IS THE CURRENT CORRECTION OVER (II)? Yield curve not inverted any more The central piece of âIS THE CURRENT CORRECTION OVERâ is the so-called Ben Put as the bond market and hedge fund perceived. The yield curve seemed to have confirmed this: âFor the first time since the Fed ended a two-year run of interest-rate increases in August, the central bank 0n 032107 signaled that its next move might be either to lower or raise borrowing costs, instead of just the latter. The Federal Open Market Committee's statement omitted a previous reference to ``additional firming'' in favor of the more general ``future policy adjustments.'' (Bloomberg.com) Also for the first time since August 2006, 10Y T yield indx exceeded 2Y T yield indx on 032207. I have talked much about Bill Grossâs long complaint that he can not make money with an inverted yield curve. Now, the inversion of yield curve has been reversed or flattened, indicating bond marketâs current expectation that Fed will cut the Fedâs fund rate, or at least not to raise it. marketreflections.com About the front end and the long end of the yield curve: Front-end is more sensitive to Fedâs rate policy. Long-term rates theoretically equal to the average of current and expected future short-term rates, which more or less reflect economic condition or growth rates, plus inflation risk premium and risk premium. Inflation risk remains: The Fed on 032107 said ``the high level of resource utilization has the potential to sustain'' inflation pressures, due to the followings: Capacity utilization rate Overall capacity utilization in February increased to 82.0 percent from 81.4 percent in January, with historical average being 81%. Rate of unemployment minus the rate of nominal annual wage growth: if it is not greater than 50 base points, it will be out of Fedâs âcomfort gapâ. Unemployment rate as of 022007: 4.5% Hourly earnings rose 0.4% in February. That is a bit stronger than expected, and puts the year-over-year increase at 4.1%. Productivity growth Productivity growth, slowed to 2.1% over 2005 and 1.4% over 2006, although possibly due to cyclical factors, while trend productivity growth is roughly 2½%. The productivity deceleration has contributed to acceleration in unit labour costs of 3.4% over the past year. Given the increased likelihood of cuts in short term rates, and may be a slightly upward movement in inflation risk, the long-end of curve may not change very much either directions, other things being equal, more likely to be lower than higher. The âworstâ had been priced in by stock market Earnings growth for S&P500 Most recent Q1 2007 Q2 2007 Q3 2007 Q4 2007 --S&P 5.3% 6.3% 3.5% 15.6% --First Call 4.3% 4.4% 6.6% Previous --One Month Ago (1) 6% 7% 7% 16% --Two Months Ago (2) 8.2% 8.5% 5.2% 16.2% (1) Combination of First Call and S&P estimates. (2) First Call forecasts. IQ and EQ by bond and stock market since Feb 27, 2007 IQ is information (mostly macro) query, more for bonds, and E for earnings or âemotionsâ, more for stocks. Most of the macro and earnings data have been already âchewedâ by market prior to Feb 27, 2007. IQ and EQ on and after Feb 27, 2007: Jolted by subprime, the market was seeing future economic scenario as worst and as far as possible, particularly on March 05, 2007, with all bad information and fears priced. One measure of intensity of EQ is VIX. â VIX, a measure of the market's expectation of 30-day volatility in the S&P500 index, jumped by the most in its 17-year history late in Februaryâ (Reuters.com) One important piece of all bad information âIQâ and âEQâed by market priced in prior to 032107 is marketâs anticipation that Fed may not change its bias on 032107. Considering all these, and noting particularly the extreme point EQ has reached, I think, stock indexes may have seen the bottom of the current correction on 03052007. Fedâs fourth representation: USD I agree with many market participants that Fed has an USD objective, which I think is to maintain some kind of order of USD movement in either direction and within certain range, numerical values unknown, just like Fedâs employment and inflation objectives. Considering that the entire US yield curve is probably going to be lower, and with front-end lower than long end, there would be some downward pressure on USD, if Europe and Japanâs yield curves are going to stay where they are. USD Indx: after touching a all YTD of 82.75 low on 032107, it is now back to 83.25, still close to all time low since April 2005, after falling below 81 in Jan 2005. USD since then has gone as high as above 92 near the end of 2006 and has been trending down after that. CCP Put I think, somehow, CCP has a strong interest in supporting an orderly USD, cooperating to some degree with Fed on its USD objective, kind of playing Japanâs similar role in the past. Here are some data (forcastglobaleconomy.com) 1. Chinaâs accumulation of USD China is currently running 100 billion dollars a year trade surplus; About 50 billion dollars of foreign capital flow into China per year to build factories to manufacture goods to be exported to US, to sell into Chinese consumer markets, or just to construct buildings There is also about 50 billion dollars a year of so called hot money flowing into China in anticipation of the upward revaluation of yuan against dollar. All together, there are about 200 billion dollars a year to be sold for yuans, about 10 % of China's GDP. Chinese government must buy up the majority of 200 billion dollars to prevent the plunge of dollar against yuan, and to maintain yuan's undervalued status vs. US dollar. By assuming that 100 billion dollar worth of yuans become excess yuans that Chinese government cannot mop up through its monetary operations, the total lending by the repeated lending of banks balloons to 10 times of the original seed money of 100 billion dollar equivalent yuans, almost 50% of the total GDP of China. In that sense we may say that China's economic expansion is rooted on its export business and the foreign capital inflow, and it is in Chinaâs interest that the trade surplus with US and foreign capital inflow continue. 2. Recycling of Chinaâs USD back into US As for the 200 billion dollars that Chinese government buys up in a year, Chinese government has no choice but to recycle them back into US financial market since US dollar is the legal tender only within US. Chinese government, using the 200 billion dollars at hand, buys US treasury instruments, mortgage backed securities and probably even commercial papers. Of course, the total US trade deficit is over 600 billion dollars a year, so the other 400 plus billion dollars are also recycled back into US financial market just like the 200 billion dollars from China; the other 400 plus billion dollars is coming from Japan, Taiwan, South Korea, Hong Kong, oil producing nations and so on that run hefty current account surpluses. The 600 plus billion dollars will eventually flow into the hands of lenders in US to be lent out repeatedly just as in the case of China. Assuming 10 fold increase of the total lending from the seed money of 600 plus billion dollars originated from US trade deficits, the total lending in US will balloon to 6 trillion dollars. In the case of US the lending goes into the hands of businesses and paid out as wages and salaries, and become consumer loans. It is already quite a stretch or a âgap upâ from Ben Put to CCP Put, let stretch a little bit further: Domestically, US manages its âbond-standardâ based economy via Fed and bond market. Internationally, US dominates and manages a âdollar standardâ based international economic and political order with CCP, an increasingly important co-stakeholder and co-manager in such an order. The first order of business in such a system is for Fedâs four representations and CCPâs three representation to be taken care of, some times at cost of others such as Iran, and again, that is politics. Speaking of Iran, I think CCP must have mixed feelings in joining US playing tough cards against it. Iran is a nation like China, with one of those four earliest world civilizations, which had made important contributions to the mankind, such as Arabâs numerical system and Chineseâs paper and printing. Without that, the world economy may still be on barter-trade and metal standard. Regardless of its glorious history and current national agenda, whatever it might be, Iran presently seems at odds with the status quo of international economic and political order, and it has to be deal with, one way or another.
032607 Mid-Mkt: âbeen there, done thatâ From my previous post of 032207 Atop of a âvertical lineâ: âLooking at Dowâs 15 minute chart: Dow jumped about 180 points from 12300 to 12480 after Fedâs release yesterday, just about 150 points below 12630, Dowâs opening point on Feb 27, 2007.â âTrading wise, bears must have seen that bulls are now atop of a âvertical lineâ. Having just scrambled for short-covering yesterday, bears took a break today.â marketreflections.com Bears got a revenge opportunity today: With a surprisingly weak new home sales data, bears pushed bulls down about 100 points, from the top of that vertical line. But so far, bulls have managed to triple bottom off 12370 level. At that level, bulls and bears much had deep thinking and talk about todayâs housing data, and their conclusions are more likely as followings: Todayâs housing FA point is not really new, âhave been there and done thatâ many times since Feb 27, 2007. Besides, more dovish comments from Fed also helped bulls stabilize at 12370 level, which may be very likely Dowâs bottom for today. Fed talks Chicago Fed's Moskow spoke in Beijing over the weekend, saying that the sub-prime world has not been infecting the broader housing market, reported Reuters. Moskow said in the heels of the surprise existing home sales report that "not only were problems in the U.S. housing market not spreading into the broader economy, but also that the housing market was in the process of stabilizing." He worried that inflation running over the policy-makers' comfort level for 3 yrs, "'That's a long time, and we all think it's too high. It gets built into expectations and then it's very hard to control, very hard to reduce. So inflation is our predominant concern,'" although he did see inflation coming down in 08. ABN's take, "This comment could be worth 10-20 pips upside for EUR-USD given that it is rare to hear dovish comments from such a veritable hawk as Moskow." The dollar got clocked on the housing report. (Bloomberg.com)
Current correction: âbottomed outâ possible, so is another leg That is because of the coming back of stagnation fear. Bonds, âThe mind of marketâ, today see the steepest yield curve since June 5 2006, with 10Y T yield rising to 4.61 intra-day, about 4 base points above that of 2Y T yield, and The gap in rates between two-year securities and 30-year Treasury bonds was 24 basis points, the widest since May 18. The gap between TIPS and the regular Treasuries also rose to the highest since September 2006. So, inflation concern seems behind the sell off of T bonds, particularly on the long ends of the curve. Marketreflections.com With money relatively moving from long end of the curve to short-end of the curve, and with curve itself âsteepenedâ, bond market is yelling at Fed: you got reduce the rate to deal with subprime, but inflation risk remains and what are you going to do with that? This is familiar scenario seen last spring and summer. The stagnation fear, if further worsening, could trig another leg down in the current correction, although unlikely to take out the bottoms which may have been found for stock indexes on March 5, 2007.
This "oil thing" could be significant. We are drifting into end-of-month money flows and "window dressing." However, come April Fool's Day beware. Any buyer may be fooled come Monday the 2nd!!!
Benranke to Gross: Sorry about âUncertaintyâ, but you have to deal with it. Uncertainty is the central point in Benâs testimony today: ``Our policy is still oriented towards control of inflation, which we consider to be at this time to be the greater risk,'' he told the Joint Economic Committee of Congress in Washington today. Still, ``uncertainties have risen, and therefore a little more flexibility might be desirable.'' Uncertainty is a traderâs friend. I made much more than yesterday. Market as a whole hates uncertainty, because uncertainty and the emotion derived from uncertainty cannot be arbitraged away. Uncertainty or emotion by definition cannot be quantified and priced, how do you arbitrage something without a price? A trader can trade uncertainty or emotion, a market cannot. A trader can take a bullet and sell it to somebody else; a market has to eat the bullet itself. âUncertaintyâ is the bullet market has to take from Fed: sorry, you just have to eat it. Having to balance among âfour representationsâ (employment, inflation, bond market, USD), and possibly with a stagnation foe at least as a ghost hanging around, Fed is having a hard time. âWait for more dataâ may be the only consoling word these Milton educated monetarist central bankers can tell themselves for now. Central banks can wait, not market participants. Bonds, stocks, all have to be priced and traded, even with uncertainty in the head, and perhaps fear in the chest. As of 1:30ET, Bond market still got a upward sloping yield curve in its mouse to chew, inflation risk and term risk not alleviated at all compared to yesterday, with more money coming in for âsafe havenâ. Stock market: Bears got their revenge done, pushing down bulls completely off âthat vertical lineâ (see my previous post, âAtop of vertical lineâ) intra day. Marketreflections.com âCAFâ, the shanghai index âred starâ is still shining, and Asian market is actually hanging on pretty well, just like their economies. Now being pushed down from âthat vertical lineâ, US bulls may not be able to see the âred starâ anymore. Short-term, momentum is with bears now, who definitely want to take bulls to revisit the âbottomâ of the trough, which was first visited on March 5, 2007.
Todayâs market: More rational than emotional As a result, I made less. marketreflections.com After a gap up at todayâs open, stock market quickly figured out that although 4Q2006 GDP was better than expected, it was then, not now. In the context of housing correction and weakening in business investment as reflected by the actual 2.5% vs. expected 3.4% increase in durable goods orders for Feb 2007, briefings.com is revising Q1 GDP down to 1.5%. Looking at GDP components: personal consumption accounts for 70%, investment 17%, government 19%, net exports -5.9%, per briefings.com. Perhaps knowing tomorrowâs data (personal income and outlays, NAPM-Chicago, construction spending, and consumer sentiment) will provide a better view of the growth for 2007, both bears and bulls seem restraint today, saving themselves for tomorrow. GDP grew 3.2% in 2005, 3.3% in 2006, what about 2007? Per National Association for Business Economics 02272007, cnbc.com): GDP will grow by 2.7% in 2007. It would be slowest annual increase in the gross domestic product since a 1.6% rise in 2002, when the economy was pulling out of the last recession. As housing stabilizes, the forecasters are looking for GDP growth to rebound to 3% in 2008. Housing construction will plunge by 14.9% in 2007, compared to the 4.2% drop in construction spending in 2006. Consumer spending will grow by 3.2% in 2007, the same as in 2006 Unemployment rate will tick up modestly to 4.7% in 2007 from 4.6% in 2006, the lowest in six years. Inflation: consumer prices will rise by just 1.9% 2007, down sharply from the 3.2% increase in 2006, the best showing in five years. Overall, their forecast is still a picture of a soft landing, and that would be what Fed has hoped for: no recession, inflation pressure further relieved, no rate change, no bear market. I think, currently both financial markets and Fed are still betting more or less on this âsoft landingâ, although it may be a little rougher than they previously thought. In that sense, the current correction is still a correction, not a beginning of a bear market.
Fed, rate, and US âChina strategyâ Todayâs market is just as theatrical as yesterday, and I made about the same. marketreflections.com As always, beauty is in the eyes of beholders, both bears and bulls get their stories from todayâs personal income and spending data: growth and inflation are all there in the data. After reading todayâs data, Bernanke and his Fed comrades must have said to themselves, like âlet the economy stay on auto pilot, we are not going to cut the rate unless economy faces a real danger of sliding into a recessionâ. With US consumers as resilient as they are, GDP growth is probably not going to fall into recession, as long as Joe has his job. Will Joe still have his job when US companies are increasingly under pressure from their Chinese counterparts? Market, as well as Fed, must thought about this question again today, when the news that Commerce Department approved duties on Chinese paper imports knocked down indexes sharply, though briefly. It would be quite a stretch to say that Fed has a âChina strategyâ in mind when formulating its monetary policy. To say that Fed, the economic policy maker of US government, is just pouncing numbers of employment and inflation without US national economic interest in the consideration would be naïve. Bernanke and his Fed comrades have long stated clearly that they donât want to stimulate current US economic growth with a rate cut, when capacity utilization rate has been consistently above historical average of 81%, and productivity has been trending down from 2.1% in 2005 to 1.4% in 2006. There could be many reasons such as cyclical factors behind the low productivity and high capacity utilization of US economy, and so are the solutions for the problem. It would be probably safe to say that for Fed to adopt a simulative monetary policy in the current situation will not be a good idea to enhance US economic competitiveness. There are actually common senses behind demand-side economics and supply-side economics: right now, with mortgage and credit debt probably already at Joeâs neck level, should Fed ease financial conditions to let Joe take on more debt? Instead, as long as Joe still has his paycheck and his employer still has accounts receivable to work for, it would not be a bad idea to let them struggle a little bit with a little pain, may be that way they can learn to compete with their Chinese counterparts. For now, just forget about plastic, it is not always a good thing, particularly when using it too much. "The China of today is not the China of years ago," Commerce Secretary Gutierrez said today. "As economic partners, we must be above all, fair." Fair or not, itâs hard to say, just ask Keynes about that. But to make a game interesting and challenging, both players have to be competent and competitive. As to Gross and his alike, the Fedâs message is fairly clear: Bernanke put is still there, just with an a lot of lower strike, and never bet your house on it, hedging is always advised.
The current trough: it may not be deep, but has length âShort the top, long the dip, just donât carryâ is a day traderâs slogan, and today stock market becomes a day trader. Alarmed by a âdistributionâ on 032807, the fifth day after âa follow-throughâ on 032107, IBD now has suspicions about the âfollow-though: according to IBDâs historical record bookkeeping, âmost successful rallies avoid higher-volume selling in the first weekâ. Call it a broken handle of a cup, which, according to IBD, should be at least five days long to be called a solid handle, which points out better probabilities of later breakouts. Or call it a âvertical lineâ erected by Ben on 032107 and broken by Ben on 032807, as written in my posts in marketreflections.com. IBD, by the way, is a good TA paper. It does what it supposed to do: comb through historical records and patterns, look for breakouts for retail investors to jump on to cash in a few bucks here and there, and most of the time history does repeat. IBD is honest too, it never goes out its core competency, pretending what it is not and talking about what it does not guess well. Last week bond market continued the sell off across the yield curve, which started on 032207, a day after Fedâs statement on 032107. Now the yield curve is almost back to the pre-Feb 27 level, although still upward sloped. The sell off across the yield curve is supposedly an indicator that bond market realizes that Fed is not going to cut the rate as market had expected. The upward sloped yield curve indicates marketâs concern about uncertainty, more than inflation. Inflation wise, marketâs pricing has not changed as much, and actually it is trending down a little bit YoY: The gap between yields on 10Y TIPS and 10Y regular T was 267 base points 042005 254 base points 042006 245 base points 03302007 244 base points 04022007 So, uncertainty about economy and Fedâs rate rather than inflation weights on the mind of market. Stocks are cheap per Fed model Companies in the S&P 500 were forecast to earn $92.76 per ``share'' of the index as of March 30, providing an earnings yield of 6.53 percent, compared with 4.65 percent for 10-year U.S. Treasury notes. The gap -- the widest since 1986, according to data compiled by Bloomberg . This measure was cited by former Federal Reserve Chairman Alan Greenspan in 1997 and is commonly known as the Fed model. A week before the bull market began in October 2002, shares of companies in the S&P 500 traded at 26.5 times reported profit. Now, the price-earnings ratio, or the inverse of the earnings yield, stands at 17.1 times. 22% of GDP is under pressure The most of the following is from briefings.com. Economic Troubles Forget subprime mortgages. They aren't the problem. Business investment is now the problem. The disappointing 2.5% increase in February durable goods new orders reported last week (after a huge 9.3% January drop) has led to reduced forecasts for business investment for the first quarter. That in turn has produced lower GDP forecasts. Our first quarter real GDP has been lowered to a 1.5% annual rate of growth from a previous 2.5% growth rate. Other Wall Street forecasts are also coming down. Business investment had been very strong from 2003 through most of 2006, generally rising at a double-digit annual rate. It provided a boost that pushed GDP growth above long-term trends. In the fourth quarter of 2006, however, business investment fell at a 3.1% annual rate. Further declines now seem likely given the poor trend in business orders. Consumer spending, which comprises 70% of GDP, is holding up fine and should trend near 3% growth this quarter and next. Residential housing construction, which comprises only 5% of GDP, has been falling at about a 25% annual rate the past three quarters slicing over 1% off GDP growth each quarter. The rate of decline has slowed, however, and the impact the next several quarters will be less. Home construction accounts for 5 percent of the U.S. economy, and when furniture, home-improvement spending and utilities are included, it rises to about 15 percent. Business investment, which is about 7% of GDP, will now also drag down growth. There simply won't be any growth from this sector for a while. Real GDP growth is therefore likely to average just 2% in the first half of this year rather than inch back up towards 3% as previously expected. This is due largely to downward revisions to business investment forecasts. Earnings Impact Lower economic forecasts for the next few quarters aren't good for the earnings outlook. Earnings forecasts have moved lower in recent weeks, and could drop even further. Forecasts right now are for first quarter operating earnings for the S&P 500 in aggregate to grow about 5% over the same quarter last year. Forecasts for the second quarter are also near 5%, but third quarter estimates are now down to 3%. Bad Inflation News There was some very bad news on inflation last week. The core PCE deflator, which is the Fed's targeted inflation indicator, rose 0.3% for February. This pushed the year-over-year increase in the core PCE to 2.4%. That is as high as the peak this cycle reached in September of last year. It is above the Fed's forecast level of 2% to 2.25% this year, and 1.75% to 2.0% for 2008. Inflation needs to come down before there is even the possibility of the Fed lowering interest rates. The data last week went in the wrong direction. Interest Rates The market blithely continues to expect the Fed to cut interest rates two more times by November despite current inflation rates. This is reflected in the chart on fed funds futures as indicated below. Expectations of Fed easing fly in the face of the statements by the person most responsible for setting policy, Fed Chairman Bernanke. In testimony to the Joint Economic Committee of Congress last week, Bernanke made it clear that fighting inflation remains the Fed's top priority. As noted above, current inflation rates remain above the Fed's forecasts (targets). The Fed isn't going to cut rates until inflation starts coming down. And in order for the core PCE to get back within the Fed's forecast for this year, there are going to have to be some better months than the 0.3% recorded for February. And supposedly, Fed would have the latitude to cut rates only if unemployment rose closer to 5 percent from its current 4.5 percent, which is close to full employment now (NYTIMES). It will take months for dusts to settle down The unwinding of housingâs problem takes time. It will almost certainly take many months for the year-over-increase in the core PCE to get back down to 2.1%. That would in fact require three more months at 0.1% and three at 0.2% over the next six months. It could happen, but it is also equally possible that inflation holds at current levels.
When the curtain goes up NBRâs âI believeâ today had a dancer talking about her career: She basically said that as a church-goer, believing that life is short and one needs to do something good and meaningful to society, she starts her life everyday when curtain goes up on stage, where she expresses in her dance the feelings and thoughts about life, of those of herself and those in audience as well. A day trader actually does the similar things, when bell rings in the market. A day trader works for bears and bulls, and bears and bulls work for the market. Without bears like Bill Gross who has been crying on housing problem since 2005, who could have sent New Century into Chapter 11? Without bulls shot up YHOO $100 intra day in one single session back in the internet bubble time, how could we google today? Before mankind can figure out something better than capitalist financial market, traders have to carry out order from bears and bulls, and have to do so in the extreme ways. Marketreflections.com Short the top, long the dip, and with a hell of a lot of fun, just donât carry. Start when the bell rings, and stop when it rings again, everyday.
A world decoupling from US Today is easy money for everyone, except for those who bought the bonds around March 14, 2007 (See my post â031407 Itâs expensive for bears tooâ, marketreflections.com). Today US stock indexes were boosted by a better than 022007 âpending home sales indexâ, and a strong tailwind from Europe and Asia. Dax today closed out of the current correction: todayâs closing of 7045 vs. Feb 27âs opening of 6988. Germans, re-united with their communist cousins after the Fall of the Berlin Wall in 1989, have the strongest economy today in Euro zone. And China, needless to say, seems on the fast track to the long-dreamed âheaven of communismâ, just through a capitalist short-cut. Decoupling or not, the rest of world economy seems doing just fine, with or without US subprime, surprising MSâs economist team. This would be bullish for US equities, mostly in terms of âanimal spiritsâ, since net exports is still -5.9% of US GDP, due to trade deficit. The consequent rising of European yield curve is however a challenge to US bond market and Fed as well: how to maintain âyield parityâ between US and Europe with raising the rates? Is this âchallengeâ a big deal? Probably not, due to the increasing size of the liquidity pie. In addition to the shortage of financial assets, most Asian countries recycle their USD reserves back to US, not only for economic reasons, but also for political considerations as well. That provides a solid support for USD as well as US bond market, particularly in long term. Short term, USD and US yield curve are obviously vulnerable to the yield challenges from Europe, and from Japan to some degree. The following numbers offer some perspective The financing of US C/A is not difficult now US total trade deficit in 2006: $763.6B. With China: $232.5B With Japan: $88.4B With AXJ: $332B, approximation With European Union: $116.6B China holds more than $353.6B B U.S. Treasury; Japan holds $648.8B US Treasury; As to AXJ (Asia excluding Japan & including China) Per MS: âSovereign debt issuance by the AXJ countries has declined sharply as a percentage of GDP since the Asian Financial Crisis a decade ago. In absolute dollar terms, total AXJ sovereign bonds outstanding currently stand at only US$830 billion, compared to US$8.4 trillion for the US, US$9.7 trillion for the EU and US$8.2 trillion for Japan. The annual total C/A surplus of AXJ is equivalent to around 40% of its own stock of sovereign bonds outstanding.â The competition of Euro bonds market âThe EUR is gaining status as an internationalized currency. Thinking about exchange rates from the perspective of the quantity of supply of financial assets can also help explain the up-trend in EUR/USD in the past five years. The value of all traded debt (sovereign, corporate and others), compiled by the BIS, issued in dollars and euros shows that the total stock of all types of debt issued in EUR exceeded that in USD back in December 2003. At present, all EUR-denominated bond instruments total US$8.3 trillion, compared to US$6.4 trillion for all USD-denominated debt. â Overall, still plenty of liquidity around âTotal corporate bonds outstanding, as a percentage of GDP, have stagnated in the US, and are rising from a very low level in Euroland. This is remarkable, given that some corporations have issued debt to finance share buy-backs or leveraged buyouts. Also, they are relatively small in absolute terms: US$2.7 trillion in the US and US$1.0 trillion in Euroland. Low new corporate bond issuance reflects the cash-rich position in which most corporations find themselves. Households, not corporations, have been the primary borrowers in the global economy in recent years. Since households mainly borrow through banks rather than the capital markets, the shift in demand for credit from corporations to households should restrain the supply of credit instruments while increasing bank loans. In any case, the supply of corporate debt is not enough to satisfy investorsâ demand. The surge in credit derivatives was, in our opinion, a direct result of financial innovation and the originatorsâ desire to manufacture supply to meet the demand for these instruments. In other words, investorsâ appetite for these securities created its own supply of this class of risky assets. The growth of credit derivatives raises the issue of âindebtednessâ in the US, that much of this type of debt does not really constitute genuine âindebtednessâ but rather exactly the opposite: flush liquidity.â (Morganstanley.com) marketreflections.com