The global government finance Bubble has seen at least its second crack develop.

The Q1 2013 Z.1 "Flow of Funds" was notable for the surprising ongoing lackluster Credit expansion throughout much of the private-sector. Even with continuing double-digit percentage growth in Federal borrowings, Total Non-Financial Debt expanded at a 4.6% rate during the first quarter (down from Q4 2012's 6.5%). Household debt contracted at a 0.6% rate, a reversal from Q4's 2.2% expansion. Surprisingly, Household Mortgage Debt declined at a 2.3% pace versus Q4's 1.0% rate of contraction. Non-mortgage Household borrowings remained relatively strong, with Q1's 5.7% pace down only slightly from Q4's 6.5%. Corporate borrowings slowed from Q4's blistering 12.1% pace to 7.6%.

The federal government's domination of U.S. Credit runs unabated. Federal debt expanded at a 10.3% rate during the quarter, down only slightly from Q4's 11.2%. Keep in mind that federal debt expanded 24.2% in 2008, 22.7% in 2009, 20.2% in 2010, 11.4% in 2011 and 10.9% in 2012. In nominal dollars, outstanding Treasury debt increased $337bn during the quarter, with a one-year gain of $1.078 TN. Treasury debt increased a staggering $6.655 TN, or 127%, during the past 19 quarters.

In seasonally-adjusted and annualized (SAAR) nominal dollars, Total Non-financial Debt expanded $1.850 TN, down from Q4's SAAR $2.585 TN but still relatively strong. For comparison, Total Non-financial debt increased $1.872 TN in 2012, $1.325 TN in 2011, $1.472 TN in 2010, $1.058 TN in 2009, $1.921 TN in 2008 and $2.554 TN in 2007. At SAAR $1.198 TN, federal borrowings during the quarter accounted for 65% of Total Non-Financial Debt growth. For comparison, federal borrowings as a percentage of Total Non-financial Debt growth were 61% in 2012, 79% in 2011, 107% in 2010, 136% in 2009 and 64% in 2008. During the boom years 2006 and 2007, federal borrowings amounted to less than 10% of Total Non-financial Debt growth.

There are a few striking facets of the most recent Z.1 report from the Fed. Importantly, private-sector Credit continues to struggle in the face of ongoing ultra-loose financial conditions and inflating asset markets. Surprisingly, even with mortgage rates at all-time lows (along with the reemergence of house price inflation), Total Mortgage Credit contracted 1.9% annualized during Q1 to $13.091 TN. This follows Q4's 0.4% gain, the first positive mortgage Credit growth since Q1 2008. Both Household and Commercial mortgage Credit contracted during the first quarter.

We'll now watch with keen interest how the significant jump in borrowing costs impacts mortgage Credit and bubbling real estate markets more generally. Even a major refinancing boom and recovery in home prices was not enough to spur even positive growth in household mortgage borrowings. For households, low returns on savings have incentivized paying down mortgage debt. While this dynamic has helped improve the Household balance sheet, it has provided ongoing headwinds against a self-sustaining private-sector Credit resurgence. Said another way, despite years of zero rates, an historic increase in government debt and massive Fed monetization there is little to indicate a sustainable private-sector Credit expansion.

Total Bank Assets expanded $186bn during Q1 (to $15.244 TN), with Reserves at the Fed surging $299bn during the quarter to a record $1.790 TN. Bank loan growth slowed to a 1.3% pace, the slowest since the recession, as year-over-year loan growth slipped to 8.4%. Mortgage loans declined $38bn during the quarter after gaining $57bn during Q4. Miscellaneous Assets dropped $63bn (to $1.208 TN). Government securities holdings jumped $38bn, the strongest increase in a year.

Away from the banking system, Securities Broker/Dealer assets contracted slightly to $2.049 TN (down 0.7% y-o-y). Funding Corp assets were little changed at $2.166 TN (up 5.4% y-o-y). Securities Credit declined $28bn to $1.485bn (up 7.9% y-o-y). Finance Company assets declined slightly during the quarter (down 4.7% y-o-y) to $1.519 TN. Real Estate Investment Trust (REIT) assets were little changed for the quarter at $797bn (up 14% y-o-y). Credit Union assets expanded at a 9% rated during the quarter to $980bn (but up 3.8% only y-o-y).

With legislation in the works that would seek to "privatize" Fannie and Freddie, it's worth taking a look at this quarter's GSE data. Total Agency Securities (debt and MBS) jumped $47bn during the quarter to $7.591 TN, with a one-year gain of $58bn, or 0.8%. Despite the ongoing contraction in overall mortgage borrowings, Total GSE Securities are little changed from 2010 levels. Total GSE assets (holdings) actually increased $4.4bn during Q1 to $6.300 TN. From a year ago, total assets were down 2.1%, or $133bn. GSE (insured) MBS actually increased $26bn, or 7.2% annualized, during the quarter to $1.463 TN. GSE MBS jumped $133bn, or 10%, over the past year. In three years, GSE MBS jumped $456bn, or 45%. It will be a very tall order to ever privatize a largely nationalized household mortgage industry.

I also have no doubt that it is going to be very difficult to wean U.S. and global markets off of Federal Reserve QE liquidity. Federal Reserve assets surged $289bn, or 39% annualized, during the quarter to a record $3.244 TN. The Fed's balance sheet surpassed $1 Trillion for the first time back in 2008. Fed assets are now on track to reach $4.0 TN near year-end.

There were a couple key aspects of past "Flow of Funds" analysis that came to mind as I made my way through recent data. I recall becoming increasingly concerned with mortgage Credit dominance over system Credit expansion back in 2005/06. And the longer that trend continued the greater my fear for the deep structural impacts that this unusual flow of finance was having on our financial system and the underlying real economy.

The dominance of Washington finance has similarly long overstayed its welcome. When the Fed was aggressively expanding its balance sheet in 2008/09, its purchases were essentially accommodating financial sector de-leveraging (i.e. the Fed providing a liquidity backstop for troubled banks, leveraged hedge funds, securities firms, REITs and such). Federal Reserve buying (monetization) over the past six months has been of an altogether different kind. Instead of accommodating de-risking/de-leveraging, the Fed purchases have instead incited risk-taking and leveraged speculation.

Even former Fed chair Alan Greenspan went public (CNBC) Friday with his call to begin tapering: "The sooner we come to grips with this excessive level of assets on the balance sheet of the Federal Reserve, which everyone agrees is excessive, the better... The issue is not only a question of when we taper down, but when do we turn? And I think that the markets may not give us all of the leeway we would like to do that."

Well, the Fed is supposedly one of these days going to "come to grips with this excessive level of assets on the balance sheet." But there's a heck of a dilemma developing. The Fed has been using its balance sheet to stoke the asset markets, in the process incentivizing risk-taking and leveraging. If the Fed does at some point decide to restrict asset purchases, where will the markets look to for their coveted "liquidity backstop?"

I recall the 1993 bond market Bubble as if it were yesterday. I was confident in the analysis that extraordinary speculative leverage had accumulated through the hedge funds and derivatives markets. The Greenspan Fed's low short-term rates and orchestrated steep yield curve created powerful market incentives and distortions. I was convinced that an inevitable bond market reversal would unleash considerable turmoil and market dislocation. And I was right, to a point. When the Fed began to reverse its loose monetary policy in early 1994, many were stunned by the dramatic jump in market yields all along the curve. After trading at 4% in early January, 2-year yields spiked to 7.7% by year-end.

There was considerable pain and even a few fund failures. The surge in yields even precipitated financial and economic collapse in Mexico. At the same time, I was surprised that a major speculative de-leveraging wasn't having a more profound impact on overall financial conditions. I suspected at the time that Fannie Mae and Freddie Mac purchases were providing the leveraged players an important liquidity backstop. The 1994 experience had a profound impact on my Macro Credit and Bubble Analysis.

"Flow of Funds" data tell the story pretty well. GSE assets surged an unprecedented $148bn in 1994, or 23%, to $782bn. With little fanfare, Fannie and Freddie had morphed from insuring mortgage securities to highly leveraged holders of mortgages and debt that were more than happy to buy huge quantities of securities (at top dollar) in the midst of acute market turbulence. And the GSEs were anything but finished in 1994.

GSE assets increased $115bn in 1995, $92bn in 1996 and another $112bn in 1997. When markets were rocked by the collapse of LTCM and attendant speculative deleveraging, the GSE's expanded holdings an unprecedented $305bn in 1998 - followed by another $317bn in Bubble year 1999. The GSEs added another $822bn during the tumultuous 2000-2002 period. By the end of 2003, GSE assets had inflated to $2.4 Trillion, in the process having transformed the marketplace for mortgage finance, market-based Credit and speculative finance more generally.

In the late-nineties, I was explaining to anyone that would listen (basically no one) that the GSEs had evolved into quasi central banks. With the revelation of accounting fraud and malfeasance at Fannie and Freddie, the leveraged speculating community had lost their liquidity backstop. By then, however, the mortgage finance Bubble had gained such powerful momentum that a euphoric marketplace saw no reason to fret.

But as mortgage Credit came to so dominate the financial and economic systems, with each quarterly analysis of the Z.1 in the 2006/07 period I would contemplate how the system might function during the next period of market de-risking/de-leveraging. There was no doubt in my mind that the backstop function would rest exclusively with the Federal Reserve. Further, I believed a bursting of the Mortgage Finance Bubble would likely require Trillions of market liquidity support. The rest is history. I look at 2013 as nearing the "Twenty-year Anniversary of the Liquidity Backstop"

Well, this is year five of the "global government finance Bubble." This Bubble encompasses the world's securities markets. Having played such a profound role in fueling this Bubble, it's not easy for me to conceptualize how central bank balance sheets will now be looked upon to backstop global markets in the next major de-risking/de-leveraging episode. A serious global de-leveraging would require multi-trillions of liquidity support, which I fear at this point might unleash currency and market chaos.

The liquidity backstop issue becomes especially pertinent to the MBS marketplace. Pressure is (again) mounting for Fannie and Freddie to further shrink their holdings. It would appear they're out of the market backstop business for good. Moreover, pressure mounts for the Fed to wind down its foray into mortgage support ("Credit allocation"). Meanwhile, as the Fed apparently prepares to back away from its historic experiment in suppressing market yields, the situation becomes only more intriguing. MBS are a particularly problematic security in a rising yield and extraordinarily uncertain market environment. Perhaps this helps explain why MBS yields are up 74 bps since May 1st and mortgage borrowing costs this week jumped to a 14-month high.

U.S. homebuyers are not alone in confronting rising borrowing costs, while MBS investors have plenty of global company when it comes to contemplating prospective market liquidity backstops. Bloomberg's William Pesek titled his most recent article "Specter of Another Bond Crash Is Spooking Asia." "Developing" markets were this week showing heightened instability - bonds, currencies and equities. The thesis of problematic underlying financial and economic fragility is coming to fruition.

Indonesian equities were hit for 5.2%, the Philippines 4.6% and Thailand 2.9%. South Korea's Kospi sank 3.8%, and China's Shanghai composite dropped 3.9%. India was down 1.7% and Taiwan fell 1.9%. Brazil's Bovespa dropped another 3.5% (20-month low) and Mexico's Bolsa fell 3.3%. And while Eastern Europe equities held up better than "developing" Asia and Latin America, stocks in Turkey were slammed for almost 9% after an eruption of public protests and a rather undemocratic crackdown.

Market instability was certainly not limited to "developing" markets. Currency market instability now worsens by the week. The yen abruptly surged 3% against the dollar this week. The yen has a huge hedge fund short position and has surely been a source of cheap "carry trade" finance (sell yen and use proceeds to buy higher-yielding securities elsewhere). Moreover, the notion of Japanese institutions and retail investors flooding the world with liquidity as they escape from the collapsing yen has played a not insignificant role in recent Financial Euphoria.

Nowhere did the perception of boundless Japanese buying power boost market sentiment more than in peripheral Europe. Notably, when the yen launched its Thursday melt-up, Spanish, Italian and Portuguese bonds were taken out to the woodshed (yields up 25, 23 and 27 bps, respectively). For the week, Portuguese 10-year yields jumped 54 bps to a six-week high (6.14%) - having now reversed the entire "BOJ" rally. Italian and Spanish yields ended the week slightly higher, while their equities markets came under pressure. Notably, Italian stocks were hit for 3.0%. It is worth noting that European financial Credit default swap (CDS) prices jumped higher again this week - and it appears this important risk market has turned increasingly unstable.

Returning to the Fed's Z.1 report, the Household Balance Sheet provides some of the most pertinent analysis. Household Net Worth (assets minus liabilities) inflated $3.0 TN during the quarter to a record $70.349 TN. One has to go back to the Bubble year 2005 ($6.308 TN) to surpass the recent one-year $6.164 TN gain in Household Net Worth. It's worth pondering a few analytical facts. Never has there been such a creation of (perceived) household wealth in the face of weak economic growth.

Never has there been such a divergence between stagnant private-sector Credit expansion and inflating securities and asset prices. Never has there been such a strong correlation between federal debt and securities prices. And, I would add, never has there been massive QE in a non-crisis (non-deleveraging) market environment.

I have posited that the Greek/European debt crisis was the first crack in the "global government finance Bubble". Well, we are now witnessing the next important crack unfold in the "developing" markets and economies. And I don't think it's a stretch to suggest that another very important crack is emerging in the U.S. bond market (MBS, Treasuries and corporates). U.S. equities markets have shown resilience, not a shocking occurrence with sentiment so bullish and QE effects so powerful.

With the rapidly deteriorating global financial environment hitting an already fragile economic backdrop, it would be better for systemic stability if some air started to come out of the U.S. equities Bubble. But as Bubbles become deeper entrenched and increasingly speculative, it is more the nature of distended speculative Bubbles to disregard faltering fundamentals until it's too late.

Above I noted the lack of a self-sustaining private-sector Credit upturn. Four years ago, I was writing that Washington's reflationary gamble "was betting the ranch." Increasingly, the marketplace is coming to better appreciate the fragility four years of Credit and financial excess has wrought on "developing" economies. Money has begun to flee some of these markets and the lesson of rapidly evaporating liquidity is learned the hard way - again. Confidence that large international reserve holdings would provide a liquidity backstop for the "developing" markets is waning. Here at home, the surge in market yields (and widening spreads) in the face of the Fed's $85bn portends future liquidity issues.

I noted above the "Twenty-year Anniversary of Market Backstops." I wonder if historians will look back at this period as a strange aberration in financial history. If the Fed really plans on reining in its bloated balance sheet, then the markets will at some point have to contemplate a world without liquidity backstops. From my perspective, that would ensure higher global yields, wider Credit spreads and larger risk premiums generally. In such a world, I would expect corporate profits - inflated by enormous deficits and further inflated by Fed monetization and financial engineering - would deserve higher discount rates and significantly lower equities market valuations. But for now, the focus will be on how the emerging markets dislocation and the unfolding global "risk off" play out.

For the Week:

The S&P500 gained 0.8% (up 15.2% y-t-d), and the Dow rose 0.9% (up 16.4%). The Morgan Stanley Consumer index added 1.4% (up 20.2%), and the Utilities rose 1.0% (up 7.5%). The Banks were unchanged (up 20.1%), while the Broker/Dealers jumped 2.1% (up 33.8%). The Morgan Stanley Cyclicals slipped 0.5% (up 15.8%), while the Transports advanced 0.9% (up 19.5%). The S&P 400 MidCaps dipped 0.3% (up 15.8%), while the small cap Russell 2000 gained 0.4% (up 16.3%). The Nasdaq100 increased 0.3% (up 12.4%), and the Morgan Stanley High Tech index rose 0.4% (up 11.4%). The Semiconductors gained 0.6% (up 22.8%). The InteractiveWeek Internet index rose 0.6% (up 17.2%). The Biotechs fell 1.5% (up 26.3%). Although bullion was down only $5, the HUI gold index fell 1.9% (down %).

One and three-month Treasury bill rates ended the week at 4 bps. Two-year government yields were up a basis point to 0.30%. Five-year T-note yields ended the week 8 bps higher to 1.10% (14-month high). Ten-year yields rose 4 bps to 2.17%. Long bond yields were 6 bps higher at 3.34%. Benchmark Fannie MBS yields jumped 9 bps to 3.02% (12-month high). The spread between benchmark MBS and 10-year Treasury yields widened 5 to 85 bps. The implied yield on December 2014 eurodollar futures added a basis point to 0.655%. The two-year dollar swap spread increased 2 to 18 bps, and the 10-year swap spread rose 2 to 20 bps. Corporate bond spreads widened. An index of investment grade bond risk increased 2 to 81 bps. An index of junk bond risk jumped 13 to a seven-week high 404 bps. An index of emerging market debt risk jumped 17 to a nine-month high 313 bps.

Debt issuance has slowed markedly. Investment grade issuers included EMC $5.5bn, Baxter International $3.5bn, Allstate $1.0bn, AFLAC $700 million, Beam $500 million, Buckeye Partners $500 million, Pacificorp $300 million, Nextera Energy $250 million, Lexington Realty $250 million, and Indianapolis Power & Light $170 million.

Junk bond funds saw record outflows of $4.6bn (from Lipper). Junk issuers included Eagle Midco $400 million, Hot Topic $355 million, Semgroup $300 million, Approach Resources $250 million and Jack Cooper Holdings $225 million.

Convertible debt issuers included Array Bio $115 million and Jarden Corp $250 million.

The notably short list of international dollar debt issuers included Royal Bank of Scotland $1.0bn and Intergen $750 million.

Italian 10-yr yields increased 3 bps to 4.19% (down 32bps y-t-d). Spain's 10-year yields jumped 11 bps to 4.53% (down 74bps). German bund yields were unchanged at 1.54% (up 22bps), while French yields rose 5 bps to 2.12% (up 12bps). The French to German 10-year bond spread widened 5 to 58 bps. Ten-year Portuguese yields surged 54 bps to 6.04% (down 71bps). Greek 10-year note yields rose 6 bps to 9.22% (down 125bps). U.K. 10-year gilt yields jumped 7 bps to 2.07% (up 25bps).

Japan's unstable Nikkei equities index sank 6.5% (up 23.9% y-t-d). Japanese 10-year "JGB" yields ended another volatile week little changed at 0.84% (up 6bps). The German DAX equities index declined 1.1% for the week (up 8.4%). Spain's IBEX 35 equities index slipped 0.7% (up 1.2%). Italy's FTSE MIB sank 3.0% (up 2.6%). Emerging markets were under liquidation. Brazil's Bovespa index was hit for 3.5% (down 15.3%), and Mexico's Bolsa sank 3.3% (down 8.0%). South Korea's Kospi index was hit for 3.8% (down 3.7%). India's Sensex equities index fell 1.7% (unchanged). China's Shanghai Exchange dropped 3.9% (down 2.6%).

Freddie Mac 30-year fixed mortgage rates jumped another 10 bps to 3.91% (14-month high), with a five-week gain of 56 bps (up 24bps y-o-y). Fifteen-year fixed rates were up 5 bps to 3.03% (up 9bps). One-year ARM rates gained 4 bps to 2.58% (down 21bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates surging 13 bps to 4.31% (up 3bps).

Federal Reserve Credit declined $2.9bn to $3.350 TN. Fed Credit expanded $564bn during the past 35 weeks. Over the past year, Fed Credit expanded $519bn, or 18.3%.

M2 (narrow) "money" supply expanded $16.4bn to $10.558 TN. "Narrow money" expanded 6.6% ($656bn) over the past year. For the week, Currency increased $0.9bn. Demand and Checkable Deposits rose $7.4bn, and Savings Deposits jumped $11.1bn. Small Denominated Deposits declined $2.7bn. Retail Money Funds slipped $0.7bn.

Money market fund assets declined $2.5bn to $2.611 TN. Money Fund assets were up $46bn from a year ago, or 1.8%.

Total Commercial Paper outstanding dropped $17.1bn this week to $1.031 TN. CP has declined $35bn y-t-d, while having expanded $17bn, or 1.6%, over the past year.

Currency and 'Currency War' Watch:

June 3 - Bloomberg (Lyubov Pronina): "The worst month in a year for emerging-market currencies will prove to be more than a momentary bout of weakness to strategists at firms from UBS AG to Societe Generale SA that see the Federal Reserve weaning investors off its extraordinary stimulus. South Africa's rand led declines among the 24 developing- nation currencies tracked by Bloomberg last month, tumbling 11.3%. JPMorgan Chase & Co.'s Emerging Markets Currency Index fell 3.3%, the most since it slipped 7% in May 2012. Only China's yuan gained, rising 0.51%. 'For these emerging-market currencies, this is the beginning of a trend that perhaps is going to be longer and deeper in terms of a correction,' Tom Levinson, a currency strategist in London at ING Groep NV... said..."

The U.S. dollar index dropped 2.0% to 81.67 (up 2.4% y-t-d). For the week on the upside, the yen increased 3.0%, the British pound 2.4%, the Swiss franc 2.0%, the Canadian dollar 1.8%, the Norwegian krone 1.7%, the euro 1.7%, the Danish krone 1.7%, the South African rand 1.3%, the Singapore dollar 1.2%, the South Korean won 1.2%, the Swedish krona 0.9%, the Taiwanese dollar 0.6%, the Brazilian real 0.4% and the Mexican peso 0.3%. For the week on the downside, the Australian dollar declined 0.8% and the New Zealand dollar fell 0.7%.

Commodities Watch:

The CRB index rallied 2.1% this week (down 2.5% y-t-d). The Goldman Sachs Commodities Index jumped 2.5% (down 2.4%). Spot Gold slipped 0.4% to $1,383 (down 17.4%). Silver fell 2.2% to $21.74 (down 28.1%). July Crude surged $4.06 to $96.03 (up 4.6%). July Gasoline jumped 4.2% (up 4%), while July Natural Gas dropped 3.9% (up 14%). July Copper declined 0.7% (down 10%). July Wheat fell 1.3% (down 11%), while July Corn gained 0.6% (down 5%).

U.S. Bubble Economy Watch:

June 6 - Bloomberg (Michelle Jamrisko): "Household wealth in the U.S. jumped to a record in the first quarter, exceeding its pre-recession peak for the first time, bolstered by gains in the stock and housing markets that are helping Americans mend finances. Net worth for households and non-profit groups increased by $3 trillion from January through March... to $70.3 trillion, the Federal Reserve said... Household wealth eclipsed its pre-recession level as gains in the stock and housing markets help Americans withstand an increase in the payroll tax this year."

June 3 - Bloomberg (Tim Jones and Brian Chappatta): "With handshakes, hugs and a few kisses, Illinois lawmakers left the capitol May 31 without repairing a leaking pension system that they have been saying for years must be fixed. Now they wait to discover the consequences of inaction; Illinois, already the lowest-graded state in the nation, faces yet another credit-rating cut. 'They've moved another notch in the wrong direction, which justifies a bond downgrade and a slippage in bond prices,' said Richard Ciccarone, managing director at... McDonnell Investment Management... 'Credit erosion will continue until they show a willingness to address this problem.'"

Federal Reserve Watch:

June 4 - Bloomberg (Steve Matthews): "Federal Reserve Bank of Kansas City President Esther George, who has dissented against record stimulus at every policy meeting this year, urged the Fed to reduce its $85 billion in monthly bond buying as growth quickens and low interest rates prompt investors to take on more risk. 'In light of improving economic conditions, I support slowing the pace of asset purchases as an appropriate next step for monetary policy,' George, 55, said... 'Waiting too long to acknowledge the economy's progress and prepare markets for more-normal policy settings carries no less risk than tightening too soon,' she said. George, in her first year as a Federal Open Market Committee voter, has opposed continuing monthly purchases of $40 billion in mortgage-backed securities and $45 billion in Treasuries, saying record stimulus may destabilize financial markets and push up long-term inflation expectations... 'A slowing in the pace of purchases could be viewed as applying less pressure to the gas pedal, rather than stepping on the brake... It would importantly begin to lay the groundwork for a period when markets can prepare to function in a way that is far less dependent on central bank actions and allow them to resume their most essential roles of price discovery and resource allocation.'"

June 5 - Bloomberg (Aki Ito and Ari Altstedter): "Federal Reserve Bank of Dallas President Richard Fisher, one of the most vocal critics of quantitative easing by the central bank, called for a reduction in the $85 billion in monthly asset purchases while saying he sees an end to a three-decade bull market in bonds. 'This is the end of a 30-year rally' in bonds, Fisher said... 'It would be prudent to dial back the rate of purchases we are making in mortgage-backed securities' now that 'the housing market is in a good state, construction has started again, housing prices are appreciating significantly... We've had a 30-year bull bond market,' with 'the lowest rates in the history of the United States right now... At some point secular markets change.'"

June 7 - Bloomberg (Jeanna Smialek): "Alan Greenspan... said the central bank needs to begin cutting back on its unprecedented asset purchases and move toward stopping them altogether. 'The sooner we come to grips with this excessive level of assets on the balance sheet of the Federal Reserve, which everyone agrees is excessive, the better... The issue is not only a question of when we taper down, but when do we turn? And I think that the markets may not give us all of the leeway we would like to do that..." Asked if he thinks the economy is strong enough to drop the policy, known as quantitative easing, to zero, Greenspan said 'we've got to do it even if we don't think it's strong enough... If we do move too rapidly with respect to Fed action, it will really shock the market. Gradual is adequate, but we've got to get moving.'"

Central Bank Watch:

June 7 - Bloomberg (Simon Kennedy and Jeff Black): "European Central Bank President Mario Draghi isn't racing to the rescue of Europe's banks or economy this time. Almost a year since his promise to do 'whatever it takes' to protect the euro soothed investors, and a month since cutting interest rates, Draghi signaled... that governments, not the ECB, should do more to fight recession and boost credit to businesses in cash-strapped countries such as Spain.'

Global Bubble Watch:

June 6 - Financial Times (Sam Jones): "Some of the world's biggest quant hedge funds have suffered steep losses in the past two weeks following the sell-off in US bond markets. So-called 'CTAs', which use computer models to spot and ride market trends automatically, were caught out as investors anticipated an end to the US Federal Reserve's measures to stimulate the economy. Many quant funds have been major buyers of bonds as their algorithms have followed yields lower over the past few years. AHL, the $16bn flagship fund of Man Group, the world's second-largest hedge fund, lost more than 10% of its net asset value in the past two weeks alone..."

June 4 - Bloomberg (Ari Altstedter): "Carry trades are losing the most money in a year on speculation the Federal Reserve will pare stimulus measures and make it harder to profit from borrowing in low-interest-rate currencies to buy higher-yielding assets. Deutsche Bank AG's G10 FX Carry Basket index fell 3.3% last month, the biggest decline since May 2012, reducing its gain this year to 1.6%. Traders who made 2.2% in March by selling U.S. dollars and investing in assets denominated in the Australian currency in May lost 7.5%... 'Carry works as long as things don't change, and what really changed in our mind a few weeks ago was the messaging from the Fed,' Rajiv Setia, the head of U.S. rates research at Barclays... said... 'Once you start worrying about hikes, all these trades start to fail massively.'"

June 7 - Bloomberg (Sarika Gangar, Mary Childs and Charles Mead): "The most relentless surge in borrowing costs for U.S. corporate debt in four years is threatening to derail this year's record pace of sales as concern deepens the Federal Reserve will curtail unprecedented stimulus. Yields are climbing for a sixth straight week from last month's record lows and touched 3.78%, the highest level since September... While the Fed has enabled companies to borrow $5.74 trillion in the bond market since the end of 2008 by suppressing benchmark interest rates at close to zero percent, debt investors are becoming more discriminating as policy makers consider tapering their monthly bond purchases. That may blunt the record pace of sales, which reached $756.7 billion this year, after an unprecedented $1.48 trillion of issuance in 2012..."

June 7 - Bloomberg (Charles Stein): "U.S. bond funds suffered their second-worst withdrawals last week in more than two decades after speculation about an eventual end to the Federal Reserve's bond purchases sent fixed-income markets lower. Investors pulled $9.1 billion from fixed-income mutual funds and exchange-traded funds in the week ended June 5... Lipper said... That's the second-biggest redemptions for a week since the company started tracking the data in 1992. Corporate high-yield funds saw redemptions of $3.2 billion... the largest weekly withdrawal on record... Global bond markets posted their biggest monthly losses in nine years in May, as the more than $40 trillion of bonds in the Bank of America Merrill Lynch Global Broad Market Index fell 1.5% on average."

June 7 - Bloomberg (Sridhar Natarajan and Mary Childs): "U.S. high-yield funds recorded their biggest outflow on record this week, according to Bank of America... Investors pulled an unprecedented $4.8 billion from funds that purchase notes sold by companies rated below investment grade... That was accompanied by outflows from high-grade funds, the first weekly decline this year, even as leveraged loans attracted about $1 billion, bringing this year's gains to $28.5 billion, a 38% increase in assets since the start of the year..."

June 6 - Bloomberg (Katie Linsell): "Bondholder's losses on high-yield debt are deepening in Europe as issuance of junk securities this year exceeds the total for all of 2012, with companies taking advantage of record-low borrowing costs... Losses are mounting as sales of high-yield bonds surge to 34.6 billion euros ($45.3bn), the busiest start to a year on record..."

June 5 - Bloomberg (Gabrielle Coppola): "Foreign investors are dumping Brazilian real-denominated bonds sold overseas after the currency posted the second-biggest plunge in emerging markets. Yields on the country's real-linked debt due in 2028 have jumped 1.12 percentage points in the past month, touching a record 8.73% on June 3. The bonds lost 13.4% in dollars in the period, the worst among local-currency government notes issued abroad after Peruvian debt. That exceeds the 12.3% loss in real-denominated bonds issued locally..."

June 4 - Bloomberg (Lisa Abramowicz): "Corporate bond trading is soaring to record levels in the U.S. with the biggest buyers churning more of their funds as policy makers consider tapering unprecedented economic stimulus. Regulatory data show average investment-grade trading rose to $13.9 billion for the busiest May ever..."

Global Credit Watch:

June 5 - Bloomberg (Carlos Manuel Rodriguez and Jose Enrique Arrioja): "Petroleos Mexicanos's bondholders are losing confidence in President Enrique Pena Nieto's ability to overhaul oil policies after he failed to propose an energy bill and the political pact he engineered shows signs of fraying. Yields on $2 billion of bonds due in 2022 sold by Pemex, as the state-owned oil producer is known, have jumped 85 bps... in the past month to 3.97%... Yields on Brazilian oil producer Petroleo Brasileiro SA's 2021 notes rose 69 bps in the past month."

June 6 - Bloomberg (Lisa Abramowicz): "Losses on junk-bond exchange-traded funds are outpacing the broader U.S. speculative-grade market by the most in three years, signaling a deepening slump for debt that traded at record-high prices less than a month ago... After reaping returns of 127% since 2008, junk-bond buyers are demonstrating concern that rising interest rates will erode future gains as Federal Reserve policy makers consider a pullback from stimulus measures... While ETFs hold less than $40 billion of the $1.15 trillion U.S. high-yield bond market, they act as a quicker gauge of market sentiment because their shares trade more frequently than most corporate bonds."

June 6 - Bloomberg: "Global markets will face increased volatility as central banks bring interest rates back to normal levels, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said. 'We should all hope for a normalization of interest rates -- that's a good thing,' Dimon said... 'As we go back to normal, it's going to be scary, and it's going to be kind of volatile.' Investors have been encouraged to buy riskier assets as global central banks unleashed unprecedented monetary stimulus after the financial crisis of 2008."

China Bubble Watch:

June 7 - Bloomberg: "The rate China's lenders charge one another on overnight loans jumped the most in almost two years as shrinking capital inflows led to a cash squeeze before a three-day holiday. Yuan positions at local financial institutions, an indication of money pouring into Asia's largest economy, rose 294 billion yuan ($48bn) in April and China International Capital Corp. estimates the gain slowed to around 100 billion yuan last month."

June 7 - Dow Jones: "China's central bank has warned of rising risks from 'shadow banking' and said the time is right to move ahead with a bank deposit insurance system. The People's Bank of China... gave its most specific assessment of plans for the long-debated subject of deposit insurance, seen as a key part of plans to liberalize the financial system. 'The central bank, along with other government departments, is studying how to improve the plan and will set up a system as soon as possible.' It also said the state effectively has an 'invisible' guarantee system for deposits and this has hampered the development of market constraints on bank activities. China is widely believed to be willing to step in to support any bank in trouble."

June 6 - Bloomberg: "China's crackdown on fake export invoices used to disguise money flows is probably cutting the nation's trade figures, revealing subdued global demand that will weigh on economic growth. Outbound shipments may have grown 7.1% in May from a year earlier, less than half the previous month's reported 14.7%, based on the median estimate of 34 economists... Successful deterrence of fraudulent data through regulatory scrutiny of companies and banks would help restore trust in trade figures, while more accurate numbers may also highlight the urgency for Premier Li Keqiang to shift growth toward domestic consumption."

June 4 - Bloomberg: "Beijing, which already has China's strictest real estate curbs, is being forced to take additional steps to contain surging home prices as demands for record-high down payments fail to deter buyers. The city has enforced citywide price caps since March by withholding presale permits for any new project asking selling prices authorities deem too high, according to developer Sunac China Holdings Ltd. and realtor Centaline Group. Local officials will need further tightening as they struggle to meet this year's target of keeping prices unchanged from last year, said Bacic & 5i5j Group, the city's second-biggest property broker."

June 6 - Bloomberg: "China Vanke Co. Chairman Wang Shi said the country's property market faces the risk of a 'bubble,' reiterating concerns the nation's biggest developer by sales raised three months ago. The bubble isn't 'light,' Wang said... 'If the bubble lasted, it will be dangerous.' Home prices have been increasing even as the government in March stepped up a three-year campaign to cool the market, which has included raising down-payment and mortgage requirements, imposing a property tax for the first time in Shanghai and Chongqing, and enacting purchase restrictions in about 40 cities."

Japan Bubble Watch:

June 6 - Bloomberg (Masaki Kondo, Mariko Ishikawa and Shigeki Nozawa): "Bank of Japan Governor Haruhiko Kuroda's success in fueling inflation expectations has caused some investors to seek a revival in his predecessor's policies to temper to the worst government-bond losses in nine years. Japanese government bonds maturing in more than 10 years have lost 3.7% so far this quarter, the most since the period ended June 2004... That compares with a first-quarter gain of 6.4%, the most since 2008, when Masaaki Shirakawa was head of the central bank... 'Bond investors used to be in a comfortable lukewarm bath, relying on the BOJ' before Kuroda, said Kazuya Ito, the head of fixed income... at Daiwa SB Investments Ltd., which oversees the equivalent of $49 billion. 'If the BOJ adopts some of Shirakawa's recipe, investors will be relieved.'"

June 6 - Bloomberg (Toru Fujioka and Masahiro Hidaka): "The Bank of Japan is divided over whether to authorize a measure designed to quell bond-market volatility, with some officials concerned it would return the BOJ to a pattern of incremental steps that failed in the past, according to people familiar with the discussions."

India Watch:

June 7 - Bloomberg (Kartik Goyal and Sharang Limaye): "India's wide budget deficit and moderating foreign-direct investment inflows are weighing on the rupee and constraining scope for a higher sovereign credit rating, Moody's... said."

Latin America Watch:

June 3 - Bloomberg (Nacha Cattan): "Analysts cut their growth estimates for Latin America's two largest economies after expansion in both Brazil and Mexico missed economists' expectations in the first quarter. Mexico's economy will grow 2.96% this year, according to the median estimate in the central bank's monthly survey..., compared with the 3.35% estimated in the previous poll. Brazil economists cut their growth forecast for a third week to 2.77%... Growth in the two economies that make up almost two thirds of Latin America's gross domestic product slowed in the first quarter as exports weakened and domestic demand remained sluggish."

June 7 - Bloomberg (Blake Schmidt and Josue Leone): "Brazil's real fell to a four-year low after Standard & Poor's cut the government's credit-rating outlook to negative amid an economic slump that's threatening to drive up the country's debt levels. The currency depreciated 0.3% to 2.1351 per U.S. dollar... The benchmark Ibovespa stock index tumbled 2.2% to... the lowest level on a closing basis since October 2011. Prices on the nation's dollar bonds due in 2023 fell, driving yields up 0.07 percentage point to 3.62%."

June 6 - Bloomberg (Raymond Colitt): "Brazilian President Dilma Rousseff's decision to scrap a levy on bond purchases is failing to convince bond investors that the move will help the central bank tame inflation in Latin America's biggest economy. The real lost as much as 1.1% against the dollar... even after Brazil on June 5 eliminated a 6% tax on foreign purchases of local debt to buoy the currency and make imports cheaper, which help ease inflation."

Global Economy Watch:

June 5 - Bloomberg (Michael Heath): "Australia's economy expanded at the slowest annual pace in almost two years as manufacturers and builders detracted from growth... Gross domestic product expanded 2.5% in the first quarter from a year earlier, the weakest reading since the second quarter of 2011..."

Europe Watch:

June 5 - Bloomberg (Jonathan Stearns): "The European Union imposed tariffs as high as 67.9% on solar panels from China in the largest EU commercial dispute of its kind, seeking to help revive a withering industry in Europe. The duties punish Chinese manufacturers of solar panels for allegedly selling them in the 27-nation EU below cost, a practice known as dumping... EU producers such as Solarworld AG, Germany's No. 1 maker of the renewable-energy technology, have suffered 'material injury' as a result of dumped imports from China, the European Commission... said..."

June 5 - Bloomberg (Kati Pohjanpalo): "Finland's economy shrank in the first quarter, entering a recession as its fellow euro-area countries struggle with austerity and surging unemployment. Gross domestic product... contracted 0.1% from the prior three months, when it shrank a revised 0.7%..."

Germany Watch:

June 7 - Bloomberg (Jeff Black): "Germany's Bundesbank cut its forecasts for growth in Europe's largest economy for this year and next, while signaling confidence that the worst of the recession in the euro area is over. The... central bank cut its 2013 growth projection to 0.3 from the 0.4% predicted in December..."

June 5 - MarketNews International: "German Finance Minister Wolfgang Schaeuble said... he saw no sign of a housing price bubble in Germany. 'There is currently not much pointing in the direction of a housing bubble,' Schaeuble said... 'The big price increases occur only in the agglomerations but not throughout the country.' Still, the minister cautioned that 'the current environment of persistent low interest rates can foster the emergence of bubbles.' He insisted that "this has to be carefully eyed by central banks.'"