As you read my opening summary of the Fed's latest quarterly Z.1 "flow of funds" report, keep in mind the Fed's recent decision to move to an altogether more aggressive monetary policy stance.

For the second quarter, Total Non-financial Credit market debt expanded at a 5.0% rate, the strongest expansion since Q4 2008 (14 quarters ago). Debt growth increased from Q1's 4.4% rate and was almost double Q2 2011's 2.6%. Corporate Credit market borrowings expanded at a 6.9% pace, up from Q1's 4.7%. Total Household debt expanded at a 1.2% pace, the strongest growth since Q1 2008. Consumer Credit grew at a robust 6.2% rate, the strongest in 19 quarters (Q3 '07). Home mortgage Credit contracted at a 2.1% pace, an improvement from Q1's 3.3% pace of decline. State & Local borrowings increased at a 0.8% pace, compared to Q1's 1.2% rate of contraction.

For the quarter, Total Non-Financial Credit expanded at a seasonally-adjusted and annualized (SAAR) $1.946 TN. This was the strongest debt expansion since Q4 2008's SAAR $2.082 TN. And for comparison, the current pace of debt growth compares to 2008's total growth of $1.906 TN, '09's $1.063 TN, 2010's $1.437 TN and 2011's $1.326 TN. In the past I've posited that our maladjusted Bubble economic structured requires in the neighborhood of $2.0 TN annualized Credit growth to retain reflationary momentum throughout the economy and asset markets.

And while Corporate and Consumer Credit (non-mortgage: i.e. credit cards, student loans, auto and installment debt, etc.) are now expanding robustly, the Credit system remains largely dominated by the historic expansion of federal debt. Federal borrowings expanded SAAR $1.183 TN during the quarter, down from Q1's SAAR $1.428 but up notably from Q2 2011's $792bn pace. Federal borrowings expanded at a 10.9% pace during the quarter, up from the 8.2% rate from a year ago. In 16 quarters, Treasury debt has expanded a historic $5.775 TN, or 110%, to $11.026 TN. Outstanding Treasury debt expanded 24.2% in '08, 22.7% in '09, 20.2% in '10 and 11.4% in '11.

Consensus thinking has it that our system is progressing through a difficult "deleveraging" process. In contrast, I see much more system reflation than actual deleveraging. Sure, Household debt has declined $800bn since the end of 2007 to $13.456 TN. Meanwhile, federal debt has expanded more than seven times the decline in household borrowings. Indeed, Total Non-Financial debt ended Q2 at a record $38.924 TN, having expanded $6.550 TN, or 20.2%, in 16 reflationary quarters. As a percentage of GDP, total Non-financial debt has increased from 124% of GDP in June of 2008 to 249.4% to end 2012's second quarter.

The ongoing inflation of system incomes made possible by the historic expansion of federal debt has been the key dynamic of this latest reflationary cycle. For the five Bubble years 2003 through 2007, National Incomes jumped 32% to $12.396 TN, with Compensation rising 29% to $7.856 TN. National Income and Compensation dropped 3.8% and 3.3%, respectively, during the recessionary year 2009. Importantly, however, over the past 12 quarters National Income has jumped 13.7% ($1.662 TN) to a record $13.791 TN, while Compensation has risen 9.5% ($743bn) to a record $8.563 TN. Q2 National Incomes were up 3.7% y-o-y, with Compensation 3.3% higher.

Income gains have supported spending growth, corporate profits and renewed asset inflation. This reflationary cycle has seen Household Net Worth bounce back strongly. Household assets ended Q2 at $76.127 TN, up $1.423 TN y-o-y, and now are only about 3% below the late-2007 peak. At $62.668 TN, Household Net Worth (assets minus liabilities) has inflated $9.335 TN, or 17.5%, over the past eight quarters to less than 3% below Bubble period highs. And while Real Estate values remain significantly below Bubble highs, the value of Household sector Financial Asset holdings has reached new records at about $52 TN. Household financial asset holdings have inflated $8.505 TN in 24 months, or 19.6%.

"De-leveraging" discussions have been intriguing. Hedge fund manager Ray Dalio has been public with his framework. According to Mr. Dalio, deleveraging can be broken down into three processes: Austerity, debt restructuring and money printing. He has even referred to the ongoing "beautiful deleveraging" here in the U.S. that has supposedly found the right mix of austerity, restructuring and printing appropriate to ward of deflation while promoting slow growth.

As one would expect, most financial market operators focus their analysis on the financial aspects of so-called "deleveraging." And, no doubt about it, the titans of today's gigantic global leverage speculating community are precisely those players that have most adroitly played the ongoing cycle of global central bank reflationary policymaking. Their astounding financial success provides them a public forum in which to shape both the analytical debate and general viewpoints.

I tend to believe that conventional thinking - albeit from central bankers, bond and hedge fund kings or FT and WSJ columnists - is wrong on deleveraging. Deleveraging is not predominantly a financial issue. Economic structure matters - and it matters tremendously. Importantly, true deleveraging requires that system debt loads are reduced to a level supportable by the capacity of an economy to produce real wealth. A system can achieve stability and robustness only when a sound economy supports a manageable amount of system financial assets. Yet with a highly unsound economy, ongoing rampant inflation of non-productive debt and highly unstable financial markets, from my framework our system remains very much in a financial leveraging Credit Bubble Cycle.

Today, a consensus view holds that money printing will inflate incomes and prices to levels that reduce the overall burden of system debt. The belief is that a doubling of federal debt in four years has supported private-sector deleveraging - in the process creating a more robust system. Higher risk asset prices are viewed as confirmation of the adeptness of this policy course.

And while it's widely recognized that we are witnessing experimental monetary management, few seem to appreciate that we are similarly watching a historic experiment in economic structure. Never before has a world-leading economy been so dominated by consumption and services. This is especially noteworthy in terms of historical comparisons of deleveraging cycles. I would strongly argue that if policymakers throw Trillions of fiscal and monetary stimulus at a maladjusted consumption and asset inflation-based economy - the end result will be only a more distended maladjusted economy.

"Inflationists" have again come to Dr. Bernanke's defense, and it's worth noting that some don't hesitate taking shots at the "liquidationist" naysayers. And if I were writing my CBB back in the late-twenties, I would be categorized as one of those dreadful liquidationists - and one of Dr. Bernanke's "Bubble poppers." My argument is along the same lines as those economic thinkers that believed that either a Bubble economy and associated price levels be allowed to settle back to sustainable levels - or a runaway inflation of Credit would risk systemic collapse. Historical revisionism notwithstanding, those knucklehead "Bubble poppers" had the analysis right.

Historic Bubbles require a spectacular backdrop. The ongoing Bubble and the "Roaring Twenties" share important similarities, especially in the realm of extraordinary technological advancement. Epic periods of innovation significantly impact economic structures, and they also tend to stoke optimism as well as policy mistakes. Resulting booms spur Credit, economic and speculative excesses. And while such backdrops beckon for tighter monetary policy regimes, during the twenties and throughout this prolonged Bubble policymakers administered the opposite. The confluence of economic and financial complexities was beyond the grasp of policymakers.

Contemporary economies have an unprecedented capacity to absorb inflating Credit/purchasing power. Apple expects to sell 10 million iPhone 5's this weekend. Throw more Credit and higher incomes at our economy, and folks can acquire more cool technology products, enjoy more downloads, do more laser treatments or dine at more upscale restaurants. Literally Trillions of deficits and Fed monetization can be readily absorbed with hardly an impact on CPI. A services and consumption-based economy is - at least during a Credit cycle's upside - something to behold - and confound.

Our economic structure certainly enjoys unmatched capacity to absorb Credit excess without engendering traditional consumer price inflation. Yet there is indeed a huge problem that no one seems to want to recognize: Our system also has an unprecedented capacity to expand Credit that is backed by little in the way of wealth-creating capacity. Our government literally throws Trillions at the economy - Credit that inflates incomes and sustains consumption and elevates asset prices. The downside of this economic miracle is that, at the end of the day, there's little left to show for the whole exercise except for an ever-expanding mountain of suspect financial claims. Moreover, market values of these claims are sustained only by the unrelenting expansion of additional claims/Credit. This is Minsky's "Ponzi Finance" at a systemic level.

A real deleveraging would see the economy and financial markets weaned off of rampant Credit growth. Non-financial Credit growth averaged about $700bn annually during the nineties. This inflated to about $2.4 TN at the Mortgage Finance Bubble pinnacle in 2007. As I noted above, we're currently running at an annualized Credit growth rate of nearly $2.0 TN. This is posing great unappreciated risk to system stability.

A real deleveraging would see price levels (and market-based incentives) adjust throughout the economy in a manner that would spur business investment - in the process incentivizing sound investment-based lending and resulting job growth. Real deleveraging would see a shift in the economic structure from Credit-fueled consumption to savings and productive investment. Real deleveraging would give rise to our endemic trade deficits shifting to surplus. Real deleveraging would see a meaningful reduction in non-productive debt. Real deleveraging would see market prices dictated by fundamentals rather than governmental intervention, manipulation and inflationism.

The "raging" debate is whether recent elevated unemployment is a "cyclical" or "structural" phenomenon. Academic "white papers" not required. After all, find a system that doubles mortgage Credit in about six years and then proceeds to double federal debt in four - and you will no doubt locate a deeply maladjusted economic structure. Such gross financial imbalance ensures economic imbalance. And, importantly, the longer such imbalances are accommodated/incentivized by loose fiscal and monetary policies the deeper the structural impairment. Throw massive fiscal stimulus and monetize Trillions and such a structure will surely demonstrate historic deficiencies and fragilities.

Deleveraging - the process of unwinding the economic damage wrought from years of excess - will be a quite arduous economic process; one that will commence at some unknown date in the future. Oh, I guess I failed to mention that total (financial and non-financial) Credit ended Q2 at a record $55.031 TN, or 353% of GDP. And Rest of World holdings of our financial assets ended the quarter at a record $19.100 TN, a $3.860 TN increase from the end of 2008.

For the Week:

The S&P500 slipped 0.4% (up 16.1% y-t-d), and the Dow dipped 0.1% (up 11.2%). The Morgan Stanley Cyclicals fell 1.9% (up 14.1%), and the Transports sank 5.9% (down 2.2%). The Morgan Stanley Consumer index rose 0.7% (up 10.7%), while the Utilities declined 0.2% (down 0.9%). The Banks were down 2.8% (up 27.5%), and the Broker/Dealers were 4.9% lower (up 2.4%). The broader market gave back some of recent outperformance. The S&P 400 Mid-Caps fell 2.0% (up 14.4%), and the small cap Russell 2000 declined 1.1% (up 15.5%). The Nasdaq100 was up 0.2% (up 25.6%), while the Morgan Stanley High Tech index declined 1.0% (up 18.6%). The Semiconductors dropped 2.8% (up 8.4%). The InteractiveWeek Internet index lost 1.1% (up 15.0%). The Biotechs jumped 3.6% (up 46.6%). With bullion little changed, the HUI gold index gained 1.6% (up 5.4%).

One-month Treasury bill rates ended the week at 4 bps and three-month bills closed at 10 bps. Two-year government yields were up a basis point to 0.26%. Five-year T-note yields ended the week down 3 bps to 0.67%. Ten-year yields fell 11 bps to 1.75%. Long bond yields dropped 15 bps to 2.94%. Benchmark Fannie MBS yields declined 31 bps to 1.82%. The spread between benchmark MBS and 10-year Treasury yields narrowed 20 to a record low 7 bps. The implied yield on December 2013 eurodollar futures rose 2 bps to 0.40%. The two-year dollar swap spread was little changed at 13 bps, and the 10-year dollar swap spread declined 2 to one basis point. Corporate bond spreads widened from last week's multi-month lows. An index of investment grade bond risk jumped 13 to 96 bps. An index of junk bond risk rose 14 to 458 bps.

Debt issuance remained exceptionally strong. Investment grade issuers this week included JPMorgan $3.0bn, Novartis $2.0bn, Ford Motor Credit $1.0bn, Duke Energy Carolinas $650 million, Franklin Resources $600 million, Sempra Energy $500 million, Nextera Energy $500 million, New York Life $500 million, Church & Dwight $400 million, Southern Cal Gas $350 million, Digital Realty Trust $300 million, Torchmark $300 million, Ingredion $300 million, Tampa Electric $250 million, System Energy Resources $250 million, and North Shore Long Island $135 million.

Junk bond funds saw inflows jump to $1.3bn (from Lipper). The long list of junk issuers included Biomet $2.6bn, VPI $1.75bn, Rockwood Specialties $1.25bn, Nielsen $800 million, Continental Airlines $800 million, Hovnanian Enterprises $800 million, Sabre $800 million, FMC Technologies $800 million, Fiserv $700 million, Harley-Davidson $600 million, General Cable $600 million, Serta Simmons $650 million, Valeant Pharmaceuticals $500 million, SBA Communications $500 million, Sky Growth $490 million, Jones Group $400 million, Air Lease Corp $400 million, Kohl's $350 million, Amkor Technology $300 million, Sotheby's $300 million, CNO Financial Group $275 million, Ryland Group $250 million, P.H. Glatfelter $250 million, Michaels Stores $200 million and Baker & Taylor $145 million.

I saw no convertible debt issued.

International dollar bond issuers included Ukraine $2.6bn, National Bank Australia $2.5bn, Bank Nederlandse Gemeenten $2.25bn, ING Bank $2.0bn, Corp Andina de Fomento $1.5bn, Hazine Mustesarligi $1.5bn, Total Capital International $1.5bn, Banco Santander $1.35bn, Vodafone $2.0bn, Kommunalbanken $1.25bn, Ontario $1.25bn, Westpac Banking $2.25bn, Grupo Aval $1.0bn, PKO Finance $1.0bn, Nordea Bank $1.0bn, Bangkok Bank $1.2bn, Korea Finance $800 million, Schneider Electric $800 million, Banko Pactual $800 million, Colombia Telecom $750 million, Alpha Bank $750 million, Banco del Peru $650 million, Intelsat Jackson $640 million, Anglo American $1.35bn, Development Bank of Japan $500 million, Novolipetsk Steel $500 million, Rentenbank $250 million and Maestro Peru $200 million.

Spain's 10-year yields declined 3 bps to 5.70% (up 66bps y-t-d). Italian 10-yr yields added 3 bps to 5.03% (down 200bps). German bund yields fell 11 bps to 1.60% (down 23bps), and French yields added a basis point to 2.26% (down 88bps). The French to German 10-year bond spread widened 12 bps to 66 bps. Ten-year Portuguese yields jumped 49 bps to 8.26% (down 451bps). The new Greek 10-year note yield sank 80 bps to 19.46%. U.K. 10-year gilt yields fell 13 bps to 1.83% (down 14bps). Irish yields were 31 bps lower to 4.77% (down 349bps).

The German DAX equities index added 0.5% (up 26.3% y-t-d). Spain's IBEX 35 equities index gained 0.9% (down 3.9%), while Italy's FTSE MIB fell 3.8% (up 6.0%). Japanese 10-year "JGB" yields were unchanged at 0.79% (down 19bps). Japan's Nikkei declined 0.6% (up 7.7%). Emerging markets were mostly lower. Brazil's Bovespa equities index declined 1.3% (up 8.1%), and Mexico's Bolsa fell 0.9% (up 8.8%). South Korea's Kospi index slipped 0.3% (up 9.7%). India's Sensex equities index rose 1.6% (up 21.3%). China's Shanghai Exchange sank 4.6% (down 7.9%).

Freddie Mac 30-year fixed mortgage rates dropped 6 bps to 3.49% (down 60bps y-o-y). Fifteen-year fixed rates fell 8 bps to 2.77% (down 52bps). One-year ARMs were unchanged at 2.61% (down 21bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 4 bps to 4.15% (down 62bps).

Federal Reserve Credit added $1.0bn to $2.807 TN. Fed Credit was down $33bn from a year ago, or 1.2%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/19) rose $7.4bn to $3.584 TN. "Custody holdings" were up $164bn y-t-d and $116bn year-over-year, or 3.4%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $387bn y-o-y, or 3.8% to a record $10.611 TN. Over two years, reserves were $2.032 TN higher, for 24% growth.

M2 (narrow) "money" supply jumped $34.6bn to a record $10.124 TN. "Narrow money" has expanded 7.1% annualized year-to-date and was up 6.7% from a year ago. For the week, Currency increased $1.6bn. Demand and Checkable Deposits fell $16.4bn, while Savings Deposits surged $53.6bn. Small Denominated Deposits declined $1.8bn. Retail Money Funds fell $2.8bn.

Total Money Fund assets declined $10bn to $2.568 TN. Money Fund assets were down $127bn y-t-d and $53bn over the past year, or down 2.0% y-o-y.

Total Commercial Paper outstanding fell $7.2bn to $1.008 TN. CP was up $49bn y-t-d, while having declined $22bn from a year ago, or down 2.1%.

Currency Watch:

The U.S. dollar index recovered 0.6% to 79.328 (down 1.1% y-t-d). For the week on the upside, the Japanese yen increased 0.3%, the Taiwanese dollar 0.3%, and the British pound 0.1%. For the week on the downside, the Danish krone declined 1.2%, the euro 1.1%, the Mexican peso 1.1%, the Norwegian krone 1.0%, the Australian dollar 0.9%, the South African rand 0.9%, the Swiss franc 0.7%, the Brazilian real 0.5%, the Canadian dollar 0.5%, the South Korean won 0.2%, and the Swedish krona 0.1%.

Commodities Watch:

September 20 - Bloomberg: "China passed the U.S. last year for the first time to become the biggest importer of agricultural products and also increased its exports... Imports, including food and beverages, rose 34% to $144.7 billion in 2011 from $108.3 billion in 2010... Exports gained 25% to $64.6 billion, beating Canada to become the sixth largest..."

The CRB index dropped 3.7% this week (up 1.2% y-t-d). The Goldman Sachs Commodities Index sank 4.4% (up 3.0%). Spot Gold added 0.2% to $1,773 (up 13.4%). Silver was little changed at $34.64 (up 24%). November Crude dropped $6.44 to $92.89 (down 6%). October Gasoline declined 2.4% (up 11%), and October Natural Gas fell 2.0% (down 4%). December Copper declined 1.1% (up 10%). December Wheat fell 2.9% (up 37%), and December Corn dropped 4.3% (up 16%).

Global Credit Watch:

September 21 - Wall Street Journal (Marcus Walker and Matina Stevis): "A confrontation is brewing among Greece's international creditors over who will provide the financing needed to keep the country afloat. A report by international inspectors, due in October, will state how big the funding shortfall is in Greece's bailout program, but European officials say the deficit is far too big for Greece to close on its own. That means the International Monetary Fund, the European Central Bank, and euro-zone governments such as Germany will have to negotiate over which of them will make painful concessions to ease Greece's debt-service burden. That is intended to avoid a Greek bankruptcy that could force the country out of the euro and reignite financial panic across the currency bloc."

September 21 - Bloomberg (Anchalee Worrachate): "The European Central Bank's plan to buy bonds is proving more successful at keeping borrowing costs for France and Belgium near record lows than persuading investors to lend to Spain and Italy for less. Spain's three-year yield is back up to 3.83% after dipping to 3.37% on Sept. 7... The cost of insuring French debt against default has declined 24%, almost twice the 13% drop in Italian default-swap costs."

September 21 - New York Times (Raphael Minder): "Prime Minister Mariano Rajoy, already under pressure from his European counterparts to clean up Spain's banks and public finances, failed on Thursday to ease what has recently turned into his biggest domestic challenge: a separatist push by the nation's most economically powerful region, Catalonia. Instead, Catalonia's leader, Artur Mas, accused Mr. Rajoy of losing a 'historic opportunity' to safeguard the relationship between his region and the rest of Spain, after Mr. Mas was unable to persuade Mr. Rajoy to change the tax rules for Catalonia. Mr. Mas warned that Mr. Rajoy's refusal to negotiate any fiscal changes was likely to increase resentment toward the Madrid government among Catalans, after hundreds of thousands of people in the region held the largest-ever pro-independence rally, on Sept. 11 in Barcelona. 'The people and society of Catalonia are on the move, as we have seen on Sept. 11, and not willing to accept that our future will be gray when it could be more brilliant,' Mr. Mas said... after a two-hour meeting with Mr. Rajoy."

September 21 - Bloomberg (Chiara Vasarri and Lorenzo Totaro): "Italy and Spain won't request bailouts unless a new surge in bond yields leaves them shut out of markets as no government will voluntarily accept conditions imposed for the aid, a senior Italian government official said. 'There won't be any nation that voluntarily, with a preemptive move, even if rationally justified, would go to an international body and say -- 'I give up my national sovereignty,'" Gianfranco Polillo, undersecretary of finance, said... 'I rule it out for Italy and for any other country.'"

September 18 - Bloomberg (Anne-Sylvaine Chassany): "European banks pledged last year to cut more than $1.2 trillion of assets to help them weather the sovereign-debt crisis. Since then they've grown only fatter. Lenders in the euro area increased assets by 7% to 34.4 trillion euros ($45 trillion) in the year ended July 31... BNP Paribas SA, Banco Santander SA, and UniCredit SpA, the biggest banks in France, Spain and Italy, all expanded their balance sheets in the 12 months through the end of June. They have Mario Draghi to thank. The ECB president's decision nine months ago to provide more than 1 trillion euros of three-year loans to banks eased the pressure to sell assets at depressed prices... 'Deleveraging isn't taking place, especially in Spain and Italy,' said Simon Maughan, a bank analyst at Olivetree Securities... 'The fact that we haven't got on with it, or very slowly, suggests that when the time comes we'll need another ECB injection to roll over the first one, just to keep the balance sheets of Italian banks in business.'"

September 21 - Financial Times (Peter Spiegel and Miles Johnson): "EU authorities are working behind the scenes to pave the way for a new Spanish rescue programme and unlimited bond buying by the European Central Bank, by helping Madrid craft an economic reform programme that will be unveiled next week. According to officials involved in the discussions, talks between the Spanish government and the European Commission are focusing on measures that would be demanded by international lenders as part of a new rescue programme, ensuring they are in place before a bailout is formally requested."

September 17 - Bloomberg (Charles Penty): "Spanish banks, already hooked on cheap European Central Bank loans, are haemorrhaging deposits as the government debates whether to seek a bailout. Households and companies drained 26 billion euros ($34bn) from Spanish bank accounts in July, driving the ratio of loans to deposits among lenders to 187% from 183% in December and 182% a year earlier... Shrinking deposits undermine the ability of banks to support economic growth by lending to companies and consumers. 'There are significant outflows of deposits now in Spain and they won't start coming back until people are sure they're safe and that Spain is secure,' said Simon Maughan, a financial strategist at Olivetree Securities..."

September 20 - Reuters (Jesús Aguado and Julien Toyer): "An independent stress test of Spain's banking sector will likely reveal capital needs of 50 billion to 60 billion euros (47.9 billion pounds)... Spain became the latest focus point earlier this year of the euro zone debt crisis after it became clear its banks would need financial support to clean up their balance sheets of around 185 billion euros of toxic real estate assets. Sources told Reuters the Bank of Spain had started to communicate to the banks the results of the stress tests earlier on Thursday and that all of them would be informed by Monday."

September 17 - MarketNews International: "European Central Bank Governing Council Member Luc Coene thinks it is unlikely that the central bank will engage in outright bond purchases. Coene told an audience... that Spain and other countries would have to request a program with the euro zone's bailout fund in order for the ECB to buy its bonds: 'I think it's very unlikely - given the mandate we have and the treaty we have - that the ECB will engage in outright bond purchases. Of course, never say never as they say. It's clear that if Spain decides not to demand a program with the EFSF we will not buy Spanish bonds, the same is valid for the other countries ... Whatever country wants us to buy its bonds has to submit to the program with appropriate conditionality and then only on that condition will we buy bonds and only on the short part of the maturity.'"

Global Bubble Watch:

September 19 - Bloomberg (Toru Fujioka): "The Bank of Japan unexpectedly expanded its asset-purchase fund by 10 trillion yen ($126bn), seeking to counter an increasing danger of contraction in the world's third-largest economy. The BOJ's program, in which it buys mainly government debt, or JGBs, was enlarged to 55 trillion yen..."

September 18 - Reuters (Sudip Roy): "Emerging markets sovereigns, corporates and financial institutions could raise nearly $400bn of external debt this year as they seek to take advantage of benign issuance conditions, according to ING. Borrowers have already raised a record $314bn year-to-date, one-third more than the amount they issued over the same period last year."

September 21 - Bloomberg (Jody Shenn): "A measure of relative yields on mortgage securities that guide U.S. home-loan rates is poised for its biggest weekly drop in almost four years on speculation that the Federal Reserve will find a shortage of the bonds as it expands purchases... This week's drop of 34 bps, the largest since December 2008, exceeds the decline of 19 seen in the final two days of last week after the Fed's Sept. 13 announcement that it would expand its balance sheet with monthly purchases of $40 billion of government-backed housing debt until the economic recovery strengthens."

September 18 - Bloomberg (Lisa Abramowicz): "Investors are so attracted to junk bonds that they're accepting less compensation than holders of loans, which get paid first in bankruptcies. Yields on U.S. speculative-grade notes have fallen to 6.2%, 1 basis point less than a measure of what's being paid by senior secured loans, according to JPMorgan Chase & Co. That's the first time the gap has vanished, with junk bonds paying an average 103 basis points, or 1.03 percentage points, more than loans over the past three years... Junk-bond buyers are demanding lower yields to take on greater risk as they seek alternatives to Treasuries paying the least ever. Investors have unleashed an unprecedented flood of cash into the junk-bond market this year that's almost 18 times the deposits into funds that buy floating-rate loans..."

September 18 - IFR (Sudip Roy): "Emerging markets sovereigns, corporates and financial institutions could raise nearly USD400bn of external debt this year as they seek to take advantage of benign issuance conditions, according to ING. Borrowers have already raised a record USD314bn year-to-date, one-third more than the amount they issued over the same period last year. And the Dutch Bank foresees a further USD78.4bn of issuance this year..."

September 17 - Bloomberg (Mary Childs): "Exchange-traded funds are poised to overtake credit derivatives by year-end as a way to speculate on junk bonds. The value of corporate securities held by the five-largest junk ETFs almost doubled in the past year to a record $31.4 billion, while the net amount of protection bought or sold on the debt using the two current credit-default swaps indexes declined 3% to $35 billion... The ETFs are growing at an average 5.2% monthly pace this year, which would put assets at more than $36.5 billion by Dec. 31."

September 15 - Bloomberg: "China's former banking chief called the Federal Reserve's third round of quantitative easing 'irresponsible,' while an official at the regulator said the stimulus won't provide sustained support to the U.S. economy. 'It's irresponsible to the U.S., and also irresponsible to us,' Liu Mingkang, former chairman of the China Banking Regulatory Commission, told Bloomberg... Liu's comments were the latest from China warning of risks from the U.S. stimulus program, which drove commodities higher and spurred stocks to the highest levels since 2007."

September 20 - Financial Times (John Paul Rathbone and Jonathan Wheatley): "Guido Mantega, Brazil's finance minister, has warned that the US Federal Reserve's 'protectionist' move to roll out more quantitative easing will reignite the currency wars with potentially drastic consequences for the rest of the world. 'It has to be understood that there are consequences,' Mr Mantega told the Financial Times... The Fed's QE3 programme would only have a marginal benefit [in the US] as there is already no lack of liquidity . . . and that liquidity is not going into production."

Germany Watch:

September 18 - MarketNews International): "The sister party of German Chancellor Angela Merkel's CDU, the Bavarian CSU, is arguing that Germany's share in the European Central Bank's new bond-buying program must be part of the E190 billion that parliament approved as the country's contribution to Europe's permanent bailout fund, the European Stability Mechanism (ESM). CSU party leader Horst Seehofer told German weekly Der Spiegel... that the agreed E190 billion for the ESM must also include the ECB bond purchases. 'The E190 billion is what counts - including the ECB,' he said. According to Der Spiegel, the ECB leadership is worried about the announcement by the CSU and has called for a meeting with Seehofer."

September 19 - Bloomberg (Annette Weisbach): "Offenbach, a city of about 120,000 people neighboring Germany's financial capital Frankfurt, is so mired in debt it had to ask the state of Hesse for a 211 million-euro ($277 million) bailout in June. In so doing, it became one of the largest of 102 municipalities to tap 3.2 billion euros of aid Hesse is making available as the first of Germany's 16 federal states to introduce a formal rescue fund for struggling towns and cities."

China Watch:

September 18 - Bloomberg: "A Chinese manufacturing survey pointed to an 11th month of contraction and Japan's exports fell in August... The preliminary reading was 47.8 for a China purchasing managers' index... by HSBC Holdings Plc and Markit Economics, compared with a final level of 47.6 last month... Japan's overseas shipments slid 5.8% on weakness in demand from Europe and China."

September 18 - Bloomberg: "Net sales of foreign currency by China's central bank and financial institutions accelerated last month, suggesting capital outflows picked up as the nation's economic slowdown deepened... The report follows data showing foreign investment in China fell in July to the lowest level in two years amid signs economic expansion may decelerate for a seventh quarter."

September 18 - Bloomberg: "Three Chinese bond issuers have delayed or canceled bonds in the past week, as concerns grow that the U.S. Federal Reserve's monetary easing will stoke accelerating inflation in China. Sichuan Expressway Construction & Development Co.... will delay 3 billion yuan ($475 million) of notes that had been planned for sale by the end of this month... That follows cancellation of a debt sale by China Development Bank, the country's biggest lender to government projects, and the postponement of an offering by Xinao China Gas Investment Co. last week."

September 18 - Bloomberg: "Prices for newly constructed homes in China rose in fewer cities in August than the previous month, reducing the likelihood that policy makers will strengthen steps designed to constrain property prices. Thirty-five of 70 cities covered by the statistics bureau's monthly report had price gains, compared 49 in July..."

September 18 - Bloomberg (Joshua Fellman): "619-sq.m. unit in Cofco's Ocean One development in 'Little Lujiazui' area sold for record total price [$18.4 million]..."

Japan Watch:

September 18 - Bloomberg: "Japan's Fast Retailing Co. and Aeon Co. shuttered stores in China, the world's second-biggest economy, as a territorial dispute and the anniversary of the Japanese invasion prompted thousands to protest in Beijing, Shanghai and other cities... Nissan Motor Co., the largest Japanese carmaker in China, halted production at two factories in the country. Japan's purchase last week of uninhabited islands claimed by both countries is threatening trade ties of more than $340 billion and complicating efforts to fortify growth in both countries as the European debt crisis saps demand for exports. Protesters in China have ransacked retailers, smashed store fronts and overturned cars, with fires having damaged a Panasonic Corp. plant and a Toyota Motor Corp. dealership."

India Watch:

September 18 Wall Street Journal (Prasanta Sahu and Mukesh Jagota): "India will overshoot its fiscal deficit target for this financial year as economic growth has fallen short of initial estimates, the head of a top government think tank said... The fiscal deficit target--5.1% of gross domestic product--was set when the government was expecting the economy to grow around 7.5% in the current financial year through March, said Montek Singh Ahluwalia, deputy chairman of the Planning Commission. 'But we know growth rate is going to be less than that, may be 6.5%,' Mr. Ahluwalia said. 'For that reason alone, fiscal deficit will widen.' Many Economists expect the deficit could widen to as much as 6.0% of GDP this fiscal year, from 5.75% last year..."

European Economy Watch:

September 20 - Reuters (Daniel Flynn): "French business activity took a sharp turn for the worse in September, shrinking at its fastest pace since April 2009 as weak domestic demand and a deepening slowdown in southern Europe dragged the euro zone's No. 2 economy towards contraction. Economists suggested that the downbeat picture from France... showed that unemployment running a 13-year high and a raft of tax rises announced by Socialist President Francois Hollande may be weighing on activity. The Markit/CDAF flash composite purchasing manager's index (PMI), a preliminary estimate of firms' activity that covers both manufacturing and services, slid to 44.1 in September, its lowest level in 41 months, from 48.0 in August."

September 18 - UK Guardian (Henry MacDonald): "Economists have long tried to perfect the art of forecasting recessions, but others believe there are straightforward warning signs that have nothing to do with algebra or computerised modelling. For Jonnie and Derek Keys, two Irish brothers who run a vehicle and machinery auction company in Co Tyrone, Northern Ireland, the canary in the coal mine is the spike in construction equipment leaving a country at knockdown prices. ...Jonnie Keys has noticed a recent increase in the purchase of diggers, loaders, lorries and other mechanical equipment from Italy. 'We are already familiar with a surplus of vehicles, diggers, trucks and generators in Spain. Now we have noticed a large amount of kit for sale coming out of Italy at low prices. It's a sure sign of a slowdown, a warning light that things are about to get much worse, especially in the country's construction industry. That is what is now happening in Italy,' Keys says as he surveys his enormous auction yard."

September 21 - Bloomberg (Svenja O'Donnell): "Euro-area services and manufacturing output fell to a 39-month low in September as European leaders struggled to reverse the single-currency bloc's slide into recession."

September 18 - Bloomberg (Ola Kinnander): "Ford... led the steepest decline in European car sales in six months as the region's economic woes hurt demand in Germany. Industrywide car registrations fell 8.5% from a year earlier to 722,483 vehicles in August... The European car market has shrunk for 11 consecutive months as governments grapple with a sovereign-debt crisis, and the ACEA is forecasting a 17-year low for full-year sales."

September 21 - Bloomberg (Gonzalo Vina): "Britain posted its biggest August budget deficit on record, heaping pressure on Chancellor of the Exchequer George Osborne as the recession hits tax revenue and pushes up spending on welfare. The shortfall excluding government support for banks was 14.4 billion pounds ($23.5bn)... Tax revenue rose 1.8% and government spending climbed 2.5%."

September 21 - Bloomberg (Stefan Riecher): "The European Central Bank said the cost of its new Frankfurt headquarters will jump by as much as 41% due to higher prices for construction materials and 'a number of unforeseen challenges.' The 185-meter twin-towered skyscraper will now cost as much as 1.2 billion euros ($1.6bn), up to 350 million euros more than the initial price of 850 million euros... The central bank's relocation to the new premises remains scheduled for 2014... The cost blowout comes as the ECB castigates profligate European governments for failing to control their own spending."

Global Economy Watch:

September 18 - Bloomberg (Ilan Kolet and Theophilos Argitis): "Canadian existing home sales fell the most in more than two years in August as a market slump in Toronto deepened, a realtor group said. The sale of homes fell 5.8% in August to 35,869... Home sales were down 8.9% from the same month last year. The average national price for existing homes rose 1.1% from July and 0.3% from a year earlier."

U.S. Bubble Economy Watch:

September 20 - Bloomberg (Liz Capo McCormick): "The Federal Reserve's decision to hold borrowing costs steady into 2015 and buy mortgage debt each month is reducing bond market volatility and demand for options that hedge against changes in interest rates. Mortgage bond holders often use swaptions, or options on interest-rate swaps, to guard against swings in rates... Bond market volatility is already approaching the lowest levels since just before the global financial crisis."

September 21 - Dow Jones (Patrick McGee): "Weekly high-grade corporate-bond issuance is on its way to hit $30 billion for a third straight week, as more companies capitalize on a voracious appetite for fixed-income assets. Just more than $25 billion had priced as of Wednesday, and six deals are in the market Thursday for a combined $4 billion. The high-grade market has only seen a trifecta of consecutive $30 billion weeks three times in the past 17 years, most recently in early 2011, data provider Dealogic shows."

Central Bank Watch:

September 19 - UK Telegraph (Jeremy Warner): "Forget QE3 in the US, or whatever round of quantitative easing we are now up to here in the UK; in Japan they are about to embark on QE7, or is that QE8 - it's hard to keep up. In the land of the setting sun, QE is now such an everyday part of the economic landscape that it would barely have warranted a mention, let alone an entire column, but for the fact that the latest dollop of 'unconventional' policy action appears to be part of a co-ordinated, global response to the economic slowdown. Like big deficits and mountainous public debt, in Japan, QE no longer generates the same agonised debate it does in the West. It just is. For Japan, the 'unconventional' is now very much the conventional. And little good does it seem to have done either. The Japanese economy remains firmly frozen in time, having barely grown for more than 20 years now...."

September 16 - Bloomberg (Joshua Zumbrun): "Richmond Federal Reserve President Jeffrey Lacker said that he opposed the central bank's third round of quantitative easing in mortgage-backed securities because allocating credit should be the province of fiscal authorities such as the U.S. Treasury or Congress. 'I strongly opposed purchasing additional agency mortgage- backed securities,' Lacker said... 'Such purchases, as compared to purchases of an equivalent amount of U.S. Treasury securities, distort investment allocations and raise interest rates for other borrowers.' Lacker said that 'channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve.'"

September 18 - Bloomberg (Joshua Zumbrun and Mark Clothier): "Federal Reserve Bank of Chicago President Charles Evans said the central bank's third round of quantitative easing will help the economy keep growing despite headwinds from Europe's debt crisis as well as potential U.S. tax increases and spending cuts. 'Given the slow and fragile recovery, the large resource gaps that still exist, and the large risks we face, it remains clear that we needed a more resilient economy,' Evans said..."

September 20 - Bond Buyer: "QE3 is battling, as intended, the threat of decades of a 'Great Stagnation,' accelerating recovery but still in need of reinforcing fiscal policy, Boston Federal Reserve Bank President Eric Rosengren said... In an extended defense of the Fed's latest unconventional policy stimulus, Rosengren framed the effort as the Fed's refusal to accept high unemployment and low resource utilization as the status quo. The FOMC's 'forceful' actions, an example to 'policymakers of all sorts,' are in contrast, he said, to Japan's 'muted' response that helped prolong that country's stagnation into two decades."

California Watch:

September 21 - New York Times (Mary Williams Walsh): "Gov. Jerry Brown of California announced when he came into office last year that he had found an alarming $28 billion 'wall of debt' looming over the state, which had to be dismantled. Since then, he has slowed the issuance of municipal bonds, called for spending cuts and tried to persuade the state's famously antitax voters to approve a tax increase this fall. On Thursday, an independent group of fiscal experts said... the 'wall of debt' was several times as big as the governor thought. Directors of the State Budget Crisis Task Force said their researchers had found a lot of other debts that did not turn up in California's official tally. Much of it involved irrevocable promises to provide pensions to public workers, health care for retirees, the cost of delayed highway maintenance and an estimated $40 billion bill to bring drinking water up to federal standards. They also pointed out many of the same unpaid bills from previous years that the governor had brought to light, like $8 billion in delayed payments to schools and community colleges... The task force estimated that the burden of debt totaled at least $167 billion and as much as $335 billion. Its members warned that the off-the-books debts tended to grow over time..."

Muni Watch:

September 17 - Bloomberg (Michelle Kaske): "U.S. tax-exempt debt is poised to cheapen relative to Treasuries as issuance in the $3.7 trillion municipal market leaps by the most in two years. New York's Metropolitan Transportation Authority... is scheduled to lead about $8.6 billion of borrowing this week, up 87% from the previous five days... It would be the biggest jump in consecutive non-holiday weeks since May 2010. The surge may extend into October, the busiest month of issuance for the past three years."