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A Year in Reflation

For the week, the S&P500 jumped 3.1% (up 2.1% y-t-d), and the Dow gained 2.3% (up 1.3%). The broader market has been exceptionally strong. The S&P 400 Mid-Caps surged 4.3% (up 6.0%), and the small cap Russell 2000 jumped 6.0% (up 6.5%). The Banks jumped another 2.4% (up 13.8%), and the Broker/Dealers rose 3.0% (up 2.2%). The Morgan Stanley Cyclicals surged 4.8% (up 4.4%), and the Transports increased 1.5% (up 2.3%). The Morgan Stanley Consumer index gained 2.7% (up 2.8%), and the Utilities rose 2.8% (down 4.6%). The Nasdaq100 jumped 3.8% (up 1.5%), and the Morgan Stanley High Tech index gained 3.6% (up 0.3%). The Semiconductors rose 3.7% (down 2.3%). The InteractiveWeek Internet index jumped 4.8% (up 2.2%). The Biotechs surged 12.7%, increasing 2010 gains to 24.5%. With bullion up almost $15, the HUI gold index jumped 6.1% (down 0.3%).

One-month Treasury bill rates ended the week at 9 bps, and three-month bills closed at 13 bps. Two-year government yields jumped 8 bps to 0.81%. Five-year T-note yields gained 4 bps to 2.26%. Ten-year yields increased 7 bps to 3.68%. Long bond yields jumped 9 bps to 4.64%. Benchmark Fannie MBS yields were little changed at 4.33%. The spread between 10-year Treasury and benchmark MBS yields narrowed 7 to 65 bps. Agency 10-yr debt spreads increased 2 to 36 bps. The implied yield on December 2010 eurodollar futures rose 7 bps to 0.875%. The 10-year dollar swap spread was cut in half to 4.25, and the 30-year swap spread declined 2 to negative 16. Corporate bond spreads narrowed. An index of investment grade bond spreads narrowed 3 to 89 bps, and an index of junk spreads narrowed 2 to 520 bps.

Debt issuance picked up to a respectable $20.0bn (from Bloomberg). Investment grade issuers included Dexia Credit $4.0bn, Goldman Sachs $2.0bn, Time Warner $2.0bn, Republic Services $1.5bn, Baxter International $600 million, John Deere $500 million, US Bancorp $500 million, Johnson Controls $500 million, Southwestern Electric Power $350 million, Puget Sound Energy $325 million, Teco Finance $550 million, Public Service E&G $300 million, and Western Massachusetts Electric $95 million.

Junk bond funds saw inflows of $314 million. Junk issuers included HCA $1.4bn, Masco $500 million, Avis Budget Car Rental $450 million, TW Telecom $430 million, Alliance Oil $350 million, Solutia $300 million, Reddy Ice $300 million, Pioneer Drill $250 million, Zayo Group $250 million, Conexant Systems $175 million, Express $250 million, and Holly Energy $150 million.

I saw no converts issued.

International dollar debt sales remain robust. Issuers included Mexico $2.0bn, South Africa $2.0bn, Export-Import Bank of Korea $1.0bn, Rabobank $1.0bn, and Bank of Moscow $750 million.

U.K. 10-year gilt yields added 3 bps to 4.06%, and German bund yields increased 5 bps to 3.15%. Bond yields in Greece dropped 30 bps to 6.06%. The German DAX equities index surged 5.0% (down 1.3% y-t-d). Japanese 10-year "JGB" yields were little changed at 1.30%. The Nikkei 225 was up 2.4% (down 1.7%). Emerging markets were mostly strong. For the week, Brazil's Bovespa equities index jumped 3.5% (up 0.4%), and Mexico's Bolsa increased 2.5% (up 1.0%). Russia's RTS equities index surged 5.7% (up 4.6%). India's Sensex equities index rallied 3.3% (down 2.7%). China's Shanghai Exchange slipped 0.7% (down 7.5%). Brazil's benchmark dollar bond yields sank 14 bps to a 2010 low 4.84%, and Mexico's benchmark bond yields dropped 20 bps to a record low 4.80%.

Freddie Mac 30-year fixed mortgage rates dropped 8 bps to 4.97% (down 18bps y-o-y). Fifteen-year fixed rates fell 7 bps to 4.33% (down 39bps y-o-y). One-year ARMs jumped 12 bps to 4.27% (down 59bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down a basis point to 5.87% (down 101bps y-o-y).

Federal Reserve Credit declined $6.7bn last week to $2.263 TN. Fed Credit is up $371bn, or 19.6%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 3/3) rose $4.4bn to a record $2.969 TN. "Custody holdings" expanded $372bn, or 14.3%, over the past year.

M2 (narrow) "money" supply rose $10.3bn to $8.537 TN (week of 2/22). Narrow "money" has increased $25.3bn y-t-d. Over the past year, M2 expanded 1.9%. For the week, Currency increased $2.2bn, while Demand & Checkable Deposits slipped $0.6bn. Savings Deposits increased $13.9bn, while Small Denominated Deposits declined $4.2bn. Retail Money Funds fell $2.2bn.

Total Money Market Fund assets (from Invest Co Inst) increased $1.7bn to $3.168 TN. In the first nine weeks of the year, money fund assets dropped $126bn, with a one-year drop of $738bn, or 18.9%.

Total Commercial Paper outstanding dropped $20.3bn last week to $1.134 TN. CP has declined $36.4bn, or 18.0% annualized year-to-date, and was down $347bn over the past year (23.4%).

International reserve assets (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.160 TN y-o-y, or 17.4%, to a record $7.821 TN.

Global Credit Market Watch:

March 3 - New York Times (Landon Thomas Jr.): "As Greece's debt troubles batter the euro, Britain has done its utmost to stay above the fray. Until now, that is. Suddenly, investors are asking if Britain may soon face its own sovereign debt crisis if the government fails to slash its growing budget deficits quickly enough to escape the contagious fears of financial markets... Without a strong political majority to tackle Britain's lumbering fiscal problems, investors could start to make it greatly more expensive for the government to raise funds, setting the stage for a potential double-dip recession, if not worse. 'If you really want a fiscal problem, look at the U.K.,' said Mark Schofield, a fixed-income strategist at Citigroup. 'In Europe, the average deficit is about 6% of G.D.P. and in the U.K. it's 12%. It is only just beginning.'"

March 4 - Bloomberg (Caroline Salas): "The thawing of the credit markets in 2009 spawned record debt sales as companies sought to ensure they had enough capital to run their businesses and meet their debt obligations. Corporate bond sales worldwide climbed 31% to $3.04 trillion and issuance of high-yield, high-risk securities -- the most lucrative market for underwriters -- ballooned by 181% to $207 billion... Both set records. The new bond issues earned bankers $18.8 billion in fees from debt underwriting, a 31% increase over 2008 and equal to the record set in 2007."

March 4 - Bloomberg (Rebecca Christie and Phil Mattingly): "The Obama administration's legislative draft of the so-called Volcker Rule incorporated exemptions that may ease the impact on financial markets should it be enacted. President Barack Obama... sent Congress the five-page proposal to ban proprietary trading and block mergers that give banks more than a 10% market share... It also would bar banks from owning or investing in hedge funds and private equity firms... left out are trading in Treasury and agency securities, including debt issued by Ginnie Mae, Fannie Mae and Freddie Mac. Such exemptions may help to avoid market disruptions that could affect small investors, said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ..."

March 1 - Bloomberg (Joel Schectman and Sapna Maheshwari): "The 8.8-magnitude earthquake that struck Chile last week may cost insurers more than $2 billion, according to catastrophe-modeling firm AIR Worldwide. The earthquake killed more than 700 people, cut off the nation's main highway, knocked out power lines and damaged 1.5 million homes, officials said. Economic losses may exceed $15 billion..."

Global Government Finance Bubble Watch:

March 5 - Bloomberg (Caroline Salas and Jody Shenn): "The Federal Deposit Insurance Corp. sold $1.81 billion of debt backed by mortgage securities, as it seeks to raise cash after the worst financial crisis since the Great Depression."

March 5 - Bloomberg: "China will sell 200 billion yuan ($29.3bn) of bonds for a second year to help local governments fund infrastructure projects, Premier Wen Jiabao told today's annual meeting of the National People's Congress... The central government's role in local debt sales has reduced the cost of building roads and railways as part of a two-year $586 billion spending package..."

March 4 - Bloomberg (Andres R. Martinez and Jens Erik Gould): "Mexico's sale of $1 billion in 10-year international bonds today was 2.5 times oversubscribed, said Gerardo Rodriguez, head of the public debt unit at the Finance Ministry. They sold at the lowest yield ever... The government sold 60% of the debt to investors in the U.S., 28% to Europe, 10% to Mexico and 2% to Asia, Rodriguez said... Favorable market conditions for the debt sale were present for the past eight to 10 days, he said. 'This was a very interesting opportunity to access the market,' Rodriguez said. 'We saw a very clear window of opportunity.'"

Currency Watch:

March 3 - Reuters: "Chinese commercial banks absorbed about $170 billion in foreign exchange from the financial system last year, mainly through yuan-dollar swaps, state media...cited a former official as saying. ...the State Administration of Foreign Exchange (SAFE), the foreign exchange regulator, absorbed about 1 trillion yuan through the swaps in 2009. SAFE is an arm of the central bank and is in charge of foreign exchange policy and managing the country's $2.4 trillion in foreign reserves. Authorities have been struggling to absorb a massive amount of yuan liquidity that has flowed into the interbank market as a result of inflows of foreign exchange from the trade surplus, foreign investment and speculative capital."

February 28 - Bloomberg (Bo Nielsen): "The rise of carry trades, in which investors take advantage of interest-rate differences between countries, may signal bigger swings in currencies during crises, the Bank for International Settlements said. Variations in interest rates played a larger role in the latest financial turmoil than in either the Asian financial crisis of 1997-1998, or following the Russian debt default in 1998... That may reflect the 'increasing role carry trades play in exchange rate movements,' it said. 'This factor may have changed the dynamics of exchange rates around crises more generally, affecting a broader set of currencies and leading to more pronounced swings in exchange rates during and after crisis episodes,' the BIS said."

The dollar index was little changed this week at 80.46 (up 3.3% y-t-d). For the week on the upside, the South African rand increased 4.2%, the Canadian dollar 2.1%, the South Korean won 1.7%, the Brazilian real 1.7%, the Australian dollar 1.4%, the Mexican peso 1.1%, the Singapore dollar 0.5%, and the Taiwanese dollar 0.5% For the week on the downside, the Japanese yen declined 1.5%, the British pound 0.7%, and the New Zealand dollar 0.2%.

Commodities Watch:

March 1 - Bloomberg (David Wilson): "Rising commodity costs threaten an anticipated resurgence in U.S. corporate profits, according to Adam S. Parker, a Sanford C. Bernstein & Co. strategist. The... year-to-year percentage changes in U.S. producer prices for crude goods, primarily commodities, on an overall basis and excluding food and energy. Both gauges surged from record lows, set last year, and Parker cited the overall index in a report today. 'Headwinds on commodity costs' are likely to hold back earnings growth by the second half, Parker wrote. Makers of consumer staples, including food and beverages, and capital- equipment producers are most at risk, in his view."

The CRB index gained 0.8% (down 2.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) rallied 1.7% (up 0.3% y-t-d). Gold gained 1.3% to $1,132 (up 3.2% y-t-d). Silver jumped 5.1% to $17.37 (up 3.1% y-t-d). April Crude rose $2.08 to $81.74 (up 3.0% y-t-d). April Gasoline rallied 4.1% (up 11% y-t-d), while April Natural Gas dropped 4.5% (down 17.5% y-t-d). May Copper jumped 4.2% (up 2.3% y-t-d). March Wheat dropped 5.0% (down 8.9% y-t-d), and March Corn declined 3.5% (down 9.4% y-t-d).

China Bubble Watch:

March 3 - Bloomberg: "China's hidden borrowing may push government debt to 96% of gross domestic product next year... Professor Victor Shih said. 'The worst case is a pretty large-scale financial crisis around 2012,' said Shih, a political economist at Northwestern University... who spent months researching borrowing transactions by about 8,000 local-government entities...Surging borrowing by local-government entities, uncounted in official estimates of China's debt-to-GDP ratio, is the key reason for Shih's concern... By Shih's count, China's debt may reach 39.838 trillion yuan ($5.8 trillion) next year. His forecast for debt-to-GDP compares with an International Monetary Fund estimate for China of 22% this year, which excludes local-government liabilities. The IMF sees Spain at 69.6%, the U.S. at 94%, Greece at 115% and Japan at 227%."

March 3 - Bloomberg (Simon Packard): "China overtook the U.S. as the world's biggest property investment market last year and will probably keep the lead in 2010 on economic growth and a lower reliance on debt, Cushman & Wakefield LLP said. Real estate investment in China more than doubled to $156.2 billion last year, while the total for the U.S. slumped 64% to $38.3 billion... Excluding residential investments, the U.S. came third after China and the U.K."

March 3 - Bloomberg: "China's economy, the world's third biggest, will top last year's 8.7% growth in 2010, said Su Ning, a central bank deputy governor. 'China's economy will perform better than last year,' Su said... He said that he was referring to the 'pace, structure and growth quality.'"

March 4 - Bloomberg (Joji Mochida): "China's sharpest import increase on record in January signals an export surge through at least this quarter, reducing the impact of monetary tightening on economic growth, Nomura Institute of Capital Markets Research said... 'The latest data portends that exports will increase sharply in the first quarter of this year. A surge in overseas shipments would allow China to consider revaluation of the yuan.' Imports rose 56% in December and 86% in January from the same periods a year earlier, driven by shipments of metals including copper and aluminum."

March 3 - China Knowledge: "China's exports of electronics and information technology products jumped 38.5% in January, according to... the Ministry of Industry and Information Technology. The export value of Chinese electronics and IT products reached US$37.35 billion in the period, accounting for 34.1% of the country's total exports."

March 3 - Bloomberg: "China's airlines flew 59% more passengers internationally in February compared with last year, the country's civil aviation director Li Jiaxiang said..."

Japan Watch:

March 1 - Bloomberg (Makiko Kitamura): "Toyota Motor Corp. and Honda Motor Co., Japan's two biggest automakers, led the seventh straight increase in the nation's monthly auto sales... Sales of cars, trucks and buses, excluding minicars, rose 35% to 294,887 vehicles in February from a year earlier..."

India Watch:

March 4 - Bloomberg (Kartik Goyal): "India's food-price inflation rate stayed above 17% for a sixth week and may accelerate after truckers raised freight rates citing higher fuel costs."

Asia Bubble Watch:

March 3 - Bloomberg (Nguyen Kieu Giang): "Vietnam's banking credit rose 1.14% in February from a month earlier, raising concerns that the government may fail to achieve its 25% loan growth target for the year."

Latin America Bubble Watch:

March 4 - Bloomberg (Laura Price and Juan Pablo Spinetto): "Brazil's economy may overheat as too much foreign investment flows into the country, said Luciano Coutinho, president of state development bank BNDES. 'We are worried about excessive inflow or excessive growth this year,' Coutinho said...He added that the government is seeking economic growth of 5% to 5.5% in 2010."

March 5 - Bloomberg (Adriana Brasileiro and Andre Soliani): "Brazil's inflation quickened in February to the fastest pace in 21 months, cementing expectations the central bank will raise interest rates no later than April. Consumer prices, as measured by the benchmark IPCA price index, jumped 0.78% in February..."

March 1 - Bloomberg (Alexander Ragir and Tal Barak Harif): "Buyout firms are poised to spend $9 billion in Brazil on everything from infrastructure to oil exploration as the economy recovers from a recession, the nation's private equity and venture capital association said."

March 1 - Bloomberg (Eliana Raszewski): "Argentine inflation is poised to accelerate as President Cristina Fernandez de Kirchner gains access to as much as 24.7 billion pesos ($6.4 billion) in central bank profits to help her avoid cutting spending."

March 2 - Bloomberg (Daniel Cancel): "Venezuela will raise prices on some food goods 11% to 47% following the devaluation of the bolivar and a drought that has cut production, El Nacional said..."

Unbalanced Global Economy Watch:

March 1 - Bloomberg (Greg Quinn): "Canada's economy expanded at a 5% annualized rate in the fourth quarter, faster than predicted by the Bank of Canada, raising pressure on policy makers to increase interest rates later this year. Gross domestic product grew at the fastest pace since the third quarter of 2000..."

March 5 - Bloomberg (Theophilos Argitis and Greg Quinn): "Canadian Prime Minister Stephen Harper's five-year plan to cut defense spending, foreign aid and government operations won't be rejected by opposition lawmakers, putting the country on course to be the first in the Group of Seven to erase its deficit."

March 1 - Bloomberg (Scott Hamilton): "U.K. mortgage approvals dropped in January by more than economists forecast to an eight-month low, adding to evidence that the housing-market recovery may be losing momentum."

March 3 - Bloomberg (Steve Bryant): "Turkey's inflation rate rose in February to 10.1% from 8.2% a month earlier..."

Central Bank Watch:

March 4 - Bloomberg (Christian Vits): "The European Central Bank may have to decide just how much it's prepared to allow Greece dictate monetary policy for the euro region as a whole... 'With a Greek roadblock on the exit lane, the ECB will have to drive carefully,' said Carsten Brzeski, an economist at ING Group... 'The one-size-fits-all approach isn't functioning when there are divergent trends in the member states.'"

March 1 - Bloomberg (Craig Torres and Peter Cook): "Federal Reserve Bank of Richmond President Jeffrey Lacker said the central bank is 'being made a scapegoat' to satisfy anger over bailouts as Congress seeks to limit its consumer-protection and bank-supervision powers. 'People are mad at us,' Lacker said... 'I can understand the ire after what happened in 2008. It was so unexpected, and it seemed to over- step boundaries that everyone thought we were going to obey.' Lacker said he wouldn't 'second guess' moves by Federal Reserve Chairman Ben S. Bernanke to backstop non-bank financial institutions... He said proposals to curtail the Fed's supervision authority would weaken its ability to lend to banks."

March 1 - Wall Street Journal (David Wessel and Jon Hilsenrath): "Donald L. Kohn, the 67-year-old vice chairman of the Federal Reserve Board who has been a close adviser to Fed chairmen Ben Bernanke and Alan Greenspan, said he will step down from the post when his term ends in June. The retirement gives President Barack Obama a third seat to fill on the seven-member Fed board... 'At no time since the Great Depression have this ability and dedication been tested as they have been over the past several years,' Kohn said in a letter to Mr. Obama. 'I am confident that history will judge the Federal Reserve, under the leadership of Chairman Ben Bernanke, to have met these challenges with great speed, imagination, and effectiveness.'"

Real Estate Watch:

March 4 - Bloomberg (Courtney Schlisserman): "Fewer Americans than expected signed contracts to purchase previously owned homes in January, indicating the extension of a tax credit is doing little to lure buyers... The drop in contract signings adds to evidence the housing market at the center of the worst recession since the 1930s is struggling to rebound..."

GSE Watch:

March 5 - Bloomberg (Dawn Kopecki): "Fannie Mae and Freddie Mac bondholders shouldn't assume the government will make them whole on their investments as Congress retools the companies, House Financial Services Committee Chairman Barney Frank said. 'Please don't think this is federally guaranteed, I don't think it is, I don't think it should be, I don't feel any obligation to bail you out,' Frank told reporters... Congress will 'certainly not' extend any new protections to bond and mortgage-security investors beyond what exists, Frank said. A 'whole range' of options is being considered for investors in the two government-seized companies, 'from paying nothing to a haircut to whatever,' Frank said."

March 4 - MarketNews International (Yali N'Diaye): "Amid reports that government-sponsored enterprises are preparing to ask lenders to repurchase over $20 billion of loans that they originated, a Freddie Mac spokesman said... his company is simply being responsible with taxpayers' money. He added that loan repurchase requests are the result of an aggressive quality control policy, although rising delinquencies are also a driver of the increasing amounts of repurchase requests."

New York Watch:

March 3 - New York Times (Patrick McGeehan): "In fall 2008, after Lehman Brothers collapsed and other Wall Street firms seemed ready to topple, New York appeared to be headed for a brutal recession, one that would rival the worst downturns in the city's history. Now city officials and private economists are revising their forecasts with a drastic change in tone. The gathering consensus is that the recession is nearly over in the city and, largely because of the enormous amount of federal aid poured into the big banks, the toll on New York will be much less severe than most had feared."

Muni Watch:

March 5 - Bloomberg (Terrence Dopp): "New Jersey Transit proposed raising fares by a record 25 percent system-wide and reducing service to help close a $300 million budget deficit."

Speculation Watch:

March 3 - Bloomberg (Ben Moshinsky): "Banks and regulators across Europe were summoned by the European Commission to discuss regulation of the market for sovereign credit default swaps in the wake of the Greek debt crisis. The European Union's executive agency will hold a meeting in Brussels 'shortly,' Chantal Hughes, a commission spokeswoman, said..."

March 3 - Bloomberg (Katherine Burton and David Scheer): "The U.S. is asking hedge funds not to destroy trading records on euro bets, according to a person with knowledge of the requests, as Europe and the U.S. step up scrutiny of the funds' role in the Greek debt crisis."

March 5 - Bloomberg (Netty Ismail): "Singapore is planning to create its own hedge-fund capital modeled after Greenwich, Connecticut, in a cluster of ex-British army homes called Nepal Hill, a 15-minute cab-ride from the city-state's main banking district."


A Year in Reflation

This week marked the one-year anniversary of a historic stock market rally. The S&P500 enjoys a one-year gain of 66.8%. The broader market has fared even better. The small cap Russell 2000 and S&P400 Mid-Caps sport 12-month gains of 90.6% and 87.4%. The past year also witnessed record junk debt issuance and an amazing turnabout in financial conditions. Housing markets may be stuck in the mud, but government-induced reflation has worked wonders for equities, corporate debt and global risk assets more generally.

Long-time readers may have noticed that awhile back I stopped the weekly presentation of bank Credit and asset data. For the record, bank Credit declined $470bn over the past year, or about 5%. I specifically have not emphasized this bank contraction, believing it had become a deceptive indicator of financial conditions. Also luring in those anticipating deflationary conditions, M2 "money supply" expanded just under 2% over the past year. There has been no reason to fret a substandard $200bn one-year expansion of narrow "money," with Treasury and agency securities inflating a couple Trillion and the Fed monetizing a Trillion of MBS.

One year ago, the Federal Reserve held $69bn of mortgage-backed securities. Their hoard now surpasses $1.027 TN. Over the past year, Treasury has run deficits of about $1.5 TN. Our government's "electronic printing press" has dispersed unprecedented purchasing power to households and businesses throughout the economy. The Fed's Trillion dollar monetization has unleashed unmatched liquidity throughout the financial markets.

March 5 - Bloomberg (Wes Goodman): "Investors plowed a record $2.6 billion into global bond funds in the week ended March 3, moving out of money markets to seek higher returns because of the threat of quickening inflation, EPFR Global said... U.S. bond funds drew in $2 billion, attracting cash for a 61st straight week... 'Flows into these funds remained incredibly robust in early March,' EPFR said. 'Cash continues to flee the safe havens of 2006-08.'"

Brazil's Bovespa has gained 84.2% in 12 months, Mexico's Bolsa 86.8%, and Argentina's Merval 140.8%. In Asia, China's Shanghai Composite gained 36.5%, Hong Kong's Hang Seng 70.2%, Taiwan's Taiex 65.3%, South Korea's Kospi 54.4%, Australia's S&P/ASX 200 49.5%, the Thai index 73.6%, the Jakarta Composite 100.2%, and the Ho Chi Minh index 108.1%. In Europe, the Prague stock index has gained 80.8%, Budapest 131.3%, and Russia's RTS index 170.1%. Emerging Market debt spreads (EMBI) were above 730 a year earlier yet closed this week below 300 bps. Mexican bond yields traded to a record low today (4.80%). Over the past year, the South African rand has gained 43%, the Australian dollar 42%, the New Zealand dollar 39.5%, the South Korean won 37.5%, the Brazilian real 34.5%, the Swedish krona 30.8%, and the Canadian dollar 25.6%. The price of crude oil has almost doubled in 12 months, and the CRB Commodities index has gained 35%.

Over the past six weeks of Greek and European debt consternation, emerging debt markets remained notably resilient. Brazil's 10-year dollar bond yields barely traded above 5.3%, while Mexico's yields stayed below 5.2%. Around the world, debt markets hardly flinched. It is also worth mentioning that Greece's bond offering yesterday was three times oversubscribed. They had to pay up somewhat (6.385%), but there was no shortage of bids.

At this point, global reflationary forces appear well entrenched. There is little indicating that the dollar's rally is forcing the unwind of the so-called "dollar carry trade." It is difficult to identify signs of deleveraging and fading liquidity. There are instead indicators pointing to unrelenting liquidity overabundance. If this were an environment with tight global financial conditions, Greece would likely be in a heap of trouble. In a backdrop of risk aversion and deleveraging, Greek contagion would likely be a serious global issue. In some ways, the Greece debt crisis is providing a litmus test for the global risk and liquidity backdrop. At least so far, there is ample confirmation of extraordinarily loose global financial conditions.

After the bursting of the technology Bubble, the Federal Reserve was content to live with mortgage excesses as it worked toward its objective of systemic reflation. The post-Bubble focus was to make sure the bad guys were punished (Enron, Worldcom, Arthur Anderson, etc.) and that accounting rules were significantly tightened up. The causes behind the system's proclivity toward dangerous financial excess - the root of the problem - were so easily disregarded. The Greenspan/Bernanke Fed's overriding objective was to ensure abundant cheap liquidity and foment reflationary forces. I am unsympathetic to Federal Reserve President Jeffrey Lacker's assertion this week that the Fed is "being made a scapegoat."

Today, the Fed's overriding objective - understood in the markets more clearly than ever - remains ensuring abundantly cheap liquidity. This period's bad guys - the bankers - are under the spotlight, as the focus for this round of reform turns to ensuring that the banks are not the instigators of future crises. And I expect the "Volcker rule" to be about as successful as the Sarbanes-Oxley Act when it comes to protecting the system from financial excess and devastating Bubbles.

March 4 - Bloomberg (Rebecca Christie and Phil Mattingly): "The Obama administration's legislative draft of the so-called Volcker Rule incorporated exemptions that may ease the impact on financial markets should it be enacted. President Barack Obama... sent Congress the five-page proposal to ban proprietary trading and block mergers that give banks more than a 10% market share... It also would bar banks from owning or investing in hedge funds and private equity firms. The rule, which is aimed at reducing the risk of another financial crisis, exempts mergers that exceed the market-share limit in cases when a firm acquires a failing bank with regulators' approval. Also left out are trading in Treasury and agency securities, including debt issued by Ginnie Mae, Fannie Mae and Freddie Mac."

Throughout the post-tech Bubble reflationary period, mortgage Credit expansion was viewed as integral to the solution. Mortgage finance was basically off limits from a regulatory standpoint, with this dynamic providing major impetus for historic Credit and speculative excess. Rather than recognizing an unfolding mortgage finance Bubble as a systemic risk, policymakers were content to feed the excess and look the other way. Of course, a speculative marketplace figured this all out and took full advantage. The government's multifaceted (Fed, GSEs, Treasury, etc.) support of mortgage finance fanned speculative excess and directly fueled the Bubble.

These days, the Administration's watered-down "Volcker rule" - which will likely be diluted to water-like reform legislation in Congress - excludes the government debt markets from proprietary trading restrictions. Government finance is today's unfolding Bubble and, not surprisingly, this Bubble is off limits for regulatory reform. Government deficits are integral to the Bubble, and there will be no serious effort to rein them in. The Fed's balance sheet is a serious Bubble issue, but it also remains untouchable. Treasury, GSEs, and Federal Reserve Credit are viewed as the solution, and a historic Bubble is emboldened and builds momentum.

The markets' perception of "too big to fail" has for years been an integral facet of Bubble dynamics. And despite all the talk of trying to rid the marketplace of this notion, the markets remain more persuaded than ever: the unfolding global government finance Bubble is much too gigantic for policymakers to risk letting it come anywhere close to failing. Massive U.S. deficits and near-zero interest rates ensure a steady flow of finance (newly created as well as an ongoing exodus out of low-yielding instruments) to debt markets around the world. Confidence runs high that ultra-loose U.S. financial conditions will continue to underpin Credit expansions globally. Politicians may talk tough, and they do put on a good show. Meanwhile, markets function with reticent aplomb, knowing they've got policymakers right where they want them.


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