The Dow dipped 0.2%, and the S&P500 declined 0.6%. Economically sensitive issues outperformed. The Transports jumped 3%, and the Morgan Stanley Cyclical index added 0.4%. The Amex Oil index jumped 2.7%. The Utilities declined 1.6%, and the Morgan Stanley Consumer index retreated 0.5%. The Broader market was flattish. The small cap Russell 2000 dipped 0.4%, while the S&P400 Mid-cap index gained 0.1%. The NASDAQ100 declined 0.8%, and the Morgan Stanley High Tech index fell 0.6%. The Semiconductors were hit for 1.8%, and the NASDAQ Telecommunications index sank 3%. The Biotechs declined 1.3%. The financials were mixed. The Broker/Dealers rallied 2.2%, while the Banks declined 1.3%. Bullion added $2.40, while the HUI gold index rose almost 6%.

For the week, two-year Treasury yields rose 10 bps to 5.26%. Five-year yields jumped 11 bps to 5.21%, and bellwether 10-year yields gained 10 bps to 5.23%. Long-bond yields rose 9 bps to 5.26%. The 2yr/10yr spread ended the week inverted 3 bps. Benchmark Fannie Mae MBS yields jumped 10 bps to 6.44%, this week again performing in line with Treasuries. The spread on Fannie's 4 5/8% 2014 note ended the week two wider at 32, and the spread on Freddie's 5% 2014 note little changed at 31. The 10-year dollar swap spread increased 1.2 to 58.7. Corporate bond spreads were volatile but generally little changed during the week. The implied yield on 3-month December '06 Eurodollars jumped 11 bps to 5.70% (2-wk gain of 27.5bps).

Investment grade issuers included Merrill Lynch $3.3 billion, Goldman Sachs $1.75 billion, Citigroup $1.0 billion, Bank of America $1.0 billion, Shell $1.0 billion, Tate & Lyle International $600 million, Puget Energy $250 million, and South Carolina E&G $125 million.

Junk issuers included Nevada Power $700 million, Petrohawk Energy $650 million, Ohio Edison $600 million, Dominion Resources $300 million, Transdigm $275 million, Torchmark $250 million, Stone Energy $225 million, Hilcorp Energy $200 million, Northwest Pipeline $175 million, Baker & Taylor $165 million, and International Coal Group $175 million.

Convert issuers included Equity Operating Properties $1.3 billion, Medimmune $1.0 billion, American Medical Systems $325 million, Group 1 Auto $250 million, and Lifetime Brands $75 million.

Foreign dollar debt issuers included Intelsat Bermuda $2.5 billion and Region of Campagnia $1.0 billion.

June 23 - Bloomberg (Michael Tsang): "Emerging-market stock funds suffered a fifth week of withdrawals after investors pulled out a further $2 billion..."

June 21 - Financial Times (Paul J Davies): "Retail investors worldwide have been ploughing their savings into increasingly exotic assets by means of complex structured products in the past 18 months, according to a survey from BNP Paribas... The volume of options with names such as 'Asian calls', 'Reverse convertibles' and 'Arianes' sold to retail investors worldwide rose by 15 per cent in 2005 to €230bn... Investors eagerly jumped on the momentum of rising markets globally and increased their exposure to options on asset classes that have outperformed during recent years, such as commodities, real estate and emerging markets. Such action is likely to lead to concerns about how well investors understand the risks associated with these products as speculative money that has helped drive recent gains begins to be pulled out."

Japanese 10-year "JGB" yields rose 6.5 bps this week to 1.87%. The Nikkei 225 index recovered 1.6%, lowering its 2006 loss to 6.1%. German 10-year bund yields jumped 14 bps to 4.07%, as European 2-year yields moved to almost 4-year highs. Emerging debt markets were under pressure, while equity markets generally rallied. Brazil's benchmark dollar bond yields jumped 21 bps to 7.36%. Brazil's Bovespa equity index increased 0.8%, increasing 2006 gains to 3.6%. The Mexican Bolsa rose 2.8% this week (up 4.2% y-t-d). Mexico's 10-year $ yields jumped 16 bps to 6.60%. Russian 10-year dollar Eurobond yields jumped 10 bps to 7.05%. The Russian RTS equities index rallied 1%, increasing 2006 gains to 19.5% and 52-week gains to 91.5%. India's hyper-volatile Sensex equities index jumped 5% (up 10.7% y-t-d).

June 23 - Financial Times (Joanna Chung and Neil Buckley): "Russia yesterday agreed to repay its entire $21.3bn debt to the Paris Club of creditor nations by the end of August, plus a $1bn early repayment premium. The agreement is an important political step for Russia ahead of the summit of the Group of Eight industrial nations next month, and highlights how its finances have been transformed in recent years thanks to high energy prices. The reduction of its debt stock also raises the possibility of further credit rating upgrades, analysts said."

June 22 - Bloomberg (Adriana Arai and Valerie Rota): "Mexico will pay back $7 billion of debts with the World Bank and Inter-American Development Bank ahead of schedule, part of a push by developing nations to use surging commodity export revenue to reduce foreign liabilities."

Freddie Mac posted 30-year fixed mortgage rates jumped 8 bps to 6.71%, the high since June 2002 and up 114 basis points from one year ago. Fifteen-year fixed mortgage rates surged 11 bps to 6.36%, 120 bps higher than a year earlier. One-year adjustable rates rose 9 bps to 5.75%, an increase of 148 bps over the past year. The Mortgage Bankers Association Purchase Applications Index was little changed this week. Purchase Applications were down 13.2% from one year ago, with dollar volume down 13.6%. Refi applications dipped 2.2% last week. The average new Purchase mortgage slipped to $224,800, while the average ARM fell a thousand to $340,100.

Bank Credit expanded $16.0 billion last week to $7.940 Trillion, with a y-t-d gain of $434 billion, or 12.5% annualized. Bank Credit inflated $771 billion, or 10.8% over 52 weeks. For the week, Securities Credit jumped $21.6 billion. Loans & Leases declined $5.5 billion for the week, although are up $267 billion y-t-d (10.6% annualized). Commercial & Industrial (C&I) Loans have expanded at a 15.6% rate y-t-d and 13.3% over the past year. For the week, C&I loans dipped $1.1 billion, while Real Estate loans gained $3.3 billion. Real Estate loans have expanded at a 12.2% rate y-t-d and were up 12.7% during the past 52 weeks. For the week, Consumer loans rose $4.1 billion, while Securities loans declined $12.9 billion. Other loans added $1.1 billion. On the liability side, (previous M3 component) Large Time Deposits declined $1.9 billion.

M2 (narrow) "money" supply dipped $700 million to $6.8 Trillion (week of June 12). Year-to-date, narrow "money" has expanded $117 billion, or3.8% annualized. Over 52 weeks, M2 has inflated $302 billion, or 4.6%. For the week, Currency declined $0.6 billion. Demand & Checkable Deposits dropped $25.6 billion. Savings Deposits jumped $17.4 billion, and Small Denominated Deposits rose $4.1 billion. Retail Money Fund assets gained $4.1 billion.

Total Money Market Fund Assets, as reported by the Investment Company Institute, were unchanged last week at $2.106 Trillion. Money Fund Assets have increased $49 billion y-t-d, with a one-year gain of $196 billion (10.2%).

Total Commercial Paper rose $0.4 billion last week to $1.777 Trillion. Total CP is up $128 billion y-t-d, or 16.1% annualized, while having expanded $232 billion over the past 52 weeks (15.0%).

Asset-backed Securities (ABS) issuance surged to $27 billion this week. Year-to-date total ABS issuance of $360 billion (tallied by JPMorgan) is running even with 2005's record pace, with y-t-d Home Equity Loan ABS sales of $253 billion 11% above last year.

Fed Foreign Holdings of Treasury, Agency Debt ("US marketable securities held by the NY Fed in custody for foreign official and international accounts") increased $4.6 billion to a record $1.637 Trillion for the week ended June 21st. "Custody" holdings are up $118 billion y-t-d, or 16.2% annualized, and $201 billion (14.0%) over the past 52 weeks. Federal Reserve Credit added $1.1 billion to $826 billion. Fed Credit has declined $0.5 billion y-t-d, or 0.1% annualized. Fed Credit is up 4.8% ($38bn) during the past year.

International reserve assets (excluding gold) - as accumulated by Bloomberg's Andy Burt - are up $406 billion y-t-d (21% annualized) and $605 billion (16%) in the past year to $4.452 Trillion.

June 21 - Dow Jones: "Mexico's foreign reserves climbed $669 million last week to a record $76.72 billion on June 16...As of June 16, reserves were up $8.05 billion from the end of 2005..."

June 23 - Bloomberg (Anoop Agrawal): "India's foreign-exchange reserves rose $157 million to $163.03 billion in the week..."

Currency Watch:

The dollar index ended the week up 1.1%. On the upside, the Brazilian real gained 0.6%, the Mexican peso 0.3% and the Thai baht 0.1%. On the downside, the South African rand fell 7.3%, the Turkish lira 7.2%, the Romanian leu 4.3%, and the Polish zloty 2.3%.

Commodities Watch:

June 23 - Bloomberg (Yanping Li): "China should buy some gold with its foreign-exchange reserves to avoid devaluation of its U.S. dollar holdings, the official Shanghai Securities News reported... Using some of the currency reserves to buy gold would secure and increase the value of China's dollar holdings, Zhao Qingming from the central bank's Financial Research Institute and Luo Bin from the bank's accounting department wrote..."

June 21 - Financial Times (Sheila McNulty): "North America will be the world's biggest importer of liquefied natural gas (LNG) by 2010, according to Wood Mackenzie, an energy consultancy. But experts believe the future shift in trade flows will be volatile and exploited by arbitrageurs until US gas supplies become critical. 'All the US gets is the leftovers, what the others do not want or are not prepared to pay the price for,' said Gavin Law, Wood Mackenzie's co-head of global LNG."

June 20 - Bloomberg (Gemma Daley): "Australia, the world's second-largest wheat exporter, cut its harvest forecast by 9 percent after below-average rainfall delayed planting."

June 19 - Bloomberg (Claire Leow): "Raw sugar futures in New York may reach the highest average price in at least 20 years by the December quarter, as demand for ethanol rises, Barclays Plc said. Sugar may average 19 cents a pound in the final quarter... The sweetener has averaged 16.92 cents a pound this year, 69 percent higher than last year."

Gold gained 0.4% to $583.55 and Silver 1.5% to $10.285. Copper fell 2.2%. August crude gained 67 cents to $70.87. July Unleaded Gasoline jumped 4.4%, while July Natural Gas fell 13.3%. For the week, the CRB index declined 1.2% (y-t-d up 1.0%). The Goldman Sachs Commodities Index (GSCI) slipped 0.3%, reducing y-t-d gains to 8.4%.

China Watch:

June 19 - Bloomberg (Rob Delaney and Yanping Li): "China will be 'more active' in draining funds from the financial system and give the market a bigger role in setting the yuan's exchange rate, the central bank said. The People's Bank of China will 'further curb excessive loan growth' and control 'rapid investment growth...' China should 'strengthen management over liquidity in the banking system' and 'continue to guide commercial banks in keeping the pace and scale of their medium- and long-term loans at a reasonable level.'"

June 22 - Bloomberg (Nerys Avery): "Profits at Chinese industrial companies grew 25.5 percent in the first five months of the year after increasing 22.1 percent through April."

June 21 - Financial Times (Geoff Dyer): "China's steel mills...accepted the 19 per cent increase in iron ore prices that other large steel companies globally have already agreed to, according to the official Xinhua news agency. The decision represents a significant reversal for China, which attempted to use its rapidly increasing buying power in the iron ore market to achieve a reduction in prices..."

June 20 - Financial Times (Ben White): "Whether it should be called a long march or a safari, China's leaders are all bending their steps towards Africa. The seven-country tour of Africa by Wen Jiabao, the Chinese premier, marks the third visit to the continent by a senior Chinese leader this year and demonstrates the extent of China' surging demand for the continent' natural resources. Mr Wen is due today in Angola, now second only to Saudi Arabia as a source of imported oil for China's energy-hungry economy... Two-way trade between China and Africa soared by 35 per cent last year to $39.7bn..."

June 21 - Bloomberg (Yanping Li): "Beijing's property prices increased 7.1 percent in the first five months of the year because of strong demand... Prices of new commercial housing rose 8 percent year-on-year during the period, and second-hand property prices rose 9.5 percent..."

June 19 - Bloomberg (Nipa Piboontanasawat): "Hong Kong's unemployment rate fell to an almost five-year low in May as an expanding economy caused companies to increase hiring. The seasonally adjusted jobless rate dropped to 4.9 percent from 5.1 percent..."

Asia Boom Watch:

June 19 - Bloomberg (Cherian Thomas and Kartik Goyal): "India's exports of gems, textiles and other manufactured products expanded at the fastest pace in nine months in May, spurring industrial growth. Exports rose 29.6 percent to $9.3 billion in May from a year ago, the fastest since August 2005..."

June 23 - Bloomberg (Nipa Piboontanasawat): "Taiwan's export orders grew at the fastest pace in more than a year in May as overseas demand for the island's electronics increased. Export orders, indicative of actual shipments in one to three months, rose 26 percent from a year earlier to $24.6 billion..."

June 22 - Bloomberg (Kim Kyoungwha): "South Korea's financial watchdog has ordered domestic banks to cut monthly mortgage lending by half, virtually halting new loans to homebuyers, the Maeil Business Newspaper reported, citing banking officials."

June 21 - Bloomberg (Kyunghee Park): "South Korea's seven shipbuilders, makers of 38 percent of vessels delivered globally in 2005, said they may raise prices to take advantage of record orders and protect their profits from increasing steel costs. Carriers of containers, oil and minerals may cost about 5 percent more this year, said Kang Soo Hyun, chief executive of Hyundai Samho Heavy Industries Co."

June 19 - Bloomberg (Beth Jinks and Laurent Malespine): "Bangkok's cement skeletons and empty towers, abandoned during the 1997-98 Asian financial crisis, are transforming into hotels and offices as developers return. The 'ghost buildings,' as local media call them, were repossessed by banks and left derelict. Last month the five-star, 543-room Millennium Hilton opened on the bank of the Chao Phraya River, a building that was started more than a decade earlier as Accor SA's Sofitel."

Unbalanced Global Economy Watch:

June 21 - CNW: "Affluent Canadians are fuelling unprecedented demand for luxury homes from Halifax to Vancouver this year, according to a report released today by RE/MAX. 'Million dollar home sales are climbing at a rate never before seen in major centres across the country," says Michael Polzler, Executive VP...RE/MAX Ontario-Atlantic Canada. 'The Canadian love affair with residential real estate is far from over. If the market continues at this pace, existing sales records for all types of real estate, including upscale properties, will be shattered by year end.'"

June 20 - Bloomberg (Brian Swint): "U.K. mortgage lending rose to the highest in two years in May, the British Bankers Association said, extending a revival in Britain's $6 trillion housing market."

June 20 - Bloomberg (Gabi Thesing and Simone Meier): "Producer price inflation in Germany, Europe's largest economy, last month accelerated to the fastest in almost 24 years, led by higher energy costs. Goods from plastics to newsprint were 6.2 percent more expensive in May than a year earlier..."

June 20 - Bloomberg (Sheyam Ghieth and Flavia Krause-Jackson): "Italy's unemployment rate in the first quarter unexpectedly declined to the lowest in more than a decade as Europe's fourth-largest economy recovered from stagnant growth and more immigrants received job contracts. The jobless rate adjusted for seasonal factors dropped to 7.4 percent from a revise 7.6 percent..."

June 22 - Bloomberg (Evalinde Eelens): "Dutch consumer spending accelerated in April, led by increased purchases of electronics, clothes and other durable goods. Consumer spending, adjusted for calendar effects, increased 3.8 percent in April from a year earlier..."

June 21 - Bloomberg (Jonas Bergman): "Swedish economic growth will accelerate to 3.8 percent this year as consumer and government spending rises, the National Institute of Economic Research said."

June 21 - Bloomberg (Jonas Bergman): "Sweden's unemployment rate fell to 4.8 percent in May as the government spent more on training to combat a stagnant labor market. The rate fell from 5.5 percent in April..."

June 19 - Bloomberg (Svenja O'Donnell): "Russian industrial production rose an annual 10.6 percent in May, more than expected and the fastest pace since November 2004."

June 22 - Bloomberg (Nasreen Seria): "South African domestic spending growth more than tripled in the first quarter as interest rate reductions and tax cuts boosted consumer spending and investment... Gross domestic expenditure surged an annualized 14.5 percent, the fastest pace since the second quarter of 1999..."

Latin America Watch:

June 21 - Bloomberg (Patrick Harrington): "Mexico's unemployment rate fell to its lowest level in five months in May as automakers hired to produce new models for export to the U.S. Mexico's jobless rate fell to 2.9 percent from 3.3 percent..."

June 23 - Bloomberg (Patrick Harrington): "Mexico posted an unexpected trade deficit in May as imports of consumer goods including gasoline surged. Imports rose 24.8 percent to $22.8 billion. Exports rose 24.2 percent to $22.7 billion..."

June 22 - Bloomberg (Daniel Helft): "Argentina current account surplus rose to $1.2 billion in the first quarter, the government said."

June 23 - Bloomberg (Andrea Jaramillo): "Colombia's economy expanded in the first quarter as interest rates near record lows boosted consumer spending and investment. Gross domestic product...grew 5.23 percent from the year-earlier period, following revised growth of 3.85 percent..."

Central Bank Watch:

June 20 - Bloomberg (Jonas Bergman): "Sweden's central bank raised the benchmark interest rate by a quarter of a percentage point to 2.25 percent to contain inflation and indicated it may carry out three more increases this year. 'It's possible there will be a need for slightly more rate increases over the coming year than recent market expectations have implied,' Riksbank Governor Stefan Ingves said today..."

June 21 - Bloomberg (Simone Meier and Gabi Thesing): "European Central Bank President Jean-Claude Trichet comments on...inflation... "We ourselves are called by the treaty to deliver price stability on headline inflation not on core inflation and this is something which any of us can experience on a day-to-day basis. It is not documented by research that core inflation is a good predictor on future inflation. There are a great number of cases where core inflation joins up headline inflation and not headline inflation going down to core."

June 20 - Bloomberg (Mayumi Otsuma): "The Bank of Japan needs to adjust interest rates from near zero without delay if the economy and prices follow the path the bank predicted, Governor Toshihiko Fukui said. 'We are entering a tough phase in which we need to implement policy steps without delay, little by little...'"

Bubble Economy Watch:

May Durable Goods Orders were up 5.1% y-o-y, with Orders Ex-Transportation 11.5% ahead. Non-Defense Capital Goods Orders were down 0.7% y-o-y.

June 22 - EconoPlay.com (Gary Rosenberger): "A surge in packaging shipments in May, accompanied by aggressive price increases, points to an accelerating economy entering the summer - and possibly the most promising prospects for the packaging industry in decades, producers say. Few would have predicted May's year-over-year jump of 9.5% in corrugated container demand reported last week by the Fibre Box Association, which more than tripled the year-to-date average of 2.9%. The packaging industry has pushed through three aggressive price increases since October - and there's talk of two more by January. Prices now stand at about $510 to $520 a ton for linerboard and $490 to $500 a ton for corrugated medium (the main components of paper packaging), up 30% from the pre-Katrina bottom last August and fast approaching the 1995 peak of $530 a ton."

June 21 - The Wall Street Journal (Thaddeus Herrick): "Complete with a glass exterior and terrazzo floors, the $276 million Sprint Center is scheduled to open next year in this city's downtown. The 18,000-seat arena is designed to help anchor a massive project that includes nine blocks of retail, residential and office space that local officials say will revive Kansas City's faltering central business district. Already, there's a waiting list for luxury suites. 'It was what we needed to do,'said Wayne Cauthen, Kansas City's city manager. There's just one problem: Kansas City has no major-league team to play there. The city is hoping for a National Hockey League team, but so far it doesn't even have a minor-league tenant for its new venue. Like Des Moines, Iowa, and Little Rock, Ark., Kansas City is among a growing number of U.S. cities taking an 'If you build it, they will come' approach to stadiums, ballparks and particularly arenas. Encouraged by a building boom since the early 1990s in which major cities built new sports facilities for their professional teams, municipalities are raising money by such means as issuing bonds or imposing taxes to finance the building of new arenas in hopes of energizing their economies."

June 19 - New York Times (Carol Vogel): "A dazzling gold-flecked 1907 portrait by Gustav Klimt has been purchased for the Neue Galerie in Manhattan by the cosmetics magnate Ronald S. Lauder for $135 million, the highest sum ever paid for a painting."

June 22 - Bloomberg (Greg Bensinger): "New York taxi medallions sold for as much as $554,147.50 in an auction today of 254 of the small metal plates for use on alternative fuel yellow cabs, breaking the previous record by 16 percent."

June 23 - Bloomberg (Josh P. Hamilton): "A chance to dine with billionaire investor Warren Buffett drew a high bid of $455,100 in the first hours of a week-long charity auction on EBay Inc."

Real Estate Bubble Watch:

At 1.957 million annualized units, May Housing Starts were stronger-than-expected while down 3.8% from May 2005.

June - 22 - Central Valley Business Times: "A total of 51,750 new and resale houses and condos were sold statewide last month, according to DataQuick... That's up 9.5 percent from 47,250 for April but down 15.2 percent from...May 2005. Last year's May was the strongest May in DataQuick's statistics, which go back to 1988. The median price paid for a home last month was $469,000, a new record. That was up 0.2 percent from $468,000 for April, and up 9.8 percent from...a year ago. The typical mortgage payment that homebuyers committed themselves to paying last month was $2,298. That was up from $2,271 in April, and up from $1,899 for May a year ago."

June 22 - Dow Jones (Campion Walsh): "A Federal Reserve advisory panel Thursday addressed loan brokers' role in the growth of risky unconventional mortgages, while a Fed governor said non-bank brokers are the responsibility of state-level authorities. With three Fed governors and the central bank's chairman on hand, members of the Fed's Consumer Advisory Council raised concern that brokers outside the federally regulated banking system may be peddling complex home mortgage loans to customers who cannot afford them over the long-run."

Financial Sphere Bubble Watch:

June 22 - Financial Times (Ben White): "Goldman Sachs is now the world's biggest hedge fund manager with $21bn in assets, according to a survey by industry publication Alpha Magazine. Goldman, which has increased hedge fund assets by a striking 85 per cent in each of the past two years, moved up two spots in the rankings to unseat Farallon Capital Management... Farallon dropped to fourth with $16.4bn in assets behind Bridge-water Associates with $20.9bnand D.E. Shaw Group with $19.9bn. Goldman, historically known for its blue-chip investment banking franchise, has emerged as a leading asset manager in large measure because of strength in alternative products such as hedge funds and private equity."

Energy and Crude Liquidity Watch:

June 22 - Bloomberg (Will McSheehy): "The six oil-exporting Arab monarchies of the Persian Gulf are forecast to achieve record current account surpluses this year as crude prices remain high, the United Arab Emirates state news agency WAM reported. The Gulf Cooperation Council states, which include Saudi Arabia, Kuwait and the U.A.E., will record a fiscal surplus of about $173 billion..."

June 21 - Bloomberg (Todd Prince): "Russia, the world's largest energy producer, forecasts its windfall oil fund will surge to more than $150 billion by the end of next year as commodity prices are expected to remain high... Revenue in the fund grew to 1.9 trillion rubles ($71 billion) at the end of last month."

June 21 - Bloomberg (Jim Polson and Lars Paulsson): "NRG Energy Inc., the U.S. power producer...plans $16 billion in new plants, including nuclear reactors in Texas, to capitalize on increasing electricity demand. The 10-year expansion, to be financed through partnerships and borrowings, would increase the company's U.S. generation capacity by 46 percent..."

June 21 - Financial Times (Virginia Marsh): "Australia's liquefied natural gas industry is on the brink of a US$37bn investment boom that is set to make it the world's third-largest LNG exporter within five years... 'There is a massive acceleration in the development of the industry' says Diane Brookman, an analyst at Citigroup in Sydney. 'A paradigm shift is occurring. Since last year it has been a seller's market for the first time since the 1980s.'"

June 20 - Bloomberg (Rob Dieterich): "Imperium Renewables, a two-year-old Seattle company backed by Microsoft Corp. billionaire Paul Allen, plans to control 40 percent of the growing U.S. market for diesel fuel made from vegetable oil by 2009. Imperium said last month it will build a plant in Gray's Harbor, Washington, that will be the largest biodiesel refinery in the U.S. The plant, set to open a year from now, will make 100 million gallons a year. Three more of that size are planned by the end of 2008..."

Speculation Watch:

June 21 - Financial Times (Gillian Tettand and Anuj Gangahar): "Volume of trading in equity options has jumped 47 per cent in the past year in the US, says the International Securities Exchange, the electronic trading platform based in the US. The sharp rise follows similarly striking increases in the previous two years - and means that the total volume of such trading on all US exchanges has tripled to about 1.8bn contracts a year, compared to about 700m in the early part of this decade. The market could continue to grow sharply in the coming year, the ISE forecasts, as institutional investors display greater appetite for equity options."

June 21 - Bloomberg (Patricia Kuo): "Citigroup Inc. was approached by more than 30 banks last month, three times the number it was seeking, as it lined up lenders to finance Kohlberg Kravis Roberts & Co.'s first leveraged buyout in India. 'Every bank is trying to chip in on these deals to tap the high returns and growth potential of the buyout industry,' says Alan Hirakawa, managing director for Asian leveraged finance at Citigroup..."

Hays Interviews The Master:

In the past I have referred to Henry Kaufman as "The Master of Macro Credit Analysis." To state that I am a huge fan and admirer is an understatement. His 1986 "Interest Rates, the Markets, and the New Financial World," and 2001 "On Money and Markets: A Wall Street Memoir" are must read "classics." So it was a real treat yesterday to see him interviewed by Bloomberg's Kathleen Hays. Many readers likely didn't have the opportunity to catch it, so I will share the exchange this evening. I found his analysis characteristically exceptional and virtually in complete agreement with our view (and I certainly couldn't have said it any clearer or more concisely!).

Bloomberg's Kathleen Hays: "He is one of the world's most respected economists and credited, in fact, as the founder of Fed watching - a very popular sport for the financial markets especially just one week before the Fed's next policy meeting. With me now is Henry Kaufman..."

Kathleen Hays: "So let's take a look at where the Federal Reserve is now, because there have been many people in the markets complaining loud and long about Ben Bernanke and his colleagues talking too much about inflation - worrying too much about inflation. When you put Ben Bernanke in context, when you think of Alan Greenspan's first months on the job - when you think of Paul Volcker taking over as Chairman. How is he doing and do you share any of those complaints?"

Mr. Henry Kaufman: "I don't think his job is any more difficult now than when either Paul Volcker or Alan Greenspan came in. Paul Volcker came in at a very difficult time, when the dollar was under attack, when the inflation rate was exceedingly high, when Federal Reserve credibility was not very high. Alan Greenspan came in at a time when interest rates were still relatively high - but not that high, but shortly thereafter the stock market declined 500 on the Dow on October 19th. Both of those Chairmen initially served in a very turbulent period of time. And the time since Ben Bernanke has gotten into that assignment has been rather modest and comfortable, considering."

Kathleen Hays: "Well, except there's been a big sell-off in commodities and a big sell-off in emerging markets the last couple weeks since he really came out stridently against inflation - signaling that he is going to fight inflation more than he is going to worry about economic growth - if I can paraphrase the Fed Chairman."

Mr. Henry Kaufman: "Well, I think it is very difficult to think about the economy without thinking about inflation here. The sell-off in all these market which you spoke about just now occurred against a substantial increase in the values of all of those commodities prior to that sell-off. And I think it is incorrect to believe that prices just go up and up and up without any kind of correction."

Kathleen Hays: "Some people are worried that Ben Bernanke is going to over do it - Ben Bernanke and his colleagues at the Fed - because they are going to keep raising rates in part because they have to prove they're good, strong inflation fighters - they're going to go too far and push the economy into recession. Do you worry about that?"

Mr. Henry Kaufman: "I don't worry about that for the immediate future. I worry a little bit more about the probability that the Federal Reserve has missed its timing all along, and therefore whenever you miss your timing there is a penalty to be paid. But that is not in the immediate future in terms of the economy sliding into an economic recession."

Kathleen Hays: "When you talk about missing their timing... the Bernanke Fed or the Greenspan Fed?"

Mr. Henry Kaufman: "I think it started before Ben Bernanke. It started earlier - under the previous regime."

Kathleen Hays: "You're saying that the Fed's timing is off. Do you think the Fed has somehow gotten behind the curve? Not a lot of people arguing that it seems, but is that what you're saying?

Mr. Henry Kaufman: "I believe the Federal Reserve is behind the curve. And it's very difficult to get back on the curve without some problems. For example, you start with the year 2000 to the present. We've had a very substantial expansion in non-financial debt - the debt of households; of business; of corporations. The expansion in debt has been much greater than the increase in nominal gross national product. That (non-financial debt) increased 5%, 6%, 7%, 8%, 9% in each of those consecutive years and in the first quarter by 11%. Nominal GDP increased less than 50% of that. So, therefore, we're seeing an event taking place that the Fed has not correctly calibrated. To get back into some normalcy and some adjustment - is going to be difficult. And I don't think the Fed will attack that issue very quickly."

Kathleen Hays: "Should the Fed get more aggressive? Some people say there is a small probability that the Fed might do an increase of 50 basis points, twice what they've done in the past two years at least."

Mr. Henry Kaufman: "Well, the tendency for the Federal Reserve in recent years is to pursue two approaches: measured response and transparency. Measured response has meant 25 basis point increases in the funds rate after each meeting of the FOMC. Transparency has tried to tell the market what they're about to do. That does not give you control over Credit creation. In the new financial markets that we've lived in over the last decade or so, financial markets are vibrant - they're calculating. And when you tell an investment banking firm - a commercial banking firm - that it's 25 basis points, there are many people who will analytically tell you what the risks are in the market along the interest-rate curve or in other Credit instruments, and will take the opportunity to leverage those positions and extend Credit. This is a dilemma that the Federal Reserve does not want to tackle."

Kathleen Hays: "Let's really look at that, because you're saying that if you signal it as Greenspan did - Greenspan started at 25 basis points, no surprises, measured pace - you're saying they adjust and they go ahead and issue Credit anyway. And what the Fed is trying to do with higher interest rates is to stop the creation of Credit or slow it down. So you're saying their own policy has made it impossible for them to do what they want to do?"

Mr. Henry Kaufman: "That's right. This is one of the main reasons why the yield curve has flattened - where intermediate and long-term rates have not risen above the short-term interest rates. And that the Fed does not want to tackle, because tackling financial market behavior in a more direct way is far more difficult to do. It's complex. And for most participants in the marketplace, it's not desirable."

Kathleen Hays: "Global central banks raising their interest rates. Some people say they are sucking liquidity out and that could cause market instability and some sort of uglier times ahead."

Mr. Henry Kaufman: "The extent to which liquidity is being sucked out - so to speak - is very modest. In Japan, interest rates have been at zero. In Europe, they're below 3%. In the United States, our interest rate structure from a historical perspective is still moderate. A Fed funds rate at 5%. Ten-year government bonds at 5.19% or 5.18% - wherever they are today. These are not extraordinarily repressive interest rates. Today, anyone who really wants to borrow can borrow. Today, anyone who wants to borrow creates Credit. And the Federal Reserve is not yet at that point where there is some pain in the system."

Kathleen Hays: "What is the main takeaway people should have right now from Federal Reserve policy and this interaction you're talking about with the financial markets - where the Fed raises rates but it does it in such a way that the big financial institutions continue to create lots of Credit. So, even as we look and talk about rates going up and how the Fed's tightening, you're saying that's not happening. What should the Fed be doing now? What should investors be anticipating as all these forces come together?"

Mr. Henry Kaufman: "The Federal Reserve is going to have to decide when to abandon this measured response of 25 basis points. That's a very difficult chore for them, considering how long they have pursued this policy here in the past. Secondly, I think as financial market participants we will continue to create a lot of Credit until there is much more uncertainty in the interest-rate structure. I think there is going to be significant volatility in the financial markets over time. But for the time being, looking out into the rest of this calendar year and part of next year, economic expansion will continue, even though the volatility in the financial markets will probably pick up."

Kathleen Hays: "Final moments, how high do you expect the Federal Funds rate to go?"

Mr. Henry Kaufman: "I really feel that somewhere in the next twelve months we'll head to at least 6%."

My brief comments: Yes, "the new financial markets..." As analysts, we must routinely remind ourselves of how we reside in an (unparalleled) Era of Unlimited Global Finance. Whether it's much higher oil prices or higher rates, unrestrained and overheated global Credit systems will tend towards indifference when it comes to dynamics that in the past would have acted to induce lending, liquidity, and general financial market restraint.

Agreeing with Mr. Kaufman, "I think it is very difficult to think about the economy without thinking about inflation here." As long as prices (real and financial assets, products and services) are tending to inflate at a pace ahead of comfortably rising interest rates (or, in the case of Japan, near zero cost of funds), there is sound analytical basis for expecting (disparate) inflationary pressures to strengthen in the face of "telegraphed baby-step" rate normalization. Rising rates do not imply restraint, particularly in a Credit Inflation Bubble Environment. Excess surely begets excess until there is sufficient monetary pain meted out to pop financing and asset Bubbles, in the process quashing (what have evolved into highly intransigent) Inflationary Monetary Processes.

Today, these "Processes" include the Mortgage Finance Bubble, the global securities finance/leveraging Bubble, the derivatives Bubble, an increasingly global Bubble in "structured finance" generally, the global leveraged speculating community Bubble, The global M&A Bubble, the Global Dollar Reserves Bubble, the China Bubble, and myriad others. Quite problematically, these powerful inflationary forces are now deeply embedded into the global financial and economic landscape. The notion of a coveted soft-landing has become contemptibly inapt. And to not act with determination and forcefulness on the monetary front is to only accommodate the current structure of gross excess and resulting imbalances. There really is no room left for compromise at this point - no letting the air out gently over time. Ironically, the professor that has blasted the late-twenties "Bubble Poppers" will, inevitably, have the unenviable distinction - one way or another - of having Bursting Bubble Turmoil Befoul his Fed chairmanship.

Bond markets have been buffeted of late by the recognition that even meaningful global equities and commodities markets downdrafts are likely to have little impact on general Credit Availability and Credit market liquidity. The hope that rising oil prices would slow spending has faded, as has the hope that a housing slowdown would do the trick. Instead, energized global economies maintain quite a head of steam, while frenetic financiers and market participants are in the mood to do anything but roll over and succumb to timid little monetary restraint. There are still perceptions of way too much easy "money" (financial profits) to be made and little sense that the neophyte Bernanke Fed has the mettle to take on the markets.

Still, the previous consensus "worst-case" scenario of 5% Fed funds is giving way to the marketplace-troubling recognition that the rate outlook today is in the process of turning open-ended. If the Fed and global central bankers actually intend - or at some point become compelled - to impose major financial conditions restraint, how high might rates have to eventually go?

The Fed and global central bankers are not only behind the curve, they are in aggregate significantly behind the curve in the context of a highly unusual and uncertain financial and economic backdrop. Uncertainty now reigns over interest rate markets globally, which implies uncertainty in the currency markets and financial markets generally. In this age of unrestrained and integrated global securities finance, low interest rates in Europe and Japan act as a strong countervailing force to Fed rate increases. Yet the ECB and BOJ are hamstrung by an overall tenuous backdrop, forced to follow the Fed's course of slow, measured rate increases. This might support the dollar in the short-term, but at a cost of an unanticipated and potentially destabilizing jump in U.S. yields.

To what extent the recent surge in yields has instigated a self-reinforcing unwind of leveraged trades - certainly including interest-rate derivative/mortgage hedging-related selling - is difficult to assess this evening. But if Fed funds are on the way to at least 6%, as Mr. Kaufman forecasts, then there is likely sufficient liquidation and market tumult on the horizon to pose a serious challenge to the indefatigable U.S. Credit Bubble. Extraordinary marketplace uncertainty and volatility is about the only safe bet for awhile.