CREDIT BUBBLE BULLETIN
Commentary and weekly watch by Doug Noland
Federal Reserve holdings inflated US$190 billion, or 7.9%, during the first quarter to conclude the first quarter at a record $2.597 trillion. Such expansion is unprecedented in a non-crisis environment, with recent growth in Fed surpassed only by 2008's extraordinary third and fourth quarters. Keep in mind that the Fed's balance sheet ended April 2008 at about $860 billion. International central bank reserve assets increased $358 billion during the quarter (as tallied by Bloomberg) to a record $9.382 trillion. Global reserves were about $6.5 trillion back in the spring
of '08. Too routinely, the dollar index declined 4.1% during the just completed quarter.
For the first quarter, crude oil jumped 13% and gasoline surged 21% (to the highest price levels since September 2008). The Goldman Sachs Commodities Index rose 14.8%. For the quarter, cotton jumped 39%, pork bellies 23%, silver 23%, gasoline 21%, corn 10%, cattle 10% and hogs 9%. It is worth noting that Hershey raised prices this week by almost 10%, while Wal-Mart's chief executive warned that American consumers face "serious" inflation in the coming months.
And while Federal Reserve (and global central bank) liquidity operations have fueled one heck of an inflationary boom throughout commodities and equities markets, arguably more consequential effects reverberate throughout bubbling global fixed-income marketplaces. Despite a lengthening list of market concerns, first quarter total global securities issuance was down only 4% from exceptionally strong year ago issuance to $1.96 trillion (Dealogic). At $279 billion, Q1 investment-grade debt issuance was up 19% from a year ago to the third-highest level on record. Here at home, a booming quarter of corporate debt issuance ended on a strong note. Corporate sales rose to about $33.4 billion this week, the third-largest week on record, while pushing year-to-date US issuance to a record $399.5 billion (from Bloomberg).
Globally, high-yield bond sales jumped 30% y-o-y to about $90 billion. March saw a record $41.2 billion of junk bonds sold. For the quarter, total high-yield issuance jumped to $113.8 billion, up 35% from a year earlier to surpass the record level set the previous quarter. And from Dow Jones (Katy Burne): "Two years ago, the average market premium on high-yield debt over comparable government debt was 16.9 percentage points, compared to 4.76 percentage points now ... " According to Bloomberg, leveraged loan volumes jumped to $149 billion, the strongest quarter since Q4 2007.
As always, deal-making luxuriates in loose "money". Global mergers and acquisition volume jumped 16% from a year ago to $716.3 billion (Dealogic). US volumes surged 45% to $290.8 billion. European deal volume rose 10% y-o-y to $192.3 billion. M&A volume in Asia jumped 29% from Q1 2010 to $146.2 billion (Dealogic), the strongest first-quarter volume since 2008's $155 billion. Emerging market M&A posted record Q1 volumes of $205.7 billion (up 1% y-o-y). According to Bloomberg (Zachary Mider), "acquirers paid a median 9.2 times earnings before interest, , depreciation and amortization for companies in the period, the most since the second quarter of 2008 ... " Analysts see global deal volume jumping 15-20% this year, this following 2010's 27% rise.
On the equities side, global initial public offerings (IPO) volume of $43.6 billion was down somewhat from the year ago $51.9 billion (Dealogic). US IPOs raised $12.5 billion during the first quarter compared to $3.7 billion from Q1 2010.
Clearly, the first quarter was replete with monetary excess. The second-quarter monetary backdrop is less certain. On the one hand, the Fed still has three long months of weekly Treasury purchases in the offing. On the other, the markets should begin to contemplate a post-quantitative easing landscape. Divergent comments from various members of the Fed are not offering much in the way of clarity for what is shaping up to be unusually muddied monetary prospects.
Federal Reserve Bank of St Louis president James Bullard - an early and leading proponent for "QE2" - said this week that the Fed should consider wrapping up its quantitative easing $100 billion short of its original $600 billion objective. Today, Federal Reserve Bank of Philadelphia president Charles Plosser and Federal Reserve Bank of Richmond president Jeffrey Lacker both stated the possibility of the Fed hiking rates later this year, a day after Federal Reserve Bank of Minneapolis president Narayana Kocherlakota suggested the same. A chorus of "hawkish" Fed comments - along with a decent jobs report - on Friday morning had the dollar catching a bid and the bond market living on the edge. That was, until a series of dovish headlines from New York Fed president William Dudley's speech crossed the wires.
A "still tenuous" recovery is "far from the mark" - "We must not be overly optimistic about the growth outlook" - "The coast in not completely clear" - "I don't see any reason to pull back ... " Mr Dudley's dovishness was what the market wanted. The dollar immediately weakened, bond prices strengthened and the "risk-on" trade, well, it was further emboldened.
It's difficult to take issue with the markets' view that Team Bernanke/Dudley (Fed chairman Ben Bernanke and Federal Open Market Committee vice chairman William Dudley) will win the day - and that an increasingly divided Fed will bicker, float mixed signals and, at the end of the day, stick with ultra-loose for the foreseeable future. And as much as a few prominent policymakers would like to contemplate - and begin planning for - an unwind of the Federal Reserve's bloated balance sheet, Mr Market listens politely while speculating "a cold day in hell".
Yet, markets will most likely three months from today be operating without additional Fed liquidity injections. As policymakers had hoped, QE2 provided a powerful jolt. Continued massive issuance of Treasury debt has been accommodated; equity prices have surged; confidence has been boosted; corporate debt issuance has boomed; leveraged lending has been fully revived; an M&A boom has been unleashed; the hedge fund industry has more than recovered; intensive "animal spirits" have been enlivened throughout - and some private-sector jobs have returned.
But has The Jolt incited ample momentum within the private-sector credit system and throughout the economy to now enable a successful "hand-off" from massive public-sector stimulus to a self-sufficient private-sector credit up-cycle? Examining recent corporate debt issuance, stock prices, M&A, and global risk asset prices generally, there is a case to be made for a sustainable expansion cycle. On the other side of the ledger, moribund housing and mortgage credit, along with vulnerabilities in municipal , point to ongoing system credit stagnation. Total bank credit contracted during the quarter, and most likely total mortgage debt posted little or no growth. And in the midst of booming debt issuance, it is worth nothing that, at $46.4 billion, first quarter municipal debt sales were only about half the year ago level and the lowest amount since Q1 2000 (Thomson Reuters).
It's been my view that the power of QE2 was not so much with the $600 billion. It was, instead, that the Fed was right there guaranteeing more than ample marketplace liquidity at the first sign of market tumult. It was the markets' perception of "systemic too big to fail" - confirmed, just as the markets expected. And why not speculate on risk assets, assured that central bankers would be quick to bolster the markets at the first sign of trouble? Why not, especially appreciating that Fed interventions would both add liquidity and pressure the dollar - bolstering a powerful monetary process now deeply entrenched in traders' psyche? Why not just ignore risk and speculate, emboldened by the reality that systemic fragilities ensure a potent punchbowl filled to the brim? QE2 was one more in an ongoing series of mistakes by our central bank.
As we begin the second quarter, it's increasingly difficult for the Fed to ignore mounting inflationary pressures. Commenting on tame "core" Consumer Price Index is not going to resonate. Yet, as a committee, they surely will disregard inflation and cling closely (as Mr Dudley did on Friday morning) to their "full " mandate.
Still, some Federal Reserve presidents and governors are growing uncomfortable with a prolonged loose policy stance. There will be louder talk of the inevitability of rate increases - and some will push for the unwind of QE2. I doubt the market will be all that intimidated by the prospect of a few little baby steps, in the style of Bernanke's predecessor at the Fed, Alan Greenspan, commencing sometime near year-end.
It will, however, be a different story if this idea of the Fed liquidating QE2 holdings gains momentum. Especially after the QE2-induced inflation of global risk assets - and with massive Treasury issuance as far as the eye can see - the marketplace will become only more sensitive to potential liquidity issues going forward. QE2 makes it quite difficult for the Fed to now reverse course and attempt to normalize market liquidity and market perceptions.
I'll assume the Fed will attempt to pull back on liquidity operations, while at the same time working to ensure the marketplace that its liquidity backstop support remains very much in place. And we'll soon have the vantage point of press briefings in which to view this juggling act. From reading and listening to comments from some prominent (hawkish) members of the Fed, it seems that they are clearly more focused on inflation risk and much less wedded to a liquidity backstop function than Team Bernanke/Dudley. Friday was the first day of what will be an intriguing quarter for our central bank.
For the week, the S&P500 gained 1.4% (up 5.9% y-t-d), and the Dow advanced 1.3% (up 6.9%). The broader market was quite strong. The S&P 400 Mid-Caps surged 2.7% (up 9.8%), and the small cap Russell 2000 gained 2.8% (up 8.1%). The rose 1.2% (up 0.4%), and the Broker/Dealers gained 1.2% (up 0.4%). The Morgan Stanley Cyclicals gained 2.0% (up 7.0%), and the Transports jumped 3.1% (up 5.2%). The Morgan Stanley Consumer index increased 1.3% (up 0.9%), and the Utilities rallied 2.1% (up 1.7%). The Nasdaq100 increased 1.1% (up 5.6%), and the Morgan Stanley High Tech index added 0.5% (up 2.6%). The Semiconductors slipped 0.8% (up 5.1%). The InteractiveWeek Internet index gained 1.5% (up 3.4%). The Biotechs jumped 5.6% (up 6.2%). With bullion little changed, the HUI gold index increased 0.8% (down 0.6%).
One-month Treasury bill rates ended the week at 2 bps and three-month bills closed at 6 bps. Two-year yields rose 7 bps to 0.81%. Five-year T-note yields ended the week up 8 bps to 2.24%. Ten-year yields were little changed at 3.45%. Long bond yields ended the week down one basis point at 4.49%. Benchmark Fannie MBS yields were up one basis point to 4.28%. The spread between 10-year Treasury yields and benchmark MBS yields widened one basis point to 83 bps. Agency 10-yr debt spreads declined 5 to negative 3 bps. The implied yield on December 2011 eurodollar futures slipped 3.5 bps to 0.61%. The 10-year dollar swap spread was little changed at 10.5 bps. The 30-year swap spread was unchanged at negative 22 bps. Corporate bond spreads were mixed. An index of investment grade bond risk declined one to 94 bps. An index of junk bond risk rose 25 bps to 438 bps.