For the week, the S&P500 dropped 2.4% (up 3.4% y-t-d), and the Dow fell 2.4% (up 5.0%). The broader market was weak. The S&P 400 Mid-Caps fell 3.0% (up 6.0%), and the small cap Russell 2000 dropped 3.5% (up 3.1%). The Morgan Stanley Cyclicals fell 4.0% (down 0.6%), and the Transports declined 3.6% (up 2.2%). The Morgan Stanley Consumer index lost 3.6% (up 0.6%), and the Utilities declined 1.4% (up 4.4%). The Banks were hit for 4.3% (down 8.7%), and the Broker/Dealers sank 4.4% (down 9.6%). The Nasdaq100 declined 1.9% (up 3.4%), and the Morgan Stanley High Tech index fell 3.0% (down 0.5%). The Semiconductors were down 3.5% (up 1.6%). The InteractiveWeek Internet index lost 2.4% (up 0.7%). The Biotechs added 0.5% (up 13.2%). Although bullion was up $6, the HUI gold index declined 2.4% (down 6.3%).

One-month Treasury bill rates ended the week at 2.5 bps and three-month bills closed at 3 bps. Two-year government yields declined 5 bps to 0.42%. Five-year T-note yields ended the week down 10 bps to 1.60%. Ten-year yields dropped 8 bps to 2.99%. Long bond yields declined 2 bps to 4.23%. Benchmark Fannie MBS yields declined 5 bps to 3.89%. The spread between 10-year Treasury yields and benchmark MBS yields widened 3 to 90 bps. Agency 10-yr debt spreads were little changed at negative 4 bps. The implied yield on December 2011 eurodollar futures was little changed at 0.395%. The 10-year dollar swap spread increased 2.75 to 12.5 bps. The 30-year swap spread declined one to negative 26 bps. Corporate bond spreads were wider. An index of investment grade bond risk rose 4 bps to 95 bps. An index of junk bond risk jumped 21 bps to 474 bps.

Debt issuance slowed during a holiday-shortened week. Investment-grade issuers included Applied Materials $1.75bn, John Deere $850 million, Union Bank $700 million, Camden Properties $500 million, Coventry Health Care million $600 million, Whirlpool $300 million, and Airgas $250 million.

Junk bond funds saw outflows of $237 million (from Lipper). Junk issuers included Vulcan Materials $1.1bn, AES Corp $1.0bn, W & T Offshore $600 million, Puget Energy $500 million, Southern Natural Gas $300 million, Cinemark $200 million, Sunstate $170 million and International Wire Group $100 million.

I saw no converts issued.

International dollar bond issuers included ING $2.5bn and Asian Development Bank $1.5bn.

U.K. 10-year gilt yields slipped one basis point this week to 3.28% (down 23bps y-t-d), while German bund yields rose 7 bps to 3.06% (up 10bps). On the back of an agreement for additional Eurozone and IMF assistance, two-year Greek yields sank 245 bps this week to 22.17%. However, Greek 10-year bond yields declined only 48 bps to 15.74% (up 328bps). Spain's 10-year yields declined 9 bps to 5.22% (down 22bps). Ten-year Portuguese yields rose 23 bps to 9.59% (up 301bps). Irish yields declined 27 bps to 10.58% (up 153bps). The German DAX equities index slipped 0.8% (up 2.8% y-t-d). Japanese 10-year "JGB" yields added a basis point to 1.135% (up 1bps). Japan's Nikkei slipped 0.3% (down 7.2%). Emerging markets were resilient. For the week, Brazil's Bovespa equities was little changed (down 7.2%), while Mexico's Bolsa dropped 1.9% (down 8.9%). South Korea's Kospi index gained 0.6% (up 3.0%). India's equities index rose 0.6% (down 10.4%). China's Shanghai Exchange increased 0.7% (down 2.9%). Brazil's benchmark dollar bond yields dropped 8 bps to 4.16%, and Mexico's benchmark bond yields fell 9 bps to 3.99%.

Freddie Mac 30-year fixed mortgage rates declined 5 bps to a 26-wk low 4.55% (down 24bps y-o-y). Fifteen-year fixed rates declined 4 bps to 3.74 (down 46bps y-o-y). One-year ARMs were up 2 bps to 3.13% (down 82bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 4 bps to 5.04% (down 63bps y-o-y).

Federal Reserve Credit jumped $20.1bn to a record $2.771 TN (30-wk gain of $490bn). Fed Credit was up $363bn y-t-d and $451bn from a year ago, or 17.8%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 6/1) declined $9.7bn to $3.432 TN. "Custody holdings" were up $82bn y-t-d and $357bn from a year ago, or 11.6%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $1.491 TN y-o-y, or 17.8%, to a record $9.858 TN. Over two years, reserves were $3.116 TN higher, for 47% growth.

M2 (narrow) "money" supply increased $10.4bn surpassing $9.00 TN for the first time. "Narrow money" has expanded at a 4.8% pace y-t-d and 4.8% over the past year. For the week, Currency increased $0.4bn. Demand and Checkable Deposits jumped $17.2bn, while Savings Deposits dipped $2.6bn. Small Denominated Deposits declined $4.3bn. Retail Money Funds slipped $0.2bn.

Total Money Fund assets sank $21.9bn last week to $2.726 TN. Money Fund assets were down $84bn y-t-d, with a decline of $114bn over the past year, or 4.0%.

Total Commercial Paper outstanding slipped $1.2bn to $1.197 Trillion. CP was up $228bn y-t-d, or 46% annualized, with a one-year rise of $134bn.

Global Credit Market Watch:

June 3 - Bloomberg (John Glover and Emma Charlton): "Greek bondholders may be about to receive an offer they can't refuse. The European Central Bank was said to back a plan this week to persuade investors to replace maturing Greek bonds with new, longer-dated securities. The idea is modelled on the Vienna Initiative for eastern Europe in 2009. Greece, which faces a 30 billion-euro ($43bn) funding gap next year, is locked out of markets. Its 10-year bonds yield more than 16%."

May 31 - Bloomberg (Zeke Faux): "Bond sales from the U.S. to Europe to Asia soared in May, propelled by speculative-grade companies taking advantage of borrowing costs at historic lows to issue a record amount of dollar-denominated debt. EchoStar... led $382.8 billion of global issuance, a 47% increase from April when offerings reached $261.3 billion... U.S. junk-bond sales of $44.5 billion were almost triple the five-year monthly average, as yields fell to a record low 7.19% on May 19... Investors poured $43.7 billion into bond funds this quarter, exceeding inflows in the three months ended in March of $31.7 billion, according to EPFR Global..."

June 3 - Bloomberg (Sapna Maheshwari and Zeke Faux): "Borrowers are selling the most long-maturity dollar-denominated corporate bonds in three years as a slowing global economy pushes yields on the debt to the lowest level since November. Caterpillar... led issuers selling $21.3 billion of investment-grade bonds due in more than 10 years last month..."

June 2 - Bloomberg (John Fraher): "Greece's risk of default was raised to 50% by Moody's... as European officials rushed to put together the second bailout plan in two years to stave off renewed financial turmoil in the region. Moody's downgraded Greece to Caa1 from B1, putting it on a par with Cuba... The move came after policy makers considered asking investors to reinvest in new Greek debt when existing bonds mature."

June 1 - Bloomberg (Lisa Abramowicz): "Prices of loans to high-yield, high- risk borrowers fell the most in almost a year last month as signs emerged that the U.S. economy is decelerating. The Standard & Poor's/LSTA U.S. Leveraged Loan 100 index decreased 0.7% to 95.17 cents..."

Global Bubble Watch:

June 3 - Bloomberg (Jonathan Stearns and Maria Petrakis): "European Union and International Monetary Fund officials agreed to pay the next installment to Greece under last year's 110 billion-euro ($161bn) bailout, paving the way for an upgraded aid package that includes a 'voluntary' role for investors."

May 31 - Reuters (Benjamin Kang Lim and Kevin Yao): "China's regulators plan to shift 2-3 trillion yuan ($308-463bn) of debt off local governments, sources said, reducing the risk of a wave of defaults that would threaten the stability of the world's second-biggest economy. The plan is the first concrete move by the government to tackle the bad debt in local government financing vehicles. It could boost investor confidence in Chinese banks, which provided many of their loans as part of the massive economic stimulus program launched by Beijing in late 2008... That program resulted in unfettered lending to local government financing vehicles, hybrid government-company bodies that governments used to get around official borrowing restrictions... Beijing has determined from a months' long investigation that local governments have borrowed around 10 trillion yuan, said one of the sources. The governments may default on around 2 trillion yuan of loans, the Chinese media have reported."

June 2 - Bloomberg (Katrina Nicholas): "Investors outside Hong Kong are being lured to so-called dim sum bonds in greater numbers, drawn by a pickup in higher-yielding issues and prospects for yuan appreciation. Global funds accounted for 3% to 5% of sales in the 'early stages' of the market, which started in 2008, and their share increased to about 15% in recent deals, said Becky Liu, a credit strategist at HSBC... The funds are expected to account for as much as half of trading in the securities by the end of this year, up from 25% now, according to... Deutsche Bank AG."

May 31 - Bloomberg (Boris Korby): "Brazilian companies... are selling the most overseas bonds in four months, taking advantage of the lowest borrowing costs since November to finance infrastructure spending. This month's offerings of $9.46 billion are the most since companies issued $10.5 billion in January, which was the highest monthly figure since Bloomberg began tracking the data in 1999. U.S. high-yield bond sales climbed to a record $44.5 billion while offerings from Mexico were the most in 11 months."

June 2 - Bloomberg (Belinda Cao and Andres R. Martinez): "A rally in the Mexican peso and inflation near a five-year low are luring a record amount of foreign investment into the country's bond market. International investors bought $21 billion of Mexican debt denominated in pesos in the six months through March, the most since the central bank began compiling the data in the 1960s."

June 1 - Bloomberg (Anoop Agrawal): "India will allow its companies to increase their borrowing from abroad by 50% this year as rupee funding costs spiral and higher interest rates slow the second-fastest growing major economy. The cap on foreign-currency debt that firms can raise in a year will increase to a record $30 billion..."

Currency Watch:

The U.S. dollar index dropped 1.6% to 73.78 (down 6.6% y-t-d). For the week on the upside, the South African rand increased 3.2%, the Danish krone 2.2%, the euro 2.2%, the Swiss franc 1.9%, the Norwegian krone 1.8%, the Swedish krona 1.4%, the Brazilian real 1.2%, the Japanese yen 0.6%, the Singapore dollar 0.6%, the Taiwanese dollar 0.6%, the South Korean won 0.2%, and the Australian dollar 0.1%. On the downside, the Mexican peso declined 0.5%, the British pound 0.5%, the New Zealand dollar 0.4%, and the Canadian dollar 0.2%.

Commodities and Food Watch:

The CRB index gained 0.7% (up 4.8% y-t-d). The Goldman Sachs Commodities Index added 0.2% (up 10.8%). Spot Gold increased 0.4% to $1,542 (up 8.5%). Silver dropped 4.4% to $36.19 (up 17%). July Crude slipped 37 cents to $100.22 (up 10%). July Gasoline declined 1.3% (up 22%), while July Natural Gas rose 4.2% (up 7%). July Copper was down 1.2% (down 7%). July Wheat dropped 5.6% (down 2.6%), and July Corn slipped 0.6% (up 20%).

China Bubble Watch:

June 1 - Bloomberg: "China's home prices rose for the ninth straight month in May as smaller cities withstood government efforts to curb risks of asset bubbles, according to SouFun Holdings Ltd. Home prices gained 0.5% in May from April... Residential prices increased in 76 out of 100 cities tracked by SouFun, with average home values nationwide climbing to 8,819 yuan ($1,361) a square meter (10.76 square feet)."

June 2 - Bloomberg: "China's central bank urged 'paying attention' to the credit risks of local-government financing vehicles because their debts have long maturities and are difficult to oversee. Some companies set up by provincial and municipal governments to fund infrastructure projects are unsustainable, the People's Bank of China said... The loans are 'generally large, with long maturities, and it is difficult to oversee their use,' the central bank said. China is increasing scrutiny of local-government borrowing to fund the construction of roads, airports and other infrastructure because of the risk of banks being saddled with bad loans. Local governments, barred from selling bonds or borrowing directly from banks, had set up more than 10,000 financing vehicles by the end of 2010 to raise money, mostly for infrastructure, the central bank said."

June 2 - Bloomberg: "China's plan to rein in property prices with a record homebuilding program may worsen local debt risks even as it proves a boon to companies from domestic cement makers to Chilean copper exporters. Premier Wen Jiabao aims to build 36 million low-cost homes by 2015, an initiative that will see 2 trillion yuan ($307bn) added to local government borrowing by 2012, bringing it to a total 12 trillion yuan, Standard Chartered Plc estimates. The surge of loans to local authorities may spark a wave of bank bailouts that hobble economic growth. 'We're going to see more financial shenanigans, we're going to see more money pushed off balance sheets' as banks seek to mask the extent of their lending to local governments, said... Fraser Howie, who co-wrote 'Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise,' and has been an investment banker in Asia for almost two decades."

June 3 - New York Times (Ian Johnson): "China's three decades of rapid economic growth have left it with a 'very grave' environmental situation even as it tries to move away from a develop-at-all-costs strategy, senior government officials said... In a blunt assessment of the problems facing the world's most populous country, officials from China's Ministry of Environmental Protection delivered their 2010 annual report."

June 1 - Bloomberg (Frederik Balfour): "China has more than a million millionaires as economic growth, savings and a strengthening currency helped swell their ranks by 262,000 last year, according to a Boston Consulting Group survey. Millionaire households jumped 31% in 2010 from the previous year to 1.11 million..."

June 2 - Bloomberg (Frederik Balfour): "Christie's International set a record of HK$3.65 billion ($470 million) for a series of Hong Kong auctions last night as Chinese bidders battled for items from their heritage. The figure would have been higher had an 18th-century Chinese vase valued at HK$200 million sold... The six-day event was estimated to raise HK$2.4 billion from the sale of fine wines, gems, watches, Chinese ceramics, classical paintings and Asian contemporary art... 'A lot of coal miners and listed company owners and financiers have built wealth and are comfortable spending it on art,' Qian Weipeng, a Shanghai-based dealer, said..."

May 31 - Bloomberg (Marco Lui): "Hong Kong's retail sales rose 27.7% by value in April from a year earlier, the government said..."

Japan Watch:

May 31 - Bloomberg (Keiko Ujikane and Aki Ito): "Japan's debt rating was put on review for a downgrade by Moody's... Faltering growth prospects and 'a weak policy response' may hinder government efforts to cut the nation's debt burden, said Moody's, which had put Japan's Aa2 rating on negative outlook in February."

June 1 - Bloomberg (Shigeru Sato): "The cost of dismantling the Fukushima Dai-Ichi nuclear plant crippled by the March 11 earthquake and tsunami may reach 20 trillion yen ($246bn), according to the Japan Center for Economic Research."

India Watch:

May 31 - Bloomberg (Kartik Goyal): "India's economy grew at the slowest pace in five quarters as manufacturing and services cooled, a moderation that has yet to curb pressure for more increases in interest rates to damp inflation. Gross domestic product rose 7.8% in the three months... after a revised 8.3% gain in the previous quarter..."

June 1 - Bloomberg (Andrew MacAskill and Kartikay Mehrotra): "To run his fan, lamp and small television, Sikander strings a homemade wire hook over power cables outside his one-room New Delhi house, helping perpetrate the world's biggest energy heist. 'The cables are right there, it's really easy to take it,' said Sikander... who... earns less than $2 a day... 'You have to be very careful when it rains because you can get electrocuted tying the wires together.' About one-third of the 174 gigawatts of electricity generated in India annually is either stolen or dissipates in the conductors and transmission equipment that form the country's distribution grid, Power Secretary P. Uma Shankar said..."

Asia Bubble Watch:

June 1 - Bloomberg (Eunkyung Seo): "South Korea's inflation exceeded the central bank's target for a fifth straight month in May, adding to the case for the bank to raise interest rates... Consumer prices rose 4.1% from a year earlier after a 4.2% gain in April... Exports advanced 23.5%, missing projections..."

Latin America Watch:

May 31 - Bloomberg (Alexander Ragir): "Brazil's industrial production fell in April by the most since 2008, surprising analysts who had expected output to expand in Latin America's biggest economy. Industrial production fell 2.1% from March... Output fell 1.3% from a year ago."

Unbalanced Global Economy Watch:

June 1 - Bloomberg (Svenja O'Donnell): "Manufacturing growth from China to the euro region and the U.K. slowed in May, adding to signs that momentum is weakening in a global economy facing headwinds from rising commodity costs and regional shocks... The synchronized drop in global factory indicators is adding to evidence that the world's economy is struggling to withstand the combination of rising oil prices, the aftermath of Japan's earthquake and Europe's sovereign debt crisis."

May 31 - Bloomberg (Patrick Donahue and Christian Vits): "German unemployment fell in May for a 23rd straight month as export-driven growth and increased spending by businesses and consumers extended a jobs boom... The jobless rate declined to 7%, the lowest since records for a reunified Germany began in 1991."

May 30 - Bloomberg (Emma Ross-Thomas): "Spain's inflation rate held near a 2 1/2-year high in May... Consumer prices, based on European Union calculations, rose 3.4% from a year earlier..."

May 30 - Bloomberg (Ali Berat Meric): "Turkish loan growth is expected to slow in the second half to a central bank target of an annual 25% at the end of the year, Ugur Delikanli, deputy chief of the banking regulator in Ankara, said..."

U.S. Bubble Economy Watch:

June 3 - Bloomberg (Shobhana Chandra): "Payrolls grew at the slowest pace in eight months and the U.S. jobless rate unexpectedly climbed to 9.1% in May, reinforcing signs that a slowdown in the world's largest economy is persisting into the second quarter. Employers added a less-than-projected 54,000 jobs last month, after a revised 232,000 gain in April that was smaller than initially estimated..."

June 3 - Bloomberg (Simone Baribeau): "Employment at local governments, which provide 11 percent of all U.S. nonfarm jobs, fell to the lowest since July 2006 as municipalities cut payrolls to balance budgets. Cities, towns and counties eliminated 28,000 jobs in May, the most since November, reducing their workforce to 14.2 million... State governments cut 2,000 staff, lowering employment to 5.1 million, the least since January 2007."

May 31 - Bloomberg (Joshua Zumbrun): "For all the attention given to almost $4-a-gallon gas, the biggest threat to containing U.S. inflation may be the shift away from homeownership, which is pushing up the cost of leases across the nation's 38 million rented residences. Shelter represents about 40% of the consumer price index excluding food and energy and accounted for almost one quarter of the 1.3 percentage point rise in April. That share has grown as falling home prices shake Americans' confidence in housing as an investment."

Real Estate Watch:

May 31 - Bloomberg (Bob Willis): "Home prices in 20 U.S. cities dropped in March to the lowest level since 2003... The S&P/Case-Shiller index of property values in 20 cities fell 3.6% from March 2010, the biggest year-over-year decline since November 2009... At 138.16, the gauge was the weakest since March 2003."

June 3 - Bloomberg (David M. Levitt): "Midtown Manhattan office values are within 15% of their mid-2007 peak, as real estate investors flock to the city expecting rent growth, Green Street Advisors Inc. said."

Central Bank Watch:

May 30 - Bloomberg (Eric Martin): "Federal Reserve Bank of Kansas City President Thomas Hoenig, the central bank's longest-serving policy maker, said the U.S. needs to raise interest rates to encourage individuals to save and avoid future asset bubbles."

Muni Watch:

June 2 - New York Times (Michael Cooper): "Half the states plan to cut spending on higher education, and nearly a third plan cuts to elementary and high schools. Public assistance and transportation face cuts. Eighteen states have proposed slashing aid to struggling cities and local governments. Some states will raise taxes or fees. Others plan to lay off workers, or cut their salaries or benefits. Although state tax collections are picking up after several brutal years, a new survey by the National Governors Association and the National Association of State Budget Officers found that states still expect to collect less tax revenue and spend less money in the coming fiscal year than they did before the Great Recession began."

May 30 - Bloomberg (David Mildenberg): "Texas lawmakers passed a two-year spending plan... that cuts spending on health care, hospitals and higher education in the second most-populous U.S. state, and provides $4 billion less to schools than mandated by law... The budget calls for $86.9 billion in general-fund spending in the two years that start in September, down 1.9% from the current period... Including U.S. funds and money dedicated to specific uses, the state would spend $172.3 billion, or 8.1% less than the current period."

Dismal Payroll Data

Today's payroll data were dismal. The unemployment rate jumped back above 9% (to 9.1%), while the 54,000 gain in Non-farm Payrolls was the weakest increase since last September. Most alarming, the manufacturing sector lost 5,000 jobs during May. This was the first decrease since November 2010, providing added confirmation that the recovery is not on solid footing.

Between November 2007 and December 2009, manufacturing jobs dropped 2.3 million (1.15 million during the worst six month period). So far, the recovery has engendered a return of only 238,000. It is worth noting that the current 11.694 million employed in manufacturing compares to 17.637 million back in March of 1998. Not surprisingly, recent incredible fiscal and monetary stimulus has provided minimal support for our country's much needed industrial renaissance. Worse yet, the massive expansion of government debt is backed by little in the way of added wealth-producing capacity. This is a dangerous ("Bubble") dynamic both from an economic and financial stability perspective.

Sentiment is shifting. Optimism in the sustainability of the recovery is dimming, as analysts come to better appreciate that key sectors remain unhealthy and immune to government stimulus. While the export sector remains robust, its relatively diminished stature limits the overall economic impact. During the past decade, much of our atrophied productive capacity was directed to supplying the housing and related consumption boom. It is now becoming clear that the (post-mortgage finance Bubble and housing mania) recovery will be a protracted and arduous process. Boom-time malinvestment ensures that the value of too much of our productive capacity is impaired in the current economic landscape. Meanwhile, the state & local government sector faces heightened austerity headwinds.

Talk will now likely shift from "soft-patch" to possible "double-dip." Either way, such weak economic performance in the midst of double-digit-to-GDP deficits is disconcerting. The booming federal government sector is anything but transmitting "animal spirits" to the private economy. So, the argument that Washington is sucking energy (incentives, real resources, investment and finance) from the rest of our nation's economy becomes more difficult to disregard by the week.

QE2 stoked equities and risk asset prices - along with energy and food costs. Some gained, some lost, while the marketplace turned highly speculative. With markets now levitated and the inflation outlook more clouded, uncertainty is a greater issue these days than it was pre-QE2. Meanwhile, the freakish nature of Washington's fiscal and monetary management creates powerful disincentive for long-term productive investment. Myriad atypical financial and economic factors impede the formation of a sound and sustainable recovery.

Alan Greenspan had another hour on CNBC this morning. As an antagonist of historical revisionism, I take special interest in comments from our former Fed chairman. I find it ironic that he assails "a whole structure of [government] activism that has occurred in the aftermath of the crisis." After all, the so-called "free market economist," Mr. Greenspan, is the father of "activist" central bank planning. And the current predicament is a direct consequence of more than 20 years of misguided Federal Reserve market intervention.

Not surprisingly, Mr. Greenspan presses ahead with his focus on post-Bubble policy mistakes - regulatory and fiscal, in particular. I'll not back away from placing primary responsibility on the errors and misconceptions from the Bubble years. The history of booms and busts is rather clear: major Credit booms are precarious in large part because they will eventually lead to strident political responses in financial regulation, spending profligacy and excessive government control over the real economy. Flaws in the Greenspan/Bernanke notion of ignoring asset Bubbles - while being ready to implement aggressive "mopping up" strategies when they burst - should now be readily apparent.

Another Greenspan comment piqued my interest: "We're dealing with a fiat money system; you have to regulate it in some form or another." He then stated that "the ideal regulation is capital adequacy," while brushing off the issue of off-balance sheet finance. "We could have prevented all the nature of the crisis if we had adequate capital... It would solve 'too big to fail' because they wouldn't fail." If he really believes this, Mr. Greenspan fails to grasp the essence of this historic Credit Bubble.

The fiscal situation worries Mr. Greenspan, although his analysis never links previous Credit excesses to today's fiscal "activism" and runaway deficits. The so-called "fiat money system" failed spectacularly throughout the private-sector Credit boom, yet the role this dysfunctional system is now having in perpetuating a government finance Bubble remains unaddressed.

Somehow, there is no mention of how loose monetary policy incentivized systemic excesses throughout the mortgage/Wall Street finance Bubble - and how even looser "money" is today complicit in profligate federal borrowing and spending. It is incredulous to suggest that "capital adequacy" is somehow going to resolve the issue of unfettered non-bank ("fiat") Credit expansion. The basic problem remains the unchanged: a malfunctioning marketplace can neither effectively price, intermediate or regulate marketable debt.

This week, the stock market took more seriously the weak economic data that it had been content to disregard. Until recently, disappointing economic reports were viewed as holding any tightening move by the Fed further at bay. Besides, a somewhat weaker economy would pressure the dollar lower, a process that bolstered the global "risk on" trade. U.S. equities this week seemed to decouple with other risk assets. U.S. stocks and the dollar declined in tandem. Meanwhile, Treasury yields sank and German bund yields rose - as global speculators faced markets moving in all different directions.

Our stock market and economy are now increasingly vulnerable to a self-reinforcing confidence problem. QE2 effects boosted stock prices, and a strong market bolstered confidence. Policy led the markets which then lugged the real economy. Today, the soundness of economic underpinnings is increasingly in question, while QE2's weeks are numbered. Fiscal and monetary policies have little left to offer a marketplace that has luxuriated in policy largess. And, as always, market direction tends to dictate the tenor of the news/analysis. For about a year now, the bias has been to disregard the bearish and focus instead on the more optimistic interpretation of things. I would not be surprised if this week's stock market break proves an inflection point with respect to a more "glass half empty" view of our structurally-challenged economy and policy framework.