For the week, the S&P500 slipped 0.2% (up 0.9% y-t-d), and the Dow declined 0.6% (up 3.1%). The broader market outperformed. The S&P 400 Mid-Caps gained 1.4% (up 4.3%), and the small cap Russell 2000 rallied 2.1% (up 1.8%). The Morgan Stanley Cyclicals rallied 2.2% (down 0.4%), and the Transports gained 1.1% (up 2.1%). The Morgan Stanley Consumer index dipped 0.6% (down 0.1%), and the Utilities declined 0.8% (up 4.1%). The Banks dropped 2.4% (down 11.3%), and the Broker/Dealers sank 2.5% (down 14.4%). The Nasdaq100 gained 1.1% (unchanged), and the Morgan Stanley High Tech index rallied 0.7% (down 5.6%). The Semiconductors gained 1.1% (down 4.7%). The InteractiveWeek Internet index rose 2.1% (down 3.9%). The Biotechs increased 1.4% (up 8.9%). Although bullion dropped $37, the HUI gold index rallied 0.9% (down 12.6%).

One-month Treasury bill rates ended the week at zero and three-month bills closed at one basis point. Two-year government yields fell 4 bps to 0.33%. Five-year T-note yields ended the week down 15 bps to 1.38%. Ten-year yields fell 7 bps to 2.87%. Long bond yields slipped 2 bps to 4.19%. Benchmark Fannie MBS yields declined 7 bps to 3.84%. The spread between 10-year Treasury yields and benchmark MBS yields was little changed at 97 bps. Agency 10-yr debt spreads declined one to negative 2 bps. The implied yield on December 2012 eurodollar futures fell 7 bps to 0.88%. The 10-year dollar swap spread was little changed at 14.5 bps. The 30-year swap spread declined 5 bps to negative 31 bps. Corporate bond spreads were wider. An index of investment grade bond risk increased 2 bps to a nine-month high 101 bps. An index of junk bond risk jumped 7 bps to 514 bps.

Debt issuance remained notably slow. Investment-grade issuers included JPMorgan $2.5bn, Danaher $1.8bn, and Lincoln National $300 million.

Junk bond funds outflows jumped to a record $3.5bn $ (from EPFR). Junk issuers included AMC Networks $700 million, Ducommun $200 million and Harbinger Group $150 million.

Convertible debt issuers this week included Nuvasive $400 million and Insulet $125 million.

International dollar bond issuers included $2.2bn, BAA Funding $1.0bn, and Hydro-Quebec $1.0bn.

German bund yields sank 13 bps to 2.83% (down 13bps y-t-d), and U.K. 10-year gilt yields declined 7 bps this week to 3.13% (down 38bps). Greek two-year yields ended the week up 63 bps to 27.11% (up 1,487bps). Greek 10-year note yields declined 11 bps to 16.48% (up 402bps). Spain's 10-year yields rose 11 bps to 5.67% (up 23bps). Ten-year Portuguese yields jumped 50 bps to 11.11% (up 453bps). Irish yields surged 57 bps to 11.72% (up 266bps). The German DAX equities index slipped 0.6% (up %3.0 y-t-d). Japanese 10-year "JGB" yields were one basis point lower to 1.105% (down 2bps). Japan's Nikkei rallied 3.5% (down 5.4%). Emerging markets were notably resilient. For the week, Brazil's Bovespa equities index was little changed (down 12%), while Mexico's Bolsa rallied 0.9% (down 8.3%). South Korea's Kospi index jumped 2.9% (up 1.9%). India's equities index gained 2.1% (down 11.1%). China's Shanghai Exchange surged 3.9% (down 2.2%). Brazil's benchmark dollar bond yields dropped 15 bps to 3.93%, and Mexico's benchmark bond yields declined 5 bps to 3.96%.

Freddie Mac 30-year fixed mortgage rates were unchanged at 4.50% (down 16bps y-o-y). Fifteen-year fixed rates added 2 bps to 3.69% (down 44bps y-o-y). One-year ARMs rose 2 bps to 2.99% (down 78bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 2 bps to 4.98% (down 54bps y-o-y).

Federal Reserve Credit jumped $16.9bn to a record $2.827 TN (33-wk gain of $546bn). Fed Credit was up $419bn y-t-d and $498bn from a year ago, or 22.8%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 6/22) increased $12.9bn to $3.460 TN. "Custody holdings" were up $109bn y-t-d and $370bn from a year ago, or 12.0%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $1.453 TN y-o-y, or 17.3%, to $9.859 TN. Over two years, reserves were $3.061 TN higher, for 45% growth.

M2 (narrow) "money" supply increased $11.7bn to a record $9.038 TN. "Narrow money" has expanded at a 5.0% pace y-t-d and 5.3% over the past year. For the week, Currency increased $2.0bn. Demand and Checkable Deposits fell $6.1bn, and Savings Deposits increased $14.8bn. Small Denominated Deposits dipped $3.8bn. Retail Money Funds gained $4.7bn.

Total Money Fund assets declined $8.2bn last week to $2.699 TN. Money Fund assets were down $111bn y-t-d, with a decline of $118bn over the past year, or 4.2%.

Total Commercial Paper outstanding jumped $20.8bn to $1.227 Trillion. CP was up $258bn y-t-d, or 45.8% annualized, with a one-year rise of $128bn.

Global Credit Market Watch:

June 24 - Financial Times (Rachel Sanderson): "Moody's has changed its outlook on 13 mid-sized and smaller Italian banks to negative and warned it could downgrade the long-term debt ratings of 16 others following its announcement last week that it had put the country's sovereign debt on review for possible downgrade. The move by the rating agency follows sharp falls in the share prices of Italian banks in recent days. Its warning affects Italy's largest retail bank, Intesa Sanpaolo, and Monte dei Paschi di Siena, its third-largest bank by assets. UniCredit, Italy's largest bank by assets, has recently been downgraded by Moody's. The Italian banking sector weathered the financial crisis better than other European economies due to its relatively conservative lending culture and high levels of savings among retail customers. These remain strengths, but concerns about the possibility of contagion from Greece alongside low economic growth in Italy have cast a pall over the sector's stock market performance."

June 22 - Bloomberg (Stephanie Bodoni): "The Greek crisis has 'radically intensified' and risks turning 'the entire euro zone on its head,' Luxembourg Prime Minister Jean-Claude Juncker said... 'If we make mistakes in the way we handle the Greece crisis, it will jump to other euro countries and will bit by bit turn the entire euro zone on its head,' Juncker, who also leads the group of euro-area finance ministers, said..."

June 21 - Bloomberg (Aaron Kirchfeld and Elena Logutenkova): "A year after European officials bailed out Greece, investors say the region's banks haven't raised sufficient capital or cut loans enough to withstand the contagion that may follow a default. While European lenders reduced their risk tied to Greece by 30% to $136.3 billion last year by not renewing loans, writing down the value of debt and shifting it off their books, they still have almost $2 trillion linked to Portugal, Ireland, Spain and Italy... 'The Greek debt situation certainly has the potential to create havoc with the European banking system,' said Neil Phillips, a fund manager at BlueBay Asset Management... 'A Greek default and the ramifications of that would be too ghastly for Europe and the European banking system to contemplate right now.'"

June 22 - Bloomberg (Lukanyo Mnyanda and Keith Jenkins): "Spain, which escaped debt-market contagion as Portugal sought a bailout in April, risks a return to the center of Europe's debt crisis as local governments struggle to contain borrowing and leaders squabble over Greece. The extra yield that investors demand to hold Spain's 10- year bonds instead of German bunds of similar maturity rose to the highest since November as speculation about a Greek default intensifies. Demand for Spanish debt declined at a sale of six- month bills yesterday, a week after the central bank released data showing the regions' finances are worsening."

June 22 - Bloomberg (Emma Ross-Thomas): "The International Monetary Fund said Spain must step up efforts to overhaul its economy as Europe's sovereign-debt crisis threatens to damp growth. 'The repair of the economy is incomplete and risks are considerable," the... IMF said... There must be 'no let-up in the reform momentum' to bolster the recovery and reduce a 21% unemployment rate that is 'unacceptably high,' the fund said. Spain's Socialist government is carrying out the deepest budget cuts in at least three decades while raising the retirement age and reducing firing costs... 'Financial conditions could deteriorate further, reflecting rising concerns about sovereign risks in the euro area,' the IMF said. 'This could put additional pressure on sovereign and bank funding costs for Spain, which in turn could feed back to the real economy.'"

June 21 - Bloomberg (John Glover and Zeke Faux): "Relative yields on junk bonds are rising at the fastest pace since the start of Europe's sovereign debt crisis in May 2010 on rising concern that Greece's debt burden will further roil Europe and depress the global economy. The extra yield investors demand to own speculative grade corporate debentures instead of government debt has risen 56 bps this month to 568 bps on average... That's the most since the spread widened by 142 last May."

June 17 - Bloomberg (Abigail Moses): "European policy makers are on a collision course with the bond market as they seek to resolve the Greek debt crisis without triggering payouts under credit-default swap insurance contracts. European Central Bank chiefs are determined to ensure any Greek debt restructuring won't be deemed a credit event enabling buyers of protection to seek compensation from swaps sellers... A debt restructuring that doesn't trigger swaps would be more damaging to the market as it would devalue contracts, according to analysts at JPMorgan... and Merrill Lynch. Such a move would leave banks with unprotected, or unhedged, holdings, forcing them to sell bonds and ultimately drive sovereign borrowing costs higher. 'The ECB fears having to admit a colossal mistake when it declared euro zone governments as undefaultable,' said Georg Grodzki, head of credit research at Legal & General Investment Management... 'The ECB wants to protect its balance sheet and reputation.' The ECB's total exposure to Greece may be between 130 billion euros ($184 billion) and 140 billion euros, Dutch Finance Minister Jan Kees de Jager said.... The ECB provided 90 billion euros of liquidity to Greek banks, he said."

June 20 - Financial Times (Joe Leahy): "Consumer defaults in Brazil are expected to increase by a third by the end of this year, according to a leading credit rating agency, fuelling concerns over a boom in lending that some economists fear could turn into a credit bubble. The level of loans overdue by 90 days has risen rapidly in recent months to 6.1% and is expected to reach 8% by the end of December, said Ricardo Loureiro, president of Experian Latin America..."

Global Bubble Watch:

June 24 - Financial Times (Jamil Anderlini): "Chinese premier Wen Jiabao has declared victory over domestic inflation, saying that the government has successfully reined in price pressures. 'China has made capping price rises the priority of macro-economic regulation and introduced a host of targeted policies. These have worked...We are confident price rises will be firmly under control this year.' Consumer price inflation has been rising since the middle of last year, reaching a 34-month high of 5.5% in May."

June 22 - Bloomberg (Craig Torres and Jeannine Aversa): "Federal Reserve officials decided to keep the central bank's balance sheet at a record to spur the slowing economy after completing $600 billion of bond purchases this month. 'The economic recovery appears to be proceeding at a moderate pace, though somewhat more slowly than the committee had expected,' Fed Chairman Ben S. Bernanke said..."

June 21 - Bloomberg (Alexander Cuadros): "The emerging-market initial public offering boom, predicted for Brazil, Russia and India, is fizzling as inflation sends interest rates up, share prices down and prompts companies to scale back or cancel sales. While Brazil's stock exchange chief, Russia's biggest underwriter and India's government projected IPOs would rise threefold this year to $64 billion, issues are falling. Brazil dropped 29% from the year before to $2.7 billion and India sank 74% to $753 million, the least for the period for both since 2009..."

June 20 - Bloomberg (Scott Reyburn): "The year's biggest test so far for contemporary art dealers, in Switzerland, ended with galleries saying that demand and prices have returned to 2008 levels. Billionaires splashed out on the best of $1.8 billion works shown at the world's largest modern and contemporary art fair in Basel... The spree marks a return to the peak of the boom that ended in 2008... 'This was the busiest Art Basel for a long time,' said London-based collector Amir Shariat, chief executive of Auctor Capital Partners... 'There was a lot of aspirational buying from collectors I hadn't seen. The market is deeper and broader now. It's a symptom of the growing gap between rich and poor.'"

Currency Watch:

For the week, the U.S. dollar index gained 0.8% to 75.58 (down 4.4% y-t-d). For the week on the upside, the Swiss franc gained 1.8%, the South Korean won 0.7%, the Norwegian krone 0.6%, and the Taiwanese dollar 0.3%. On the downside, the South Korean won declined 2.0%, the British pound 1.5%, the Swedish krona 1.3%, the Australian dollar 1.2%, the Canadian dollar 0.9%, the Danish krone 0.8%, the Euro 0.8%, the Japanese yen 0.5%, the Brazilian real 0.4%, the Singapore dollar 0.4%, and the New Zealand dollar 0.1%.

Commodities and Food Watch:

June 21 - Bloomberg (Alan Bjerga): "More of the U.S. corn crop will be used to fuel cars than feed animals for the first time during the marketing year that starts in September, the Agriculture Department projects. The proportion of the harvest going to ethanol has almost quadrupled since 2002... The share will reach 40% in the current marketing year and be close to that level in 2011-2012."

The CRB index fell 1.7% (down 0.9% y-t-d). The Goldman Sachs Commodities Index sank 3.6% (up 2.1%). Spot Gold declined 2.4% to $1,503 (up 5.8%). Silver dropped 3.1% to $34.65 (up 12%). August Crude fell $2.24 to $91.16 (unchanged). July Gasoline sank 5.8% (up 13%), and July Natural Gas declined 2.2% (down 4%). July Copper was little changed (down 7%). July Wheat sank 5.4% (down 20%), and July Corn fell 4.3% (up 7%).

China Bubble Watch:

June 20 - Bloomberg (Sophie Leung): "China's local-government debt amounts to the biggest 'time bomb' for the nation that Credit Suisse Group AG economist Tao Dong has seen... 'We do need to pay keen attention to this particular problem, as this is one of the major threats to Chinese economic stability,' he said... Local-government debt may rise to 12 trillion yuan ($1.85 trillion) by 2012, Standard Chartered Plc has estimated. 'The local-government debt problem is the biggest problem I have seen as a time bomb in my 17 years of covering the Chinese economy,' Tao said. 'However I do not anticipate an immediate blow-up of local debt because the property sector isn't showing any drastic sign of slowdown.'"

June 23 - Bloomberg: "China's property boom is shifting from Beijing and Shanghai as government measures to curb the market haven't kept prices from rising in secondary cities. New home prices rose in 67 of 70 cities in May led by smaller centers as developers hold off price cuts, even as existing home prices cool following higher interest rates and down-payment requirements. Standard & Poor's on June 15 cut its outlook on Chinese developers... Efforts to rein in property prices have been focused on the nation's largest urban areas, leaving less affluent cities... with surging home values as developers increased building there. That raises challenges for a government... 'Purchase restrictions in the major cities drove speculators to second- and third-tier cities,' said Liu Li-Gang, who formerly worked for the World Bank... 'China should raise interest rates and basically use monetary policies to curb demand, otherwise negative interest rates and few appealing options will send more speculation into the property market.'"

June 21 - Bloomberg (Katrina Nicholas): "Junk bonds sold by Chinese companies have turned into the worst-performing U.S. dollar high-yield debt this month as scrutiny of Sino-Forest Corp. highlights the risks of investing in the world's fastest-growing major economy."

Latin America Watch:

June 20 - Bloomberg (Alexander Ragir and Matthew Bristow): "Economists covering Brazil raised their 2012 inflation forecast for a second week, as they expect wage increases to reignite inflation next year. Consumer prices will rise 5.18% next year..."

June 22 - Bloomberg (Veronica Navarro Espinosa and Boris Korby): "Brazilian companies are selling the fewest bonds in overseas markets in a year as concern Greece may default erodes demand for emerging-market debt... Issuance is down 92% from May's total of $9.8 billion. In the U.S., companies sold $29.4 billion of debt in June through yesterday, on pace for the slowest month since May 2010."

June 22 - Bloomberg (Andre Soliani and Alexander Ragir): "Brazil's unemployment rate fell to the lowest ever for the month of May... The jobless rate fell to 6.4% in May, from 7.5% a year earlier..."

Unbalanced Global Economy Watch:

June 22 - Bloomberg (Abdel Latif Wahba and Alaa Shahine): "Egypt cut its target for the budget deficit for the fiscal year starting July 1 after reducing planned spending... The interim government said it plans to reduce the gap to 8.6% of gross domestic product from 9.5% in the fiscal year that ends this month..."

U.S. Bubble Economy Watch:

June 20 - Bloomberg (Christopher Palmeri and William Selway): "One-fourth of America's metropolitan areas have unemployment rates of 10% or more, topping the national average, and dozens of cities won't see jobs return to pre-recession levels for years, the U.S. Conference of Mayors said. The subdued rebound means a 'lost decade' in 48 cities where employment isn't forecast to return to previous highs through 2020 at least, the organization said... Jobless rates in 103 of 363 population centers are in double digits, compared with a national rate of 9% when the numbers were compiled in April."

Real Estate Watch:

June 22 - Bloomberg (Kathleen M. Howley): "U.S. home prices fell 5.7% in April from a year earlier, signaling the housing market is struggling to recover as foreclosures weigh down values. The decline was led by an 11% drop in the region that includes Nevada and Arizona... The second- largest slump was 8.6% in the area that includes Florida... It would take 9.3 months to sell all the homes on the market in May at the current sales pace, up from 7.5 months in January..."

Central Bank Watch:

June 22 - Bloomberg (Svenja O'Donnell): "Bank of England minutes showed some policy makers see a potential need for further bond purchases as the economic recovery struggles and 'downside' risks to growth and inflation mount. For the majority of the nine-member Monetary Policy Committee, 'the fiscal challenges in the euro-area periphery highlighted the potential for further adverse shocks to demand... For some of these members, it was possible that further asset purchases might become warranted if the downside risks to medium-term inflation materialized.'"

Fiscal Watch:

June 22 - Washington Post (Lori Montgomery): "The national debt will exceed the size of the entire U.S. economy by 2021 -- and balloon to nearly 200% of GDP within 25 years -- without dramatic cuts to federal health and retirement programs or steep tax increases, congressional budget analysts said... The dire outlook from the nonpartisan Congressional Budget Office comes as the White House and congressional leaders are locked in negotiations aimed at cutting spending and stabilizing future borrowing. The CBO report highlights the enormity of that task and the immense difficulty of paying off the debt, given an aging population and soaring health-care costs. Over the long term, the CBO said, a projected explosion in government spending outside interest on the debt is 'attributable entirely' to the ballooning cost of 'Social Security, Medicare, Medicaid, and (to a lesser extent) insurance subsidies' intended to help finance coverage for the uninsured under President Obama's new health-care law."

Red Alert

With limited time to write, I chose brief comments over "just the facts."

The week provided added confirmation of the bear thesis, although with interesting twists. While Greece Prime Minister Papandreou's government survived a no-confidence vote, this positive development provided little reprieve for the marketplace. Contagion jumped the fire line thought to protect Spain, as Italy arose as a cause for concern. Yesterday, Moody's lowered its outlook on 13 Italian banks and warned that 16 others were vulnerable to Credit ratings downgrades. The Italian bank sector was pummeled today, with some of the leading stocks down as much as 5.0%. Credit default swap (CDS) prices spiked dramatically throughout the Italian banking sector the past two sessions. In reference to signals of financial stability, ECB President Trichet admitted things had turned to code "red". The eruption of systemic risk within Italy should be viewed as a serious debt contagion escalation.

Following last Friday's warning of a possible sovereign debt downgrade, Italy's 10-year sovereign yields jumped 16 bps this week to 4.97%. Yields were up 35 bps in three weeks to the highest level since early March. Perhaps more noteworthy, Italian 2-year yields spiked 24 bps in the past two sessions to 3.27%, the high since late 2008. The price of Italy CDS jumped 34 bps in two days to surpass 200 bps for the first time since January. Spain's 2-year yields jumped 21 bps this week to 3.66%, the high since early January. Ireland saw its 10-year yields jump 57 bps to a record 11.72%, as Portuguese yields surged 50 bps to a record 11.11%.

Greek contagion fears now cast quite a pall. There were indications of ongoing de-risking and de-leveraging. The energy and commodities sectors suffered another tough week, and the leveraged players certainly can't feel better about the world. And it is an important part of the thesis that a debt crisis-induced tightening of financial conditions will particularly weigh on those economies suffering structural short-comings. Italy fits the bill.

At 119%, Italian debt as a percentage of GDP is second only to Greece (143%) in Eurozone (according to Bloomberg data). Fortunately, a highly accommodative global marketplace has to this point made Italy's heavy debt-load manageable. At about 5%, Italy's annual deficit looks favorable relative to many countries in and outside the region. And with Italian banks having limited exposure to periphery debt, the market had believed the sector was largely immune to the crisis.

Yet Italy today hangs very much in the balance. Contagion fears are pushing up Italy's funding costs, risking a problematic jump in future debt service costs (and deficits). And as was demonstrated in Greece, when market sentiment changes and things turn sour... The Italian economy now faces additional austerity measures. Voting with their feet, the marketplace this week scampered away from the Italian financial sector. A tightening of lending by the markets and the banking sector comes at an inopportune time for the moribund Italian economy. GDP expanded only 1.3% in 2010, this following 2009's 5.2% contraction and 2008's 1.3% drop.

Not dissimilar to the United States of America, Italy's debt mountain ($2.3TN) is sustainable only with decent and persistent economic growth. And when global market confidence is running high, liquidity abundant and risk-taking in vogue, envisaging an optimistic scenario comes relatively easy to the marketplace. But when the clouds darken, things can turn dismal in a hurry. And when folks become nervous about a debt-laden and structurally-challenged economy, they will quickly take a keen interest in capital ratios and the general soundness of that economy's banking system. Economic and debt structures suddenly move to the front burner. That's where we are with Italy, and others, these days, as contagion effects gain important momentum by the week.

The VIX index (the market's estimate of the near-term future volatility of the S&P500) actually declined this week. It is interesting to note that at 21.10, the VIX closed today slightly above its one-year average (20.19). The VIX spiked above 37 last July and briefly traded above 30 last March. It is remarkable that contagion effects, having made it to Italy, are not provoking a dramatic market response in the equity options marketplace. Clearly, the markets have bought into "global too big to fail." Apparently, the more troubling Greek contagion risks become, the greater the markets' faith that global policymakers will find the necessary resolve to come together to ensure things don't spiral out of control.

I would be remiss not mentioning the notably strong performance by Asian markets this week, a region still holding the potential to underpin (exceedingly unbalanced) global growth. And, curiously, today from the Financial Times: "Chinese premier Wen Jiabao has declared victory over domestic inflation [in an op-ed piece in today's FT], saying that the government has successfully reined in price pressures. 'China has made capping price rises the priority of macro-economic regulation and introduced a host of targeted policies. These have worked...We are confident price rises will be firmly under control this year.'" Ok. And it would be consistent with my thesis that the unfolding "Greek" crisis tempts the Chinese and others to back away from their rather timid tightening measures, giving an extended lease on life to dangerous Credit Bubbles.

I have no doubt global policymakers will act to help stabilize the system; I'm just increasingly concerned with unintended consequences. A few examples: European policymakers have, for the most part, reached a consensus view that any Greek debt restructuring must avoid triggering defaults within the expansive CDS marketplace. In the process, such maneuverings come with the high cost of damaging the integrity of this market and, perhaps, the derivatives markets more generally. Why purchase insurance if politicians and political pressure can come to bear on the fulfillment of contractual obligations? Elsewhere, politicians can release oil reserves and at least temporarily reduce energy prices for the benefit of consumers and economies. Yet, in an age of highly speculative markets, such moves exacerbate market turbulence, risk aversion and de-leveraging. And as Chairman Bernanke claims that the Fed retains considerable firepower to support the recovery, the marketplace is left to ponder what the devil he has in mind.