Today's Tidbits

Economic Outlook for Remainder of 2007 Looking Less Rosy
From Bloomberg: “The consensus forecast of a trouble-free second half rests on three pillars: a diminishing drag from the housing market, consumer-spending growth of 2-1/2 to 3 percent and stronger business investment. Tighter credit poses a risk to all three… Consumers are showing some signs of stress. They fell behind on loan payments in the first quarter at the highest rate since 2001, the American Bankers Association reported. Retailers feel the fall-out. The International Council of Shopping Centers and UBS Securities last week cut their forecast for June sales growth at retailers to 1.5 to 2 percent, from 2 percent… Automakers sold cars and light trucks at an annual rate of 15.6 million last month, the lowest for June since 1997…”
From UBS: “The data continue to be mixed enough to keep alive the debate over whether the apparent pickup in growth in Q2 marks the start of a sustained recovery or just a temporary bounce within a still-weak trend. In our view, much of the pickup
reflects a reversal of inventory-related weakness in Q1, with the trend in demand
still sluggish. Consumer spending appears to have slowed sharply in Q2.”
From Morgan Stanley: “Compared with the second quarter, in which we estimate that GDP rose by 3.8% annualized, we expect growth to slow noticeably in the second half of 2007, reflecting tighter mortgage lending standards, the ongoing housing recession, and higher energy prices. We also expect a slight pickup in both core and headline inflation in the second half of the year.”

Treasuries Looking Like a Poor Investment
From Citi: “U.S. 10s, JGBs and Bunds all posted bearish weekly reversals with last weeks close (weekly reversals towards lower prices/higher yields). This completes the set of developments on U.S. 10s seen since the price peak in June at 106 1/32 which point to the potential for a new low in price/high in yields for this cycle over the coming weeks (i.e. U.S. 10 year yields can move above 5.33%).”
From Bloomberg: “U.S. bonds offer cold comfort. With ultra-safe six-month Treasury Bills yielding as much as 5 percent, your real return is paltry after inflation and taxes.”
From Bloomberg: “…economists at Lehman Brothers Holdings Inc., Morgan Stanley and RBS Greenwich Capital…estimate 10-year government notes will return 1.28 percent this year, not even enough to cover inflation. The performance would be the worst since 1999, when they lost 8.25 percent, Merrill Lynch & Co. index data show…``It isn't a very appetizing environment'' for bond investors…”

Europe’s Financial Importance Growing
From Cumberland Advisors: “The European financial market place is rapidly growing and has exceeded that of the US in some areas…In the global bond world, the Euro denominated bonds now are a larger component in the international bond segment than the United States, 46% for the euro vs. 38% for the US dollar…This is critically important to understand since it is the world’s bond markets which are now driving bond interest rates in a powerful way. America is still the world’s leader in equities but our position has been declining. The US is about 40% of the world’s stock market capitalization. This is down from 50% a decade ago. In stocks the growth in the world has been in emerging market values. Japan has only added about 1% share of world value in the last decade and the Euro zone about the same. While the dollar is still the dominant world reserve currency, its role has been declining. US dollars constitute about 65% of global reserves, the lowest level since the advent of the euro. Compare this with a 24% euro position. Every indication points to a continuation of this trend as the Euro based financial markets continue to develop as an alternative to the US…Remember, the United States now has the second highest corporate tax rates in the world (Japan is highest) and contends with the Sarbanes-Oxley type reporting and regulatory requirements. Amazing as this statement may sound, business and corporate taxation in Europe is friendlier than in the US…European insurance companies (life and non-life) now receive more premium income than the US based insurers ($1.3 trillion vs. $1.1 trillion in 2005). This has been the trend since 2003 and the spread continues to widen. European bank assets are almost 4 times those of their American counterparts. Average revenues from European investment bank customers are up to 71% of those from American customers and the trend is continuing to rise.”

Energy
From JP Morgan: “Crude oil prices are making new highs and have broken out of the $60/bbl to $70/bbl range that held from April through June. The higher price is providing better fundamental support for product prices even as margins had begun to narrow in the gasoline market (both the crack spread and the markup of retail over spot), bringing down the retail price. As of last week, the US retail gasoline price had fallen 8% from its May peak.”
From Morgan Stanley: “The price of crude oil is rising again. In the short term, it could rise as high as $80/bbl. We believe that the markets are reacting to higher uncertainties regarding supply, against a backdrop of robust (but not surprising) demand. In addition, OPEC members, especially Gulf producers, are willing to protect their purchasing power, in a context of extreme weakness of the USD dollar…In the long term, however, we continue to expect the real price of oil to rise at a fast clip.
…we do not think that the rise is large enough to threaten global growth, unless other and independent supply side shocks happen. Although OPEC is announcing a 15% capacity margin, we believe that the market is so tight that a supply side disruption, caused for instance by an embargo against Iran, would send prices much higher. Only unexpected and clear signs of weakness in the global economy could bring prices down, at this stage, we think.”
From Bloomberg: “Global spare oil production capacity will shrink after 2010, increasing the risk of high crude prices as demand outpaces growth in production outside OPEC, the International Energy Agency said. Brazil and Russia will lead production growth outside of the Organization of Petroleum Exporting Countries while oil output in Europe will fall below that of Iran by 2012…OPEC's supply cushion of unused capacity rises until 2010, then declines to ``uncomfortably low levels,'' …all of the growth in non-OPEC supply over 2007-2012 comes from gas liquids, extra heavy oil, biofuels'' and by 2012 some coal-to-liquids production in China…By 2012, the quantity of OPEC crude oil theoretically needed to balance world supply and demand will rise to 36.2 million barrels a day, up from 31.3 million barrels a day for this year.”
From Bloomberg: “Far more than safety and environmental concerns, the biggest hurdle to fulfilling Bush's ambition to build the equivalent of three new nuclear plants a year by 2015 is money. U.S. utilities will have to invest about $350 billion by 2025 to satisfy the country's growing appetite for electricity…TVA is alone in executing the objective. Of the 16 U.S. electricity producers that have told the government they are interested in building new nuclear plants, none has committed to the projects. The challenges TVA faced at Browns Ferry…demonstrate how difficult it will be to relaunch the U.S. nuclear power industry. The tasks range from lining up billions of dollars in financing to securing scarce components in a manufacturing sector decimated decades ago, and hiring and training a new generation of skilled workers at a time when about one-third of the industry's existing workforce is close to retirement…the overwhelming stumbling block is that it costs about 28 percent more to build a new nuclear plant than the value Wall Street assigns to existing reactors…To satisfy an estimated 40 percent increase in U.S. electricity demand by 2025, the Bush administration is promoting nuclear power's development with tax credits, loan guarantees and a streamlined regulatory review process…The Nuclear Energy Institute estimates that only about 10 percent of the U.S. manufacturing capacity that existed to build the current generation of nuclear reactors remains. Most companies that produced the heavy steel forgings, cables, pumps and valves that went into U.S. reactors in the 1960s and 1970s have since been acquired by non-U.S. companies or folded, making parts hard to find and expensive…a drought in the Tennessee Valley that has reduced by 50 percent TVA's river-based hydro-electric generation, its cheapest energy source.”
From Bloomberg: “Ethanol tumbled 43 percent in the past 12 months, making the corn-based fuel additive cheaper than gasoline for the first time in two years…A rebound in ethanol became more likely after corn prices dropped 27 percent from a 10-year high in February. U.S. farmers planted more corn than in any year since World War II. Every $1- a-bushel decline in corn lowers the cost to make a gallon of ethanol by 25 cents…The U.S. ethanol industry, propped up by 25 years of federal subsidies, still needs government support to ensure its future…”
From Merrill Lynch: “The U.S. Senate has approved a bill that would allow the Justice Department to sue OPEC nations for price manipulation in U.S. courts. The "No Oil Producing and Exporting Cartels Act of 2007" would revoke the sovereign immunity OPEC members enjoy. The White House has threatened to veto the measure. OPEC President Mohammed al-Hamli considered the development a "really dangerous step," and said that OPEC had successfully deterred two prior attempts by Washington against the 12-member group. During a meeting with EU energy officials, OPEC Secretary-General Abdullah al-Badri said that OPEC does not currently see a shortage in crude oil. Not a view the market seems to hold.”

MISC

From Stone & McCarthy: “The Fed’s Consumer Credit surged by +$12.9 bln in May, following a revised +$2.3 bln gain in April…The primary strength in May consumer credit was in the revolving credit component…an indication that people are spending even with the additional burden from higher gasoline prices and the housing slowdown…”

From Bloomberg: “Keeping rates unchanged is the best option for promoting faster growth and slower inflation, according to Federal Reserve Bank of San Francisco President Janet Yellen. ``The virtues of this path are that it avoids exposing the
economy to unnecessary risk of a downturn while, at the same time, it is likely to produce enough slack in goods and labor markets to relieve inflationary pressures,'' …”

From Lehman: “Almost every indicator of employment growth has shown a slowdown in the first half of 2007 relative to 2006.”

From Stone & McCarthy: “``It is noteworthy that household employment, when adjusted for differences in definition with payroll employment, has slowed in a fairly pronounced fashion over the past six months, averaging only 45,000 a month, in sharp contrast to the payroll series, which has averaged 145,000 a month,''… ``We think that the BLS monthly payroll estimate is overstating the pulse of labor market conditions.''”

From Lehman: “In certain construction trades illegal immigrants are thought to reptese

From JP Morgan: “The NFIB small business optimism index declined to 96.0 in June from 97.2 in May. The 2Q average of 96.7 is below average for 1Q (98.1), 4Q06 (99) and 3Q06 (97.8), and has not shown sign of improvement like the ISM manufacturing and nonmanufacturing surveys have. One reason for this is the disproportionate share of construction firms: between 25% and 30% of survey respondents are in the construction industry, far higher than the industry’s share of value-added in GDP (about 3%). In June plans for hiring, capital expenditures, and inventories all softened slightly, while the net percent of firms expecting higher sales in six months dipped to its lowest value since last August. More firms are also raising selling prices, a source of upside inflation risk.”

From Bloomberg: “U.S. home sales in 2007 will drop to the lowest level since the start of the five-year housing boom in 2001 as mortgage rates and foreclosures increase, according to a forecast by Freddie Mac.”

From The Financial Times: “US corporate profits grew at the slowest rate in more than five years in the past quarter…”

From Citi: “Earnings season kicks off today…and really gets going in earnest next week. It's been a while since we've had a down move in SPX during earnings season. The last three have seen an average S&P gain of 3.3% (approximately) and you have to go back to last year at this time to see the S&P dropping during a reporting. By all accounts, 1Q was punk and 2Q wasn't great either, especially for retailers/restaurants, etc. as gasoline prices soared. Technology has led and could be the saving grace though.”

From Merrill Lynch: “Stocks (+6.3%) strongly outperformed Bonds (-2.1%) and Cash (1.3%) in the second quarter…Leadership is narrowing…The "Nifty Fifty" (largest 50 companies in the S&P500) outperformed the "Not-So-Nifty 450" (rest of the index) in the second quarter…Energy led sector performance by a sizeable margin in the second quarter, whereas Utilities lagged. Year-to-date, Energy led performance, whereas Financials lagged.”

End-of-Day Market Update
The 10y Treasury curve is settling at 5.15%, down 3.5bp, and the 2/10 Treasury curve flattened 1.5bp, as the 10y yield is now 18bp higher than the 2y yield.
Equities are closing higher, with the Dow up 36 and Nasdaq up +5 to its highest close since 2001.
The dollar is essentially unchanged after hitting a 26 year low versus the British Pound last week, and remains near its lowest level versus the euro since the currency was created.
Crude oil fell 62 cents, but closed above $72 a barrel in NY, and near a 10 month high.