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With the debt markets having inflated at a much more rapid pace than the real economy over the life of this Amazing Credit Bubble, Credit and Speculative Dynamics throughout the Financial Sphere Now Significantly Overshadow Those of the Economic Sphere. To be sure, speculative leveraging these days in the fixed-income markets has an unparalleled capability of creating abundant liquidity for the markets and system generally. And as bond prices inflate in response to heightened speculative leveraging and resulting liquidity creation, those that had been positioned for higher rates (both speculations and hedges) are forced to unwind these trades – in the process creating only more price inflation and liquidity over-abundance. Meanwhile, the yield curve gyrates and causes bloody havoc for myriad curve and rate speculations…..

We should also anticipate $900 billion Current Account Deficits in the not-to-distant future. The atypical slowdown now unfolding is rather concentrated in the housing and U.S. automobile manufacturing sectors. The Fed is focused on economic vulnerability, ensuring an exaggerated response from highly over-liquefied and speculative markets. There has been little indication of waning household consumption, while the markets' histrionic over-reaction will ensure robust household and business demand for imports. Alas, the specter of unending Credit Bubble excess, unending Current Account Deficits and resulting unending foreign buying of U.S. Treasuries, agencies, ABS, and MBS is providing the impetus for one heck of a liquidity-driven dislocation in bond market pricing.

There is certainly nothing like a concurrent descent in energy prices and bond yields to get the inflation doves chirping rather maniacally. Yet, the reality of the situation is that sinking bond yields and attendant gross liquidity excess are poised to stoke fires for sectors already demonstrating flaming inflationary biases. Sitting near the top of the list, you should assume Mr. Income Inflation is salivating from recent market trading dynamics.

And, yes, Income Inflation is supporting inflated home prices that sustain the Mortgage Finance Bubble - that maintain over-consumption - that assures endless massive Current Account Deficits - that guarantee massive foreign buying of U.S. securities while writing yet another chapter in History’s Greatest Bond Market Bubble. Inevitably, however, there will come a point when The Unrelenting Inflation in the Quantity of Late-Cycle U.S. Debt Instruments Collides with the Grossly Inflated Market Price of Total Dollar Financial Claims. And, sure, U.S. financial sector and bond market dynamics certainly increase the likelihood that this collision manifests in the currency markets. Even assuming that dollar confidence holds in the near-term, there remains the more nebulous issue of a bloated and foolhardy leveraged speculating community faced with the Upshot of Heightened Monetary Disorder, including wild volatility across the spectrum of global financial markets, widening spreads, wildly vacillating marketplace liquidity dynamics, and acute general financial and economic uncertainty. The bond market rally has become destabilizing.

Doug Noland is a market strategist at Prudent Bear Funds. Their website is www.prudentbear.com.