Today's Tidbits

Weak Dollar Reducing OPEC Profits and Europe’s Energy Costs From The Financial Times: “The falling US dollar is lowering the Organisation of the Petroleum Exporting Countries’ purchasing power by up to a third, making the powerful oil cartel more reluctant to increase production and cut prices. Although oil is trading near last August’s record $78.65 a barrel, Opec calculations show that, when adjusted for the weaker dollar and inflation, an average of the 12 Opec members’ crude oil prices has fallen in the past year…Growing trade between Opec members, especially in the Middle East and North Africa, and the European Union is aggravating the problem because the pound and the euro have risen… a Morgan Stanley economist, estimates that a 10 per cent drop in the dollar against major currencies cuts Opec’s Middle East members’ crude oil purchasing power by about 5 per cent…the refusal of the cartel to increase its production to force a drop in the oil price was “more understandable if the lower value of Opec’s spending power...is taken into account”. But the decline in the value of the dollar is insulating some countries from high oil prices, which provides Opec with strong demand even as oil prices soar above $75 a barrel.”

Weak Dollar Increasing Tourism to US and Pushing Inflation Higher
From Merrill Lynch: “The weaker dollar and solid income growth abroad are bolstering the US travel/tourism industry in a major way and this is one segment of the consumer group has no correlation with the housing market… hotels have big-time pricing power - up 7% year-on-year, but this masks what has happened in the past three months where pricing has soared at a 28% annual rate, which is the strongest pricing power the sector has posted since January 1991. Airlines are seeing some nice price increases too - up 0.9% sequentially in June and a 5.4% annual rate since over the six months to June. Restaurants are actually enjoying solid pricing growth at 3.5% on a year-over-year basis, which is above average for the economy as a whole. High-end stuff that tourists buy, such as jewelry, is also seeing strong pricing power - up in 6 of the past 8 months and the year-on-year trend solid at 6%… real (inflation adjusted) consumer spending on accommodation has risen a solid 4.4% y/y; airlines are seeing 1.5% volume growth; sightseeing expenditures, again in real terms, have risen nearly 2% in the past year and attendance at museums increased by 5.5%. Restaurants are seeing close to
3% year-over-year volume growth to go along with the decent pricing…What we do know with certainty is that US spending on travel abroad has declined 10% year-on-year (the weakest since mid-2003) while foreigner spending on travel/tourism in the USA is up 3.7%...”

Home Prices Likely to Continue Falling
From Bloomberg: “U.S. house prices may decline by as much as 15 percent in the next two to three years, reducing the value of the property market by a fifth since mid-2006 and prompting an increase in defaults and delinquencies, according to analysts at JPMorgan Chase & Co… JPMorgan sees scope for a total decline of as much as 20 percent ``from the June 2006 peak before this cycle hits bottom, potentially two or three years from now.''… ``Further declines in home prices will exacerbate the default problem, both by making it harder for borrowers to qualify for modifications and by reducing their incentive to continue making payments on homes that are worth less than the amount owed on the mortgage,'' the JPMorgan analysts wrote.”
From Wachovia: “…home prices may be far from bottoming…contrasts the home price decline in the current cycle with that between 1989 and 1994 for major metro areas. In percentage terms, the drop in home prices to date is only 40% to 50% of that during the ’89-‘94 cycle. In terms of time duration, the current decline has lasted only 25% of the ’89-94 cycle (70% if measured to the trough of the sharp initial drop). If we benchmark the current cycle with the last major housing market down turn, there would be significant room for additional weakness in terms of price depreciation and time duration.”
From CNN: “Countrywide Financial Corp. Chief Executive Angelo Mozilo said the U.S. housing market is unlikely to recover before 2009, as lenders and homeowners work through oversupply, stagnating home prices and the excesses of recent lax lending standards in much of the mortgage industry.”

MISC
From Merrill Lynch: “The year-over-year growth rate in headline consumer inflation (CPI) has bested the growth rate of the core CPI index 73.1% of the time in the decade of the 2000s (compared to just 26.7% of the time in the 1990s), the most persistent such out-performance since 1960…only the decade of the 1970s has headline consumer inflation persistently outperformed core inflation even close to the extent that it has in the decade of the 2000s…. The combination of lower potential GDP growth (our models point to +2.5% y/y in the current decade), along with the persistent out-performance of running headline inflation versus the core, means that the Fed must be vigilant against the risk that headline inflation creeps into core inflation via an unwelcome rise in inflation expectations (which the Fed assesses to be "imperfectly anchored").”

From Merrill Lynch: “… the monthly issuance of Collateralized Debt Obligations (CDOs), or packages of debt instruments bundled together to form a "portfolio" of debt, dropped from $42 billion to $3 billion in the latest month. That 93% drop represents a significant tightening of liquidity that is starting to ripple throughout the credit markets.
The fixed-income markets appear to be starting to understand that the days of free-flowing liquidity are likely to be behind us. Most credit spreads are widening. However, the equity markets seem to be clinging to the past and ignoring the debt markets' signals…Mergers and acquisitions have garnered a disproportionate amount of equity investors' attention. Today's New York Times, for example, has an article titled "Merger Activity Helps Shares Bounce Back." Unless such deals are going to be increasingly done for cash, we think equity investors better realize soon that the last days of the debt-financed M&A and LBO spree are probably not too far off.”

From Market News: The negative results from DuPont have added to concerns about the wider impact of the downturn in the US housing market and its potential impact on consumer sentiment…the 2% drop in US demand that has drawn focus from credit traders and analysts looking at wider housing sector contagion from sub-prime. Also slow car sales contributed to lower paint sales, yet another indication of possible consumer fatigue.”[Maker of Tyvek house wrap used in 40% of new homes]

From RBSGC: “Countrywide's earnings slumping 33% has set the negative tone for the mortgage market today, with broader questions being asked about Alt-A…”

From Barclays: “The extra interest investors demand to own junk-rated debt
rather than Treasuries of similar maturity has widened 103 basis
points to 344 basis points since touching the lowest on record on
June 5…”

From JP Morgan: “The Richmond Fed manufacturing survey was stable in July, with both the headline composite (4) and ISM-weighted composite (52.7) being exactly equal to their June values. Capital expenditure plans did rise sharply, from 13 to 25; capex plans in the other regional Fed surveys released so far this month have also improved. On the whole, the July Empire, Philadelphia, and Richmond Fed surveys have showed steady manufacturing growth this month.”

From Merrill Lynch: “Throughout Asia, industrial production (IP) has surprised on the upside. A simple average of Asian IP numbers for April and May exceeded consensus by 0.45 standard deviations. This is the highest meaningful figure since the very strong October/November 2005 showing (0.62 standard deviations above consensus), which was associated with strong FX performance in early 2006.”
From The US Treasury: “Treasury Secretary Henry M. Paulson, Jr. will travel to China at the end of this week to meet with government officials and discuss the U.S.-China Strategic Economic Dialogue (SED) launched by Presidents Bush and Hu last year. "This trip is part of an ongoing process to strengthen our strategic economic relationship – to address long term issues such as working with China to rebalance its growth and increase the flexibility of its currency, and also to address short term issues as they arise," said Paulson.”

End-of-Day Market Update

Treasuries rallied late in the day as the equity market tanked. The yield curve steepened as shorter maturities declined more in yield than long expiries. Two year Treasuries are closing down 3.5bp at 4.74% while thirty year bonds are down 1.5bp to 5.04%.
Today’s 20-year TIPS auction had the strongest bidding ever seen for a TIPS auction according to Morgan Stanley. Very little went to dealers.
Equities were under pressure all afternoon. The Dow closed down 227 points to finish near the low for the day. The S&P lost a substantial 50bp, or 2% in value. The homebuilders index fell to a four year low, and financial shares fell to a four month low, on concerns about mortgage defaults.
The dollar index reached a low of 80.016 on the US open, but recovered slightly to close down .25 at 80.10, another record low for this year. The 20 year low for the dollar index is 78, with the 80 level having been tested two times in the past 15 years.
Oil fell precipitously again today, declining almost $2 before bouncing back 50 cents. Oil is down over $3 from its 11-month high last week.