Today's Tidbits

Wider Impacts of Credit Tightening
From Bear Stearns: “Credit markets remain on alert as a wave of supply needs to be distributed in the days ahead. While sub-prime has been the lead story during the widening, focus in now shifting to corporate credit. Not only is the supply a major hurdle but the earnings outlook is being viewed through a more skeptical lens. The major underlying concern is that credit markets freeze up. A repricing of risk assets is not going to prompt the Fed to ease, but a credit lock down is a different story. With the focus moving toward traditional credit concerns the calendar of headline deals will take on added importance The Chrysler deal is reportedly due to trade this week. If this deal goes off, albeit at wider spreads, it could prove a turning point for credit markets. Conversely if the deal falters, look out.”
From Morgan Stanley: “The question that continues to loom over the market, is if the biggest catalyst for the equity market (LBOs) will be significantly affected by the recent credit shake up. So far 20 levered deals have been postponed or modified, and there are $220B in the pipe line in the US, with an additional $50B in Europe.”
From Deutsche Bank: “While we think that spreads in both subrpime and credit will continue to widen as part of repricing to a new level of risk premium, we don't think it will reach systemic proportions. Therefore there is little basis for a significant Treasury market rally to accompany the spread widening. Markets appear stable from Friday's close. Attention is shifting away from subprime and toward the credit markets, particularly in the knock-on effects on equities. Private equity has slowed down its pace of deals, with the more marginal ones being held up, and much of the large financings being delayed until September or October. Then there will be a battle between investors who need to put money to work and issuers who need to finance their deals. The only question is where the market will clear. We think that today's announcement that China Development Bank and Temasek are helping to finance Barclays' bid for ABN Amro might be significant in this regard. If Asia comes in with even modest flows into the credit markets, the balance of forces will shift toward the issuers, and bring spreads back down. Thus, credit spread widening is still an ongoing saga, unlike the subprime sector, where large losses in the underlying loans will continue to be an issue.”
From Market News: “Barclays is close to raising around 10 bln from the Chinese and Singaporean governments to help finance its takeover of the Dutch bank giant, ABN, the BBC reports. If it succeeds and if Barclays acquires ABN, the Chinese state would emerge with a shareholding of around 7% in the enlarged group. The Asian cash will be used to help Barclays increase its takeover for ABN to around 50 bln, the report says. A smaller stake of around 3% would be taken by Temasek Holdings, the Singapore government-owned investment firm.”
From JP Morgan: “July AAA spreads are now implying a default rate equivalent to the historical default rate for BBB-rated corporates...all lower rated indices are implying default rates of high yield debt. The fact that this is happening in credit during a period of historically low default rates (we've have the fewest defaults YTD in high yield since 1981) is some of the best evidence that this is largely about technicals in credit rather than a fundamental story (obviously different in this respect than what is happening in the ABS market).”
From Merrill Lynch: “Over the past 5 months, there have been many loss estimates published over the size of the sub-prime investment debacle, and our desk range runs at near $160.0 to $180.0 bln (conservatively speaking). As a percentage of GDP, that $160.0/$180.0 bln loss estimate is near +1.2% of GDP, versus the +2.5% share of GDP of the S&L crisis in the early 1990s. As a concentration of the investor base, we simply note that Anglo, Caribbean and Pacific-based hedge fund and institutional buying further
dilutes the US domiciled investor risk exposure. Hence, overall, we continue to expect that the Fed will not pre-empt the mortgage melt-down (Fed on hold well into 2008), and that the Fed will continue to urge private sector solutions to the problem - at the very
least to avoid moral hazard problems.”
From Bank of America: “Stocks are indeed pricing in higher risk premia evident in the bond market. Outperformance of the large caps over smaller companies has been noticeable since the market’s mid-February highs; record highs for the oft-cited Dow Jones Industrials reflect 1) higher international economy exposure; 2) more aggressive
payout policies; 3) unchallenging valuations in the context of the broad market; and 4) greater liquidity/visibility to foreign investors who are rapidly increasing their exposure to US stocks. A “flight to quality” in the bond market is also occurring among stocks, as the distribution of earnings yields has widened, reflecting a higher risk premium for slower-growing, cyclical companies.”
From The Financial Times: “The stricken US subprime mortgage market is likely to suffer further setbacks in coming months as $500bn of risky home loans sold with initial low "teaser" interest rates are reset at much higher levels, analysts warn… Over the next 18 months, adjustable-rate home loans sold at the peak of the high-risk lending boom in 2005 and 2006 will be reset. Given a recent tightening of lending standards as banks try to rein in their mortgage exposures, this raises the prospect of further serious losses. Christopher Flanagan, strategist at JPMorgan, estimates up to 45 per cent of borrowers facing resets will not meet criteria to refinance into new home loans. The mounting problems could force ratings agencies to downgrade billions of dollars of mortgage securities below investment grade, a move that would in turn force many investors to sell their holdings and exacerbate the spiral of losses. "The potential repercussions are quite serious," … Ratings agency downgrades of subprime-related securities have already gained momentum in recent weeks, helping to push a key derivatives index tracking such securities to record lows. The ABX index tracking 2006-issued subprime bonds rated BBB- fell to a low of 41 cents on the dollar on Friday, down more than 50 per cent since January. "There is a possibility that one or two money centre banks and dealers could be a casualty along with hedge funds and institutional investors,"… JPMorgan, Citigroup and Bank of America increased future loss provisions for bad loans in second-quarter earnings reports.”
From The Wall Street Journal: “Hoping to slow the quickening pace of home foreclosures, about a half-dozen state are setting up funds to help homeowners with high-risk subprime mortgages refinance to more-affordable loans. The States – which include Maryland, Massachusetts. New Jersey, New York, Ohio, and Pennsylvania – are expected to invest a total of more than $500 million in the effort. That isn’t much, given the size of the problem, but state officials hope it will be enough to keep some vulnerable low- and moderate- income neighborhoods from sliding into decline.”

Commodities Power African Growth
From Merrill Lynch: “According to the IMF, African growth has been outpacing world growth since the beginning of the commodity bull market in late 2001. Since that year, annual economic growth in Africa has averaged 5.0%, while overall world growth rose
only 4.2%....Almost two-thirds of African countries remain below the $2,000 level for per capita GDP, despite the commodity price boom we have witnessed for the last several years. Despite the rise in incomes in the region, even the wealthiest African countries are still far below developed-country standards, and only four are above the $2,400 threshold the UN sets as “middle income” status for a country. It is interesting to note that all four of those countries – Botswana, Mauritius, South Africa, and Namibia – are in the southern part of the continent. None of those four countries are oil exporters and only two, Botswana and Namibia, generate sizeable income from mining operations….In central Africa, the largest economy and one of the fastest growing is Nigeria. The country is an oil and agricultural products exporter and is also rapidly expanding its financial center.
Regionally, Northern Africa is very wealthy because many of those countries are oil
exporters. Libya, Algeria, and Egypt are major oil exporters, possessing 51% of
Africa’s proven oil reserves… In the North, real per capita GDP is almost four times that of the countries in the southern region. According to the World Bank, the five countries of the North (Algeria, Egypt, Libya, Morocco, and Tunisia) all boasted real per capita GDP above $1,000 in 2004…. The income disparities in Africa are stark and much higher than we see in the US or in the G-7 countries…. Even a fairly developed economy like that of South Africa has an income inequality measure of more than … twice that of the US and more than three times that of the G-7… One of the key sources of wealth in Africa is oil. The continent boasts 8% of the world’s proven oil reserves, putting it ahead of Asia and Latin America. While there are 12 oil exporting countries in Africa, the bulk of the reserves – almost 86% – are held by four countries: Libya, Nigeria, Algeria, and Angola… Other countries possess natural resources like gold, silver, platinum and various other commodities… Another source of economic growth is food as many African nations are agricultural exporters. In fact, agriculture is a main source of revenue for many African countries…. Foreign direct investment (FDI) into Africa has soared in the last few years and is expected to continue. The World Bank estimates that net inflows of FDI into Africa jumped to almost $40 billion in 2006 from less than $10 billion in 2000… As China and India continue their rapid expansion, commodity exporters will be the prime beneficiaries…. According to the UN, population growth in Africa through 2015 is expected to rise the fastest in the world at 2.2%. The result of this population explosion is that Africa is expected to house the largest youth population in the world. By 2015, according to the UN Human Development Report, Africa’s youth (those under the age of 15) is expected to rise to 42% of its total population. The next closest region is the Arab states where 33% of the population should be under 15. This presents some interesting possibilities because it will provide the nations of Africa with young workers who will want to earn, learn, and burn (their earnings). The challenges for the governments, in our view, will be to provide the healthcare, education, and business infrastructure so that they can become productive workers in the new African global economy…. Given the abundant natural resources available, we view Africa as a key complement to China’s growth needs. In mid-May China pledged $20 billion to Africa to help provide the capital necessary to build roads and other infrastructure. The funds are to be delivered in the next three years, and the $20 billion would go toward projects such as the rehabilitation of railway networks in Angola and Nigeria and the building of a hydroelectric dam in Ethiopia. According to the US Energy Information Administration, China accounted for 40% of total growth in oil demand in the last four years, and is now the second-largest consumer of oil globally (after the US). Africa’s five most resource-rich countries – Angola, South Africa, Sudan, Equatorial Guinea, and Congo – account for more than 80% of Africa’s exports to China….”

History Repeats
From The Financial Times: “The Jungle,… Upton Sinclair's 1906 novel… For many Americans watching the safety scandals that have engulfed Chinese exports to the US in recent months, Sinclair's book is something of a road map for contemporary China. In their own way, the tales about "filthy" catfish and poisonous toothpaste fit neatly into one of the grand narratives of our time, that China's booming economy is following a path similar to the US just over a century ago. Here is a continent-sized nation with new cities bursting with entrepreneurial energy and roads and railroads opening up once-isolated regions. Such rapid expansion has left the institutions of government scrabbling to keep up, opening space for unscrupulous businessmen to cut every imaginable corner. Copies of The Jungle are being dusted off because as well as illuminating the dark side of hasty industrialisation, it also provoked outrage that helped pave the way for the creation of the Food and Drug Administration. The uproar over Chinese products in the US is also an eye-opener about just how far globalisation has reached…. Whether we like it or not, China's problems are now everyone's problems. If food regulators in China cannot impose standards on the fish farms and vegetable producers they patrol, it is no longer just Chinese consumers at risk. The challenge facing regulators in Beijing is daunting, with hundreds of thousands of small companies operating in the industry, many with powerful connections to the local officials who should be keeping an eye on them… the more intriguing title of "China's Upton Sinclair". It included extracts from a book written in 2004 by a writer called Zhou Qing that describes in excruciating detail all the things residents of China have heard about the food supply but did not want to think about. At a factory making pickled vegetables, he watched workers pour in insecticides to get rid of bugs. Or there is the Shanghai shop that fumigated cakes with sulphur powder and added industrial bleach to make them look whiter. Or the Nanchang drinks company that scraped off the sell-by date that had expired and added a new one to the bottles. Corruption and powerful local vested interests are always in the background of his tales - all written in the very best muck-raking tradition. The big question is how quickly in China's one-party state, with its internet firewalls and media restrictions, such stories will translate into sustained pressure on the authorities. The other day I had a browse in some Shanghai bookshops and did manage to find The Jungle. But there were no copies of Zhou Qing's books.”

Oil Headed Higher?
From Morgan Stanley: “We think that oil producers are trying to offset the purchasing power lost to a weaker dollar by restraining crude supply, thus keeping prices high. They likely are also diversifying portfolios away from the dollar to hedge returns, and some worry about the possibility that USD assets might be frozen or confiscated… we can't rule out a further surge in crude quotes that could hurt both US consumers and global growth.”
From Bloomberg: “The $100-a-barrel oil that Goldman Sachs Group Inc. said would prevail by 2009 may be only a few months away. Jeffrey Currie, a London-based commodity analyst at the world's biggest securities firm says $95 crude is likely this
year unless OPEC unexpectedly increases production, and declining inventories are raising the chances for $100 oil. Jeff Rubin at CIBC World Markets predicts $100 a barrel as soon as next year. ``We're only a headline of significance away from $100
oil,'' said John Kilduff, an analyst in the New York office of futures broker Man Financial Inc… Currie, Goldman's global head of commodities research in London, is predicting that oil prices will probably touch a record and stay at unprecedented levels for months or years…``Ultimately, the key to the outlook going forward is when will Saudi Arabia ramp up production,'' he said… The cost of finding and pumping oil is rising steadily,
convincing analysts such as Rubin and Deutsche Bank AG chief energy economist Adam Sieminski that higher prices will last. Shortages of deepwater drilling ships and rigs has pushed daily rents to records, and the skilled workers needed to run rigs, weld pipes, pilot vessels, fix refineries and build oil-sands projects command ever-higher wages… A pullout from Iraq may be the event that pushes oil to $100 a barrel, according to Boone Pickens… `At face value this market is strikingly similar to a year ago,'' Currie said. ``What is different? Supply is down a million barrels a day, demand is up a million barrels a day. The market is in a deficit.''”
From UBS: “Once again, the price of energy topped investors’ concerns in July, followed by the federal budget deficit, and housing… in response to special questions related to consumer spending plans and high energy prices, 62% of investors said they plan on cutting back on nonenergy related spending. We view this as an important development, given that the UBS survey is a survey of investors and should mostly exclude the relatively non-affluent families who sometimes are thought to be main consumers adversely affected by higher energy prices. In fact, the detailed breakdown of the UBS survey showed 48% of “substantial investors” (those with more than $100,000 in invested assets) planned on cutting back other spending given energy and gasoline prices. And 70% of “average investors” (those with less than $100,000 in invested assets), expected to curtail other spending. Broken out by gender, females (70%) expect to cut back more than males (53%), and investors between the ages of 18-39 years (70%) planned to pare back more than any other age group”
From Dow Jones: “The Organization of Petroleum Exporting Countries’ head of research said that a fair price for crude oil was between $60 and $65 a barrel.”

Dollar at Record Lows
From The Financial Times: “The US currency has fallen 4.5 per cent against the euro this year and 4 per cent against sterling, hitting a new 26-year nadir against the pound last week. The trade-weighted dollar index dropped to its lowest since 1992. The dollar exchange rate is important because the US relies on hefty foreign purchases of securities and other assets to fund its current account deficit. "At some point, the fall in the dollar will translate into foreign investors no longer buying US assets and selling their existing holdings,"… The beleaguered US currency was hardly helped by Ben Bernanke, Federal Reserve chairman, last week. Questioned by Congress, he declined any chance to say the dollar was undervalued…. Official silence on the dollar's woes extends to Hank Paulson, US Treasury secretary. "You get the sense the administration wants a weaker dollar,"…”
From Bloomberg: “The currency [US dollar] has lost 13.2 percent since January 2001, when George W. Bush took office, the most under any president since at least Gerald Ford… The dollar set a new low of $1.3845 per euro today, and is the weakest in 26 years versus the British pound… Against the Canadian dollar, it's the lowest since 1977 and it's the weakest in seven years versus Brazil's real… The 13.2 percent tumble under Bush compares with a 18.3 percent gain under Bill Clinton and declines of 0.2 percent
under George H. W. Bush, 0.4 percent under Ronald Reagan, 3.0 percent under Carter and 2.3 percent during Ford's tenure, the Fed's U.S. Trade-Weighted Real Broad Dollar Index shows.”

MISC
From Deutsche Bank: “In the reported data on Friday, banks showed an increase in whole loan mortgage holdings and a decrease in short term assets. We would also point out that a crucial compromise has been made between the federal bank regulators and the banking industry that will enable Basel II to go forward, starting in January 2008, with 11 large banks likely to adopt the new analytic risk-based capital requirements. This will favor holding whole loans over MBS.

From Bank of America: “Foreign buying of U.S. stocks surged to a new record in May, according to data released last week by the U.S. Treasury. Net purchases of +$42B were half-again as large as the prior record (reached in February 2000 and nearly achieved again in April 2007).…While much of the incremental foreign demand for US equities represents recycled petrodollars, some major investors appear to be increasing equity allocations, because of the superior long-term expected returns for equity and its historic ability to behave as a natural hedge against dollar weakness.”

From The Financial Times: “Competition for investment is driving down corporate tax rates around the world, with average rates falling from 27.2 per cent to 26.8 percent over the past year…”

From The Wall Street Journal: “…a growing number of Japanese companies…are [now] pursuing woman workers with new vigor. That’s a big change from the past, when many companies viewed women primarily as a temporary source of labor…a growing labor shortage is spurring a change in attitude. The world’s second biggest economy is continuing to expand, and last year there were more jobs than job seekers for the first time in 14 years. The labor crunch is expected to get worse in the next few years …working-age population is expected to fall 15% between 2005 and 2025…Women in Japan hold only 10% of managerial posts…Only 23% of women who had a job a year before having a child were employed 18 months after giving birth…while women are supposed to receive equal pay under the law, in reality they earn only 67% of what men earn.”

From The Wall Street Journal: “Because the risks are spread so widely, regulators can do little but watch and try to reassure everybody it is all under control…it is hard to overstate how dramatically it has changed in the past decade…there are worrisome downsides to this financial architecture. The system hides risk and concentrates it in hedge funds that regulators and other investors don’t understand…’We don’t really know where the bodies are buried until after the fact”…A system designed to distribute risk also tends to breed it. At their core, subprime loans and other mortgage innovations – ‘piggyback’ loans, Alt-A mortgages, ‘no-doc’ loans – brought credit to people who wouldn’t otherwise have gotten it. Few of these products would have become so popular if they hadn’t been packaged into securities and sold widely to investors.”

From Bloomberg: “U.S. farmers this spring planted the most acreage with corn since 1944…”

From Dow Jones: “Assets controlled by hedge funds grew by about 36% over the past year to $1.74 trillion, Hedge Fund Research Inc. said , after investors poured $58.7 billion into these investments in the second quarter. HFR said the inflow was second only to the previous quarter, when investors poured $60 billion into hedge funds. The growth in assets is being driven in large part by institutional investment in hedge funds, including allocations to fundof- hedge-fund firms that select and monitor pools of hedge to diversify risk. In the second quarter, funds of hedge funds raised $17.4 billion of the net new assets, bringing their collective assets under management to $745 billion, or about 43% of the total hedge fund universe.”

End-of-Day Market Update

Treasuries traded in a relatively tight range on reduced volume. The curve flattened though with two year yields rising 2.5bp to close at 4.79%, and the ten year yields only rising .5bp to settle at 4.96%.

Equities recovered some of Friday’s sell-off. The Dow is closing up 92 at 13,943, and the S&P500 is closing up 5 at 1550.

The dollar index tested last week’s low in the overnight hours, but closed slightly firmer, rising .06 to 80.35.

Oil futures fell almost a dollar, after hitting a new 11-month high late last week. Gasoline prices fell six cents to a 3-month low.