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Lying in Wait?


For the week, the Dow gained 1.6% and the S&P500 added just over 1%. The Transports and Morgan Stanley Consumer indices gained 1%. The Morgan Stanley Cyclical index rose 2%, while the Utilities posted a slight decline. The broader market rally continues, with the small cap Russell 2000 and S&P400 Mid-cap indices posting gains of less than 1%. Technology stocks performed well. The NASDAQ100 and Morgan Stanley High Tech indices rose about 2%. The Semiconductors and The Street.com Internet index added 1%. The NASDAQ Telecommunications index gained 1.6%. The Biotechs were slammed for almost 5%. The financial stocks were mixed. The Broker/Dealers declined less than 1%, while the Banks added less than 1%. With bullion down $5.30, the HUI gold index dropped about 5%.

With Mr. Greenspan and other Fed officials dabbling in relative "hawkishness," the bond market remained on the defensive. Short-dates securities suffered the worst. December 3-month Eurodollar yields jumped 10 basis points to 2.67%. The yield on 2-year Treasury securities surged 12 basis points to 2.81%, the highest level since July 2002. Five-year and 10-year yields rose 3 basis points to 3.98% and 4.80%. Long-bond yields added 2 basis points 5.47%. Benchmark Fannie Mae MBS yields rose 3 basis points. The spread on Fannie's 4 3/8 2013 note narrowed 1 to 40. The spread on Freddie's 4 ½ 2013 note narrowed 2 to 38. The 10-year dollar swap spread dipped .75 to 48.25. The corporate bond market more than held its own, with junk spreads narrowing meaningfully for the second consecutive week. The Banc of America High Yield Broad Market index returned to a small positive y-t-d gain this week (from Bloomberg).

Corporate issuance was a respectable $13.2 billion during the four-day week. Investment Grade issuance included Genworth Financial $1.9 billion, SLM Corp $850 million, Hospira $700 million, Key Bank $300 million, Pacific Energy $250 million, First Industrial LP $125 million, and TCF Financial $75 million.

Junk bond funds reported modest outflows of $59.8 million for the week (from AMG). Interestingly, junk issuance remains strong. Stater Brothers Holdings sold $825 million, Celestica $500 million, Iasis Healthcare $475 million, Abitibi-Consolidated $400 million, US Unwired $360 million, Swift Energy $150 million, and Cadmus Communication $125 million.

Convert issuance included Epix Medical $100 million and Terremark Worldwide $75 million.

Foreign dollar debt issuers included European Investment Bank $3 billion, Pemex $1.5 billion, Eksportfinans $1 billion, and Den Danske Bank $750 million.

Brazilian benchmark bond yields rose 9 basis points to 11.36%. Russian 10-year Eurobond yields added 3 basis points to 6.60%, with Mexican govt. yields up 5 basis points to 6.32%.

Freddie Mac posted 30-year fixed mortgage rates added 2 basis points this week to 6.30%. Fifteen-year fixed-rate mortgage rates rose 4 basis points to 5.67%. One-year adjustable-rate mortgages could be had at 4.14%, up 16 basis points for the week and 27 basis points over two weeks to the highest level since December 2002. Adjustable-rates are up 78 basis points over the past 11 weeks. The Mortgage Bankers Association Purchase application index declined 8.9% last week. With y-o-y comparisons becoming much more difficult, Purchase applications were actually down 6.8% from one year ago (dollar volume up 2%). Refi applications declined 13.9%. The average Purchase mortgage was for $215,700, and the average ARM was for $287,100. ARMs accounted for 32.6% of applications last week.

Broad money supply (M3) rose $4.0 billion. Year-to-date (22 weeks), broad money is up $377.5 billion, or 10.1% annualized. For the week, Currency added $2.8 billion. Demand & Checkable Deposits declined $12.9 billion. Savings Deposits jumped $11.1 billion. Saving Deposits have expanded $238.6 billion so far this year (17.9% annualized). Small Denominated Deposits dipped $600 million. Retail Money Fund deposits declined $3.4 billion. Institutional Money Fund deposits dropped $5.2 billion, while Large Denominated Deposits added $3.2 billion. Repurchase Agreements rose $4.7 billion. Eurodollar deposits gained $4.3 billion.

ABS issuance totaled ("roughly") $5.4 billion (from JPMorgan), with y-t-d issuance of $240.9 billion 22% ahead of comparable 2003. Year-to-date Home Equity ABS issuance of $140.9 billion is running 65% above a year ago.

Bank asset and liability data will be released Monday. Bank Credit was up $263.3 billion during the first 22 weeks of the year, or 10.4% annualized. Real Estate loans were up $159.6 billion y-t-d, or 17.8% annualized. Elsewhere, Total Commercial Paper rose $10.9 billion (reversing the previous week's $11.4bn decline) to $1.3434 Trillion. Financial CP added $8.2 billion, with Non-financial CP up $2.7 billion. Year-to-date, Total CP is up $74.9 billion, or 13.3% annualized.

Fed Foreign "Custody" Holdings of Treasury, Agency debt rose $7.4 billion to $1.228 Trillion. Year-to-date, Custody Holdings are up $377.5 billion, or 34.2% annualized.

Currency Watch:

A late-week rally put the dollar index up better than 1.5% this week. The New Zealand dollar and Japanese yen gained better than 1%, while the European currencies generally took it on the chin (Norwegian krone down 3.5%, the Swedish krona, euro and Danish krone down 2.25%).

Commodities Watch:

June 8 - Bloomberg (Sri Jegarajah): "Asia, which consumes almost a third of the world's oil, may boost imports for emergency reserves after prices surged to a record on concern terrorist attacks may disrupt supply from the Middle East... An Asian emergency oil reserve, with a capacity of half a billion barrels, would require about $15 billion in investment alone to fill it with crude oil priced at $30 a barrel, said Damien Criddle, a lawyer at Baker & McKenzie in Hong Kong, who specializes in oil and gas. 'It's a major capital undertaking,' he said. Japan, China and South Korea may help fund the reserve because 'it's in their interest to see their neighbors stable.'"

June 10 - Bloomberg (Janet Ong): "Shanghai, China's biggest commercial city, will raise coal inventories at power plants to at least 10 days to minimize the blackouts that interrupted production at 4,000 companies last year... Coal shortages forced some of the nation's power plants to shut and left others with inventories for only one more day... China's coal stockpiles fell to...a 20-year low, at end-April... Shanghai's power demand may rise as much as 15 percent during the peak period from June 15 until Sept. 17 compared with a year ago... In April, the city government said it plans to invest more than 100 billion yuan ($12 billion) by 2010 to double electricity-generating capacity... Asian coal prices this month rose to a record because of soaring demand in China, South Korea and Taiwan."

The CRB index declined 1.8% for the week (up 5.7% y-t-d). The Goldman Sachs Commodities Index dipped 0.8%, reducing 2004 gains to 13.1%.

Central Bank Watch:

"The Bank of England's Monetary Policy Committee today voted to raise the Bank's repo rate by 0.25 percentage points. The global economic recovery is continuing. In the United Kingdom, official data and business surveys suggest that output growth remains around, or above, trend. Household spending, public consumption and investment have all grown strongly and the housing market remains buoyant. The labour market has tightened further. CPI inflation has been below the 2 percent target, but cost pressures are rising. As indicated in the May Inflation Report, a small and diminishing margin of spare capacity means that inflationary pressures are likely to continue building."

Reserve Bank Governor Dr. Alan Bollard after the Reserve Bank of New Zealand this week raised rates for the third time this year to 5.75%. "The New Zealand economy has enjoyed strong growth over an extended period. For some time, we have been expecting growth to slow due to a range of factors such as the high exchange rate and declining population growth. But activity has continued to prove stronger than expected, and stretched productive resources have caused inflation pressures to increase across a range of industries. There remain compelling reasons to expect that momentum in the economy will slow. However, improvements in global demand, rising commodity export prices, and the recent fall in the exchange rate to a less contractionary level point to stronger activity than we projected in March. Moving interest rates higher is thus appropriate to ensure that medium-term inflation remains within the target range. At this stage, further increases in interest rates look likely to be needed over the year ahead, but to a modest degree by historical standards."

China Watch:

June 11 - Bloomberg (Philip Lagerkranser and Le-Min Lim): "China's exports surged 33 percent in May as demand for clothes, computers and cell phones picked up in the U.S., Japan and Europe. Overseas sales jumped to $44.9 billion from $33.8 billion a year earlier, China's official Xinhua news agency said, citing customs bureau statistics. Last month's gain followed a 32 percent increase in April. Imports climbed 35 percent to $42.8 billion, leaving a trade surplus of $2.1 billion."

June 11 - XFN: "China's retail sales surged 17.8% year-on-year to 416.6 billion yuan in May, up from 13.2% growth in April, on the back of rising inflation and a low comparative base caused by the impact of the SARS epidemic on spending last year, the National Bureau of Statistics said. Urban retail sales rose 21.1% to 281.3 billion yuan, while rural sales rose 11.5% to 135.3 billion yuan. China's consumer price index (CPI) rose 4.4% in May from the same period a year earlier, the highest year-on-year growth in more than seven years."

June 10 - Bloomberg (Tian Ying): "Chinese car-production growth slowed in May as government curbs on lending and investment curtailed manufacturing in the world's third-largest automotive market. Car production expanded 32 percent from a year earlier, slowing from almost 44 percent growth in April..."

June 10 - Bloomberg (Philip Lagerkranser and Tian Ying): "China's industrial production growth slowed in May and money supply had its smallest gain in 1 ½ years, suggesting lending curbs are working and easing pressure on the central bank to raise interest rates. Growth in production and M2, the broadest measure of China's money supply, both slowed to 17.5 percent from 19.1 percent in April... Production growth has slowed from 23.2 percent in February."

Asia Inflation Watch:

June 7 - Bloomberg (Francisco Alcuaz Jr): "Philippine central bank Governor Rafael Buenaventura said faster-than-expected May inflation won't prompt the central bank to raise key interest rates because price increases stemmed from record crude-oil costs, which may decline and are beyond the bank's control. 'If the pressure on inflation is supply driven, increasing interest rates is not the answer,' Buenaventura said..."

June 11 - Bloomberg (Cherian Thomas and Mrinalini Datta): "India's industrial production grew at its fastest pace in four years in April as rising rural incomes and the cheapest borrowing costs in three decades spurred demand for Mauruti Udyog Ltd.'s cars and other manufactured goods. Production at factories, utilities and mines rose 9.4 percent in April, the fastest since March 2000... The median forecast of 10 analysts was for 7.5 percent growth."

June 7 - Bloomberg (Koh Chin Ling): "Taiwan's exports grew faster than expected in May, climbing to a record as electronics makers sent more components to factories in China and global demand for cell phones, flat-panel displays and laptop computers increased. Overseas sales climbed 40 percent from a year earlier to $15.7 billion after rising 23 percent in April... That beat the median 27 percent growth forecast..."

June 7 - Bloomberg (Philip Lagerkranser and Clare Cheung): "Hong Kong's retail sales rose more than expected in April, marking a ninth straight increase as falling unemployment and property price gains helped boost consumer confidence, and tourism boomed. Sales increased 23 percent from a year earlier after rising 9.4 percent in March..."

June 10 - Bloomberg (Anuchit Nguyen): "Thai tax receipts in May rose 49 percent from a year earlier as an expanding economy and higher consumer spending boosted corporate profits, personal incomes and retail sales, helping the government collect more taxes... Thailand this year may post its first budget surplus since 1996 as the expanding economy boosts consumer spending, employment and company profits."

Global Reflation Watch:

June 11 - Bloomberg (Mayumi Otsuma): "Japan needs an annual gain of 1 percent to 2 percent in the consumer price index to ensure the end of six years of deflation, said Haruhiko Kuroda, an adviser to Prime Minister Junichiro Koizumi. 'It's premature to discuss the Bank of Japan's exit' from its current easy monetary policy, Kuroda, Japan's former top currency official, said... 'To be sure, the Japanese economy is showing a strong recovery, but deflation is continuing.'"

June 9 - Bloomberg (Lily Nonomiya and Lindsay Whipp): "Japan raised its estimate for first-quarter economic growth to a 6.1 percent annual pace because companies increased inventories more than predicted to meet rising demand for cell phones, flat-panel displays and digital cameras."

June 10 - Bloomberg (Greg Quinn): "Canadian new home prices rose 5.6 percent in April from the year-ago month, the fastest pace since March 1990, as the cost of labor and materials rose."

June 8 - Bloomberg (Sam Fleming): "U.K. house prices jumped in the three months through May at the fastest annual pace since June 2003, HBOS Plc said...The average cost of a home grew 20.4 percent from a year ago to 157,849 pounds ($290,615) in May..."

June 10 - Bloomberg (Duncan Hooper): "U.K. construction orders jumped 19 percent in the three months through April from the previous quarter, bolstering the case for an increase in interest rates today."

June 9 - Bloomberg (Julia Kollewe and Sam Fleming): "U.K. manufacturing production in April increased at the fastest pace in more than 1 1/2 years..."

June 9 - Bloomberg (Sonja Dieckhoefer): "German exports rose the most in 20 months in April, as accelerating global growth led by the U.S. and Asia boosted demand for goods from Europe's biggest economy. Sales abroad, adjusted for seasonal swings, increased 5.2 percent from March, the fastest since August 2002..."

June 8 - XFN: "China's trade with the EU surged 49% year-on-year in the first four months of the year to $3.29 billion, the official Xinhua news agency reported, citing figures from Chinese customs."

June 10 - Bloomberg (Flavia Krause-Jackson): "Italy's economy returned to growth in the first quarter as consumer spending rose the most in four years, offsetting an unexpected drop in exports."

June 8 - Bloomberg (Thomas Mulier and Todd White): "Spanish home prices, which doubled in the past five years as the economy expanded, maintained their growth rate in the first quarter, defying predictions for a slowdown by institutions such as stockbroker Ibersecurities. Average prices rose 17.2 percent from a year ago..."

June 11 - Bloomberg (Andrew J. Barden): "Argentina's economy likely expanded 10 percent to 10.5 percent in the first quarter of the year, compared with the year-earlier period, La Nacion newspaper reported, citing unidentified Economy Ministry officials."

California Bubble Watch:

June 11 - Los Angeles Times (Jesus Sanchez): "Los Angeles County home prices continued to spiral up in May to record heights but sales counts weakened as mortgage rates rose, according to a real estate report today. The median sales price of all homes sold in Los Angeles County in May rose 25.9% to $394,000 - a new record, according to DataQuick... It was the 11th consecutive month that the median sales price exceeded 20% on a year-over-year basis... Condominiums posted the largest price increases in May as Los Angeles County buyers snapped the relatively affordable units. The median sales price of an existing condo soared 30.8% in May to $320,500... The median price of an existing, detached house sold in Los Angeles Los Angeles County in May hit $410,000, up 26.2% from the same month last year."

June 10 - San Diego Union-Tribune (Jenifer Goodwin): "San Diego County housing prices have reached staggering heights, minting tract-home millionaires each month. With the April median price hitting $439,000, houses appreciated $967 a day in that month - more than most people earn in a week. The unprecedented run-up in home prices has infected San Diegans with a feverish fascination. 'I am absolutely obsessed with it and most people I know are, too,' said Kevin Schugar, who owns a home in Carmel Valley worth well over $1 million. Neighbors are chatting over backyard fences about what to do with their equity and speculating how high prices can go. They're cruising Web sites such as Realtor.com and Domania.com, finding out for fun the latest astronomical asking price and how much the poor schmo down the street paid. The hottest classes at the Learning Annex, which offers adult education classes on everything from belly dancing to nonsurgical face lifts, are those that teach wanna-be investors how to make a bundle - fast! - in real estate: 'Real Estate Riches: How to Make Big $$$ With Minimal Investment,' 'How to Find Great Real Estate Deals in San Diego's Next Hot Neighborhoods,' 'Buying Fixer-Uppers. Make Big Profits - Part Time!' 'Two years ago, we had one or two pages of real estate classes,' said Rick Dilliott, operations manager at the Learning Annex. 'Now there's five or six, even some all-day events. We just keep adding classes and people just keep taking them.'"

U.S. Bubble Economy Watch:

June 8 -BusinessWire: "Unexpectedly strong job growth will buffet the impact of higher interest rates and help to push existing-home sales to a record in 2004, according to the National Association of Realtors. NAR projects existing-home sales to hit a record 6.17 million in 2004, which would be 1.2 percent higher than last years 6.10 million record. New-home sales should be essentially stable, slipping 0.4 percent to 1.08 million this year, just shy of the record 1.09 million in 2003..."

May Import Prices were up 1.6% for the month, double the consensus estimate. Year-over-year Import Prices were up 7.0%. The current pricing environment is a far cry from the y-o-y declines in import prices that our economy enjoyed during 1997 to mid-1999, and then again from early 2001 to late 2002.

U.S. Financial Sphere Bubble Watch:

Countrywide enjoyed a solid May, especially considering the rising rate environment. Average Daily Application Volume was down only 5% from April to $1.945 billion. Purchase application volume was up 5% for the month and 43% from May 2003 to a record $14.58 billion. Non-purchase (refi) volumes were down 41% from one year ago to $17.24 billion. Record Home Equity fundings of $2.27 billion were up 65% from May 2003, and record Subprime fundings were up 89% to $3.04 billion. Record adjustable-rate fundings were up 147% from a year ago to $15.75 billion. ARMs accounted for a record 49% of total fundings. "Securities trading volume at Countrywide Securities Corporation grew by 5 percent over May 2003 to $292 billion, and brought year-to-date volume to $1.3 trillion. Total assets at Countrywide Bank reached $26 billion, up $14 billion over May 2003."

Z.1 Q1 2004

How time flies... The Fed released their first quarter Z.1 "flow of funds" report on financial flows yesterday. As always, it makes for interesting perusing and contemplating. Total (financial and non-financial) Credit market debt expanded at a seasonally-adjusted $2.733 Trillion to $34.625 Trillion. Total Credit Market borrowings expanded $2.741 Trillion (8.6%) over the past year and 16% over two years. Since the beginning of 1998, Total Credit Market borrowings have surged 68% and in the process have increased from about 255% of GDP to 302%.

Total Non-Financial Credit expanded at a seasonally-adjusted annual rate of $1.927 Trillion during the quarter, trailing only last year's second-quarter borrowing surge. Non-financial debt expanded at an 8.6% rate. The last year of stronger debt growth was 1988's 9.1%. Non-financial debt expanded by 8.2% last year, 7.0% during 2002, 6.2% during 2001, 4.9% during 2000, 6.3% during 1999, and 6.8% during 1998. Examining seasonally-adjusted data, Federal Government debt expanded at an 11.6% rate, State & Local 9.6%, the Household sector 10.9%, and Business 4.1%. One can only be discouraged by the continuing surge in non-productive debt growth.

 The Household sector increased debt at a record annualized $1.008 Trillion. For comparison, this was more than double the $426.6 billion annualized increased during the first quarter of 1998. During the decade of the nineties, Household debt expanded, on average, $307 billion annually. We now surpass that amount in less than 4 months. Annual Household borrowings surpassed $400 billion for the first time during 1998.

Total Mortgage debt increased $251.3 billion ($1.01 Trillion annualized), or 10.7%, to $9.618 Trillion. Total Mortgage debt was up $1.04 Trillion over the past year (12.1%), with growth of 24% over two years and 83% over the past 25 quarters (since the beginning of 1998). Household Mortgage debt expanded at an 11.4% rate during the first quarter ($819bn annualized), 26% over two years and 85% over 25 quarters. Since the beginning of 1998, Total Mortgage debt has increased from 65% to 85% of GDP.

In an interesting development, Financial Sector borrowings slowed to a seasonally-adjusted annualized rate of 7.3%. Total GSE assets increased by only $11 billion during the quarter (1.7% annualized) to $2.825 Trillion, the smallest increase since the first quarter of 1997. This dropped year-over-year GSE growth to 8.8%. MBS expansion dropped from the fourth quarter's 14% rate to 2.4% (to $3.5 Trillion). ABS growth slumped from 8.4% to 4.0% (to $2.41 Trillion). Combined (GSE, MBS, ABS) "structured finance" expanded at 2.6% rate to $8.75 Trillion, down from the fourth quarter's 8.4% rate and the most tepid expansion since the fourth quarter of 2002.

And while the GSEs and marketable securities slowed markedly, the banking system shifted into high gear. The banks increased holdings of financial assets at a record seasonally-adjusted annual rate of $1.281 Trillion to $8.044 Trillion (1998-2003 average of $424bn). Holdings increased 11.9% annualized during the quarter and were up 8.3% y-o-y. Total Bank Credit expanded at a 12.9% rate during the quarter. For comparison, Bank Credit expanded 6.7% in 2003, 7.4% in 2002, 4.0% in 2001, 8.6% in 2000, 6.8% in 1999 and 8.2% in 1998. During the quarter, loans expanded at a 6.7% rate to $4.47 Trillion (up 6.9% y-o-y). "Government" Securities (including agencies) expanded at a 38% rate to $1.24 Trillion (up 13% y-o-y and 27% over two years). Corporate and Foreign bonds increased at a rate of 14.4% to $524.6 billion (up 14.4% y-o-y).

To finance this enormous expansion, we see that Total Deposits expanded at a 10% rate (up $113bn) during the quarter to $4.53 Trillion. "Fed Funds & Security Repo" rose at a 34% rate (up $91bn) to $1.16 Trillion. Fed Funds & Repo borrowings are up 51% over two years. For the quarter, Credit Market Instrument liabilities expanded at a 26% rate (up $42bn) to $704 billion. Credit Market borrowings were up 12% y-o-y and 25% over two years.

Banks were not alone in taking up the slack from the stagnant GSEs. Credit Unions expanded assets at an 11% rate during the quarter to $634.5 billion (up 7.7% y-o-y). REITs expanded borrowings at a 27% rate during the quarter to $307.1 billion (up 16.5% y-o-y). Finance Company asset growth slowed to a 5.4% rate, with assets ending the quarter at $1.40 Trillion (up 17.7% y-o-y). Elsewhere, Funding Corporations ("funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations) expanded holdings $42.4 billion, or 13.6% annualized, to $1.294 Trillion.

The Securities Broker/Dealers expanded assets by $111.5 billion, 28% annualized, during the quarter to a record $1.725 Trillion. Broker/Dealer assets were up $339 billion, or 25%, y-o-y (and have almost doubled since the beginning of 1999). For the quarter, the asset Security Credit expanded at a 36% rate to $199 billion, while Miscellaneous surged $87.7 billion (41% ann.) to $946.5 billion. On the liability side, Security Credit increased at a rate of 33% to a record $746.3 billion and Repos at an 18% rate to a record $498.8 billion. Repo positions are up almost 50% y-o-y.

 "Rest of World" (foreign sector) flows have become the most fascinating to follow. During the quarter, Foreign Direct Investment (FDI) increased at an abysmal seasonally-adjusted annualized rate of $2.1 billion (compared to 2000's $321bn). Meanwhile, Credit Market Instrument holdings surged at a record seasonally-adjusted $1.16 Trillion (compared to 2000's $226bn). Global dollar balances/"flows" - the residual of runaway U.S. imbalances - have become not only massive but massively distorted.

Foreign sources accumulated U.S. financial assets at a stunning pace during the quarter, expanding a record $423 billion (not annualized!) to $8.43 Trillion (a 21% growth rate). To put this number into perspective, Rest of World (ROF) Financial Assets expanded $628 billion (8.5%) during 2003, $396 billion (5.7%) during 2002, $389 billion (5.9%) during 2001, and $771 billion (13.2%) during the investment boom of 2000. Over six years, ROW holdings have ballooned 73%. And consistent with Bubble Dynamics, these holdings are now "Going Parabolic."

To make things even more interesting, foreign borrowings in the U.S. have been declining. ROW Liabilities dropped $159 billion during the quarter, or 19% annualized, to $3.255 Trillion. Institutions have likely seen the weak dollar as a good opportunity to reduce dollar liabilities. In fact, since the first quarter of 2003 ROW has reduced U.S. Liabilities by $686 billion, or 17%. And while the paydown of dollar denominated debt has lent support to our currency over the past year, our foreign Creditors' net long position in U.S. instruments has skyrocketed (not a development one would expect to mark a bear market bottom).

ROW began 1998 with a net exposure to U.S. assets of about $2.1 Trillion (assets of $4.63TN and liabilities of $2.56TN). Foreign holdings of dollar assets - our net foreign liabilities - amounted to 25% of GDP. By the end of 2001, ROW net exposure had increased to almost $3.2 Trillion (assets of $6.75TN and liabilities of $3.57TN) - almost 32% of GDP. But with dollar holdings surging (the accumulation of massive Current Account deficits) and liabilities declining, the ROW net dollar position has mushroomed. At the end of the first quarter, the Net foreign position in U.S. assets had increased to $5.17 Trillion. With asset holdings up $3.8 Trillion (82%) in 25 quarters and Liabilities up $696 billion (27%), the ROW net position in dollar assets has exploded by $3.1 Trillion, or 150%. Our net foreign liabilities have quickly jumped to 45% of GDP.

By asset category, holdings of "corporate bonds" (including ABS) jumped $64.6 billion during the quarter, or 16.7% annualized, to $1.612 Trillion. Security RPs (repurchase agreements) surged $67.7 billion, or 59% annualized. Curiously, ROW holdings of RPs ballooned from $161.5 billion to $528.0 billion over the past year. "Private" holdings of Treasuries increased $74.5 billion to $718.1 billion (also 46% annualized), while Private agency holdings jumped $62.8 billion, or 39% annualized, to $708.9 billion. "Official" (central bank) holdings of Treasuries jumped $95.5 billion during the quarter, or 46% annualized, to $934.6 billion. "Official" holdings of Treasuries and Agencies expanded an unprecedented $170.0 billion during the quarter, or 46% annualized, to $1.653 Trillion.  Over the past year, "Official" holdings were up $402.1 billion, or 32.2%.

Bloomberg's Alex Tanzi has put together a useful schedule of "international reserve assets, excluding holdings of gold, by country." The data captures the global explosion of largely dollar balances noted above. Over the past year, Worldwide central bank reserves have surged 27% to $3.249 Trillion. Of the stunning $692 billion increase, $545 billion (79%) has been accumulated by the six largest Asian central Banks. Japan's reserves have surged $273.4 billion, or 52%, to $797.2 billion. China's reserve position is up $123.8 billion, or 39%, to $439.8 billion. Taiwan's reserves are up $53.8 billion, or 31%, to $229 billion. Hong's Kong's are up $4.0 billion to $120.1 billion, while India's reserves are up $36.9 billion, or 48%, to $114.33 billion. Singapore reserves are up $15.33 billion, or 18%, y-o-y to $101.1 billion.

If we assume that foreign central bank dollar reserves have increased in the neighborhood of $650 billion over the past year, then (from the Z.1) the increase in "Official" holdings of Treasuries and Agencies of about $400 billion leaves $250 billion unexplained. And there is the intriguing $366.5 billion increase (to $528) in RPs acquired by the Rest of World over the past year. Could it be that foreign central banks are now aggressively accumulating repo positions - financing the U.S. securities repurchase agreement market?

Well, I have no idea if foreign central banks are becoming major player in the repo market, or whether or not the Federal Reserve Bank of New York is lending securities from its massive $1.22 Trillion portfolio of Treasuries and Agencies held in "custody" for foreign central banks and financial institutions. But we do know, from the New York Fed, that the size of Primary Dealer repurchase agreements has recently increased to a record $2.87 Trillion, up $461 billion (19%) from one year ago.

Chairman Greenspan Tuesday began talking a little tougher to the markets: "...the FOMC is prepared to do what is required to fulfill our obligations to achieve the maintenance of price stability..." depending on how "economic and financial forces" evolve. He also went out of his way to pronounce his belief that much of mortgage-related hedging has already been accomplished and that balance sheet adjustments and the unwind of the "carry trade" are well underway. Are these assertions credible or are we likely witnessing more Greenspan machinations?

With outstanding repo positions approaching $3 Trillion, with bank balance sheets ballooning, and with the ongoing massive GSE asset/liability mismatch and unknown speculative leveraging, it is wishful thinking at best to aver that that the system has done anything other than scratch the surface of adjusting to a rising rate environment. Then, what else could Mr. Greenspan have in mind?

Tuesday morning prior to chairman Greenspan's comments, the dollar index traded as low as 88.41, having lost about 5% of its value over the past three weeks. The euro was quickly approaching 124, with the dollar at its weakest level in over two months. And keep in mind that over this period, 10-year Treasury yields are up almost 100 basis points. Was the Fed attempting to talk up the dollar with newfound hawkishness and, at the same time, hoping to comfort the bond market with hopeful impressions that that there is in fact no mountain of hedging and speculative-related selling overhanging the bond market?

As usual, I have more questions than answers. Yet, examining a dollar chart going back to early 2002 - when the dollar index traded at 120 - puts the recent 3 month rally from 85 to 92 into proper perspective. Even in terms of what one would expect from a typical bear market rally, the dollar has been notably feeble. For some time, there had been a perception in the marketplace that the dollar would significantly benefit from the unwind of a huge short position, as well as the expectation that much of the dollar's weakness was related to interest rate differentials.

And throughout the dollar's retreat, there was a sanguine perception that the Fed had sanctioned the dollar's decline and remained in control of the process. Such perceptions and inherent optimism would today appear misplaced. There is, then, heightened possibility of one of those problematic market mood swings from "the dollar's fundamentally ok" to "oh my God, not even massive foreign central bank buying has been able to stabilize a truly sick currency."

Contemplating the most recent "flow of funds" report leaves me especially alarmed for our currency's prospects. If anything, the historic inflation of non-productive dollar claims has accelerated (govt. and mortgage debt). Of the seasonally-adjusted $1.927 Trillion of Non-financial Sector borrowings during the first quarter, the federal govt. was responsible for $466 billion, State & Local govt. $150 billion, Mortgages $1.096 Trillion, and Consumer Credit $123 billion. Not much left for true productive investment, and clearly foreign businesses have no interest in investing here. And to see the Banking sector balloon holdings of mortgages and securities at this late stage of the Credit and interest-rate cycle - while not surprising - is nonetheless disconcerting.

The key issues with regard to The Great Credit Bubble have always been the system's capacity to generate sufficient Credit to sustain both increasingly inflated asset prices and a distorted consumption-based economy. Financially, the Bubble would necessitate ongoing domestic financial sector ballooning, which would propagate ongoing current account deficits and the massive accumulation of foreign liabilities. Well, I will assume the first quarter's unprecedented bank balance sheet expansion coupled with the astounding increase in foreign holdings of U.S. marketable securities (in the face of a sinking dollar) indicate that the environment for financing The Great Credit Bubble has now taken a more challenging turn.

I believe the Greenspan Fed, while certainly never admitting as much, will in reality now be compelled by the weak dollar to more forcefully raise rates. I would further argue that systemic risk to an abrupt dollar decline is more acute today than it has been over the two year decline. And, perhaps (please excuse me for daydreaming) the Greenspan Fed has actually begun to recognize the necessity for true "tightening" - for rates high enough to meaningfully quell the massive Credit inflation that has placed our financial sector and currency on a road to ruin. The recent jump in adjustable mortgage rates would be consistent with such a strategy.

Perhaps the more "hawkish" machinations will support the dollar in the near-term. And, with a little luck, a stronger dollar, weaker commodity prices, and friendlier economic data will calm the highly leveraged and vulnerable U.S. Credit system. But there is also the scenario of a faltering dollar, rising rates, widening spreads, de-leveraging and a crisis in confidence in dollar assets that's always out there - Lying In Wait.

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