps. The
implied yield on December 2013 eurodollar futures
declined 5.5 bps to 0.615%. The two-year dollar
swap spread dropped 7 to 30 bps. The 10-year
dollar swap spread declined 3 to 19 bps. Corporate
bond spreads narrowed. An index of investment
grade bond risk ended the week 6 bps lower at 120
bps. An index of junk bond risk sank 66 to 638
bps.
Total debt issuance was on the slow
side. Investment grade issuers included GE Capital
$2.25bn, American Express $2.0bn, Ford Motor
Credit $1.5bn, Deere & Co $2.25bn, Time Warner
$1.0bn, Tyson Foods $1.0bn, Viacom $900 million,
Sysco $750 million, Union Pacific $600 million,
Liberty Property LP $400 million, Gulf South
Pipeline $300 million, Paccar $550 million, Duke
Realty $300 million, GATX $250 million, Safeway
$250 million and TCF National Bank $110 million.
Junk bond funds saw outflows jump to
$2.9bn (from Lipper), with notable three-week
outflows of about $6bn. Junk issuers included
Fifth & Pacific $150 million.
I saw no
convertible debt issued.
International
dollar bond issuers included Corp Andina de
Fomento $600 million and Norbord $165 million.
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
