The Year In Review

By: Doug Noland | Fri, Jan 1, 2010
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For the final week of 2009, the S&P500 declined 1.0% (up 23.5% y-t-d), and the Dow fell 0.9% (up 18.8% y-t-d). The Banks sank 1.5% (down 3.6%), and the Broker/Dealers lost 1.1% (up 48.5%). The Morgan Stanley Cyclicals dropped 2.1% (up 74.6%), and Transports fell 2.2% (up 15.9%). The Morgan Stanley Consumer index declined 1.1% (up 21.8%), and the Utilities gave back 1.4% (up 4.9%). The S&P 400 Mid-Caps fell 1.8% (up 35.0%), and the small cap Russell 2000 declined 1.4% (up 25.2%). The Nasdaq100 (up 53.5%) and the Morgan Stanley High Tech index (up 69.6%) each slipped 0.5%. The Semiconductors dipped 0.3% (up 69.64%). The InteractiveWeek Internet index declined 0.9% (up 74.8%). The Biotechs were unchanged (up 45.6%). With bullion down $10, the HUI gold index declined 2.0% (up 42.2%).

One-month Treasury bill rates ended the week at 4 bps, and three-month bills closed at 6 bps. Two-year government yields jumped 11 bps to end the year at 1.04%. Five-year T-note yields rose 11 bps to 2.61%. Ten-year yields increased 4 bps to 3.84%. Long bond yields declined 5 bps to 4.62%. Benchmark Fannie MBS yields were little changed at 4.56%. The spread between 10-year Treasury and benchmark MBS yields narrowed 2 to 72 bps. Agency 10-yr debt spreads narrowed 7 to 30 bps. The implied yield on December 2010 eurodollar futures jumped 10.5 bps to 1.545%. The 10-year dollar swap spread declined 1.75 to 13.25 bps, while the 30-year swap spread increased one to negative 11.25 bps. Corporate bond spreads narrowed further into year-end. An index of investment grade bond spreads narrowed 2 to a 2009 low 121 bps, and an index of junk spreads narrowed 15 to a 16-month low 539 bps.

Investment grade issuers included Piper Jaffray $120 million.

I saw no junk, convert or dollar-denominated international debt issues this week.

U.K. 10-year gilt yields added 2 bps to 4.01%, and German bund yields increased 7 bps to 3.38%. Bond yields in Greece increased 4 bps to 5.77%. The German DAX equities index was unchanged (up 23.9% y-t-d). Japanese 10-year "JGB" yields added 1.5 bps to 1.285%. The Nikkei 225 added 0.5% (up 19.0%). Emerging markets ended the year mostly firmer. For the week, Brazil's Bovespa equities index jumped 1.5% (up 82.7%), while Mexico's Bolsa declined 1.5% (up 43.9%). Russia's RTS equities index slipped 0.4% (up 128.6%). India's Sensex equities index added 0.6% (up 81.0%). China's Shanghai Exchange surged 4.1%, boosting 2009 gains to 80.0%. Brazil's benchmark dollar bond yields were little changed at 5.05%, while Mexico's benchmark bond yields declined a basis point to 5.16%.

Freddie Mac 30-year fixed mortgage rates jumped 9 bps (4-wk gain of 43bps) to a 4-month high 5.14% (up 4bps y-o-y). Fifteen-year fixed rates rose 9 bps to 4.54% (down 29 bps y-o-y). One-year ARMs declined 5 bps to 4.33% (down 52bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates jumping 21 bps to 6.20% (down 78bps y-o-y).

Federal Reserve Credit expanded $5.6bn last week to an 11-month high $2.220 TN. Fed Credit is down $26.6bn from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 12/23) declined $2.4bn to $2.955 TN. "Custody holdings" expanded $439bn, or 17.4%, in 2009.

M2 (narrow) "money" supply declined $9.3bn to $8.396 TN (week of 12/21). Narrow "money" has expanded at a 2.5% rate y-t-d. For the week, Currency declined $0.9bn, while Demand & Checkable Deposits increased $2.9bn. Savings Deposits added $0.8bn, while Small Denominated Deposits declined $6.8bn. Retail Money Funds fell $5.3bn.

Total Money Market Fund assets (from Invest Co Inst) jumped $21.6bn to $3.294 TN. For the year, money fund assets declined $537bn, or 14.0%.

Total Commercial Paper outstanding increased $10.8bn last week (20-wk gain of $95bn) to $1.170 TN. CP declined $511bn this year (30.4%). Asset-backed CP was little changed last week at $486bn, with a 52-wk drop of $248bn (33.8%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $868bn y-o-y, or 12.8%, to a record $7.632 TN.

Global Credit Market Watch:

December 31 - Bloomberg (John Detrixhe): "JPMorgan Chase & Co. retained its place this year as the top underwriter of U.S. corporate bonds, leading banks managing a record $1.24 trillion of fixed-income offerings..."

December 28 - Bloomberg: "Inflows of speculative capital, or 'hot money,' are contributing to volatility in China's stock and property markets, said Fan Gang, the academic member of the central bank's monetary policy committee. While the inflows help make it cheaper to borrow, 'it will also cause asset bubbles,' Fan said... He also said that capital will keep heading into emerging markets for 'a considerable period' because of limited or zero growth prospects in the industrialized economies... Fan is among Asian officials who have warned in recent weeks that the U.S. Federal Reserve's policy of keeping its benchmark interest rate near zero is spurring global liquidity that's heading to emerging markets."

December 31 - Bloomberg (David Wilson): "Goldman Sachs Group Inc.'s forecast that Brazil, Russia, India and China would eventually eclipse the Group of Seven countries economically has been described as 'the biggest market call of the decade.'"

December 31 - Bloomberg (Pete Young): "Health care, the municipal bond segment with the highest proportion of downgrades in the first three quarters of 2009, yielded the year's best return. The... Standard & Poor's index of hospital, life care, nursing home and related bonds led total returns at 28%."

December 31 - Dow Jones (Kejal Vyas and Riva Froymovich): "An improving global economic picture and positive investor sentiment helped emerging-market assets break several records in 2009... With the last trading session of the year drawing to a close, the MSCI Emerging Markets stocks index was up nearly 73% in 2009, beating all previous year-to-date advances...Stock funds saw net inflows of $80 billion in the year, according to fund-tracker EPFR Global. It is the most money since EPFR started tracking data in 1996."

December 29 - Bloomberg (Chua Kong Ho and David Yong): "Emerging-market equity funds inflows tripled last week as the outlook improved for developing-nation exporters, EPFR Global said. The funds attracted $1.7 billion in the week... That added to a record $80.3 billion of investments in emerging-market stock funds so far this year, compared with outflows of $48 billion in the same period in 2008... The MSCI Emerging Markets Index has rallied 73% this year, set for its best annual performance. Developing nations were the 10 best-performing markets this year..."

December 28 - Bloomberg (Alison Vekshin and James Sterngold): "A one-page proposal gaining traction in Congress could turn back the clock on Wall Street 10 years, forcing the breakup of banks, including Citigroup Inc. Lawmakers in both parties, seeking to prevent future financial crises while soothing public anger over bailouts and bonuses, are turning to an approach that's both simple and transformative: re-imposing sections of the 1933 Glass-Steagall Act that separated commercial and investment banking. Those walls came down with passage of the Gramm-Leach- Bliley Act of 1999. A proposal to reconstruct them, made by U.S. Senators John McCain and Maria Cantwell on Dec. 16, would prevent deposit-taking banks from underwriting securities, engaging in proprietary trading, selling insurance or owning retail brokerages."

December 28 - Bloomberg (Oliver Biggadike and Daniel Kruger): "If Morgan Stanley is right, the best sale of U.S. Treasuries for 2010 may be the short sale. Yields on benchmark 10-year notes will climb about 40% to 5.5%, the biggest annual increase since 1999, according to David Greenlaw, chief fixed-income economist at Morgan Stanley... The surge will push interest rates on 30-year fixed mortgages to 7.5% to 8%, almost the highest in a decade, Greenlaw said... Rising borrowing costs risk jeopardizing a recovery from a plunge in the residential mortgage market that led to the worst global recession in six decades. 'When you take these kinds of aggressive policy actions to prevent a depression, you have to clean up after yourself,' Greenlaw said... 'Market signals will ultimately spur some policy action but I'm not naive enough to think it will be a very pleasant environment.'"

Global Government Finance Bubble Watch:

December 31 - Bloomberg (Daniel Kruger): "Treasuries were the worst performing sovereign debt market in 2009 as the U.S. sold $2.1 trillion of notes and bonds to fund extraordinary efforts to bolster the economy and financial markets. Investors in U.S. debt lost 3.5% on average through Dec. 30... the biggest annual slide since at least 1978. The 10-year Treasury yield reached its highest level in six months yesterday..."

December 28 - Bloomberg (Dawn Kopecki): "Fannie Mae and Freddie Mac, the linchpins of the American housing market, continue to bedevil the U.S. financial system. In February 2003, their regulator issued a report saying the companies were taking on too much risk by using implicit government backing to plunge deeper into the mortgage market... Five years later, regulators seized the mortgage-finance companies. Since then, leaders... have argued the companies can't be sustained in their dual roles -- a for-profit enterprise beholden to shareholders and a tool of housing policy -- and should be nationalized or sold. Nothing has happened. Instead, Fannie Mae and Freddie Mac, which buy home mortgages from banks and package them into bonds sold to investors, have been bailed out with $1.5 trillion in direct and indirect government aid."

Currency Watch:

December 31 - Bloomberg: "China's management of its foreign-exchange reserves will face a bigger challenge in 2010, People's Bank of China Governor Zhou Xiaochuan said in a statement posted on the central bank's Web site today after a New Year visit to the foreign-exchange regulator."

The dollar index increased 0.2% this week to 77.86, ending the year with a decline of 4.2%. For the week on the upside, the New Zealand dollar increased 2.4%, the South African rand 1.7%, the Australian dollar 1.7%, the Swedish krona 1.6%, the South Korean won 1.6%, the British pound 1.3%, and the Brazilian real 1.1% For the week on the downside, the Japanese yen declined 1.6%, the Mexican peso 1.6%, the Euro 0.4%, the Danish krone 0.4% and the Canadian dollar 0.3%.

Commodities Watch:

December 31 - Bloomberg (Stuart Wallace and Chanyaporn Chanjaroen): "Commodities posted the biggest annual gain in four decades, led by a doubling in copper, sugar and lead prices, as Chinese demand compensated for the longest slump in the global economy since World War II. In 2009, the S&P GSCI Index of 24 raw materials rose 50%, the most since at least 1971, and commodities drew record investment of $60 billion this year, Barclays Capital estimated."

The CRB index closed 2009 with a gain for the week of 0.9% (up 23.5% for the year). The Goldman Sachs Commodities Index (GSCI) jumped 1.7% (up 50.3%). Gold slipped 0.9% to close 2009 at $1,095 (up 24.2%). Silver dropped 3.2% to $16.88 (up 49.4%). February Crude surged $1.51 to $79.56 (up 78%). January Gasoline rose 3.2% (up 93%), while January Natural Gas lost 1.9% (down 1%). March Copper added 1.5% (up 137%). March Wheat rose 3.2% (down 11%), and March Corn gained 1.8% (up 2% y-t-d).

China Bubble Watch:

December 31 - Bloomberg: "China's President Hu Jintao said the country is aiming to achieve relatively fast economic expansion in 2010, and will pay more attention to the quality of growth and public welfare to maintain social stability and 'harmony'. In a New Year message broadcast on state radio and television, Hu reaffirmed that the government will maintain policy continuity while also ensuring there is adequate flexibility to adjust to changes in the economic environment."

December 28 - Wall Street Journal Asia (James T. Areddy and Shen Hong): "Chinese Premier Wen Jiabao discussed growing inflation expectations in his nation, expressing concerns in a rare domestic media interview about fast-rising real estate prices and acknowledging that Beijing may be paying a price for its aggressive response to the global financial crisis. ... Mr. Wen flatly rejected rising foreign criticism of China's exchange-rate policy, saying that stability in the yuan's value helps the global economy and that China won't bow to pressure to let the yuan appreciate. 'Keeping the yuan's value basically steady is our contribution to the international community at a time when the world's major currencies have been devalued,' Mr. Wen said... So far, the government has done little to reverse policies aimed at stimulating growth through bank lending and government spending. But it has taken increased steps to signal excesses won't be tolerated -- a point Mr. Wen reinforced."

December 28 - Bloomberg: "China should draft 'reasonable' measures for managing liquidity to ensure stable economic growth, according to Bank of China Ltd. Chairman Xiao Gang. The government must strengthen the focus and flexibility of its monetary policy to manage inflation expectations and control money supply to limit lending growth, Xiao wrote... An increase of overseas capital inflows into China and other emerging markets has aggravated excess liquidity and fueled speculation in asset prices, Xiao wrote. A withdrawal of 'hot' money will cause sharp market fluctuations, he said."

December 28 - Bloomberg: "Chinese Premier Wen Jiabao said the government will cool property prices, resist pressure for the yuan to appreciate and keep inflation at 'reasonable' levels. 'Property prices have risen too quickly in some areas and we should use taxes and loan interest rates to stabilize' them, Wen said... China's property prices climbed last month at the quickest pace since July 2008, adding to concern that record lending and inflows of money will inflate asset bubbles in the world's fastest-growing major economy... 'It's difficult to see how serious the government is about cooling the property market,' said Andy Xie, former Morgan Stanley chief Asian economist. 'The issue isn't about introducing new measures but enforcing existing measures.'"

December 28 - Bloomberg (Chua Kong Ho): "China's stock and property markets may develop into a 'full-blown' bubble next year as inflation accelerates, according to BofA Merrill Lynch Research. 'Next year could be the year we see a full-blown asset bubble,' David Cui said... 'We're likely to see massive savings migration as we head into real negative interest-rate territory,' where people 'save less, spend more and invest more,' he said."

December 28 - Bloomberg: "Chinese industrial companies' profits surpassed pre-crisis levels in the past three months, underscoring a strengthening economic rebound... Net income rose 7.8% in the 11 months through November from the same period a year earlier, to 2.59 trillion yuan ($379bn)..."

December 29 - China Knowledge: "China's outbound tourism has been back to a double-digit growth since October this year... In October alone, the number of Chinese outbound travelers grew 11% from a year ago..."

December 29 - Bloomberg (Sophie Leung): "Hong Kong's retail sales rose by the most in 18 months... Sales grew 11.7% in November from a year earlier..."

Japan Watch:

December 28 - Bloomberg (Aki Ito): "Japan's wages slid at the fastest pace in four months in November... Monthly wages including overtime and bonuses slipped 2.8% from a year earlier to 277,261 yen ($3,030)... the 18th straight drop."

December 28 - Bloomberg (Aki Ito and Toru Fujioka): "Japan's industrial production climbed the most in six months in November... Factory output rose 2.6% from the previous month, the Trade Ministry said... Retail sales advanced 0.2% after a 0.9% drop in October..."

India Watch:

December 31 - Bloomberg (Rajhkumar K Shaaw and Paresh Jatakia): "Foreign fund flows into India's stock market rose to $17.5 billion in 2009, close to a record set two years ago..."

December 31 - Bloomberg (Kartik Goyal): "India's benchmark measure of food inflation held near an 11-year high after rains failed, adding pressure on the central bank to raise borrowing costs. An index of food articles compiled by the commerce ministry increased 19.83%... from a year earlier..."

December 31 - Bloomberg (Kartik Goyal): "India's current account deficit more than doubled last quarter as an accelerating economy increased demand for oil and machinery imports. The measure of trade and investment flows posted a $12.63 billion deficit in the three months ended Sept. 30 after a $5.99 billion shortfall in the previous quarter..."

Asia Bubble Watch:

December 29 - Bloomberg (Shinhye Kang and Seyoon Kim): "South Korea posted a current-account surplus for a 10th month in November... The surplus was $4.3 billion last month from a revised $4.8 billion in October..."

December 31 - Bloomberg (Jason Folkmanis): "Vietnam's economy expanded at the fastest pace in more than a year in the fourth quarter as lending growth fueled construction and consumer sales. Gross domestic product grew 6.9% from a year earlier..."

Latin America Bubble Watch:

December 24 - Bloomberg (Vidya Root): "Brazilian President Luiz Inacio Lula da Silva was named the 'Man of the Year' by French newspaper Le Monde, the first time in its history the daily has made such a designation."

December 29 - Bloomberg (Iuri Dantas): "Brazilian outstanding bank lending expanded 1.5% in November from the previous month... State and non-state bank lending rose to 1.39 trillion reais ($800bn)..."

December 29 - Bloomberg (Katia Cortes): "Brazil's tax collection may increase 11% in 2010, Budget Minister Paulo Bernardo said..."

December 30 - Bloomberg (James Attwood and Drew Benson): "Argentina's main stock index completed its biggest annual gain in 18 years as a rebound in prices on the country's commodity exports eased concern that the government will default for a second time this decade."

Unbalanced Global Economy Watch:

December 28 - Bloomberg (Alaric Nightingale and Alexander Kwiatkowski): "A 26-mile-long line of idled oil tankers, enough to blockade the English Channel, may signal a 25% slump in freight rates next year. The ships will unload 26% of the crude and oil products they are storing in six months, adding to vessel supply and pushing rates for supertankers down to an average of $30,000 a day next year, compared with $40,212 now, according to the median estimate in a Bloomberg News survey... 'The tanker market has been defying gravity,' said Martin Stopford, a... director at Clarkson Plc, the world's largest shipbroker... More than half of the ships are in European waters, with the rest spread out across Asia, the U.S. and West Africa. Lined up end to end, they would stretch for about 26 miles."

December 31 - Bloomberg (Svenja O'Donnell): "U.K. house prices rose for an eighth month in December... Prices rose 5.9% from a year earlier."

December 29 - Bloomberg (Johan Carlstrom): "Swedish household credit growth accelerated for a fifth month in November as the central bank repeated plans to keep its benchmark rate at a record-low until autumn next year. Household borrowing grew an annual 9%, compared with 8.6% the previous month..."

U.S. Bubble Economy Watch:

December 27 - United Press International: "Most Americans have a dim view of the first decade of the 21st century, a survey suggests. Those who have a negative view of the decade outnumber those with a positive view almost 2-to-1, the Pew Research Center survey found. The results stand in sharp contrast to the public's assessments of other decades. The 1960s, 1970s, 1980s and 1990s all polled more positive than negative feelings, Pew found. In the latest survey, respondents associated the decade with words like downhill, decline, chaotic, disaster and depressing."

December 28 - Bloomberg (Linda Sandler): "U.S. retail sales rose an estimated 3.6% this holiday season from a year earlier... data from MasterCard Advisors' SpendingPulse showed... A jump in purchases the week before Christmas helped year- over-year electronics sales increase 6% since Black Friday on Nov. 27, and 5.9% for the holiday season starting Nov. 1... More shopping occurred online, with sales rising 18% from Nov. 27 to Dec. 24."

Central Bank Watch:

December 31 - Bloomberg (Craig Torres): "Federal Reserve officials are considering a proposal to schedule limited sales of bonds from the central bank's $2.2 trillion balance sheet as part of a range of tools for withdrawing record monetary stimulus. The Federal Open Market Committee discussed asset sales at its November meeting, with some members in favor and others warning that it would cause 'sharp increases' in longer-term interest rates, according to minutes... A middle route now being studied would allow small amounts of bonds to be unloaded at announced times."

GSE Watch:

December 28 - Bloomberg (Jody Shenn): "The U.S. Treasury Department's expansion of its capital backstops for Fannie Mae and Freddie Mac may foreshadow a shift in the government's mortgage-modification tactics, Keefe, Bruyette & Woods analysts said. The Treasury announced Dec. 24 that the two mortgage- finance companies, which were seized by the U.S. almost 16 months ago, could tap an unlimited amount of capital for three years, up from as much as $200 billion each. The companies' needs would be unlikely to exceed the prior limits 'even in a stress case scenario,' Bose George and Jade Rahmani... wrote... 'Given this outlook, we believe that the main driver of this significant change is the flexibility it gives the government to take more aggressive action to support the housing market, including potentially going down the road of allowing some form of principal writedown," the analysts wrote."

December 28 - Bloomberg (Jody Shenn): "The U.S. government's expanded capital backstops and portfolio limits for Fannie Mae and Freddie Mac increase "the prospect of large-scale" purchases by the companies of delinquent mortgages out of the securities they guarantee, according to Credit Suisse Group analysts. The Treasury Department announced Dec. 24 that the two mortgage-finance companies, which were seized by the U.S. almost 16 months ago, could tap an unlimited amount of capital for three years, up from as much as $200 billion each. It reworked caps on Fannie Mae and Freddie Mac's mortgage-asset portfolios to require the holdings to fall to $810 billion each by Dec. 31, 2010, rather than about $690 billion. 'This announcement increases the prospect of large-scale voluntary buyouts by removing the portfolio cap hurdle and helping funding by potentially increasing debt-investor confidence," Mahesh Swaminathan and Qumber Hassan, the Credit Suisse debt analysts in New York, wrote..."

Fiscal Watch:

December 30 - Bloomberg (Dakin Campbell, David Mildenberg and Robert Schmidt): "GMAC Inc., the auto and home lender bailed out twice by the U.S. government, received a third rescue package valued at $3.79 billion that gives taxpayers a majority stake in the... company."

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

December 31 - Bloomberg (Jody Shenn): "Mortgage bonds are poised to slump after a record rally as the Federal Reserve's unprecedented buying of $1.25 trillion of the securities ends as soon as March... Analysts at BNP Paribas SA, Credit Suisse Group AG and JPMorgan Chase & Co. say the extra yield over benchmark rates that investors demand to hold the securities will widen as much as half a percentage point as the Fed stops purchasing."

Muni Watch:

December 28 - Bloomberg (Martin Z. Braun): "Ithaca, New York, the home of Cornell University, is among a handful of U.S. states and local governments planning to sell bonds during the last week of the year, traditionally a quiet period for markets... Overall, municipal borrowers sold $374 billion through the week of Dec. 14, 11% more than the $338 billion during the entire previous record year of 2007, based on weekly data, excluding variable-rate offerings, compiled by Bloomberg."

December 29 - Bloomberg (Jerry Hart): "State and local tax collections fell for the fourth straight quarter... Collections in the three months ended Sept. 30 fell 6.7% from the period last year to $266.5 billion..."

California Watch:

December 31 - Wall Street Journal (Stu Woo): "Facing a $21 billion shortfall through June 2011, California leaders want billions of dollars in budget relief from Washington that could head off deep cuts expected to state programs. Gov. Arnold Schwarzenegger will ask the White House to waive rules that require the state to spend its own money on certain programs to receive federal funds... Such relief, combined with additional stimulus funds, could save the state as much as $8 billion in the next 18 months, the officials said."

New York Watch:

December 29 - Bloomberg (Sharon L. Lynch): "Manhattan office rents in the Midtown North neighborhood fell 33% in the last year to $59.31 a square foot, broker FirstService Williams said..."

Crude Liquidity Watch:

December 28 - Bloomberg (Henry Meyer and Zahraa Alkhalisi): "Saudi Arabia's M3 money supply growth rate slowed for a second month to 11.3% in November from 11.4% in October..."

December 29 - Bloomberg (Henry Meyer and Zahraa Alkhalisi): "Saudi Arabian inflation accelerated to 4% in November as oil prices increased in global markets and the cost of imported food rose."

Speculation Watch:

December 30 - Bloomberg (Jeff Kearns): "Investors locking in gains from the biggest stocks rally in seven decades pushed options trading in the U.S. to a seventh straight annual record. The number of options on stocks, indexes and exchange-traded funds that changed hands in 2009 reached 3.59 billion contracts..."


The Year In Review

For the five quarters ended September 30, 2009, combined growth of federal government (Treasury) borrowings and outstanding GSE-guaranteed mortgage-backed securities (MBS) jumped to an unprecedented $2.810 TN. This massive growth/inflation of "federal" finance was arguably one of history's great Credit splurges. No discussion of 2009 is near complete without examining the government's momentous role in stabilizing the U.S. Credit system and economy.

The Treasury was certainly not acting alone. Throughout the year - and despite global market and economic recoveries - the Federal Reserve held short-term interest rates down at near zero. Importantly, Fed holdings of mortgage-backed securities ballooned from nothing to end the year approaching $1.0 TN. This unprecedented monetization reliquefied markets, pushed mortgage borrowing costs to record lows, fueled a refinancing boom, and worked surreptitiously to transform hundreds of billions of problematic "private-label" mortgages into (market-appealing) government-backed securities.

When final year-2009 data is tallied, I would not be surprised to see combined Fannie, Freddie, FHA and Ginnie Mae government mortgage guarantees to have expanded as much as $600-$700bn (in a year of flat to down total mortgage debt growth!). This massive government intervention/nationalization coupled with zero rates stabilized the securitization marketplace and stemmed the decline in national home prices.

The U.S. economy notably lagged in spite of massive fiscal and monetary stimulus. Even with the meaningful boost from "cash for clunkers," the best our maladjusted economy could muster was a 2.2% third-quarter growth rate (preceded by 4 straight quarters of negative growth). Third quarter nominal GDP was still down 2.1% y-o-y. After beginning the year at 7.2%, unemployment jumped to as high as 10.2% in October (before declining to 10.0% in November).

The year 2008 saw the collapse of the Wall Street/mortgage finance Bubble. Two thousand and nine marked the full-fledged emergence of the Global Government Finance Bubble and attendant Global Reflation. I have expected this reflation to be altogether different from those of the past. The bursting of the Wall Street/mortgage Bubble brought an abrupt end to our housing mania and discredit to U.S. private-sector Credit instruments - in the processes quashing powerful inflationary biases so easily in the past manipulated by our central bank. It is the nature of post-Bubble reflations to neglect the burst Bubble, fueling instead new and increasingly unwieldy ones.

No longer will Fed rate cuts rapidly transmit into huge home equity extraction, a surge in real estate transactions, inflating home prices, surging household net worth and spending, and self-reinforcing Credit expansion. It is worth noting that during the five quarters (ended 9/30) of unprecedented federal borrowings and policy-induced reflation, Household Net Worth actually declined $6.6 TN.

Moreover, the massive expansion of non-productive U.S. Credit further weakened global confidence in the dollar. As we witnessed throughout 2009, the new reflationary backdrop has liquidity inundating non-dollar asset classes, certainly including the emerging markets and commodities. Not surprisingly, foreign central banks began to more aggressively diversify away from U.S. financial assets and into hard assets.

I will suggest that 2009 marked a historic inflection point in global finance. I have argued that years of policy mismanagement led to the breakdown in the dollar reserve "system" - that for more than 60 years worked (with varying success) in restraining global Credit expansion. This year saw key inflationary/reflationary biases move decidedly from the "Core" (U.S.) to the "Periphery" (notably China, Asia, Brazil, India and the "emerging" markets). Importantly, a discredited dollar and the prospect of ongoing U.S. policy-induced currency devaluation created a backdrop of extraordinary market accommodation for "Periphery" Credit systems.

To an extent never before imagined, economies around the globe could partake in aggressive fiscal and monetary stimulus, rapidly expand Credit, reflate markets and economies - and have little worry about currency vulnerability or an outflow of speculative finance (a far cry from the '90s). The world had changed, and global asset prices were revalued based on a backdrop of expected ongoing dollar devaluation and newfound resiliencies in Credit system and financial flows to ("undollar") "Periphery" economies and non-dollar asset classes.

Chinese equities (Shanghai Composite) ended the year with a gain of 80.0%. While impressive, Chinese stocks finished last in the "bric" sweepstakes. Russian (RTS Index) stocks surged 128.6% in 2009, followed by Brazil's (Bovespa) 82.7% and India's (Sensex) 81.0% advances. Other notable gains included Taiwan's 78.3%, Thailand's 63.3%, South Korea's 49.7%, Indonesia's 87.0%, Argentina's 115.0%, Peru's 99.0%, Chile's 50.7%, Mexico's 45%, Turkey's 95.9%, Israel's 88.9%, Ukraine's 90.1%, Hungary's 73.4%, and Bulgaria's 61.7%.

Emerging debt markets enjoyed a huge year. JPMorgan's Emerging Market Bond Index ended the year with a 28% gain. After trading as high as 750, emerging market debt spreads ended the year at 290 bps - the low since pre-Lehman collapse. Mexico's dollar bond yields ended the year at 5.16% and Brazil at 5.05%. Brazil, in particular, found itself in the unusual position of being able to enjoy extravagant Credit expansion simultaneously with low interest rates and a robust currency. Credit systems around the globe have been set loose.

But it is China that resides at the very epicenter of global reflationary forces. A $600bn stimulus package and an incredible $1.0 TN first-half expansion of bank lending propelled a remarkable economic turnabout. After slowing modestly to 6.1% annualized in Q1, GDP jumped back to almost 9% by the third quarter. Some are now forecasting a return to double-digit growth in 2010. For the first time, 2009 saw Chinese vehicle sales surpass those of the U.S. Record Credit growth also stoked the reemergence of real estate inflation and rampant asset speculation.

It's my view that 2009 marked the onset of China's "terminal phase" of Credit Bubble excess. The China Bubble is enormous and it is historic. It's poised to make Japan's late-eighties Bubble era appear rather petite - and to perhaps even rival the scope of the U.S. Credit Bubble. Importantly, "terminal" phases of excess notoriously create acute financial and economic fragilities. They tend to foment perilous asset market distortions; distribute wealth poorly/inequitably; foster systemic malinvestment and structural impairment; and create a financial/economic structure dependent upon unrelenting Credit expansion and speculation. Only determined policymaking - with a willingness to pierce Bubbles and live with the consequences - can stem what evolves into powerful Bubble momentum and an expanding constituency supporting uninterrupted monetary accommodation.

Chinese foreign reserve holdings jumped almost 20% this year to a staggering $2.273 TN. Overall, official foreign reserves inflated almost $900bn during 2009 to a record $7.732 TN (5-year gain of 90%!). The Chinese, in particular, rummaged the world in search of commodities and resource assets. Global reflationary forces certainly fueled a spectacular 2009 for the traded commodities markets. The Goldman Sachs Commodities Index surged 50.3%. Gold jumped 24.2% and silver surged 49.4%. Crude oil jumped about 78% and gasoline surged around 93%. Copper gained 137%. The so-called "commodity currencies" posted big gains this year. The Brazilian real gained 32.7%, the South African rand 28.5%, the Australian dollar 27.6%, the New Zealand dollar 25.1%, the Norwegian krone 20.0%, and the Canadian dollar 15.9%.

Here at home, the Fed's zero interest-rate policy coerced U.S. savers out of money funds, CDs and Treasuries and stoked a spectacular return to risk markets. Stocks excelled and the riskiest stocks really excelled; junk excelled; collateralized debt obligations excelled; leveraged loans excelled; virtually everything excelled. It was a year of record flows into the emerging markets. It was a record year of junk bond issuance. After trading as high as 1300 bps, junk debt spreads ended the year at a 2009 low of 536 bps. Investment-grade spreads dropped from 290 bps in March to end the year at 123 bps.

A stock market revival emboldened bullish analysis. Many spoke of sound U.S. corporate balance sheets, disregarding the reality that this "strength" is a direct consequence of the massive expansion of household and, more recently, public sector debt. Many optimistically spoke of de-leveraging, while the government borrowing binge pushed total system debt further into uncharted territory. With bank lending stagnant at best, U.S. reflation was fueled by massive issuance of Treasury, corporate and municipal marketable debt securities.

The year saw four million jobs lost. Yet there was little in the way of readjustment to an economy that invests and produces more, consumes less, and operates on a reasonable amount of Credit. Indeed, the shift in (fiscal and monetary) policymaker objectives from system stabilization to one of inciting rapid market and economic recovery created an impediment to fundamental economic restructuring.

This year was pivotal from the perspective of the "Moneyness of Credit." The year 2008 saw the breakdown of "Moneyness" for Wall Street Credit instruments. No longer did the marketplace trust this Credit as a highly liquid store of nominal value ("money"). This change in fortunes had a profound impact on the capacity of this ("Ponzi finance") Credit mechanism to expand sufficiently to sustain both inflated asset prices and the underlying U.S. Bubble economy.

This year saw monumental interventions by the Fed and Treasury - essentially a case of Washington moving to back (directly and indirectly) the entire U.S. Credit system. As such, "Moneyness" was restored to U.S. debt instruments specifically on the grounds of a massive and open-ended commitment to federal debt issuance and guarantees; Federal Reserve monetization and market intervention; and a prolonged period of near-zero rates to bolster housing and mortgages, while forcing savers out to the risk assets.

With the U.S. system stabilized, an over-liquefied global financial "system" then rushed feverishly back to asset markets. Synchronized U.S. and global market intervention rejuvenated the hedge funds and, more generally, the "leveraged speculating community." Indeed, 2009 was a historic year of global, government-induced synchronized reflation and speculation in virtually all markets, everywhere. The greater the financial and economic fragilities, the more speculators could bank on an extended period of ultra-loose financial conditions.



Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin

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