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Risk and the Dollar Carry Trade

For the week, the S&P500 declined 1.3% (up 3.7% y-t-d), and the Dow fell 1.0% (up 4.0%). The Banks added 0.5% (up0.7 %), while the Broker/Dealers slid 1.8% (down 0.2%). The Morgan Stanley Cyclicals slipped 0.5% (up 2.4%), while the Transports rallied 1.3% (up 0.4%). The Morgan Stanley Consumer index was little changed (down 0.3%), while the Utilities gained 1.8% (up 2.9%). The S&P 400 Mid-Caps dropped 1.6% (up 5.0%), and the small cap Russell 2000 sank 2.7% (up 2.5%). The Nasdaq100 fell 2.6% (up 3.7%), and the Morgan Stanley High Tech index dropped 3.6% (up 1.9%). The Semiconductors sank 6.9% (up 3.9%). The InteractiveWeek Internet index fell 2.5% (up 1.3%). The Biotechs lost 1.0% (down 1.0%). With bullion down $13, the HUI gold index sank 4.4% (down 4.3%).

One-month Treasury bill rates ended the week at 3 bps and three-month bills closed at 7 bps. Two-year government yields were down 4 bps to 0.64%. Five-year T-note yields ended the week down 13 bps to 2.055%. Ten-year yields dropped 9 bps to 3.41%. Long bond yields ended the week 5 bps lower at 4.55%. Benchmark Fannie MBS yields were 3 bps lower at 4.23%. The spread between 10-year Treasury yields and benchmark MBS yields widened 6 bps to 82 bps. Agency 10-yr debt spreads were little changed at 3 bps. The implied yield on December 2011 eurodollar futures declined 3.5 bps to 0.57%. The 10-year dollar swap spread declined one to 11.5 bps. The 30-year swap spread was unchanged at negative 23 bps. Corporate bond spreads were wider. An index of investment grade bond risk increased 2 bps to 86 bps. An index of junk bond risk rose 15 bps to 420 bps.

Investment grade debt issuers included DirecTV $4.0bn, Cisco $4.0bn, Best Buy $1.0bn, Bunge $500 million, Health Care REIT $400 million, and Medtronic $1.0bn.

Junk bond funds saw outflows of $574 million (from Lipper). Issuers included Hertz $1.0bn, Dresser-Rand Group $375 million, Headwaters $400 million, Rotech Healthcare $290 million, Eastman Kodak $250 million, Deluxe Corp $200 million, CKE Holdings $200 million, HOA Restaurant $180 million, and Bumble Bee $150 million.

Convertible debt issuers included Cemex SAB $1.4bn, WebMD $400 million, Renesola $175 million and Tivo $150 million.

International dollar debt issuers included BP $3.7bn, Ensco $2.5bn, Commonwealth Bank of Australia $2.4bn, ING $3.25bn, Dai-Ichi Mutual $1.3bn, Vodafone $1.1bn, WPE Intl $390 million, and Dexus $250 million.

U.K. 10-year gilt yields dropped 8 bps this week to 3.55% (up 16bps y-t-d), and German bund yields declined 6 bps to 3.21% (up 25bps). Ten-year Portuguese yields jumped 20 bps to 7.48% (up 86bps). Spanish yields added 4 bps to 5.41%. Irish yields jumped 26 bps to 9.49%, and Greek 10-year bond yields surged 54 bps to 12.66%. The German DAX equities index dropped 2.8% (up 1.0% y-t-d). Japanese 10-year "JGB" yields fell 5 bps to 1.245%. Japan's Nikkei sank 4.1% (up 0.2%). Emerging markets were lower. For the week, Brazil's Bovespa equities index dropped 2.0% (down 3.8%), and Mexico's Bolsa fell 2.2% (down 6.4%). South Korea's Kospi index fell 2.5% (down 4.7%). India's equities index declined 1.7% (down 11.4%). China's Shanghai Exchange slipped 0.3% (up 4.5%). Brazil's benchmark dollar bond yields fell 6 bps to 4.56%, and Mexico's benchmark bond yields declined 7 bps to 4.35%.

Freddie Mac 30-year fixed mortgage rates added one basis point last week to 4.88% (down 7bps y-o-y). Fifteen-year fixed rates were unchanged at 4.15% (down 17bps y-o-y). One-year ARMs were 2 bps lower to 3.21% (down 101bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 2 bps to 5.40% (down 42bps y-o-y).

Federal Reserve Credit jumped $28.0bn to a record $2.547 TN (18-wk gain of $266bn). Fed Credit was up $139bn y-t-d and $284bn from a year ago, or 12.6%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 3/9) rose $12.3bn to a record $3.397 TN. "Custody holdings" were up $415bn from a year ago, or 13.9%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $1.545 TN y-o-y, or 19.8%, to a record $9.365 TN.

M2 (narrow) "money" supply rose $15.9bn to a record $8.909 TN. Over the past year, "narrow money" grew 4.8%. For the week, Currency increased $3.0bn. Demand and Checkable Deposits jumped $18.1bn, and Savings Deposits added $2.4bn. Small Denominated Deposits declined $3.2bn. Retail Money Funds were down $4.4bn.

Total Money Fund assets slipped $1.4bn last week to $2.750 TN. Money Fund assets fell $340bn over the past year, or 11.0%.

Total Commercial Paper outstanding declined $1.1bn to $1.063 Trillion. CP is up $93.7bn y-t-d, although it was down $82bn, or 7.2% from a year ago.

Global Credit Market Watch:

March 10 - Financial Times (Richard Milne and Peter Wise): "The cost of borrowing for Portugal, Ireland and Greece has hit euro-era highs, amid concern in the market that European leaders will fail to take concerted action to dispel fears of sovereign defaults. The long-term market interest rate for Spain has come close to setting a record and Italy's borrowing cost rose above 5% for the first time since November 2008."

March 10 - Bloomberg (Emma Ross-Thomas): "Spain's credit rating was cut to Aa2 by Moody's... which said the cost of shoring up the banking industry will eclipse government estimates... The risks to public finances are 'skewed to the downside,' the company said... The outlook is 'negative,' suggesting more rating cuts are under consideration."

March 10 - Bloomberg: "China, America's largest creditor, should stop buying U.S. Treasuries because the 'cost' of lending to a nation that may face a default on its debt is too high, said former Chinese central bank adviser Yu Yongding... 'China has kept on lending money to the U.S. to keep its export machine going, and to prevent losses' on its holdings of Treasuries, said Yu. 'Perhaps it is too late to do anything about the existing stock without causing a serious political and financial backlash. But at least China should stop continuing building up its holdings.'"

March 7 - Bloomberg (Simon Kennedy): "Emerging-market central banks risk triggering a '1994-style' sell-off in global bonds as soon as next year if they're still tightening monetary policy when the Federal Reserve begins raising interest rates. That's the warning of JPMorgan... Chief Economist Bruce Kasman, who calculates that even with recent increases, benchmark rates in developing countries remain about 200 basis points below their 2008 average and, adjusted for inflation, will end this year near their recession lows. Underlying inflation levels also are moving higher, he finds. A reluctance to act faster means the central banks of these economies ultimately may fail to contain inflation at home while fanning it abroad..."

Muni Watch:

March 7 - Bloomberg (David Mildenberg): "Texas Republicans in the House of Representatives may vote as early as tomorrow on using $4.3 billion in reserve funds to close a deficit for the current fiscal year, according to the chamber's lead budget writer."

Global Bubble Watch:

March 11 - Bloomberg: "China's central bank considers more than consumer-price increases when making interest rate decisions, including the impact on capital flows, said Governor Zhou Xiaochuan. The People's Bank of China's desire to keep the return on deposits above the pace of inflation, ensuring positive real rates over the medium term, must be balanced with the impact higher rates have on the cost of capital and inflows of funds from overseas, Zhou said. As a result, China will at times in the short term have negative real rates as consumer-price gains outpace rate increases, he said. 'Interest rate adjustment should not only focus on consumer-price inflation,' Zhou said... 'It has many other policy targets.'"

March 8 - Financial Times (Anousha Sakoui): "Sovereign wealth funds increased their assets under management by 11% over the past year to $4,000bn, for the second year in succession... While some SWFs have suffered withdrawals, the aggregate assets under management increased from $3,590bn in 2010 to $3,980bn at the start of 2011... Ian Moore, partner at law firm Norton Rose, said the results highlighted how SWFs had made changes in their approach to investing. 'They have come out of the tough times looking robust and making a recovery that people might not have expected a couple of years ago,' said Mr Moore."

March 7 - Bloomberg (Jeff Kearns): "Global derivatives trading on exchanges rose the most since 2003 last year as volume for contracts listed to commodities surged, the World Federation of Exchanges said. Volume rose 25% to 22.4 billion contracts last year... Commodity derivatives trading rose 34%, with Chinese exchanges making up more than half of that volume... Investors are turning to exchange-listed derivatives instead of private, customized over-the-counter transactions... Futures trading increased 35% last year to 11.2 billion contracts while options trading rose 16% to 11.1 billion..."

March 7 - Bloomberg (Zachary R. Mider and Jeffrey McCracken): "The merger boom that started in 2010 isn't looking like any of the past three. The takeover binge of the 1980s was fueled by Michael Milken's junk bonds; the late- 1990s wave of Internet and telecom deals, by inflated stock prices; and the private-equity frenzy that produced a record year for deals in 2007, by leveraged loans. The more recent surge comes from the expanding BRIC economies -- Brazil, Russia, India and China -- and beyond. Deals are rising among the companies that supply raw materials to these countries. Worldwide deals in energy, power and basic materials made up about a third of the merger and acquisition market in 2010, compared with about 20% in the previous decade... Emerging-market acquisitions helped the total value of announced deals for 2010 grow 27% to $2.2 trillion, driving up advisory fees."

March 9 - Bloomberg (Sapna Maheshwari): "Leon Black's Apollo Global Management LLC and Fortress Investment Group LLC are bringing back bonds that let companies make interest payments in the form of extra debt as investors chase returns about 12 times greater than those for investment-grade securities... Sales of the bonds have more than tripled this year to $1.3 billion from $375 million in all of 2010... 'I actually thought these kinds of deals would be dead after the last meltdown because some of these PIK notes traded down to worthless,' said Marc Gross, a money manager... at RS Investments... Investors are 'going out as far as they can on the risk spectrum,' he said."

March 8 - Financial Times (Aline van Duyn): "Demand is growing for 'synthetic' financial instruments that enable investors to take positions in the US junk bond market without owning the underlying securities. The instruments, created by using credit derivatives on junk bond or high-yield indices, resemble transactions linked to US mortgages that proliferated before the financial crisis. The collapse of these synthetic mortgage-backed collateralised debt obligations when mortgages turned sour was a big feature of the crisis... Now, hedge funds are buying the riskiest parts of instruments linked to bonds. This demand reflects more bullish views on the US economy, which investors believe will translate into lower corporate defaults. 'We see much interest in synthetic high yield, more than we would have predicted just a few months ago,' said Sivan Mahadevan, managing director at Morgan Stanley."

Currency Watch:

The U.S. dollar index rallied 0.4% to 76.685 (down 3.0% y-t-d). On the upside for the week, the Mexican peso increased 0.8%, the New Zealand dollar 0.6%, the Japanese yen 0.6%, and the Swedish krona 0.2%. On the downside, the British pound declined 1.2%, the South Korean won 0.9%, the Taiwanese dollar 0.7%, the Danish krone 0.7%, the Brazilian real 0.6%, the Euro 0.6%, and the Norwegian krone 0.5%.

Commodities and Food Watch:

March 10 - Bloomberg (Isis Almeida): "The price of Colombian mild coffee soared to the highest price in almost 34 years as global stockpiles of beans dropped to the lowest levels since records began, according to the International Coffee Organization... Coffee inventories in exporting countries are 13 million bags, according to the London-based group. 'That's the lowest stocks in recorded history,' Jose Sette, head of the organization..."

The CRB index dropped 3.0% (up 5.7% y-t-d). The Goldman Sachs Commodities Index fell 2.6% (up 11.0%). Spot Gold slipped 0.9% to $1,431 (down 0.2%). Silver rallied 1.7% to $35.92 (up 16%). April Crude dropped $3.77 to $100.65 (up 10%). April Gasoline fell 2.0% (up 23%), while April Natural Gas rallied 2.4% (down 12%). May Copper dropped 5.6% (down 4.8%). May Wheat sank 13.6% (down 9.5%), and May Corn fell 8.8% (up 5.6%).

China Bubble Watch:

March 11 - Bloomberg: "China's inflation and industrial production exceeded forecasts in February, underscoring the challenge for Premier Wen Jiabao as he seeks to prevent price increases from stirring social unrest. Consumer prices rose at an annual 4.9% pace in February and output increased 14% in the first two months of 2011... Producer prices jumped 7.2% last month, the most since September 2008. Today's reports signaled the central bank's monetary tightening has been insufficient so far to contain prices, in an echo of pressures across Asia that spurred South Korea, Thailand and Vietnam to raise interest rates this week... 'Inflation risk is very high as oil prices and food costs are rising, and wages have increased substantially,' said Shen Jianguang... economist at Mizuho Securities Asia..."

March 7 - Bloomberg: "Premier Wen Jiabao's pledge to stem inflation in China underscored forecasts for more interest-rate increases as a jump in food and housing prices risks sparking public anger. Wen... said that reining in consumer and property prices is the nation's top priority. That will be welcome to fruit vendor Song Zhiqiang, 56, of the southwestern city of Guiyang, who says: 'My rent's doubled in a year and my family's food budget has increased to 3,000 yuan, 'or $456, from 1,200 yuan... Without higher deposit rates to encourage saving, and a stronger currency to ease import costs, the risk is that price pressures will keep escalating in coming months. 'The skew of risks is very much for an extended period of uncontained inflation,' said Glenn Maguire, chief Asia economist at Societe Generale ... 'The danger is that inflation spikes as high as 10% in the third quarter, causing households tremendous pain and fuelling widespread social discontent.'"

March 9 - Bloomberg: "China's passenger-car sales growth in February fell to the slowest in more than two years after the government ended vehicle-buying incentives and a week-long national holiday stymied demand. Wholesales of passenger cars... increased 2.6% from a year earlier to 967,200 units last month..."

March 9 - Bloomberg (Phoebe Sedgman): "China's milk imports from New Zealand surged more than five-fold since 2008 as rising incomes stoked demand, sending prices to a record and bolstering the economy as it recovers from the deadliest earthquake in 80 years."

Japan Watch:

March 11 - Bloomberg (Christopher Anstey and Mayumi Otsuma): "Japan's central bank pledged to ensure financial stability after the strongest earthquake in at least a century..."

March 10 - Bloomberg (Keiko Ujikane): "Japan's economy contracted more than the government initially estimated in the fourth quarter... Gross domestic product shrank at an annualized 1.3% rate in the three months ended Dec. 31..."

Asia Bubble Watch:

March 10 - Wall Street Journal (Patrick Barta): "Fears are growing that Asia's recent troubles with inflation could go deeper than initially expected as countries bump up against labor shortages and other problems commonly seen in times of too-fast growth. Inflation concerns in Asia have grown in the past few months, but have focused on rising food costs... But unease is now growing around so-called core inflation, which typically excludes volatile elements such as energy and food, and which has also been rising in much of the region."

March 10 - Bloomberg (Simon Packard): "The money earmarked for property investments in the Asia-Pacific region rose 45% in the second half as China's expanding economy made them more attractive, according to estimates compiled by DTZ Group Plc. Real-estate funds and companies had about $104 billion available for investments in the region, up from $71 billion a year earlier..."

India Watch:

March 10 - Bloomberg (Kartikay Mehrotra): "India's exports rose at a faster pace last month... supporting economic growth and providing scope for the central bank to raise interest rates. Merchandise shipments surged 49.8% to $23.6 billion in February from a year earlier... That compares with the 32.4% gain in January and would be the biggest increase in 11 months..."

March 10 - Bloomberg (Ameya Karve and Anil Varma): "Finance Minister Pranab Mukherjee's plan to raise 400 billion rupees ($9bn) from asset sales to narrow the budget deficit spurred almost $1 billion in capital inflows into India in a week, the most in two months."

March 9 - Bloomberg (Karthikeyan Sundaram and Siddharth Philip): "Car sales in India rose to a record for the second month in February... Deliveries climbed 23% to 189,008 vehicles..."

Latin America Watch:

March 7 - Bloomberg (Randy Woods and Sebastian Boyd): "Chile's economy expanded in January at the fastest pace since August as retail sales surged... The central bank's monthly Imacec indicator, a proxy for gross domestic product, increased 6.8% from a year ago..."

Unbalanced Global Economy Watch:

March 10 - Financial Times (Alan Rappeport): "The number of billionaires in leading emerging economies has surpassed the number of those in Europe for the first time and is quickly closing in on the US, according to... Forbes. The US still has the world's most billionaires with 413 individuals with a total net worth of $1,500bn. At the beginning of this year, the Brics countries- Brazil, Russia, India and China - had 301 billionaires, 108 more than in the previous year, and one more than Europe. 'The global billionaires this year reflect what's going on in the global economy,' said Steve Forbes... As the world economy recovered, the number of billionaires rose to a record 1,210 in 2011, boasting a total net worth of $4,500bn... The regional breakdown, however, reveals diverging fortunes. In Asia, the number of billionaires has nearly tripled in the past two years to 332, with 115 in mainland China alone... India's 55 billionaires have an average net worth of $4.5bn... Japan, once the economic engine of Asia, is now lagging with just 26 billionaires. Europe's fortunes are also starting to slow, with its number of billionaires overtaken by Asia for the first time in more than a decade. Booming commodity prices have helped Russian billionaires."

U.S. Bubble Economy Watch:

March 10 - Bloomberg (Shobhana Chandra): "The U.S. trade deficit widened more than forecast in January to the highest level in seven months as a surge in imports led by costlier crude oil overshadowed record exports. The gap in goods and services increased 15% to $46.3 billion, from $40.3 billion in December... Imports jumped 5.2%, the most since March 1993, while exports grew 2.7%... Imports were the highest since August 2008..."

March 10 - Bloomberg (Ashley Lutz): "When Vaughn Bullman moved to Drummer Avenue in 1961, thousands of people built cash registers at the NCR Corp. in Dayton, Ohio, and assembled cars at a General Motors Co. plant in nearby Moraine. Now, 10 of Drummer Avenue's 30 houses are empty... NCR and General Motors are gone... 'This whole street used to be full of families who owned their homes,' said Bullman... 'Today, the neighborhood is so different because there is no feel of community and no way to take pride in living here.' Dayton has 21.1% of its housing stock vacant... The city exemplifies a trend in Ohio of depopulation and de- industrialization. That means less tax revenue, fewer jobs and less political clout."

March 10 - Bloomberg (Clea Benson): "Two years ago, 97% of senior citizens who took out reverse mortgages withdrew their home equity in small amounts at variable interest rates whenever they needed some extra cash. Today, more than 70% of reverse-mortgage borrowers choose to take the maximum amount of equity out of their houses in one lump sum and pay a fixed interest rate. The dramatic shift is the outcome of federal policy changes governing the secondary market for reverse mortgages, analysts say. Federal programs have pumped new investor capital into the reverse-mortgage industry, helping lenders such as Urban Financial Group Inc. and Wells Fargo & Co. originate more loans."

March 11 - Bloomberg (Mason Levinson): "The New York Knicks said they will raise season-ticket prices by an average of 49% next National Basketball Association season, while the National Hockey League's New York Rangers will boost average seat costs by 23%."

Fiscal Watch:

March 10 - Bloomberg (Vincent Del Giudice): "The U.S. government, facing a record annual fiscal shortfall and a congressional impasse over financing, posted the largest monthly deficit ever in February, reflecting increased spending. The gap totaled $222.5 billion last month compared with a $220.9 billion shortfall in February 2010... This year's budget deficit is projected to reach $1.5 trillion... The Treasury's report today showed that government spending rose 1.4% in February to $333.2 billion and revenue and other fees increased 2.9% to $110.7 billion. Individual income tax receipts rose 26.6% to $422.8 billion on a fiscal year-to-date basis. Corporate income tax receipts fell 15.9% on a fiscal year-to-date basis..."

March 4 - Bloomberg (Eric Engleman): "The U.S. Social Security Administration's aging computer center is increasingly likely to fail and snarl the processing of thousands of applications for mortgages, credit cards and driver's licenses, officials say. The agency houses its trove of records on 460 million people, living and dead, in a 32-year-old building plagued with electrical and plumbing problems that may bring its computers to a crashing halt..."

Central Banking Watch:

March 7 - Bloomberg (Steve Matthews): "Federal Reserve Bank of Atlanta President Dennis Lockhart said the central bank shouldn't rule out asset purchases beyond the $600 billion planned by June because the U.S. economy could slow again. 'With the information I have today, my first inclination is to be very cautious about extending asset purchases after June,' Lockhart said... 'Given the emergence of new risks, however, I prefer a posture of flexibility as regards policy options.' Lockhart's comments echoed Fed Chairman Ben S. Bernanke, who told Congress last week that economic conditions continue to justify holding the central bank's target rate at near zero as well as additional monetary stimulus."

California Watch:

March 9 - Bloomberg (Michael B. Marois): "California Governor Jerry Brown's self-touted political acumen will be put the test as his plan to erase a resurgent $25.4 billion deficit goes before the state Legislature. Lawmakers... are scheduled to begin voting as early as tomorrow on his package of budget bills and companion measures that would slash spending by $12.5 billion and call a special election in June for voters to decide on extending more than $9.3 billion of tax increases..."

March 9 - Bloomberg (James Nash): "California's tax and fee collections for February fell 2.4% short of projections in Governor Jerry Brown's proposed budget... Receipts totaled $5.66 billion, or $139.4 million less than the amount forecast... California faces the biggest deficit of all U.S. states, and has the lowest credit rating. Brown proposes $12.5 billion of spending reductions and wants lawmakers to call a special election in June on extending more than $9.3 billion in higher vehicle fees, sales taxes and income-tax rates to avoid even deeper cuts. State collections for the month were 5.4% lower than a year earlier, led by a 7.1% decrease in sales taxes and an almost 50% drop in corporate taxes, Chiang said."

Speculator Watch:

March 6 - Financial Times (Peter Garnham): "Hedge funds and forex dealers are betting record amounts against the dollar, reflecting a growing belief that the US currency has lost its haven appeal and that eurozone interest rates will soon rise... Figures from the Chicago Mercantile Exchange, which are often used as a proxy for hedge fund activity, showed that short dollar positions surged from 200,564 contracts in the week ending February 22 to 281,088 on March 1. This meant that the value of bets against the dollar on the CME rose $11.5bn in the week to March 1 to $39bn, $3bn more than the previous record of $36bn in 2007."

Risk and the Dollar Carry Trade

Civil war unleashed in Libya, protests turn violent in Saudi Arabia, and deep social unrest throughout much of the Middle East. And today Japan is hit by its worst earthquake in 140 years. Here at home, ugly twin deficit news had a record $223bn federal deficit and a dismal $46.3bn trade deficit for the single month of February. And whether it is risk associated with high food and energy prices, earthquakes, flood and droughts, or financial market instability, it doesn't take much these days to entice the market into a bout of speculating on QE3. It shouldn't be all too difficult this week to convince folks that the market environment is risky.

Yet, U.S. markets have done an especially notable job of late downplaying heightened risk. Things seemed to begin to change Thursday. The broader equity market, in particular, was under significant selling pressure. At the same time, bond market Credit premiums began to rise meaningfully. MBS, municipal and investment grade corporate spreads all widened. An index of junk bond risk (CDX) jumped 12 basis points. At the same time, the dollar rallied.

I don't believe it is any coincidence that U.S. and global risk markets now trade tightly with the inverse of the dollar. This is not a new dynamic, of course. For some time now, structural dollar weakness has supported the steady (escalating?) flow of finance from the U.S. "Core" out to the "Periphery." This now fully entrenched Monetary Process has been fundamental in spurring a self-reinforcing flow of finance to the emerging markets and economies, along with driving price inflation throughout the commodities complex. The "core to periphery" dynamic has done wonders for emerging market Credit systems, powerhouses that today enjoy robustness and resilience of uncommon proportions.

As one would expect from prolonged periods of loose finance and expanding Credit, excesses and imbalances have mounted. Around the "periphery," respective booms have taken on lives of their own. Not to worry, as the probability of a (nineties-style) destabilizing flight back to the lowly dollar is perceived as slim to none.

In a world of uncertainties, I would place "the dimensions of the dollar carry trade" near the top of my wish list of things beckoning for some clarity. There is no doubt that by late-2007 enormous speculation positions against the dollar had accumulated, proceeds from "shorts" that were financing holdings of higher returning assets (emerging debt and equities, global sovereigns and corporate, leveraged loans, commodities, etc.). On the margin, liquidity emanating from these trades had become integral to overall market liquidity. To be sure, the predictability of Fed monetary policy and the attendant steep 2007 dollar decline - that persisted well into 2008 - made it too easy to garner speculative profits in non-dollar assets. And as the 2008 crisis unfolded, the unwind of bearish dollar bets - and resulting de-leveraging - were instrumental in fomenting acute illiquidity, uncertainty and fragility.

The dollar has been trending lower for much of the past 10 months. Dollar bearishness has again become prominent, underpinned by about the most dollar bearish fiscal and monetary backdrop imaginable. And not dissimilar to '07/early-'08, commodities markets have been on a run. For the most part, borrowing in dollars and lending/speculating elsewhere has provided an ongoing profit bonanza. Especially knowing that hedge fund and sovereign wealth fund assets have recovered back to record levels, it's not crazy to suspect that that the old "dollar carry trade" has re-emerged as well.

Those of the bullish persuasion have been emboldened by market resiliency. It's been a record run - and classic "climb the wall of worry" - for global risk assets. Bonds and stocks have largely disregarded rising global inflation pressures. Surging food and energy prices - with prospects for hoarding, food riots and mayhem - have been a market yawner. Middle East unrest and a brutal civil war in Libya hardly garnered a market response. Tightening measures in China and throughout Asia, along with recent hawkish talk from the ECB, captured a few headlines but little market attention. Little wonder the bulls enjoy that cozy bulletproof feeling.

As tempting as it is to bemoan the marketplace for ignoring important fundamental developments, I suspect (the big and powerful) players are instead keenly focused on crucial market dynamics. China/Asia tightening might typically be seen as a bearish development, except that moderately rising rates only strengthen the magnetic force attracting torrents of finance from the "Core" out to the vast "Periphery."

Surging commodities markets and heightened inflation would in the past have been cause for worry. Nope. Not today, as they bolster the case for shorting dollars and speculating in anything "undollar." Besides, rising commodities prices and global inflation are perceived to bolster the creditworthiness of much of the (resource rich) periphery.

Unrest, civil war and potential energy supply disruptions should promote a bad case of market angst - you'd think - except when additional uncertainty and vulnerabilities increase the probabilities for QE3 - and another round of policy-induced dollar devaluation. A tightening of monetary conditions in the Eurozone is today no cause for alarm, not if it ensures widening interest-rate differentials to the U.S. and unrelenting dollar headwinds. And a devastating quake equates with more loose money.

U.S. stocks today handily disregarded added uncertainties wrought from the devastating Japanese earthquake. And it must not have hurt sentiment that the dollar was today comfortably back in its losing ways. I've posited for a couple years now that policymaking unleashed a new Bubble. This Bubble is big and it is global, and I suspect dollar weakness and attendant speculative flows have become a force to be reckoned with. And I get especially concerned when I see speculative market dynamics trump troubling fundamental developments.

So far, 2011 has brought a few market cracks and the occasional whiff of tumult. The resources stocks were hammered to begin the year. Emerging equities have disappointed. Commodities and equities have turned increasingly volatile (i.e. crude, wheat, semiconductors...) - one could argue unstable. The respite in the European periphery debt crisis has come to an end, perhaps portending a similar circumstance for the U.S. municipal debt market. The world is, after all, not oblivious to structural debt issues. The accident in waiting - referred to generally as the "Treasury market" - is garnering increasing amounts of attention (none constructive). On a few occasions, it has seemed almost as if the leveraged players were about to find themselves on the wrong side of the markets. But throughout it all, the old stalwart weak dollar has refused to let the marketplace down. Presuming that myriad global uncertainties will not find resolution anytime soon, I'm left pondering how the markets will react when the dollar inevitably musters some sort of rally.


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