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Ebbs & Flows and Dollar Woes


Stocks were generally on the defensive, with the Dow, S&P500, and Transports declining around 1%. The Morgan Stanley Cyclical index declined 2%. The Morgan Stanley Consumer index was about unchanged, while the Utilities declined about 0.5%. The small cap Russell 2000 and S&P400 Mid-cap indices declined less than 1%. The NASDAQ100 and Morgan Stanley High Tech indices fell 1%. The volatile Semiconductors sank 4%. The Street.com Internet index was unchanged, while the NASDAQ Telecommunications index added 1%. The Biotechs posted a small decline. Financial stocks were mixed but mostly lower. The Broker/Dealers were down 2% and the Banks declined less than 1%. With bullion declining $3.90, the HUI gold index dropped 1.5%.

Weaker economic data enthralled the bond market. For the week, 2-year Treasury yields sank 20.5 basis points to 2.53%, the lowest yields in more than a month. Five-year Treasury yields dropped 23 basis points to 3.61%, the low since April 28. Ten-year yields sank 19 basis points to 4.46% (low since April 27), and long-bond yields dropped 13 basis points to 5.21% (also low since April 27). Benchmark Fannie Mae MBS yields sank 21 basis points. The spread (to 10 year Treasuries) on Fannie's 4 3/8% 2013 note narrowed 3 to 37, and the spread on Freddie's 4 ½ 2013 note narrowed 3 basis points to 36. The 10-year dollar swap spread dipped 1.25 to 48. Corporate spreads generally widened in the face of surging Treasuries, with Ford and GM bonds significantly under-performing this week. The implied yield on 3-month December Eurodollars collapsed 22.5 basis points to 2.34%.

Corporate issuance sank to $4.0 billion, with no investment grade issues sold. Junk bond funds reported inflows of $2.2 million for the week (from AMG). Junk issuance included Horizon Lines $250 million, Belden & Blake $190 million, Seitel $190 million, Allied Security $180 million, Medcath Holdings $150 million, Buhrmann Inc. $150 million, and Speedway Motorsports $100 million.

Convert issuance included Novell $500 million, Chiron $385 million Goodyear Tire $300 million, Capital Source $300 million, Four Seasons $250 million, CV Therapeutics $150 million, and Allscripts Healthcare $75 million.

Foreign dollar debt issuers included Aries Vermogens $2.4 billion, BCP Caylux Holdings $1.225 billion, and Philippines $250 million.

June 30 - Bloomberg (Terence Flanagan): "General Motors Corp. and Citigroup Inc. were among companies that sold about $121 billion of notes and bonds in the U.S. this quarter, the least since 2002, as rising interest rates reduced borrowings. Sales since the end of March are down 34 percent from the first quarter, according to data compiled by Bloomberg. The last quarter that companies sold less debt in the U.S. was the final three months of 2002, when issuance totaled $103 billion... Investment-grade corporate bonds handed investors a loss of 3.3 percent on average this quarter, the worst since the third quarter of 1981, based on Merrill Lynch & Co.'s U.S. Corporate Master Index."

Japanese 10-year JGB yields declined 4 basis points for the week to 1.79%. Brazilian benchmark bond yields sank 27 basis points to 10.60%, down 73 basis points in three weeks to the lowest yields since late April. Russian 10-year Eurobond yields dropped 13 basis points to 6.44%. Mexican govt. yields were down 17 basis points this week to 6.03%, the lowest yields since May's first session.

Freddie Mac posted 30-year fixed mortgage rates declined 4 basis points this week to 6.21% (down 11 bps in two weeks). Fifteen-year fixed mortgage rates dipped 2 basis points to 5.62%. One-year adjustable-rate mortgages could be had at 4.19%, up 6 basis points. The Mortgage Bankers Association Purchase application index declined 4% last week. Purchase applications were about unchanged from one year ago, with dollar volume up 8%. Refi applications dropped 5%. The average Purchase mortgage was for $215,700, and the average ARM was for $292,300. ARMs accounted for 33.9% of applications last week. It will be interesting to follow how applications respond to sharply lower mortgage rates.

Broad money supply (M3) declined $10.5 billion (week of June 21). Year-to-date (25 weeks), broad money is up $430 billion, or 10.1% annualized, about double the comparable period growth for 2003. For the week, Currency added $1.2 billion. Demand & Checkable Deposits rose $11.8 billion. Savings Deposits declined $16.3 billion. Saving Deposits have expanded $243.5 billion so far this year (16% annualized). Small Denominated Deposits dipped $500 million this week. Retail Money Fund deposits declined $1.1 billion. Institutional Money Fund deposits dropped $7.1 billion, while Large Denominated Deposits declined $10.7 billion. Repurchase Agreements jumped $16.9 billion (up $35bn in four weeks). Eurodollar deposits declined $4.4 billion.

ABS issuance dropped to $6 billion (from JPMorgan) this week, with y-t-d issuance of $288.5 billion 30% ahead of comparable 2003. Year-to-date Home Equity ABS issuance of $173.6 billion is running 70% above a year ago.

Bank Credit decline $16.3 billon for the week of June 23, ending four weeks of strong gains. Bank Credit has expanded $304.5 billion during the first 25 weeks of the year, or 10.2% annualized. Securities holdings added $1.3 billion. Commercial & Industrial loans gained $400 million for the week, while Real Estate loans declined $4.1 billion. Real Estate loans are up $169.8 billion y-t-d, or 15.9% annualized. Consumer loans declined $1.4 billion for the week, and Securities loans declined $10.8 billion. Other loans dipped $1.8 billion. Elsewhere, Total Commercial Paper dipped $2.7 billion to $1.321 Trillion. Financial CP added $1.5 billion, with Non-financial CP down $4.2 billion. Year-to-date, Total CP is up $52.5 billion, or 8.3% annualized.

Fed Foreign "Custody" Holdings of Treasury, Agency Debt added $1.5 billion to $1.225 Trillion. Year-to-date, Custody Holdings are up $158.7 billion, or 30% annualized.

Currency Watch:

The dollar index traded to a near one-month low after today's jobs report, ending the week down 1.2%. The euro traded above 123 today to a four-week high. The strongest currencies this week were the Turkish lira, South African rand (trading to a 4 ½ year high) and Indonesian rupiah, all up about 3%. The Brazilian real (trading to an 8-week high) and Canadian dollar gained almost 2%. The Norwegian krone dropped 1.3%, the Mexican peso 1.2%, and the Japanese yen 0.8%.

Commodities Watch:

Corn dropped to a 5-month low and Cattle futures suffered their worst week this year. For the week, the CRB index declined 1.5 % (up 5.1% y-t-d). With August crude up 84 cents to $38.39, the Goldman Sachs Commodities index added 0.5% (up 12.5% y-t-d).

Central Bank Watch:

July 2 - Market News: "'I am very concerned about the increase in inflation expectations,' (the ECB's Otmar) Issing said during a panel discussion at an ECB-sponsored conference on 'The ECB and its Watchers'. 'We have to deal with that,' he continued, stressing the importance of the ECB being 'very clear' in its commitment to keep inflation 'low, below 2%.'

China Watch:

June 30 - XFN: "China's gross domestic product (GDP) is set to grow around 9% this year, lower than 9.1% in 2003 as slower expansion in the second half counters a strong first six months, said the National Bureau of Statistics. In a report in today's Shanghai Securities News, the NBS said second half growth will slow to around 8% as the government's credit-tightening campaign cools economic expansion."

June 30 - XFN: "China's measures to cool the economy may have gone too far, a member of the monetary policy committee warned, saying that growth in money supply has been slowing down rapidly and that overcapacity is threatening major industries. In an interview...Li Yang, a member of the central bank's monetary policy committee, said government authorities are now monitoring money supply closely and would take necessary measures if growth continued to fall. 'If June and July money supply growth continues to fall, certain measures may be taken.'"

June 28 - Bloomberg (Sam Fleming): "The U.S., Germany and the U.K. claimed a smaller share of global investment flows last year, the Organisation for Economic Co-operation and Development said, as economies struggled to grow and companies pumped money into China. Foreign direct investment into the U.S. slid 44 percent to $40 billion in 2003, while flows into Germany dropped 64 percent to $12.9 billion and the U.K. got $14.6 billion, half its 2002 total, the OECD estimated. China overtook the U.S. as the biggest recipient, garnering $53 billion."

Asia Inflation Watch:

July 1 - Reuters: "Morgan Stanley, which is helping to engineer a landmark Chinese acquisition by Anheuser Busch Cos, was the top advisor for mergers announced in the first half in Asia Pacific as activity jumped 64 per cent. Regional merger and acquisition (M&A) volume, excluding Japan, rose to nearly $107.0 billion in the first half of 2004 from $65.4 billion a year ago, according to...Dealogic. Australia, with $42.3 billion of deals, and China dominated two-thirds of regional M&A volume... 'The nature of activity in China is not only growing, but it's changing,' said Gokul Laroia, head of Asia Pacific M&A for Morgan Stanley... 'Multinationals are willing to be more aggressive in how they approach transactions in China,' Laroia said. 'They are more comfortable with the country and are willing to make bigger and more public commitments.'"

July 1 - Bloomberg (Takahiko Hyuga): "Merrill Lynch & Co., the world's biggest securities firm by capital, led overseas brokerages in posting record profit in Japan, as the nation's biggest stock rally in three decades fueled more share sales and trading... Wall Street firms joined Nomura Holdings Inc. and other Japanese brokerages in boosting earnings after the Topix Index jumped 50 percent in the period. The 21 foreign brokerages operating in Japan earned a record 63.9 billion yen, rebounding from an 8 billion yen net loss a year earlier..."

July 1 - Bloomberg (Seyoon Kim): "South Korean exports surged to a record last month... Exports jumped 40 percent from a year earlier to an all-time high of $21.9 billion... Imports increased 39 percent to $18.6 billion... "

June 29 - Bloomberg (Meeyoung Song and Seyoon Kim): "South Korea's current-account surplus widened to a six-year high of $3.76 billion in May, helped by surging exports, the central bank said. That's the biggest surplus since September 1998... Central bank Governor Park Seung said in April the current-account surplus may widen to $15 billion this year, more than an earlier forecast of $6 billion."

July 1 - Bloomberg (Amit Prakash and Shanthy Nambiar): "Indonesian exports rose in May at more than twice the expected pace, helped by higher oil prices and increased shipments of coal, timber and other commodities to China and Japan. Inflation accelerated in June. Exports from Southeast Asia's biggest economy grew 11 percent from a year earlier to $5.5 billion, the Central Statistics Bureau said..."

June 28 - Bloomberg (Chan Tien Hin): "Malaysia's broadest measure of money in circulation rose at a slower pace in May after accelerating at its fastest in six years in the M3, the most closely watched measure of money supply, rose 10 percent in May previous month, the country's central bank said. from a year earlier, compared with a 10.9 percent expansion in April..."

July 1 - Bloomberg (Anuchit Nguyen): "Thailand's inflation rate rose in June at its fastest pace in more than five years as transport and production costs rose with higher prices of gasoline and other fuels. The consumer price index, which measures the cost of goods and services, rose 3 percent from a year earlier..."

June 30 - Bloomberg (Anuchit Nguyen): "Thailand's factory production growth unexpectedly slowed in May on lower sugar and latex production, the central bank said. Manufacturing production expanded 6.8 percent, after a 6.9 percent gain in April..."

June 30 - Bloomberg (Cherian Thomas): "India's economy expanded 8.2 percent in the first quarter from a year earlier, a pace beaten only by China among the world's 20 biggest economies, as rising farm incomes spurred consumer spending."

June 30 - Bloomberg (Bharat Ahluwalia and Sam Nagarajan): "India's current account surplus more than doubled to $8.7 billion in the fiscal year ended March 31, as exports of computer software grew, the central bank said..."

Global Reflation Watch:

June 30 - Reuters: "Worldwide stock and bond underwriting totaled $1.29 trillion (for the quarter), down 10 percent from a year earlier, Thomson data show. For the year, volume is up 5 percent to $2.99 trillion. Reported fees, meanwhile, totaled $3.28 billion, down 33 percent from the first quarter's $4.86 billion, and down 17 percent from a year earlier. Year-to-date fees totaled $8.21 billion, up 15 percent from a year earlier."

July 1 - Dow Jones: "Debt issuance from governments and companies in emerging markets rose 30% in the first half of 2004 from a year earlier... Data service group Dealogic reported that international issuance in emerging markets reached $77.7 billion in the first six months, up from $596 billion a year earlier. In total, 1,123 debt issues were carried out in the first half of 2004, compared with 871 deals in the year-earlier period. However, issuance declined to $33.6 billion in the second quarter from $44.1 billion in the first three months."

July 1 - Bloomberg (Lily Nonomiya): "Japanese manufacturing executives are the most confident since the nation's asset-price bubble burst in 1991, amid surging demand for their products from the U.S. and China, the Bank of Japan's Tankan quarterly survey showed. The index of confidence among large manufacturers rose to 22 in June from 12 in March."

June 30 - Bloomberg (Julia Kollewe): "The U.K.'s economy expanded at the fastest annual pace in 3 1/2 years in the first quarter and more than previously reported during much of last year, strengthening the case for higher interest rates. Real gross domestic product grew 3.4 percent from a year ago in the first three months of the year, more than the previous estimate of 3 percent..."

June 29 - Market News: "Home construction in France continued booming in May as housing permits posted a 23.2% rise on the year, while starts were up 27.5%, according to non-seasonally adjusted data released Tuesday by the Construction Ministry."

June 29 - Bloomberg (Simon Packard): "French manufacturers' confidence climbed in June, matching April's three-year high, as executives said in a survey they expect to lift production amid rising exports and declining inventories."

June 29 - Bloomberg (Jeffrey T. Lewis): "Consumer prices in Spain rose at the fastest pace in 14 months in June from a year earlier, according to a preliminary estimate released by the National Statistics Institute. The increase of 3.5 percent compares with a rise of 3.4 percent in May..."

July 1 - Bloomberg (Fergal O'Brien): "The Irish economy expanded at the strongest annual pace in more than a year in the first quarter as consumers spent more and overseas demand improved. Gross domestic product rose 6.1 percent from a year earlier after expanding 5.1 percent in the previous three months..."

June 29 - Bloomberg (Victoria Batchelor): "Australian exports rose to a 16-month
high in May
, spurred by stronger Chinese and global demand for commodities such as metals, meat, and coal."

July 1 - Bloomberg (Mark Bentley and Ben Holland): "Turkey's exports jumped 40 percent in June from a year earlier, the Turkish Exporters' Association said... Exports of $5.3 billion in the month brought the total for the first half of the year to $29.3 billion, an increase of 37 percent from a year earlier..."

June 30 - Bloomberg (Ben Holland): "Turkey's gross national product, the country's main indicator of economic output, surged 12.4 percent in the first quarter, exceeding economists' forecasts. GNP was expected to expand 8.0 percent..."

July 1 - Dow Jones: "Brazil posted a $3.81 billion trade surplus in June - its biggest monthly trade surplus ever - as a cheap currency fueled exports and import substitution, Trade Minister Luiz Furlan said... The result topped May's $3.1 billion trade surplus, which had marked a new monthly record, and left the trade surplus since Jan. 1 at $15.1 billion. Brazil is expected to post a $27 billion trade surplus this year to exceed last year's $24.8 billion record."

July 1 - Bloomberg (Romina Nicaretta): "Brazil's economy will probably grow more than 4 percent in 2004, Development and Trade Minister Luiz Fernando Furlan said."

Mortgage Finance Bubble Watch:

Freddie Mac finally released 2003 financial data. For the year, the company earned $4.891 billion, down from 2002's huge $10.1 billion, yet still up significantly from 2001's $3.323 billion and 2000's $2.539 billion. Total Assets ended the year at $803.5 billion, up about 7% during the year. Shamefully, the company announced that it would not be releasing 2004 earnings reports until March 31, 2005.

July 1 - Boston Globe (Thomas C. Palmer Jr.): "Rising interest rates are bound to hurt home prices in Boston: It's just a question of how much. Home prices in the area have risen 64.4 percent over the past five years, among the steepest increases anywhere in the country. Last year alone, for instance, prices rose 8.4 percent."

May Construction Spending was up 9.7% y-o-y to a record $988.5 billion annualized. Private spending was up 10.7% y-o-y, and Public was up 6.6%. Construction spending is up 10% annualized y-t-d. Residential Construction was up 15.3% y-o-y and 28% over two years. Office Construction spending was up 12.8% y-o-y, Highway/Street 15.9% and Health Care 9.8%, while Lodging was down 17.5% and both Commercial and Educational were unchanged.

From Merrill Lynch: "We estimate U.S. [commercial mortgage-backed securities] (excluding Agency and resecuritization deals) will total just north of $43 billion as we close out the first half (25% more than last year's pace)."

U.S. Bubble Economy Watch:

June 30 - Bloomberg (Eddie Baeb): "California, New York and Illinois are among seven U.S. states without budgets even as tax revenue rises above forecasts with the improving economy, leaving most states with surpluses on the last day of their fiscal year. The three states, with 67 million people or almost one in four U.S. residents, face total deficits of $19 billion for the 2005 fiscal year. State deficits peaked at $94 billion in February 2003 with 33 states projecting spending gaps, according to the National Conference of State Legislatures. 'The fiscal crisis is over,' said Scott Pattison, executive director of the...National Association of State Budget Officers.... State tax revenue rose 8.1 percent in the first quarter of 2004, the fastest pace since 2000, according to the Nelson A. Rockefeller Institute of Government... Thirty-two states predict that they will end their fiscal year with surpluses totaling $6.4 billion..."

June 29 - Business Wire: "Wholesale dollar sales of all boats were up 20.8 percent in the first quarter 2004 compared to the same period last year, according to data from the National Marine Manufacturers Association (NMMA). The trade association, which represents companies that manufacture an estimated 80 percent of marine products used in North America, also said that unit shipments through March are up 19.8 percent compared to the first quarter of 2003."

July 1 - Dow Jones: "Government-backed student loan rates are at historic lows Thursday as new rates from the U.S. Department of Education take effect. For borrowers with Stafford loans issued since July 1998, the interest rate for the coming year is 3.37%, down from 3.42% during the previous year. The new rate is at the lowest point in nearly 35 years, the Department of Education said. For borrowers who are still in school, within a six-month grace period or with deferred loans, the new rate is 2.77%."

Personal Income data does not receive the attention they deserve. Personal Income rose a stronger-than-expected 0.6% during May. Personal Income was up 5.8% y-o-y (the same as April) to the highest level since December 2000. Year-to-date, Personal Income is on pace to expand $630 billion (6.7%), which would compare to 2003's increase of $429 billion (4.8%), 2002's $206 billion (2.3%), 2001's $213 billion (2.5%) and 2000's high water mark $501 billion (6.2%). Disposable Income was up 6.4% y-o-y, while growing at a 7.8% annualized rate over the first five months of the year (which would be the strongest since 1992). Disposable Income is on track to expand $652 billion, which would compare to 2003's $447 billion (5.6%), 2002's $404 billion (5.4%), 2001's $238 billion (3.3%), and 2000's $405 billion (5.9%).

And for those of us comparing and contrasting today's environment to that from 1994, it is worth noting that Disposable Income expanded 3.1% during 1993 and 3.4% during 1994. Last month, Personal Spending jumped 1%, the strongest rise since October 2001. Spending was up 6.7% y-o-y, the strongest increase since October 2000.

U.S. Financial Sphere Bubble Watch:

From Bloomberg: "After a traditionally quiet first quarter, second quarter activity picked up over 118%, leading to $590.3 billion in proceeds being raised year to date. This represents a 40.4% increase over the $420.5 billion issued during 2003-H1."

June 28 - Bloomberg (Ed Leefeldt): "Bank of America Corp. arranged the most high-risk, high-yield loans in the U.S. in the first half as its takeover of FleetBoston Financial Corp. helped the bank surpass J.P. Morgan Chase & Co... Loans to companies without investment-grade credit ratings comprise a third of the U.S. market for syndicated lending this year, up from about a quarter in the year-earlier period. Banks arranged $161.3 billion of U.S. leveraged loans, which are usually sold in pieces to money managers, in the first half - 69 percent more than in January-June of last year, Bloomberg data show."

June 30 - Reuters: "U.S. asset-backed securities issuance in the first half of 2004 increased by more than 30 percent from a year ago, driven by a supply surge in the home equity sector. New supply of asset-backed bonds totaled $381 billion for the first half of 2004, up from $288.3 billion during the same period a year ago, Thomson Financial said on Wednesday... Home equity borrowing has bucked the trend, helped by healthy home appreciation and ongoing growth of the subprime sector... This flood of home equity loans made by a fledging segment of independent lenders has found its way to the ABS market. ABS issuance hit a record in the second quarter, totaling $194.8 billion... Countrywide Securities Corp....was the top underwriter of U.S. asset-backed securities for first six months... For the first half, Countrywide's investment banking arm arranged 37 ABS deals worth $37.3 billion, equivalent to a 9.8 percent market share..."

June 30 - Reuters: "Issuance of all federal credit agency debt fell to $571.2 billion in this year's first half from $673.6 billion in the same period a year earlier, according to Thomson Financial, as negative portfolio growth decreased the need for agencies to issue debt... Banks have been heavy buyers of mortgage assets this year. With a lull in commercial lending and a steep yield curve, that makes it attractive to borrow at cheap short-term rates and invest in longer-term higher-yielding assets. That bank buying made mortgage securities expensive to purchase. The agencies slowed their investment portfolios as a result, and thus needed to issue less long-dated agency debt to fund such purchases."

June 30 - Reuters: "U.S. mortgage-backed securities issuance fell sharply during the first half of 2004 from a year ago on falling loan demand due to rising interest rates, Thomson Financial said... The supply of new mortgage-backed securities totaled $359.7 billion for the first half of 2004, down from $534.5 billion for the same period a year earlier, the financial data firm said."

June 30 - Reuters: "U.S. corporate bond issuance fell in the first half of the year, as rising bond yields dampened the appetite of companies to borrow, according to data (from) Thomson Financial. Investment grade issuance fell to $327 billion in the first half from $356 billion in the year-ago period. Convertible issuance fell almost 50 percent to $31 billion in the first half, from $60 billion in the same period in 2003. High-yield issuance bucked the trend of other markets and rose to $73.9 billion in the first half from $66 billion a year ago..."

July 1 - Reuters: "The Chicago Board of Trade's three-month streak of futures and options trading volume records was snapped in June... Derivatives turnover on the No. 2 U.S. futures exchange grew 21 percent from a year ago, but the increase was the smallest for the year to date. The CBOT traded 49.7 million contracts for the month, down from the record 55.1 million in May. Year-to-date volume is running 40 percent above 2003."

July 1 - Market News: "The Chicago Mercantile Exchange Inc. Thursday said overall exchangewide volume was up fractionally in June led by an increase in volume in foreign exchange and interest rate products while equity futures and options volume was down. The CME traded a total of 70,318,385 contracts in June...up 10.5% from a year-ago figures. Year-over-year volume is up 25.2%."

Ebbs & Flows and Dollar Woes:

There is, understandably, much focus these days on the intricacies of U.S. economic data. The bears now have some data points to rally around, especially June's sagging auto sales, weaker low-end retailing, less robust factory orders, and one month of reduced job creation. The bulls have plenty to hang their sanguine hats on, including record home sales and construction, strong factory output, booming exports, a generally robust global economy, low rates, and heady income growth.

My analytical framework continues to dictate that I tread cautiously when it comes to writing off the U.S. Bubble economy. The Credit system and Mortgage Finance Bubbles are running at full throttle and Credit Availability remains ultra-easy. Key sectors of the economy are demonstrating strong inflationary biases. My sense is that - despite all the focus and pontification - the U.S. economy is not THE story right now. The financial markets still call the shots - the "horse" pulling the economic "cart."

For some time, any ebbing of economic activity would immediately incite an exaggerated flow of enthusiasm throughout the interest-rate markets. This dynamic has certainly been fostered by the huge (and expanding) leveraged speculating community and their proclivity to aggressively play the steep yield curve, as well as by enormous derivative (trend-reinforcing) hedging strategies. More recently, weak data hits the dollar, eliciting expectations of foreign central bank Treasury purchases.

The marketplace has accurately assumed that the Greenspan Fed would err on the side of aggressive accommodation. As such, seemingly any data providing our central bank an excuse to stick with the status quo have only heightened preoccupation with "carry trades" and leveraged speculation. Such dynamics have created what I refer to as a strong "inflationary bias" in the U.S. (and now global) Credit market. This environment, then, plays an instrumental role in financing the booming and distorted U.S. Bubble economy, as well fueling global growth more generally.

I have waited intently for this "inflationary bias" to wane and have watched central banks respond aggressively to counteract any such development. I expected that a weaker dollar, along with the attendant commencement of foreign-sourced liquidation of U.S. securities, would have by now provided a catalyst. Unprecedented central bank dollar and Treasury purchases worked instead to reinforce this inflationary bias. And with strong economic growth, escalating U.S. imbalances, surging commodities, booming housing markets, and rising general price pressures, one would have presumed that market expectations for a wearisome Fed tightening cycle would have by now quelled the Credit system's "animal spirits." This dynamic was in play one year ago but was squelched by the Fed.

The Fed's unusual efforts to communicate ongoing "TTL" (Transparent Tightening Lite) accommodation - and to entice with ongoing speculative profits - have similarly worked to reinforce the markets' inflationary bias. Our central bank and its foreign (largely Asian) counterparts - with there extraordinary market interventions and manipulations - have orchestrated a rather perverse outcome from the perspective of traditional monetary management. In stark contrast to 1994, market participants are convinced that Fed rate increases will be capped at a very low level, despite much stronger inflationary pressures and truly unparalleled imbalances.

Ten-year government yields are down 35 basis points over the past three weeks to 4.46%. Emerging market currencies and debt markets have rallied. Benchmark Fannie MBS yields are down 38 basis points to the lowest level since April 27. Once again, incipient indications of ebbing economic expansion evoke a hyper market reaction, ensuring unending excess flows right to the Mortgage Finance Bubble. We therefore should hold off numbering the final days of the U.S. Bubble economy. This will change when weaker data do not incite bond market rallies, or when some type of financial dislocation impinges marketplace liquidity and Credit Availability. There is, at this stage of the cycle, a fine line between ebbing economic expansion and the lingering flow of Credit Bubble Nirvana.

At this time, the weight of evidence strongly supports that worst-case scenario of prolonged systemic Credit inflation, endemic leveraged speculation, runway mortgage finance excess and massive external deficits. As one would expect, there continues to be some ebb and flow associated with both economic activity and marketplace perceptions. Recently, sentiment has shifted to expectations for softer U.S. growth, a harder Chinese economic landing, and some ebbing in global demand for energy and commodities. Attention is today focused on U.S. interest-rates and the American and Chinese economies as the key risks to sustained global expansion. I believe the near-term risks associated with these two Bubble economies are exaggerated, while I continue to be intrigued by the general complacency with regard to U.S. imbalances and the vulnerable U.S. dollar.

Today from Market News: "If left unchecked, the U.S. current deficit could impose 'considerable costs' to the U.S. and global economies, including higher interest rates, ECB Chief Economist Otmar Issing said Friday. Moreover, the risk of an adjustment of this global imbalance in a 'disorderly fashion with disruptions' will rise the longer it takes for it to be addressed, Issing warned... And failure to address the current account shortfall could lead to protectionist pressures because of misallocation of global savings, he added. The large purchases of U.S. Treasury securities by China to defend its exchange rate peg to the U.S. dollar may decrease the risks from the U.S. deficit in short-term but may increase them in the longer term, Issing said."

Dr. Issing comments, as quoted by Bloomberg: "There is a risk that an adjustment may take place in a disorderly fashion." "The crucial choice is not between correction or no correction, but between correction sooner rather than later." On U.S. deficits and the global economy: The "deterioration in the U.S. budget position, if left unchecked, may impact considerable costs on the U.S. and the global economy in the medium term by bringing about a global increase in long-term interest rates." On global money supply: Issing said he sees 'signs of global excess liquidity.' He said it is 'uncertain' how this liquidity will be used."

Perhaps it was only coincidence that Dr. Issing's comments came after a significant decline in U.S. market rates and renewed dollar weakness. U.S. rates had been rising since late-March, a development that had worked to stabilize the value of our currency. I would envisage that Dr. Issing had hoped that rising U.S. yields signaled the onset of some degree of Credit system restraint, a necessary first step in inhibiting runaway U.S. imbalances. However, market dynamics - the powerful inflationary bias in the U.S. bond market and Credit system - are proving, to this point, the nemesis of any orderly adjustment process. I can appreciate Dr. Issing's apprehension.

It seems like a lot of things have been biding time over the past six months - the economy, the markets, politicians, geopolitics and the dollar. Some things will be "resolved" during what will surely be an exciting and challenging second-half. Commodity prices, after posting impressive gains over the preceding two years, have been in a mild "ebbing" posture over the past few months. The dollar has been the mirror image - a most tepid "flowing." Perhaps commodities have traded at their highs and the dollar at its low, but for the life of me I cannot convince myself of the analytical merits supporting the Pollyannaish consensus view.

It is certainly reasonable to contemplate the possibility that the commodities bull and the dollar bear have yet to run their courses. I suspect that a renewed dollar decline could prove surprisingly problematic - perhaps providing a seminal development with respect to global financial market and economic stability. The marketplace is much too complacent considering the scope of the dollar problem and the risks involved.

Much of the 2002/2003 dollar decline corresponded with a general backdrop of global deflationary concerns. As such, global central bankers likely perceived much to gain versus the minimal risk associated with large-scale dollar support/monetization. In concert, global central bank purchases amounted to the greatest global "reflation" the world has ever experienced. Invariably, the initial effects of inflation are seemingly positive and benign. Inflation is, however, seductively problematic. How to administer the demanded ongoing inflationary stimulus without augmenting price distortions and exacerbating Monetary Instability?

Foreign central bank interventions averted a dollar collapse. Their massive buying provided the liquidity necessary to maintain the perception of dollar soundness, while preserving the viability of the currency derivatives marketplace. But, in the process, the massive monetization radically altered the global inflationary landscape. An inflationary boom enveloped Asia and, especially, China. And, more importantly, these interventions sustained the U.S. Credit Bubble and bolstered the Mortgage Finance Bubble. The consequences include unrelenting massive Credit inflation and greater U.S. imbalances, including current account deficits approaching $600 billion ("as far as the eye can see").

Renewed dollar weakness at this point would test global central bankers' mettle. And perhaps the recent ebb in commodity prices and Chinese growth would provide some degree of assurance that continued dollar support does not pose an inflationary risk. But it may not take long for a faltering dollar to incite another bout of global commodities buyers' panic. My wild imagination also conjures thoughts of another round of fervid speculative flows to "un-dollar" markets and asset classes across the globe.

Such a liquidity deluge could be expected to impose disparate - perhaps even radically divergent - inflationary effects in today's "inflationary" environment as compared to the previous "dis/de-flationary" global backdrop. A weak dollar and rampant global over-liquidity would certainly complicate Chinese efforts to cool an overheated economy (and allay global inflationary pressures). How would global - Asian in particular - central bankers respond to a faltering dollar in the face of a conspicuous inflationary threat? Monetize an additional $600 to $800 billion? What if they don't?

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