M2 rates declining

I am an old money supply guy. I was trained with a monetarist and watched the number closely in the 80's. Over last to decades, money was not an interesting story. It is still not an interesting story for most. Yes, there is a focus on the Fed balance sheet but not on the aggregates yet they are telling us something.

M2 has been declining at some of the fastest rates in 30 years. Some accommodation by the Fed. Retail money funds and small time deposits are shrinking at a fast rate. Savings deposits have increased but money is flowing from the liability side of the bank balance sheet. Banks do not seem to care or they would be raising rates. This suggests that there has not been a lot of lending on the asset side of the balance sheet.

The behavior of the monetary aggregates was not expected and require going back to basics to find out what are the links between money, lending and economic activity.

PIGS get slaughtered by rating agencies

This week S&P downgraded:

Spain to AA from AA+ and kept a negative outlook;
Greece to BB+ from BBB+ (three notches) moving it to junk levels; (Moody's downgraded Greece to A3 last week. It is surprising it was not larger.)
Portugal was cut two notches to A- with a negative outlook.

Moody's and Fitch have not yet weighed in so it is likely we will have more bad news although the market impact will be less pronounced.

While it was not surprising, the market reaction was swift. Greek bond spreads exploded higher and stocks got hit. The IMF also stated that Greece will need almost double what as expected just a few weeks ago. The most interesting point is that EM countries that needed IMF funds usually still had a either a default or a devaluation. The death spiral of rising spreads and needs for more funds almost always end poorly. The price on both the country or bondholders will be high.

Interesting comment from Brown Brother's Win Thin who stated that Greek bond spreads are at the same level as before joining the Euro zone. The quality of credit has not changed after all of the benefits of having the Euro.

Potato or .... what is the right name for China's currency?

Renminbi is the name of China’s currency.

Yuan is the unit in which prices are measured.

This is similar to the distinction between sterling as the currency for the UK but prices are measured in pounds. There is nothing comparable in the EU, Japan or the US.

No matter wwhat the wording, there still has not been any change in the dollar peg. If there is no talk how is the global imblance problem going to change.

“There wasn’t any talk about the yuan,” Japanese Finance Minister Naoto Kan said. “I know everyone is interested. But it wasn’t discussed openly at the G7 or G20 probably because everyone there knew that China won’t like that very much.”

Interesting development in Taiwan.

The "renminbi shopping fad" has caused shortages of Chinese yuan banknotes in Taiwan, a development that prompted local banks to become reluctant to sell the currency renminbi, with some even implementing a "buying only, no selling" strategy.

Term premium and volatility

There has usually been a nice relationship between the steepness of the yield curve and volatility. Call it a liquidity premium. Higher volatility was often associated with a steeper curve. When volatility declined or the liquidity premium declined, there would be a flattening of the yield curve. The relationship has not held up in the last year. Bond volatility has fallen off a cliff since the highs at the end of 2008, yet we have seen the yield curve get steeper and no decline in sight. So what is going on?

There is not an inflation effect because price increases have been tame even with the recent increase in PPI. In fact, after an inflation expectation scare. The market seems to believe we will be in a benign inflation environment.

A more likely scenario is a price pressure effect from government debt. The relationship between debt and the yield curve has been measured to be positive but slight. However, this was under pre-2008 conditions. The size of debt has been multiples larger. Yet, even this story has problems. Up until recently, the debt markets have not issued a significant amount of private deals so it is harder to argue for a crowding of private capital.

The steep curve story will be one of the more important fixed income mysteries to be unraveled in 2010.