Page 1 of 3 CREDIT BUBBLE BULLETIN Difficult decisions ahead
Commentary and weekly watch by Doug Noland
The latest Group of 20 meeting was dominated by deep divisions over Syria in an increasingly divisive global backdrop. The Middle East is precariously divided. In Europe, leaders remain deeply divided over how best to deal with Eurozone issues. The American population is deeply divided on political, social and economic issues. Congress is deeply, deeply divided on seemingly everything.
The Federal Reserve is divided on the merits of unconventional
measures and the future course of policymaking. The emerging markets (EM) see developing world monetary policy as highly destabilizing, with QE having stoked ''hot money'' inflows and ''tapering'' risking problematic outflows.
Within the G-20, common interests have been largely supplanted by mistrust and, seemingly, irreconcilable differences. Members these days lack even a European crisis response to try to rally around. I believe the ''G'' conferences have basically lost the capacity to have real impact on very serious ongoing global financial and economic issues.
One could argue that traditional frameworks for myriad key policy decisions - from monetary policy to crisis response to acts of war - are being transformed before our eyes. This ensures added uncertainty in an already uncertain world. Markets see only QE.
The ''Credit Bubble Bulletin'' focuses (ok, fixates) on credit. I strive to keep my analysis close to home, steering clear of political debate and geopolitical pontification. Yet credit - sound or, more pertinently, otherwise - has a profound impact on wealth (creation and destruction) and wealth distribution. Protracted credit Cycles - with their attendant booms, busts and destruction - have momentous impacts on societies and geopolitics. I work to provide an accurate chronicle of relevant events.
It's been my thesis that we're at the late phase of a historic global credit boom. During much of the bubble's upside, the global economic pie was getting bigger. This provided powerful impetus to mutual interests, cooperation and integration. There was the capacity to forge international consensus on various pressing financial and economic issues - as well as even the ability to muster a ''coalition of the willing'' for major military operations.
The world is transitioning into a quite different environment. Despite desperate measure after desperate measure, a most over-extended global bubble is convulsing erratically. The economic pie is stagnating - and on its way to contracting. This dynamic ensures an increasingly powerful pull of diverging interests, disagreement, fragmentation and confrontation.
The world has turned increasingly skeptical of US policymaking, certainly including monetary policy. Round the globe, citizens and their leaders have grown tired of cooperating on just about everything - from finance to climate change to global policing. This runs up against heightened need for all of the above in an increasingly disorderly and hostile - faltering bubble - world.
I have argued that desperate monetary inflation stoked a dangerous divergence between inflated global securities prices and deteriorating fundamental prospects. With US equities near all-time highs, the market and media focus remains on Mr Brightside.
The cautious and darn right skeptical have been discredited and shoved out of the way. It has been easy to disregard the unstable global geopolitical backdrop. It's been easy to ignore the rapidly deteriorating situation in the Middle East. With the Fed injecting unprecedented amounts of liquidity into overheated markets, it has been effortless - and highly profitable - to ignore risk more generally. Indeed, the bullish view holds that we're in the initial phase of a new bull market - and, surely, a return to robust global growth, prosperity and cooperation.
There will come a point where the divergence between bubbling securities markets and a sobering reality is narrowed. The longer massive monetary inflation extends this gap, the more destabilizing the eventual market dislocation.
The greater the global market dislocation the greater the strain on economies, societies and alliances. And, in contrast to conventional thinking and that of the Fed, a lot of damage can be wrought in relatively short order when finance is running amuck. It's reached the point where QE has minimal benefit, while dilly dallying and ''tapering'' bear great costs.
Yet with global markets having come to wield unprecedented influence on credit, perceived wealth, economic activity and overall cohesion, the temptation for central banks to continue sustaining market bubbles is just too great. This dynamic creates great uncertainty, while at the same time further opening the window of opportunity for destabilizing speculative excess.
Understandably focused on economic issues at home, American public opinion is strongly opposed to intervention in Syria. Understandably focused on economic and domestic interests at home, few in the global community are willing to join the US on Syria. President Obama has very difficult decisions ahead.
The Federal Open Market Committee faces its own difficult decisions of its own making. It's notoriously difficult to withdraw monetary accommodation. Central banks are invariably late in removing the punchbowl. Perhaps more pertinent, there is never a painless path to ending aggressive monetary inflation. And that's precisely why history demonstrates that once the process of ''money'' printing (currency or ''virtual'') is embraced it becomes nearly impossible to dis-embrace.
The past five years (or, if you choose, go back 20) have illustrated how one bout of seemingly innocuous monetary inflation invariably begets proliferation and, in the end, intransigent monetary disorder. The big unknown is how this historic global experiment in central bank management of unrestrained, market-based electronic ''digital'' money and credit plays itself out.
This is an inopportune time for the emerging markets to face any moderation of Federal Reserve accommodation. But this dilemma was inevitable. When the US and the developed world moved aggressively with post-mortgage finance bubble reflationary measures, EM was the ''fledgling bubble'' poised to be on the receiving end of unparalleled liquidity flows. Global credit systems and economies diverged. In time, interests would diverge.
For going on five years now, loose money and increasingly aggressive QE pushed EM financial and economic bubbles to precarious extremes. Meanwhile, developed world recoveries badly lagged. The ''money'' flowed and latent global fragilities mounted.
Over the past year, incredible measures by the European Central Bank, Federal Reserve and Bank of Japan have had major effects. EM ''terminal phase'' Bubble excess was granted a bonus year to wreak havoc. In the US, stock prices inflated about 30%, as speculation went into overdrive.
Throughout the US corporate debt market (and only to a somewhat lesser extent globally), Bubble excesses ran wild. In the real economy, rapid price inflation reemerged in housing markets across the country. Quite simply, powerful Bubble conditions intensified, and an expanding number of sectors within the economy began to participate.
Considering the backdrop, $85 billion of monthly QE is inappropriate - I would argue reckless, a 7.3% unemployment rate notwithstanding. But both the global financial and economic spheres have grown addicted to aggressive monetary inflation.
EM bubble fragility has turned conspicuous. There is the global securities market bubble, most obvious in mispriced bond markets around the world. There are less appreciated bubbles in global equities and the ''global leveraged speculating community'' more generally. All in all, there is ample global financial and economic fragility to ensure the most timid rendition of monetary policy restraint imaginable.
On the one hand, I believe a global re-pricing of debt securities has commenced. On the other, there remains sufficient global monetary inflation and emboldened ''animal spirits'' to beg the question: How crazy do things get?
Syria is a frightening place. It's in a tough and rapidly disintegrating region. The situation has regressed into the much feared ''proxy war'' on too many fronts. And it doesn't take a wild imagination to see Syria as a catalyst for escalating global tensions that could stumble into a major confrontation. The Russians and Iranians are staring President Obama down.
Meanwhile, outside of crude oil, global markets show minimal concern. After all, analysts suggest it could be up to two more weeks - a veritable eternity for a speculative marketplace - before President Obama might act. Besides, non-farm payroll data were soft. This is expected to only further embolden the dovish contingent that was already pushing against any move to reduce accommodation (last week from Kocherlakota and Evans). It was another week that illuminated dichotomies. The reality is that the world is in the midst of far-reaching - I'm convinced troubling - changes. The market reality is that primary focus remains on the monetary backdrop.
The S&P500 gained 1.4% (up 16.1% y-t-d), and the Dow added 0.8% (up 13.9%). The Morgan Stanley Consumer index increased 1.1% (up 19.9%), while the Utilities declined 0.9% (up 3.8%). The Banks recovered 1.5% (up 23.2%), and the Broker/Dealers jumped 4.0% (up 44.5%). The Morgan Stanley Cyclicals were 2.5% higher (up 20.4%), and the Transports gained 1.9% (up 20.1%). The S&P 400 MidCaps gained 1.3% (up 17.5%), and the small cap Russell 2000 jumped 1.8% (up 21.2%). The Nasdaq100 rose 1.9% (up 17.8%), and the Morgan Stanley High Tech index surged 3.3% (up 16.4%). The Semiconductors jumped 3.8% (up 23.7%). The InteractiveWeek Internet index rose 3.5% (up 24.2%). The Biotechs surged 5.0% (up 39.6%). Bullion gained $3, though the HUI gold index was little changed (down 42.9%).
One-month Treasury bill rates ended the week at two bps and three-month bill rates closed at two bps. Two-year government yields rose 6 bps to 0.46%. Five-year T-note yields ended the week 12 bps higher at 1.76%. Ten-year yields jumped 15 bps to 2.94%. Long bond yields rose 16 bps to 3.86%. Benchmark Fannie MBS yields advanced 14 bps to 3.71%. The spread between benchmark MBS and 10-year Treasury yields narrowed one to 77 bps. The implied yield on December 2014 eurodollar futures jumped 8 bps to 0.775%. The two-year dollar swap spread was little changed at 16 bps, while the 10-year swap spread declined about one to 18 bps. Corporate bond spreads narrowed. An index of investment grade bond risk narrowed 2 to 82 bps. An index of junk bond risk fell 7 to 399 bps. An index of emerging market (EM) debt risk dropped 10 to 348 bps.
Debt issuance bounced back. Investment grade issuers included Home Depot $3.25bn, Lowes Companies $1.0bn, CME Group $750 million, Starbucks $750 million, Unilever Capital $750 million, Caterpillar $750 million, Branch Banking & Trust $750 million, Nabors Industries $700 million, Ameriprise Financial $600 million, San Diego G&E $450 million, Duke Energy $450 million, Macy's $400 million, and Kohl's $300 million.
Junk bond funds saw outflows of $416 million (from Lipper). Junk issuers last week included Sprint $6.5bn, Ally Financial $750 million, Regency Energy $400 million, Wolverine World $375 million, and Silgan Holdings $300 million.
Convertible debt issuers included Cubist Pharmaceuticals $400 million and Liberty Interactive $350 million.
International dollar debt issuers included International Bank of Reconstruction & Development $5.1bn, Toronto Dominion Bank $3.75bn, Bank of Tokyo-Mitsubishi $3.0bn, Royal Bank of Canada $2.0bn, Asian Development Bank $2.0bn, Bank Nederlandse Gemeenten $1.75bn, Japan Finance Org. for Municipalities $1.5bn, South Korea $1.0bn, Municipality Finance Plc $1.0bn, American Movil $750 million, Nakama RE $300 million and Holcim $250 million.
Ten-year Portuguese yields surged 39 bps to 6.98% (up 23bps y-t-d). Italian 10-yr yields gained 10 bps to 4.50% (unchanged). Spain's 10-year yields slipped a basis point to 4.52% (down 75bps). German bund yields rose 9 bps to 1.95% (up 63bps). French yields were up 8 bps to 2.54% (up 54bps). The French to German 10-year bond spread narrowed one to 59 bps. Greek 10-year note yields rose 19 bps to 10.21% (down 26bps). U.K. 10-year gilt yields jumped 17 bps to 2.94% (up 112bps).
Japan's Nikkei equities index ended the week up 3.5% (up 33.3% y-t-d). Japanese 10-year "JGB" yields jumped 6 bps to 0.71% (down bps). The German DAX equities index gained 2.1% for the week (up 8.7%). Spain's IBEX 35 equities index was up 4.4% (up 6.0%). Italy's FTSE MIB rose 2.2% (up 4.8%). Emerging markets rallied. Brazil's Bovespa index surged 8.1% (down 11.4%), and Mexico's Bolsa rose increased 1.1% (down 8.7%). South Korea's Kospi index gained 1.5% (down 2.1%). India's Sensex equities index rallied 3.5% (down 0.8%). China's Shanghai Exchange jumped 2.0% (down 5.7%).
Freddie Mac 30-year fixed mortgage rates jumped 6 bps to 4.57% (up 102bps y-o-y). Fifteen-year fixed rates rose 5 bps to 3.59% (up 73bps). One-year ARM rates were up 7 bps to 2.71% (up 10bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates 10 bps higher to 4.79% (up 59bps).
Federal Reserve Credit expanded $5.5bn to a record $3.607 TN. Over the past year, Fed Credit was up $809bn, or 29%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $577bn y-o-y, or 5.4%, to $11.177 TN. Over two years, reserves were $951bn higher, for 9% growth.
M2 (narrow) "money" supply jumped $35.9bn to $10.778 TN. "Narrow money" expanded 7.2% ($722bn) over the past year. For the week, Currency increased $2.7bn. Total Checkable Deposits jumped $25.7bn, and Savings Deposits rose $5.2bn. Small Time Deposits declined $3.0bn. Retail Money Funds gained $5.6bn.