With regard to recent market surge, the monetary environment presents an analytical dilemma because it is simultaneously the dominant driver of rising asset prices and also the greatest area of risk for the markets.
When considering the factors that would place the bull market in jeopardy, rising interest rates and reduced availability of credit would have to top the list. For the time being, credit remains cheap and readily available throughout the world. As a result, there continues to be tremendous monetary inflation sustaining nominal GDP growth and supporting asset prices.
M3, the broadest measure of money supply growth in the U.S., is rising at 12% per annum. Other major currencies around the world are also expanding at double-digit rates, as are various measures of global credit growth. International reserve assets held by foreign central banks are up 21% on a year-over-year basis.
As a reflection of the unbridled growth of securities-based finance in our economy, the five largest U.S. investment banks grew their balance sheets in the first quarter of 2007 at an astounding 41% annualized rate.
Outside of the financial sector, inflation continues to be broad based and has recently accelerated in labor costs, food prices, gasoline prices, and health care costs. Given widespread global inflation pressures, all of the major global central banks are either tightening official interest rates or have a bias for tightening.
We continue to view the persistent hopes and expectations of interest rate cuts from the Federal Reserve to be way off base. Meanwhile, the disconnect that has been in place for several years between market-based bond yields and inflation trends continues. Though it has been creeping up of late, the 10-year Treasury yield trades at a non-threatening level of 4.68%.