The stock market enjoyed broad-based gains. For the week, the Dow gained almost 2% and the S&P500 added better than 1%. Economically sensitive stocks performed well, with the Morgan Stanley Cyclical index up 3% and the Transports up 2%. The Utilities added 2%, while the Morgan Stanley Consumer index posted a small gain. The broader market rose, with the small cap Russell 2000 gaining 2% and the S&P400 Mid-cap index up 1%. Technology stocks rallied, with the NASDAQ100 and Morgan Stanley High Tech indices up 2%. The Semiconductors rose 3%, and The Street.com Internet index added 2.5%. The NASDAQ Telecom index was notable for its lackluster performance, ending the week about unchanged. The Biotechs jumped 4%, recovering some of recent poor performance. The financial stocks were mixed, with the Broker/Dealers up 2% and the Banks gaining about 0.5%. Although Bullion was down $9.10, the HUI gold index managed a 3% gain for the week.

Interest-rate markets were quite volatile. For the week, 2-year Treasury yields gained 3 basis points to 2.68%. Five-year Treasury yields rose 2 basis points to 3.69%. Ten-year yields increased 4 basis points to 4.47%. Long-bond yields ended the week at 5.20%, up 3 basis points on the week. Benchmark Fannie Mae MBS yields gained only 2 basis points. The spread (to 10-year Treasuries) on Fannie's 4 3/8% 2013 note narrowed 1 to 37, and the spread on Freddie's 4 ½ 2013 note narrowed 1 to 36. The 10-year dollar swap spread increased 0.5 to 48.75. Corporate bond spreads were generally little changed on the week, although AT&T spreads widened up to 40 basis points after Moody's downgraded the company's debt to junk status. The implied yield on 3-month December Eurodollars dipped 3.5 basis points to 2.36%.

Corporate debt issuance totaled a slow $7.0 billion (from Bloomberg). Investment grade issuers included Encana $1.0 billion, Washington Mutual $750 million, Marshall & Ilsley $600 million, Hertz $500 million, Lear $400 million, HRPT Properties $400 million, Host Marriott $350 million, CSX $300 million, Archstone-Smith Trust $300 million, and Wisconsin Power & Light $100 million.

Junk bond funds reported outflows of $358 million for the week (from AMG). Junk issuance included Panamsat $1.0 billion, Smithfield Foods $400 million, and Chesapeake Energy $300 million.

Convert Issuance Century Aluminum $150 million and Titan International $115 million.

Foreign dollar debt issuers included Ukraine $500 million.

Japanese 10-year JGB yields gained 4.5 basis points for the week to 1.85%. Brazilian benchmark bond yields declined 11 basis points to 10.49%. Mexican govt. yields dipped 2 basis points this week to 5.80%. Russian 10-year Eurobond yields rose 7 basis points to 6.60%. According to Emerging Portfolio.com, emerging bond funds received their first positive inflows this week after 11 weeks of outflows.

Freddie Mac posted 30-year fixed mortgage rates jumped 10 basis points this week to 6.08%, abruptly ending five weeks of declining rates. Fifteen-year fixed mortgage rates rose 10 basis points to 5.49%, the highest level in four weeks. One-year adjustable-rate mortgages could be had at 4.17%, up 5 basis points last week and 15 basis points over two weeks. The Mortgage Bankers Association Purchase application index added 1% last week. Purchase applications were up 4% compared to a strong year ago period, with dollar volume up 15.5%. Refi applications were about unchanged. The average Purchase mortgage was for $215,800, and the average ARM was $289,000. ARMs accounted for 33.3% of applications last week.

Broad money supply (M3) expanded $21 billion (week of July 19). Year-to-date (29 weeks), broad money is up $448.4 billion, or 9.5% annualized. For the week, Currency added $0.5 billion. Demand & Checkable Deposits gained $5.8 billion. Savings Deposits dipped $1.5 billion. Saving Deposits have expanded $277.5 billion so far this year (15.8% annualized). Small Denominated Deposits added $0.9 billion. Retail Money Fund deposits declined $7.5 billion. Institutional Money Fund deposits gained $8.1 billion. Large Denominated Deposits rose $10.8 billion (up $31.8 billion in four weeks) to $1.04 Trillion, with y-t-d gains of $174.8 billion (36% annualized). Repurchase Agreements dipped $0.4 billion. Eurodollar deposits added $4.1 billion.

Bank Credit added $0.4 billon for the week of July 21. Bank Credit has expanded $301.4 billion during the first 29 weeks of the year, or 8.6% annualized. Securities holdings rose $8.4 billion. Commercial & Industrial loans gained $3.9 billion, while Real Estate loans declined $6.7 billion. Real Estate loans are up $178.7 billion y-t-d, or 14.4% annualized. Consumer loans increased $2.1 billion for the week, while Securities loans declined $7.4 billion. Other loans were about unchanged. Elsewhere, Total Commercial Paper rose $6.7 billion (up $29.9 billion in three weeks) to $1.352 Trillion, the highest level since July 2003. Financial CP gained $3.2 billion, with Non-financial CP up $3.6 billion (up $16.4 billion in four weeks). Year-to-date, Total CP is up $83.0 billion, or 11.3% annualized, with Non-financial CP up $26.0 billion, or 41.7% annualized.

ABS issuance totaled $10.0 billion (from JPMorgan) this week, with y-t-d issuance of $344.4 billion 37% ahead of comparable 2003. Year-to-date Home Equity ABS issuance of $207.4 billion is running 76% above a year ago.

Fed Foreign "Custody" Holdings of Treasury, Agency Debt rose $687 million to $1.239 Trillion. Year-to-date, Custody Holdings are up $172.7 billion, or 28% annualized. For comparison, Federal Reserve Credit has expanded $5.7 billion so far this year, or 1.3% annualized, to $752.2 billion.

Currency Watch:

This week the yen weakened to a two-month low against the dollar. The dollar index gained 0.7%. Latin American currencies were generally notable for their strong performance.

Commodities Watch:

July 27 - Bloomberg (Stephen Voss): "New York Mercantile Exchange oil-trading rights are worth 18 percent more than a membership in the New York Stock Exchange, as surging energy prices boost investor interest and trading volume rises to a record. A full Nymex membership seat, enabling the holder to buy and sell contracts such as crude oil on the trading floor, last sold on May 7 for a record $1.65 million, according to Nymex, with the latest bid at $1.66 million. An NYSE seat last sold for $1.4 million on July 8, down 47 percent from an August 1999 peak of $2.65 million."

July 27 - Dow Jones (James Covert): "Safeway Inc. said sales recently have 'plateaued' after improving for months in the aftermath of a California grocery strike, and that sales have slowed partly because of price inflation on meat and dairy products... 'extraordinary' inflation on meat and dairy products continues to dog the company, with prices on some goods surging more than 50%. While Safeway has protected its profits by increasing prices accordingly, those price increases have had a 'dampening effect' on sales, Burd said. 'The inflation is not causing us to lose profits,' (CEO Steven) Burd said. 'The inflation is impacting top-line sales growth.'"

July 28 - Bloomberg (Claudia Carpenter): "Copper prices in New York had their biggest gain in five months amid forecasts that supplies this year won't keep up with growing global demand... Phelps Dodge Corp., the world's second-biggest copper producer, said yesterday that global demand will exceed supply from mines and scrap yards by as much as 700,000 metric tons this year. That's up from a forecast of 600,000 tons in April."

July 27 - Bloomberg (Simon Casey): "Copper prices will average 54 percent higher in 2004 compared with last year because of expanding demand in China, the world's biggest consumer, said Natexis Metals."

July 30 - Bloomberg (Mark Shenk): "Crude oil rose to a record in New York for the second time this week on concern that supply from the world's top exporters will be disrupted as fuel consumption surges... 'There is not much more productive capacity left in the world,' said Michael Fitzpatrick, a broker with Fimat USA Inc...'Unless the U.S., EU, and the Chinese economies cool considerably we may soon run into capacity constraints.'"

Weak soybean and grain markets pressured the CRB. For the week, the CRB index dipped 0.9%, with y-t-d gains of 4.9%. But with September crude surging $2.09 to a record $43.80, the Goldman Sachs Commodities index added 2.1% (up 18% y-t-d).

China Watch:

July 26 - Bloomberg (Samuel Shen): "China's home prices rose 10.4 percent in the second quarter from a year ago, more than double the 4.8 percent pace in the first three months, as the government curbed real estate loans and usage, cutting supply. Shanghai led the increase, with home prices climbing 21.4 percent from April through June, followed by the neighboring city of Ningbo, where prices expanded 19.9 percent..."

July 28 - Bloomberg (Jianguo Jiang): "China predicts retail sales growth will pick up this year as incomes climb in the world's fastest-growing major economy. Sales will probably rise 10.5 percent to more than 5 trillion yuan ($604 billion) after increasing 9.1 percent in 2003, the Beijing-based commerce ministry said..."

July 26 - Bloomberg (Philip Lagerkranser): "Hong Kong's export growth picked up in June as the city's ports handled more components bound for China and Chinese-made toys, clothes and computers en route to the U.S., Europe and Japan. Shipments, most of which are made in China, rose 18 percent from a year earlier... Surging trade with China, the world's seventh-largest economy, is spurring investment and hiring in Hong Kong, where unemployment is at a two-year low."

July 29 - Bloomberg (Ravil Shirodkar): "China imported 2.08 million tons of flat steel products in June, or 35 percent less than a year ago, Tex Report said, citing data from China's General Administration of Customs. China's steel imports fell 7.5 percent to 15.5 million in the January-to-June period from a year ago..."

July 29 - Bloomberg (Allen T. Cheng): "The People's Bank of China said it will spend 100 billion yuan ($12.9 billion) bailing out the nation's agricultural credit cooperatives freeing them to make more loans which will help increase rural consumer spending."

Asia Inflation Watch:

July 27 - Bloomberg (Theresa Tang): "Taiwan bank lending rose 9.1 percent in June, slowing for the first time since September, as lower-than-expected export growth cooled demand for funds for investment."

July 29 - Bloomberg (Seyoon Kim): "South Korean industrial production unexpectedly fell in June for the first time in three months as chipmakers cut output on concern industry demand will slow. Production dropped a seasonally adjusted 2 percent from the previous month after rising 1.9 percent in May..."

July 27 - Bloomberg (Anuchit Nguyen): "Thailand's exports in June rose 28 percent from a year earlier on rising sales of automobiles, rubber, rice and other products, the commerce ministry said. Exports last month amounted to $8.47 billion, a record for any month, from $6.62 billion in the same month a year earlier, the ministry said in a statement. Imports rose 41 percent to $8.23 billion, also a monthly record."

July 28 - Bloomberg (Laurent Malespine): "Thailand's commerce ministry raised its export growth forecast for the year, for the second time in two months, after surging overseas sales of rice, electrical appliances and automobiles helped exports rise to a record in June. The ministry estimates overseas sales will rise 20 percent to $96 billion..."

July 27 - Bloomberg (Francisco Alcuaz Jr.): "The Philippine economy probably expanded more than 6 percent in the second quarter, putting it on course to achieve the government's target of as much as 5.8 percent growth in 2004, Economic Planning Secretary Romulo Neri said."

July 27 - Bloomberg (Khoo Hsu Chuang): "Malaysia's automotive association raised its 2004 forecast after vehicle sales in June rose 37 percent to the highest this year as faster economic growth boosted demand."

Global Reflation Watch:

July 28 - Reuters: "Global air passenger traffic rose over 20 percent in the first half of this year as travel recovered from the effects of an economic downturn and the SARS virus in Asia, an airline industry group said Wednesday. The outlook for the full year was also bright, with the Geneva-based International Air Transport Association (IATA) forecasting double-digit growth in international air passenger traffic for the year as a whole."

July 29 - Bloomberg (Sam Fleming): "U.K. house-price inflation accelerated in July to the fastest annual pace since May of last year, indicating that four interest rates increases since November have failed to damp demand for property. House prices gained an annual 20.3 percent in July..."

July 27 - Bloomberg (Sam Fleming): "U.K. home-loan approvals rose in June compared with the same month a year earlier, the British Bankers' Association said, suggesting borrowing costs at a 2 1/2 year high haven't curbed demand for credit. The number of mortgages approved rose 4 percent to 87,310 from June last year. The value of those approvals jumped 23 percent from a year ago"

July 27 - Bloomberg (Andreas Cremer): "German economic growth may accelerate to the fastest pace in five years in 2005 as exports start fueling consumer demand and spur companies to resume hiring, government adviser Wolfgang Wiegard said."

July 27 - Bloomberg (Francois de Beaupuy): "French housing starts rose 17.2 percent in the second quarter from a year earlier as the lowest benchmark interest rates in almost six decades stoked demand. Building work began on 31,030 homes last month, the Paris-based Housing Ministry said. That brought total housing starts in the three-month period to 91,055. Housing permits, a barometer of future demand, rose 30 percent in the same period a year ago."

July 28 - Bloomberg (Francois de Beaupuy): "French manufacturers' confidence rose in July to the highest in more than three years, buoyed by rising consumer spending and growing exports."

July 29 - Bloomberg (Francois de Beaupuy): "Optimism among executives of French service companies increased to a 3 1/2-year high in July as rising consumer spending and exports boosted demand, a quarterly government survey showed."

July 30 - Bloomberg (Tracy Withers): "New Zealand home-building approvals rose 32 percent to a record in June, buoyed by apartment construction that suggests the central bank's interest-rate increases this year aren't slowing the housing market."

July 27 - Bloomberg (Tracy Withers): "New Zealand's annual trade deficit unexpectedly widened in June amid rising oil prices and consumer spending that boosted monthly imports to the highest since October 2002... In June, imports rose 24 percent from a year earlier to NZ$3.1 billion. Crude oil imports were 70 percent higher than a year earlier as prices rose... Exports rose 20 percent in June from the year earlier after rising commodity prices and a lower New Zealand dollar."

July 27 - Bloomberg (Romina Nicaretta and Carlos Caminada): "Brazilian bank lending surged for a fifth month in June as consumers tapped lower-cost financing to fund purchases of goods such as cars and refrigerators. Outstanding loans, excluding state banks, rose 1.3 percent to 266 billion ($87 billion) from 262 billion in May, the central bank said."

July 28 - Bloomberg (Heather Walsh): "Chilean manufacturing production in June had its longest stretch of expansion in almost four years after textile companies and bottle makers geared up to meet rising demand abroad and at home. Output rose 5.1 percent in June from a year earlier, expanding for an 11th month..."

California Bubble Watch:

The historic California Housing Bubble runs unabated. Statewide median prices rose another $5,480 during June to a record $469,170. Unit sales were up 10.8% compared to the year ago period. Median prices were up a staggering $94,630 over twelve months, or 25.3%. Year-to-date, prices are up $64,650, or 32% annualized. Prices were up $144,530 (45%) over two years; $202,240 (76%) over three years; and $260,170 (124%) over six years. Statewide condo median prices were up $8,700 during June to a record $375,260. Prices were up 30.1% over one year, 55% over two years, 79% over three years and 142% over six years. Notable region y-o-y price gains include Los Angeles up 31.6%, Orange County $37.2%, San Diego 38.5%, Riverside/San Bernardino 37.1%, Ventura 37.2%, Palm Spring/Lower Desert 34.8%, High Desert 46.4%, Monterey County 36.6%, Santa Barbara County 46.9%,Sacramento 27.6%, and Northern California 21.7%. The inventory of homes available for sale remains quite low at 2.6 months.

U.S. Bubble Economy Watch:

July 29 - Financial Times (Dan Roberts): "Executive pay in the US is rising faster than previously thought, according to a new analysis which includes the value of cashed-in stock options. Total compensation for chief executives at the top 500 companies rose 22.2 per cent in 2003, double the rise in the previous year, says the Corporate Library, an independent research firm."

"Beginning at 12:01 a.m. on August 1, 2004 tolls will increase on the Pennsylvania Turnpike. The tolls for passenger vehicles will increase 1.8 cents per mile (44%) from the current rate of 4.1 cents per mile to a new rate of 5.9 cents per mile. Commercial vehicles would see an average increase of 5.3 cents per mile. The increase matches the rate of inflation over the 13 years since the last hike in 1991." (A little inflation catch-up?)

June inbound containers into the ports of Long Beach and Los Angeles were up a combined 19% from one year ago to 601,377. Outbound containers were up 7% to 171,928. Containers leaving empty were up 17% from June 2003 to 332,874.

Mortgage Finance Bubble Watch:

July 26 - "Just like June's temperatures, Florida's housing market blazed red-hot and set a record pace for the month. Statewide sales of existing single-family homes rose 31 percent with a total of 26,791 homes sold compared to 20,428 homes a year ago, according to the Florida Association of Realtors (FAR). Realtors in many markets across Florida report that the supply of homes for sale is extremely tight, demand remains high and prices are rising. Despite modest increases, interest rates remained favorably low in June, which likely contributed to the low inventory of available homes in many areas... The statewide median sales price rose 19 percent to $189,700 last month; a year ago, it was $159,800. In June 1999, Florida's median sales price was $105,200...resulting in an increase of 80.3 percent over the five-year period."

July 26 - "The surge in Illinois home sales continues as sales of existing, single-family homes in June increased 15.3 percent to 14,608 homes sold, according to the Illinois Association of Realtors... The statewide median cost of an existing, single-family home in June rose 8.1 percent to $198,500... Year-to-date sales (January through June) show a healthy increase of 7.2 percent to 59,770... There were a total of 6,197 condominium sales in Illinois this June, up 26.8 percent... The statewide condominium median price was $192,700, up 8.2 percent.... 'Statewide, home sales were red hot in the first summer month of 2004. The moderate rise in interest rates spurred home-buying substantially in June,' said John C. Kmiecik, CRB, president of the Illinois Association of Realtors. 'We do not expect to see a significant slowing of the economy and the variety of mortgage options should forestall any dramatic impact higher interest rates may have on home-buying decisions..."

Housing markets are on fire across the nation. June Existing Home sales jumped to a record 6.95 million annual rate. To put this number into some perspective, it is more than double the 3.19 million homes sold during 1991, and is almost 60% higher than "pre-Bubble" 1997's 4.38 million. Average June (mean) prices rose to a record $245,400, up 9.9% from June 2003. Average Prices rose to records in the Northeast (up 10.7% y-o-y to $263,500), Midwest (up 7.1% to $193,400), South (up 12.3% to $231,800), and West (up 9.2% to $317,800). Sales gains are similarly broad-based: up 14.5% y-o-y in Northeast, 13.4% in the Midwest, 21.1% in the South, and 28.0% in the West. Nationally, Sales Volume was up 17.4%, with annualized Calculated Transaction Value (CTV) up 29% y-o-y to $1.71 Trillion. CTV is 51% over two years (Prices up 16% and Volume up 29%), 68% over three years (Prices up 28% and Volume up 31%), and 110% over six years (Prices up 49% and Volume up 41%). Year-to-date, Existing Home Sales are running almost 11% ahead of last year's record pace. The Supply of Homes Available for Sale declined to 4.1 months, the lowest since December 2001.

New Homes Sold at a stronger-than-expected annualized rate of 1.326 million units during June, only slightly below May's all-time record. This compares to the 698,300 average annual new home sales during the nineties. Average (mean) Prices were up 9.5% y-o-y to $262,400. Median Prices were up 11.7% y-o-y to $209,900.

Combined Exiting and New Home Sales rose to a record 8.276 million annualized pace, up 16.3% from last year's record pace. This compares to the average rate of 4.41 million during the first eight years of the nineties (nineties avg. of 4.72 million). Combined Existing and New annualized Calculated Transaction Value jumped to a record $2.05 Trillion during June. This was up 27.7% y-o-y, 52% over two years, 71% over three years and 114% over six years. These numbers rather succinctly illuminate the dimensions of the Great Mortgage Finance Bubble.

Mortgage bank IndyMac reported earnings of $55 million, up 34% from the year ago period. Mortgage originations of $9.4 billion were up 36% from the first quarter and were 18% above the second quarter of 2003. Total Assets expanded by $1.0 billion, or 28% annualized, to $15.5 billion. Assets were up 45% y-o-y and have more than doubled over two years.

Trouble at the Core:

This is an exceptionally challenging analytical environment. The U.S. economy has somewhat decelerated. But what was the impact - and will it prove temporary - of virtually the entire country fearing a spike in mortgage borrowing costs as the Fed raised rates for the first time in awhile back in June? There are specific reasons to be extra cautious when it comes to forecasting an imminent economic downturn. It would be quite unusual for a Bubble Economy to falter with housing sales and prices at record levels, record mortgage Credit creation, robust federal and state spending, strong (inflation-induced) profits and income growth, a booming export sector, a generally robust global economy, low global interest rates and generally profligate Credit Availability and liquidity conditions. It would not, however, be unusual for such conditions to hasten financial crisis.

For some time now, I have read analysis attempting to call the top in the housing market. Some ascribe recent housing strength to a final rush by buyers to beat higher mortgage rates. Perhaps there is merit to such a view, but it nonetheless disregards key dynamics that are in play. Over the past six years, historic inflation has re-priced virtually the entire nation's housing stock. Price gains have accelerated significantly ("blow-off") during the past two years of Fed-orchestrated reflation. And the bottom line is that we now have tens of millions of homeowners with substantial and growing "equity" in their residences. Tens of thousands are regularly extracting record amounts through home-equity borrowings. Meanwhile, untold millions have and will continue to use this perceived windfall to take on additional debt and purchase that larger home (in that appealing neighborhood!) they have always dreamt about. This is a very powerful dynamic, at least until the liquidity spigot falters.

When it comes to the housing markets, we must continually remind ourselves that Bubble Dynamics have taken firm grip. In these most uncertain times, housing has attained the coveted status of the perceived absolute best investment - of all-time - ensuring both safety and strong returns (not to mention tax-breaks, comfort and the status of ownership). I would argue that the all-embracing nature of this manic conviction is unparalleled. Furthermore, aggressive financial innovation has assured, to this point, an unending flow of cheap finance. Indeed - and as our Federal Reserve officials should have learned several years ago - the capacity of contemporary finance to rise to the occasion and finance run-away Asset Bubbles creates an especially dangerous environment. And I do appreciate that this line of analysis is a reiteration and obvious to many, but it is worth again recalling that NASDAQ went to unbelievable extremes and then doubled (in self-destructing excess) in less than a year.

I also read that the American consumer is "tapped out," but does such an assertion make sense when the median home price in California is up almost $65,000 since the beginning of the year? Perceived gains in household home equity continue to rise much more quickly than surging debt levels. And I remain of the view that, with current market dynamics, any soft economic data will incite lower rates. These lower rates would then exacerbate the Mortgage Finance Bubble and stimulate the U.S. Bubble Economy.

At this point, I am not tempted to back away from my contention that the financial markets are the driving force dictating the performance of the economy. So, are there indications that the financial markets are stumbling and vulnerable? Well, I think there are. The U.S. stock market has clearly lost its momentum, with some players bloodied by the technology sell-off. Others have been stung in the interest-rate markets. And, importantly, there are indications that the tide has turned on the Leveraged Speculating Community. This is a development we must monitor closely.

July 28 - Bloomberg: "Shares in Man Group Plc, the world's largest publicly traded hedge fund company, and smaller manager RAB Capital Plc dropped on concern about the outlook for the industry. Man Group's stock fell as much as 5 percent and RAB Capital, which today called the second quarter 'disappointing' when posting an increase in first-half earnings, slumped 12 percent. 'It's been a torrid time for hedge funds, especially in the second quarter,' said Tejinder Randhawa, an analyst at Evolution Beeson Gregory in London. RAB Capital have 'given no real idea of the outlook and it's difficult to know how to forecast it.' Rising bond yields and oil prices have been hurting the $850 billion hedge fund industry, with the average fund falling about 1 percent in the period... Man Group's biggest hedge funds are struggling because of losses from investments in stock and commodity futures. Ten of the 11 biggest funds run by the London-based Man Group, the world's largest publicly traded hedge fund manager, declined in the first half of 2004...The $1.8 billion AHL Diversified fund, which uses computers to invest in the futures markets, fell 9.9 percent in the six-month period."

July 30 - Reuters: "Deutsche Bank AG, Germany's biggest bank, reported a 30 percent decline in quarterly profits due to dwindling trading income at its core investment bank, missing analysts' expectations." "Market 'corrections' also impacted the bank's hedge fund operations..."

I don't want to get all carried away here. After all, the major indices of hedge fund performance do not indicate much cause for concern, although paltry y-t-d returns are poised to disappoint overly-optimistic investors. Some funds and proprietary trading desks have suffered losses in a market environment that has become a lot less hospitable. Importantly, the Great Reflation Trade - that for some time provided as sure a bet as speculators could ever have wished for - is today anything but a sure thing. Players have been roughed up in volatile global interest-rates, equities, currencies, and commodities, after pocketing handsome profits during 18 months of "one way" markets. The risk of rising rates is significant, with unstable currency markets providing only more uncertainty. And with the conclusion of accommodating one-directional markets, comes the breaking of ranks by the speculators. No longer will everyone choose to all crowd comfortably together on the long side (stocks, bond, commodities, and currencies). This has significant consequences for what has been a long spell of leveraged buying fostering bullish global liquidity dynamics.

Some may be tempted to compare today's environment with that which unfolded with the Russian collapse and faltering hedge funds during the summer of 1998. I just don't, today, buy the comparison. It is worth noting that the Goldman Sachs Commodities index was at about 150 (and declining) when the Russian crisis broke in August 1998, about half of today's level. Crude was trading at about $14. A lengthy list of economies and currencies were struggling and vulnerable after the 1997 S.E. Asia domino collapse. The general environment back in 1998, especially for the emerging markets, was one of a troubling combination of a weak global pricing environment coupled with outflows of speculative (and investor) finance. Central bank currency reserves were generally small and shrinking. The dollar had trended higher since 1995, with monthly U.S. trade deficits averaging about $14 billion.

In some ways, the current environment is the mirror image of 1998. Today, most global central banks are awash with currency reserves, as monthly U.S. trade deficits approach an astonishing $50 billion. Global trade flows are these days a dominant liquidity mechanism, in contrast to the speculative flows that left emerging economies and financial systems so vulnerable during the nineties. Not that speculative flows are insignificant today, but trade flows have ballooned with massive U.S. current account deficits. There is, as well, an inflationary bias in global commodities markets unlike anything experienced in years. Case in point is the role oil and commodity inflation has played of late in Russia. Despite troubling business and political developments, along with a banking crisis, Russia's foreign currency reserves ended June up 15% y-t-d to a record $84.5 billion. This is not 1998 (when reserves dropped 40% to $7.8 billion).

So my sense is that it is not a valuable use of our analytical efforts today to craft scenarios of global currency contagion collapses and economic dislocation. At the same time, I in no way want to dismiss the possibility that we are in the initial stage of what could be some very serious developments for "speculative finance." I continue to believe it is a very valuable exercise to contemplate ramifications for a faltering global leveraged speculating community.

Generally, one would look for weakness and faltering liquidity conditions to manifest first at the "periphery." Credit Bubble analysis dictates that, during periods of heightened systemic stress, the marginal borrower and risk-taking lender are the first impacted. But I would posit that, from a global perspective, there has never been a comparable circumstance where such dangerous and unmanageable liquidity excess originates from "The Core" (the U.S. - and, more specifically, mortgage finance). And as much as I fret when writing "this time it's different," my analysis forces me to one conclusion: This time stress may not show first at the periphery, but instead manifest as Trouble at the Core. Monetary Disorder, at this point, continues to spew liquidity at the periphery.

Analyzing The Core's vulnerabilities, two especially stand out. First, the dollar is an accident in wait, as I have addressed ad nauseam. The second is the massive "carry trade," especially shorting Treasuries to take leveraged positions in mortgage-related instruments and securities. In theory, this trade should be relatively "safe," with Treasury and mortgage yields moving in conjunction. But no theory would have incorporated today's confluence of complexities, market distortions, gross excesses and various susceptibilities.

Extreme mortgage Credit excess ensures an endless supply of mortgage paper to be financed. There is, however, some limit to the amount of Treasuries to sell (although borrowing and shorting securities increases the "float" in the marketplace) and, one would expect, speculative demand. And there is, as well, massive and growing interest-rate exposure to be hedged in the market, also entailing shorting Treasuries and other securities. Between the "carry trade" and hedging programs, the amount of Treasury shorting is truly massive. Derivative hedging strategies also dictate enormous trend-following trading, adding one more dimension to an uncertain market environment. And, to top it off, foreign central bank dollar support and Treasury purchases have become a major factor in the marketplace. In combination, this market has many dimensions with all the requisite characteristics for acute fragility.

Inherent marketplace instability and vulnerability can remain dormant for years, only to be roused by sometimes subtle changes in the environment. Today, there is a confluence of developments that is more than subtle. First of all, market volatility that causes minimal hindrance when players are sporting solid returns and confidence turns increasingly disruptive and disconcerting when performance and confidence falter. Second, with Fed funds at 1.25%, the market must grapple on a daily basis with the reality that rates will likely be moving significantly higher. Third, the leveraged players have been stung by difficult conditions in various markets. And with surging industry inflows and a mushrooming number of funds, the leveraged speculating community as a whole is now vulnerable to the downside of Bubble dynamics. Fourth, mortgage finance excesses have gone to problematic "blow-off" extremes. Too much mortgage Credit of increasingly suspect quality must be financed by highly leveraged players and institutions, with the entire Bubble vulnerable to any moderation of lending or speculative leveraging. And, fifth, the global inflationary backdrop (and almost $44 crude!) is not necessarily the most comforting environment for holders of long-term bonds.

There is today, however, little indication of heightened stress with regard to the Great Mortgage Spread Trade. Still, the environment is demonstrating many characteristics of NASDAQ 1999 - where runaway excesses and myriad distortions set the stage for the imminent bursting of the Bubble. Over the coming weeks, expect discernable indications of Trouble at the Core. But I also want to warn that I believe we have likely entered a period that will be marked by exceptional volatility in global equity, bond, currency and commodities markets. The leveraged players are on edge and markets should be expected to trade accordingly. Prices may, at times, be more determined by trading dynamics than fundamentals. Be careful out there.