Today's Tidbits

Economists’ Thoughts on Bernanke’s Testimony
From Barclays: “Chairman Bernanke's seminannual monetary policy testimony was largely consistent with the message of recent FOMC statements. He continued to expect moderate economic growth, slowing core inflation, and emphasized that inflation is the predominant policy risk. The FOMC projections that accompanied the testimony indicate that the Fed expects that real GDP growth will average below 3% through the end of 2008, that the unemployment rate will be gradually rising, and that core inflation will
be gradually falling. These can be thought of as triggers; the Fed is likely to remain on hold as long as these forecasts hold.”
From Morgan Stanley: “… it’s a bit surprising that the FOMC lowered the estimated growth rate for 2008 – to a range of +2.50% to 2.75%. Such a growth pace is: “close to the economy’s underlying trend” – suggesting that the Fed believes the economy’s potential growth rate has slipped below 3%... On the issue of headline vs core inflation, the Fed Chief recognized the recent elevation in food and energy prices, but reiterated that policymakers remain focused on the core because they must be forward looking and the core represents “a better gauge than overall inflation of underlying inflation trends.”… Bernanke’s testimony reinforced the sense that the Fed views much of the recent shake-out in credit markets as a sensible repricing of risk that will prove beneficial to the economy over the long run. Indeed, while credit spreads “have widened somewhat” and “terms for some leveraged business loans have tightened,” spreads remain near the low end of their historical ranges and “financing activity in the bond and business loan markets has remained fairly brisk.””
From Lehman: “…the Fed opted not to lower their central tendency forecast for core inflation in 2007. Given that the current level of core inflation is already below the forecast they reported, this suggests that they truly are not convinced that the recent drop in inflation can be sustained. Overall, the notation of financial conditions and the numerous comments related to total inflation and inflation expectations provided an overall hawkish tone to the report even as he acknowledged a weaker housing sector. Indeed, the report can be viewed as that much more hawkish because of his willingness to downplay the housing and credit risks.”
From Merrill Lynch: “Bernanke gave considerable lip service to food and energy and cited their rapid increases as "unwelcome developments". And, added that total PCE inflation of 4.4% so far this year "if maintained, would clearly be inconsistent with the objective of price stability"…He also added that headline inflation, if it were to move higher "for an extended period" would also become "embedded in longer-term inflation expectations" and that, as a result, "the re-establishment of price stability would become more difficult and costly to achieve".”
From HSBC: “The key downside risk to growth was a possible housing spillover into
consumption. But on balance Bernanke highlights consumption should continue to grow thanks to good employment and real wage gains (assuming futures markets are correct about commodity prices, and so headline inflation drops to raise real wages). The Fed also see consumption as a possible upside risk (without explaining why) and that could lead to above trend growth and hence more inflation, given resource utilization is already high.”
From FTN: “Bernanke clearly believes his stringent anti-inflationary tone has won him respect in the markets, and he is not willing to risk his credibility by even hinting at an ease…Bernanke finished his policy update by highlighting three risks to the outlook. 1. A deeper housing correction, with spillover to consumer spending could result in slower than expected growth. But, 2. Consumer spending could strengthen if income and job growth remain “strong.” And, 3. If food and energy inflation continues to rise and spills into the core, higher inflation expectations could become entrenched. The message is clear. This Fed has no intention of easing until either the unemployment rate rises to 5% or the inflation rate falls to the center of the Fed’s 1%-2% target range.”
From JP Morgan: “Almost half of Chairman Bernanke's prepared remarks addressed consumer protection regulation, and the limited and somewhat uninteresting discussion of monetary policy may in part reflect a desire not to rock the boat at a time when the Fed is under political pressure for its role in the subprime problems.”

Inflation Can Give Illusion of Profits
From The International Herald Tribune: “The idea that stock prices tend to rise over time really should not be surprising. The price of almost everything rises over time, thanks to inflation. Each year, governments print more money, which is the main reason that the price of groceries, cars, clothes and, yes, stocks keeps on going up. Of course, incomes are rising, too. This doesn't mean, however, that everything is always getting more expensive and everyone is always getting richer (which would be a contradiction). And the stock market's record high does not mean that stocks have been a wonderful investment lately. They haven't been. The S&P 500, which is a much better measure than the Dow, closed Tuesday at 1,549.37, just 1.4 percent higher than the peak it reached in March 2000. Think about what that means. While the price of nearly everything has risen in the United States over the least seven years - the price of bread has increased nearly one-third, for instance - stocks have barely budged. They have only marginally outperformed cash sitting in a bureau drawer… I realize that this point can sound like statistical nitpicking, but it actually relates to something quite important. When you overlook inflation, you can start to think that every investment is a can't-miss investment, because its value always seems to be going up… The only meaningful way to measure an investment is to strip away the distortions caused by inflation. You're then able to focus on its real value - what it can buy in the marketplace - rather than just a number on a piece of paper. (A good rule of thumb is that something appearing to have doubled in price or value since the early 1980s costs the same now, in real terms, as it did then.) When you make these adjustments, it becomes disturbingly obvious that stocks and real estate are by no means can't-miss investments. The average house in the New York region sold for roughly the same nominal price in 1997 as it had in 1988, which in inflation-adjusted terms means its value dropped 31 percent. House prices in New York didn't exceed their 1988 real value until 2002. Then they soared like never before. The New York stock market has suffered through even longer stretches of mediocrity. The S&P 500 first went over 100 in the summer of 1968. In 2007 dollars, that means it was up near 600. It then entered a long period in which it failed to keep pace with inflation - leading to BusinessWeek's famous 1979 magazine cover article, "The Death of Equities" - and didn't exceed its real 1968 high until 1992. Over the next eight years, it tripled, even after taking inflation into account. Today, the S&P remains 17 percent below its inflation-adjusted 2000 peak. A share in a mutual fund tied to the S&P 500, in other words, can't buy nearly as much today as it could in early 2000. Now, in a way, this might be considered a good sign. If the market isn't really at a record high, it may still have a lot of running room. But I wouldn't be too confident about that. Relative to corporate earnings, stocks remain more expensive than they have been at any time except the 1920s and the 1990s.”

Oil Demand Continues to Rise, But Supply May Not Keep Up
From MSNBC: “Record-high prices for gasoline this year haven’t dampened U.S. drivers’ demand for fuel…Drivers consumed a record 9.2 million barrels, or 388 million gallons, of gasoline on average every day during the first half of the year, up 1.5 percent from last year’s levels, the American Petroleum Institute said…”
From Bloomberg: “[Gasoline] Supplies dropped 2.24 million barrels… Gasoline imports plunged 36 percent to an average 915,000 barrels a day, the lowest since the week ended March 16, the report showed. The oil market often follows gasoline during the summer months, when motor-fuel demand rises to an annual peak. ``The significant gasoline draw instead of an expected gain, coupled with the drop in imports, is a dramatic story,'' said Tim Evans, an energy analyst at Citigroup Global Markets Inc. in New York. ``It's impossible to know if the drop in imports is the beginning of a trend or we will see imports rebound to higher levels for the balance of the summer.'' Crude oil for August delivery rose $1.03, or 1.4 percent, to $75.05 a barrel at the 2:30 p.m. close of floor trading on the New York Mercantile Exchange. If the futures settle there it will be the highest close since Aug. 9, 2006. Oil is up 23 percent this year.”
From Bloomberg: “Oil supplies may fall short of demand by 13 million barrels a day by 2030, according to a study led by former Exxon Mobil Corp. Chairman Lee Raymond and based on forecasts from the world's largest oil companies…. ``We need energy efficiency, we need to moderate the rate of growth of demand,'' [U.S. Energy Secretary] Bodman told reporters today after the report was released… The gap between the industry and U.S. government forecasts is ``about the equivalent of the current production of Saudi Arabia,'' said Donald Paul, vice president and chief technology officer of Chevron Corp.”

Forbes Magazine Ranks Riskiest U.S. Housing Markets
From Forbes: “[Miami] ranks first on our list of the nation's riskiest real estate markets. There, a high share of adjustable-rate mortgages, high vacancy rates and slumping prices still too elevated for the local populous means should long-term bond yields climb, interest rates jump or the housing crisis linger much longer, things could go from bad to worse. Affairs are not much better farther north--or west. Following in Miami's wake are Orlando, Sacramento and San Francisco… Others, like Chicago or Phoenix, are generally stable markets that are currently under significant strains. Finally, some, like Cincinnati or Kansas City, are precariously teetering and are not well equipped to handle further downturn… high ARM share generally means a market is unaffordable to its residents. The metros with the highest shares of ARMs, according to the National Association of Realtors, are in San Francisco, San Diego and Los Angeles, respectively. These three cities are also the most overpriced, according to our price-to-earnings measure. And these areas are three of the four least affordable to the local population, according to the National Association of Home Builders… Another arbiter of risk? Cities with a high proportion of mortgages with loan-to-value ratios in excess of 90%. Loan-to-value (LTV) measures the size of the mortgage to a home's overall value. In a standard home buy, the down payment is 10% of the overall value, meaning the LTV is 90%. When the loan-to-value ratio is above 90%, it means buyers have little equity in their homes. And homeowners with low equity are far more likely to default or walk away from a mortgage. If the market teeters and lenders take a hit from defaults, it can depress prices overall, as is currently being seen with the subprime lending fallout. For that reason, Kansas City is particularly vulnerable. It has a 39% share of mortgages with LTV ratios above 90%. The median rate for cities on our list was 11%, according to the National Association of Realtors… The price-to-earnings ratio highlights two significant risks. It magnifies risk factors in overly expensive markets in which there is more money at stake. For example, a 5% drop in median home prices in San Francisco is possible; but the nominal equivalent, a 24% price drop in Dallas, is not something the market is likely to bear. Second, overvalued bubble markets are more likely to face downward price pressures in a slumping market as overvalued markets are, by definition, most likely to experience a correction. A final factor was vacancy rates. It's not a complicated or glamorous measurement, but it's difficult to find a better indicator of supply and demand. Orlando's staggering 5.2% vacancy rate represents a significant risk factor for the city. Strong local economic indicators like job growth and immigration significantly mitigate that risk, but it is in a vulnerable position should there be an economic slowdown or a disruptive hurricane season. Two larger cities that performed very well by this measure were Los Angeles and New York, which ranked fourth and eighth for lowest vacancy rate. While both cities had high ARM shares and high P/Es, their low vacancy rates bode well for those markets.”

MISC

From Bloomberg: “The risk of owning corporate bonds soared to the highest in two years in Europe after Bear Stearns Cos. said investors in two U.S. subprime hedge funds will get little or no money back, credit-default swap prices show.”

From UBS: “Reports swirled about dealer losses in subprime (JPM increased charge-offs for home-equity loans on lower home prices) and Fitch and S & P both chimed in about increased scrutiny/worry over CDO's and Alt-A.”

From Reuters: “Credit risk poses the greatest threat to financial market stability, according to Merrill Lynch’s latest fund manager survey…for July, which polled 186 fund managers controlling $618 billion in assets, a net 72% of managers said that credit or default risk was the biggest threat to financial markets….The next largest risk to financial market stability is monetary policy, according to a net 44% of managers, with geopolitical risk and protectionist risk close behind, according to a net 39% and 38% of managers that responded to the survey.”

From AFP: “A key Chinese parliamentary committee has warned that the country's runaway economy is in danger of overheating amid rising inflationary pressure, state press reported Wednesday.”
From Bloomberg: “ U.S. builders unexpectedly started work on more homes last month, even as permits for future construction fell to the lowest level in a decade, the Commerce Department said today. ``All of the strength was in a 12.5 percent rise in multifamily starts, which in itself is odd given the Bureau of Labor Statistics report on the high vacancy rate in multifamily housing,”...The plunge in permits leaves the series beneath a five-year moving average of 712,000. The series has dropped below two deviations of the 120-month trend and is below the 20-year, two deviation trend as well …''
From The Houston Chronicle: “Allstate customers in Texas could see an increase in their home insurance rates…The insurer has filed a statewide rate increase of 6.9 percent with the Texas Department of Insurance. The increase will go into effect July 26 as policies come up for renewal, barring a rejection by state regulators. Allstate, which has about 750,000 policyholders in the state, has stopped writing new home owners business in some Texas coastal areas. Allstate … attributed the rate increase to construction costs and the cost of reinsurance, or insurance the company buys for itself to cover claims in the event of a catastrophe.”
End-of-Day Market Update
Treasuries rose, pushing the ten year yield back below 5% after Bernanke’s testimony, before closing 2.5bp lower at 5.02%.
Equities sold off hard during the morning. The Dow traded down 147 points before recovering late in the day to settle only 53 points lower.
The dollar was very volatile overnight with the dollar index hitting a new low of 80.23 after the Bear Stearns news broke. The dollar recovered to above yesterday’s closing level by the US open, but is ending the day down .09 at 80.45. Gold rallied $8 to test the highs of early June, and is settling at $673.
Oil rallied over a dollar to close at a new 11-month high of $75.08 for futures in NY.