For the week, the S&P500 slipped 0.7% (up 19.5% y-t-d), and the Dow declined 0.2% (up 13.6%). The Banks dropped 1.7% (up 4.9%), and the Broker/Dealers were hit for 4.0% (up 52.8%). The Morgan Stanley Cyclicals gained 0.9% (up 64.2%), while the Transports were hammered for 5.4% (up 7.6%). The Morgan Stanley Consumer index declined 1.0% (up 18.9%), and the Utilities dipped 0.8% (down 0.5%). The S&P 400 Mid-Caps declined 0.9% (up 30.3%), and the small cap Russell 2000 fell 2.5% (up 20.3%). The Nasdaq100 gained 0.8% (up 44.7%), and the Morgan Stanley High Tech index added 0.5% (up 59.4%). The Semiconductors dropped 2.0% (up 49.1%). The InteractiveWeek Internet index gained 1.0% (up 67.2%). The Biotechs dropped 5.8% (up 35.5%). Although Bullion added $2, the HUI gold index was hit for 3.6% (up 42.1%).

One-month Treasury bill rates ended the week at 3 bps, and three-month bills closed at 6 bps. Two-year government yields rose 5.5 bps to 0.955%. Five-year T-note yields surged 10 bps to 2.42%. Ten-year yields were 8 bps higher to 3.50%. Long bond yields added 5 bps to 4.30%. Benchmark Fannie MBS yields rose 4 bps to 4.40%. The spread between 10-year Treasuries and benchmark MBS yields narrowed 4 to 90 bps. Agency 10-yr debt spreads were little changed at 4.5 bps. The implied yield on December 2010 eurodollar futures was unchanged at 1.77%. The 10-year dollar swap spread declined one to 17.75 bps; and the 30-year swap spread was little changed at negative 7.0 bps. Corporate bond spreads were a little wider. An index of investment grade bond spreads widened 2 bps to 140, and an index of junk spreads widened 3 bps to 570 bps.

Investment grade issuers included Citigroup $7.5bn, JPM Chase $1.0bn, Boeing $1.0bn, Navistar $1.0bn, Terra Capital $600 million, Southern Co. $300 million, and Black Hills Power $180 million.

Junk bond funds enjoyed inflows of $262 million (from AMG). Junk issuers included Crown Castle $500 million, Meccanica $500 million, Murray Energy $500 million, Boise Paper $300 million, Headwaters $320 million, Viasat $275 million, Rite Aid $270 million and Mohegan Gaming $200 million.

I saw no converts issued.

International dollar-denominated debt issuers included Petrobras $4.0bn, Temasek $1.5bn, Santander $1.5bn, Westpac Banking $1.0bn, Navios Maritime $400 million, Controladora $350 million, TAM $300 million, Lumena Resources $250 million, and MDC Partners $225 million.

U.K. 10-year gilt yields jumped 17 bps to 3.67%, and German bund yields increased 6 bps to 3.35%. The German DAX equities index was about unchanged (up 19.3% y-t-d). Japanese 10-year "JGB" yields increased 3.5 bps to 1.36%. The Nikkei 225 added 0.2% (up 16.1%). Emerging equities were mixed and emerging bonds came under pressure. Russia's RTS equities index jumped 3.9% to a new 2009 high (up 131.5%). India's Sensex equities declined 2.2% (up 72.3%). China's Shanghai Exchange surged 4.4%, boosting 2009 gains to 70.7%. Brazil's benchmark dollar bond yields jumped 21 bps to 5.10%. Brazil's Bovespa equities index fell 1.7% (up 73.3% y-t-d). The Mexican Bolsa slipped 0.4% (up 36.8% y-t-d). Mexico's 10-year $ yields jumped 18 bps to 5.33%.

Freddie Mac 30-year fixed mortgage rates increased 8 bps to 5.00% (down 104bps y-o-y). Fifteen-year fixed rates rose 6 bps to 4.43% (down 129bps y-o-y). One-year ARMs fell 6 bps to 4.54% (down 69bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 5 bps to 6.05% (down 141bps y-o-y).

Federal Reserve Credit surged $65.1bn last week to a 22-wk high $2.172 TN. Fed Credit has declined $65.1bn y-t-d, although it expanded $366.6bn over the past 52 weeks (21%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 10/22) jumped $22.6bn to a record $2.887 TN. "Custody holdings" have expanded at an 18.2% rate y-t-d, and were up $378bn over the past year, or 15.2%.

M2 (narrow) "money" supply declined $9.1bn to $8.332 TN (week of 10/12). Narrow "money" has expanded at a 2.1% rate y-t-d and 5.2% over the past year. For the week, Currency slipped $0.7bn, while Demand & Checkable Deposits added $1.4bn. Savings Deposits rose $7.5bn, while Small Denominated Deposits fell $8.0bn. Retail Money Funds declined $9.3bn.

Total Money Market Fund assets (from Invest Co Inst) fell $31.3bn to $3.372 TN. Money fund assets have declined $458bn y-t-d, or 14.8% annualized. Money funds declined $164bn, or 4.6%, over the past year.

Total Commercial Paper outstanding jumped $39.9bn (10-wk gain of $292bn) to $1.366 TN. CP has declined $315bn y-t-d (23.2% annualized) and $83bn over the past year (5.7%). Asset-backed CP increased $5.9bn to $549bn, with a 52-wk drop of $146bn (21.1%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $485bn y-o-y to a record $7.406 TN. Reserves have increased $641bn year-to-date.

Global Credit Market Watch:

October 22 - Bloomberg (Oshrat Carmiel): "Home sales in the Hamptons, the Long Island beach retreats favored by Hollywood celebrities and Wall Street financiers, surged 32% in the third quarter..."

October 22 - Bloomberg (Julianna Goldman, Ian Katz and Robert Schmidt): "The Obama administration slammed Wall Street by ordering pay cuts of an average of 50% and caps on benefits for top executives at companies owing the government billions of dollars from taxpayer-funded bailouts. The news triggered debate about the government's reach into private industry, whether pay reductions would spread to other companies and if a talent drain from U.S. firms would ensue. Others cheered the move."

Government Finance Bubble Watch:

October 20 - Bloomberg: "Chinese central bank Vice Governor Ma Delun warned that monetary-policy challenges will increase as expectations for a stronger yuan boost inflows of capital. As global markets revive, 'capital flows increase and the U.S. dollar weakens, there will be an expectation for the yuan to appreciate, leading a large amount of international capital to return,' Ma said... Inflation pressures are building, and policy makers need to rein in the effects of extra liquidity on asset and consumer prices, Ma said."

October 20 - Bloomberg (Andrew Atkinson): "Britain had the biggest budget deficit for any September since records began in 1993 as the recession ravaged tax revenue and drove up welfare costs. The 14.8 billion-pound ($24.3 billion) shortfall compared with a deficit of 8.7 billion pounds a year earlier..."

October 22 - Bloomberg (Simone Meier): "The euro-area economy had a wider budget deficit in 2008 than previously estimated, with five member states breaching the European Union limit... The total budget shortfall for the 16-nation euro region widened to 2% of gross domestic product last year... France, Spain, Greece, Ireland and Malta had 2008 deficits above the EU limit of 3% of GDP."

October 22 - Bloomberg (Steve Scherer): "European countries' rising debt won't trigger across-the-board credit-rating downgrades because countries are measured relative to each other, Moody's... said... Moody's ranks Germany and France among the countries with the highest credit ratings. European governments spent billions of euros to fight the region's worst recession since World War II. As a result, the commission forecasts that euro-area debt will rise to 77.7% this year from 69.3%..."

Currency Watch:

The dollar index slipped 0.2% to 75.47. For the week on the upside, the Swedish krona increased 2.4%, the New Zealand dollar 1.9%, the Norwegian krone 0.9%, the Swiss franc 0.8%, the Danish krone 0.6%, the Australian dollar 0.6% and the Euro 0.6%. For the week on the downside, the the South African rand declined 1.5%, the Canadian dollar 1.5%, the South Korean won 1.5%, the Japanese yen 1.3%, and the Brazilian real 0.4%.

Commodities Watch:

October 22 - Bloomberg (Jana Randow): "Oil is 'too cheap' and should rise to $88 a barrel in coming months after the dollar's decline against the euro, a DekaBank study suggests... 'Oil is too cheap at the moment,' said Christian Melzer... foreign exchange analyst at DekaBank... The study shows that over the last 10 years "oil prices have adjusted to changes in the euro-dollar exchange rate," he said."

October 22 - Bloomberg: "Investor Jim Rogers took a 'senior consultant' position with China's Dalian Commodity Exchange because he is 'excited' about the exchange's efforts to grow. 'I expect China to become the commodity trading center of the world once they open their currency and open their economy,' Rogers said... 'I'm keen on all the three exchanges but I'm excited about what they're doing in Dalian.'"

Yet another solid week for most commodities. The CRB index gained 1.5% (up 22.1% y-t-d). The Goldman Sachs Commodities Index (GSCI) jumped 2.2% (up 48.8% y-t-d). Gold added 0.2% to close at $1,055 (up 19.6% y-t-d). Silver gained 1.7% to $17.71 (up 56.8% y-t-d). December Crude gained $1.00 to $80.02 (up 79% y-t-d). November Gasoline jumped 3.0% (up 92% y-t-d), and November Natural Gas added 0.6% (down 14% y-t-d). December Copper surged 6.2% to a one-year high (up 114% y-t-d). December Wheat rocketed 9.8% higher (down 10% y-t-d), and December Corn jumped 6.9% (down 2% y-t-d).

China Bubble Watch:

October 22 - Bloomberg: "China's economy expanded at the fastest pace in a year as stimulus spending and record lending growth helped the nation lead the world out of recession. Gross domestic product rose 8.9% in the third quarter from a year earlier..."

October 21 - Financial Times (Geoff Dyer): "China needs an 'urgent' tightening of monetary policy to prevent the huge stimulus measures introduced this year from inflating stock and property bubbles, one of the country's leading bankers has warned. Qin Xiao - chairman of China Merchants Bank, the country's sixth-biggest - says... 'Monetary policy must not neglect asset-price movements... Therefore it is urgent that China shifts from a loose monetary policy stance to a neutral one.' Mr Qin's unusually frank warning comes ahead of... third-quarter gross domestic product figures..."

October 22 - Bloomberg: "China is risking property-market 'bubbles' to encourage growth in the world's third-largest economy, according to former Morgan Stanley Asian economist Andy Xie. 'People are looking at the bubbles as a way to gain economic growth in the short term,' Xie said... 'They are not sure of long-term damages that they may suffer... Land prices have become so elevated... The economy has become so dependent on property and the prices are so high and it carries a lot of risk for the country going forward.'"

October 22 - Bloomberg: "China urged its banks to lend 'reasonably' this quarter, after a surge in credit increased risks in the nation's banking system. The China Banking Regulatory Commission will closely monitor the impact of global capital flows and domestic policy adjustments on liquidity in the banking system, Chairman Liu Mingkang said... The CBRC will ensure that 'ample liquidity is always maintained,' he said. Chinese banks doled out a record 8.67 trillion yuan ($1.27 trillion) of new loans in the first nine months, an increase of about 150% from the same period a year earlier..."

Japan Watch:

October 19 - Bloomberg (Mayumi Otsuma): "The Bank of Japan said the economy is improving in all of the country's nine areas as the nation emerges from its worst postwar recession."

October 22 - Bloomberg (Jason Clenfield): "Japan's exports fell at the slowest pace in 10 months in September as stimulus spending in China drove demand for the nation's cars and machinery. Shipments abroad dropped 30.7% from a year earlier, compared with a 36% decline in August..."

India Watch:

October 22 - Bloomberg (Anil Varma): "India's central bank said it faces a 'major challenge' in managing the government's debt sale plan, which has fueled a record jump in bond yields this year and made it 'difficult' to keep prices stable."

Asia Bubble Watch:

October 22 - Bloomberg (Joyce Koh): "Asia's rich are again favoring the leveraged investments that backfired on them during last year's market turmoil, according to the head of DBS Group Holdings Ltd.'s wealth management unit. 'Investors have short memories,' Amy Yip, who oversaw Hong Kong's $245 billion foreign-reserves fund before joining Southeast Asia's biggest bank in 2006, said... 'Many of the Asian clients are back in the very aggressive leveraged posture that they had adopted in the fall of 2008.' Rich investors in Asia are borrowing more to fuel returns, spurred by record-low interest rates and a stock market recovery."

October 20 - Bloomberg (Nguyen Kieu Giang and Nguyen Dieu Tu Uyen): "Vietnamese loan growth may exceed 30% this year and liquidity in the banking system will increase 25%, Prime Minister Nguyen Tan Dung said."

October 21 - Bloomberg (Aloysius Unditu and Novrida Manurung): "Indonesia's economy may expand at the fastest pace in a year this quarter, Finance Minister Sri Mulyani Indrawati said, driven by rising consumer spending. 'Fourth-quarter growth this year is expected to be better than fourth-quarter growth last year,' Sri Mulyani told reporters... Gross domestic product may expand between 4.5% and 5% in the three months through December from a year earlier, she said."

Latin America Watch:

October 19 - Bloomberg (Adriana Brasileiro and Andre Soliani): "Brazil will impose taxes on purchases by foreign investors of real-denominated, fixed-income securities and on purchases of stocks, Finance Minister Guido Mantega said. The measures are being taken 'to avoid an excess speculation in the stock market and in capital markets,' Mantega told reporters... The real has gained 35% since the beginning of the year..."

October 19 - Bloomberg (Alexander Ragir): "Brazilian hedge funds are luring more money than any type of investment pool in the country after record withdrawals last year... Local hedge funds attracted a net 33.7 billion reais ($19.7bn) this year through Oct. 15... Third-quarter inflows surged to 36.3 billion reais..."

Unbalanced Global Economy Watch:

October 20 - Bloomberg (Brian Swint and Jurjen van de Pol): "European finance officials are concerned the euro's climb to a 14-month high against the dollar is eroding exports as an aide to French President Nicolas Sarkozy called the move a 'disaster' for the economy. 'Excessive volatility' in currency rates is 'bad for economic development,' European Central Bank President Jean-Claude Trichet said... 'It's a problem which worries us,' said Luxembourg's Jean-Claude Juncker, who led the talks."

October 23 - Bloomberg (Jennifer Ryan): "U.K. gross domestic product unexpectedly dropped in the third quarter as enduring slumps in services, manufacturing and construction kept the economy mired in its longest recession on record."

October 19 - Bloomberg (Svenja O'Donnell): "London home sellers raised asking prices to a record high this month and led gains across the U.K. as the shortage of properties for sale intensified, Rightmove Plc said. The average cost of a home in the capital rose 6.5%, the most since records began in 2002, to 416,157 pounds ($680,000)..."

October 22 - Bloomberg (Brian Swint): "U.K. retail sales unexpectedly stagnated in September for a second month as Britons spent less on food and clothing, a sign the country is struggling to escape the recession."

October 23 - Bloomberg (Niklas Magnusson): "Sweden's National Debt Office expects the government to post smaller budget deficits this year and next than it estimated in June as the country's banks prove resilient enough to manage without state help. The central government shortfall will reach 179 billion kronor ($26.2bn) in 2009 and 64 billion kronor in 2010..."

October 19 - Bloomberg (Jacob Greber): "Australia's economy is likely to benefit from rising Asian demand for raw materials including iron ore and coal, surging business investment in new mines, and a rising population, central bank official Philip Lowe said."

U.S. Bubble Economy Watch:

October 21 - Bloomberg (Timothy R. Homan): "Unemployment rose in 23 U.S. states in September and hit records in Nevada, Rhode Island and Florida. Nevada's jobless rate, at 13.3%, was the second-highest among U.S. states behind Michigan... Unemployment in Rhode Island reached 13%, and Florida's rate climbed to 11%, the highest since data began in 1976."

MBS/ABS/CDO/CP/Money Fund and Derivatives Watch:

October 20 - Bloomberg (Ben Moshinsky and Matthew Newman): "Traders may face limits on positions they can take in the over-the-counter derivatives market, valued at $592 trillion, under a draft European Union proposal. The European Commission will propose rules giving regulators the authority to set limits 'to counter excessive price movements or excessive concentration of speculative positions,' according to a draft proposal obtained by Bloomberg..."

October 23 - Bloomberg (Dunstan McNichol): "New Jersey taxpayers are sending almost $1 million a month to a partnership run by Goldman Sachs Group Inc. for protection against rising interest costs on bonds that the state redeemed more than a year ago. The... state is making the payments under an agreement made during... 2003..."

Real Estate Watch:

October 23 - Bloomberg (David M. Levitt): "Real estate investor Peter Duncan, who negotiated the nation's biggest property deal of the year in buying Manhattan's Worldwide Plaza, is now in charge of a skyscraper that's 40% empty. The Italian marble south lobby of Worldwide Plaza, the gateway to 14 vacant floors, is quiet. It's one reason Duncan, president of George Comfort & Sons Inc., was able to buy the 49- story building in July for $590 million, two years after it sold for almost three times as much."

Central Banker Watch:

October 20 - Bloomberg (Jacob Greber): "Australia's central bank signaled it's prepared to keep raising interest rates and tolerate further appreciation in the nation's currency to help restrain consumer prices as the economy strengthens. A 'very expansionary setting of policy was no longer necessary, and possibly imprudent,' officials said..."

October 21 - Bloomberg (Jennifer Ryan): "Bank of England Governor Mervyn King stepped up his call for governments to tackle the dangers posed by banks that are 'too important to fail,' saying new capital rules won't shield taxpayers from funding any future bailouts. 'The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history,' he said... He indicated that one solution could be to split up banks and separate riskier activities from more stable businesses such as taking deposits... 'Capital requirements reduce, but not eliminate, the need for taxpayers to provide catastrophe insurance,' King said. He added it is 'hard to see why' proposals such as those of former Federal Reserve Chairman Paul Volcker to separate proprietary trading from retail banking are 'impractical.'"

GSE Watch:

October 23 - Bloomberg (Jody Shenn): "Freddie Mac... said defaults among its loans rose to another record high last month, while its portfolio of residential assets grew at an annualized rate of 7.3%. Mortgages at least 90 days late or in foreclosure among the single-family loans that Freddie Mac either owns or guarantees rose to 3.33% in September, from 3.13% the previous month and 1.22% a year earlier..."

Muni Watch:

October 21 - Bloomberg (Jeremy R. Cooke): "Municipal bonds headed for their worst monthly performance in a year, as state agencies from California and Alabama plan to tap the debt markets for more than $750 million apiece... State and local government bonds have dropped almost 2% since Sept. 30..."

New York Watch:

October 21 - Bloomberg (Michael Quint): "New York Governor David Paterson said the state may not have enough money in December to pay all its bills, as he urged legislators to quickly agree to plans to close a $3.1 billion deficit and raise cash."

October 20 - Bloomberg (Martin Z. Braun): "A 40% jump in Wall Street bonuses this year may bring relief to New York City and Albany as the state and its biggest metropolis struggle with a combined $14 billion in budget deficits this fiscal year and next. New York investment houses will dole out $26 billion in bonus checks by the end of March, said Alan Johnson, president of compensation consultant Johnson Associates Inc. The money will probably boost sales of multimillion-dollar co-op apartments and generate extra income-tax revenue for state and city governments."

Speculation Watch:

October 22 - Bloomberg (Tomoko Yamazaki): "Hedge-fund assets increased by about $34 billion in September, a fifth straight monthly gain... Eurekahedge Pte said. Net inflows into hedge funds totaled $15.1 billion in September, while performance-based gains made up $18.7 billion, bringing total assets under management to $1.43 trillion..."

October 21 - Bloomberg (Saijel Kishan): "Raj Rajaratnam, the billionaire founder of Galleon Group charged last week by federal prosecutors with insider trading, told investors he will liquidate his hedge funds. Galleon, which managed about $3.7 billion, is exploring various alternatives for the business..."

October 22 - Bloomberg (Victoria Richards and Tomoko Yamazaki): "John Meriwether is setting up a new hedge fund called JM Advisors Management... The new fund comes after Meriwether, who roiled global markets when Long-Term Capital Management LP collapsed in 1998, decided to shut his second hedge fund... JWM Partners LLC decided to close its main Relative Value Opportunity II fund after losing 44% from September 2007 to February 2009."

Crude Liquidity Watch:

October 20 - Bloomberg (Andrew MacAskill and Jon Menon): "Qatar will make about 633 million pounds ($1 billion) as it sells shares in Barclays Plc a year after it helped bailout Britain's second-biggest bank. Qatar Holding LLC... plans to exercise warrants to sell more than 379 million Barclays shares..."

Mortgage Madness

October 22 - MarketNews International (Steven K. Beckner): "Federal Reserve Vice Chairman Donald Kohn said Thursday that prices of mortgage-backed securities are likely to fall when the Fed eventually begins selling MBS from its portfolio. He gave no indication when that might be. But Kohn, echoing earlier comments by New York Federal Reserve Bank President William Dudley, said the Fed may well avoid any losses on its asset holdings, as well as on its liquidity facilities. 'These programs may be unwound without loss,' Kohn said, commenting from the audience at a Boston Federal Reserve Bank conference. He said the Fed entered the market 'when prices were depressed by high premiums' and so 'the Fed could finance without risk.' That in turn will mean they can be 'unwound without loss.'"

Federal Reserve holdings of mortgage-backed securities (MBS) this week exceeded those of Treasuries for the first time ($777bn vs. $774bn). The Fed is now well past half way through its program to purchase $1.25 TN of MBS - which is slated to be completed in March. Federal Reserve Credit jumped to $2.172 TN, up from less than $900bn to begin September 2008.

Mr. Kohn is too optimistic. My view is that the Fed is paying too dearly for these mortgage securities and large losses are inevitable. And while Fed-induced price distortions are not having a big impact on U.S. housing, they exert enormous influence on finance and markets globally. I don't expect the Federal Reserve's MBS portfolio to be unwound anytime soon. Instead, the Fed will live with this exposure for years to come - and will likely expand the scope of mortgage exposure in future crisis periods. And I expect Washington's conglomeration of mortgage risk will at some point make or break the dollar.

In the five years preceding the Lehman collapse, benchmark Fannie Mae MBS yields averaged 5.60%. A very strong case can be made that Fannie, Freddie and the entire mortgage Bubble pushed mortgage borrowing costs artificially low. Over the past year, as the Fed has been building its Trillion dollar MBS holding, benchmark yields averaged 4.30%. Fed officials have been talking confidently of their success in unwinding various liquidity facilities that were implemented during the crisis. Yet the most meaningful government intervention runs unabated throughout the mortgage marketplace. Between the Fed, Fannie, Freddie, Ginnie Mae, and the FHA - it's full speed ahead into the uncharted waters of mortgage market nationalization. It is not easy to envisage a viable exit strategy. Few contemplate the costs.

The consensus view holds that this unprecedented - and ongoing - intervention is fundamental to crisis resolution and sustainable recovery. I counter that such massive market intrusions always create the backdrop for excesses and the next crisis. Most believe inflation does not these days pose a risk and that loose monetary policies no longer foster financial leveraging and other dangerous excess. Indeed, most see this as an atypical backdrop with little risk to fiscal and monetary looseness. Many argue that sticking with unprecedented policy responses for an extended period is the appropriate course to combat deflation. I contend that each government-induced reflationary period comes with its own set of inflationary biases, market responses, excesses, and risks. But they're not going to jump up and down and make themselves obvious.

Yet some aspects of policy risk are becoming more apparent. This week, China reported 8.9% third quarter GDP growth. The Chinese economy has bounced back convincingly, and Bubble dynamics have returned in full force. Increasingly, there is a case for a surprisingly strong recovery throughout Asia and the emerging markets. Crude oil this week traded to $82. The Goldman Sachs Commodities index jumped 2.2%, increasing y-t-d gains to 48.8%. Global reflation has attained a head of steam - and the Bernanke Fed is falling only further behind the curve.

Of course, the counter-argument is that U.S. unemployment is 9.7% and the recovery is fragile. The Fed's dual mandate - price stability and full employment - certainly provides good cover for sticking with ultra-loose monetary policy. Besides, few see meaningful risk inherent with Fed policymaking anyway. Nonetheless, the bottom line remains that U.S. monetary policy and the weak dollar are the dominant forces powering inflationary forces globally.

It is a fundamental tenet to my thesis that the unfolding reflation will be altogether different than previous reflations. The old were primarily driven by Fed-induced expansions of U.S. mortgage finance and Wall Street Credit. Our mortgage industry, housing and securitization markets, and Bubble economy were at the epicenter of global reflationary dynamics. The new reflation is fueled by synchronized fiscal and monetary stimulus across the globe. China, Asia and the emerging markets/economies have supplanted the U.S. at the epicenter. U.S. housing is completely out of the mix.

Those fixated on old reflationary dynamics look today at tepid U.S. housing markets, mortgage loan growth, consumer spending, and employment trends and see ongoing deflationary pressures. The Fed is wedded to the old and is positioned poorly to respond to new reflationary dynamics. A stable dollar used to work to restrain global finance - hence global inflationary forces. The breakdown in the dollar's stabilizing role has unleashed altered inflationary dynamics - forces that the Federal Reserve disregards.

Two open questions come to mind. First, when will the new global reflationary dynamics meaningfully impact the U.S. inflation outlook? Second, what impact will the prospect of foreign central bank tightenings have on U.S. market yields?

U.S. market yields are not priced for a global reflationary backdrop. Notions of a "new normal" and a central bank content with an extended hiatus tug U.S. and global yields artificially down. Fragile U.S. underpinnings have global markets convinced both that the Fed will err on the side of ultra-loose monetary policy and that dollar weakness will constrain global policy tightening. The brunt of global reflationary forces may have shifted overseas, but the U.S. remains firmly at the epicenter of market distortions.

And nowhere do price distortions have more impact than in the mortgage arena. While Washington and the media focus on Wall Street compensation and regulatory reform, an incredible amount of mortgage risk quietly shifts to the American taxpayer. Beyond the Fed's $1.25 TN of MBS, Fannie's and Freddie's "books of business" continue to expand, while the FHA and Ginnie Mae balloon their exposure to risky mortgages. In the short-run, this process reduces systemic stress and boosts market liquidity. The markets remain quite happy with this dynamic - for now.

The secular bear thesis and the next round of financial crisis don't require a wild imagination: The U.S. economy underperforms in the new global reflationary backdrop. The Fed stays ultra-loose for too long - along with timid Chinese and other central bankers around the globe. The U.S. fixed income marketplace - especially MBS - becomes too predisposed to artificially low Fed funds and market yields. Historically low U.S. yields - in the face of booming Asia/emerging markets - continue to weigh on the dollar. Dollar devaluation and global dynamics set the stage for an inflationary surprise. And any jump in inflation fears would find U.S. bond and mortgage markets especially poorly positioned, with the U.S. economy extraordinarily vulnerable to any spike in yields. A crisis in a rising rate environment would be especially problematic for a Fed and Treasury confronting Trillions in mortgage Credit and interest-rate risk. Foreign holders of our mortgage paper could lose big if market prices and the dollar move against them simultaneously. And it's safe to say that the Federal Reserve wouldn't be profitably unwinding its MBS portfolio.