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A Credit Theory and 'Ro, Ro' Update

My thesis contends that we are in that late-stage of a multi-decade global Credit Bubble. From a Macro Credit Theory perspective, this period of serial Bubbles has some well-defined general characteristics. First of all, monetary policy is the prevailing force behind the boom and bust cycles. Each Bubble will be larger than its predecessor, and each successive post-Bubble policy response will be more aggressive and encompassing. The government's role expands - before it becomes even bigger.

Curiously - one might say "ironically" - as each grander new Bubble becomes more systemic the excesses generally turn less conspicuous. The technology/Internet Bubble was spectacular, although Bubble-related (financial and economic) impacts were generally contained to specific industries/sectors (technology), financial assets (tech stocks and telecom debt) and geographical regions (California). The consequences from the Mortgage Finance Bubble were less conspicuous than Nasdaq 5,000, while the impacts on spending and investment patterns had much broader impacts on the underlying structure of the U.S. economy.

Today, in the midst of the greatest financial Bubble in history, most contend there's no Bubble at all. Bubble excesses have made it to the heart/foundation of the U.S. and global Credit system, while most analysts fail to see problematic asset-price overvaluation (stocks, bonds, real estate, etc.). "Money" and "money"-like instruments have at this late-stage of the cycle become the core source of monetary inflation for this crowning Bubble. This is critical, as inflationary impacts have evolved to become deeply systemic - and sufficiently all-encompassing to ensure impacts are not readily evident and of a different ilk from previous Bubble manifestations.

Treasury debt has surreptitiously further inflated incomes throughout the economy, spreading inflationary purchasing power in a more balanced - and seductively much less disruptive/alarming - fashion than the previous tech and mortgage finance Bubbles. This has worked to sustain a problematic economic structure and only exacerbate U.S. and global imbalances. Importantly, Treasury and Fed monetary fuel has inflated financial asset prices across equities, bonds and fixed-income more generally. Furthermore, monetary inflation has inflated real assets, especially anything providing an income stream (i.e. farm land, rental homes, commercial real estate, etc.) more enticing than depressed cash and bond returns. Moreover, the atypically systemic inflation in securities prices has worked to broadly loosen financial conditions and boost perceived wealth throughout the economy, again limiting the degree of conspicuous inflation and associated excess in particular sectors.

It is also important to appreciate that the nature of Bubble Dynamics dictates that the reflation of system Credit, spending and risk-taking will require ever greater policy measures to combat fallout from the bursting of each larger/more systemic Bubble. One can think in terms of lower interest rates, larger Fed purchases and more obtrusive market interventions/manipulations. The Fed took rates down to 1.75% in the 2000/'01 post-Bubble rate collapse, while the Fed's balance sheet ballooned about $100bn (to $660bn). In the post-mortgage finance Bubble reflation, the fed slashed rates to zero and the Fed's balance sheet inflated about two trillion. The government intervened throughout various asset markets (i.e. essentially nationalizing mortgage Credit), and the Fed radically altered its (market speculation-friendly) communications strategy.

As each boom and bust cycle is met with easier financing conditions and greater official sector market intervention, the resulting market incentive structure entices heightened speculation while bolstering speculative returns. Accordingly, the scope of speculation throughout the markets inflates right along with the overall size of both the Bubble and the government's role in inflating the markets and economic activity. Importantly, the policy and market backdrops heavily distort the system's pricing and incentive mechanisms, skewing returns in favor of financial speculation and at the expense of productive investment throughout the real economy (i.e. "Bernanke put" viewed as improving risk-taking prospects in financial assets, although associated policy, market and economic uncertainties provide a powerful disincentive for major private-sector capital investment projects).

Inevitably, overbearing policy will ensure a problematic divergence/decoupling between inflated securities market prices and vulnerable Bubble Economy underpinnings. This, importantly, creates heightened uncertainty and market instability. Resulting extreme monetary accommodation then ensures that this divergence Bubble Dynamic gathers further momentum. Right here one can identify the root forces behind the "risk on, risk off" ("ro, ro") dynamic that has increasingly taken command of global markets over the past few years.

I would contend that "ro, ro" is in some ways a microcosm of the overall Bubble environment. "Ro, Ro" also naturally gains momentum with each successive round of mini market boom/bust and attendant aggressive policy responses. In 2011 and 2012, "ro, ro" market instabilities grew more powerful following each intervention. Global markets rallied strongly after 2011 policy measures (the ECB's LTRO, the Fed's "twist," etc.). Yet global markets were on the verge of a much more serious crisis in the summer of 2012. Acute financial and economic fragilities ensured even more dramatic policy responses (OMT from the ECB, more "twist" and open-ended QE from the Fed, and various stimulus from the BOJ, SNB, PBOC, "developing" central banks, etc.) that provoked much greater price inflation throughout global equities and fixed-income markets.

I tend to believe it's helpful to think of 2012 as a defining "capitulation year" in terms of global policymaking. Global Bubble fragilities and an increasingly destabilizing "ro, ro" speculative market backdrop compelled policymakers to go "all in" with their commitment to unlimited market backstops and open-ended quantitative easing programs. The "do whatever it takes" Draghi Plan and the Fed's open-ended $85bn monthly QE program are the poster children for overwhelming policy responses that took almost complete command over unsettled global markets.

Here's where I see the problem: The increasingly overpowering and unstable "ro, ro" environment incited the "do whatever it takes" capitulation policy response. Global central bankers and policymakers saw the European crisis spiraling out of control, with potentially catastrophic consequences for the global financial "system" and economy. They responded with the overwhelming power they believed necessary to quash "risk off" - only to motivate a runaway "risk on."

Last week's release of the minutes from the December 11/12 FOMC meeting caused a notable, though brief, market response. Particular comments raised eyebrows: Several members "thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013... Participants were approximately evenly divided between those who judged that it would likely be appropriate for the Fed to complete its asset purchases sometime around the middle of 2013 and those who judged that it would likely be appropriate for the asset purchases to continue beyond that date... While almost all members thought that the asset-purchase program begun in September had been effective and supportive of growth, they also generally saw that the benefits of ongoing purchases were uncertain and that the potential costs could rise as the size of the balance sheet increased."

What happened? The tone from the minutes differed meaningfully from the previous tones from both the Fed's release on December 12th and the chairman's press conference. Please indulge me, as I conjecture as to what might be at work at the Fed.

First, I tend to believe that the Fed's decision to move forward with open-ended QE was primarily dictated by international financial and economic fragilities unfolding over the summer. Supporting the viewpoint of the critical role of coordinated global central bankers responses were two Wall Street Journal articles from Fed meeting day, December 12, 2012: "Inside the Risky Bets of Central Banks" (John Hilsenrath and Brian Blackstone) and "MIT Forged Activist Views of Central Bank Role and Cinched Central Bankers' Ties" (Jon Hilsenrath). These articles implied that the core of Fed policy has been dictated by secretive meetings attended by a handful of global central bankers.

Mario Draghi's stunning "Do whatever it takes" pronouncement was soon followed by Bernanke's extraordinary commitment to open-ended QE. Acute summer fragilities convinced central bank chiefs of the need for an overwhelming coordinated response. Along the way, the Bernanke Fed was compelled to tell a little fib: it explained its aggressive QE as a response to weak U.S. growth and unacceptably high unemployment. And despite some unusually assertive pre-meeting public dissent (Lacker and Fisher), the committee decided in December to follow through with the Chairman's late-summer commitment with a planned $85bn monthly bond purchase program. The committee also proceeded with a new economic indicator-based communications strategy, tying (politically palatable) policy accommodation to the U.S. unemployment rate.

Confident that high unemployment will persist for some time, analysts were quick to extrapolate $85bn monthly Fed purchases out as far as 2015. Estimates for the future size of the Federal Reserve's balance sheet inflated to as high as five to six Trillion. The problem was that the entire idea of an aggressive new QE program emanated from a potentially catastrophic "risk off" market environment replete with destabilizing de-risking, de-leveraging and general global turmoil. By the December FOMC meeting, however, the markets were increasingly succumbing to destabilizing "risk on." And by last week's FOMC minutes release, the degree of speculative excess apparent in global risk markets must have been alarming to many members of the committee.

The way I see it, the Fed is now in a bit of a pickle. With Bernanke's "it's all about jobs, jobs and jobs," the little fib justifying aggressive QE evolved more into a white lie. Some Fed officials have been opposed to any additional QE. Some were likely convinced by Bernanke over the summer/fall that the fragile global backdrop made aggressive monetary stimulus necessary. But today, with global markets on fire, only the hard-core doves would likely believe massive ongoing QE is warranted. Many would today likely see the risk of fueling asset Bubbles as overshadowing suspect QE benefits.

To this day, the ECB is still pilloried for bumping up rates in July 2008. There remains a rivalry between Federal Reserve and ECB policymaking doctrines. The Fed began slashing rates aggressively in 2007. The ECB stood firm. With crude at $140 and global markets still "dancing," the disciplined ECB was "leaning against the wind." There are those (mainly on this side of the Atlantic) that believe the ECB's July rate increase provided an important catalyst for the 2008 crisis. There are others (including myself) convinced that the Fed's aggressive 2007 policy response stoked a problematic round of global "risk on" that ensured that highly speculative markets became perfectly synchronized for a major crisis.

How's this line of analysis today relevant? Well, the European Central Bank this week gathered some composure, stood up and actually leaned gingerly against the wind. There was unambiguous recognition that the backdrop had changed. Draghi assumed a somewhat more hawkish tone - speaking of a return of "normal" financial conditions. And while I would bicker a little with "normal" describing the ongoing collapse in Spanish and Italian bond yields (spreads to German bunds have collapsed more than 60bps in two weeks), along with the melt-up in Spain's (up 6.1% y-t-d) and Italy's (up 7.6%) equities markets, market participants got the message. With the ECB leaning against and the Fed sprinting with the wind, the euro sailed right past the dollar this week. "Risk on" more than held its ground.

Tradition dictates that the ECB avoid pre-committing to a future policy course. This safeguards the central bank's flexibility to implement policy adjustments as circumstances evolve and change. It has in the past also worked to limit the marketplace from speculating excessively on the future course of policymaking. One might say such an approach helps keep the markets "honest." The Fed, on the other hand, loves to pre-commit. It views manipulating market outcomes as part and parcel to its mandate and has grown well-accustomed to using market speculators as integral to the contemporary monetary policy transfer mechanism. The ECB this week managed to shift gears a bit, while the Fed is for now locked in an $85bn monthly monetary blunder.

The markets last week briefly reacted to the release of the FMOC minutes, as if the Fed had fired a shot across the bow. For good reason, market participants remain confident that the timid Fed will again hesitate to reverse course. My guess - and supported by various comments from Fed officials - is that there is heightened concern within the committee regarding the current QE program. I believe there will likely be a move to reverse course in coming months. At the same time, every market operator today has strong conviction that the Bernanke Fed will lack the courage to admit a change of heart until after it sees resolution to the impending fiscal policy confrontations. Indeed, highly speculative markets celebrate the existence of significant systemic risk - risk that ensures the Fed keeps running with the wind and spiking the punchbowl along the way.

It's safe to add the Fed's "pre-commitment" of $85bn monthly QE - and tying such extreme accommodation to the unemployment rate - as one more major policy error for the history books. The Fed's quandary is today compounded by its obfuscation and convoluted communications strategy.

A mini "exit strategy" is definitely in order - and it's been awhile since the markets had to fret about a reversal of Fed accommodation. And, importantly, the longer "risk on" spurs global market excesses - the more pressing it will be for the Fed to act. Yet, ongoing "fiscal cliff" risks abound. Fed timidity raises the probabilities that an unleashed "risk on" finds an opening. And a scenario of runaway "risk on" - and a Fed some months down the road forced to reverse course - would play right into the "2013 fat tails, bi-polar outcome possibilities" thesis. Less hypothetical is today's predicament that highly speculative global risk market behavior is dictated by expectations for ongoing extreme policy accommodation - although I suspect policymakers have little clarity on the future course of policy because they haven't a clue as to what the future holds for a rather robust and unwieldy "risk on, risk off" speculative market Bubble Dynamic.


For the Week:

The S&P500 added 0.4% (up 3.2% y-t-d), and the Dow increased 0.4% (up 2.9%). The Morgan Stanley Cyclicals were little changed (up 4.3%), while the Transports gained 0.7% (up 5.0%). The Morgan Stanley Consumer index slipped 0.2% (up 2.7%), and the Utilities fell 1.2% (up 1.2%). The Banks were down 1.0% (up 3.7%), and the Broker/Dealers declined 0.7% (up 4.1%). The S&P 400 Mid-Caps added 0.2% (up 3.7%), and the small cap Russell 2000 increased 0.2% (up 3.7%). The Nasdaq100 was gained 0.9% (up 3.3%), and the Morgan Stanley High Tech index jumped 1.3% (up 4.1%). The Semiconductors rose 1.3% (up 4.9%). The InteractiveWeek Internet index gained 1.0% (up 4.0%). The Biotechs advanced 1.4% (up 5.9%). Although bullion gained $7, the HUI gold index was little changed (down 2.5%).

One-month Treasury bill rates ended the week at 4 bps and 3-month rates closed at 7 bps. Two-year government yields were down about 2 bps to 0.25%. Five-year T-note yields ended the week down 3 bps to 0.78%. Ten-year yields slipped 3 bps to 1.87%. Long bond yields fell 5 bps to 3.05%. Benchmark Fannie MBS yields declined 4 bps to 2.29%. The spread between benchmark MBS and 10-year Treasury yields narrowed one to 42 bps. The implied yield on December 2013 eurodollar futures declined 2.5 bps to 0.36%. The two-year dollar swap spread was unchanged at 13.5 bps, while the 10-year swap spread was little changed at 3 bps. Corporate bond spreads held most of recent narrowing. An index of investment grade bond risk increased about 2 to 87 bps. An index of junk bond risk gained one to 444 bps.

Debt issuance surged, especially for foreign issuers of dollar-denominated debt. Investment grade issuers included Bank of America $6.0bn, Comcast Corp $3.0bn, Berkshire Hathaway $2.1bn, Toyota Motor Credit $1.5bn, Ford Motor Credit $1.25bn, GE Capital $1.25bn, Staples $1.0bn, MetLife $1.0bn, Markwest Energy $1.0bn, DirecTv $800 million, ADT $700 million, Public Service E&G $400 million, Connecticut Light & Power $400 million, Sunoco Logistics $700 million, and Kilroy Realty $300 million.

Junk issuers included Halcon Resources $1.35bn, Crown America $1.35bn, HD Supply $950 million, Windstream $700 million, Rockies Express Pipeline $525 million, Neustar $300 million, MDC Holdings $250 million, and Speedway Motorsport $100 million.

Convertible debt issuers included Silver Standand Resource $250 million.

International issuers included European Investment Bank $5.0bn, Mexico $4.5bn, Intesa Sanpaulo $1.5bn, KFW $4.0bn, Daimler Finance $3.0bn, Kommunalbanken $2.0bn, Total Capital Canada $3.0bn, Standard Charter $2.5bn, Sumitomo Mitsui Banking $2.5bn, Commercial Bank of Australia $2.0bn, Turkey $1.5bn, Royal Bank of Canada $1.25bn, Westpac Banking $2.25bn, Banco BTG Pactual $1.0bn, Corpbanka $800 million, Trans-Canada Pipelines $750 million, Total Capital Intl $750 million, Kodiac Oil & Gas $350 million, Automotores Gildemeister $300 million, and Corp Pesquera Inca $250 million.

Spain's 10-year yields dropped 16 bps this week to 4.86% (down 34bps y-t-d). Italian 10-yr yields fell 13 bps to 4.12% (down 36bps), low market yields since November 2010. German bund yields rose 5 bps to 1.58% (up 27bps), and French yields added a basis point to 2.15% (up 17bps). The French to German 10-year bond spread narrowed 4 to 57 bps. Ten-year Portuguese yields rose 8 bps to 6.25% (down 50bps). The new Greek 10-year note yield jumped 59 bps to 11.51%. U.K. 10-year gilt yields slipped 3 bps to 2.08% (up 26bps).

The German DAX equities index slipped 0.8% for the week (up 1.4% y-t-d). Spain's IBEX 35 equities index jumped 2.7% (up 6.1%). Italy's FTSE MIB surged 3.2% (up 7.6%). Japanese 10-year "JGB" yields declined a basis point to 0.80% (up 2bps). Japan's Nikkei added 1.1% (up 3.9%). Emerging markets were mixed. Brazil's Bovespa equities index fell 1.6% (up 0.9%), while Mexico's Bolsa added 0.7% (up 2.7%). South Korea's Kospi index declined 0.8% (unchanged). India's Sensex equities index slipped 0.6% (up 1.2%). China's Shanghai Exchange declined 1.5% (down 1.2%).

Freddie Mac 30-year fixed mortgage rates jumped 6 bps to 3.40% (down 49bps y-o-y). Fifteen-year fixed rates were up 2 bps to 2.66% (down 50bps). One-year ARM rates rose 3 bps to 2.60% (down 16bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 4 bps to 4.02% (down 58bps).

Federal Reserve Credit jumped $9.3bn to $2.906 TN. Fed Credit has increased $94.8bn in 9 weeks. Over the past year, Fed Credit expanded $22.7bn.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $719bn y-o-y, or 7.1%, to $10.910 TN. Over two years, reserves were $1.667 TN higher, for 18% growth.

M2 (narrow) "money" supply surged $74.9bn to a record $10.506 TN. "Narrow money" has expanded 7.9% ($772bn) over the past year. For the week, Currency increased $1.7bn. Demand and Checkable Deposits dropped $21.7bn, while Savings Deposits jumped $88.2bn. Small Denominated Deposits declined $2.9bn. Retail Money Funds jumped $9.5bn.

Money market fund assets rose $11.5bn to $2.716 TN. Money Fund assets have expanded $10bn y-o-y, or 0.4%.

Total Commercial Paper outstanding jumped $23.2bn to $1.105 TN CP was up $141bn in 9 weeks and $142bn, or 14.7%, over the past year.

Currency Watch:

January 11 - Bloomberg (Mariam Fam and Abdel Latif Wahba): "Egypt appointed Hisham Ramez to take over as governor of a central bank that's fighting to preserve public confidence in the pound after it plunged to a record low... The pound has slid more than 5% in two weeks."

The U.S. dollar index dropped 1.2% to 79.56 (down 0.3% y-t-d). For the week on the upside, the euro increased 2.1%, the Danish krone 2.1%, the Norwegian krone 1.3%, the Swiss franc 1.2%, the Swedish krona 1.1%, the South Korean won 0.9%, the Mexican peso 0.7%, the New Zealand dollar 0.6%, Australian dollar 0.5%, the Australian dollar 0.5%, the British pound 0.4%, the Canadian dollar 0.2%, the Taiwanese dollar 0.2%, and the Singapore dollar 0.2%. For the week on the downside, the Brazilian real declined 0.1%, the Japanese yen 1.2%, and the South African ran 1.8%.

Commodities Watch:

January 11 - Bloomberg: "China, owner of the world's largest foreign exchange reserves, may increase gold holdings to diversify away from the U.S. dollar, a researcher said. 'There's no reason why the Chinese central bank should hold a disproportionate amount of other countries' reserve currencies such as the dollar,' David Marsh, chairman of the Official Monetary and Financial Institutions Forum, said... 'It is likely that the Chinese authorities will carry on purchasing gold in modest amounts and they will do it in a way calculated not to disturb the market.'"

The CRB index gained 0.9% this week (up 0.6% y-t-d). The Goldman Sachs Commodities Index increased 0.4% (0.5%). Spot Gold gained 0.4% to $1,663 (down 0.7%). Silver recovered 1.5% to $30.41 (up 0.6%). February Crude added 47 cents to $93.56 (up 1.9%). February Gasoline declined 0.9% (down 0.8%), while February Natural Gas gained 1.2% (down 0.7%). March Copper fell 1.1% (unchanged). March Wheat gained 1.0% (down 3.0%), and March Corn jumped 4.2% (up 1.5%).

Fiscal Watch:

January 9 - Bloomberg (Stephen Joyce): "A reprieve the $3.7 trillion municipal bond market received in the U.S. budget agreement last week may be only temporary. The deal extended several types of narrowly focused bond- related activities, such as funding school renovations or paying for construction projects in New York near the area of Sept. 11, 2001, terrorist attacks. It revised the alternative minimum tax, and without that, some types of bonds could have been unattractive to tens of millions of taxpayers. It didn't eliminate the tax exemption on municipal bond income, an idea contemplated by lawmakers."

January 10 - Bloomberg (Shobhana Chandra): "Lawmakers focusing on deficit-reduction over the next 10 years overlook an explosion of U.S. debt lurking just beyond that time horizon, says Michael Feroli, chief U.S. economist at JPMorgan... The BGOV Barometer shows publicly-held debt would balloon to 236% of gross domestic product in 30 years, from 73% in 2012... according to JPMorgan projections. Even a plan that combined $1 trillion in higher revenue with a like amount of government spending cuts would still let the debt climb to 213% of GDP by 2042. An aging population puts pressures on long term debt that will begin to bite around 2025, just beyond the 10-year window used in budget negotiations, Feroli said."

Global Bubble Watch:

January 11 - Bloomberg (Alexis Xydias and Whitney Kisling): "Investor deposits with global equity mutual funds in the first week of January were higher than any other period except one, a sign they may be coming back to stocks after withdrawing cash for the past six years. About $22 billion flowed into equity funds around the world in the week ended Jan. 9, according to... research firm EPFR Global going back to 1996."

January 7 - Bloomberg (Jim Brunsden, Giles Broom and Ben Moshinsky): "Global central bank chiefs gave lenders four more years to meet international liquidity requirements and watered down the measures in a bid to stave off another credit crunch. Banks won the delay to fully meet the so-called liquidity coverage ratio, or LCR, following a deal struck by regulatory chiefs meeting... in Basel, Switzerland. They'll be able to pick from a longer list of approved assets including equities and securitized mortgage debt as they seek to build up buffers of liquidity for use in a financial crisis. Bank shares soared after the decision to overhaul the proposed ratio, which top officials such as European Central Bank President Mario Draghi argued would choke interbank lending and make it harder for authorities to implement monetary policies."

January 11 - Bloomberg (Aki Ito): "Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank may not be doing enough to combat unemployment and meet its goal for price stability. 'Inflation will run below the Fed's target of 2% over the next two years and the unemployment rate will remain elevated,' Kocherlakota said... 'If anything, monetary policy is currently too tight, not too easy.'"

January 7 - Bloomberg (Nikolaj Gammeltoft and Alexis Xydias): "Speculators are abandoning money- losing bets that stocks with the closest links to the U.S. economy will fall as America's most-hated shares stage the best rally in a year relative to the broader market. The 20 stocks with the highest short sales in the Standard & Poor's 500 Index rose an average of 5.1% in December, compared with 0.7% for the full gauge... The Bloomberg Global Aggregate Hedge Fund Index, which tracks average performance in the $2.19 trillion industry, increased 1.1% last year."

January 8 - Bloomberg (Jesse Westbrook and Chris Larson): "Hedge funds that use computers to follow trends lost money for a second straight year in 2012 as political debates over the U.S. fiscal cliff and Europe's sovereign-debt crisis roiled markets. The Newedge CTA Trend Sub-Index, which tracks the performance of the largest computer-driven, or quant funds, fell 3.4% last year after a 7.9% decline in 2011... The performance of the funds belies their popularity with investors, who've poured $108.2 billion into the pools since the end of 2008..."

January 11 - Bloomberg (Michael Patterson): "Emerging-market equity funds recorded their biggest-ever weekly inflows as the U.S. budget deal and China's economic rebound fueled investor demand for riskier assets. The funds attracted a net $7.4 billion in the week ended Jan. 9 and assets under management reached an all-time high of $781 billion... Developing-nation debt funds lured their second-largest inflows of $2 billion, Garner said... Mutual fund purchases have helped spur a 22% rebound in the benchmark MSCI Emerging Markets Index from last year's low on June 4."

January 8 - Bloomberg (Mayumi Otsuma): "Japan plans to use its foreign-exchange reserves to buy bonds issued by the European Stability Mechanism and euro-area sovereigns, as the nation seeks to weaken its currency, Finance Minister Taro Aso said. 'The financial stability of Europe will help the stability of foreign-exchange rates, including the yen,' Aso told reporters... 'From this perspective, Japan plans to buy ESM bonds,' he said."

January 7 - Bloomberg (Nikolaj Gammeltoft and Cecile Vannucci): "The cost of U.S. stock options fell the most ever last week after a budget resolution and better-than-estimated jobs report sent equities to a five-year high. The Chicago Board Options Exchange Volatility Index, known as the VIX, plunged 39% to 13.83 last week, the biggest drop since the gauge was created in 1990."

January 8 - Bloomberg (Max Abelson): "Sitting onstage in Washington's Ronald Reagan Building in July, Lloyd C. Blankfein said Goldman Sachs Group Inc. had stopped using its own money to make bets on the bank's behalf. 'We shut off that activity,' the chief executive officer told more than 400 people at a lunch organized by the Economic Club of Washington, D.C., slicing the air with his hand. The bank no longer had proprietary traders who 'just put on risks that they wanted' and didn't interact with clients, he said. That may come as a surprise to people working in a secretive Goldman Sachs group called Multi-Strategy Investing, or MSI. It wagers about $1 billion of the New York-based firm's own funds on the stocks and bonds of companies, including a mortgage servicer and a cement producer..."

Global Credit Watch:

January 11 - Bloomberg (Rebecca Christie): "Bondholders are in the crosshairs as conservative European leaders gather in Cyprus amid talks over a bailout that may be as big as the nation's entire economy. German Chancellor Angela Merkel said this week Cyprus won't get 'special' treatment as it negotiates the rescue it requested in June."

January 10 - Bloomberg (Lisa Abramowicz): "Investors' preference for the most-liquid corporate debt is running higher than any time since the credit crisis, a signal they're preparing for the four-year rally to end. The expense incurred by credit traders to complete bond transactions was the lowest last year relative to costs implied by the market's average bid-ask spread since 2009, according to Barclays Plc. The shift, a sign that buyers are favoring securities that are easiest to trade, has helped financial bonds beat industrial debt by the biggest margin on record..."

January 9 - Bloomberg (Anthony Effinger and Mary Childs): "Andrew Feldstein, the Harvard-educated lawyer who leads BlueMountain Capital Management LLC, has had a good run. His firm boasts just one losing year since it was started in 2003. Assets have swelled to $12.7 billion, and he has 150 people in New York and London helping him manage the abstruse derivatives contracts he likes to trade: credit-default swaps, collateralized debt obligations, synthetic CDOs, mortgage bonds, swaptions -- the alphabet soup of stuff that went bad in 2008. Feldstein is best known for his June coup, when he bet against the London Whale - JPMorgan... trader Bruno Iksil -- who was long and wrong on $100 billion in credit derivatives. That play reaped $300 million for BlueMountain... JPMorgan lost $6.2 billion. Feldstein did more than make money. He also helped Chief Executive Officer Jamie Dimon unwind JPMorgan's trades, earning points with America's most powerful banker..."

January 8 - Bloomberg (Katie Linsell): "Euribor, the base rate for trillions of euros of lending, may face an exodus of contributors after Rabobank Groep's departure, according to the banking lobby that administers the scandal-hit benchmark. 'If some other very important banks witness Rabobank deciding to leave, they might do the same,' Cedric Quemener, director of... Euribor-EBF..., said... Rabobank 'is a very credible institution' and Euribor 'could lose some credibility,' he said."

Germany Watch:

January 8 - Bloomberg (Jeff Black): "German exports declined more than economists forecast in November... Exports... fell 3.4% from October, when they unexpectedly rose 0.2%... That's the steepest decline in more than a year."

January 9 - Bloomberg (Jeff Black and Stefan Riecher): "German Chancellor Angela Merkel's economic machine is beginning to show signs of neglect. As the continent's growth engine and self-appointed fiscal paragon orders budget cuts for its peers, investors, economists and policy makers are starting to warn Germany is turning a blind eye to its own weaknesses. Joerg Asmussen, a European Central Bank board member nominated by Merkel, has gone as far as to predict a return to the status of 'Sick Man of Europe' should they go unfixed. Without Merkel and a largely supportive German electorate ready to back over 300 billion euros ($393bn) in bailouts and guarantees, Europe's debt crisis could have already broken up the single currency. At the same time, the drive to rescue Europe has distracted her from signs of economic drift at home as labor costs rise at the fastest pace in a decade..."

Italy Watch:

January 7 - Bloomberg (Andrew Frye): "Former Italian Prime Minister Silvio Berlusconi renewed his partnership with the Northern League and signalled he is willing to forgo the premiership if his coalition wins the general election next month. Berlusconi's People of Liberty party reached an agreement with the League to run together in February elections, he said... While the coalition's campaign will be led by Berlusconi, the premiership would be determined after the vote and he would consider serving as finance minister, he said."

Spain Watch:

January 8 - Bloomberg (Ben Sills and Esteban Duarte): "Spanish Prime Minister Mariano Rajoy added more than 3 billion euros ($3.9bn) to his debt load in the closing hours of 2012 with a New Year's Eve order removing a cap on utilities' government-guaranteed losses. The decision... added to the snowballing power-tariff debt, which isn't included in the public accounts. The shortfall exceeded 20 billion euros at year end... Spain's government-controlled electricity system has raised less revenue from consumers than it pays to power companies for most of the past decade. Officials have covered the difference with bonds in the so-called FADE program."

January 8 - Bloomberg (Angeline Benoit): "Spain plans to sell 59 billion euros ($77bn) of bonds after maturities in 2013 to finance the euro-region's second-largest budget deficit. Net bond issuance for this year compared with net sales of 62.7 billion euros least year and an initial target of 35.8 billion euros for 2012, Spain's Treasury chief, Inigo Fernandez de Mesa, told reporters... Gross issuance will reach 215 billion euros to 230 billion euros and include 23 billion euros in financing for Spain's regions, he said. That compares with 249.6 billion euros in gross issuance last year, he said."

January 11 - Bloomberg (Angeline Benoit): "Industrial output in Spain dropped for a 15th straight month in November and almost twice as much as economists predicted as the recession in Europe's fourth largest economy deepens. Output at factories, refineries and mines... fell 7.2% from a year earlier..."

January 8 - Bloomberg (Angeline Benoit): "Catalonia is pleading for a budget deficit target higher than 0.7% of GDP this year, Expansion reports, citing comments by regional finance chief Andreu Mas-Colell."

European Economy Watch:

January 7 - Bloomberg (Ambereen Choudhury): "Euro-region banks may shrink their loan books by 132 billion euros ($172bn) this year in response to tougher regulation and capital rules, according to Ernst & Young LLP. The outlook for bad loans has also worsened as credit quality in the 17-nation currency area has deteriorated more sharply than expected... Non-performing loans will rise to 7.6% of lending in the region in 2013 from 6.8% in 2012, Ernst & Young estimated."

January 8 - Bloomberg (Marcus Bensasson): "The euro-area jobless rate rose to a record in November as the fiscal crisis and tougher austerity measures deepened Europe's economic troubles. Unemployment in the 17-nation region rose to 11.8% from 11.7% in October... That's the highest since the data series started in 1995..."

January 11 - Bloomberg (Simon Kennedy): "European policy makers are shifting focus from a financial crisis to an economic-growth crisis. 'We are now back in a normal situation from a financial viewpoint, but we are not at all seeing an early and strong recovery,' European Central Bank President Mario Draghi said. Luxembourg Prime Minister Jean-Claude Juncker, who leads euro-area finance ministers, echoed that by saying, 'the worst is over, but what we still have to do is difficult.' As the Euro Stoxx 50 posts its best start to a year since 2003 and bond yields from Greece to Spain recede from euro-era highs..."

China Bubble Watch:

January 9 - Bloomberg: "China's bank loans as a share of funding in the economy may have fallen to a record low, highlighting the growth of alternative financing channels that have prompted warnings of rising credit risks. New yuan loans probably dropped 14% last month from a year earlier, according to the median projection in a Bloomberg... survey of 37 analysts... That would give bank lending a 55% share of aggregate financing for 2012, based on UBS AG estimates, the least in figures dating to 2002. The decline underscores the waning ability of official loan data to capture the scale of debt in the world's second-largest economy as borrowers and investors turn to less-regulated, higher-return shadow-banking products... 'China's economic performance in 2013 will be significantly affected by how seriously Chinese regulators are going to treat non-bank financing,' said Shi Lei, a Beijing-based analyst with broker Founder Securities Co.... Lending by so-called trust companies surged five times to 1.04 trillion yuan ($167bn) in the first 11 months of 2012 compared with the whole of 2011. A 'large part' of the sector's lending is to higher-risk entities including local-government investment vehicles and property developers, and investors may underestimate risks, the IMF said..."

January 9 - Bloomberg: "China's local government bonds are rallying as brokerages say a regulatory crackdown on new issuance won't stop refinancing needed to fend off defaults. The average yield on the bonds has fallen 16 bps over the last three months to 6.28%... Net issuance may top 800 billion yuan ($129bn) in 2013, from more than 700 billion yuan last year, according to Orient Securities Co. Cities and counties are turning to the bond market to pay off debt that surged to 10.7 trillion yuan following spending on roads, bridges and subways after the global financial crisis. While the country's leadership under Xi Jinping said last week it will curb local debt expansion, it has also pledged to support urban development to spur growth in the world's second-largest economy."

January 11 - Bloomberg: "China's inflation accelerated more than forecast to a seven-month high as the nation's coldest winter in 28 years pushed up vegetable prices, a pickup that may limit room for easing to support an economic recovery. The consumer price index rose 2.5% in December from a year earlier... That compares with the 2.3% median estimate... 'With growth momentum firming up and inflation picking up, the likelihood of any further easing has disappeared and the next interest-rate move will probably be an increase,' which could come as early as the fourth quarter, Zhu Haibin, chief China economist at JPMorgan... in Hong Kong, said... Inflation may temporarily accelerate to more than 3 percent next month, Zhu said, reflecting the impact of cold weather on food prices and the weeklong Chinese Lunar New Year holiday, which fell in January last year... Food prices rose 4.2% in December from a year earlier, the most since May... Vegetable prices increased 14.8% from a year earlier..."

January 7 - Bloomberg: "The coldest winter in 28 years in China, the world's largest wheat producer, may hamper the developing winter crop, according the official China National Grain and Oils Information Center. Southern China will be hit by a new cold front this week, with temperatures dropping to as low as minus 5 degrees Celsius... Guizhou and Hunan provinces may experience snowstorms, it said. Widespread snowfall and lower temperatures since Jan. 2 have affected crops in southern growing regions and along the Huai River..."

Japan Bubble Watch:

January 9 - Bloomberg: "The last time a dispute between Japan and China blew up in 2010 over eight uninhabited islands, the economic fallout lasted less than a month. This time, the spat is prolonging a recession in the world's third-largest economy. Four months after Chinese consumers staged a boycott of Japanese products over the islands in the East China Sea, sales of Japanese autos in China have yet to recover, Chinese factories began to favor South Korean component suppliers, and the U.S. has displaced China as Japan's largest export market. 'The spats have become increasingly costly as Japan's dependence on China as an export market has risen,' said Tony Nash... managing director at IHS Inc.... 'Nationalism around the issue has resulted in lower demand for Japanese products in China and even Chinese firms sourcing products from Korean suppliers.' As China's confidence in asserting its territorial claims has grown, and trade between the two nations has tripled since 2000 to more than $300 billion..."

January 11 - Bloomberg (Keiko Ujikane and Mayumi Otsuma): "The Japanese government will spend 10.3 trillion yen ($116bn) to drive a recovery from a recession in Prime Minister Shinzo Abe's first major policy initiative to end deflation and boost growth. About 3.8 trillion yen will be for disaster prevention and reconstruction, with 3.1 trillion yen directed to stimulating private investment and other measures... Extra spending will increase gross domestic product by about 2 percentage points and create about 600,000 jobs... The stimulus may heighten concern that the government's commitment to fiscal reform is slipping, adding to the risk that a public debt more than twice the size of the economy may trigger a surge in bond yields."

January 9 - Bloomberg (Andy Sharp and Keiko Ujikane): "Prime Minister Shinzo Abe said the Bank of Japan should aim for 2% inflation at the first meeting in four years of a panel that brings together government and central bank officials. Abe said that the government and the BOJ should strengthen cooperation to achieve the price goal, in opening remarks at the Council on Economic and Fiscal Policy today in Tokyo that were open to the press. BOJ Governor Masaaki Shirakawa told reporters after the meeting that it was 'meaningful' and that the central bank is in close cooperation with the government. The meetings may help to decide whether the government pushes for a formal accord with the central bank as Abe calls for a doubling of the BOJ's 1% inflation goal."

January 9 - Bloomberg (Masaki Kondo, Mariko Ishikawa and Kazumi Miura): "Prime Minister Shinzo Abe's plan to reverse Japan's efforts to rein in the world's largest debt reduced demand at his inaugural sale of benchmark bonds. The ratio of bids to 10-year securities on offer at the auction yesterday fell for a second time, even after the coupon rose to 0.8% from 0.7%. Japan's extra yield on 20-year debt over five-year notes rose to 1.60 percentage points, the most in more than two years... The gap between similar debt is 1.80 points in the U.S. and 1.76 points in Germany. 'There's a bearish mood in the bond market,' said Makoto Suzuki, a senior bond strategist... at Okasan Securities Co."

January 7 - Bloomberg: "Toyota Motor Corp. pushed back plans to make China its third million-unit market until after this year as Asia's biggest carmaker waits for anti-Japan sentiment to subside and demand to return to normal.... Sales in December dropped 16% to 90,800, the sixth straight monthly decline..."

January 11 - Bloomberg (Toru Fujioka and Andy Sharp): "Japan posted a larger-than-expected current account deficit as exports fell, underscoring the challenges facing Prime Minister Shinzo Abe as he prepares a stimulus package to pull the economy out of a recession. The shortfall in the widest measure of the nation's trade in November was 222.4 billion yen ($2.5bn)..."

India Watch:

January 9 - Bloomberg (V. Ramakrishnan): "Indian lenders sold the most bonds in almost four years last month to meet tighter capital rules, and the nation's leading underwriter says demand will stay strong as the central bank cuts interest rates. Banks sold at least 124.4 billion rupees ($2.3bn) of debt... the most since March 2009... The yield on 10-year notes issued by AAA banks fell 51 bps last year to 8.91%. The similar rate in China was 5.28%."

U.S. Bubble Economy Watch:

January 11 - Wall Street Journal (Kristina Peterson): "The Federal Reserve sent a record $88.9 billion in profits to the Treasury Department in 2012 as it reaped gains from the unconventional programs it launched to spur economic growth. Last year's remittance to Treasury topped the previous record of $79.3 billion in 2010... Since the financial crisis and ensuing recession, the Fed has initiated a host of bond-buying programs and other efforts... In the process, the Fed has expanded its portfolio of securities and loans to $2.9 trillion at the end of 2012 from less than $900 billion before the crisis. The stimulus efforts for now are generating large profits as the central bank earns interest on the assets."

Central Banking Watch:

January 11 - MarketNews International (Steven K. Beckner): "St. Louis Federal Reserve Bank President James Bullard issued stark warnings Friday about the 'politicization' and 'fiscalization' of monetary policy. Bullard, a voting member of the Fed's policymaking Federal Open Market Committee this year, was particularly critical of the European Central Bank and its Outright Monetary Transaction program. 'Financial crisis aftershocks have introduced a 'creeping politicization' of central banking globally,' he said... 'To the extent that central bank independence is weakened globally, macroeconomic stabilization policy will not be executed as well in the future as it has been since the mid-1980s... This suggests more macroeconomic volatility ahead.' Bullard further warned that 'fiscalization of monetary policy will tend to complicate the policymaking process substantially.'"

January 11 - MarketNews International (Steven K. Beckner): "Federal Reserve Vice Chairman Janet Yellen expressed the hope Saturday that the Fed will be able to 'exit' from its very loose monetary policy, but gave no sense of when that will be possible. Yellen said that the Fed's ability to raise the rate of interest it pays on excess reserves will play a key role when that time comes. She was hosting a panel discussion... and reflecting on 'how much things have changed' since she last taught macroeconomics in 2003. 'The tools of policy have actually changed a great deal over the last decade... For example, the Federal Reserve no longer needs to regulate short-term interest rates by varying the quantity of monetary base or bank reserves because we are now allowed to pay interest on reserves.'"


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