The stock market run continued. For the week, the Dow and S&P500 added 1.5%. The Transports added 1.6%, increasing 2004 gains to 21%. Up 3% for the week, the Utilities’ y-t-d gain rose to 20%. The Morgan Stanley Cyclical index jumped 2.6%, and the Morgan Stanley Consumer index added 1%. The broader market rally runs unabated, with the small cap Russell 2000 rising 3% (up 12% y-t-d), and the S&P400 Mid cap index up 2% (up 10% y-t-d). The NASDAQ100 gained 2%, and the Morgan Stanley High Tech index rose 3%. The Semiconductors gained 1.5% and the NASDAQ Telecommunications index added 1%. The Street.com Internet index gained 3%, increasing y-t-d gains to 29%. The Biotechs were about unchanged. The Broker/Dealers increased 2% (up 10% y-t-d), and the Banks gained 1% (up 6% y-t-d). With bullion up $4.30 to $437.85, the HUI gold index rose 1.5%.
For the week, 2-year Treasury yields rose 5 basis points to 2.82% (up 25bps in 8 sessions). Five-year Treasury rates added 3 basis points to 3.50%. Ten-year Treasury yields were about unchanged at 4.18%. Long-bond yields ended the week unchanged at 4.90%. Benchmark Fannie Mae MBS yields were also unchanged. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note narrowed 2 to 44, and the spread on Freddie’s 5% 2014 note narrowed 2 to 40. The 10-year dollar swap spread declined 1 to 42.5. Corporate bonds continue to trade well. The implied yield on 3-month December Eurodollars added 1 basis point to 2.43%.
Corporate debt issuance surged to about $19 billion this week (from Bloomberg). Investment grade issuers included Bellsouth $2.0 billion, KWF Bank $2.0 billion, Bank of America $1.0 billion, IBM $1.0 billion, American Express $1.0 billion, XL Capital $950 million, Ford Motor Credit $800 million, Barrick Gold $750 million, Kraft $750 million, Citizens Communications $700 million, Countrywide $650 million, FPL Group $553 million, Flextronics $500 million, Kinder Morgan Energy $500 million, Jetblue Airlines $500 million, Axis Capital $500 million, Petro-Canada $400 million, Alabama Power $300 million, Dex Media West $300 million, Entergy $275 million, Nevada Power $250 million, Indiana Michigan Power $175 million, and OGE Energy $100 million.
November 9 – Dow Jones (Simona Covel ): “After months of expectation, the high-yield market faces an explosion of new issuance as about $1.6 billion in deals is expected to hit the market Tuesday and Wednesday. The new deals come from issuers all over the rating spectrum… The new deals are expected to fare well in an environment where investors, frustrated by the last few months’ trickle of issuance, are desperate for fresh buying opportunities.”
Junk bond inflows jumped to $601.5 million (from AMG), with funds now enjoying positive flows in 11 of the past 12 weeks. Issuers included Elan $1.15 billion, Tenneco $500 million, Inmarsat Finance $450 million, Thornburg Mortgage $305 million, Alrosa Finance $300 million, Affina Group $300 million, Williams Companies $270 million, Ultrapetrol $180 million, AAC Group Holding $132 million, Integrated Alarm $125 million, and Gabelli Asset Management $71million.
Convert issuers included NCI Building Systems $150 million.
Japanese 10-year JGB yields dropped 5 basis points to 1.46%. Brazilian benchmark bond yields declined 5 basis points to 8.38%. Mexican govt. yields ended the week at 5.20%, down 2 basis points. Russian 10-year dollar Eurobond yields added 5 basis points to 5.79%.
Freddie Mac posted 30-year fixed mortgage rates basis rose 6 points this week to 5.76%, with rates up 12 basis points in two weeks. Fifteen-year fixed mortgage rates were up 8 basis points to 5.16% (up 15bps in 2 weeks). One-year adjustable-rate mortgages could be had at 4.16%, up a notable 16 basis points for the week (20bps in 2 weeks) to the highest level in 15 weeks. The Mortgage Bankers Association Purchase application dipped 2.7% last week, giving up little of the previous week’s big jump. Purchase applications were up about 30% from one year ago, with dollar volume up 44%. Refi applications declined 6.7% during the week. The average Purchase mortgage was little changed at $224,500, while the average ARM rose to $310,100. ARMs accounted for 35.3% of total applications last week.
Broad money supply (M3) expanded $5.6 billion (week of November 1). Year-to-date (44 weeks), broad money is up $483.6 billion, or 6.5% annualized. For the week, Currency rose $2.0 billion. Demand & Checkable Deposits dropped $12.9 billion. Savings Deposits jumped $21.7 billion, with a year-to-date gain of $342 billion (12.8% annualized). Small Denominated Deposits added $1.5 billion. Retail Money Fund deposits dipped $1.0 billion, while Institutional Money Fund deposits rose $7.0 billion. Large Denominated Deposits declined $1.3 billion. Repurchase Agreements declined $4.9 billion, and Eurodollar deposits fell $6.4 billion.
Bank Credit increased $3.5 billion for the week of November 3 to $6.713 Trillion. Bank Credit has expanded $438.9 billion during the first 44 weeks of the year, or 8.3% annualized. For the week, Securities holdings rose $6.0 billion, while Loans & Leases dipped $2.5 billion. Commercial & Industrial loans declined $3.8 billion, while Real Estate loans jumped $9.4 billion. Real Estate loans are up $270.7 billion y-t-d, or 14.4% annualized. Consumer loans were down $1.7 for the week, while Securities loans dropped $9.4 billion. Other loans were up $3.0 billion. Elsewhere, Total Commercial Paper declined $7.0 billion to $1.369 Trillion. Financial CP dipped $1.8 billion to $1.234 Trillion, expanding at a 7.3% rate so far this year. Non-financial CP declined $5.2 billion (up 28.8% annualized y-t-d) to $134.9 billion. Year-to-date, Total CP is up $100.0 billion, or 9.1% annualized.
November 11 – Financial Times (Jennifer Hughes and David Wells): “Issuance of asset-backed bonds in the US has reached a record level this year and is set to overtake more traditional corporate sales for the first time. Data from the American Securitization Forum and the Bond Market Association show that $662.9bn worth of asset-backed securities was issued in the US in the first three quarters of 2004 - already a record for the market - compared with $535bn of corporate bonds. Last year, corporate issuance was much higher than its asset-backed counterpart at $764.8bn compared with $585bn. Home equity issuance was the biggest driver of the rise in asset-backed securities."
November 9 – Bloomberg (Mariko Yasu): “JPMorgan Chase & Co., the second-largest U.S. bank by assets, will nearly triple sales of securities that repackage loans this year, tapping rising demand from investors in Japan… JPMorgan expects to sell about $4 billion of so-called collateralized loan obligations arranged in the U.S., 2.7 times more than last year… Banks create CLOs by bundling together loans and using the income from the credits to repay investors. Global sales of repackaged high-yield loans amounted to $21.2 billion in the first nine months, nearly as much as in all of 2003…”
This week’s ABS issuance amounted to about $10.5 billion (from JPMorgan). Total year-to-date issuance of $549 billion is 38% ahead of comparable 2003. 2004 home equity ABS issuance of $348 billion is running 81% ahead of last year’s record pace.
Fed Foreign “Custody” Holdings of Treasury, Agency Debt rose $5.15 billion to $1.306 Trillion. Year-to-date, Custody Holdings are up $239.2 billion, or 25.9% annualized. Federal Reserve Credit added $1.4 billion for the week to $774.8 billion, with y-t-d gains of $28.2 billion (4.4% annualized).
The euro closed today at an all-time high of 1.2975 against the dollar. The dollar index lost about 0.3% this week to close below 84 for the first time since November 1995. The Swedish krona gained 1.45%, the Thai baht 1.43%, the Polish zloty 1.13% and the Brazilian real 1.0%. The dollar this week made up ground on the Zimbabwe dollar (1.78%), the Romanian leu (0.75%), and Botswana pula (0.5%).
November 10 – Bloomberg (Koh Chin Ling): “China, the world’s biggest producer of corn, may this year become a net importer of cereals including rice, corn and wheat for the first time since 1996, a state grain administration affiliate said. China may buy 5.36 million metric tons more of cereals this year than it exports… The last time China imported more than it exported was in 1996…”
November 10 – Bloomberg (Jeff Wilson): “Hog prices rose 2 cents a pound, the maximum allowed by the Chicago Mercantile Exchange, as pork demand by meat processors and exporters climbed. The wholesale value of a 185-pound hog carcass rose 1.7 percent to a four-week high yesterday as ham prices soared 7 percent to a record… Turkey supplies in U.S. frozen storage fell 18 percent on Sept. 30 from a year earlier… ‘There is a real shortage of holiday entrees that will support a very strong ham market into December,’ said Dan Vaught, a livestock analyst…”
November 10 – Bloomberg (Laura Humble and Jason Gale): “Coffee prices rose the most in almost three months in London after the U.S. Department of Agriculture cut its export forecast for Brazil, the world’s biggest producer of the beans, by 12 percent for 2004-05. Farmers in Brazil are holding back supplies to try to boost prices, the department said in a report.”
November 10 – Bloomberg (Jeff Wilson and Daniel Goldstein): “An aggressive fungal disease known as soybean rust has been found on plants in Louisiana, the first U.S. case, threatening a crop valued at $17.8 billion last year, the government said. Soybean futures gained the most in two weeks. The fungus was found on two Louisiana State University research plots near Baton Rouge, the U.S. Department of Agriculture said. A team of USDA specialists is being sent to the state to determine how far the disease spread.”
Gold today closed at a 16-year high, copper at a 1-month high, and wheat at an 18-month low. With December crude declining $2.29 to a $47.32, the Goldman Sachs Commodities index dipped 1.7% for the week. This reduced year-to-date gains to 28.6%. The CRB index was about unchanged for the week, with y-t-d gains of 11.0%.
November 9 – XFN: “China’s gross domestic product growth will reach 9.25% in 2004 compared with last year's 9.1% rise, with growth slowing to about 8% in 2005, the World Bank said.”
November 10 – Bloomberg (Philip Lagerkranser): “China’s exports grew in October at the slowest pace in nine months as high oil prices left consumers in the U.S., Europe and Japan with less to spend on Chinese-made toys, televisions and clothes. Overseas sales increased 29 percent from a year earlier to $53 billion after climbing 33 percent in September…”
November 10 – Bloomberg (Philip Lagerkranser): “China’s industrial production growth slowed in October as government lending restrictions hurt sales of automakers including General Motors Corp. and exports flagged. Production rose 15.7 percent from a year earlier after climbing 16.1 percent in September…”
November 8 – Bloomberg (Clare Cheung and Philip Lagerkranser): “Hong Kong’s retail sales growth picked up in September as surging tourist arrivals and falling unemployment helped boost spending in the city. Sales rose 8.7 percent from a year earlier to HK$15 billion ($1.9 billion) after climbing a revised 5.7 percent in August…”
Asia Inflation Watch:
November 10 – Bloomberg (Sumit Sharma and Kartik Goyal): “India’s President A.P.J. Abdul Kalam wants the country’s foreign-exchange reserves to be used for investments, he told a bankers' conference in New Delhi. ‘The bankers can have a mission -- how to invest and multiply a portion of foreign-exchange reserves, if they are made available for investing in relatively higher-yield enterprises.’”
November 9 – World Bank: “East Asia’s economies are growing at their swiftest pace since before the financial crisis with fewer people than ever living in extreme poverty, according to the latest East Asia and Pacific Regional Update… Economic growth is expected to top 7 percent for East Asia and Pacific (excluding Japan), while developing economies in the region are expected to expand by more than 8 percent.”
November 8 – Bloomberg (Theresa Tang): “Taiwan’s exports rose in October at their slowest pace in seven months as high crude-oil costs left companies and consumers in the world’s biggest economies with less to spend on computers, flat-panel displays and cell phones. Shipments increased 17.5 percent from a year earlier to $15.4 billion after climbing 19.2 percent in September…”
November 10 – Bloomberg (Laurent Malespine): “Thailand’s new vehicle sales rose about 20 percent last month from a year earlier to 55,341 units, Toyota Motor…said.”
November 8 – Bloomberg (Stephanie Phang): “Malaysia’s industrial production rose at its weakest pace in a year in September as mining barely grew. Output may slow further as record oil prices curb spending on electronics and other manufactured goods, analysts said. Output at factories, mines and utilities rose 9.8 percent from a year earlier…”
Global Reflation Watch:
November 10 – Bloomberg (Kevin Bell): “Canada may end the fiscal year with a budget surplus of C$7.7 billion ($6.5 billion), almost twice a government forecast made earlier this year, according to the Canadian Centre for Policy Alternatives, the Globe and Mail reported.”
November 9 – UPI (Robin Shephard): “Fancy making a quick buck? You could have done a lot worse this year than if you’d put your money into the stock exchanges of the new members of the European Union from central and eastern Europe. In the first 10 months of 2004 Hungary’s benchmark BUX index was up 57 percent. Prague’s PX50 gained 49 percent and Poland’s WIG 20 was up 29 percent. If you’d invested in the BET-C, the key index of EU candidate Romania…you’d now be sitting on whopping 82 percent return. The figures from central and eastern Europe are calculated in dollar terms and, therefore, partly reflect declines in the U.S. currency against non-dollar denominated assets.”
November 8 – Bloomberg (Gonzalo Vina): “The cost of goods leaving British factories rose in October at the fastest annual pace since December 1995 as the price of metals and oil jumped. Producer prices rose a non-seasonally adjusted 3.5 percent, from 3.1 percent in September, the National Statistics office in London said.”
November 11 – Bloomberg (Tracy Withers): “New Zealand’s economy added almost twice as many jobs as economists expected in the third quarter, cutting the unemployment rate to 3.8 percent, the lowest in more than 18 years.”
November 11 – Bloomberg (Victoria Batchelor): “Australia’s unemployment rate fell to 5.3 percent in October, the lowest in more than 26 years, and the economy added twice as many jobs as expected as higher corporate profits spurred hiring.”
November 9 – Bloomberg (Adriana Arai): “Mexico’s 12-month inflation rate rose in October to its highest in 19 months, fueling speculation that the central bank will lift interest rates twice more this year. Consumer prices jumped 0.69 percent last month… that boosted the 12-month inflation rate to 5.4 percent…”
November 10 – Bloomberg (Romina Nicaretta): “Brazil will end 2004 with a current account surplus of about $10 billion, Antonio Palocci, Brazil’s Finance Minister, said. ‘We had a very significant change in term of trade balance and current account,’ Palocci said…”
Dollar Consternation Watch:
November 10 – Market News International: “French Prime Minister Jean-Pierre Raffarin argued Wednesday that the dollar exchange rate is out of line with economic fundamentals and called on international leaders to remedy the situation. ‘The dollar is too low and this does not correspond to state of the various economies… The crisis of the dollar, the collapse of the dollar is a real problem and I truly hope the international community will deal with all the consequences of the situation.’”
November 11 – Bloomberg (John Fraher): “Former European Central Bank President Wim Duisenberg said the U.S. current account deficit is the biggest risk to the dozen-nation euro region’s economy, the Frankfurter Allgemeine Zeitung said, citing an interview. The record deficit ‘can’t continue’ and the euro’s exchange rate will probably bear the brunt of any dollar depreciation adjustment as a result of it…Duisenberg retired in November last year. Duisenberg said the deficit will probably eventually lead to Asian and Latin American currencies appreciating against the dollar…”
California Bubble Watch:
November 11 – Los Angeles Times (Annette Haddad ): “After a summer of flattening prices, the median home price in Los Angeles County edged higher last month to $409,000, a 23% increase over a year ago… That made October’s median price the second-highest recorded for Los Angeles County in nearly 17 years, according to DataQuick…. The county’s median peaked at $414,000 in June… Meanwhile, the total number of homes sold fell 17.8% to 9,709 last month, down from 11,805 a year ago, and down 7.5% from September.”
Bubble Economy Watch:
November 10 – Market News International (Gary Rosenberger): “Cargo entering the U.S. in September and October overwhelmed ports, railways and trucks, gumming up real-time inventory deliveries in what marks the heaviest peak-shipping season ever, industry officials say. By mid-October there were 94 ships idling around the ports of Long Beach and Los Angeles, the nation's gateway for most Asian goods, unable to discharge. The bottlenecks were two-thirds as severe as during the worst of the port lockout two years ago and could leave a misleading impression of slowing imports. If anything, the trade gap would continue to balloon if undelivered goods were factored in to port data. Indeed, diversions away from southern California are generating record inbound volumes at other ports and are likely to widen the trade gap in September, and more so in October and November as sea-lanes are cleared.”
The September Trade Deficit contracted marginally to $51.6 billion (up 25% from Sept. ’03). Goods Exports were up 15.4% to $68.9 billion, while Goods Imports were up 17.2% to $124.5 billion. Goods Exports would need to rise 81% to match Imports. October year-over-year Import Prices were up 9.7%, the strongest rise since 1988. To illustrate how the pricing environment has changed, it is worth noting that year-over-year Import Prices were negative from March 2001 through September 2002.
November 9 – Bloomberg (Mark Shenk and Jim Kennett): “Homeowners in the U.S. Northeast will pay 37 percent more for heating oil this winter than a year earlier and natural gas users in the Midwest will see costs rise 15 percent, the Energy Department said in a monthly report.”
Mortgage Finance Bubble Watch:
Freddie Mac raised its 2004 forecast for mortgage originations 3.7% to $2.725 Trillion. The company expects residential mortgage debt to grow at an annual rate of 15.4% during the third quarter, then to slow to 14.3% during the fourth quarter. For all of 2004, residential mortgage debt is expected to expand 13.4%, followed again by 13.4% during 2005. Growth is then expected to slow somewhat to 11.6% during 2006. It is worth noting that 2004 growth of 13.4% would be the strongest rate of growth since 1985. And the forecasted $958 billion increase in residential mortgage debt this year would compare to the average during the 90’s of $234 billion. And if Freddie’s forecasts for 2005 and 2006 prove accurate, this would have mortgage debt ending 2006 at $10.3 Trillion – six straight years of double-digit growth, with residential mortgage debt having ballooned 160% over nine years (since the beginning of 1998).
Countrywide Financial enjoyed a strong October. Average daily fundings of $1.99 billion were up 27% from October 2003. The Total Pipeline of $52.0 billion was an increase of 22% from one year ago. Purchase fundings were up 20% from a year earlier to $14.9 billion, while Refis were down 14% to $14.3 billion. ARMs comprised 56% of total fundings (down from Sept.’s 68%) at $16.3 billion, but ARM volume up 53% from comparable 2003. Home Equity fundings were up 73% from one year ago to $3.1 billion and Subprime 35% to $3.3 billion. Total Bank Assets were up 113% from one year ago to $36.4 billion.
Mortgage REIT Redwood Trust Total Assets expanded at a 34% annualized rate to $23.9 billion, with assets up 60% from one year ago. Shareholders’ Equity ended the quarter at $902 million.
November 11 - Dow Jones (Allison Bisbey Colter): “Fannie Mae is expanding its mobile home-lending program, allowing more borrowers to purchase a manufactured home with a down payment of just 5% on a 30-year mortgage. In the past, borrowers who wanted to purchase manufactured housing, or mobile homes, with a 30-year mortgage had to come up with a downpayment of at least 10%. But in February, Fannie Mae began a pilot program with 10 lenders allowing would-be borrowers to finance up to 95% of the value of a mobile home with a 30-year mortgage. The program is now being expanded to allow all of the lenders with whom Fannie Mae does business to offer the lower-cost financing.”
November 10 – Bloomberg (James Tyson): “The senior Democrat on a congressional panel that oversees Fannie Mae today opposed increased funding for the company’s regulator pending the public release of a report into the agency’s political impartiality. The regulator, the Office of Federal Housing Enterprise Oversight, has said it may have to curtail next month its investigation into Fannie Mae’s accounting unless it receives a budget increase to $59.2 million for the fiscal year that began on Oct. 1, from $39.9 million in the prior year…”
November 10 – Bloomberg (Miles Weiss): “Bear Stearns Cos. invested $25 million with a former executive who started a hedge fund specializing in securities backed by commercial mortgages, a regulatory filing shows… Commercial mortgage-backed securities are bonds backed by loans on properties such as office and apartment buildings, hotels and shopping centers. The securities recently have become more popular among hedge funds. ‘There is a proliferation of these’ types of hedge funds, said Tad Philipp, managing director of commercial mortgage-backed securities for Moody’s…‘A lot of people sense the opportunity… As more firms come to the table, the arbitrage begins to shrink. Spreads are narrowing for junior bonds and subordinated loans on properties.’”
U.S. Bubble Watch:
November 9 – New York Times (Mark Landler): “Commerzbank, stung by its foray into the volatile world of proprietary trading, announced Tuesday that it would shut the bulk of its investment banking operations outside Germany… Commerzbank’s securities division, which encompasses trading and investment banking, lost 171 million euros ($221 million) in the third quarter, after losing 47 million euros ($61 million) the previous quarter. ‘Despite strained market conditions, there is no acceptable excuse,’ the bank’s chairman, Klaus-Peter Müller, said…adding that the division was a ‘problem child.’ The mounting problems forced Mr. Müller, a genial commercial banker who once ran Commerzbank’s office in New York, to all but erase the bank’s presence there.”
Excerpts from the Bond Market Association Research Quarterly
The average daily volume of total outstanding repurchase (repo) and reverse repo agreement contracts totaled $4.82 trillion for the first three quarters of 2004, an increase of 21.4 percent from the average volume of $3.97 trillion during the same period of 2003. Daily outstanding repurchase agreements averaged $2.8 trillion through September, an increase of 21.0 percent from the $2.32 trillion volume during the same period of 2003… Through the third quarter of 2004, over $256.8 trillion in repo trades were submitted by Government Securities Division participants, with an average daily volume of approximately $1.4 trillion.
With three months to go in 2004, the asset-backed securities market already surpassed the previous issuance record of $585.0 billion, set in 2003. New issue activity totaled $661.1 billion in the first three quarters of the year, 54.8 percent higher than the $427.1 billion issued in the same period of 2003… The resilient housing market has created an environment in which consumers extensively use home equity as a source of additional funds. Issuance in the HEL (home equity loan) sector increased 75.1 percent in the first three quarters of the year, to $309.2 billion, compared to $176.6 billion in the same period in 2003… The student loan ABS sector continued to grow despite a significant decrease in issuance during the third quarter. Year-to-date issuance totaled $38.4 billion [up 27% from comparable 2003]...
Gross issuance of U.S. coupon Treasury securities totaled $639.2 billion in the fist three quarters of 2004, a 20.5 percent increase over the $530.3 billion issued in the same period in 2003… TIPS issuance of $21 billion in the quarter was more than twice the volume of the fourth quarter of last year. Daily trading volume of Treasury securities by primary dealers averaged $496.3 billion during the first three quarters of the year, up 13.2 percent from the $438.6 billion over the same period a year ago. During the third quarter, daily trading volume by primary dealers rose, peaking at $517.6 billion in September.
Issuance of long-term debt by federal agencies totaled $732.2 billion in the first three quarters of 2004, down 27.5 percent… [During the past year, Freddie’s short-term debt has increased 9.3% to $218.5bn and Fannie’s 7.2% to $340.4bn].
Total short- and long-term municipal issuance declined in the fist three quarters of 2004 to $315.3 billion, 9.2% lower than the $347.1 billion issued in the same period of 2003.”
Corporate bond issuance rose sharply in the third quarter, regaining the momentum from earlier in the year after a pause in the second quarter. New issue volume totaled $171.5 billion in the third quarter, up 25.9 percent from the $136.1 billion issued a quarter earlier and up 9.1 percent from the volume issued during the third quarter a year ago… Over the past year, profits and cash flows have increased significantly for corporate issues, resulting in an ample supply of internally generated funds… Stone and McCarthy Research Associates reports that the Merrill Lynch index spread for investment grade hit a five-month low in mid-October…and its speculative grade index hit its tightest spread since 1998 in early October…
Issuance of mortgage-related securities, which include agency and private-label pass-throughs and CMOs, totaled $407.1 billion in the third quarter, down from the $539.3 billion issued in the second quarter, but nearly unchanged from the first quarter… The private-label MBS sector was the bright spot in the mortgage-related market. Issuance decreased slightly in the first three quarters of the year, to $272.1 billion… The private-label performance reflects product innovation in this sector and the demand for jumbo mortgage refunding… Average daily trading volume in agency mortgage-backed securities by primary dealers decreased 6.4 percent, to $205.2 billion in the first three quarters of the year…
The hedge fund industry has grown at a rapid pace in the past 10 years. At the end of the second quarter of 2004, there were over 5,000 funds managing nearly $900 billion, up from less than 2,000 funds and $160 billion managed in 1994.
I would like to proffer that the primary issue today with respect to unrelenting Credit inflation is missed in the interminable “inflation vs. deflation” debate. Instead, we should focus our analytical attention on Monetary Disorder and attendant destabilizing excess Liquidity. Granted, this is not an area without significant challenges. There are no price indices to measure for upward or declining trends, nor is there really much that we could hope to quantify. One might have expected that the phenomenon of heightened Monetary Disorder would have manifested in expanding risk and Credit premiums. Instead spreads have done just the opposite and collapsed. Monetary Disorder has much to do with speculative market dynamics, as it does with provoking unpredictable and aberrant system behavior.
I am again drawn to the use of the “Financial Sphere” and “Economic Sphere” framework in an attempt, in this case, to raise some issues relevant to the concept of Monetary Disorder. It is valuable to examine the effects of Credit inflation and attendant liquidity excesses on the structure of the economy, as well as on financial system and asset market dynamics.
Imagine a prosperous small community that had accumulated tremendous (economic and financial) wealth over generations. Over time it had become possible to import most of its goods from less wealthy communities operating with cheaper labor and generally lower cost structures. Prosperous Community - with a gradual but steady increase in prices - lost its capacity to competitively manufacture most goods. Yet there was little concern, as the air was fresher, and most workers preferred the employment opportunities and environment offered by the “service” sector. Imported goods became only cheaper and more plentiful, and Prosperous Community was able to use a larger percentage of its rising income for the purchase of services and luxury items. And the more income and wealth rose, the greater the demand for the expanding array of services and luxury items offered by the New Economy.
Traditional inflation was quite low and quiescent. The powerful combination of steadily rising income, declining interest-rates and easy Credit Availability stoked asset inflation and the booming “financial services.” Citizens could spend most income on consumption, but still have plenty of resources for accumulating “wealth” for retirement. An increasing amount of funds were directed to investment and retirement accounts, much of it borrowed directly or indirectly against inflating home prices.
A few points: First, over time, spending patterns changed rather profoundly. A much reduced percentage of income went toward the purchase of the traditional basket of basic necessities (associated with “CPI”). This, combined with downward price pressure commensurate with the flood of imported goods, basically made the CPI a useless (at best) indicator of general monetary conditions. Indeed, a stable CPI in the “Economic Sphere” became a leading factor supporting the ballooning “Financial Sphere.”
Second, the move to a “services” economy significantly altered the character of output, as well as income and profits generation. Local businesses borrowed to fund advertising campaigns, increasing “output” and income for the booming media sector. The “hospitality” sector was a major contributor to local economic growth, along with the construction and home improvement trade. Agents selling inflating assets or asset-related services saw incomes surge.
Third, investing in the capacity to produce and sell widgets was a dying force. Lending – as opposed to investment – became the economy’s driving force. The community’s entrepreneurs and risk-takers all gravitated to finance and the markets. The Titans of Industry “ran money.”
Fourth, no longer would over-stimulation foster bottlenecks, inefficiencies, shortages and price pressures in the goods-producing area. Rather, the community’s citizens would enjoy eating out more and enjoying the expensive entrees at their neighborhood bistros, buying luxury foreign autos, moving up to more expensive McMansions, purchasing more insurance and annuity products, acquiring more technology gadgets, downloading more digital music, movies, publications and video games, and going on more lavish vacations. Expensive fad diets, bright white teeth, Lasik eye repair, and plastic surgery all became the rage. GDP expansion was almost as certain as Credit growth, although few appreciated the the "business cycle" had been supplanted by the "credit cycle."
With lending and “liquidity” abundant throughout the community, interest-rates remained low, asset price inflation persistent and Credit growth unrelenting. And the old CPI - well, it hardly budged. The newly created liquidity and wealth – with a hankering to flow to the asset markets - caused minimal additional demand or price pressure for items comprising the “core” of that anachronistic basket of basic goods and services. Goods imports surged, but fortunately our trading partners were happy to accept our IOUs and stuff them in mattresses. Prosperous Community, after all, had been prosperous for a very long time.
There are several hopefully pertinent dynamics that I will try to illuminate by examining the two “spheres.”
Economic Sphere: Through the perspective of traditional analysis, it was near economic nirvana. “Wealth’ surged, with rising home and asset prices. Consumer prices were stable, while rising “output” was created by fewer working less hours. Profits from making widgets continued to erode, although businesses providing services and finance enjoyed a growth and profits windfall. And the more the economy transformed away from producing goods to providing services and lending, the better “returns” appeared for the system as a whole. The dynamics of de-industrialization became powerful. Spending throughout the economy was dictated by financial profits, led by financing housing and consumption. Few goods-producing ventures were funded because the risk was perceived as much higher than was the case for mortgage, securities and credit card lending. Systemic liquidity excess and pricing distortions incited a major building boom for housing, sports venues, campus upgrades and additions, "hospitality" and retail space. There was no appreciation for how deep structural changes had signficantly increased the economy's vulnerability to any reduction in Credit growth or liquidity.
Analytically, the Economic Sphere sets trap after analytical trap. The more impaired the underlying structure of the economy, the greater the boon for the Financial Sphere. Lending and speculating excess for some time sustain the Bubble economy, while embarrassing the naysayers. Policymakers, attempting to mitigate effects from previous mistakes, can be expected to take extreme measures to sustain booms and hope for the best.
Financial Sphere: Funding business investment was no longer the chief source of new liquidity for the economy. Instead, financing asset purchases (homes and securities) and borrowing to fund (imports and “services”) consumption were the primary sources of new liquidity. Over time, there was an unprecedented decoupling of the liquidity-creating mechanism away from actual wealth creation in the real economy, while liquidity and asset markets became tightly interlinked. The era of self-reinforcing asset Bubbles had taken hold. The more liquidity created, the greater asset prices inflated. This begat only more lending and liquidity excess. Speculative finance and its powerful liquidity-creating capacity took increasing command over the Economic Sphere.
A seductively dangerous circumstance evolved where massive ongoing inflation in financial claims corresponded with little of anything “real” to support their value (non-productive debt growth) or demonstrated little if any impact on CPI. Lending would fund spending on services, which would drive income and asset inflation. But at the end of the day the economy had added no real wealth or wealth creating capacity. And, importantly, with policymakers and lenders trapped in a bygone framework of judging the appropriateness of monetary conditions from changes in CPI, monetary policy became largely detached from monetary conditions. This is where Monetary Disorder really took hold. Monetary expansion was no longer limited by the authorities. Moreover, traditional inherent limitations to Credit excess available from funding finite profitable investments were inapplicable. On the contrary, perceived limitless financial profits ushered in an historic market dislocation in the guise of A New Era of Unlimited Liquidity.
And it is important to appreciate that over years a confluence of factors afforded the Financial Sphere dominance over the Economic Sphere. These factors also fomented Monetary Disorder. For one, the expanding quantity of financial claims created enormous financial sector profits (lending and managing assets) and power. For everyone, there was an increasing proclivity to play the financial profits boom, which eventually led to egregious "blow-off" lending and speculating excess. The resulting heavy debt load and exposure to market forces also led to some strange social and political trends. And every year the pool of liquidity seeking financial profits increased, only exacerbating destabilizing speculation, asset inflation and Bubbles, and general boom and bust dynamics – the very essence of Monetary Disorder.
When the unsuspecting public suffered from a stock market boom gone bust, the ever enlarging pool of liquidity simply rushed to play the sure thing of bond and real estate inflation. And the latest hot game captured imaginations: professional speculators positioned (“hedged”) to make out-sized returns no matter what the stock market environment. And while the speculators would play any market to try to eek out a trading gain, the bread and butter was borrowing cheap and lending dear. The old “inflation” saw of “too much money [in the Economic Sphere] chasing too few goods” was replaced by “too much liquidity [in the Financial Sphere] aggressively chasing financial profits.” Each year only more liquidity was created in the process of financing (leveraging) Credit Bubble-induced non-productive debt, and much of this liquidity flowed right to financial profit speculators. Leveraged speculation became the instrumental source of liquidity for the Financial Sphere that had taken complete command of the Economic Sphere.
And while true economic wealth was stagnant at best for the Economic Sphere, Credit and asset Bubbles ensured that increasing amounts of liquidity flowed into the ballooning financial sphere every day, week, month and year. Moreover, each year the accumulated claims held by Prosperous Community’s trading partners ballooned. They finally decided to begin cashing a few IOUs and spending the proceeds, both impacting the value of the IOUs and forever changing the global pricing environment (additional sources of Monetary Disorder).
When the margins from building and selling widgets contract, viable options don’t usually include aggressively increasing volume. But when lending and speculating “profits” narrow - as they do when too many rush to play the same game - more aggressive lending and leveraging will suffice for awhile. All the while, rising community perceived “wealth” and liquidity incite a rising appetite for risk. And there is a great dilemma associated with Monetary Disorder being unleashed in contemporary economies and financial systems: there is no monetary authority or self-adjusting mechanism to bring it back into line.
I will return to reality and try to get this less-than-cohesive analysis wrapped up. This year we have now witnessed destabilizing “melt-up” behavior in the three most important markets in the world: U.S. fixed income, global energy, and now American Equities. Globally, emerging debt and equity markets have enjoyed spectacular returns, with generally strong gains for most “developed” stock and bond markets. The proliferation of leveraged strategies and unprecedented leveraged speculation has created an environment of unparalleled global over-liquidity. And in an age of trend following speculations and derivative trading, the global liquidity backdrop creates a system with a proclivity for inciting bouts of panic buying. And, as always, rising speculative markets create their own liquidity.
The U.S. bond market remains the epicenter for liquidity excess. With Fed assurances of continuous marketplace liquidity; guarantees that they will act to support stable and strong markets; and promises that they will forewarn participants to rising rates, the U.S. Credit system has become a bastion of over-liquidity and speculative excess. Strong economic data has had minimal impact on market yields, while weak data incites big bond rallies. Big stock gains are a yawner, while appearances of equity market vulnerability incite major bond rallies. And, amazingly, surging energy prices incited – what else but a bond market rally. Importantly, these bond market rallies created additional liquidity that then stimulated stocks and underpinned the economy. And these dynamics rest at the heart of today’s Monetary Disorder - destabilizing liquidity that has created unstable asset inflation, boom and bust dynamics, and financial asset prices increasingly detached from underlying economic wealth. Financial markets have been extricated from reality.
In short, the Fed has remained ultra-easy because of the systemic risk brought on by unprecedented financial leveraging and speculation. This has only nourished the dysfunctional Financial Sphere to greater Credit inflation, liquidity excesses, and endemic Bubble excess. Fed policy nurtures the Great Credit Bubble. And those merely focusing on the seductively deceiving exploits of the New Economic Sphere and asset prices have no appreciation for the great risk posed by our vulnerable currency and Intransigent Monetary Disorder.
Sunday, September 7, 2014
Now that was something else… For the week, the Dow gained 3.6% and the S&P500 rose 3%. Economically sensitive issues were on fire (as were many non-economically sensitive). The Transports gained 3%, increasing y-t-d gains to almost 19%. The Utilities added 2%, with 2004 gains of 17%. The Morgan Stanley Cyclical index jumped 6% to an all-time high (up 7% y-t-d). The Morgan Stanley Consumer index rose 4%. The broad market was quite strong. The small cap Russell 2000 surged 3.5%, and the S&P400 Mid-cap index gained 3%. The NASDAQ100 rose 2.6%, and the Morgan Stanley High Tech index advanced 3%. The Semiconductors and NASDAQ Telecommunications indices each added 1%, and The Street.com Internet index gained 2%. The Biotechs jumped 4%, increasing 2004 gains to 9.4%. The Broker/Dealers jumped 5%, and the Banks gained 3%. Bullion traded up $5 to a 15-year high $433.55. The HUI gold index gained 2%.
The vulnerable Treasury market took it on the chin. For the week, 2-year Treasury yields surged 22 basis points to 2.77%. Five-year Treasury rates jumped 20 basis points to 3.48%. Ten-year Treasury yields rose 15 basis points to 4.175%. Long-bond yields ended the week at 4.90%, up 11 basis points. Benchmark Fannie Mae MBS yields increased 10 basis points. The spread (to 10-year Treasuries) on Fannie’s 4 3/8% 2013 note was unchanged at 27, and the spread on Freddie’s 4 ½ 2013 note was unchanged at 26. The 10-year dollar swap spread increased 0.5 to 43.5. Corporate bonds were mixed but generally performed well. The implied yield on 3-month December Eurodollars jumped 9.5 basis points to 2.42%.
Corporate debt issuance dropped to $10 billion this week (from Bloomberg). Investment grade issuers included Morgan Stanley $4.5 billion, Washington Mutual $1.5 billion, Wachovia $1.0 billion, L-3 Communications $650 million, HBOS $300 million, Knight-Ridder $200 million, Leggett & Platt $180 million, and Great-West $175 million.
Junk bond inflows increased to $361 million (from AMG), with funds now enjoying positive flows in 10 of the past 11 weeks. Issuers included K&F Acquisition $315 million, Building Materials Corp $250 million, Rockwood Specialties $200 million and Herbst Gaming $170 million.
Convert issuers included Powerwave Tech $150 million, Ryerson Tull $145 million, Conmed $125 million, and Audiocodes $100 million.
Foreign dollar debt issuers included Stats Chippac $215 million.
November 5 – Bloomberg (Bharat Ahluwalia): “Indian 10-year bonds fell, pushing yields up by the most in 18 months, on speculation banks will buy less debt at a sale Nov. 8 after their surplus cash shrank. As funds with lenders dropped, bonds fell for the fifth day in six, and the central bank moved to address the shortage by adding money to the banking system for the first time since March 28, 2003… Demand also slid on concern inflation may accelerate after India’s oil refiners raised fuel prices yesterday.”
Japanese 10-year JGB yields rose 2 basis points to 1.51%. Brazilian benchmark bond yields sank 18 basis points to 8.43%. Mexican govt. yields ended the week at 5.22%, up 4 basis points. Russian 10-year dollar Eurobond yields declined 9 basis points to 5.74%.
Freddie Mac posted 30-year fixed mortgage rates rose 6 basis points this week to 5.70%. Fifteen-year fixed mortgage rates were up 7 basis points to 5.08%. One-year adjustable-rate mortgages could be had at 4.00%, up 4 basis points for the week. The Mortgage Bankers Association Purchase application surged 12% last week to the highest level since the first week of July. Purchase applications were up about 23% from one year ago, with dollar volume up 38%. Refi applications increased 3% during the week. The average Purchase mortgage dipped to $224,000, while the average ARM increased to $309,000. ARMs accounted for 34.4% of total applications last week.
Broad money supply (M3) expanded $18 billion (week of October 25). Year-to-date (43 weeks), broad money is up $480 billion, or 6.6% annualized. For the week, Currency added $1.6 billion. Demand & Checkable Deposits jumped $24.4 billion. Savings Deposits dropped $23.8 billion, with a year-to-date gain of $320 billion (12.3% annualized). Small Denominated Deposits added $1.8 billion. Retail Money Fund deposits gained $1.0 billion, while Institutional Money Fund deposits dipped $2.8 billion. Large Denominated Deposits increased $4.5 billion. Repurchase Agreements added $2.6 billion, and Eurodollar deposits increased $8.8 billion.
Bank Credit dipped $2.4 billion for the week of October 27 to $6.713 Trillion. Bank Credit has expanded $438.8 billion during the first 43 weeks of the year, or 8.5% annualized. For the week, Securities holdings slumped $21.1 billion, while Loans & Leases advanced $18.7 billion. Commercial & Industrial loans gained $5.5 billion, while Real Estate loans rose $3.5 billion. Real Estate loans are up $262.9 billion y-t-d, or 14.3% annualized. Consumer loans were about unchanged for the week, while Securities loans expanded $8.1 billion. Other loans gained $1.9 billion. Elsewhere, Total Commercial Paper rose $3.5 billion to $1.376 Trillion (up $45.3bn in five weeks). Financial CP added $3.7 billion to $1.235 Trillion, expanding at a 7.6% rate thus far this year. Non-financial CP dipped $200 million (up 35% annualized y-t-d) to $140.1 billion. Year-to-date, Total CP is up $107 billion, or 10% annualized.
This week’s ABS issuance amounted to about $12 billion (from JPMorgan). Total year-to-date issuance of $535 billion is 38% ahead of comparable 2003. 2004 home equity ABS issuance of $338 billion is running 80% ahead of last year’s record pace.
Fed Foreign “Custody” Holdings of Treasury, Agency Debt increased $1.8 billion to $1.30 Trillion. Year-to-date, Custody Holdings are up $234 billion, or 26% annualized. Federal Reserve Credit inflated $2.75 billion for the week to $773.4 billion, with y-t-d gains of $26.8 billion (4.2% annualized).
November 5 – Bloomberg (Julie Ziegler): “China said it’s concerned that eliminating its nine-year-old currency peg might trigger capital inflows at a time when the country is trying to cool the economy, according to the International Monetary Fund.”
The euro ended today at an all-time high of 1.2964 against the dollar. The dollar index declined 1% this week to a near 9-year low. The “commodity” currencies enjoyed a strong week, with the Chilean peso up 2.4%, Australian dollar 1.9%, and New Zealand and Canadian dollars 1.6%. The dollar mustered a 0.6% gain against the Nigerian naira and 0.9% rise versus the Uruguay peso, and that was about it.
November 4 – Bloomberg (Loretta Ng and Vicki Kwong): “China’s crude steel consumption may rise as much as 39 percent between 2005 and 2010 to 330 million metric tons, according to one of India’s largest exporters of iron ore. China’s steel needs should reach at least 237 million tons next year…”
With December crude declining $2.15 to $49.61, the Goldman Sachs Commodities index declined 3.8% for the week. This reduced year-to-date gains to 30.9%. The CRB index was unchanged on the week, with y-t-d gains of 11.1%.
November 1 – XFN (Claire Leow): “China’s economy will grow 8-8.5% year-on-year in 2005, according to a government think tank… ‘Considering slowing investment and cooling export growth, China’s GDP growth will slide to 8-8.5% next year,’ said the National Development and Reform Commission’s (NDRC)… The NDRC report predicts an 18% growth in investment next year, with consumer price index growth of about 3%, and retail sales -- after being adjusted for inflation -- up about 9.5%.”
November 3 – Bloomberg (Jianguo Jiang): “The worst drought in half a century in southern China has caused 4 billion yuan ($483 million) in economic losses and reduced water supply for 7.2 million people, the Xinhua news agency said…”
November 2 – Bloomberg (Koh Chin Ling): “China will need to add 2,194 new planes in the next two decades to meet demand for air travel, the China Daily newspaper reported, citing Liao Quanwang, vice-director of the Aviation Industry Development Research Centre of China. China's expected to more than triple its passenger planes to 2,373 from 664 in the period through 2023…”
November 2 – Bloomberg (Janet Ong): “China’s top foreign-exchange regulator said it will step up a crackdown on ‘speculative capital inflows’ to preserve financial stability, seeking to deter bets on a yuan revaluation after last week's interest rate increase. Illegal foreign-exchange settlements by some banks and companies are hampering government efforts to cool growth in the world’s seventh-largest economy, the Beijing-based State Administration of Foreign Exchange said…”
Asia Inflation Watch:
November 4 – Bloomberg (Rob Stewart): “JPMorgan Chase & Co. Chief Executive Officer William Harrison said he plans to expand in India, where the government and local companies sold a record $7.1 billion of stock this year and competitors including Merrill Lynch & Co. already have local ventures. ‘The momentum here is good,’ Harrison, 61, said… ‘As Asia grows, we will continue to build our business here.’”
November 5 – Bloomberg (Cherian Thomas): “India’s inflation rate accelerated more than expected in the third week of October as food and fuel prices rose, adding pressure on the central bank to raise interest rates. Bonds extended earlier losses. Wholesale prices rose 7.38 percent from a year earlier…”
November 5 – Bloomberg (Manash Goswami): “India ended a freeze on auto and cooking fuel prices in a move aimed at stemming declining profit at oil refiners, rekindling concerns over inflation in Asia’s third-largest oil consumer.”
November 5 – Bloomberg (Cherian Thomas and Kartik Goyal): “India’s Finance Minister P. Chidambaram said the country can raise its economic growth rate to an 8 percent pace over the next decade…”
November 5 – Bloomberg (Theresa Tang and James Peng): “Taiwan’s foreign-currency reserves, the third-highest in the world, rose in October for a 40th month to a record $235 billion… The reserves, which rank behind those of Japan and China, rose from $233 billion in September…”
November 2 – Bloomberg (Theresa Tang): “Taiwan’s economy will probably expand 5 percent next year, the Economic Daily reported, citing the cabinet’s Council for Economic Planning and Development.”
November 2 – Bloomberg (Stephanie Phang): “Malaysian exports rose at their fastest pace in nine months in September, boosted by record shipments of oil and commodities and a rebound in electronics sales to China. Exports jumped 29 percent from a year ago to 44.4 billion ringgit ($11.7 billion)…”
November 1 – Bloomberg (Seyoon Kim and Heejin Koo): “South Korean exports rose in October at their slowest pace in 11 months and growth may ease further in coming months as won strength makes the nation's products more expensive overseas, the commerce ministry said. Exports rose 21 percent from a year earlier after climbing 23 percent in September…”
November 5 – Bloomberg (Francisco Alcuaz Jr. and Jun Ebias): “Philippine inflation accelerated to a five-year high in October as record crude oil costs pushed prices higher. Central bank Governor Rafael Buenaventura said interest rates are unlikely to be raised to curb price gains. The consumer price index rose 7.1 percent from a year earlier…”
November 1 – Bloomberg (Claire Leow): “Indonesia’s exports rose more than twice as fast as analysts expected in September, boosted by higher oil prices and shipments of palm oil, nickel and coal. Exports rose 41 percent from a year earlier to $7.15 billion, the highest since Indonesia’s recession in 1998…”
Global Reflation Watch:
November 4 - ECB President Jean-Claude Trichet: “Persistently high and rising oil prices have had a visible direct impact on consumer prices this year, and inflation is likely to remain significantly above 2% in the coming months. This is a worrisome development, but there is no strong indication as yet that medium-term inflationary pressures are building up in the euro area. In particular, wage growth appears to remain limited, in the context of ongoing moderate real GDP growth and weak labor markets ... However, there are upside risks to price stability over the medium term. Strong vigilance is therefore warranted with regard to all developments which could increase such risks…”
November 5 – Bloomberg (Edward Evans): “U.K. demand for workers increased to its highest since January 2001 in October as skills shortages rose to their highest in seven years…”
November 1 – Bloomberg (Ben Holland): “Turkey’s exports climbed 20 percent in October from the same month last year, according to preliminary figures announced by the Turkish Exporters’ Association. The country had exports of $5.91 billion in September… Exports in the first nine months of the year rose 32 percent to $51.5 billion…”
November 4 – Bloomberg (Adriana Arai): “Mexico will keep raising interest rates after seven increases this year to push down an inflation rate that has climbed to a 17-month high, central bank Deputy Governor Jesus Marcos Yacaman said.”
November 4 – Bloomberg (Romina Nicaretta): “Brazil’s government raised its growth forecast for next year as an expected drop in domestic interest rates will fuel growth in South America’s biggest economy… Brazil’s Finance Ministry raised the country’s growth forecast for 2005 to 4.3 percent from a previous forecast of 4 percent…”
November 5 – Bloomberg (Adriana Arai): “Chile’s economy grew 7.7 percent in
September from a year earlier, spurred by stronger spending at home and demand for exports abroad.”
November 2 – Bloomberg (Dylan Griffiths): “South African vehicle sales rose 23 percent in October from the same month last year, as the lowest interest rates since 1981 boosted consumer and business spending, an industry group said.”
Bubble Economy Watch:
October 31 – Dow Jones: “The most expensive presidential advertising campaign in history closes Tuesday after eight months with President Bush, Sen. John Kerry, their political parties and allied groups having spent more than $600 million. That’s triple the amount spent on TV and radio commercials in 2000.”
November 4 – Bloomberg (Brendan Murray and Simon Kennedy): “The U.S. current account deficit, which reached a record $166.2 billion in the second quarter, reflects international investment and low U.S. savings, said John Taylor, the U.S. Treasury’s undersecretary for international affairs. Faster economic growth and more flexible currencies overseas along with a lower federal budget deficit and higher U.S. savings will help narrow the gap, Taylor told a conference in Washington. ‘When investment in the United States is higher than domestic saving, foreigners make up the difference and the United States has a current account deficit,’ he said. The deficit in the second quarter was equivalent to 5.7 percent of the nation’s $11.6 trillion economy, up from 5.1 percent in the first quarter. The U.S. needs to attract about $1.8 billion a day in foreign capital to plug the shortfall.”
November 4 – Bloomberg (Karen Brettell): “Two-thirds of leveraged loans issued in the U.S. primary market are packaged into structured products known as collateralized debt obligations, said Standard & Poor’s. ‘CDOs are driving the whole leveraged-loan industry at the moment,’ said Richard Gugliada, managing director of structured finance… CDOs that bundle leveraged loans are in strong demand, though the scarcity of the credits in the primary market is posing challenges for them… Banks create CDOs by packaging assets and using income on the debt to repay investors. They may be leveraged and offer higher returns than their underlying securities. Issuance of loans by U.S. institutions rose to 114 in the third quarter of this year, compared with 65 at the same time last year, and a 2003 total of 91 loans, S&P said.”
November 3 – Bloomberg (Dianne Finch): “Property insurers paid a record $21.3 billion in third-quarter claims following four hurricanes, the Associated Press reported, citing New Jersey-based Insurance Services Office Inc. Property-loss claims relating to eight disasters including Hurricanes Charley, Frances, Ivan and Jeanne exceeded claims of $3.7 billion in the same period a year earlier, $715 million in 2002, and $19.15 billion in 2001...”
November 2 – The Wall Street Journal (Jane E. Kim): “At a time when health-care costs are continuing to climb at near-double-digit rates, more Americans are being forced to cut back on their retirement savings and make lifestyle changes to pay for medical care, according to a new survey. About one-quarter of U.S. households that have experienced growing medical bills have reduced their retirement-savings contributions, while nearly half have reported cutting back on their other savings… Nearly 20% say medical bills are making it more difficult to pay for necessities such as food and housing, while one-quarter say they are close to tapping out their savings to pay such bills.”
November 4 – Dow Jones: “A new survey indicates the number of foreign graduate students enrolling for the first time at American universities is down 6% this year -the third straight decline after a decade of growth. Educators worry the trend is eroding America’s position as the world’s leader in higher education.”
Mortgage Finance Bubble Watch:
November 3 – Freddie Mac: “In the third quarter of 2004, 60 percent of Freddie Mac-owned loans that were refinanced resulted in new mortgages at least five percent higher in amount than the original mortgages, according to Freddie Mac’s quarterly refinance review. This is in contrast to the second quarter of 2004, when 42 percent of refinanced loans had higher new loan amounts… Based on our October outlook for mortgage originations and refi activity in 2004, we expect the amount of home equity cashed-out to total $118 billion. Total equity cashed out in the third quarter is estimated at $41 billion, up from the estimated second quarter cash-out amount of $28.5 billion… The Cash-Out Refinance Report also revealed that properties refinanced during the third quarter of 2004 experienced a median house-price appreciation of 17 percent during the time since the original loan was made, up considerably from the seven percent appreciation on loans refinanced in the second quarter. For loans refinanced in the third quarter of 2004, the median age of the original loan was 2.6 years…”
November 3 – Honolulu Star-Bulletin (Allison Schaefers): “While many say Oahu’s residential real estate market is showing signs of cooling, demand was still hot enough last month to spark record highs for asking prices and sales prices of single-family homes. The median asking price of single-family homes climbed in October to $675,000, a year-on-year gain of 22.7 percent. Meanwhile, the median resale price of a single-family home on Oahu rose 21.5 percent to $485,000 last month, according to monthly sales data from the Honolulu Board of Realtors.”
November 3 – Dow Jones (Dawn Kopecki): “Freddie Mac won’t provide investors with timely financial statements until early in 2006, postponing registration with the Securities and Exchange Commission until the middle of that year at the earliest, executives said… The $1.5 trillion mortgage finance company hasn’t reported its financial results on time since late 2002 after Freddie replaced auditor Arthur Andersen with PriceWaterhouseCoopers, which found widespread accounting problems at the company and forced it to restate several years of earnings. Freddie has delayed its statements to sort out its accounting problems and revamp internal systems, something Chief Executive Richard Syron said still needs a lot of work.”
Subprime mortgage lender New Century Financial reported quarterly earnings of $107.3 million, up 65% from 2003’s comparable quarter. Total Assets expanded at a 31% rate during the quarter to $15.9 billion. Assets have more than doubled over the past year and have increased from $2.8 billion to end last year’s first quarter. The company has completed its transformation to a REIT, while ending the quarter with Shareholder’s Equity of $818 million.
Vice President Cheney spoke confidently of having won a broad national “mandate,” while President Bush exclaimed, “I earned capital in the campaign, political capital, and now I intend to spend it.” There is no reason to doubt that the Administration will forcefully pursue its ambitious agenda. The President and his team are empowered, with an overarching goal of a second term worthy of an historic legacy. It is, as well, rational that they would today edge toward overconfidence and complacency when it comes to the great risks they will confront during the next four years.
I have no intention to attempt what would surely be amateur political analysis, and I am an analyst and not a partisan. There is no shortage of political insight and pontification these days. Yet I do see a dearth of cogent analysis of the financial, economic and social backdrop that will play a profound role in the political process as we go forward. We witnessed an incredible campaign of “guns and butter” from the opposing parties, heavy on promises and featherweight on economic realities. And now the undoubting victor will attempt to lead a deeply divided nation on an aggressive course in an environment fraught with significant and myriad risks – some discernable.
Never before have financial markets played such a central role in society. More are exposed to marketable securities; more giddily play the mortgage and housing markets; and more have their retirement tied directly to the stock and bond markets. And never before have so many livelihoods been associated with financial and real estate asset prices. The melding of politics to wealth creation – in this case financial wealth - is an innate process, and fanciful notions of an “ownership society” do indeed captivate while in the bosom of an historic asset Bubble. I believe it is reasonable to suggest that had the stock market not recovered, had mortgage rates not dropped to record lows, and had home prices not inflated significantly, the political agenda today would be altogether different. I don’t think one can exaggerate the profound political and social effects of The Great Reflation. And with no intention of being flippant, I do not expect gay marriage to be a major issue in 2008.
In my mind, there is a paramount analytical issue to contemplate: The Bush administration today ardently believes that their policy choices were responsible for what has developed into sustainable economic recovery. And having persevered through a stock market scare, technology collapse, recession, 9/11, Enron and corporate malfeasance, a sinking currency and going to war, there must now be great faith that a much more favorable financial and economic backdrop exists to bless their aggressive agenda. Yet the reality of the environment is not as perceived, and this fact of life will not be efficiently recognized: An historic reflation, inciting “blow-off” Credit Bubble excess, was the dominating feature of the second-half of President Bush’s first term. It is, moreover, at best unsustainable.
It is this evening worth recalling the backdrop that greeted the 2001 inauguration. Fed funds began the year at 6.5%. The late-90s boom had filled the Treasury’s coffer, with talk of a Trillion dollar surplus and a coming shortage of government debt instruments. Gold, at $270, was near a multi-decade low. The CRB commodities index began the year at about 230, down from the 1996 high of about 260 and about where the index stood in 1990 (and significantly below 1980!). Crude oil traded near $27. With Asian, Latin American and other “developing” Credit systems still afflicted with post traumatic stress disorder, liquidity was at a premium for many economies and markets. Global price pressures were generally more forceful to the downside. The dollar index was at about 110, with more than a year remaining of its King Dollar (“blow-off”) run to 120, while the fledgling euro had stumbled badly out of the blocks.
The global appetite for U.S. securities was for all purposes insatiable, with faltering demand for tech stocks instantaneously more than compensated by a newfound lust for (Greenspan) bonds. American financial assets enjoyed a strong inflationary bias when compared to vulnerable global goods, commodities and securities markets. High quality bonds were about to enjoy an historic rally, the speculative instrument of choice for playing the Greenspan Fed’s too-well-telegraphed strategy for responding to the bursting of the equity market Bubble. GSE debt had come into its own as a higher-yielding and highly-liquid near-perfect substitute for Treasuries.
Importantly (and oh so clear in hindsight), the U.S. system in 2001 enjoyed considerable flexibility and capacity to absorb continued Credit and speculative excess without traditional inflationary effects. Indeed, the spectacular “blow-off” throughout the technology sector fogged the analysis that the Credit system and economic Bubbles had room to run. With respect to the real economy – and paralleling global imbalances – some sectors had been starved for finance as liquidity mindlessly inundated tech and telecom.
There was back in 2001 extraordinary capacity for government spending stimulus, while the Fed was heavily armed and poised for historic monetary stimulus. After years of strong expansion, the mortgage finance super-sector was quite well positioned for spectacular excess (waiting only for the next round of reflation, and for homeowners to appreciate that homes, and not stocks, always went up in price). Similar and not unrelated dynamics were in play with respect to the ballooning global “leveraged speculating community.” And with a strong (“King dollar”) bias to own U.S. securities – speculative and otherwise – heightened liquidity (domestic and global) would conveniently rush to purchase Treasuries, agencies, U.S. corporate bonds, MBS and structured products (reminder: “Liquidity Loves Inflation”). This basically gave the U.S. government, Federal Reserve, GSEs, Wall Street and the financial sector, generally, blank checks for which to stimulate and reflate. Especially when the global technology Bubble burst, the Greenspan-commanded U.S. bond market became “the only game in town” for an increasingly powerful speculating community.
With bond vigilantes an extinct species, The Game quickly evolved into a mad dash to leverage the most liquid and inflating asset in the world – U.S. long-term debt instruments – affording absolutely no constraints on over-issuance. Resulting “excess” global dollar liquidity was a misnomer, as it was readily “recycled” right back to profit from The Great Yield Collapse. There was even fancied talk of Argentina and other “developing” economies switching completely to dollar-based monetary regimes.
Many things are less than clear these days, but the stark contrast between the backdrops from 2001 and the soon to commence 2005 should not be one of them. The year 2001 provided the capacity – fiscally and monetarily – for an historic reflation, with a quite atypical global financial and economic backdrop that would prove amazingly accommodative to gross U.S. excess. A strong case can be made as to the aberrational characteristics of the King Dollar period. Importantly, few at home or abroad perceived that there were risks associated with U.S. reflationary policies, and no one protested. Many were keen to the windfall profit opportunities available from financial assets.
These days, oil and energy markets trade at all-time highs, the euro at a record, the dollar index at a multi-year low, gold at a 16-year high, the CRB index not far off all-time highs. Foreign equity and bond markets are outperforming their dollar-denominated counterparts. Most significantly, the U.S. economy and financial markets now face the uncertain and problematic downside of an historic reflation – the mirror image of 2001’s promising upside. The Fed is hopelessly behind the curve, bond yields have overshot on the downside, and equity prices have become distorted to the upside from reliquefication-induced inflated profits and excess marketplace liquidity. Real estate prices are generally over-heated, with California and other upper-end markets demonstrating dangerous Bubble excess. Mortgage finance demonstrates uncomfortable parallels to NASDAQ 1999. And while not yet appreciated, manic over-expansion and excess have destroyed profit opportunities for the bloated U.S. financial sector and leveraged speculating community. The initial light breeze of developing Credit system headwinds has made landfall.
Of more immediate concern, Monetary Disorder is fostering unsound markets. Commodities markets are increasingly unstable. The bond market succumbed to distortions, speculative excess and, more recently, a short-squeeze and is now vulnerable to a destabilizing jump in rates. And even today’s strong employment data and rate rise could not slow the dollar’s descent. The stock market has lunged higher in a bout of euphoria, hedge unwinding, and short-covering. Extrapolations and daydreams of protracted bull markets are setting the stage for disappointment and worse.
And unlike 2001 or even 2003, there is today a growing list of parties fully cognizant that they are being hurt be inflation. From drivers to homeowners to businesses, energy costs are biting. Housing affordability has become a major issue for millions; the cost and availability of medical care for tens of millions.
Importantly, the weak dollar has become a cause for serious concern. Asian central bankers are rightfully nervous, as surging energy and commodity costs along with unwieldy liquidity create great inflation and economic uncertainty. The ECB is on guard to heightened inflationary pressures, appreciating the risks associated with prolonged energy and commodity price inflation in the event of continued dollar weakness. Expect European political leaders to become increasingly vocal critics of U.S. budget and trade deficits. No longer will our Credit inflation and dollar devaluation go unnoticed or be appreciated. Blather that our massive current account deficits are caused by foreign inflows and the attractiveness of U.S. investment will not go unanswered.
Reiterating analysis from previous Bulletins, history provides some clarity with regard to the nature of inflation cycles: once unleashed, inflation becomes only more difficult to control and there are always hopes that just a little more will suffice. Few initially recognize the eventual costs, while many clamor and yearn for the perceived benefits. Politicians adore inflation, at least until their constituents learn to abhor it. Over time inflation’s losers become more attentive and the detriment more conspicuous. For society as a whole, the insidious effects of debt and inflation spawn angst, animosity, and polarization. Globally, the redistribution of wealth foments acrimony and conflict.
Today, our administration is understandably ecstatic with the prospect of four more years. And they would surely be content with four additional years of reflation and attendant dollar debasement. But our foreign creditors are being impaired and must be losing patience. Meanwhile, global central bankers are coming to grips with the prospect of ongoing dollar weakness and the associated increasingly unwieldy liquidity and pricing environment. Monetary Disorder has become manifest. And, let’s not forget, the U.S. bond Bubble. It appears that the transition away from the aberrational “weak dollar is good for bonds” period has begun, with unclear but potentially significant consequences. Myriad issues for bond holders now include foreign selling, rising risk and inflation premiums, speculative unwinding, derivative-related selling and policymakers much more attune to the needs of the economy and stock market.
Why do I have the sense that it is only a matter of time until the administration’s agenda is placed on the back burner to deal with more pressing issues such as financial and economic instability, or even the dollar’s role as the world’s reserve currency? The scenario I find most troubling is an oblivious policymaking team steadfast in its pursuit of a legacy, stubbornly refusing to accept reality, and in no position or having any inclination to cooperate with our global partners. And it is a tragedy that our nation will face its next crisis so ill-prepared and polarized, and in this regard there is certainly plenty of blame to spread around.