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April 24, 2009

Reflation Watch
by Doug Noland

For the week, the S&P500 slipped 0.4% (down 4.1% y-t-d), and the Dow declined 0.7% (down 8.0%). The Morgan Stanley Cyclicals surged 7.0% (up 8.4%), and the S&P Homebuilding index gained 4.6% (up 31.9%). The Morgan Stanley Retail index jumped 3.9%, increasing 2009 gains to 31.2%. The Transports rose 1.4% (down 11.3%). The Morgan Stanley Consumer index fell 1.6% (down 4.8%), and the Utilities declined 2.1% (down 14.2%). The S&P 400 Mid-Cap (up 2.2%) and small cap Russell 2000 indices (down 4.1%) were both about unchanged. The Nasdaq100 gained 1.4% (up 13.3%), and the Morgan Stanley High Tech index jumped 3.4% (up 23.7%). The Semiconductors declined 0.5% (up 19.6%), while the InteractiveWeek Internet index rose another 2.3% (up 30.7%). The Biotechs sank 3.3% (down 4.6%). The Broker/Dealers dipped 0.4% (up 19.6%), and the Banks were hit for 7.1% (down 22.0%). While Bullion little changed, the volatile HUI Gold index rallied 12.9% (up 2.8%).

One-month Treasury bill rates ended the week at 8 bps, and three-month bills closed at 12 bps. Two-year government yields declined 2 bps to 0.94%. Five year T-note yields rose 5 bps to 1.93%. Ten-year yields gained 5 bps to 2.96%. The long-bond saw yields jump 8 bps to a 5-month high 3.88%. The implied yield on 3-month December '09 Eurodollars fell 5.5 bps to 1.325%. Benchmark Fannie MBS yields dropped 8 bps to 3.97%. The spread between benchmark MBS and 10-year T-notes narrowed 13 to 98 bps. Agency 10-yr debt spreads tightened 8 to 48 bps. The 2-year dollar swap spread increased 1.25 to 61.5 bps; the 10-year dollar swap spread declined 2 to 15 bps; and the 30-year swap spread declined 4.25 to negative 36.5 bps. Corporate bond spreads ground tighter. An index of investment grade bond spreads was one tighter to 236 bps, and an index of junk spreads tightened 23 to 1,084 bps.

Corporate issuance slowed this week. Investment grade issuers included Stanford $1.0bn, and Toledo Edison $300 million.

Junk issuers included Georgia-Pacific $750 million, Lennar $400 million, and Digitalglobe $355 million.

I saw no convert issuance this week.

International dollar debt issuers included Swedbank $1.4bn and Export Development Bank Canada $1.0bn.

U.K. 10-year gilt yields jumped 13 bps to 3.48%, and German bund yields fell 8 bps to 3.19%. The German DAX equities index was little changed (down 2.8%). Japanese 10-year "JGB" yields were down 2 bps to 1.42%. The Nikkei 225 gave back 2.2% (down 1.7%). The emerging markets were mixed. Brazil's benchmark dollar bond yields rose 5 bps to 6.37%. Brazil's Bovespa equities index gained 1.6% (up 24.6% y-t-d). The Mexican Bolsa rallied 1.6% (up 0.9% y-t-d). Mexico's 10-year $ yields jumped 25 bps to 6.13%. Russia's RTS equities index dipped 0.5% (up 31.5%). India's Sensex equities index gained 2.8% (up 17.4%). China's Shanghai Exchange slipped 2.2% (up 34.5%).

Freddie Mac 30-year fixed mortgage rates declined 2 bps to 4.80% (down 123bps y-o-y). Fifteen-year fixed rates were unchanged at 4.48% (down 114bps y-o-y). One-year ARMs declined 3 bps to 4.82% (down 47bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down another 5 bps to 6.28% (down 89 bps y-o-y).

Federal Reserve Credit surged $70.3bn last week to $2.169 TN (high since the first week of January). Fed Credit has dropped $77bn y-t-d, although it expanded $1.300 TN over the past 52 weeks (150%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt last week (ended 4/22) rose $6.5bn to a record $2.648 TN. "Custody holdings" have been expanding at a 16.9% rate y-t-d, and were up $395bn over the past year, or 17.5%.

Bank Credit gained $6.0bn to $9.711 TN (week of 4/15). Bank Credit was up $299bn year-over-year, or 3.2%. Bank Credit expanded $300bn over the past 32 weeks, while it was down $202bn y-t-d (7.1% annualized). For the week, Securities Credit rose $3.7bn. Loans & Leases increased $2.3bn to $7.037 TN (52-wk gain of $157bn, or 2.3%). C&I loans fell $5.8bn, with one-year growth of 1.9%. Real Estate loans dropped $12.9bn (up 4.5% y-o-y). Consumer loans slipped $0.5bn, while Securities loans jumped $18.1bn. Other loans gained $3.5bn.

M2 (narrow) "money" supply added $1.6bn to $8.249 TN (week of 4/13). Narrow "money" has expanded at a 2.2% rate y-t-d and 8.3% over the past year. For the week, Currency added $1.4bn, while Demand & Checkable Deposits dropped $69.5bn. Savings Deposits jumped $82.9bn, while Small Denominated Deposits fell $5.5bn. Retail Money Funds declined $7.7bn.

Total Money Market Fund assets (from Invest Co Inst) declined $11.4bn to $3.806 TN (low since December). Money fund assets have declined $24bn y-t-d, or 2.0% annualized. The 52-wk expansion was reduced to $323bn, or 9.3%.

Total Commercial Paper outstanding slipped $1.7bn this past week to $1.472 TN. CP has declined $209bn y-t-d (41% annualized) and $314bn over the past year (17.6%). Asset-backed CP dropped $9.9bn to $671bn (low since 12/04), with a 52-wk drop of $1180bn (15%).

More signs of liquidity returning to the ABS market. Year-to-date total US ABS issuance of $25.7bn (tallied by JPMorgan's Christopher Flanagan) is approaching half of the $62.7bn from comparable 2008. U.S. CDO issuance of $20.9bn compares to last year's y-t-d $13.0bn.

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were little changed y-o-y to $6.663 TN. Reserves have declined $284bn over the past 27 weeks.

Global Credit Market Dislocation Watch:

April 21 - Bloomberg (Timothy R. Homan): "Worldwide losses tied to rotten loans and securitized assets may reach $4.1 trillion by the end of 2010... the International Monetary Fund said. Banks will shoulder about 61% of the writedowns, with insurers, pension funds and other nonbanks assuming the rest... The fund projected losses of $2.7 trillion at U.S. financial institutions, an increase from its estimates of $2.2 trillion in January and $1.4 trillion in October."

April 24 - Bloomberg (Mark Pittman): "The Federal Reserve took on more than $74 billion in subprime mortgages, depreciating commercial leases and other assets after Bear Stearns Cos. and American International Group Inc. collapsed."

April 20 - Bloomberg (Simon Kennedy and Sandrine Rastello): "The International Monetary Fund may be so conscious of having handed out bad advice to needy countries in the past that it isn't offering them enough guidance now. The... lender is combating the worst financial turmoil in its 64-year history with more than $55 billion in loans for nations from Pakistan to Serbia. As the fund prepares to lend even more, it is retreating from its practice -- carried out with adverse effects a decade ago in Asia -- of demanding that governments overhaul their economic systems in return for aid... 'The pendulum may be swinging too far,' says Claudio Loser, former head of the fund's Western Hemisphere department and now a fellow at the Inter-American Dialogue... There was a strong perception that the IMF used to ask too much of countries. Now there is a major danger it's moved too far in the direction of not setting enough conditions.'"

April 24 - Bloomberg (John Detrixhe): "Corporate borrowing costs fell this week to the lowest since October amid signs that government efforts to repair broken credit markets are working. The extra yield investors demand to own corporate debt instead of Treasuries fell to 698 bps as of yesterday from the December peak of 896 bps, according to Merrill Lynch..."

Government Finance Bubble Watch:

April 22 - Bloomberg (Michael McKee): "Millions of lost jobs mean billions in lost tax revenue for the U.S. government, and billions in additional Treasury debt to fund a federal budget deficit that may soar to more than four times last year's record $454.7 billion... With spending on unemployment insurance and other safety- net programs rising, the deficit is already at a record $956.8 billion six months into the fiscal year."

April 23 - Bloomberg (Andrew MacAskill): "U.K. government support for the banking system has risen to 1.4 trillion pounds ($2 trillion) and may climb higher as the financial crisis spreads to building societies and economists warn lenders may need more aid. Prime Minister Gordon Brown's government... offered to guarantee some mortgage-backed bonds, adding as much as 50 billion pounds to the bailout that began with the collapse of Northern Rock Plc in 2007. The amount invested in, loaned to or pledged to back bank assets now equals Britain's gross domestic product, or 22,800 pounds for every person in the U.K."

April 20 - Bloomberg (Gonzalo Vina and Neil Unmack): "Chancellor of the Exchequer Alistair Darling this week will introduce guarantees for mortgage-backed bonds, allowing buyers to unload the securities at no loss, an effort to kick start lending and wean U.K. banks off government aid, two people familiar with the plan said. The Treasury will offer guarantees for about 50 billion pounds ($73 billion) of the securities through the new mechanism..."

April 22 - Bloomberg (Svenja O'Donnell and Brian Swint): "Britain's deficit swelled to the largest since World War II and unemployment rose to the highest in 12 years, highlighting the challenge facing Gordon Brown's government... The gap almost tripled to 90 billion pounds ($117 billion) in the fiscal year through March..."

April 23 - Bloomberg (Anchalee Worrachate): "The U.K.'s plan to sell a record 220 billion pounds ($318 billion) of gilts this year to revive the economy may cause investor 'indigestion,' according to some of Britain's biggest bond traders. The amount, 50% more than the 146.4 billion pounds sold in the fiscal year that ended March 31, may be too much for the market to absorb, according to Royal Bank of Scotland Group Plc. The issuance plan... is a 'surprise,' according to Barclays Capital."

April 24 - Bloomberg (Daniel Tilles and Matthew Brown): "The U.K.'s top sovereign credit rating may be at risk as the government's finances worsen, Moody's... said. Britain's 'balance sheet is deteriorating rapidly, due to a combination of weakening revenues and the accumulation of sizeable assets and contingent liabilities as a result of successive bank bailouts,' analysts at Moody's led by Arnaud Mares... wrote... 'The government is taking risks with public finances.'"

April 21 - Finacial Times (Lindsay Whipp, David Oakley and Michael Mackenzie): "Japan is to issue an extra Y10,800bn ($110bn) of government bonds this fiscal year to help it tackle its worst recession since the second world war. The bonds will fund the bulk of the government's $154bn stimulus plan and will bring its expected total new issuance for the fiscal year starting this month to a record Y44,100bn, a 33% rise on last year. This comes as governments around the globe are taking on record debt levels... The US is expected to issue about $2,000bn in the fiscal year starting last October... The eurozone governments are set to raise €800bn ($1,050bn) this calendar year, 23% up on 2008."

April 22 - Bloomberg (Emma Ross-Thomas): "The euro area's budget deficit widened to the biggest in three years in 2008, with five euro members breaching the European Union limit... The total budget shortfall for the euro region widened to 1.9% of gross domestic product last year, the largest since 2005... France, Spain, Greece, Malta and Ireland had deficits above the bloc's 3% limit."

Currency Watch:

The dollar index fell 1.5% this week to 84.71 (up 4.2% y-t-d). For the week on the upside, the Swedish krona gained 4.1%, the South African rand 2.5%, the Swiss franc 2.3%, the Japanese yen 2.1%, the Norwegian krone 2.0%, the Danish krone 1.5%, and the Euro 1.5%. On the downside, the Mexican peso declined 1.6%, the South Korean won 0.9%, and the British pound 0.8%.

Commodities Watch:

April 22 - Bloomberg (William Bi): "Copper and aluminum imports by China, the largest consumer, jumped in March as the country's 4 trillion yuan ($585 billion) stimulus program increased demand... Inbound shipments of refined copper advanced 10% from the previous month... Copper imports were a record, Wanxiang Resources Co. analyst Sheng Weimin said. Zinc, lead and tin purchases gained."

Gold was volatile but ended the week little changed at $868 (down 1.6% y-t-d). Silver jumped 9.1% to $12.89 (up 14% y-t-d). June Crude dropped 97 cents to $51.51 (up 16% y-t-d). May Gasoline fell 3.7% (up 35% y-t-d), and May Natural Gas sank 12.6% (down 42% y-t-d). Copper dropped 6.7% (up 46% y-t-d). July Wheat rallied 1.6% (down 11% y-t-d), while July Corn was unchanged (down 5% y-t-d). The CRB index declined 1.3% (down 2.9% y-t-d). The Goldman Sachs Commodities Index (GSCI) fell 2.4% (up 5.6% y-t-d).

China Reflation Watch:

April 24 - Bloomberg (Keiko Ujikane): "China's economy may expand between 7% and 8% this year, helped by the government's 4 trillion yuan ($585 billion) stimulus package, central bank adviser Fan Gang said..."

April 22 - Bloomberg (Shamim Adam and Kevin Hamlin): "China's economy will expand faster than previously forecast this year and next as the government's 4 trillion-yuan ($586 billion) stimulus package spurs domestic demand and boosts investment, Goldman Sachs Group Inc. said. The world's third-largest economy will expand 8.3 percent in 2009, from an earlier estimate of 6%... economists Helen Qiao and Yu Song wrote... CLSA Asia-Pacific Markets also increased its estimate for growth this year to 7% from 5.5% earlier..."

April 23 - Bloomberg (John Liu): "China's trade surplus will swell to a record $325 billion this year, boosting its foreign-exchange holdings and adding pressure on the central bank to find an alternative reserve currency to the dollar, ING Groep NV said. The gap will expand as lower prices help reduce the nation's commodity import bill by $86 billion, Tim Condon, head of Asia research at ING said..."

April 22 - Bloomberg (Tom Kohn): "China is attracting derivatives bankers, who lost money in the U.S. last year for the first time, after trading in its futures markets expanded 76%. 'We very much see China as a future market, as many others do,' said Peter Weibel... chief executive officer for Asia at TriOptima... 'The derivatives market there is at an early stage. We want to be there from the start.'"

April 23 - Bloomberg (Chua Kong Ho): "China's corporate profits fell 73% to 43.4 billion yuan ($6.4 billion) in the fourth quarter, Haitong Securities Co. said... The report is based on 1,255 so-called A-share companies that have released their results so far, Haitong said, and they make up 80% of the 1,602 businesses whose shares trade on the two mainland exchanges. Full-year profits fell 14% to 706.09 billion..."

April 21 - Bloomberg (Dune Lawrence): "Beijing Sunshine Care House opened in January 2008, seeking to attract the city's elderly with a tropical conservatory, billiard room and calligraphy studio. By the end of this year, the retirement home will triple the number of beds to 700... The world's third-largest economy is aging so rapidly that by 2050, there may be only two working-age people for every senior citizen, compared with 13 to one now."

Japan Watch:

April 22 - Finacial Times (Michiyo Nakamoto): "Japan suffered its first trade deficit in nearly 30 years in the year to March... The trade deficit last year reflects the sharp rise in commodity prices earlier in the year and the severe contraction in exports... Exports in March fell 45.6 per cent year-on-year, an improvement over the record 49.4% drop in February..."

India Watch:

April 21 - Bloomberg (Cherian Thomas): "India's central bank reduced interest rates for the sixth time in as many months to a record low... The Reserve Bank of India cut the reverse repurchase rate to 3.25% from 3.5%..."

Latin America Watch:

April 21 - Bloomberg (Jeb Blount): "Petroleo Brasileiro SA, Brazil's state-controlled oil company, said it won't provide crude as collateral for loans from China worth as much as $10 billion. Chinese companies will instead receive right of first refusal on some future output as part of a deal being finalized between Brazil and China's Development Bank, Petrobras CEO Jose Sergio Gabrielli said... The... company, which announced the Americas' largest oilfield discovery in three decades in 2007, is tapping overseas partners to help fund a $174.4 billion five- year investment plan."

April 20 - Bloomberg (Andre Soliani): "Brazil will try to convert a promise to lend more money to the International Monetary Fund into more say on how the agency spends as much as $750 billion to rescue crisis-stricken nations, a former IMF official said. 'The fact you become a potential creditor makes your voice stronger,' Claudio Loser, head of the IMF's Western Hemisphere Department from 1994 to 2002, said... 'Brazil has been pushing very hard, together with countries such as India, China and Mexico, for the fund to better reflect the importance of emerging economies.'"

April 24 - Bloomberg (Diana Kinch and Andre Soliani): "Brazil's unemployment rate rose to 9% in March, the highest since 2007, the national statistics agency said..."

Central Banker Watch:

April 21 - Bloomberg (Johan Carlstrom): "Sweden's central bank, the world's oldest, cut the benchmark interest rate to a record 0.5% and said it's ready to take further steps to revitalize the Nordic region's largest economy... The... Riksbank, founded in 1668, lowered the seven-day repo rate by half a percentage point..."

Real Estate Bubble Watch:

April 22 - Bloomberg (Dan Levy): "California and Florida metropolitan areas led the U.S. in foreclosures in the first quarter... RealtyTrac Inc. said. Las Vegas had the highest overall rate of foreclosure filings, with 4.5% of households receiving a default or auction notice or being seized by a lender. California had 13 cities among the top 25 with the highest rates. Florida had eight while Nevada and Arizona each had two..."

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

April 22 - Bloomberg (Katrina Nicholas and Abigail Moses): "Credit-default swap dealers cut the volume of outstanding trades to $38.6 trillion last year as they tore up overlapping contracts amid pressure from regulators to scale down the privately negotiated market and reduce risk. Outstanding contracts fell 38% in 2008, the... International Swaps and Derivatives Association said... It's the first annual decline, after the market increased 100-fold over the previous seven years as investors used the derivatives to protect against bond losses and speculate on creditworthiness."

April 23 - Bloomberg (Jody Shenn): "The head of Greenwich Financial Services LLC warned bond investors in Washington last month that government efforts to reverse the housing slump are doing more harm than good by undermining debt contracts. More than 30 money managers with stakes in the $6.7 trillion mortgage bond market that underpins the real-estate industry heard Bill Frey's March 25 talk... Since then, a group of investors with home-loan bonds totaling more than $100 billion have hired Patton Boggs LLP, Washington's biggest lobbying law firm... Bondholders are preparing for a fight over legislation approved last month by the House of Representatives that would shield companies that collect homeowners' payments from lawsuits over modified mortgages, even if new terms harm investors."

Unbalanced Global Economy Watch:

April 23 - Bloomberg (Mark Deen): "Chancellor of the Exchequer Alistair Darling raised taxes on motorists, smokers and the rich as he forecast the worst recession since World War II and the biggest budget deficit in the Group of 20 nations. The Treasury will borrow 269 billion pounds ($392 billion) more in the next five years fiscal years. It will drag in 3.2 billion pounds more from people earning more than 100,000 pounds a year and 6 billion pounds on duties for alcohol, tobacco and gasoline..."

April 24 - Bloomberg (Jennifer Ryan and Brian Swint): "The U.K. economy shrank more than economists forecast in the first quarter in the biggest contraction since Margaret Thatcher came to power in 1979. Gross domestic product fell 1.9% from the final three months of 2008 as manufacturing and business services posted record declines..."

April 24 - Bloomberg (Scott Hamilton): "For British rats, the worst of times has turned out to be the best of times. The vermin more associated with the Dickensian era than modern Britain are thriving, with shuttered shops and half-built housing sites to live in, rotting piles of uncollected garbage for dinner and fewer exterminators sent out to kill them."

April 24 - Bloomberg (Emma Ross-Thomas): "Spain's unemployment rate rose to 17.4% in the first quarter, more than double the European Union average, as the global recession ravages an economy that was once one of the region's strongest performers."

Bursting Bubble Economy Watch:

April 22 - Associated Press: "The historic collapse of the American newspaper industry was evident at every turn as the 2009 Pulitzer Prizes were announced. One winner was laid off three months ago. Winning newspapers have eliminated home delivery and editions to stay afloat. A photographer celebrated his victory while lamenting the loss of colleagues who are about to be laid off. But Pulitzer administrators said the winners, including stories that brought down two philandering politicians, were a victory for old-fashioned watchdog journalism at a time when the industry's very survival is in question."

April 20 - Wall Street Journal (Lavonne Kuykendall): "Insurers used to suggest that home- and auto-insurance policies were fairly recession-proof, with drivers and homeowners typically maintaining the same coverage each year... Not anymore. Auto-insurance coverage quotes obtained online at insurance-shopping Web site Insurance.com dropped an average $100 in March from six months earlier, the result of drivers who are doing everything they can to cut their coverage to the bone..."

April 16 - Bloomberg (Brendan Murray): "Poker champion Barry Greenstein says it's getting harder to rake a buck. The U.S. recession and backlash against executives' pay has reduced the number of rich amateurs willing to play at $2,000-to $4,000-limit tables... His winnings are down by a third from a few years ago. 'There's less loose money around,' said Greenstein... 'We used to have a guy in the movie industry or some guy in the computer industry who had money to blow who doesn't have that anymore.'"

California Watch:

April 23 - Bloomberg (Jeremy R. Cooke): "California bonds from the state's largest taxable debt issue rose after yesterday's $6.85 billion sale... California 7.55% taxable, 30-year securities were sold to customers in $1 million-plus blocks at prices as high as 105.3 cents on the dollar to yield 7.12%..."

New York Watch:

April 23 - Bloomberg (Oshrat Carmiel): "Home prices in the Hamptons, the oceanside getaway of celebrities and Wall Street financiers, plummeted in the first quarter as the financial crisis cut demand for vacation properties. The median price fell 23% from a year earlier to $675,000... 'The primary reason is linkage to Wall Street,' said Miller Samuel President Jonathan Miller."

Muni Watch:

April 24 - Bloomberg (Jeremy R. Cooke): "Municipal bond yields dropped the most in three months as state and local governments sold more taxable than tax-exempt issues this week to reap new federal subsidies on interest costs from Build America Bonds."

Speculator Watch:

April 22 - Bloomberg (Tomoko Yamazaki and Komaki Ito): "Hedge fund redemptions slowed in March as industry returns outperformed global benchmarks this year, according to Eurekahedge Pte. The industry lost $136 billion in the first quarter, shrinking 32% from a peak of $1.95 trillion at the end of June 2008, and bringing total assets under management to $1.34 trillion, the...research firm said... Net redemptions in March totaled $15.7 billion..."

April 20 - Bloomberg (Alexis Xydias and Lynn Thomasson): "Companies with the most debt and lowest returns on assets are turning the biggest six-week rally in stocks since 1938 into a bloodbath for last year's best- performing trading strategy. Investors in so-called quantitative momentum funds... have become this year's biggest losers... Quant momentum managers may have tumbled 27% this month in the U.S., the most since at least 1993...according to... JPMorgan Chase... 'Not in a million years would we have expected this gyration to be as vicious and enduring as it has been,' Steven Solmonson, the head of Park Place Capital Ltd., a hedge fund... said... 'The quants got whipsawed badly.'"

Crude Liquidity Watch:

April 22 - Bloomberg (Ayesha Daya): "Dubai house prices may slump as much as 70% from their peak late last year as demand drops and banks fail to resume mortgage lending, prompting mergers, UBS AG said. 'We are still in relatively early stages of the property down-cycle in United Arab Emirates,' Saud Masud, a Dubai-based analyst at the Swiss bank, wrote..."

Reflation Watch:

The Morgan Stanley Cyclical index surged 7.0% this week and has now rallied 85% off of March 6th lows. Over this period, the S&P Homebuilding index is up 85%. The banks have rallied 95% off lows, while the Morgan Stanley Retail index has risen 64%. I thought it made sense to take a closer look at global reflation dynamics.

Various risk markets have traditionally provided early indicators of reflationary dynamics. The "emerging" economies are clearly responding to the loosened global monetary backdrop. After spiking to 10.6% last fall, Brazilian government dollar bond yields have dropped to about 6.4%. At 6.13%, Mexico's dollar yields are down about 350 bps from October highs. Examining the prices of Credit default protection, after spiking above 1,100 bps in October, the cost of protecting against a Russian default has dropped to about 380 bps. CDS (Credit default swap) prices have dropped from 850 to 335 bps for Turkey, 640 to 450 bps for Hungary, and from almost 700 to 290 bps for South Korea. It is worth noting that South Korea today reported first quarter GDP growth of a positive 0.1%, a performance thought impossible a few months ago.

A much faster-than-expected recovery appears to be unfolding in Asia. Today, Bank of China advisor Fan Gang stated that the Chinese government's $585bn stimulus package would help support 2009 growth in the range of between 7% and 8%. Goldman Sachs economists this week raised their estimates of China GDP growth to 8.3% from 6.0%. CLSA Asia-Pacific Markets increased their China growth forecast to 7.0% from 5.5%.

Examining stock markets, China is leading exceptional performance by the "Bric" equities markets. Brazil's Bovespa has posted 2009 gains of 24.6%, Russia's RTS 31.6%, India's Sensex 17.4%, and China's Shanghai Composite 34.5%. Asia's markets have been especially robust. Taiwan's major index has posted a 2009 gain of 28.1%, South Korea 20.4%, Indonesia 17.4%, Malaysia 13.2%, and the Philippines 12.3%. It is also worth noting that Japan's Nikkei (down 1.7%), Hong Kong's Hang Seng (up 6.1%), and Australia's S&P/ASX (down 0.3%) are among the world's best performing major stock indices.

Currency markets also point toward a reflationary bias. The "commodities" currencies are among the strongest performers so far this year. The South African rand has gained 7.7%, the Norwegian krone 6.1%, the Brazilian real 5.5%, the Mexican peso 3.4%, the Australian dollar 2.4%, and the Canadian dollar 0.4%.

In commodities markets, industrial metals have bounced back meaningfully. Copper has gained about 45% so far this year. Platinum has jumped 25%, with strong gains also for lead and zinc. And let's not forget gold and silver, with their respective year-to-date gains of % and %. Overall, the CRB commodities index is down 2.9% y-t-d, while the Goldman Sachs Commodities index is up 5.6%. Now, if energy markets get going...

According to Dealogic, year-to-date global M&A activity has jumped to $449bn, a level now only 14% below comparable 2008. With PepsiCo's acquisition of Pepsi bottling companies and Oracle's purchase of Sun Microsystems, this past week was one of the strongest for M&A in months. Recall that first quarter "global debt capital issuance" was up 26% year-over-year to $1.53 TN (data from Dealogic). Asia issuance was up 55% year-on-year ($176bn). Here at home, there was record first quarter investment grade debt issuance ($298bn).

Companies are again able to raise finance in the junk bond market. Over the past two weeks $5.5bn of high yield bonds have been sold. It is worth noting (citing AMG data) that high-yield funds attracted $532 million of inflows this week, up from last week's $433 million. Notably, six-week inflows now stand at an impressive $3.38bn. Supported by various Washington-based programs, U.S. corporate debt issuance is on record pace.

Taking a look at U.S. debt market risk premiums, junk spreads are at the narrowest level since last October. Investment-grade spreads are at their tightest since February (from Merrill Lynch Credit indices). Corporate bonds have generally performed well for investors so far this year. Muni bond yields have dropped to the lowest level since September in what has developed into a mini municipal issuance boom ($9.2bn issued this week inclusive of California's "Build America Bonds").

This week, inter-bank lending risk premiums tightened to levels not seen since before the failure of Lehman. According to Bloomberg, the "Libor-OIS" spread has narrowed to 0.87%, down from an October high of 3.64%. We'll be learning much more about the "stress test" over the next couple weeks. Examining financial CDS prices, there remains extraordinary stress but apparently somewhat less of it as it pertains to bank defaults. JPMorgan CDS prices have dropped to about 170, down from as high as 240 bps last month. Morgan Stanley CDS is down about 120 to 360 bps. At 245 bps, Goldman Sachs CDS is down about 130 bps from March highs. Wells Fargo CDS is down about 60 from highs to 240 bps. The "problem child," Citigroup, has seen its CDS prices come in a moderate 90 to a still high 575 bps.

Monday, the U.S. Equities VIX index (expectations for future market volatility/risk) dropped below 34 to the lowest level since the Lehman collapse. The S&P Homebuilding Index is now up 30% for the year. The Morgan Stanley Retail Index (35 companies) has now posted a 2009 gain of 30%. The Morgan Stanley High Tech index is up 21% y-t-d, and the InteractiveWeek Internet index is 31% higher.

It is worth noting that the Mortgage Bankers Association weekly application index is near the highest level since the summer of 2003. Of course, this boom is being driven by refinancings - which are now running about double the year ago level. Mortgage rates are these days at historic lows. As a disciplined analyst, I cannot disregard an indicator that has many times in the past proven its worth.

The unfolding refi boom has the potential to significantly impact systemic reflation. For one, millions of households will be reducing their monthly mortgage payments. Many with adjustable-rate, shorter-term, or various "exotic" mortgages now have an opportunity to stretch things out to 30 years at quite favorable rates. While certainly a fraction of previous inflated levels, there will be meaningful equity extraction used to pay down higher cost debt and, perhaps even, buy things (weekly retail sales trends have stabilized). There is also the dynamic where holders of millions of old mortgages will receive early repayment in a process that works to reliquefy segments of the MBS marketplace. And I'll assume that the GSE's will increase their holdings of new MBS, perhaps creating a significant impetus for system reflation. At the minimum, Fannie, Freddie, and the FHA will be stamping their (I mean the taxpayers') guarantee on hundreds of billions of MBS, creating more "money-like" debt instruments out of Wall Street's previous "private-label" variety of (discredited) mortgage security.

It's my view that the markets generally lead the economy - not vice-versa. If this stock market rally is sustained, I would expect the summer home selling season to surprise on the upside in many locations. When some semblance of confidence returns to housing markets, I would not be surprised to see some pent up demand positively impact auto sales. Anecdotally, it appears consumer Credit conditions are beginning to loosen - even in auto finance.

If we step back and ponder the unprecedented scope of today's global fiscal and monetary stimulus, we shouldn't be all that surprised by the fledgling reflationary forces observable both at home and abroad. I have labeled emerging dynamics the "Government Finance Bubble." There is mounting evidence that this Bubble is developing critical mass and should be taken seriously.

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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