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Z1 and the Doves

With taper worries out of the way for now, the markets will watch to see if Washington can avoid a government shutdown.

From the Federal Reserve's Q2 2013 Z.1 "flow of funds" report, Total (non-financial and financial sector) System Credit increased $176bn during the quarter to a record $57.563 TN. Total Credit jumped $1.971 TN over the past year.

Non-Financial Sector Borrowings increased at a 3.1% rate, down from Q1's 4.5%. Corporate borrowings accelerated to an 8.4% pace, up from Q1's 6.8%. Federal borrowings expanded at a 2.5% rate, slowing sharply from Q1's 10.1%. State & Local debt growth slipped from Q1's 2.4% to 1.1%. Total Household Sector borrowings expanded at a 0.2% rate compared to Q1's 0.5% contraction. Non-mortgage Consumer Credit grew at a 5.6% pace, down slightly from Q1's 6.2%. Surprisingly, mortgage Credit still hasn't been able to turn the corner. Household Mortgage Debt contracted at a 1.7% pace, somewhat less than Q1's 2.1% rate of decline.

Total Non-Financial Debt (NFD) expanded at a seasonally-adjusted and annualized rate (SAAR) of $1.251 TN, down from Q1's SAAR $1.974 TN, to a record $40.938 TN. During the past year, NFD expanded $1.678 TN, or 4.3%. Despite all the talk of "de-leveraging," NFD has inflated $6.679 TN, or 19.5%, over the past four years. While Household Sector Liabilities declined $686bn over the past four years, during that period outstanding Treasury securities jumped $5.550 TN.

Already strong business Credit growth accelerated. Total Business borrowings increased SAAR $742bn during Q2, up from Q1's $594bn. Though little changed for the quarter, Corporate bonds were up $879bn, or 7.2%, over the past year to a record $13.026 TN.

Financial Sector borrowings increased at a 0.5% rate to $13.902 TN during the quarter. With the Federal Reserve's balance sheet excluded from Financial Sector tabulations, the rapid expansion of Fed holdings continues to restrain overall Financial Sector growth. And chiefly because of Fed balance sheet inflation, Financial Sector borrowings remain today significantly below the $17 TN level reached back in 2007.

Financial Sector Credit market borrowings increased only SAAR $63.6bn during the quarter. GSE securities jumped SAAR $137bn and Other Loans and Advances gained SAAR $126bn. Corporate (financial sector) Bonds declined SAAR $250bn. MBS increased SAAR $40bn and Depository Institution (bank) Loans gained SAAR $28.1bn.

Meanwhile, Federal Reserve assets expanded SAAR $1.116 TN during Q2, with holdings of Treasury Securities growing SAAR $548.5bn and GSE-backed Securities expanding SAAR $548.7bn. In nominal dollars, Federal Reserve assets increased $283bn during the quarter to a record $3.526 TN. Fed assets were up a whopping $571bn in two quarters. In five years, Fed assets have inflated $2.574 TN, or 270%.

Bank ("Private Depository Institutions") assets increased nominal $351bn during the quarter to a record $15.595 TN, a notably strong 9.2% growth rate. However, over half of this expansion is explained by the ballooning of reserves held at the Fed. Yet Bank Loans did expand SAAR $206bn and Consumer Credit SAAR $47bn. Mortgages contracted SAAR $16bn, while Miscellaneous Assets expanded SAAR $436bn.

There continues to be scant evidence of a general upswing in traditional lending. Beyond slow growth in Bank loans, Credit Union liabilities were little changed during the quarter (up $54bn, or 5.8% y-o-y) to $997bn. Finance Company assets were down slightly for the quarter and shrank $39bn, or 2.6%, from a year earlier.

Elsewhere, Security Credit expanded at a 5% rate during the quarter to $1.512 TN, with y-o- year growth of $101bn, or 7.2%. Funding Corps were little changed during Q2, with assets up $101bn y-o-y, or 4.7%, to $2.232 TN. Real Estate Investment Trust (REIT) liabilities were down slightly during the quarter, but jumped $69bn, or 9.5%, from a year ago to $794bn. Security Broker/Dealer assets declined slightly during the quarter to $2.083 TN, although assets were up $30bn, or 1.5%, from Q2 2012.

Despite the ongoing contraction in mortgage Credit, the GSEs continue to grow. Agency Securities (debt and MBS) increased a nominal $58bn during Q2 to $7.648 TN. Agency Securities increased $107bn over the past year.

Rest of World (ROW) holdings of U.S. assets increased (nominal) $216bn during Q2 to a record $21.437 TN. Interestingly, Interbank Assets increased $267bn (to $588bn). Treasury holdings declined by $121bn to $5.601 TN. Uncharacteristically, "official" (central bank) Treasury holdings declined $81bn (to $4.009 TN) after having increased $368bn during the previous four quarters. ROW Agency Securities holdings dropped $65bn during the quarter to $876bn, with a two-quarter decline of $130bn.

Belying weakened Credit growth, National Income increased $123bn during the quarter, or 3.4% annualized, to a record $14.448 TN. Total Compensation increased $63.4bn, or 2.9%, to a record $8.812 TN. On a year-over-year basis, National Income gained 4.1% and Total Compensation rose 3.0%. It is worth noting that National Income increased about 50% in the 10 years leading up to the 2008 crisis. National Income dropped 3.8% in 2009 - only to then fully recover in seven quarters.

While Credit and economic growth may be relatively restrained, perceived Household wealth is going gangbusters. Household Sector Assets increased another $1.343 TN during Q2 to a record $88.369 TN. Household Assets were up a notable $7.692 TN, or 9.5%, over the past year. Over two years, Household Assets inflated $13.389 TN, or 17.9%. Since the end of '08, Household Assets have jumped $16.921 TN, rising from 498% of GDP to 530%. Meanwhile, Household Liabilities were little changed both during the quarter and over the past year at $13.548 TN. Since the end of 2008, Household Liabilities have declined $686bn, or 4.8%.

Household Net Worth (assets less liabilities) has become a focal point of my Macro Credit Analysis. For the quarter, Household Net Worth inflated another $1.342 TN, or 7.3% annualized, to a record $74.821 TN. At 449% of GDP, Household Net Worth is within striking distance of the record 470% of GDP back at the 2007 peak of the mortgage finance Bubble. Over the past year, Household Net Worth jumped $7.690 TN, or 11.5%. Net Worth rose a notable $13.388 TN, or 21.8%, over two years. In arguably the single most pertinent macro data point, Household Net Worth has surged $17.607 TN, or 30.8%, since the end of 2008.

It's worth our time to dig just a little into the composition of Household Assets. At the end of Q2, Financial Assets accounted for 70%, and Non-Financial Assets 30%, of Total Assets. This compares to a 65%/35% split at the end of 2008. In nominal dollars, Financial Assets increased $15.237 TN, or 33%, since 2008, while Non-Financial Assets gained $1.684 TN, or 7% to $26.516 TN (Real Estate, at $21.123 TN, comprises about 80% of Non-Financial Assets).

Even more striking is the growth divergence between Household Financial Asset categories since 2008. In particular, safer "money"-like holdings have notably lagged the historic expansion in "risk assets." Total Deposits (bank and money market), the bedrock of perceived safe and liquid "money," increased $982bn since the end of 2008, or 12%, to $9.026 TN. Treasury holdings rose about a Trillion to $1.2 TN, and agency securities increased $597bn to $1.65 TN. In total, deposits, Treasuries and agencies rose $2.58 TN, or 28%, to $11.865 TN.

Meanwhile, since '08 Household holdings of mutual funds and equities have surged $10.640 TN, or 85%, to $23.191 TN. Pension Fund Entitlements jumped $4.675 TN, or 33%, to $18.737 TN. It's no longer true that American households have the majority of their wealth in savings and real estate. These days, and much the product of experimental monetary policy, Household perceived wealth is wrapped up in the risk markets.

Post-crisis Macro Credit Analysis has provided myriad curious anomalies. Incomes have grown steadily in the face of stagnant Household debt growth. Real estate price inflation has reemerged despite an ongoing contraction in mortgage Credit. Household Assets and Net Worth have surged in the face of ongoing weak private-sector debt growth. In sum, there's been a resurgent Bubble Economy in the face of relatively modest overall system debt growth. This is definitely not how it traditionally works.

Those of a bullish persuasion would argue these dynamics confirm the underlying strength and stability of the U.S. economy. I'll counter with the view - one supported by Fed data - that massive federal deficits and Federal Reserve monetization have created unprecedented and deeply systemic financial and economic distortions.

An economy on firm footing would be one demonstrating at least a reasonable balance within the real and financial sectors. One would hope to see sound money and productive Credit financing capital investments throughout the economy - liquidity/spending power entering the system primarily in the process of financing economic wealth creation in the real economy (as opposed to financing consumption and asset speculation).

We instead these days see an unprecedented government injection of liquidity directly into securities markets, with resulting asset inflation and myriad distortions. In the real economy, massive federal deficits and ultra-low interest-rates have inflated incomes, corporate cash flows and earnings. Inflating asset markets and Household Net Worth drive sufficient consumption to sustain a deeply imbalanced economic structure.

Not unpredictably, after about five years of unmatched debt monetization and liquidity injections, the Federal Reserve today struggles with even the most timid reduction of monetary inflation. Perhaps Fed officials appreciate the dependency the U.S. and global economies have developed to speculative and inflating securities markets, along with the dependency inflated markets have to ongoing Fed and central bank liquidity injections.

September 27 - Bloomberg (Joshua Zumbrun): "Chicago Federal Reserve President Charles Evans, who votes on policy this year, said the central bank should press on with record stimulus with inflation too low and unemployment too high. 'More accommodation is appropriate, and the biggest problem we have is we're stuck at the zero-lower bound...' Evans... said concerns that stimulus is leading to too much exuberance and financial instability should be addressed with regulatory tools rather than by raising interest rates. 'It strikes me as remarkably natural to use other tools if they're available,' rather than raising interest rates to fight asset-price bubbles... 'Without meeting our inflation objective, if we increased interest rates, all the theory I know suggests inflation would be lower.'"

Evans states that the Fed has not been able to provide as much stimulus as it would like. History will not be kind. Clearly, the core dovish contingent on the FOMC will at this point find an indicator - the unemployment rate, GDP, or CPI - to justify running with this historic experiment in monetary inflation. And, if necessary, they will fall back on a so-called "tightening of Financial Conditions" for justification/rationalization. I thought Steve Liesman's September 24, CNBC interview with New York Fed President William Dudley did a good job of illustrating the confused and slippery slope the Fed is now sliding. It's worthy of historical record.

Dudley: "I think it's a question of why financial conditions are rising, and is the tightening of financial conditions modest or large relative to your expectations. At the end of the day, we set monetary policy to affect financial conditions and financial conditions affect the real economy. So let's imagine that financial conditions tighten by more than what we anticipate. We want to take that into consideration in terms of our economic forecast. And I think what happened between May and prior to this last meeting, the tightening of financial conditions was quite large, especially in terms of the mortgage market."

Liesman: "So does that mean you're sort of targeting, at least in your heads if not spoken, a range for rates that is acceptable for you in order for you to eventually move forward?"

Dudley: "No, absolutely not. I mean, we're looking at growth momentum of the economy. We're looking at how financial conditions are likely to affect that growth momentum going forward. But if the economy is not that strong and financial conditions are tightening, that's going to reduce our confidence in the economy growing fast in the future."

Liesman: "But part of the reasons why it would appear financial conditions tightened so much was because markets seem to be forever preempting or running ahead of the Federal Reserve - in the sense that it's going to tighten or bring forward future interest rate hikes."

Dudley: "We want to be very clear that the decision on asset purchases is pretty independent of the decision about actually raising short-term interest rates. We have been very clear that conditions for raising short-term interest rates are: we would expect the unemployment rate would have to fall below 6.5%, assuming the inflation outlook is still okay and inflation expectations are well anchored. In that case, we're going to wait until the unemployment rate falls past 6.5%. And that's a threshold, not a trigger. Under certain economic circumstance, we could wait a long time after the unemployment rate falls below 6.5% before we actually raise short-term rates. So people should delink these two choices. The decision on tapering is how fast are we adding accommodation - how much are we increasing our balance sheet. The decision on raising short-term interest rates is a tightening. People shouldn't conflate the two."

Liesman: "You keep saying that. You've said that several times and the chairman has said that several times. Other members of the FOMC have said that several times. But it doesn't seem like the market is agreeing with that. They seem to think a taper is a tighten."

Dudley: "We're obviously going to communicate in terms of how we're looking at things. Now, it's true that if we do something that's different than the market expectation, for example, follow a less accommodative path than what the market expects, that could cause a rise in long-term rates even though we're still adding accommodation. So, I think you have to distinguish between a change in market expectations about the path of monetary policy that can drive up short-term rates as opposed to adding, you know, buying assets. The decision about whether to taper or not, the market takes that as an independent judgment on monetary policy. So there's a taper decision. Then there's a signal that the Fed has decided to do something differently than it's done in the past. So the market, I think, views it as, okay, if the Fed has changed what they're doing, they must have seen enough information to get them more confident. So, you can't really separate those two..."

Dudley: "I can't speak for the committee, but I can speak for myself. In my mind, beginning to decide to reduce the pace of asset purchases from the current $85 billion pace requires sort of two things, in my mind. Number one, improvement in the labor market. And, number two, confidence that the economy is strong enough to support that improvement in the future."

Liesman: "Is that new? And if it's not new, why is it that the market didn't understand that beforehand?"

Dudley: "I don't think it's new. I think that what we did is completely consistent with what the chairman laid out in his June press conference. It's data dependent. It depends on how the economy is actually performing. The chairman never said that we were going to reduce the rate of asset purchases in September. He said later this year. I think that framework that he laid out is still very much intact. But we actually have to see, one, improvement in the labor market and, two, confidence that the improvement is going to continue in the future."

Liesman: "So if that's not new, then the market should have known that and it means the market thought that you believed there was improvement in the labor market and continued confidence in growth. Or did the market get the assessment of the economy wrong?"

Dudley: "Well, the economy has been a little bit weaker than we thought at the time of the June meeting. We haven't seen an acceleration in economic activity. You look at the Fed's forecast, it looks for acceleration of economic activity. The problem is that it's still a forecast. And if you look at our projections in September relative to June, you can see that we're actually expecting somewhat slower growth in the second half of 2013 than we were back in June."

Liesman: "So, if I can go back, do you have a reason for why people appeared to be surprised by the decision on Wednesday?"

Dudley: "I think my own personal view is that people jump to conclusions. I think we're trying to be very clear speaking; we're trying to be transparent. But sometimes people think that we're hinting at something. So the chairman talked about the potential path to beginning to taper, and he said later this year was possible if the economy evolves in line with our expectations. And people said, 'Oh, he must mean September.' But I think we're trying to be very plain spoken and I think people sometimes exaggerate - they sort of look for hints when we're trying to be as transparent as possible."

Liesman: "So is it possible there wasn't enough communication with markets in the lead up to the September meeting?"

Dudley: "Well, I think it's hard to communicate if you're not exactly sure what you're going to do at the meeting. I mean, that's one reason why you have the meeting. You know, the data have diverged from our expectations, but only modestly - only a little bit weaker-than-expected."

Liesman: "You repeated the remarks of chairman Bernanke from June saying that a taper was likely to happen later this year. Is that your opinion at this point, still?"

Dudley: "I certainly wouldn't want to rule it out. But it depends on the data. And the thing that we really want to emphasize is that it's driven by data, not by time. So when the chairman said later this year - that was conditioned on the economy behaving in a way in line with the Fed's forecast. So if the economy were behaving in a way aligned with the Feds June forecast, then it's certainly likely that the Fed would begin to taper later this year. But whether that's going to happen or not remains uncertain."


For the Week:

The S&P500 declined 1.1% (up 18.6% y-t-d), and the Dow fell 1.3% (up 16.4%). The broader market outperformed. The S&P 400 MidCaps were little changed (up 21.9%), while the small cap Russell 2000 added 0.1% (up 26.5%). The Morgan Stanley Consumer index dropped 1.8% (up 22.0%), and the Utilities slipped 0.6% (up 5.5%). The Banks sank 1.8% (up 21.7%), and the Broker/Dealers lost 1.1% (up 46.6%). The Morgan Stanley Cyclicals were down 0.9% (up 25.9%), and the Transports fell 1.4% (up 24.3%). The Nasdaq100 increased 0.2% (up 21.4%), while the Morgan Stanley High Tech index slipped 0.4% (up 20.5%). The Semiconductors dipped 0.5% (up 27.8%). The InteractiveWeek Internet index declined 1.0% (up 27.5%). The Biotechs fell 1.0% (up 41.9%). Although bullion gained $11, the HUI gold index was down 1.2% (down 48.2%).

One-month Treasury bill rates ended the week at one basis point and three-month rates closed the week at two bps. Two-year government yields were unchanged at 0.33%. Five-year T-note yields ended the week down 7 bps to 1.40%. Ten-year yields dropped 11 bps to 2.63%. Long bond yields fell 8 bps to 3.69%. Benchmark Fannie MBS yields dropped 13 bps to 3.30%. The spread between benchmark MBS and 10-year Treasury yields narrowed 2 to 67 bps. The implied yield on December 2014 eurodollar futures declined 3.5 bps to 0.525%. The two-year dollar swap spread was two lower at 13 bps, while the 10-year swap spread was little changed at 16 bps. Corporate bond spreads widened. An index of investment grade bond risk increased one to 81 bps. An index of junk bond risk jumped 47 to 397 bps. An index of emerging market (EM) debt risk rose 29 to 334 bps.

Debt issuance remained quite strong. Issuers included Wal-Mart $1.75bn, Southern California Edison $1.6bn, Denali Borrower $1.5bn, News America $1.0bn, Ford Motor Credit $1.0bn, AIG $1.0bn, Edwards Lifesciences $600 million, Marsh & McLennan $500 million, Liberty Property $450 million, Whiting Petroleum $400 million, Jackson National Life $350 million Marriott $350 million, Principal Life $350 million, Ventas Realty $850 million, Ralph Lauren $300 million, VCI Lease $156 million, and Valley National Bank $125 million.

Junk bond funds saw strong inflows of $3.08bn (from Lipper). In what is already a record month of junk issuance, this week's issuers included GM $4.5bn, Gannett $1.25bn, ADT $1.0bn, Aviation Capital Group $1.0bn, Howard Hughes Co $750 million, Continental Wind $600 million, Energy Gulf Coast $500 million, Nationstar Mortgage $475 million, Titan International $400 million, Avanti Communications $370 million, CPG $315 million, Sinclair Television $350 million, Grain Spectrum Funding $330 million, Allegion $300 million, Artesyn $250 million, Clayton Williams Energy $250 million and Beazer Homes $200 million, million.

I saw no convertible debt issues this week.

The long list of international dollar debt issuers included BHP $5.0bn, Mexico $3.9bn, Bank of Montreal $2.5bn, BP Capital $2.4bn, Royal Bank of Canada $2.0bn, Finland $1.5bn, Rogers Communications $1.5bn, Bangkok Bank $1.5bn, Cemex $1.4bn, CNOOC Curtis Funding $1.3bn, Caixa Economica Federal $1.25bn, Enbridge $1.15bn, African Development Bank $1.0bn, Export Development Canada $1.0bn, Societe Generale $1.0bn, Credit Agricole $1.0bn, Standard Charter $1.0bn, Kommunalbanken $1.0bn, Deutsche Annington $1.0bn, Interamerican Development Bank $1.9bn, Meg Energy $800 million, China Uranium Development $600 million, Embotelladora Andina $575 million, Coca-Cola Icecek Uretim $500 million, Woori Bank $500 million, Korea Hydro & Nuclear Power $500 million, GS Caltex $400 million, and SPCM $250 million.

Ten-year Portuguese yields dropped 30 bps to 6.72% (down 3bps y-t-d). Italian 10-yr yields jumped 13 bps to 4.41% (down 9bps). Spain's 10-year yields increased 6 bps to 4.35% (down 92bps). German bund yields dropped 17 bps to 1.78% (up 46bps). French yields fell 11 bps to 2.33% (up 33bps). The French to German 10-year bond spread widened 6 to 55 bps. Greek 10-year note yields sank 39 bps to 9.21% (down 126bps). U.K. 10-year gilt yields fell 21 bps to 2.71% (up 89bps).

Japan's Nikkei equities index ended the week little changed (up 42.0% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.67% (down 11bps). The German DAX equities index slipped 0.2% for the week (up 13.8%). Spain's IBEX 35 equities index was up 0.6% (up 13.0%). Italy's FTSE MIB dropped 1.8% (up 8.4%). Emerging markets were mostly lower. Brazil's Bovespa index declined 0.7% (down 11.8%), and Mexico's Bolsa fell 0.8% (down 6.4%). South Korea's Kospi index added 0.3% (up 0.7%). India's volatile Sensex equities index sank 2.7% (up 1.6%). China's Shanghai Exchange fell 1.5% (down 4.8%).

Freddie Mac 30-year fixed mortgage rates sank 18 bps to a nine-week low 4.32% (up 92bps y-o-y). Fifteen-year fixed rates were down 17 bps to 3.37% (up 64bps). One-year ARM rates were down 2 bps to 2.63% (up 3bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 8 bps to 4.65% (up 55bps).

Federal Reserve Credit expanded $22.6bn to a record $3.695 TN. Over the past year, Fed Credit was up $898bn, or 32.1%.

M2 (narrow) "money" supply was up $4.0bn to a record $10.794 TN. "Narrow money" expanded 6.6% ($672bn) over the past year. For the week, Currency increased $1.8bn. Total Checkable Deposits fell $4.6bn, while Savings Deposits rose $9.6bn. Small Time Deposits declined $3.0bn. Retail Money Funds were little changed.

Money market fund assets jumped $35.9bn to $2.694 TN. Money Fund assets were up $118bn from a year ago, or 4.6%.

Total Commercial Paper outstanding gained $17.3bn to $1.064 TN. CP has declined $1.6bn y-t-d, while increasing $74bn, or 7.5%, over the past year.

Currency Watch:

The U.S. dollar index added 0.1% to 80.52 (up 0.9% y-t-d). For the week on the upside, the Japanese yen increased 1.1%, the British pound 0.8%, the Swiss franc 0.5%, and the South Korean won 0.2%. For the week on the downside, the Mexican peso declined 2.2%, the South African rand 2.0%, the Brazilian real 1.9%, the New Zealand dollar 1.1%, the Swedish krona 1.1%, the Norwegian krone 1.1%, the Australian dollar 0.8%, the Singapore dollar 0.4%, and the Taiwanese dollar 0.1%. The euro, Danish krone and Canadian dollar were little changed.

Commodities Watch:

The CRB index slipped 0.2% this week (down 2.7% y-t-d). The Goldman Sachs Commodities Index declined 0.4% (down 1.6%). Spot Gold added 0.8% to $1,337 (down 20%). Silver declined 0.4% to $21.83 (down 28%). November Crude dropped $1.88 to $102.87 (up 12%). October Gasoline fell 3.1% (down 3%), and November Natural Gas sank 4.6% (up 7%). December Copper added 0.3% (down 9%). December Wheat rallied 5.7% (down 12%), and December Corn gained 0.7% (down 35%).

U.S. Fixed Income Bubble Watch:

September 25 - Bloomberg (Sarika Gangar): "Sales of corporate bonds in the U.S. reached an all-time high this month, with phone companies Verizon Communications Inc. and Sprint Corp. leading offerings of $177.9 billion. Verizon issued $49 billion on Sept. 11 in the biggest corporate bond deal ever while... Sprint raised $6.5 billion on Sept. 4 in the largest high-yield sale since 2008... Offerings broke the previous monthly record of $177.3 billion set in September 2012."

September 27 - Bloomberg (Michelle Kaske): "Wall Street securities firms are pulling back from the $3.7 trillion municipal market at the fastest pace since 1986, helping fuel the worst performance in U.S. local debt in more than a decade. Brokers and dealers held $19 billion of city and state debt as of June 30, the least since 2002 and a 39% drop from three months earlier... The companies have unloaded further since July, even as municipal debt rebounded after the Fed unexpectedly refrained from reducing its monthly bond purchases... The retrenchment can increase price swings and elevate the yield levels at which certain buyers will emerge, said Peter Hayes, head of munis at... BlackRock Inc.... 'When we do see market dislocation, it's probably going to be exacerbated because of the lack of liquidity,' Hayes said. 'It's going to take a bigger price adjustment or yield movement to attract the value buyer, and for the municipal market, that means the cross-over buyer.'"

September 26 - Bloomberg (Brian Chappatta): "Chicago and surrounding Cook County have the largest pension burdens among the 50 most-indebted U.S. local governments, according to Moody's... The third-most-populous U.S. city's pension liabilities represent 678% of its revenue, a Moody's study... shows. Cook County had the second-worst ratio at about 382%, while the Metropolitan Water Reclamation District of Greater Chicago had the sixth-highest burden at 323%. Moody's cut Chicago's bond rating three levels to A3, seventh-highest, in July and dropped Cook County a step to A1, fifth-best, in August, citing pension liabilities in both cases."

September 27 - Bloomberg (Christine Idzelis): "Private-equity firms are obtaining buyout loans at the fastest pace in six years with Blackstone Group LP expressing optimism for the industry as demand for debt with interest rates that rise with benchmarks fuels borrowings. 'You could raise around $20 billion given where markets are today,' Gerry Murray, head of JPMorgan Chase & Co.'s North America leveraged finance business, said... The Federal Reserve's surprise decision last week to not reduce its stimulus 'gave a shot of adrenaline into the leveraged markets,' said Murray. Dell Inc., HJ Heinz Co. and other companies have either raised or are in the process of obtaining more than $66 billion in loans for leveraged buyouts in 2013, exceeding the $51 billion in all of last year... Buyout financings peaked in 2007 at $189 billion."

September 25 - Bloomberg (Charles Mead and Callie Bost): "Dell Inc. is favoring loans to finance its $24.9 billion leveraged buyout after a surge in borrowing costs bolstered investor demand for floating-rate debt... The personal-computer maker this week issued less than half the $3.25 billion in secured notes it had intended to sell as part of a $13.8 billion funding commitment it obtained in February to go private. Dell is instead taking a euro-denominated term loan and increasing dollar portions that cost at least 1.125 percentage point less than its fixed-rate bonds. The changes reflect shifting investor demand since the... company disclosed the buyout Feb. 5th..."

September 25 - Bloomberg (Lisa Abramowicz): "Corporate-bond brokers may face a squeeze on profits as regulators start publishing prices for almost $1 trillion of privately sold corporate debt, if the past is any guide. The Financial Industry Regulatory Authority, seeking to 'foster more competitive pricing,' plans to start disseminating trading levels for securities issued under a rule known as 144a on its 11-year-old Trace system within the next year. That means the notes, sold only to institutional investors, will face the same price transparency as publicly registered corporate bonds... Brokers typically are paid larger fees from higher-yielding debt... There are as much as $300 billion of speculative-grade notes in the U.S. filed under the rule, and about $670 billion of dollar-denominated investment-grade corporate bonds, according to Barclays. Investors are demanding an average of 54 bps... more yield to own speculative-grade 144a bonds, which require less financial disclosure than publicly registered securities... By selling bonds under Securities Act Rule 144a, corporate borrowers can avoid filing financial disclosures as long as they sell the notes only to qualified institutional buyers, saving them money otherwise spent on regulatory compliance."

September 23 - Bloomberg (Jody Shenn): "Issuers in the reviving market for U.S. mortgage securities are creating debt with features not seen since before the financial crisis that can increase risks for certain investors, according to Moody's... The expanding ways in which investors in the various slices of deals will share cash flows from the underlying loans raise additional 'analytical challenges,' Moody's said... The structures are creating debt -- with names including super-senior support bonds, exchangeable securities, principal- only notes and pool interest-only bonds -- in which investors in some pieces can have greater losses even with the same levels of loan defaults and repayments."

September 25 - Bloomberg (Gowri Gurumurthy): "Downgrades of speculative-grade companies have exceeded upgrades for six consecutive months and do in 11 of the 12 months through July, Moody's analyst David Keisman writes... Also, the number of ratings on review for downgrade has exceeded review for upgrade every month since April 2012... Downgrades reflect increasing leverage as strong debt issuance coincides with tepid earnings growth... Credit conditions can deteriorate quickly and weaken materially and increase the population of companies with B3 or lower ratings..."

Federal Reserve Watch:

September 23 - Bloomberg (Caroline Salas Gage): "Federal Reserve Bank of New York President William C. Dudley said policy makers must 'forcefully' push against economic headwinds as the U.S. has yet to show "any meaningful pickup" in momentum. 'The economy still needs the support of a very accommodative monetary policy,' Dudley, who is vice chairman of the Federal Open Market Committee, said... 'Improving economic fundamentals versus fiscal drag and somewhat tighter financial conditions are pulling the economy in opposite directions, roughly cancelling each other.'"

September 27 - Reuters (Jonathan Spicer): "Once the Federal Reserve reduces its bond-buying program, it could then wait 'a number of years' before it raises interest rates, an influential official at the U.S. central bank said on Friday. The two things 'are very loosely connected,' said New York Fed President William Dudley. 'The amount of time that can pass between the decision to begin to taper and actually raising short-term interest rates could easily be a number of years.'"

September 24 - Bloomberg (Jeff Kearns and Steve Matthews): "Federal Reserve Bank of Atlanta President Dennis Lockhart, who has backed the Fed's $85 billion in monthly bond purchases, said U.S. monetary policy should focus on creating a more dynamic economy after a recent cooling in growth. 'Recently there appears to have been some slowing' in job creation, Lockhart, who next votes on policy in 2015, said... 'Monetary policy can help deliver appropriately favorable interest rate conditions that can promote a faster economic recovery, always in a context of low and stable inflation,' Lockhart said..."

Central Bank Watch:

September 27 - Bloomberg (Jennifer Ryan and Eshe Nelson): "Bank of England Governor Mark Carney said he doesn't see an argument for expanding quantitative easing as the recovery has gained traction. 'My personal view is, given the recovery has strengthened and broadened, I don't see a case for quantitative easing and I have not supported it,' he said..."

U.S. Bubble Economy Watch:

September 23 - Bloomberg (Adam Satariano): "Apple Inc. sold a record 9 million iPhones in the weekend debut of two new models, as the company China in the rollout and consumers snapped up handsets with more colorful options and a fingerprint reader. Sales almost doubled from the previous record even amid supply constraints for the iPhone 5s, the higher-end version of the two smartphones... 'While we've sold out of our initial supply of iPhone 5s, stores continue to receive new iPhone shipments regularly,' Chief Executive Officer Tim Cook said... 'We appreciate everyone's patience and are working hard to build enough new iPhones for everyone.'"

September 23 - Bloomberg (Michael McDonald and John Lauerman): "The number of so-called mega donations to U.S. colleges is rebounding just as Harvard University begins a $6.5 billion capital campaign, the largest in the history of higher education. There have been 16 gifts this year of at least $50 million, twice as many as for all of last year as donors gain confidence amid improving economic conditions, according to... the Chronicle of Higher Education."

September 23 - Bloomberg (Toluse Olorunnipa): "Florida Governor Rick Scott shows how governors in at least nine states are approaching re-election campaigns next year by touting surpluses and pitching tax cuts, sometimes relying on one-time revenue to fund the breaks. The 60-year-old Republican toured the state this month to highlight a proposed $500 million decrease in taxes and a projected $845.7 million surplus... Revenue topped forecasts in 30 states, partly because wealthy taxpayers shifted income into 2012 to avoid higher federal rates... Some governors seized on the extra money as evidence of fiscal skill. The tax breaks give them material for the campaign trail, even as state-finance analysts warn they're built on faulty budgeting and could force deep cuts after the elections."

September 27 - Bloomberg (Jeanna Smialek and Ian Katz): "A shutdown of the U.S. government would reduce fourth-quarter economic growth by as much as 1.4 percentage points depending on its length, economists say, as government workers from park rangers to telephone receptionists are furloughed. Mark Zandi of Moody's Analytics Inc. estimates a three-to- four week shutdown would cut growth by 1.4 points. Moody's projects a 3% rate of growth in the fourth quarter without a closure."

September 26 - Wall Street Journal (Nick Timiraos): "The Federal Housing Administration, which emerged as a major backstop of the U.S. residential-mortgage market throughout the housing downturn, is likely to require an infusion from the U.S. Treasury at the end of the month, according to people familiar with the matter. Officials haven't determined exactly how much money the FHA will need, these people said, but early projections have suggested the agency could require at least $1 billion... The FHA's main mortgage program hasn't required taxpayer support in its 79-year history. The agency doesn't have to ask Congress for money because it has what is known as 'permanent and indefinite' budget authority, allowing it to tap the Treasury. The FHA, which doesn't originate loans but insures lenders against losses, guarantees mortgages to borrowers who make down payments of as little as 3.5%. FHA-backed loans accounted for one-third of loans used to purchase homes last year among owner-occupants."

September 27 - Bloomberg (Clea Benson): "The Federal Housing Administration will take about $1.7 billion from the U.S. Treasury to shore up its insurance fund after losses on defaulted mortgages depleted reserves... The agency has about $30 billion in liquid assets and needs more because it is required to keep enough money on hand to cover all projected future losses. 'This required mandatory appropriation is an accounting transfer and does not reflect an up-to-date view' of the insurance fund's 'performance, its long-term fiscal health or its current cash position,' Galante wrote... 'In the next few months we expect updated data and economic forecasts to reflect what we already know to be true -- the health of the Fund has improved significantly.'"

Global Bubble Watch:

September 25 - Bloomberg (Sanat Vallikappen and Stephanie Tong): "Wealth among Asia-Pacific millionaires may top North America's as soon as next year as Japanese economic growth boosts investor returns in the country, a report by Cap Gemini SA and Royal Bank of Canada showed. Asians with at least $1 million in investable assets are expected to see their riches climb to $15.9 trillion by 2015 from $12 trillion last year... North American high net-worth individuals held $12.7 trillion in 2012. Japan, the world's best-performing major stock market this year, accounts for more than half of Asia's millionaires and will drive regional prosperity as Prime Minister Shinzo Abe's economic stimulus policies aim to reverse 15 years of deflation..."

EM Bubble Watch:

September 24 - Bloomberg (David Biller and Raymond Colitt): "Luciano Coutinho, president of state development bank BNDES, is pledging to cut back on lending after a threefold rise during his tenure increased the likelihood Brazil would have its credit rating cut. Bond investors aren't convinced. BNDES paid a premium of 3 percentage points over Treasuries in its sale of $1.25 billion in 10-year bonds last week, the bank's first dollar-denominated offering in almost four years... As growth slowed in the world's second-largest emerging market and private banks restricted lending, public banks such as BNDES and Caixa Economica Federal have filled the void with Treasury funds that boosted the nation's debt... Government-backed banks loaned at six times the pace of privately owned banks in the first half of the year, and as of June accounted for more than half of outstanding loans for the first time in more than a decade... BNDES' Coutinho, 66, became president of BNDES in April 2007. Lending jumped to 156 billion reais ($71bn) in 2012 from 51 billion reais in 2006 and is on track to reach as much as 190 billion reais this year, he said last month. Caixa expects its portfolio of loans to grow 37% to 38% this year, and 29% to 31% next year, Marcio Percival, Caixa's vice president of finance, said... 'The Brazilian government wants to cut loan growth' at BNDES and Caixa, [Fitch Ratings managing director Franklin] Santarelli said... 'The question is, how exactly are you going to implement that?'"

September 24 - Bloomberg (Benjamin Harvey and Taylan Bilgic): "The Turkish central bank's pledge to keep interest rates low is fueling a credit boom, perpetuating a debt-driven economic-growth model that Deputy Prime Minister Ali Babacan says is undesirable. Lending to households jumped 28% and rose 41% for businesses in the year to Sept. 13, the banking regulator in Ankara said... 'The risk is consuming while production is weak -- getting more and more in debt,' Haydar Acun, managing director of Sardis Securities in Istanbul, said... 'One day -- boom -- you can have large-scale bankruptcies in a chain.'"

China Bubble Watch:

September 25 - Bloomberg: "Chinese cities, addicted to the money they raise by selling land to developers, are undermining the government's multiyear campaign to contain housing costs. Municipal residential land deals, measured by area, rose 26% in the first eight months of the year from the same period in 2012, according to China Investment Securities Co. The average price per square meter jumped 43%, pushing proceeds up 80% to 816.5 billion yuan ($133bn). Local officials rely on revenue from the sales to repay debt, especially as economic growth slows... The cycle is driving property costs higher, complicating Premier Li Keqiang's task of preventing social unrest over the lack of affordable housing amid a massive urbanization program. 'If the momentum in the land market can't be cooled down rather quickly, it's actually a fairly dangerous signal,' Bei Fu, Standard & Poor's Hong Kong-based property credit analyst, said... 'Should it keep heating up, we're worried there might be further policy tightening, and there could be consequences for the entire market that are unpredictable at this point.'"

September 23 - Bloomberg: "A Chinese manufacturing index rose to a six-month high in September, signaling that a rebound in the world's second-largest economy is gaining steam. The preliminary reading of 51.2 for a Purchasing Managers' Index released today by HSBC Holdings Plc and Markit Economics compared with a 50.9 median estimate... The gauge was at 50.1 in August."

September 25 - Bloomberg: "China's economy slowed this quarter as growth in manufacturing and transportation weakened in contrast with official signs of an expansion pickup, a private survey showed. Increases in business-investment and real estate revenue also slowed, while service industries picked up and employees became tougher to find, the survey from New York-based China Beige Book International said... The report is based on responses from 2,000 people from Aug. 12 to Sept. 4 as well as 32 in-depth interviews conducted later in September. The quarterly report, which began last year and is modeled on the U.S. Federal Reserve's Beige Book business survey, diverges from government figures showing faster factory-output gains in July and August... Nomura Holdings Inc. is among banks skeptical that any rebound will be sustained next year. The results 'show the conventional wisdom of a renewed, strong economic expansion in China to be seriously flawed,' China Beige Book President Leland Miller and Craig Charney, research and polling director, said... The data 'reveal weakening gains in profits, revenues, wages, employment and prices, all showing slipping growth on- quarter -- no disaster, but certainly not the powerful expansion suggested by the consensus narrative.'"

September 27 - Bloomberg (Fion Li): "Hong Kong's benchmark yuan interest rate fell to the lowest since it was introduced in June as the monetary authority increased the currency's availability and demand for offshore funding eased. The six-month interbank offered rate fell to 2.93% yesterday... Comparable Hong Kong dollar and greenback rates are 0.55% and 0.45% respectively. Dim Sum bond sales totaled 6.8 billion yuan ($1.11bn) since June 30, set for the slowest quarter since 2010. Growth in yuan loans cooled in the first half."

Japan Watch:

September 25 - Bloomberg (Rocky Swift and Shigeki Nozawa): "Japan must raise its sales tax to at least 20% by the time the Olympics come to Tokyo in 2020 to avert a 'disaster' in its bond market, according to the head of a panel advising the world's biggest pension fund. The consumption levy, due to increase in April for the first time since 1997, will need to quadruple from current levels to handle Japan's increasing welfare costs and rein in the nation's debt, said Takatoshi Ito, who leads an investment panel for the 121 trillion yen ($1.22 trillion) Government Pension Investment Fund. He said funds like GPIF are at risk of being too dependent on Japanese government bonds, where 10-year yields of 0.670% are the lowest globally... 'There is a narrow path to escape from the disaster,' Ito, the dean of Tokyo University's Graduate School of Public Policy, said... 'The good news is that there is a big fiscal space to increase taxes.'"

September 27 - Bloomberg (Toru Fujioka): "Japan's inflation accelerated to the fastest pace since 2008 in August on higher energy costs, underscoring pressure on Prime Minister Shinzo Abe to drive wage increases as he seeks to end 15 years of deflation. Consumer prices excluding fresh food increased 0.8% from a year earlier..."

September 26 - Bloomberg (Rocky Swift and Shigeki Nozawa): "A panel advising the world's largest pool of retirement savings said the Japanese government should review its holdings of domestic bonds that make up the bulk of its pension assets. The interim report from the panel of economists comes as market participants say the 121 trillion yen ($1.23 trillion) Government Pension Investment Fund should increase its holdings of risk assets. Some members of the group recommended adding new assets such as real estate trusts, infrastructure and private- equity investments and commodities..."

September 27 - Bloomberg (Mariko Ishikawa, Kenneth Kohn and Yumi Ikeda): "Takeshi Fujimaki, a former adviser to billionaire George Soros and now a member of Japan's upper house of parliament, said a fiscal crisis in Asia's second-biggest economy is inevitable and neither a higher sales tax nor the 2020 Olympics will be able to stop it. 'I decided to become a politician because I think financial crisis will come sooner or later,' Fujimaki said... 'This total debt will continue to increase. I don't think Japan can survive until 2020.'"

Latin America Watch:

September 24 - Bloomberg (John Quigley): "Peru's bond risk is soaring more than any investment-grade debtor nation in the Americas as tumbling metal exports erode the country's budget surplus and prompt the government to double its borrowing. The cost to protect Peruvian dollar debt against non-payment for five years using credit-default swaps has climbed 0.4 percentage point to 1.40 percentage points in the past six months... Only contracts for Venezuela, the speculative-grade issuer rated seven levels below Peru's BBB+ grade, have increased more... The Finance Ministry said last month that Peru will sell as much as $964 million of local-currency bonds in 2014, twice the amount it plans to sell this year and the most since 2010."

Europe Crisis Watch:

September 26 - Bloomberg (Stefan Riecher): "Lending to companies and households in the euro area fell the most on record in August, signaling that the economy is still struggling to recover from its longest-ever recession. Loans to the private sector dropped 2% from a year earlier... That's 16th monthly decline and the biggest since the start of the single currency in 1999. Adjusted for loan sales and securitization, lending contracted 1.5% in August. The data shows a 'depressing picture for the credit market,' said Annalisa Piazza, an analyst at Newedge Group in London. "Although the ECB made clear that the ECB cannot do much to boost credit to the corporate sector, we expect the current picture for loans to remain one of the key reasons behind expectations of a prolonged period of accommodation.'"

September 23 - Bloomberg (Jeff Black): "European Central Bank President Mario Draghi said he's ready to deploy another long-term refinancing operation to provide funds to Europe's banking system if needed. 'We are ready to use any instrument, including another LTRO if needed, to maintain the short term money markets at the level that is warranted by our assessment of inflation in the medium term,' Draghi said... Euro-area money-market rates rose to a level that Draghi described as 'unwarranted' in July after the U.S. Federal Reserve signaled that it would begin to ease stimulus and signs emerged of a recovery in the 17-nation region. While those rates have since declined, excess liquidity in the financial system is approaching the 200 billion-euro ($270 billion) level the ECB has previously signaled as a lower limit."

September 26 - Bloomberg (Sara Eisen, Ben Sills and Esteban Duarte): "Spanish Prime Minister Mariano Rajoy said he has no knowledge of whether party officials working for him destroyed evidence sought by the National Court as part of a corruption investigation. Speaking in an interview with Bloomberg Television, Rajoy answered questions for the first time about a probe into a possible cover up, after the party failed to hand over hard drives required by a judge investigating graft allegations. 'I don't know if they were there, if they had been there, or if someone removed them,' Rajoy, 58, said... 'I absolutely do not know.'"

September 24 - Bloomberg (Anabela Reis): "Portugal is relying on pensioners to help stem a rise in borrowing costs less than a year before the country's rescue program ends. The 11 billion-euro ($14.9bn) Social Security Financial Stabilization Fund, which keeps enough money to cover at least two years of payments to retirees, is increasing the proportion of domestic debt that it holds to as much as 90%. Since the plan was proposed in May as part of Portugal's aid package, the nation's 10-year bond yields jumped almost 2 percentage points to more than 7%."

Germany Watch:

September 23 - Bloomberg (Brian Parkin and Tony Czuczka): "Germany's Free Democrats, who have held the balance of power more than any other political party in the republic's history, were ousted from parliament for the first time after voters defected to Angela Merkel's Christian Democrats and the euro-skeptic AfD. The liberal FDP, which served as the junior partner in Christian and Social Democrat-led governments, gained just 4.8% in federal elections yesterday, less than the 5% needed to enter the Bundestag... The party's worst result contrasts with its best of 14.6%, gained four years ago to rule under Angela Merkel. The FDP's exit from Germany's lower house marks the end of 64 years of parliamentary representation, in which it championed free market policies and personal freedoms, challenging the postwar consensus-orientated politics of the larger people's parties."

Italy Watch:

September 26 - Financial Times (Guy Dinmore): "Silvio Berlusconi's centre-right supporters have thrown Italy's coalition government into crisis with a threat to resign from parliament if a Senate committee votes next month to strip him of his Senate seat. The threat, issued on Wednesday night, appeared to reverse a statement by the former prime minister, who last week spoke of the importance of political stability and said his party's ministers in Enrico Letta's left-right coalition would continue to work on their economic programme. A Senate committee is due to vote on October 4 on whether to expel Mr Berlusconi from parliament as a result of his conviction for tax fraud last month."

September 27 - Bloomberg (Emma Charlton and Lukanyo Mnyanda): "Italy's government bonds fell amid speculation that traders who deal directly with the Rome-based Treasury bought most of the securities at today's auction as the nation's political tensions deterred other buyers. Italian 10-year bonds dropped for a second day before Prime Minister Enrico Letta meets President Giorgio Napolitano to discuss the government's prospects for survival. Former premier Silvio Berlusconi's allies this week threatened to step down from the coalition if he is expelled from the Senate... 'The issue is that it was a dealer-led affair and there wasn't much real-money buying,' said Harvinder Sian, a senior fixed-income strategist at Royal Bank of Scotland Group... 'The dealers have had to take too much of the debt so we're likely to see some of that coming back in to the market. For us, the risk-reward for Italian debt at these levels is not that compelling.'"

September 26 - MarketNews International (Silvia Marchetti): "Italy's fragile coalition government is facing the third major challenge in less a month that could jeopardize political stability as it struggles to keep finances under control and avoid a breach of European deficit rules. Prime Minister Enrico Letta must find additional resources that will allow him to block a planned one percentage point rise in VAT next month, put in place by the technocrat administration of Mario Monti, and still reduce the country's overall budget deficit, which last week climbed to over 3% of GDP. This follows on the heels of a controversial property tax overhaul and ahead of a pending vote in the Senate which could scrap the immunity of former premier and convicted fraudster Silvio Berlusconi."


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