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October 10, 2009

Dollar Dilemma
by Doug Noland

For the week, the S&P500 jumped 4.5% (up 18.6% y-t-d), and the Dow rose 4.0% (up 14.4% y-t-d). The Morgan Stanley Cyclicals surged 7.5% (up 58.6%), and Transports increased 5.0% (up 9.6%). The Banks surged 5.8% (up 7.0%), and the Broker/Dealers jumped 6.6% (up 60.1%). The Morgan Stanley Consumer index gained 2.6% (up 18.1%), and the Utilities advanced 2.2% (down 1.0%). The broader market was quite strong. The S&P 400 Mid-Caps jumped 5.8% (up 30.5%), and the small cap Russell 2000 rose 6.0% (up 23.1%). The Nasdaq100 gained 3.9% (up 42.6%) and the Morgan Stanley High Tech index surged 5.1% (up 59.0%). The Semiconductors rose 6.5% (up 53.9%). The InteractiveWeek Internet index gained 4.6% (up 65.1%). The Biotechs added 2.8% (up 41.2%). With Bullion rising $46, the HUI gold index surged 13.0% (up 47.5%).

One-month Treasury bill rates ended the week at 3 bps, and three-month bills closed at 7 bps. Two-year government yields jumped 9 bps to 0.85%. Five-year T-note yields rose 13.5 bps to 2.28%. Ten-year yields were 16 bps higher to 3.38%. Long bond yields surged 23 bps to 4.23%. Benchmark Fannie MBS yields rose 17 bps to 4.28%. The spread between 10-year Treasuries and benchmark MBS yields widened one to 90 bps. Agency 10-yr debt spreads narrowed 3 to 6 bps. The implied yield on December 2010 eurodollar futures jumped 12.5 bps to 1.755%. The 2-year dollar swap spread increased one to 36.5 bps; the 10-year dollar swap spread increased 1.25 to 17.5 bps; and the 30-year swap spread increased 2.75 to negative 9.25 bps. Corporate bond spreads were narrower. An index of investment grade bond spreads narrowed 3 bps to 142, and an index of junk spreads sank another 21 bps to a 13-month low 594 bps.

Corporate debt issuance remains strong. Investment grade issuers included New York Life $1.0bn, Protective Life $700 million, United Airlines $660 million, Boston Properties Pipeline Funding Co. $500 million, Diamond Offshore $500 million, and RPM International $300 million.

Junk bond funds enjoyed inflows of $516 million (from AMG). Junk issuers included Hovnanian $785 million, Sempra Energy $750 million, Wynn Las Vegas $500 million, Solutia $400 million, Hercules Offshore $300 million, Comstock Resources $300 million, and GEO Group $250 million.

I saw no converts issued.

International dollar-denominated debt issuers included Commercial Bank of Australia $3.5bn, Statoilhydro $900 million, America Movil $750 million, Amal $400 million and Nova Chemicals $700 million.

U.K. 10-year gilt yields added one basis point to 3.45%, and German bund yields rose 8 bps to 3.20%. The German DAX equities index jumped 4.5% (up 18.7% y-t-d). Japanese 10-year "JGB" yields increased 3 bps to 1.28%. The Nikkei 225 rallied 2.9% (up 13.1%). Emerging markets were mostly much higher. Russia's RTS equities index surged 11.4% (up 115.9%). India's Sensex equities declined 2.9% (up 72.5%). China's Shanghai Exchange jumped 4.8% today after their holiday break, boosting 2009 gains to 59.9%. Brazil's benchmark dollar bond yields dropped 17 bps to 4.91%. Brazil's Bovespa equities index jumped 4.7% to a 2009 high (up 70.6% y-t-d). The Mexican Bolsa rose 4.7%, also to a 2009 high (up 34.2% y-t-d). Mexico's 10-year $ yields sank 24 bps to 5.05%.

Freddie Mac 30-year fixed mortgage rates fell 7 bps to a 20-wk low 4.87% (down 107bps y-o-y). Fifteen-year fixed rates dipped 3 bps to 4.33% (down 130bps y-o-y). One-year ARMs increased 4 bps to 4.53% (down 62bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 5 bps to 6.06% (down 106bps y-o-y).

Federal Reserve Credit slipped $652 million last week to $2.120 TN. Fed Credit has declined $127bn y-t-d, although it expanded $625bn over the past 52 weeks (42%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 10/7) increased $5.6bn to a record $2.860 TN. "Custody holdings" have expanded at a 17.8% rate y-t-d, and were up $375bn over the past year, or 15.1%.

M2 (narrow) "money" supply jumped $47.5bn to $8.357 TN (week of 9/28). Narrow "money" has expanded at a 2.7% rate y-t-d and 5.5% over the past year. For the week, Currency added $0.5bn, and Demand & Checkable Deposits increased $13.2bn. Savings Deposits surged $52.6bn, while Small Denominated Deposits fell $10.7bn. Retail Money Funds declined $8.2bn.

Total Money Market Fund assets (from Invest Co Inst) increased $16.7 to $3.446 TN. Money fund assets have declined $384bn y-t-d, or 13.0% annualized. Money funds declined $12bn, or 0.3%, over the past year.

Total Commercial Paper outstanding jumped $67.7bn (8-wk gain of $225bn) to a 21-wk high $1.299 TN. CP has declined $382bn y-t-d (30% annualized) and $251bn over the past year (16%). Asset-backed CP rose $9.1bn to $531bn, with a 52-wk drop of $176bn (25%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $360bn y-o-y to a record $7.257 TN. Reserves have increased $493bn year-to-date.

Global Credit Market Watch:

October 8 - Bloomberg (Brian Faler and Julianna Goldman): "The U.S. government ended its 2009 fiscal year with a deficit of $1.4 trillion, the biggest since 1945... The deficit amounted to 9.9% of the nation's economy, triple the size of the shortfall for 2008. The nonpartisan CBO said... the government was squeezed on both sides of the budget ledger... Tax revenue fell by $420 billion, or 17%, to the lowest level in more than 50 years. Individual income taxes, the biggest source of tax receipts, fell by 20%... Corporate income taxes dropped by 54%... At the same time, federal spending rose by 18%, the CBO said."

October 5 - Bloomberg (Rebecca Christie and Christine Harper): "Federal Deposit Insurance Corp. Chairman Sheila Bair said regulators should consider making secured creditors carry more of the cost of bank failures. 'This could involve potentially limiting their claims to no more than, say, 80% of their secured credits,' Bair said... 'This would ensure that market participants always have some skin in the game, and it would be very strong medicine indeed.' Bair's comments go beyond any of her previous proposals for changing the way large and so-called systemically important financial institutions are regulated."

October 8 - Bloomberg (Ott Ummelas): "Latvia's plan to cap mortgage holders' liability has damaged the Baltic state's chances of convincing investors it can meet the terms of its bailout and avoid a devaluation, said James Oates, chief executive officer of... Cicero Capital. 'By trying to change the legislation so that the debts can only be limited to the collateral total, that kind of gives the game away, and that, together with the Swedes' saber-rattling, they really are out there on the edge now,' said Oates, former head of east European equities at UBS..."

October 7 - Bloomberg (Jon Menon and Andrew MacAskill): "A year ago today, Royal Bank of Scotland Group Plc and HBOS Plc were close to collapse, causing a chain reaction that could have ended with riots in U.K. cities, security analysts and economists said. Bank failures would have forced the government to cancel police leave and deploy troops as the breakdown of the financial payments system threatened the ability of utilities to provide essential services, said David Livingstone, a fellow at the Royal Institute for International Affairs in London, a former adviser to the government's Cobra crisis response committee. 'You are talking about a situation with mass disorder and panic,' the former Royal Navy officer said... There would be 'riots, pandemonium, everyone fending for themselves.'"

September 30 - Bloomberg (David Yong and Lilian Karunungan): "Emerging-market bonds posted the best quarterly gain in more than six years... The extra yield investors demand to own developing-nation securities rather than Treasuries shrank to 3.27 percentage points, from a seven-year high of 8.65 points on Oct. 24..."

Government Finance Bubble Watch:

October 6 - Bloomberg (Mike Dorning and Nicholas Johnston): "President Barack Obama is considering a mix of spending programs and tax cuts to respond to widening job losses that would amount to an additional economic stimulus without carrying that label. The discussion of the initiatives, including a boost in transportation spending and an extension of an expiring tax credit for first-time homebuyers, comes as the White House is balancing rising concern about unemployment and a budget deficit the Congressional Budget Office estimates will total $1.6 trillion for 2009, and $1.4 trillion in 2010."

October 8 - Bloomberg (Simon Kennedy and Gabi Thesing): "Jean-Claude Trichet needs governments to walk through the emergency exit first if he's going to be able to keep nurturing Europe's recovery with record low interest rates and cash injections. As an economic rebound allows policy makers to mull how they will withdraw stimulus measures, the European Central Bank President is demanding that when growth takes hold, lawmakers execute 'ambitious' plans to reverse the region's largest budget deficit since the euro began trading in 1999. Failure by politicians to devise a plan and then carry it out may fuel debt and inflation..."

Currency Watch:

October 6 - Bloomberg (Camilla Hall): "Saudi Arabia hasn't held talks with China and other countries on dropping the dollar as the currency for pricing oil, Saudi Central Bank Governor Muhammad al-Jasser said, denying a report in the U.K.'s Independent newspaper. The Independent report is 'absolutely incorrect' and there has been 'absolutely nothing' of that nature discussed between Saudi Arabia, the world's biggest oil exporter, and other countries, al-Jasser told reporters... The... newspaper said.... that Gulf oil producers and nations including China, Japan, Russia and Brazil had held secret talks on a nine-year plan to phase out the dollar in oil trade, and move toward pricing the fuel in a basket of currencies plus gold. It cited unidentified Gulf officials and unidentified Chinese bankers."

October 6 - Bloomberg (Francine Lacqua and Mark Deen): "European Central Bank President Jean-Claude Trichet led the region's finance chiefs in pushing China to let the yuan strengthen amid mounting concern the euro is shouldering too much of the burden of a sliding dollar. Some currencies 'have in the medium run to appreciate,' Trichet said..."

Despite today's rally, the dollar index ended the week down 0.7% to 76.45. For the week on the upside, the Australian dollar increased 4.5%, the Canadian dollar 3.5%, the South African rand 3.1%, the Norwegian krone 2.7%, the New Zealand dollar 2.6%, the Brazilian real 2.6%, the Mexican peso 2.5%, the Singapore dollar 1.5%, and the Euro 1.0%. On the downside, the dollar gained 0.6% on the British pound.

Commodities Watch:

October 7 - Bloomberg (Pham-Duy Nguyen): "Gold's rally to a record shows commodity investors remain concerned that the U.S. economic recovery will spur inflation even as Wall Street forecasts and government bonds suggest stable prices. Bullion has jumped 19% this year, heading for a ninth annual gain, after futures touched a record $1,045 an ounce yesterday... Demand for gold is increasing as U.S. government debt reaches record levels and the Federal Reserve keeps interest rates near zero percent. Inflation surged to a 14.8% annual rate in March 1980 after a four-year gain in gold that included a then-record $873 in January 1980."

October 8 - Bloomberg (Luzi Ann Javier): "Protests over high food prices, which swept the world from Haiti to Bangladesh last year, may return to Asia in 2010 as drought in India and crop losses in the Philippines may cause price spikes, CWA Global Markets Pty said. 'We wouldn't be surprised to see a return to the rice riots across Asia sometime in 2010,' Peter McGuire, managing director at CWA Global Markets Pty., said... Declining output in India 'coupled with the recent weather issues in the Philippines will cause price spikes for the rice market toward the second quarter of 2010,' he said."

October 7 - Bloomberg (Carli Lourens): "China's share of global demand for diamonds is set to double..., RBC Capital Markets said. China's share of demand for diamonds in jewelry, measured in polished wholesale prices, will probably climb to 16% after 2015 from 8% this year...analyst Des Kilalea said... citing De Beers... India's share will probably increase to 11% after 2015 from 7% this year, he said."

Great week for commodities. Gold jumped 4.6% to close at $1,049 (up 18.9% y-t-d). Silver surged 9.3% to $17.74 (up 57% y-t-d). November Crude gained $2.29 to $72.24 (up 62% y-t-d). November Gasoline added 2.2% (up 68% y-t-d), and November Natural Gas increased 1.3% (down 15% y-t-d). December Copper jumped 6.5% (up 102% y-t-d). December Wheat recovered 6.1% (down 23% y-t-d), and December Corn rallied 8.6% (down 11% y-t-d). The CRB index gained 3.8% (up 14.4% y-t-d). The Goldman Sachs Commodities Index (GSCI) surged 4.0% (up 35.3% y-t-d).

China Bubble Watch:

October 9 - Bloomberg (Sophie Leung): "China's banking regulator said it's too soon for the government to start winding down stimulus efforts even as growth in the world's third-largest economy accelerates to more than 8%. 'It's far too early to talk about an exit strategy,' Liu Mingkang, chairman of the China Banking Regulatory Commission, told a banking conference... The economy 'may face a bumpy road ahead.'"

October 5 - Bloomberg (Rob Delaney): "Chinese central bank official Yi Gang said the strength of lending in the country isn't a cause for concern and will stabilize, reflecting the government's reluctance to rein in economic stimulus measures. 'I think overall, the situation will converge to a sustainable level,' Deputy Central Bank Governor Yi told Bloomberg... 'In August, it was already not too much. June and August were pretty flat.'"

October 6 - Bloomberg (Sophie Leung and Theresa Tang): "Luxury-home sales in Hong Kong almost tripled in September from a month earlier as mainland Chinese residents bought properties in the city. The registered sales of homes worth more than HK$10 million ($1.3 million) rose to 1,351 from 500... A one-bedroom apartment in the Kowloon district sold for a record HK$24.5 million, Centaline Property Agency Ltd. said last month."

Japan Watch:

October 8 - Bloomberg (Keiko Ujikane): "Japan's current-account surplus widened in August... The surplus widened 10.4% to 1.171 trillion yen ($13.2 billion) in August from a year earlier... Renewed demand from China and other emerging nations is helping Japan emerge from its worst postwar recession."

India Watch:

October 9 - Bloomberg (Cherian Thomas): "India's Finance Minister Pranab Mukherjee said that the central bank shouldn't "compromise" on the nation's economic growth in its efforts to tame inflation."

October 6 - Bloomberg (Cherian Thomas and Pooja Thakur): "India faces a dilemma on when to raise borrowing costs to contain inflation pressures as the economic recovery 'remains weak,' central bank Governor Duvvuri Subbarao said. 'While there is a broad agreement that we need to exit from the present excessively accommodative monetary and fiscal policies, there is less agreement on when and how we should exit," Subbarao said... 'An early exit on inflation concerns runs the risk of derailing the fragile growth, while a delayed exit may endanger inflation expectations.'"

October 8 - Bloomberg (Kartik Goyal): "India's wholesale prices rose for a fourth week, making it harder for central bank Governor Duvvuri Subbarao to keep interest rates low and boost economic growth without fanning inflation."

Asia Bubble Watch:

October 7 - Bloomberg (Netty Ismail): "Asian hedge funds will attract a 'wave' of new money that could more than double the industry's assets from its peak of $250 billion as the region leads the world's emergence from the deepest recession since World War II, according to GFIA Pte. The industry in Asia will grow to two-to-three times its peak within the next five years as investors outside the region with little or no investments in Asian alternative strategies allocate to the funds, said Peter Douglas, principal of GFIA, a Singapore-based hedge-fund consulting firm."

October 5 - Bloomberg (Shamim Adam and Francine Lacqua): "South Korea still needs expansionary economic policy and the central bank has other tools available before raising interest rates if it decides it needs to contain rising asset prices, Finance Minister Yoon Jeung Hyun said. Any winding back of fiscal stimulus by the government or interest-rate increases from the Bank of Korea would be 'premature' because the economy still faces uncertainties, Yoon said..."

Latin America Watch:

October 5 - Bloomberg (Joshua Goodman): "Brazil will buy up to $10 billion in debt from the International Monetary Fund, converting the country into a net creditor of the IMF for the first time, Finance Minister Guido Mantega said. Brazil will invest part of its foreign reserves to buy the two-year bonds denominated in the IMF's special drawing rates... Mantega said today's 'radical change' would help Brazil diversify its reserves."

Unbalanced Global Economy Watch:

October 9 - Bloomberg (Theophilos Argitis): "Canadian employers added jobs for the second straight month in September... Employment rose by 30,600, Statistics Canada said today in Ottawa. The jobless rate fell to 8.4% from August's 8.7%."

U.S. Bubble Economy Watch:

October 6 - Bloomberg (Chris Dolmetsch): "Cirque du Soleil founder Guy Laliberte said the $35 million he paid to spend nine days on the International Space Station is 'worth every penny,' even with the physical challenge of being in orbit. 'The best stunt I pulled is hitting my head about three times in the same day trying to figure out how to navigate in weightlessness,' Laliberte, 50, said..."

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

October 8 - Bloomberg (Tina Seeley and Dawn Kopecki): "Legislation... to tighten derivatives regulation contains an exemption that may let most financial firms escape new collateral and disclosure rules, the head of the Commodity Futures Trading Commission said. The provision is among several loopholes in the draft legislation, officials of the CFTC and Securities and Exchange Commission said in testimony... before the House Financial Services Committee..."

Real Estate Watch:

October 7 - Wall Street Journal (Lingling Wei and Maurice Tamman): "Banks in the U.S. 'are slow' to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation... The remarks suggest that banking regulators are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital during the boom to cushion themselves when the bubble burst. 'Banks will be slow to recognize the severity of the loss -- just as they were in residential,' according to the Fed..."

October 8 - Bloomberg (Daniel Taub): "U.S. home sellers cut their asking prices by a total of $28.4 billion... Trulia Inc. said. The average discount was 10% as of Oct. 1... Homes listed for more than $2 million were cut the most, with owners taking an average of 14% off the original price. Luxury homes accounted for 25% of all of the reductions."

October 8 - Bloomberg (Daniel Taub): "Vacancies at U.S. shopping centers rose in the third quarter to a 17-year high as unemployment climbed, consumers cut spending and stores closed...Reis Inc. said. Vacancies at neighborhood and community shopping centers increased to 10.3%, the highest level since 1992, from 8.4% a year earlier..."

October 7 - Wall Street Journal (Christina S.N. Lewis): "Rent for office space is falling at the fastest pace in more than a decade as vacancies create a glut and landlords slash prices to attract tenants. Nationwide, effective office rents fell 8.5% in the third quarter compared with the same period a year ago... according to Reis Inc..."

October 6 - Bloomberg (Hui-yong Yu): "U.S. apartment vacancies rose to 7.8% in the third quarter, the highest since 1986... Reis Inc. said. Actual rents paid by tenants, known as effective rents, declined 2.7% from a year earlier... Asking rents, or what landlords sought, fell 1.8% from a year earlier."

Central Banker Watch:

October 7 - Bloomberg (Jacob Greber and Rebecca Keenan): "Australian central bank Governor Glenn Stevens has a reputation for doing the unexpected -- and getting it right. His gamble yesterday, when he became the first central bank chief among the Group of 20 nations to raise interest rates... could make or break that reputation... 'Stevens is doing what he thinks is the right thing for the broader community -- if that means flying in the face of convention, he'll do it,' said Warren Hogan, chief economist at Australia & New Zealand Banking Group..."

October 6 - Bloomberg (Scott Lanman and Michael McKee): "Federal Reserve Bank of New York President William Dudley said that the risk of slowing inflation is 'problematic' for the economy and that interest rates should stay low for a while to ensure a 'robust recovery.' 'Our near-term focus should be to keep significant monetary accommodation in place for an extended period" to achieve the Fed's congressional mandates for maximum employment and stable prices, Dudley said in a speech yesterday in New York. The U.S. jobless rate is 'much too high,' and the economy has 'significant excess slack,' he said."

October 9 - New York Times (Edmund L. Andrews): "Fissures are developing among policy makers at the Federal Reserve as they debate how and when to start raising the benchmark interest rate from its current level just above zero. With Fed officials forecasting that unemployment will average 9.8% in 2010, nobody appears to be arguing that monetary policy should be tightened anytime soon... But Fed officials have hinted at new disagreement in recent weeks. The arguments go beyond the traditional split between hawks, who worry that easy money will stoke inflation, and doves, who contend that unemployment is the top problem. The more devilish debates are about how fast to act once the decision has been made, and how to carry it out. Beyond raising the overnight federal funds rate, the Fed also has to unwind $2 trillion in special programs that prop up paralyzed banks and credit markets."

GSE Watch:

October 7 - Wall Street Journal (James R. Hagerty): Fannie Mae and Freddie Mac are preparing to introduce a program aimed at helping independent mortgage banks acquire the short-term credit they need to make home loans... The two government-backed mortgage companies, the main providers of funding for U.S. home loans, plan to provide advance commitments to purchase home mortgages that meet certain standards. The goal is to reduce risks faced by independent mortgage banks so they can obtain short-term credit."

Fiscal Watch:

October 8 - Los Angeles Times (Jim Puzzanghera): "In the wake of the mortgage meltdown, the Federal Housing Administration has emerged as a pillar of the still wobbly housing market -- providing vital insurance that enables borrowers to qualify for loans with as little as 3.5% down. This year alone the agency has backed nearly 2 million mortgages worth at least $328 billion. It insured 21.5% of all new mortgages last year, up from fewer than 6% in 2007. Some lawmakers, however, worry that the FHA may be doing its job too well -- enabling too many people with shaky finances to get loans, and in effect setting up a potential repeat of the housing bubble fueled in part by no-questions-asked subprime loans. Recent numbers appear to underscore those concerns. The percentage of FHA loans that are delinquent or in foreclosure climbed to nearly 8% at the end of June, from about 5.5% in early 2006... Congress boosted the agency's business last year by more than doubling the limit on the maximum FHA-backed loan, to $729,750, in Los Angeles and other high-cost markets. Through Aug. 31 of this year, the FHA had insured nearly 1.8 million mortgages worth at least $328 billion, or nearly half the total of $675 billion worth of mortgages on its books."

October 8 - Bloomberg (Jody Shenn): "The Federal Housing Administration, which insures mortgages with low down payments, may require a U.S. bailout because of $54 billion more in losses than it can withstand, a former Fannie Mae executive said. 'It appears destined for a taxpayer bailout in the next 24 to 36 months,' consultant Edward Pinto said... Pinto was the chief credit officer from 1987 to 1989 for Fannie Mae..."

October 9 - New York Times (David Streitfeld and Louise Story): "A year after Fannie Mae and Freddie Mac teetered, industry executives and Washington policy makers are worrying that another government mortgage giant could be the next housing domino. Problems at the Federal Housing Administration, which guarantees mortgages with low down payments, are becoming so acute that some experts warn the agency might need a federal bailout... In testimony before a House subcommittee, the F.H.A. commissioner, David H. Stevens, assured lawmakers that his agency would not need a bailout and that it was managing its risks. But he acknowledged that some 20% of F.H.A. loans insured last year -- and as many as 24% of those from 2007 -- faced serious problems including foreclosure..."

Muni Watch:

October 9 - Bloomberg (Joe Mysak): "The decline in one-year municipal debt yields to the lowest level since at least 1989 means 'It's almost as if money was free,' said Lee McElhannon, Georgia's director of bond finance... Municipalities have responded to the drop by selling $60 billion in such short-term securities... The record year for short-term issuances was 2002, according to the Bond Buyer, when $72 billion was sold. California leads all issuers of notes this year, with $18 billion."

California Watch:

October 8 - Bloomberg (Jeremy R. Cooke and Michael B. Marois): "California, which struggled to get individual investors to buy its long-term bonds this week, raised yields to draw institutions and reduced the amount offered today by 8% to about $4.1 billion. The U.S. state with the most people, the lowest credit ratings and record 12.2% unemployment got $505 million in orders during two days reserved for retail buyers... The largest single maturity, $1.75 billion of taxable 30- year Build America Bonds, were priced to yield 7.23%..."

New York Watch:

October 6 - Bloomberg (Henry Goldman): "Governor David Paterson ordered New York state agencies to cut non-personnel spending by $500 million in the current fiscal year, or about 11%, a day after saying income-tax revenue has declined 36%.. The largest reductions would come in the State University of New York, $90 million; prison system, $69.3 million, and City University of New York, $53 million..."

Speculation Watch:

October 7 - Wall Street Journal (Anton Troianovski): "Share prices of real-estate investment trusts have climbed so far that according to some analysts, the sector is trading at a premium to the value of the underlying assets -- for the first time since the heyday of the real-estate boom... During the third quarter, REITs posted a 33% return, according to the Dow Jones Equity All REIT Index... The hotel and office sectors both delivered gains of about 45%."

October 7 - Bloomberg (Saijel Kishan): "Hedge funds gained for the seventh consecutive month in September returning an average 3% as stock markets rose, Hedge Fund Research Inc. said. Funds have climbed 17% this year after losing a record 19 percent in 2008..."

October 5 - Bloomberg Tomoko Yamazaki): "Global hedge-fund assets declined 8.5% to $1.67 trillion in the first half of 2009... according to HedgeFund Intelligence. The drop extends last year's decline, when global hedge funds posted record losses... Assets declined about 38% from a peak of $2.7 trillion reached during the first half of 2008..."

Dollar Dilemma

Renewed U.S. dollar weakness has evoked calls for Washington to implement a true strong dollar policy. Larry Kudlow is calling for a supply-side cut of marginal corporate tax rates and for the Federal Reserve to hike rates 25 bps in support of our currency. He knows "none of this is gonna happen." Others believe the focus should be trimming our massive federal deficit. A move to fiscal and monetary restraint is surely needed to help stabilize the dollar. Restraint is not going to happen.

Perhaps chairman Bernanke tossed a tiny bone to the currency markets yesterday evening. Yet everyone in the world knows U.S. policymaker focus is on aggressive short-term stimulus with the objective of jump-starting rapid economic recovery. Officials from both the Federal Reserve and Treasury have stated their view that a strong U.S. economy is the best prescription for a strong dollar. Simple enough. So, perhaps they'll increasingly be compelled to tweak their comments in hope of influencing currency trading. But don't hold your breath waiting for a meaningful shift in strategy - say aggressively boosting rates or slashing spending - to protect the value of our currency. Current policy is not the primary issue anyway.

Non-productive Credit expansion/inflation is the bane of currency stability. The dollar's fundamental problem these days lies with the underlying structure of the U.S. economy. As much as near zero interest-rates and Trillion dollar deficits don't improve the situation, they are symptomatic of much broader systemic issues. Indeed, ultra-loose monetary policy, scary deficits, and ongoing dollar devaluation are all consequences of deep structural maladjustments to the services and consumption-oriented U.S. "bubble" economy.

And I would make the point that this maligned economic structure has been the driver for both policy and dollar weakness. With the collapse of the Wall Street/mortgage finance Bubble, acute structural fragilities required unprecedented stimulus in order to stem implosion. Once stabilized, policy focus turned immediately to short-term performance - positive GDP growth, spending recovery and job creation. Not surprisingly, the focus remains on finding a quick fix, with scant attention to structural issues.

As it relates to the dollar stability, I would argue that the central policy issue should be to create a backdrop conducive to far-reaching adjustment and repair to the economic structure. Aggressive stimulus would be expected to spur short-term performance gains. However, this would be at the cost of delaying necessary structural corrections. This dynamic may help explain why the bulls have been right on stocks this year but wrong that U.S. recovery would boost the dollar. Washington may believe that big GDP growth numbers will support a strong dollar, but global markets (and policymakers) seem to recognize clearly that the course of U.S. policy undermines the long-term value of our currency (and their dollar holdings).

Decades of credit excess cultivated an economic structure that produces too little and survives on too much credit. The Credit inflation/dollar debasement dilemma was masked for years. The dollar indulged both in its global reserve status and the world's keen desire to participate in our financial asset Bubble. For years, the U.S. "private"-sector Credit apparatus (Wall Street securitizations, GSE obligations, derivatives, etc.) was the global "asset class" demonstrating the strongest (most alluring) inflationary bias. As fast as our Credit system inundated the world with dollar liquidity, these financial flows would as quickly be recycled right back into U.S. securities. The dollar was king on the back of reflexive speculative flows.

The dollar was not ok - it was fundamentally weak. But it looked ok relatively, in a world of weak currencies and expansive global speculation. And as long as this recycling mechanism functioned smoothly, the U.S. Credit system could easily expand Credit on an annual basis sufficient to boost various types of "output" that tallied in GDP. And with Wall Street and mortgage credit at the heart of the U.S. Credit Bubble, financial excess fed a self-reinforcing boom in lending, asset inflation, consumption, business investment and government expenditures. Moreover, any bout of financial turmoil would see U.S. yields collapse and a virtual buying panic for agency and mortgage-related securities - rapidly reflating our Bubbles.

Many things changed with the bursting of the Wall Street/mortgage finance Bubble. For one, our "private"-sector Credit mechanism was no longer capable of creating sufficient Credit to sustain inflated real estate Bubbles or the inflation-distorted Bubble economy structure. For two, the U.S. Credit system decisively relinquished it status as the most alluring global "asset class." Years of dollar debasement had already worked to sway the inflationary biases away from the U.S. toward energy, gold, commodities and the "emerging" markets and economies. The unfolding post-Wall Street Bubble reflation has found - for the first time - the "developing" and commodities worlds supplanting the U.S. as the favored destination for speculative finance. This is big.

Granted, deleveraging and unwinding of dollar bearish bets initially propelled the dollar higher. Yet I would argue that the global crisis will be looked back on as a seminal event for our currency. Our policymakers have much less flexibility in the new financial and economic landscape. Both fiscal and monetary measures have lost potency. Trillions of dollars of deficits, zero interest rates and a $2 Trillion Fed balance sheet today get less system response than hundreds of billions and a few percent would have achieved previously. This hurts the dollar. And acute financial and economic fragilities ensure extreme policy measures will remain in place for much longer than would have previously been necessary. This also hurts dollar confidence.

Meanwhile, the "developing" world currencies, markets and economies dramatically outperform the United States. Global reflationary dynamics have put a premium on asset markets in China, Asia and the developing world. This robust inflationary bias, then, places a premium on things consumed in - and demand from - these economies.

So much of our economic structure evolved during - and for - a different era. Our Bubbles were inflating; market dynamics had created great power and flexibility for policymaking; the U.S. consumer was the king; and our securities and economic booms were the focus globally. While some of our multinational companies will benefit, too much of our economic structure is poorly positioned for today's new global landscape. Not only does our maladjusted economic structure today require too much non-productive Credit creation, it lacks the type of real economic returns necessary to attract global financial flows. This is a big predicament not easily remedied.

It is worth noting that Australia's central bank was this week the first major central bank to begin the process of removing monetary stimulus. Global markets reacted by pushing the dollar even lower. The "commodity" currencies, gold, energy, commodities and global equities surged higher.

I'll take the markets' reaction to uncommon central banking rationality as early confirmation that attempts to tighten ultra-loose monetary conditions globally will be impeded by speculative inflows already bent against the dollar. This dynamic reinforces already strong reflationary forces in non-dollar markets, while intensifying speculative selling pressure against the greenback. Expect foreign central banks to be pressured to buy a lot more dollars and global markets to experience even more destabilizing Monetary Disorder.

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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