Pondering the End of QE2
For the week, the S&P500 increased 1.0% (up 6.8% y-t-d), and the Dow gained 1.0% (up 7.0%). The broader market was strong. The S&P 400 Mid-Caps gained 1.3% (up 8.3%), and the small cap Russell 2000 rose 1.5% (up 6.5%). The Banks slipped 0.6% (up 5.7%), while the Broker/Dealers gained 1.1% (up 6.9%). The Morgan Stanley Cyclicals added 0.5% (up 8.2%), and the Transports increased 1.2% (up 3.7%). The Morgan Stanley Consumer index increased 0.5% (up 1.4%), while the Utilities slipped 0.8% (up 0.9%). The Nasdaq100 added 0.6% (up 7.9%), and the Morgan Stanley High Tech index jumped 1.5% (up 9.1%). The Semiconductors rose 1.9% (up 14.5%). The InteractiveWeek Internet index gained 0.8% (up 7.8%). The Biotechs increased 0.5% (up 0.2%). With bullion rallying $32, the HUI gold index rallied 5.8% (down 3.4%).
One-month Treasury bill rates ended the week at 7 bps and three-month bills closed at 9 bps. Two-year government yields were 8 bps lower at 0.75%. Five-year T-note yields ended the week down 9 bps to 2.23%. Ten-year yields declined 5 bps to 3.58%. Long bond yields ended the week little changed at 4.70%. Benchmark Fannie MBS yields were 5 bps lower to 4.37%. The spread between 10-year Treasury yields and benchmark MBS yields were little changed at 79 bps. Agency 10-yr debt spreads declined one basis point to 5.5 bps. The implied yield on December 2011 eurodollar futures sank 14.5 bps to 0.70%. The 10-year dollar swap spread declined 1.5 to 10.25 bps. The 30-year swap spread declined 3 bps to negative 24.75 bps. Corporate bond spreads were quiet. An index of investment grade bond risk was unchanged at 80 bps. An index of junk bond risk declined 3 bps to 383 bps.
Investment grade issuers included JPMorgan $3.0bn, Thermo Fisher Scientific $2.2bn, Noble Energy $850 million, Honeywell $1.4bn, Unitedhealth $750 million, Dover Corp $800 million, Viacom $500 million, Coca-Cola Enterprises $400 million, New York Life $400 million, Ryder $350 million and National Rural Utility $300 million.
Junk bond funds saw inflows of $375 million (from Lipper). Issuers included Clear Channel $1.0bn, Burlington Coat Factory $450 million, Claire's $450 million, Dave & Busters $180 million, and Cambium Learning $175 million.
Convertible debt issues included Prospect Capital $170 million.
International dollar debt issuers included Mexico $3.0bn, Intesa Sanpaolo $3.0bn, Ukraine $1.5bn, Deutsche Bank $1.3bn, Bank of Tokyo Mitsubishi $1.0bn, Country Garden $900 million, Afren $500 million, and BRT $460 million.
U.K. 10-year gilt yields declined 6 bps this week to 3.80% (up 41bps y-t-d), and German bund yields dipped 4 bps to 3.25% (up 29bps). Ten-year Portuguese yields jumped 20 bps to 7.37%. Spanish yields were unchanged at 5.35%, while Irish yields jumped 11 bps to 9.00%. Greek 10-year bond yields rose 20 bps to 11.57%. The German DAX equities index added 0.8% (up 7.4% y-t-d). Japanese 10-year "JGB" yields were little changed at 1.30% (up 18bps y-t-d). Japan's Nikkei jumped 2.2% (up 6.0%). Emerging markets were mostly higher. For the week, Brazil's Bovespa equities index rallied 3.5% (down 1.8%), and Mexico's Bolsa gained 1.4% (down 2.7%). South Korea's Kospi index gained 1.8% (down 1.8%). India's equities index rallied 2.7% (down 11.2%). China's Shanghai Exchange jumped 2.6% (up 3.3%). Brazil's benchmark dollar bond yields dipped 2 bps to 4.82%, while Mexico's benchmark bond yields added one basis point to 4.70%.
Freddie Mac 30-year fixed mortgage rates declined 5 bps last week to 5.00% (up 7bps y-o-y). Fifteen-year fixed rates dipped 2 bps to 4.27% (down 6bps y-o-y). One-year ARMs were rose 4 bps to 3.39% (down 84bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates unchanged at 5.57% (down 35bps y-o-y).
Federal Reserve Credit jumped $22.6bn to a record $2.492 TN (15-wk gain of $211bn). Fed Credit was up $228bn from a year ago, or 10.1%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 2/16) surged $20.9bn to a record $3.384 TN. "Custody holdings" were up $425bn from a year ago, or 14.4%.
M2 (narrow) "money" supply increased $5.6bn to a record $8.874 TN. Over the past year, "narrow money" grew 4.2%. For the week, Currency added $0.9bn. Demand and Checkable Deposits dropped $35.9bn, while Savings Deposits jumped $43.5bn. Small Denominated Deposits declined $2.8bn. Retail Money Funds were little changed.
Total Money Fund assets increased $5.6bn last week to $2.756 TN. Money Fund assets dropped $370bn over the past year, or 11.8%.
Total Commercial Paper outstanding jumped $26.9bn to a 12-wk high $1.041 Trillion. CP is now up $72bn y-t-d, although it was down $96bn, or 8.5% from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $1.476 TN y-o-y, or 18.9%, to a record $9.292 TN.
Global Credit Market Watch:
February 17 - Bloomberg (Kathleen M. Howley): "A record share of U.S. mortgages were in the foreclosure process at the end of 2010, matching the all-time high, as lenders and servicers delayed home seizures to investigate charges of improper documentation. About 4.63% of loans were in foreclosure in the fourth quarter, up from 4.39% in the previous three months, the Mortgage Bankers Association said... The combined share of foreclosures and loans with overdue payments was 14%, or about one in every seven mortgages."
Global Bubble Watch:
February 16 - Bloomberg: "Emerging-market central banks are failing to counter rising inflation, risking a 'scary' and 'synchronized' global monetary-policy tightening as early as next year, JPMorgan Chase & Co. said. Real interest rates in emerging markets remain at 'recession lows' because policy makers believe increases would pressure currency pegs to the dollar and risk exacerbating capital inflows, said chief economist Bruce Kasman..."
February 15 - Bloomberg (Jack Jordan): "Money managers are more bullish on global stocks this month than at any time in the past decade, according to a BofA Merrill Lynch Global Research survey. A net 67% of respondents, who together manage $569 billion, had an 'overweight' position on global equities, the highest level since the survey first asked the question in April 2001. That compares with 55% in January and 40% in December. Meanwhile, a net 9% is 'underweight' cash, the lowest allocation since January 2002."
February 16 - Bloomberg (John Detrixhe and Jody Shenn): "Investors are ramping up their use of borrowed money to boost returns in credit markets... A Federal Reserve measure tracking lending against bonds not tied to the U.S. government rose 42% in the past two years to $127.4 billion. That's within $500 million of a level last seen at the end of September 2008... A Fed survey of Wall Street's biggest bond dealers published last month shows hedge funds demanding more credit and banks loosening terms. Goldman Sachs... says signs are emerging of a 'gradual recovery' in borrowing to buy safer, lower-yielding debt"
February 15 - Bloomberg (Sapna Maheshwari): "Bain Capital LLC and Apollo Global Management LLC are taking advantage of the lowest borrowing costs in six years to extract money from companies they've acquired and shift potential losses to creditors. Borrowers have raised $6.7 billion through bonds and loans this month to pay dividends, accounting for 16% of sales, from $4.6 billion, or 7%, in January, according to Standard & Poor's Leveraged Commentary and Data. They sold $47 billion of debt last year, or 9% of offerings, to pay owners, compared with $11.7 billion in 2008 and 2009."
February 15 - Bloomberg (Dawn Kopecki): "JPMorgan Chase & Co. racked up a perfect trading record for the second half of last year, making money every day after accomplishing the same feat in the first three months of the year. Traders at the... bank made an average of $76 million a day last year, down from $84 million in 2009... JPMorgan's average daily trading revenue was $21 million in 2008, $39 million in 2007, $47 million in 2006 and $37 million in 2005... The investment bank lost money on eight days last year..."
February 14 - New York Times (Steven Greenhouse): "Governors and mayors facing large deficits have set their sights on a relatively new target -- the soaring expense of health benefits for millions of retired state and local workers. As they contend with growing budget deficits and higher pension costs, some mayors are complaining that their outlays for retiree health benefits are rising by 20% a year -- a result of the wave of retirements of baby boomers and longer life expectancies on top of the double-digit rate of health care inflation. The nation's governors face a daunting $555 billion in unfunded liabilities to finance retiree health coverage. The Pew Center on the States calculated those long-term obligations last year, saying New Jersey had the largest amount, $68.9 billion, with California second, at $62.5 billion."
February 17 - Financial Times (Nicole Bullock): "Cash-strapped US states and cities face the prospect of downgrades after Fitch Ratings changed the way it analyses their burgeoning pension bills... The changes to the way it assesses pension liabilities come amid growing concern over the scale of municipal debt problems and the effect on state and city finances of generous, unfunded public sector pension schemes that will run for many years. Sharp falls in equities and other risky assets during the financial crisis reduced the funding levels of nearly all these pension plans, increasing the pressure on states and local governments when they have even less cash because of dwindling tax revenues... Revenues have tumbled while spending has been rising. 'The key questions are whether states and local governments are funding their pensions, how much it is taking up of their general fund and concern about the crowding out of spending for other needs,' said Laura Porter at Fitch."
February 14 - Bloomberg (Dan Seymour): "Statistics on letter-of-credit issuance to municipalities last year indicate the municipal credit market is in dire trouble. But the statistics only tell part of the story. According to the numbers, banks wrote just $11.79 billion of letters of credit guaranteeing municipal debt in 2010. The last time banks wrote so few LOCs was 1999. The latest figure represents a 49% drop from 2009 and an 84% plunge from 2008, according to Thomson Reuters. Former stalwarts of the market like Royal Bank of Canada and Bank of New York Mellon disappeared from the LOC league tables. Nine of the top 10 municipal LOC banks in 2009 curtailed their business in 2010."
February 16 - Bloomberg (Mark Niquette): "Ohio Governor John Kasich has a toll-road to lease. Next door in Pennsylvania, Governor Tom Corbett is offering a deal on selling booze. And the Port Authority of New York & New Jersey has a bridge if you're buying. U.S. state budget deficits that may reach $125 billion in the next fiscal year are forcing governors to turn to banks and builders including Macquarie Capital (USA) Inc. and Bouygues SA to help lease or sell assets ranging from turnpikes and lotteries to liquor stores while seeking investors in bridges, roads and other public facilities."
The U.S. dollar index % to 78. (down % y-t-d). On the upside for the week, the Norwegian krone increased 3.2%, the Swiss franc 3.0%, the South African rand 1.9%, the British pound 1.5%, the South Korean won 1.5%, the Swedish krona 1.5%, the Australian dollar 1.3%, the Danish krone 1.1%4, the Euro 1.0%, the Singapore dollar 0.7%, the Japanese yen 0.3%, the Brazilian real 0.2% and the New Zealand dollar 0.1%. On the downside, the Taiwanese dollar declined 0.7%.
Commodities and Food Watch:
February 17 - Bloomberg (Madelene Pearson): "Gold imports by India, the largest user, climbed to a record in 2010... according to the World Gold Council. Purchases totaled 918 metric tons... That exceeds the projection of about 800 tons made last month by Ajay Mitra, the group's managing director for India and the Middle East... "Indications of the first month of the year has seen a very strong demand, so the momentum continues," Mitra said... Fourth-quarter imports rose to 265 tons from 204 tons a year earlier..."
February 17 - Bloomberg: "Gold investment in China, the second-largest consumer after India, may gain 40% to 50% this year as investors increase purchases of the precious metal as a store of value, said the World Gold Council. 'Chinese investors have shown great enthusiasm amid lack of other alternative investments,' Wang Lixin, China representative for the council, said..."
February 16 - Reuters (Fayen Wong): "Demand in China for physical gold and gold-related investments is growing at an 'explosive' pace and its appetite for the yellow metal is poised to remain robust amid inflation concerns, said an Industrial and Commercial Bank of China (ICBC) executive. ICBC, the world's largest bank by market value, sold about 7 tonnes of physical gold in January... nearly half the 15 tonnes of bullion sold in the whole of 2010, said Zhou Ming, deputy head of the bank's precious metals department... 'We are seeing explosive demand for gold. As Chinese get wealthy, they look to diversify their investments and gold stands out as a good hedge against inflation...There is also frantic demand for non-physical gold investments. We issued 1 billion yuan worth of gold-price-linked term deposits in 2010, but we managed to sell the same amount over just a few days in January this year,' Zhou said... The surge, which comes as Chinese investors look for insurance against rising inflation and currency appreciation... 'Unlike the property market, investment in the gold sector is something the government is encouraging," he said."
February 15 - Bloomberg (Luzi Ann Javier and Susan Li): "Global food supplies will face 'massive disruptions' from climate change, Olam International Ltd. predicted, as Agrocorp International Pte. said corn will gain to a record, stoking food inflation and increasing hunger. 'The fact is that climate around the world is changing and that will cause massive disruptions,' Sunny Verghese, chief executive officer at Olam, among the world's three biggest suppliers of rice and cotton, said... 'We're friendly to wheat, corn and soybeans and bearish on rice.' ...As food becomes less available and more expensive, 'hoarding becomes widespread,' Abdolreza Abbassian, a senior economist at FAO, said..."
February 17 - Bloomberg (Tony C. Dreibus and Luzi Ann Javier): "Cotton topped $2 in New York for the first time ever and rose to a record in Zhengzhou on increasing demand from China and after Australia, the fourth-largest exporter, lowered its production estimate."
The CRB index rose 1.2% (up 2.7% y-t-d). The Goldman Sachs Commodities Index added 0.7% (up 4.1%). Spot Gold jumped 2.4% to $1,390 (down 2.2%). Silver surged 7.7% to $32.30 (up 4.4%). March Crude recovered 62 cents to $86.20 (down 5.7%). March Gasoline jumped 3.5% (up 5.0%), while March Natural Gas declined 0.9% (down 12%). May Copper declined 1.1% (up 1%). March Wheat dropped 5.2% (up 3.5%), while March Corn added 0.5% (up 12.8%).
China Bubble Watch:
February 15 - Bloomberg (Dawn Kopecki): "China's inflation accelerated in January as prices excluding food rose the most in at least six years... Consumer prices rose 4.9% from a year earlier after a 4.6% December gain... A separate central bank report showed banks signed 1.04 trillion yuan ($158bn) in new loans, less than forecast while still the third-highest January total. 'Inflationary pressures haven't abated and China has already entered into an era of structural inflation,' said Liu Li-gang, an Australia & New Zealand Banking Group economist... The acceleration in inflation reflects rising rents, a 48% surge in money supply in two years..."
February 18 - Bloomberg: "China's central bank raised reserve requirements for lenders for the second time this year to counter inflation and curb property-price gains. Reserve ratios will increase half a percentage point... Today's move came 10 days after China raised interest rates."
February 17 - Bloomberg: "China's central bank will use an extra measure of liquidity called 'society-wide financing' to help guide monetary policy, said Sheng Songcheng, the head of the agency's statistics department. Focusing on money supply and yuan lending is no longer enough as financial products and markets evolve, Sheng wrote in an article posted on the People's Bank of China website... The extra gauge includes banks' off-balance sheet lending, local- and foreign-currency loans, and companies' bond and stock sales... Inflation and asset-bubble risks in the fastest-growing major economy underscore the need for an accurate picture of how money is driving growth. Banks flooded the financial system with cash from late 2008, breaking records for lending, to drive the nation's recovery from the global financial crisis... So-called society-wide financing, the overall amount of money feeding the economy, is more closely correlated than local-currency lending with major economic indicators such as gross domestic product and inflation, Sheng said. Using the measure, financing expanded 28% annually from 2002 to 2010, rising last year to 14.27 trillion yuan ($2.2 trillion), or the equivalent of 36% of GDP..."
February 15 - Bloomberg: "Chinese banks extended 1.04 trillion yuan ($158 billion) of new loans in January, Xinhua News Agency reported... Premier Wen Jiabao's government is grappling with elevated inflation and the risk of bubbles in the real-estate market after a boom in credit drove the nation's recovery from the financial crisis. Asian central banks may need to raise interest rates further to limit the threat of overheating and prevent a 'hard landing,' International Monetary Fund Managing Director Dominique Strauss-Kahn said... 'Excessive liquidity remains a big headache for policy makers and continued strong lending growth will complicate authorities' efforts to contain inflation and asset prices gains,' Fang Sihai, chief economist at Hongyuan Securities... Banks extended 7.95 trillion yuan of new loans last year, exceeding the government's target of 7.5 trillion yuan."
February 17 - Bloomberg: "Foreign direct investment in China climbed in January, adding to record inflows last year that are complicating Premier Wen Jiabao's efforts to tame inflation in the world's fastest-growing major economy. Investment rose 23.4% to $10 billion last month from a year earlier..."
February 15 - Bloomberg (Mayumi Otsuma): "The Bank of Japan raised its economic assessment for the first time in nine months as faster overseas growth bolsters exports and production. 'Japan's economy is gradually emerging from the current deceleration phase,' the central bank said..."
February 16 - Bloomberg (Madelene Pearson): "Metals demand in India, Asia's second-fastest growing major economy, may double in five years and remain robust for a decade, fueled by rising car sales and higher spending on infrastructure projects, analysts said. Growth in demand for base metals may jump 10% to 15% this year, said Sumit Verma, an analyst at broker Geojit Comtrade Ltd. ...'Steel demand may double in the next five years and I will not be surprised if demand for non-ferrous metals such as copper and aluminum grow at twice the pace,' said Kunal Shah, head of commodity research with Nirmal Bang Securities..."
Asia Bubble Watch:
February 16 - Bloomberg (Chinmei Sung): "India and China are among the majority of Asia-Pacific nations where inflation is outpacing benchmark interest rates, adding to the case for further increases in borrowing costs... The... 'real rate' is negative in nine of 15 markets, skewing incentives for people to spend rather than save. 'Many Asian economies have negative real rates,' said David Cohen, head of Asian forecasting at Action Economics... 'So the region's central banks will continue their recent tightening steps, and if they don't, they could be punished by a flight of capital from their markets.'"
February 18 - Bloomberg (Shamim Adam and Barry Porter): "Malaysia's economy expanded 4.8% last quarter, pushing full-year growth to the fastest pace since 2000 and putting pressure on the central bank to raise interest rates... The economy grew 7.2% last year, the most in a decade."
February 17 - Bloomberg (Simeon Bennett): "Singapore's economy may expand as much as 10.1% in the first quarter, the city-state's Business Times reported..."
February 17 - Bloomberg (Shamim Adam and Andrea Tan): "Singapore raised its inflation and export forecasts for 2011 after the economy expanded at a record pace last year, sustaining pressure on the central bank... Consumer prices may climb as much as 4% this year..."
February 17 - Bloomberg: "Vietnam's central bank raised the refinancing rate to 11% as part of its efforts to curb accelerating inflation, increasing borrowing costs for the first time since early November. The State Bank of Vietnam raised the rate from 9%, effective today..."
February 15 - Bloomberg (Ben Sharples): "Asian utilities begin negotiations with coal producers this week and may be forced to pay as much as 36% more for their fuel after heavy rain in Australia, Indonesia, South Africa and Colombia disrupted output."
Unbalanced Global Economy Watch:
February 16 - Bloomberg (Nicholas Larkin): "Countries in Latin America and Africa, including Bolivia and Mozambique, are most at risk of food riots as prices advance, the United Nations reported. The past month's protests in North Africa and the Middle East were partly linked to agriculture costs... Other countries where expensive food imports may become a 'major burden' include Uganda, Mali, Niger and Somalia in Africa, Kyrgyzstan and Tajikistan in Asia and Honduras, Guatemala, and Haiti in Latin America, he said."
February 15 - Bloomberg (Sandrine Rastello): "Rising global food prices have pushed 44 million more people into 'extreme' poverty in developing countries since June, the World Bank estimates. The... World Bank said its food-price index jumped 15% between October and January, led by wheat costs. The gauge is now 3% below a 2008 peak, when a food crisis sparked riots in more than a dozen countries. 'Global food prices are rising to dangerous levels and threaten tens of millions of poor people around the world,' World Bank President Robert Zoellick said... 'The price hike is already pushing millions of people into poverty and putting stress on the most vulnerable, who spend more than half of their income on food.'"
February 15 - Financial Times (Javier Blas): "The number of chronically hungry people is approaching 1bn, the level last seen during the 2007-08 food crisis, in the clearest sign yet of the humanitarian impact of rising agriculture commodities prices in poor countries. Robert Zoellick, World Bank president, said... that the rise in food prices had already pushed an additional 44m people into extreme poverty... The rate of the increase suggests the number of undernourished people, which the UN said last year was 925m, will now hit 1bn by the end of this year as the effect of spiralling prices filters through. 'The trends towards the 1bn are worrisome,' said Mr Zoellick. 'Global food prices are rising to dangerous levels. The price hike is already pushing millions of people into poverty and putting stress on the most vulnerable, who spend more than half of their income on food.'"
February 17 - Bloomberg (Theophilos Argitis and Rebecca Christie): "Group of 20 finance chiefs remain divided over the next steps to narrow global economic imbalances as they squabble over how to reach a diagnosis. French Finance Minister Christine Lagarde... said she's hoping for an accord on which indicators should be used to analyze imbalances that economists blame in part for the financial crisis. While there's broad agreement to use the current account as a key measure, some countries are opposed, said a Canadian official..."
February 17 - Bloomberg (Robert Hutton and Thomas Penny): "Rising inflation and unemployment have taken the U.K.'s 'misery index' to a 17-year high, as Prime Minister David Cameron promises to press ahead with the deepest budget cuts since World War II. The misery index, devised by economist Arthur Okun, combines inflation and unemployment rates."
February 16 - Bloomberg (Emma Ross-Thomas): "Spanish exports accelerated in the fourth quarter, offsetting weaker demand at home as the deepest austerity measures in three decades undermined the economic recovery. Exports rose 3.9% from the previous three months, when they increased 0.5%, and expanded 10.5% from a year earlier..."
U.S. Bubble Economy Watch:
February 15 - Financial Times (Gregory Meyer): "The prices of pork chops and hamburgers are set to rise as smaller animal herds and depleted corn stocks strain livestock markets. Lean hogs hit a nominal all-time high above 93 cents a pound... after a devastating outbreak of foot-and-mouth disease caused a spike in imports by South Korea. Live cattle, fattened for sale to meat packers, were at $1.093 a pound, a rise of 22% in the past year, and just below the record high... The resulting meat price increases show that food inflation, most severe in emerging markets, threatens to bleed into richer economies. In the US, consumer prices for meat, fish and eggs jumped 5.5% year on year in December..."
February 15 - Bloomberg (Alex Kowalski): "Confidence among U.S. homebuilders stagnated in February, reflecting a still-depressed housing market. The National Association of Home Builders/Wells Fargo sentiment index registered a reading of 16 for the fourth consecutive month... Readings below 50 mean more respondents said conditions were poor."
February 14 - Bloomberg (Daniel Kruger and Liz Capo McCormick): "Barack Obama may lose the advantage of low borrowing costs as the U.S. Treasury Department says what it pays to service the national debt is poised to triple amid record budget deficits. Interest expense will rise to 3.1% of gross domestic product by 2016, from 1.3% in 2010 with the government forecast to run cumulative deficits of more than $4 trillion through the end of 2015... Net interest expense will triple to an all-time high of $554 billion in 2015 from $185 billion in 2010, according to the Obama administration's adjusted 2011 budget. 'It's a slow train wreck coming and we all know it's going to happen,' said Bret Barker, an interest-rate analyst at... TCW Group... 'It's just a question of whether we want to deal with it. There are huge structural changes that have to go on with this economy.' The amount of marketable U.S. government debt outstanding has risen to $8.96 trillion from $5.8 trillion at the end of 2008... Debt-service costs will climb to 82% of the $757 billion shortfall projected for 2016 from about 12% in last year's deficit, according to the budget projections. That compares with 69% for Portugal, whose bonds have plummeted on speculation it may need to be bailed out by the European Union and International Monetary Fund."
February 17 - Washington Post (Steven Mufson): "Interest payments on the national debt will quadruple in the next decade and every man, woman and child in the United States will be paying more than $2,500 a year to cover for the nation's past profligacy, according to... President Obama's new budget plan. Starting in 2014, net interest payments will surpass the amount spent on education, transportation, energy and all other discretionary programs outside defense. In 2018, they will outstrip Medicare spending... The soaring bill for interest payments is one of the biggest obstacles to balancing the federal budget... The phenomenon is a bit like running up the down escalator. Without interest payments, the president's plan would balance the budget by 2017. But net interest payments that year are expected to reach $627 billion, up from $207 billion in the current fiscal year."
February 15 - Financial Times (Michael Mackenzie): "It is no secret that China's appetite for Treasuries has been waning. Official figures now bear out Beijing's stated desire to diversify away from US government debt. The market impact is likely to be muted for now, given the Federal Reserve's bond-buying under its 'quantitative easing' programme. But what happens when QE2 ends in June? ...The US Treasury market occupies the centre of the global financial system... So far, robust demand for Treasuries from the UK and, to a lesser extent, Japan and US domestic investors has helped offset China's waning appetite over the past year. The Fed effect has been supportive, too. The US central bank has become the largest single holder of Treasuries, with $1,160bn, as it continues buying securities."
Central Banking Watch:
February 16 - Bloomberg (Vivien Lou Chen): "Federal Reserve Bank of Dallas President Richard W. Fisher said he'll be among the first policy makers to push for tighter policy as the economy improves and that one possible first step may be the sale of some of the central bank's Treasury securities. 'One could make an argument that the most logical thing to do is to undo what you did last,' the regional bank chief, who votes on monetary policy this year, said... 'Markets for Treasuries are very deep and very liquid -- that gives you a lot of maneuvering room,' he said... The Fed has become the single leading owner of U.S. government securities, and Fisher noted that its holdings of Treasuries have more than doubled as a share of its total assets over the past two years, to 46%... 'The question is, 'When do you reverse gears?'' said Fisher... 'It's not clear yet. But I suspect, given my proclivities, I will be ahead of the curve of consensus in terms of shifting gears.' Fisher said central bankers have the will and the means to tighten policy when the time is right. 'There's no difference amongst us of wanting to respond in a timely way,' he said. "It's going to be a judgmental issue as to when that time is appropriate. Do we have the capacity to do so? Yes, we do... At the Fed's most recent meeting in January, Fisher voted to push forward with the $600 billion in asset purchases along with the rest of the FOMC. Fisher called the latest round of purchases a 'fait accompli' decided upon by a majority of the Federal Open Market Committee last year, and said he doesn't expect the central bank to incur large losses on its holdings. 'We've done a lot of sensitivity analysis on that portfolio,' he said. 'Given the coupons, given the structure and duration of our portfolio, it's very hard to envision a scenario in which we incur sustainable capital losses.'"
February 15 - Bloomberg (Johan Carlstrom): "Sweden's central bank raised its benchmark repo rate for a fifth time since July and signaled it will pick up the pace of monetary tightening to keep inflation and credit growth in check in Europe's fastest-growing economy. The... Riksbank raised the seven-day repo rate a quarter of a percentage point to 1.5%... The bank also raised its rate path and now expects the repo to average 2.5% in the first quarter next year, compared with 2.2% previously."
February 15 - Bloomberg (Jennifer Ryan and Svenja O'Donnell): "Bank of England Governor Mervyn King kept up his argument that an acceleration in inflation is temporary after consumer-price growth soared to twice the central bank's 2% target."
New York Watch:
February 17 - Bloomberg (Henry Goldman): "New York Mayor Michael Bloomberg will present a preliminary budget for next fiscal year today that proposes reducing the city's 80,000 teachers by 6,166, including 4,666 dismissals, administration officials said."
Real Estate Watch:
February 16 - Bloomberg (Bob Willis): "The number of applications for U.S. mortgages fell last week to the lowest level in more than two years as higher borrowing costs depressed refinancing. The Mortgage Bankers Association's index of loan applications decreased 9.5%..."
February 15 - Bloomberg (Alan Bjerga and Steve Stroth): "Farmland values in the central U.S. surged in the fourth quarter of 2010 as higher prices for corn, wheat, soybeans and cattle sparked demand for rural properties, the Federal Reserve Bank of Kansas City said. Prices jumped 14.8% for irrigated cropland from the year-earlier quarter, and gained 12.9% for non-irrigated land..."
February 16 - Bloomberg (Brian Louis): "The bidders drove over snow- and ice-covered highways for a chance to own one of the most lucrative properties in the U.S. Midwest: 120 acres of farmland in Greene County, Iowa. The winner of last month's auction at St. Joseph's Parish Center in Jefferson offered $8,200 an acre -- almost $1 million -- for the plot in Scranton Township. That's 44% higher than the $5,701 per-acre estimate for average values in the county as of Nov. 1... 'It's reflective of what we're seeing,' Mike Duffy, an Iowa State economist in Ames, said... 'There's just not a lot of ground offered for sale.'"
Pondering the End of QE2
We're now close to the half way point for QE2. The June wrap-up date should begin to move from the back of the markets' mind to the forefront. This week from the Financial Times' Michael Mackenzie: "It is no secret that China's appetite for Treasuries has been waning. Official figures now bear out Beijing's stated desire to diversify away from US government debt. The market impact is likely to be muted for now, given the Federal Reserve's bond-buying under its 'quantitative easing' program. But what happens when QE2 ends in June?"
It is central to Credit Bubble analysis that policies that artificially inflate price levels are inevitably problematic. To be sure, policy stimulus engendered specifically to create excess marketplace liquidity inflates market prices while manipulating market perceptions. The Bernanke Fed wanted stock prices higher and they've succeeded. Along the way, policymaking has fomented Bubble Dynamics - reinvigorating risk-taking and leveraged speculation. Speculative excess and inflationary forces have been unleashed upon the world.
Global policymakers have succeeded in re-inflating global securities markets - in the process they also incited rampant food and commodities price inflation. More broad-based inflationary pressures are mounting, although global policymakers in unison are slow to move away from extraordinarily loose policies. There is increased talk of how the world's central bankers - especially those in Asia - are falling further "behind the curve." Systemic fragilities are escalating along with the potential for belated monetary tightening and "hard landings"
The Fed clearly has no inclination to reverse course anytime soon. Our central bank has basically signaled that its blinders have been positioned to see little else beyond our unemployment rate. It's also apparent that structural issues and the current strain of global inflationary dynamics ensure that U.S. employment gains lag inflationary pressures. It's the wrong economic indicator for which to base monetary policy.
The Fed has convinced the markets that our central bank would feel more comfortable with a higher inflation rate. And, at some point down the road, policy could change course to manage the inflation level to some optimum point. Our central bank - along with the markets - has grown comfortable with "quantitative easing," over-confident in its capacity to control the unfolding financial boom, and complacent about what comes next.
This week, Dallas Fed President Richard Fisher suggested that it might make sense to unwind QE2 as the first step toward tightening monetary policy. As appealing as this may sound, such a policy reversal is at this point completely unrealistic. It concerns me that our leading central bankers don't appreciate how their unprecedented - and ongoing - market interventions have painted themselves into a corner.
In this week's release of the latest budget, the Administration (again) raised its estimate for the 2011 fiscal deficit to $1.6 TN - the largest ever and approaching 11% of GDP. With no end in sight to the massive supply of new Treasury debt, it is simply infeasible for our central bank to add further to the supply overhang. For a couple years now, the anticipation of Fed buying has done wonders for our debt markets. In a bit of wishful thinking, Mr. Fisher stated that "Markets for Treasuries are very deep and very liquid -- that gives you a lot of maneuvering room."
I suspect that the Treasury market won't always qualify as "very deep and very liquid." And I wouldn't be all too surprised if this day of reckoning is closer at hand than market participants anticipate. For the most part, the marketplace has remained deep and liquid throughout one of history's most protracted bull markets in debt instruments (as yields demonstrated a down-ward bias/prices an inflationary bias). It remained deep and liquid as foreign central banks accumulated Trillions of our debt obligations. And the perception of liquidity has been maintained as the Fed has ballooned its holdings of Treasury and agency obligations. On all fronts, a case can be made we've passed - or are quickly approaching - important inflections points.
As always, bull markets enjoy the perception of endless liquidity, while bear markets shatter such (excess liquidity-induced) myths. For some time now, the Treasury/agency market has defied the truism that bull market excesses dictate the pain and duration of the bear. Yet, the makings for a big bear market having been falling into place.
Our deficits are completely out of control, and the Federal Reserve has added to its list of historic blunders by accommodating Washington spending profligacy. Quantitative easing distorted the pricing of government debt and the markets perceptions of risk, thus promoting unprecedented government borrowing and spending. Without QE1 and QE2, higher Treasury borrowing cost would have some time ago commenced the necessary "austerity" measures. Instead, the Fed has aggressively manipulated borrowings costs and the Treasury has accumulated debt recklessly.
It hasn't mattered much in the market that the Chinese and other central banks have backed away from accumulating Treasurys. Few take notice that the dominant international buying now takes place through the financial hubs in the UK and the Caribbean (hedge funds and other leveraged players?). Perhaps, as the FT suggested, it might matter in June when the Fed wraps up its (latest phase of) monetary experiment.
There are reasons for the marketplace to become increasingly nervous with the confluence of massive supply, the lack of a reliable central bank (Fed, China, etc.) backstop bid, potentially "weak-handed" leveraged players becoming the marginal source of market liquidity, and a potential derivatives tinderbox. With inflationary pressures mounting in a world dominated by derivatives and sophisticated hedging programs, one has the makings for one volatile bearish concoction. And with the unprecedented trajectory of federal debt accumulation, we're now at the point that market yields don't have to surprise much on the upside for some really serious problems to unfold.
I think the sophisticated players have believed there were still a couple of years before the U.S. debt problem turned unstable. I think they may have to rethink. I have in the past pointed out that in early November 2009 Greece could borrow for two years at about 2% - and markets could pretend the Greek debt situation was manageable. The fact that markets were content to postpone the disciplining process ensured that when it did finally arrive it was serious.