Time to Pause?

By: Doug Noland | Fri, Apr 28, 2006
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It was not pretty, but stocks held together. For the week, the Dow was slightly positive, while the S&P500 was slightly negative. The Transports declined 1%, while the Utilities mustered a slight advance. The Morgan Stanley Cyclical index dropped 3%, while the Morgan Stanley Consumer index added 1%. The small cap Russell 2000 declined 1%, and the S&P400 Mid-cap index dipped 0.7%. With Microsoft getting clobbered, the NDX ended the week down 0.5%. The Morgan Stanley High Tech index declined 0.8%, and the Semiconductors slipped 0.3%. The Street.com Internet Index declined 0.6%, while the highflying NASDAQ Telecommunications index gained 0.8%. The Biotechs settled 0.2% lower. The financial stocks were wild. While the highflying Broker/Dealers fell 4%, the previously lagging Banks surged 4%. With bullion jumping $20.45, the HUI Gold index added 1.4%.

What, a pause... For the week, two-year Treasury yields declined 3 bps to 4.87%, while five-year yields added one basis point to 4.92%. Bellwether 10-year yields jumped 5 bps to 5.06%. Long-bond yields gained 7 bps to 5.16%. The 2yr/10yr spread increased 8 bps, ending the week at a positive 19 bps. Benchmark Fannie Mae MBS yields rose one basis point to 6.10%, again outperforming Treasuries. The spread on Fannie's 4 5/8% 2014 note (to the new 10-yr) ended the week at 23, and the spread on Freddie's 5% 2014 note closed at 25. The 10-year dollar swap spread declined 1.5 to 50.75. Corporate bond spreads continue to narrow, with junk bonds posting another week of solid relative out-performance. The implied yield on 3-month December '06 Eurodollars fell 4.5 bps to 5.245%.

Investment grade issuers included General Electric $2.25 billion, CIT $1.1 billion, Washington Mutual $1.0 billion, US Bancorp $1.0 billion, HSBC $900 million, ERAC USA Finance $500 million, KT Corp $200 million, and Tartan Capital $155 million.

Junk issuers included Plum Creek Timberlands $525 million, Pioneer Natural Resource $450 million, Affinion Group $300 million, PH Glatfelter $200 million, Activant Solutions $175 million, National Pizza $175 million, Rural Cellular $160 million, and Saxon Capital $150 million.

Convert issuers included Quanta Services $125 million.

Foreign dollar debt issuers included Worri Bank $1.0 billion and Sidetur Finance $100 million.

April 26 - Financial Times (Ivar Simensen): "The volume of loans to fund acquisitions have this year exceeded the total amount of loans for refinancings, reversing the trend from last year... The volume of loans to fund takeovers has soared 91 per cent to $347bn in the year to date, compared with the same period last year, data from Dealogic... The figures have also been boosted by industry consolidation and by private equity companies, which fund leveraged buyouts in the debt markets."

Japanese 10-year JGB yields slipped 1.5 bps this week to 1.92%. The Nikkei 225 index dropped 2.9% (up 5.4% y-t-d). German 10-year bund yields were unchanged at 3.95%. Emerging debt and equity markets were somewhat mixed but generally resilient. Brazil's benchmark dollar bond yields fell 10 bps to 6.66%. Brazil's Bovespa equity index gained 1.5%, increasing 2006 gains to 21%. The Mexican Bolsa jumped 2.4%, with y-t-d gains rising to 16%. Mexico's 10-year $ yields dipped 3 bps to 6.08% this week. Russian 10-year dollar Eurobond yields rose 6 bps to 6.75%. The Russian RTS equities index gained 1.5%, increasing 2006 gains to 47% and 52-week gains to 148%. India's Sensex equities index declined 1.4%, reducing y-t-d gains to 26%.

April 26 - Financial Times (Deborah Brewster): "US investors have poured $68bn into international mutual funds this year - more than twice the amount allocated to US funds. Overseas investment has slowed slightly from last year's exceptional level but remains strong as investors pile into not only established European and UK markets but also emerging markets such as South Korea, India, Russia, Brazil and Turkey. The data, compiled by...TrimTabs, underline the extent to which American retail investors are fuelling the later stages of the boom in emerging market equities... Last year Americans put about $130bn into foreign stock funds - three times the amount they invested in US stock funds... Throughout the 1990s, most US investors put much less than the 10-12 per cent of their assets typically recommended by advisers into overseas markets. Currently, 70 per cent of their new money is going abroad."

Freddie Mac posted 30-year fixed mortgage rates rose 5 bps to 6.58%, up 80 basis points from one year ago. Fifteen-year fixed mortgage rates gained 4 bps to 6.21%, up 88 bps in a year. One-year adjustable rates increased 5 bps to 5.68%, an increase of 147 bps over the past year. The Mortgage Bankers Association Purchase Applications Index fell 4.4% last week to the lowest level since December 2003. Purchase Applications were down 19% from one year ago, with dollar volume down 18%. Refi applications declined 2.4% last week. The average new Purchase mortgage declined to $231,500, and the average ARM fell to $337,000.

Bank Credit surged another $33.8 billion last week to a record $7.793 Trillion, with a y-t-d gain of $287 billion, or 12.4% annualized. Over the past year, Bank Credit inflated $724 billion, or 10.2%. For the week, Securities Credit jumped $16.7 billion. Loans & Leases expanded $17.1 billion for the week, with a y-t-d gain of $153 billion (9.1% annualized). Commercial & Industrial (C&I) Loans have expanded at a 15.5% rate y-t-d and 13.7% over the past year. For the week, C&I loans surged $11.7 billion, and Real Estate loans jumped $14.6 billion. Real Estate loans have expanded at an 11.0% rate y-t-d and were up 12.5% during the past 52 weeks. For the week, Consumer loans added $1.8 billion, while Securities loans fell $10.9 billion. Other loans were little changed. On the liability side, (previous M3 component) Large Time Deposits declined $6.2 billion.

M2 (narrow) "money" supply jumped $31.6 billion to $6.77 Trillion (week of April 17). Year-to-date, M2 has expanded $115.8 billion, or 5.6% annualized. Over 52 weeks, M2 inflated $321 billion, or 5.0%. For the week, Currency added $1.6 billion. Demand & Checkable Deposits gained $9.9 billion. Savings Deposits rose $17.5 billion, and Small Denominated Deposits increased $4.3 billion. Retail Money Fund deposits slipped $1.5 billion.

Total Commercial Paper jumped $33.8 billion last week to $1.727 Trillion. Total CP is up $75.3 billion y-t-d (17wks), or 14.0% annualized, while having expanded $244 billion over the past 52 weeks, or 16.5%.

Asset-backed Securities (ABS) issuance increased to $12 billion. Year-to-date total ABS issuance of $222 billion (tallied by JPMorgan) is now running slightly below 2005's record pace, with y-t-d Home Equity Loan ABS issuance of $164 billion running 11% above last year.

Fed Foreign Holdings of Treasury, Agency Debt ("US marketable securities held by the NY Fed in custody for foreign official and international accounts") added $1.1 billion to $1.603 Trillion for the week ended April 26. "Custody" holdings are up $84.6 billion y-t-d, or 17.0% annualized, and $213 billion (15.3%) over the past 52 weeks. Federal Reserve Credit declined $3.6 billion last week to $820 billion. Fed Credit has declined $6.2 billion y-t-d, or 2.3% annualized. Fed Credit expanded 4.3% ($33.5bn) during the past year.

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - are up $289 billion y-t-d (22% annualized) and $498 billion (13%) in the past year to a record $4.335 Trillion.

April 28 - Bloomberg (Anoop Agrawal): "India's foreign-exchange reserves rose $2.07 billion to $157.3 billion in the week ended April 21..."

Currency Watch:

The dollar index was slammed for 2.2%, ending the week at an 11-week month low. On the upside, the Iceland krona surged 5.6%, the Norwegian krone 3.4%, the Swiss franc 3.0%, the Australian dollar 3.0%, and the Swedish krona 2.9%. On the downside, the dollar gained ground on the Colombian peso (1.7%), the South African rand 0.4%, and Philippines peso (0.2%). The Canadian dollar traded today to the highest level since 1978, and Brazil's real traded to a 5-year high.

Commodities Watch:

April 24 - Bloomberg (Matthew Craze): "Arcelor SA, the world's second-largest steelmaker, will pass on the costs of zinc to its customers such as carmakers and home-appliance manufacturers after the price of the metal climbed to a record. Zinc is mostly used in galvanized steel used to make auto-body panels, washing machines and highway dividers. The price of the metal has soared 70 percent so far this year..."

Gold surged $20.45 to $654.40, and Silver gained 4.1% to $13.63. Copper rose 3.5% to another record high. After last week's record run, June crude declined $3.29 to $71.88. June Unleaded Gasoline fell 5%, and June Natural Gas sank 20%. For the week, the CRB index declined 2.4% (y-t-d up 5.4%). The Goldman Sachs Commodities Index (GSCI) dropped 4.3%, reducing y-t-d gains to 10.0%.

Japan Watch:

April 28 - Bloomberg (John Brinsley): "Japan's unemployment rate stayed at a seven-year low, adding to expectations rising wages will fuel consumer-led expansion of the world's second-largest economy. The jobless rate was unchanged at 4.1 percent..."

April 28 - Bloomberg (Megumi Yamanaka): "Japan, the world's largest consumer of oil after the U.S. and China, said crude oil imports rose for a second month, gaining 8.8 percent from a year earlier."

China Watch:

April 27 - Financial Times (Richard McGregor): "China moved to tackle a surge in new bank loans and investment on Thursday by lifting the benchmark one-year lending rate by 0.27 per cent, sparking a sell-off by investors worried that the rise signalled a slowdown in the Chinese economy. The rate rise, the first by the People's Bank of China since October 2004, surprised the markets, which had expected Beijing to use a combination of administrative measures and higher reserve requirements for banks to rein in credit growth. The key benchmark one-year lending rate will rise from 5.58 per cent to 5.85 per cent..."

April 26 - MarketNewsInternational: "China's imports and exports are expected to exceed $1.6 trillion in 2006 compared with the $1.4221 trillion in 2005, the Ministry of Commerce forecast... The ministry said the overall growth of China's trade volume in 2006 will be 15% higher than 2005..."

April 28 - Bloomberg (Lee Spears): "Incomes in China's cities and towns rose to an average of 2,461 yuan ($307) per month in the first quarter of this year, 13.9 percent higher than a year earlier..."

April 27 - Bloomberg (Nipa Piboontanasawat): "Hong Kong's exports grew at the fastest pace in six months in March as the city shipped more electronics, toys and clothes to and from China. Overseas sales rose 14.7 percent from a year earlier to...$25 billion..."

Asia Boom Watch:

April 24 - Bloomberg (Kartik Goyal): "India plans to raise growth in the manufacturing sector to 12 percent to quicken the pace of economic expansion, Indian Prime Minister Manmohan Singh said. 'The fundamentals of the Indian economy are strong and robust. We are confident of sustaining our high economic performance and growth rates of 8 percent. Indeed, we aim to raise this to the 8 to 10 percent bracket in the near future.'"

April 26 - Bloomberg (Kartik Goyal): "India's direct tax revenue from companies and personal incomes in the fiscal year that ended March 31 rose 24 percent as economic growth boosted company profits and individual salaries."

April 25 - Bloomberg (Seyoon Kim): "South Korea's economy expanded a faster-than-expected 1.3 percent in the first quarter as exports climbed to a record and consumer spending increased..."

April 26 - Bloomberg (Stephanie Phang): "Malaysia's central bank unexpectedly raised its key interest rate for the second time this year after inflation surged to a seven-year high in March. Bank Negara Malaysia increased the overnight policy rate a quarter-point to 3.5 percent..."

April 26 - Bloomberg (Naila Firdausi): "Indonesia's foreign direct investment rose 30 percent in the first quarter, after increasing fourfold in the first two months, as higher global oil prices deterred some investments. Investment rose to $2.61 billion in the three months ended March 31..."

Unbalanced Global Economy Watch:

April 25 - Bloomberg (Greg Quinn): "The Bank of Canada raised its main interest rate for the sixth straight time, and repeated it may boost rates again. Bond yields surged as investors bet on another increase next month. The quarter-point increase today brings the target rate for overnight loans between commercial banks to 4 percent, the highest since September 2001..."

April 28 - MarketNewsInternational: "The headline seasonally-adjusted annual M3 growth rate rose to +8.6% in March from a downwardly revised +7.9% (+8.0%) in February. The latest result represents the third straight rise and is well above all
expectations... Growth in loans to the eurozone private sector accelerated to +10.8% y/y in March from +10.4% (revised up from +10.3%) in February."

April 26 - Bloomberg (Simone Meier and Harry Papachristou): "European Central Bank council member Nicholas Garganas said the bank will raise interest rates further as faster economic growth and higher oil prices threaten to push up inflation. Bond yields rose. 'We have to expect more interest-rate increases,' Garganas told a press conference... The benchmark rate of 2.5 percent is still at a 'historically excessively low level and very far from the normal level.'"

April 28 - Bloomberg (Simon Kennedy): "Confidence among European executives and consumers increased to a five-year high in April and inflation accelerated more than expected, reinforcing predictions the European Central Bank is poised to raise interest rates."

April 26 - Bloomberg (Laura Humble): "The U.K. economy, Europe's second largest, sustained the fastest pace of growth in a year during the first quarter on a revival in industrial production. The economy expanded 0.6 percent..."

April 25 - Bloomberg (Simone Meier and Matthew Brockett): "German business confidence unexpectedly climbed to a 15-year high in April as growth in Europe's largest economy accelerated, prompting investors to increase bets on higher interest rates. The Ifo institute's confidence index, based on a survey of 7,000 executives, rose to 105.9, the highest since April 1991..."

April 24 - Bloomberg (Gabi Thesing): "Growth in Germany's economy, Europe's largest, is continuing to gain momentum, led by an increase in exports, the Bundesbank said. 'There is a broad-based sense of contentment and optimism throughout the economy. Exports in February were strong and the March Ifo index showed that companies expect this trend to continue.'"

April 27 - Bloomberg (Sheyam Ghieth): "Italian business confidence unexpectedly rose to the highest in more than five years on signs that accelerating growth in the euro region is sparking demand for Italian goods."

April 26 - Bloomberg (Jonas Bergman): "Sweden's trade surplus widened in March from a year earlier as exports rose to the highest level in at least 16 years. The surplus grew to 17.5 billion kronor ($2.3 billion) from 13.5 billion in the same month a year earlier... Exports rose 22 percent to 100.6 billion kronor, the highest since at least January 1990, and imports rose 20 percent to 83.1 billion kronor, also the highest in 16 years..."

April 27 - Bloomberg (Tasneem Brogger): "Denmark's jobless rate unexpectedly dropped to 4.8 percent in March, the lowest since 1974, as house-price inflation stoked demand for builders and engineers."

April 25 - Bloomberg (Marek Miler and Douglas Lytle): "The Czech economy probably grew 'close to 8 percent' in the first quarter, Prime Minister Jiri Paroubek said."

April 25 - Bloomberg (Hans van Leeuwen): "Australia's inflation accelerated faster than expected in the first quarter as health and education costs increased, suggesting the central bank may raise interest rates this year. The consumer price index increased 0.9 percent from the fourth quarter..."

Latin America Watch:

April 24 - Bloomberg (Adriana Arai and Thomas Black): "Mexico's economy grew at the fastest pace in five years in the first quarter as exports surged and domestic demand picked up, the central bank's chief economist said. More working days in the period compared with a year ago helped boost the growth figure. The rate of economic growth quickened to 5.2 percent in the first quarter from 2.7 percent in the fourth..."

April 25 - Bloomberg (Alex Emery): "Peru's exports grew at the fastest pace in three months in March on surging sales of copper, gold and zinc. Exports rose 24 percent to $1.65 billion from a year earlier..."

Bubble Economy Watch:

March home sales were meaningfully stronger-than-expected. Existing Home Sales jumped to 6.92 million units, down less than 1% from a year ago. For perspective, Annual Existing Home Sales averaged 3.993 million units during the nineties. At $266,800, March's Average (mean) Price was up 4.8% from March 2005 to $266,800 (up 20% over 2 yrs and 30% in 3). Annualized Calculated Transaction Volume (CAT) was up 4% y-o-y to $1.846 Trillion. Year-to-date, Existing Home Sales are down 2.1% from last year's record pace. New Home Sales (1.123 million annualized) were down 7.2% from the year-earlier period. Average Prices were down 3.6% y-o-y to $279,100. The Inventory of Unsold New Homes rose another 15,000 units during the month to 555,000, up 24% from March 2005. Total y-t-d Home Sales are running 2.9% below last year's record pace.

March Durable Goods Orders were up 19.7% from March 2005 (ex-transports up 11.5%). Non-Defense Capital Goods Orders were up 31.3% y-o-y. Consumer Confidence rose to the highest level since May 2002, with the Present Situation index the highest since August 2001. IRS y-t-d refund dollars are running 4.8% ahead of last year.

April 26 - Financial Times (Jon Boone): "Corporate America's greater demand for financial transparency means that accountancy graduates in the class of 2006 will enjoy the best jobs market in four years... The sellers' market is highlighted by data published by the National Association of Colleges and Employers (Nace). Its Job Outlook 2006 showed accounting was the third most popular university degree among employers. Starting salaries are also on the rise, with Nace showing a 5.4 per cent increase to $46,188 since last spring."

April 27 - Financial Times (Andrew Ward): "US railway operators have reported another quarter of record profits as solid economic growth continues to generate increased freight volumes.... Most of the industry's growth came from higher prices rather than increased volume because the network has little surplus capacity. Union Pacific's average revenues per carload climbed 13 per cent, compared with a 4 per cent growth in carload volume."

Mortgage Finance Bubble Watch:

April 27 - EconoPlay.com (Gary Rosenberger): "Spending on commercial, institutional and residential construction continues to be bolstered by an overflow of back orders, deferred capital spending by earnings-rich corporations, and government largesse - but fissures are developing that point to a likely slowdown this summer, say industry executives. Some already see a thinning pipeline of projects prompted by higher interest rates and soaring building materials costs, soon to be aggravated by the latest run-up in oil prices. The sticker shock is being mostly felt in institutional and government projects that were budgeted years ago, and some are being postponed pending redesign work or a renewed search for financing. But manufacturing, office space, retail and other commercial segments continue to ride a strong crest, while residential flattens but remains surprisingly resilient."

April 26 - Dow Jones (Danielle Reed): "The boom in condo development of the past several years could be causing a supply glut in urban areas across the U.S. Though still a small part of the overall national residential market, condo sales make up a large percentage of all transactions in some large metro markets in the West and Southeast... In March, the inventory of existing condominiums and co-ops available for sale in the U.S. swelled to a 6.9-month supply at the current sales rate, up from 6 months in February and 3.7 months in March a year earlier..."

April 24 - Bloomberg (Kathleen M. Howley): "U.S. mortgages entering foreclosure jumped 72 percent during the first quarter from a year earlier... Lenders began foreclosing on 323,102 mortgages, a ratio of one in 358 U.S. households, according to a report issued today by RealtyTrac Inc."

Energy and Crude Liquidity Watch:

April 27 - Bloomberg (Joe Carroll): "Exxon Mobil Corp., the world's biggest oil company, said first-quarter profit climbed 6.9 percent because of record prices and the first production increase in a year and a half. Net income rose to $8.4 billion..."

April 27 - Bloomberg (Wing-Gar Cheng and Cathy Chan): "Cnooc Ltd., China's biggest offshore oil producer, sold HK$15.4 billion ($2 billion) of stock to fund expansion and pay expenses as energy demand soars in the world's fastest-growing major economy."

Speculator Watch:

April 27 - Financial Times (Stephen Schurr): "European hedge funds have enjoyed their best quarter since the end of 1999 and returns so far in April have remained robust, especially at energy and commodity-oriented funds that have made the right bets. European hedge funds returned 4.65 per cent on average in the first quarter, according to EuroHedge... Industry veterans have raised concerns that the last time returns were this strong was in 1999, which was soon followed by a three-year bear market in equities.... "It is the best quarter of the century," joked Philippe Bonnefoy, who runs the investments of fund of fund Cedar Partners. 'Every strategy except shorts were up. While April has seen a bit more volatility, hedge funds have been up strongly.'"

Time to Pause?:

First quarter nominal U.S. GDP expanded at an 8.2% rate (4.8% inflation-adjusted), the strongest pace since the third quarter of 2003. It is worth noting that growth quickened sharply from the fourth quarter, a period notable for 9.5% annualized Non-Financial Credit growth. Year-to-date, Bank Credit has expanded at a12.4% rate, a notable acceleration from the fourth quarter. Bank Real Estate loans have expanded at an 11.0% rate so far this year, with Commercial and Industrial loans up 15.5% annualized. Wall Street securities firms' balance sheets are expanding at 20%-plus rates. Commercial Paper is expanding at a 14% pace, and Asset-backed Securities issuance is in line with last year's booming record pace. Time to Pause?

The NYSE Financial Index broke out to a new all-time high this week, sporting a 10% y-t-d gain and a 27% rise over the past year. The NASDAQ Other Financial Index (90 stocks) is up almost 14% in 2006 and 48% over 52 weeks. The AMEX Securities Broker/Dealer Index is up 18% y-t-d and 71% during the past 12 months. It would be atypical for financial sector managements to observe booming stock prices and not feel compelled to deliver strong profits (by lending and trading aggressively) to The Street. It is also worth noting that the breadth of speculative excess today easily outdoes 1999/early-2000. The small cap Russell 2000 is up 14% y-t-d, the S&P400 Mid-cap index 9%, and the NASDAQ Telecommunications index 20%. Time to Pause?

The Conference Board's survey of April Consumer Confidence Present Situation index jumped to the highest level since August 2001, following a month when Retail Sales were up 7.6% y-o-y (ex-auto 8.8%). March Non-Defense Capital Goods Orders were up 31.3% from March 2005. Federal government Receipts are running better than 10% ahead of last year's level, with spending up almost 9%. Despite double-digit export growth, our Trade Deficits grow only larger. The U.S. Current Account Deficit will easily exceed $800 billion this year. Time to Pause?

Gold is up 27% y-t-d to the highest price since 1980, with a 52-week gain of 51%. Silver has gained 51% in less than four months to a 23-year high (52-wk gain of 90%). Crude oil is up 18% y-t-d and 38% over the past year, last week trading to an all-time record. Unleaded Gas futures prices are up 40% from a year earlier. The Goldman Sachs Commodities Index is up 34% over the past year, closing last week at a record high. International central bank reserve holdings (mostly dollars) are expanding at a 20% clip. After trading above 120 in 2002, the dollar index sits today tenuously at 85.88, not all too far off of its 2005 low of 81.11. Time to Pause?

Looking internationally, Canada's TSX index has posted a one-year gain of 32%, Mexico's Bolsa 68%, Brazil's Bovespa 65%, Argentina's Merval 44%, Germany's DAX 44%, France's CAC 40 33%, Spain's IBEX 32%, Norway's OBX 67%, Poland's WSE 71%, Russia's RTS 148%, Japan's Nikkei 225 54%, South Korea's KRX 56%, India's Sensex 89% and Australia's SPX 31%. Eurozone broad money supply growth has accelerated to an 8.6% pace, with private-sector loan growth up 10.8% y-o-y. China's money supply has recently expanded at an almost 19% rate. India is in the midst of an unprecedented Credit boom. In short, never have global financial conditions been remotely this loose.

A few years back I began referring to the U.S. "Monetary Economy." It was becoming apparent that both the pace and composition of economic output were increasingly commanded by Credit growth and the nature of asset-based lending/speculating excesses emanating from the Financial Sphere. To insightfully analyze the U.S. economy, one must first grasp the workings and biases of the underlying Credit Apparatus. As for policymaking, to disregard the character of Financial Sphere endeavors is to go asking for major policy blunders. To accommodate the current Credit Apparatus is to feed a precarious Monetary Bubble Economy, both at home and abroad.

After building his career on a revisionist's view of the 1920's and '30's - certainly including a lambasting of the late-twenties "Bubble poppers" - it should come as little surprise that chairman Bernanke is indisposed to employing real financial condition tightening. His true chairman stripes, perhaps veiled somewhat up to this point, have shone through. The Fed is hoping that rate increases to date are in the process of imposing meaningful restraint, and they are likely preoccupied with the cooling housing sector. Yet, the reality of the situation is that financial conditions have never been looser; the Credit system continues to fire on all cylinders; and Inflationary Manifestations just keep popping out all over the place.

It is the inherent nature of a ballooning Financial Sphere (especially boom-time Credit mechanisms and attendant pools of speculative finance) to foster an ongoing series of Bubbles, the broadening scope of each new Bubble sufficient to outweigh the aged and displaced. The system will develop evolving Inflationary Biases depending on the source and disposition of the newly created flows of finance, although I suppose it is the constitution of analysts and policymakers to pay most attention to the more established (and vulnerable) Bubbles (i.e. today in mortgage finance). It is, however, the cutting edge Bubbles poised to provide the unexpected marginal source of ongoing liquidity.

Abundant liquidity flows readily to inflate a particular sector, in the process exacerbating system-wide Credit, speculative and liquidity excesses that create monetary fuel for the next fledgling Bubble. Market perceptions, expectations and infrastructure play instrumental roles in directing financial flows. When the Fed "reliquefied" the system post the Russian and LTCM collapses, it did so apparently not recognizing the intense Inflationary Bias that had taken hold throughout the technology/telecom debt arenas. When they "reflated" post-tech/telecom Bubble, the Fed - along with the elated Credit system and leveraged speculating community - ensured a historic Mortgage Finance Bubble. Today, determined to avoid bursting this Bubble, the Fed foments Propagating Global Credit and Asset Bubbles.

The Bernanke Fed is in one hell of a predicament. There is today no way to rein in escalating global excesses without a serious bout of U.S. financial and economic tumult. These days, such a scenario is simply unthinkable. Yet the status quo fosters only more problematic Monetary Disorder. Mortgage Credit growth is likely to approach last year stunning $1.4 Trillion level, while energy and M&A-related borrowings surge. Global leveraging of commodities, securities markets, and real estate is creating unfathomable liquidity excesses. Bull markets create their own liquidity until they don't.

More than ever before, U.S. consumer retrenchment and resulting recession are required for the commencement of the long-overdue and unavoidable adjustment process, although the Fed is more determined than ever to maintain the boom. At this point, boom-time conditions are sustained only by ongoing massive Credit inflation (dollar debasement), with this inflation/debasement exacerbating the increasingly destabilizing non-dollar speculative flows.

We are indeed witnessing The Critical Policymaker Credit Bubble Dilemma: the bigger and more vulnerable the Bubble, the greater the propensity for policy acquiescence and accommodation. The present course guarantees ongoing $800 billion-plus Current Account Deficits. Unconvincingly, Dr. Bernanke too loudly declares that our deficit is a global issue and - especially considering the backdrop - too conspicuously is content to do nothing.

We're now into year four of the Great Dollar Bear Market. Importantly, the Financial Sphere has by this point had ample opportunity to adapt and devise myriad instruments, avenues and strategies to profit from a declining greenback (inflating non-dollar prices). Speculators and investors have played and won overseas, and these strategies are now widely accepted as mainstream (a deepening "inflationary bias"). Global markets today capture the majority of U.S. mutual fund flows, while American stocks are bolstered by massive company buybacks. The ballooning pool of global speculative finance is more than comfortable playing global equities, emerging market debt, and commodities; and the more favorable the relative out-performance versus dollar returns, the greater the (self-reinforcing) flows from dollars to non-dollars. Additionally, pension funds are keen to participate in the easy outsized returns. Derivatives markets and other leveraging strategies have evolved to meet booming institutional demand across all markets.

Meanwhile, scores of new mutual funds, ETFs (exchange-traded funds) and other instruments have sprouted up to provide less "institutional" investors easy access to the commodities and emerging market booms. Pimco's Bill Gross even recommended an Asian ETF (twice) yesterday in a Bloomberg interview. I don't believe the ramifications for the powerful and intensifying Inflationary Bias toward non-dollar asset classes garners the analytical attention it deserves.

The Fed is playing a losing hand and keeps wagering our currency. Accommodating the current Credit Bubble guarantees massive Current Account Deficits, as well as heightened speculative flows out of dollars and into commodities and global markets. The expectation that a declining dollar would help rectify global imbalances has failed to come to fruition, a circumstance not the least bit surprising to Macro Credit Analysts. Flawed policymaking (accommodating Financial Sphere excesses) ensured escalating Credit Inflation and only more and bigger Bubbles. As buyers of last resort, foreign central bank reserves have ballooned about $1 Trillion over the past 18 months. Ominously, this incredible support has only stabilized the dollar's freefall. Time to pause?

It is today ridiculous for chairman Bernanke and Fed officials to state that changes to our trading partners' policies (chiefly to stimulate foreign domestic demand) and currency exchange values will assuage the U.S. Current Account Deficit (and other global imbalances). We've already witnessed the consequences of wholesale Global Credit Inflation: a ballooning and more unwieldy pool of global speculative finance, along with wildly inflating commodities and asset markets. Global inflation is the problem and not the solution.

The higher energy and commodities prices surge, the greater U.S. Credit expansion and resulting dollar outflows necessary to satisfy (monetize) our dependency. The more foreign asset markets inflate, the greater the tide of speculative outflows to non-dollar markets and assets. With foreign central banks fully loaded to the gills with dollars and not all too tickled about it, it is not an easy exercise to contemplate a backdrop more conducive to a run on our currency. And how ironic would it be if such a run was instigated by our own institutions and citizens, as opposed to our foreign creditors?

Time for the Federal Reserve to contemplate pausing? Of course not. Chairman Bernanke just committed his first mistake; the dollar got clobbered; and the flight to the safe-haven (non-dollar) metals intensified. The bond market froze (deer in the headlights?). And, as one would expect, global markets turned increasingly unsettled this week and are surely poised to become only more so.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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