The U.S. and Inflationism
For the week, the S&P500 slipped 0.4% (down 1.0% y-t-d), and the Dow declined 0.7% (down 1.0% y-t-d). The S&P 400 Mid-Caps slipped only 0.2% (up 1.6%), and the small cap Russell 2000 declined 0.5% (up 0.5%). The Banks gained another 1.7% (up 11.1%), while the Broker/Dealers lost 0.7% (down 0.8%). The Morgan Stanley Cyclicals dipped 0.4% (down 0.4%), while the Transports jumped 1.8% (up 0.9%). The Morgan Stanley Consumer index declined 0.4% (up 0.1%), and the Utilities sank 2.5% (down 7.2%). The Nasdaq100 declined 0.3% (down 2.2%), and the Morgan Stanley High Tech index declined 1.0% (down 3.2%). The Semiconductors dropped 1.4% (down 5.8%). The InteractiveWeek Internet index fell 1.2% (down 2.5%). The Biotechs advanced 1.5%, increasing 2010 gains to 10.5%. With bullion down about $3, the HUI gold index lost 1.6% (down 6.0%).
One-month Treasury bill rates ended the week at 7 bps, and three-month bills closed at 11 bps. Two-year government yields sank 14 bps to 0.73%. Five-year T-note yields dropped 17 bps to 2.22%. Ten-year yields declined 16 bps to 3.62%. Long bond yields fell 14 bps to 4.56%. Benchmark Fannie MBS yields fell 14 bps to 4.33%. The spread between 10-year Treasury and benchmark MBS yields widened 2 to 71 bps. Agency 10-yr debt spreads narrowed 2 to 34 bps. The implied yield on December 2010 eurodollar futures dropped 19.5 bps to 0.815%. The 10-year dollar swap spread declined 2 to 8.5, and the 30-year swap spread declined 1.5 to negative 14. Corporate bond spreads were mixed. An index of investment grade bond spreads widened one to 91 bps, while an index of junk spreads narrowed 14 to 519 bps.
Debt issuance picked up. Investment grade issuers included Comcast $2.4bn, United Technologies $2.25bn, Eastman Kodak $500 million, Enbridge Energy $500 million, and Federal Realty Investment Trust $150 million.
Junk bond funds saw inflows of $470 million. Junk issuers included Niska Gas Storage $800 million, Equinix $750 million, Oshkosh $500 million, Central Garden & Pet $400 million and Arvinmeritor $250 million.
I saw no converts issued.
International dollar debt sales were strong this week. Issuers included KFW $4.0bn, Nomura Holdings $3.0bn, European Investment Bank $1.25bn, National Australia Bank $1.25bn, VTB Capital $1.25bn, Bank of Ireland $1.0bn, Rentenbank $1.0bn, Institut Credito Oficial $1.0bn, RDS Ultra-Deepwater and Tayarra $270 million.
U.K. 10-year gilt yields sank 24 bps to 4.03%, and German bund yields dropped 18 bps to 3.10%. Bond yields in Greece fell 10 bps to 6.35%. The German DAX equities index declined 2.2% (down 6.0% y-t-d). Japanese 10-year "JGB" yields declined 3.5 bps to 1.295%. The Nikkei 225 was unchanged (down 4.0%). Emerging markets were mixed. For the week, Brazil's Bovespa equities index declined 1.6% (down 3.0%), and Mexico's Bolsa fell 1.7% (down 1.5%). Russia's RTS equities index declined 1.9% (down 3.1%). India's Sensex equities index advanced 1.5% (down 5.9%). China's Shanghai Exchange rallied 1.1% (down 6.9%). Brazil's benchmark dollar bond yields sank 17 bps to 4.99%, and Mexico's benchmark bond yields dropped 12 bps to 4.99%.
Freddie Mac 30-year fixed mortgage rates rose 8 bps to 5.05% (down 2bps y-o-y). Fifteen-year fixed rates increased 7 bps to 4.40% (down 28bps y-o-y). One-year ARMs dropped 8 bps to 4.15% (down 66bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 2 bps to 5.88% (down 101bps y-o-y).
Federal Reserve Credit expanded $5.2bn last week to a record $2.269 TN. Fed Credit is up $369bn, or 19.4%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 2/24) increased $5.6bn to a record $2.965 TN. "Custody holdings" expanded $384bn, or 14.9%, over the past year.
M2 (narrow) "money" supply jumped $40.7bn to $8.523TN (week of 2/15). Narrow "money" has increased $14.6bn y-t-d. Over the past year, M2 expanded 1.3%. For the week, Currency increased $1.8bn, and Demand & Checkable Deposits rose $16.0bn. Savings Deposits surged $26.1bn, while Small Denominated Deposits declined $3.7bn. Retail Money Funds added $0.4bn.
Total Money Market Fund assets (from Invest Co Inst) increased $5.0bn to $3.166 TN. In the first eight weeks of the year, money fund assets declined $128bn, with a one-year drop of $722bn, or 18.6%.
Total Commercial Paper outstanding rose $16.4bn last week to $1.154 TN. CP has declined $16.1bn, or 8.9% annualized year-to-date, and is down $370bn over the past year (24.3%).
International reserve assets (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.100 TN y-o-y, or 16.4%, to $7.815 TN.
Global Credit Market Watch:
February 25 - Bloomberg (Simon Kennedy and Keiko Ujikane): "Greece's debt rating may be cut within a month as it struggles to pare the European Union's largest budget deficit... Standard & Poor's said... it may lower its BBB+ rating by the end of March and Moody's... said today it may reduce its A2 grade in a few months."
February 26 - Bloomberg (Sonja Cheung and Caroline Hyde): "Corporate bond sales in Europe have plunged 50% to the lowest level in two months as Greece's struggle to cut the region's biggest budget deficit curbed investor demand for riskier company assets."
February 24 - Bloomberg (Karen Eeuwens): "A 'wall' of junk debt maturing in the next four years will increase the risk of corporate defaults in the U.S., according to Bank of America Merrill Lynch. More than $600 billion of high-yield bonds and loans are due to be repaid between 2012 and 2014... Almost 90% of loans outstanding mature in the next five years..."
February 23 - Bloomberg (Ian King): "Intel Corp., the world's largest chipmaker, and a group of about 20 venture capital firms will invest more than $3 billion in U.S. technology companies over the next two years, two people familiar with the matter said."
Global Government Finance Bubble Watch:
February 26 - Bloomberg (Brian Parkin and Rainer Buergin): "Germany is considering buying Greek bonds through state-owned lender KfW Group, German lawmakers said today. KfW is preparing measures that are part of a European plan to grant Greece as much as 25 billion euros ($34 billion) in aid should the need arise, said four lawmakers, who spoke on the condition of anonymity because the information is confidential."
The dollar index slipped 0.4% this week to 80. (up 3.1% y-t-d). For the week on the upside, the Japanese yen increased 2.9%, the Swedish krona 1.3%, the Norwegian krone 0.6%, the Singapore dollar 0.4%, the Swiss franc 0.2%, and the Euro 0.1% For the week on the downside, the British pound declined 1.5%, the Canadian dollar 1.2%, the South African rand 0.7%, the Australian dollar 0.3%, and the Brazilian real 0.3%.
February 24 - Bloomberg (Sebastian Boyd and Matt Craze): "Chile, the world's biggest copper producer, sold more than twice as much of the metal to China as to the U.S. and Japan in the last quarter of 2009, a sign of the Asian nation's growing dominance of materials consumption... China purchased $3.06 billion worth of Chilean copper cathodes and concentrate in the last three months of 2009, while purchases by the U.S., Japan and South Korea totaled $2.1 billion..."
February 23 - Bloomberg: "China's demand for import soybeans will remain 'huge and irreversible,' Han Jun, director of the rural economy department at the Development Research Center of the State Council, said... China cannot ensure self-sufficiency in all agricultural products and it has made it a state policy to import..."
The CRB index declined 1.1% (down 3.0% y-t-d). The Goldman Sachs Commodities Index (GSCI) fell 0.9% (down 1.4% y-t-d). Gold slipped 0.3% to $1,116 (up 1.7% y-t-d). Silver added 0.3% to $16.49 (down 2.1% y-t-d). April Crude declined 39 cents to $79.67 (up 0.4% y-t-d). April Gasoline declined 0.5% (up 6.6% y-t-d), and April Natural Gas dropped 5.3% (down 14% y-t-d). May Copper fell 2.8% (down 1.8% y-t-d). March Wheat rallied 3.0% (down 4.1% y-t-d), and March Corn jumped 4.6% (down 6.2% y-t-d).
China Bubble Watch:
February 23 - Bloomberg: "China may refrain from interest-rate increases until the fourth quarter after the Communist Party's Politburo reiterated a 'moderately loose' monetary policy, Bank of America-Merrill Lynch said. The party's top decision-making body... also reaffirmed a 'proactive' fiscal policy, the state-run Xinhua News Agency reported. The statement was ahead of the meeting of the National People's Congress, starting... on March 5... The latest statement signals 'that policy changes won't be a drastic U-turn and interest rates could be hiked only in the fourth quarter,' Lu Ting... at Merrill, said..."
February 24 - Financial Times (Jamil Anderlini): "China's state-controlled banks are rushing to raise money from public markets to shore up their balance sheets after a year of unprecedented loan growth and the introduction of stricter capital requirements by regulators. This week alone, Chinese lenders have announced plans to raise up to Rmb76bn ($11bn) through equity and bond sales, with at least Rmb150bn ($22bn) of bank fundraising in the pipeline, analysts say."
February 26 - Bloomberg (Ron Derby and Thomas Biesheuvel): "A diamond the size of a chicken egg unearthed in South Africa last year was sold for a record price to Hong Kong's Chow Tai Fook Jewellery Co..."
February 24 - Bloomberg (Scott Reyburn): "A collection of antique Chinese snuff bottles is expected to fetch at least 20 million pounds ($32 million) when it is offered at a series of sales in Hong Kong, the... auction house Bonhams said...Newly wealthy Chinese are keen to acquire high-quality objects from their heritage, particularly when associated with emperors from the Ming and Qing dynasties, said dealers. Prices for porcelain of these eras increased 48.2% between 2005 and 2009, according to... Art Market Research."
February 24 - Bloomberg (Frederik Balfour): "Hong Kong raised taxes on luxury homes for the first time in more than a decade, a move some analysts said may backfire by fueling speculation in the cheaper housing market."
February 24 - Bloomberg (Keiko Ujikane): "Japan's exports climbed at the fastest pace in almost 30 years in January... Shipments abroad advanced 40.9% from a year earlier... The growth was led by the biggest advance in exports to China since 1985, while shipments to the U.S. increased for the first time in more than two years..."
February 25 - Bloomberg (Minh Bui and Aki Ito): "Japan's total public debt is nearing the value of household wealth, a sign the government bond market is approaching a 'tipping point,' according to Mizuho Securities Co. ...net assets of Japanese households and total government debt. Net assets dropped to 1,065 trillion yen ($11.8 trillion) as of September and the Finance Ministry projects public borrowings will reach a record 973.2 trillion yen by March 2011."
February 23 - Bloomberg (Chris Bourke and Katsuyo Kuwako): "Tokyo replaced Hong Kong as the world's most expensive office location after rents in the Japanese capital declined at a slower pace, according to broker Cushman & Wakefield Inc."
February 26 - Bloomberg (Cherian Thomas and Kartik Goyal): "India's government pledged to shrink its budget deficit by more than one percentage point of gross domestic product this year from the highest level since 1994... Finance Minister Pranab Mukherjee... said he plans to narrow the gap to 5.5% of GDP in the year starting April 1 from 6.9% the previous year. He also said economic growth may reach 10% in 'not-too-distant future.'"
February 25 - Bloomberg (Cherian Thomas and Kartik Goyal): "India's economic growth may surpass 8% in the coming financial year, Finance Ministry projections showed... 'The economy has posted a remarkable recovery from the global recession,' according to the annual Economic Survey... 'The recovery creates scope for a gradual rollback, in due course, of some of the measures undertaken over the last 15 to 18 months.'"
Asia Bubble Watch:
February 25 - Bloomberg (Chinmei Sung): "Taiwan's export orders rose at a record pace in January as Chinese companies built inventory ahead of the Lunar New Year, spurring demand for the island's computers, mobile phones and television screens. Orders... increased 71.8% from a year earlier..."
February 26 - Bloomberg (Yu-huay Sun): "Taiwan's government sold land in downtown Taipei at record prices, indicating demand for premium housing units amid improving ties with China, the island's biggest property broker said."
February 24 - Bloomberg (Shamim Adam and Manirajan Ramasamy): "Malaysia emerged from its first recession in a decade last quarter and inflation is accelerating... Gross domestic product increased 4.5% in the fourth quarter from a year earlier..."
Latin America Bubble Watch:
February 25 - Bloomberg (Helder Marinho): "Banco do Brasil SA, Latin America's biggest lender by assets, said fourth-quarter profit rose 41% as the bank expanded its loan book... The lender's loan book increased 34% to 300.8 billion reais... Itau Unibanco Holding SA, Brazil's biggest bank by market value, said Feb. 9 that fourth-quarter profit rose 72% to 3.21 billion reais."
February 23 - Bloomberg (Adriana Brasileiro and Andre Soliani): "Brazil's inflation through mid- February quickened to the fastest pace since April 2003, as a consumer-led recovery in Latin America's biggest economy picks up speed. Brazil's consumer prices... rose 0.94% in the month..."
February 25 - Bloomberg (Adriana Brasileiro): "Brazil's jobless rate rose last month from December's one-year low as workers who were temporarily employed for the year-end holidays went back to the market... The country's unemployment rate rose to 7.2% in January from 6.8% in December..."
Unbalanced Global Economy Watch:
February 26 - Bloomberg (Svenja O'Donnell): "Britain emerged from recession at a faster pace than previously estimated in the fourth quarter... Gross domestic product rose 0.3% from the third quarter..."
February 23 - Bloomberg (Jana Randow): "German business confidence unexpectedly fell for the first time in 11 months in February as the coldest winter in 14 years damped retail sales and construction."
February 26 - Bloomberg (Gelu Sulugiuc): "Denmark's economy grew for a second quarter in the final three months of last year as stimulus measures shored up household incomes and boosted consumer spending."
February 24 - Bloomberg (Maria Levitov): "Citigroup Inc. raised its forecast for the pace of Russian economic growth to 6.2% this year as consumer spending accelerates."
U.S. Bubble Economy Watch:
February 26 - Bloomberg (Bob Willis): "Sales of previously owned U.S. homes unexpectedly dropped 7.2% in January to a seven-month low... The decline to an annual pace of 5.05 million... was the second-largest on record after December's 16.2% plunge."
February 24 - Bloomberg (Bob Willis): "Mortgage applications in the U.S. fell for a third consecutive week... The Mortgage Bankers Association's index dropped 8.5% in the week ended Feb. 19... The series of declines is the longest since October and purchase applications fell to the lowest level since May 1997..."
Central Bank Watch:
February 25 - Bloomberg (Simon Kennedy and Jana Randow): "European Central Bank officials dismissed a proposal by International Monetary Fund economists that monetary-policy makers increase inflation targets to 4%, arguing that such a shift would damage economies. 'I can only reject the idea of raising inflation rates permanently,' ECB Executive Board member Juergen Stark said... Bundesbank President Axel Weber wrote in a newspaper column today that the Washington-based lender is 'playing with fire.' The criticisms suggest the... ECB will ignore this month's suggestion by IMF economists led by Olivier Blanchard that central banks raise their inflation targets so that they have more scope to react to shocks such as the recent financial crisis..."
Real Estate Watch:
February 25 - Bloomberg (Dawn Kopecki): "The Obama administration may expand efforts to ease the housing crisis by banning all foreclosures on home loans unless they have been screened and rejected by the government's Home Affordable Modification Program. The proposal... 'prohibits referral to foreclosure until borrower is evaluated and found ineligible for HAMP or reasonable contact efforts have failed,'..."
February 24 - Bloomberg (Dan Levy and David Henry): "The default rate for commercial property mortgages held by U.S. banks more than doubled in the fourth quarter and may reach a peak of 5.4% at the end of next year, according to Real Capital Analytics Inc. The default rate for loans on office, retail, hotel and industrial properties surged to 3.8% from 1.6% a year earlier... The default rate for loans on apartment buildings climbed to 4.4% from 1.8%."
February 26 - Bloomberg (Dawn Kopecki): "Fannie Mae, the mortgage-finance company under federal conservatorship, said it will seek $15.3 billion in aid from the U.S. Treasury after posting a 10th straight quarterly loss. A fourth-quarter net loss of $16.3 billion... pushed the company to request its fifth draw on an unlimited lifeline from the government..."
February 24 - Bloomberg (Dawn Kopecki): "Fannie Mae and Freddie Mac... are reporting fourth-quarter losses after writing down the value of tax credits and setting aside money for housing-market losses. Freddie Mac posted a $6.5 billion net loss... Fannie Mae, which plans to report official results this week, said it's taking a $5 billion charge for the same reason."
New York Watch:
February 22 - Bloomberg (Michael Quint): "New York's budget deficit for this year may be $2 billion, or 43% wider than projected earlier this month by the Division of Budget, comptroller Thomas DiNapoli said."
February 26 - Bloomberg (Janet Frankston Lorin): "Anxiety over the recession is trumping the angst of New York City parents to get their children into elite private schools. Fewer children took entrance exams for private elementary schools, continuing a decline that began last year, as the economy hurt parents' ability to pay annual tuition of more than $30,000."
February 25 - Financial Times (Nicole Bullock): "As protesters and strikers took to the streets of Athens this week demonstrating against cutbacks aimed at stemming the Greek debt crisis, questions were being asked in the US about whether similar financial stress could erupt in states there. The economic downturn has decimated tax collections, ripping large holes in budgets that state lawmakers have slashed spending to plug. Last week, new research showed that states also face a gap of at least $1,000bn for pension and healthcare pledges to state workers. Similarities have been drawn between US states and some eurozone members because they are grappling with an global economic slowdown and large budget deficits."
February 26 - Bloomberg (Jeremy R. Cooke): "Benchmark state and local government borrowing costs slid to the lowest in two months as tax-exempt bond sales eased this week to less than $5 billion. Yields on top-rated general obligations due in 10 years reached 3.01%..."
February 24 - Bloomberg (Tomoko Yamazaki): "Hedge fund assets may climb 14% this year as proposed regulations ease the concerns of risk-averse investors, according to Eurekahedge Pte. Assets may reach $1.68 trillion by the end of the year..."
February 25 - Bloomberg (Saijel Kishan and Katherine Burton): "Florida's state pension system, manager of $112 billion... is set to decide next week on the size of its first investment in hedge funds. Executives of the fourth-largest state retirement program in the U.S.... will make the move amid a 7% shortfall in its ability to pay future benefits, the first in 13 years. Wisconsin's pension also plans its initial allocation this year, while Boeing Co.'s probably will raise its holdings. Public and private pensions are increasing hedge-fund commitments after slowing the flow of cash at the end of 2008."
The U.S. and Inflationism
When the yen was under selling pressure late last year, media focus turned to Japan's structural weaknesses and serious debt problem. The yen reversed course and is up 4.6% y-t-d, by far the best performance among the major currencies. To begin 2010, the markets have turned on the Greek and periphery European bond markets. Attention quickly shifted to European structural weakness and their serious debt problems. The dollar has been rallying, which has for the most part kept attention away from our structural weaknesses and serious debt problems - for now.
Today from the Financial Times' Nicole Bullock: "As protesters and strikers took to the streets of Athens this week demonstrating against cutbacks aimed at stemming the Greek debt crisis, questions were being asked in the US about whether similar financial stress could erupt in states there. The economic downturn has decimated tax collections, ripping large holes in budgets that state lawmakers have slashed spending to plug... Similarities have been drawn between US states and some eurozone members because they are grappling with an global economic slowdown and large budget deficits. With warnings from states from New York to California that they are running out of cash or suspending bill payments, it is logical to ask whether they will default - the same question that Greece is facing. In spite of these strains, experts in the $2,800bn municipal bond market where state and local government raise money, are urging calm. This helps to explain why yields in the municipal bond market have been stable to lower."
Bloomberg news ran an article today, "Tax-exempt Yields Slide to Two-Month Low..." Seemingly insatible demand allows top-rated municipal issuers to sell 10-year bonds these days at about 3.0%. Muni risk premiums collapsed in 2009, right along with investment grade corporates, junk bonds, agency debt, and agency MBS. Risk spreads remain depressed.
A Bloomberg reporter this week asked me "whether markets are underestimating risk? Is the VIX too low? What does it mean?" I gave him too long of an answer. I tried to explain my view that massive Treasury and agency MBS issuance - in concert with enormous Federal Reserve monetization - stabilized an inherently unsound Credit system. This unprecedented expansion of government finance either reflated (in the case of financial assets) or stabilized (in the case of real estate) asset markets, which stabilized the level of finance flowing to the real economy. Much of the post-Bubble Credit system remains impaired, resulting in an especially uneven flow of finance throughout.
Are markets underestimating risk? Well, I would view low risk premiums as simply an indicator of market confidence that Washington policymakers (Treasury and Fed) will forge ever ahead with their reflationary scheme - and that these measures will - until they don't - underpin securities prices and the real economy. The markets are assured that ongoing Trillion dollar deficits and near-zero interest rates will safeguard an amount of system Credit expansion sufficient to bolster asset prices, incomes, corporate cash flows, government receipts, and economy-wide spending. Market risk premiums are indicating faith that historic government-induced reflation will support the values of Credit instruments (financial assets) throughout entire the system. Students of Hyman Minsky will recognize the existance of "Ponzi Finance" dynamics.
For now, the markets are confident that the Bernanke Federal Reserve and Treasury enjoy all the flexibility they require to sufficiently expand system Credit. And it is this confidence that has ensured marketplace accommodation of massive U.S. federal government Credit expansion. Greek - and other European - policymakers, on the other hand, enjoy little capacity to reflate. This leaves market participants fearful of Credit constraints feeding a cycle of economic weakness, asset market problems and general angst.
In my readings of the history of monetary management and central banking, I was repeatedly struck by the long history of European scorn for U.S. monetary practices. Going back to at least the nineteenth century, there has been a longstanding view that we lacked both monetary discipline and the proper framework to ensure a stable Credit system and currency. Traditionally, our policymakers lacked an understanding of Credit and, when in a jam, would invariably resort to inflationism.
I was reminded of this history this week when I read European policymaker responses to an IMF paper proposing that central banks consider raising their inflation targets to 4%. The IMF paper, co-authored by IMF chief economist Olivier Blanchard (MIT and Harvard), suggests that crisis-period policymaking would have benefited from a higher pre-crisis inflation level. ECB member and Bundesbank President Axel Weber said the IMF was "playing with fire" and such a proposal was "grossly negligent and harmful." ECB Executive Board member Juergen Stark called the proposal "most unhelpful" and stated that "there is no evidence whatsoever to support that deviating from price stability and aiming at an inflation rate of 4% would enhance economic prosperity or growth." He added, "I do see the temptation for governments to ask for higher inflation in order to monetize the dramatic buildup of public debt in nearly all advanced economies."
Nowhere does the temptation for higher inflation seem as indomitable as it does here at home. And the markets are fine with it. In the old days, at least the bond "vigilantes" would have objected. But we live in the financial age where "spread trades," myriad Credit instruments, and speculator profits are all bolstered by reflationary policymaking. Throughout the system, many feel they would benefit from some additional inflation, while few fear they would be disadvantaged. Federal Reserve monetization is cheered. Inflationism dogma is as beloved as ever.
Former Fed governor Frederic Mishkin teamed up with Goldman's Jan Hatzius, Deutsche Bank's Peter Hooper, New York University's Kermit Schoenholtz, and Princeton's Mark Watson for a paper presented today at the University of Chicago. Their work introduces a new measurement of financial conditions. This research also details their study that suggests that financial conditions tightened at the end of 2009 and remain "impaired" because of problems in the so-called shadow banking system. Dr. Mishkin (now at Columbia) was on CNBC this morning trumpeting the view that "monetary policy needs to be accommodative...for an extended period."
From the Wall Street Journal's Jon Hilsenrath's: "One of the most important drivers of the economists' financial-conditions index was the asset-backed securities markets, where commercial real estate loans, car loans and many other kinds of bank loans were financed during the credit boom." And from these economists: "The new financial conditions index would be the only means available to assess the impact of policy choices with interest rates near zero"
Well, I'm compelled to disagree with both the focus of this research and the premise that financial conditions are anything but loose. The post-Bubble ABS market is today an especially poor indicator of system financial conditions. It would be akin to significantly weighting private-equity financing of technology startups as an indicator of general financial conditions after the bursting of the technology Bubble. The housing, mortgage and ABS manias/Bubbles have burst and will not be meaningful reflationary forces, at least directly. It is a major, yet predictable, error to use unavoidable post-Bubble Credit impairment as justification for loose financial conditions and policymaker accommodation of new excesses and additional Bubbles.
The pricing and expansion of mortgage Credit was by far the most important indicator of problematically loose financial conditions from 2002 through the Bubble period. Today, financial conditions should be gauged primarily by the market pricing and associated expansion of government finance. It is the unfolding Government Finance Bubble that today poses great systemic risk - not the ABS, "repo" or other components of the wreckage formally known as the "shadow banking system." That was the old Bubble. First and foremost, policymakers should be focused on ensuring that they do not foment even more dangerous Bubbles and systemic fragilities. The Creditworthiness of our entire Credit system and the credibility of monetary management and "money" are at stake.
For now, the markets are pleased to accommodate U.S. reflationary policymaking. The dollar has been strong of late, with Treasury/agency/GSE MBS yields remaining incredibly low. The market backdrop kind of makes ECB comments extolling the virtues of price stability - while lambasting inflationism - seem arcane and out of touch. Meanwhile, the markets have begun to impose discipline on profligate borrowers in Europe, while rewarding profligacy here at home (and elsewhere). One would not expect such a divergence to last forever. And I don't expect our current competitive advantage in all things "inflationism" to pay lasting dividends for our nation's currency, debt markets or economy.