Today's Tidbits

Real Interest Rates Rising Much Faster than Inflation, But Still Below Trend
From Barclays: “In TIPS, forward breakevens are up over 15 bp since mid-May…”
From Merrill Lynch: “Bond selloff NOT an inflation story… It has NOT been due to rising inflation expectations. How do we know? Well, when you look at the TIPS market, what becomes apparent is that breakeven levels have risen the grand total of six-basis points since the 10-year Treasury note yield bottomed at 4½% in late February while the real rate has risen 56 basis points. In addition, other inflation barometers, such as gold and the CRB index are down 6% and 16% respectively from their nearby highs. So there is no validation to the view that this is about inflation expectations, in our opinion. The key University of Michigan 5-10 year inflation expectation component of the May survey stood at 3.1%, still in the range (though at the top end) of the past 10 years. If this was about inflation, the dollar would be getting crushed; the exact opposite has happened.
…The major story here is that the move in the real rate has been ten times more powerful than inflation expectations.”
From JP Morgan: “Real policy rates have been moving higher but have remained below long-term norms, despite sustained above-trend growth. In the past year, a Fed pause, a BoJ crawl, and an Emerging Market reserve accumulation haul has supported low real
interest rates and narrowing risk premia across the globe. Against this backdrop, the threat ahead comes from financial market adjustments as central bankers respond to sustained above-trend growth. The compression of risk premia largely reflects a healthy structural backdrop of low inflation, balanced income, and stable growth.”
From Bear Stearns: “We interpret almost all of the recent increase in bond yields as reflecting a higher real return component, not yet a higher inflation component. Increases in core CPI and the core PCE deflator were both low in March and April. Gold prices, a reliable inflation barometer, have fallen to $650 from $690 at the end of April. The 10-year TIPs yield, a measure of real return expectations, has risen 54 basis points since the beginning of May, while the TIPs spread, the difference between the nominal Treasury yield of 5.15% and the TIPs real yield of 2.73%, is unchanged.”

Shape of Yield Curve Tells a Story
From Merrill Lynch: “Yield curves are very good forecasters of future nominal economic growth and of profits growth, although the lag times are sometimes inconsistent. Steepening yield curves, however, can occur in 2 forms. The first form, the one with which most investors are more familiar, occurs when central banks signal that they plan to ease or actually ease monetary policy. Markets begin to anticipate a liquidity infusion into the economy, and longer-term interest rates begin to discount stronger nominal growth. The second form occurs when central banks are "behind the curve". In other words, nominal growth is stronger than was previously recognized, and central banks have to tighten monetary policies to catch up to the markets and the economy. The current steepening of yield curves appears to be the latter. None of the four major central banks (the Fed, ECB, BOE, or BOJ) have even hinted at an easing of monetary policy. Rather, all are basically in some form of restrictive mode. If their policies were too tight, then curves would be inverted, and the markets would be anticipating easing. That is clearly not the case.”

Reasons Why Bond Yields Were So Low the Past Few Years
From The Financial Times: “…over the past five years, bond markets have exhibited a significant change in the way they react to economic fundamentals. Relative to comparable points in past economic cycles, bond yields are now much lower and yield curves much flatter than would typically be the case. Since both central banks and bond investors respond in a predictable manner to economic fundamentals, this change of bond market behaviour can be quantified with some precision… models show us that while short-term or official policy rates are more or less where they should be, given the current economic environment, longer-term interest rates are about one percentage point below their equilibrium value. The obvious explanation for any market anomaly is a disruption to the usual patterns of supply and demand. In this instance, the bond market is no exception. The bond market "conundrum"dates back to 2003. In that year, the global demand for bonds surged. The main source of this excess demand was a jump in global foreign exchange reserve growth, which accelerated from annual growth of $75bn in the previous decade to as much as $800bn by 2004. In tandem with accelerating reserve growth was an increase of some $300bn in bond purchases by pension and insurance funds. This latter shift in asset allocation - which was mirrored by a decrease in equity purchases of a similar magnitude - was driven by regulators tightening solvency requirements for the relevant institutions. With a horrid inevitability, the largest equity sales were at the bear market lows, the largest bond purchases at bond price highs. The total of reserve manager, pension fund and insurance company bond purchases rose from an average 30 per cent of net bond supply to over 100 per cent in 2004. Although this appetite has slowed somewhat over the past two years, it remains equivalent to 60-70 per cent of net bond issuance, double the historic average. The side effects of this depression in bond yields have been dramatic. The displacement of orthodox bond investors out of government bonds into corporate bonds and derivatives has generated the easiest credit conditions seen for a generation. The one percentage point or more depression in bond yields has not been replicated by a similar depression in equity yields, leaving equities priced at extremely cheap levels to bonds. This has spurred companies to releverage. The surge in global economic growth, commodity prices, property prices, LBO activity, private equity deals and general M&A similarly testify to the effects of the financial Viagra conferred by low long-term rates. However, these trends contain the seeds of their own reversal. Corporate releveraging is sharply increasing the overall supply of debt instruments, while simultaneously decreasing the supply of equities. On the demand side of the equation, the extraordinary size of FX reserves is prompting global reserve managers to diversify away from low risk bonds into higher return assets. China alone may be responsible for a redirection of capital away from bonds and into equities worth some $300bn-$400bn over the next 12 months or so. Like all markets, both bonds and equities are subject to the inexorable law of supply and demand. While this redirection of capital flows will initially benefit equities, we can be sure that the impending increase in bond supply and decrease in bond demand will lead to a gradual deflation of the great bond bubble. As this process unrolls, we can be equally sure that the expected returns underpinning many recent investment decisions will be subject to a similar deflation of prospects.”

FED Delinquency Study Suggests Homeownership Demand Declining
From Dow Jones: “In an economic letter, “House Prices and Subprime Mortgage
Delinquencies,” San Francisco Federal Reserve economists noted a close link between house-price appreciation and the severity of recent subprime mortgage delinquencies, with metropolitan areas where home prices decelerated the most in 2006 showing the largest rise in subprime delinquency rates. Areas near the Gulf Coast close to where Hurricane Katrina hit in 2005 were among areas with the highest delinquency rates, according to data from First American LoanPerformance, or FALP. FALP data show the median delinquency rate in 2006 among the 309 metropolitan statistical areas was 12.2%, with a range of 3% to 25%. Overall, of the 18 areas with the highest delinquency rates in 2006, 14 were in Michigan or Ohio…The delinquency rate is defined as the percent of subprime loans that are delinquent for more than 60 days….One possible explanation as to why borrowers in areas of low appreciation foreclosed more, they said, was that, given the sharp declines in the pace of home appreciation, those borrowers may have lowered expectations for future appreciation of rates, making homeownership a less attractive investment. “The finding that changes in delinquencies are related to house-price deceleration raises the possibility that the increases in delinquencies reflect not just borrower distress but also a decline in the demand for housing,” the Fed economists said.”

Local Study Indicates Real Estate Agents Might Not Be Worth Cost
From The New York Times: “Who gets the better deal: the cautious economist who sells his house through a real estate agent, or his risk-taking colleague who finds a buyer on his own? But the question — debated by two Northwestern University economists who chose different methods to sell their homes — and the research it helped prompt are serious. And the answer will be of interest to anyone who has paused to consider whether paying a real estate agent’s commission, typically 5 to 6 percent of the sale price, is worth it. The conclusion, in a study … based on home-sales data from 1998 to 2004 in Madison, Wis., is that people in that city who sold their homes through real estate agents typically did not get a higher sale price than people who sold their homes themselves. When the agent’s commission is factored in, the for-sale-by-owner people came out ahead financially… (Nationally, about 13 percent of home sales were for-sale-by-owner in 2005, the group said. For the seven-year Madison study, the market share of homes sold on the FSBO Web site was 14 percent.)… The results, from another perspective, show that with agents failing to bring a higher price, their commission pays only for the actual work they do… sellers will begin to examine more closely the cost of all the small tasks handled by agents. To justify a $12,000 fee on a $200,000 house, he said, “you’d have to have a very high hourly rate” for an agent’s work.”

Russia Is Back on the Playing Field
From The Financial Times: “On a range of issues, the most serious rift in two decades has opened between the west and Russia, stoked by Moscow's aggressive rhetoric of recent months. The question is whether the apparent slide towards a new nuclear stand-off can be reversed, and how. Part of the answer may lie in understanding what is behind Russia's sabre-rattling and what it wants to achieve. In his combative, acerbic interview with western journalists last week, Mr Putin left a hefty clue. "We want to be heard," he said. "We want our position to be understood. We do not exclude that our American partners might reconsider their decision [on missile defence]." The desire to be heeded is a message voiced with surprising unanimity by senior Russian officials. As Russia enjoys an oil-fuelled economic recovery, Moscow seethes that the west still treats it as a vanquished power. Rightly or wrongly, Russia believes it has been forced for 15 years to swallow western foreign policy actions, its objections simply trampled on. Above all, it believes the west broke an early 1990s promise that Nato would not expand eastwards. Instead, the military alliance now encompasses not just former Soviet satellites but the three former Soviet Baltic republics. Moscow ignores that these new democracies asked to join Nato, motivated largely by residual distrust of Russia. Instead, it sees attempts to encircle it… Russia has embraced a cut-throat capitalism. And while the west accuses it of using energy as a political weapon, there is something to Moscow's claims that hard-nosed business logic drove its move to raise the subsidised natural gas prices it charged former Soviet republics to market levels - even if some got longer transition periods than others. Yet if Russia is no longer committed to exporting socialist revolution, it still insists on its right to maintain a sphere of influence in former Soviet states, which the west rejects. It also opposes the Bush administration's "freedom agenda" and insists attempts to impose western democracy such as in Iraq are imperialistic and doomed to failure. Officials and analysts say Mr Putin's Munich speech was a signal that Russia is no longer prepared to be pushed around. Missile defence is the issue on which it has decided to take its strongest stand…”

From The International Herald Tribune: “President Vladimir Putin sought to reassure investors and foreign leaders that Russia remained committed to free trade and investment for businesses that work here, in spite of a chill in political relations with the West. But Putin said Russia would integrate with the world economy on its own terms - and possibly not by embracing the current rules of the global economic order. Speaking at a business forum here Sunday, Putin called for a new world economic framework based on regional alliances rather than global institutions like the International Monetary Fund. The new system, he said, would reflect the rising power of emerging market economies like Russia, China, India and Brazil, and the decline of the old heavyweights of the United States, Japan and many European countries. The developed countries, Putin said, were dominating the institutions of world trade in an "inflexible" manner, even as their own share of the global wealth is diminishing. He said the world needed a "new architecture of international economic relations based on trust and mutually beneficial integration." Putin said 60 percent of the world's Gross Domestic Product was now produced outside of the Group of 7 countries - the United States, France, Germany, Britain, Italy, Japan and Canada. Putin's combative tone came even as Russia was seeking membership in World Trade Organization, the Geneva-based regulator of the world economy, and perhaps reflected frustration at the long-drawn-out process of admission… In another swipe at the economic traditions that benefit the rich nations, Putin called for central banks to hold reserves in a wider selection of currencies. Now, banks largely hold their reserves in dollars and euros.”


MISC

From Dow Jones: “Treasury prices were under some pressure and the yield curve was steeper [Treasury curve 2y 5% (+2bp), 5y 5.07% (+3bp), 10y 5.15% (+5bp), 30y 5.26% (+5bp)]… The dollar was little changed…[Stocks finished the day near Friday’s closing levels.]… Crude oil futures edged higher…”

From RBSGC: “MBS holdings by US banks decreased by $1 bn [in May]. Both pass-through holdings and CMO holdings decreased by approximately $0.5 bn….Commercial and industrial loans…increased $16 bn since April.”

From FTN: “…members of the FOMC, including the Chairman, agree with their staff that Americans invest too much in housing.”

From Barclays: “One beneficiary of higher rates has been the corporate pension universe. They benefit because their liabilities are fixed and, thus, the present value of these obligations decreases as rates head higher. While much was noted about the pension deficits, the past few years have been very good to these pensions. Asset returns have been very strong, and the universe in aggregate has closed its funding gap.”

From Bank of America: “Equity funds investing in international markets continue to dominate investors’ interest, given their recent outperformance which stems from strong economies overseas and the weak US dollar…Equities owned directly by households amounted to $5.4 trillion at the end of 1q07, according to new estimates of macro flows and levels released last week by the Federal Reserve. As a portion of the total, households’ ownership fell -1% to 26%, with offsetting increases in the amounts held by a) mutual funds (which control $5.2T); b) the foreign sector (which owns $2.9T); and c) insurance companies (which control $1.7T). According to the Fed data, private pension plans’ exposure to equities has been relatively stagnant over the past 30 years, while public plans’ exposure keeps rising.”

From Bloomberg: “Crude oil rose more than $1 a barrel after Saudi Arabia, the world's biggest exporter, told Asian refiners that it would curb shipments for a ninth month in July. Saudi Aramco, the world's largest state oil company, will cut supplies of its Arab Light and Arab Heavy crude to refiners in Japan, China and South Korea by between 9.5 percent and 10 percent below their contracted volume, officials said. The Organization of Petroleum Exporting Countries last year pledged to cut supplies by 1.7 million barrels a day to support prices… Iran, OPEC's second-largest oil producer, will start gasoline rationing ``very shortly,''…”

From Bloomberg: “Wheat rose to an 11-year high…”

From Time: “In 2006…the U.S.’s long-running investment –income surplus gave way to a deficit of $7.3 billion If that keeps up – and all indications are that it will…the U.S. will effectively be sending big checks abroad each year to pay for good times past. Which is money American’s won’t be able to spend on oil, cars and consumer electronics.”

From JP Morgan: “China’s exports rose 3%m/m in May, boosting the trade balance to a seasonally-adjusted annual rate of $281 billion—double the level of a year ago. Back-to-back increases in exports suggest that the early-year volatility is past, with exports providing strong support for domestic manufacturers. This should drive a corresponding pickup in import demand, which would give a boost to exports and manufacturing activity elsewhere in Asia.”

From Time: “A groundbreaking new study by three socialogists shows that diversity training has little to no effect on the racial and gender mix of a company’s top ranks… Networking didn’t do much, either. Mentorships did. Among the least common tactics, one – assigning a diversity point person or task force – has the best record of success…at companies that assigned a person or committee to oversee diversity, ensuring direct accountability for results, the number of minorities and women climbed 10% in the years following the appointment. Mentorships worked too, particularly for black women, increasing their numbers in management 23.5%.”