Today's Tidbits

Comments on FOMC 50 Basis Point Rate Cut
From Goldman Sachs: “FOMC chooses aggressive option on funds rate, emphasizing risks to growth, cutting it by 50 basis points (bp); discount rate also cut 50 bp (i.e., no further narrowing of penalty); statement emphasizes uncertainty on the outlook and keeping options open.”
From CITI: “The half point cuts in the funds rate and discount rate confirm that the
Committee's sense of risks to the outlook are in line with the dramatic change in investor perceptions of the past two months. The action is is also consistent with our assessments and as a result does not change our view that modest additional easing is likely, entailing another quarter point move before yearend. The Committee departed from its usual balance of risk judgment and therefore doesn't provide too much guidance about the likely outcome of the October meeting. Nonetheless, it's important to note the tone of the discussion of the risks to growth suggests that is the greater concern. We suspect consensus may have been achieved by shifting the focus of "monitoring" to inflation developments, recognizing that recent favorable trends may still not foretell a sustained easing of price pressures. The Committee's focus on financial developments in the final paragraph is a signal that further easing like this initial move may not necessarily be data dependent but could be triggered by additional signs that financial conditions are tightening. The initial response in markets hints that they have bought themselves some time and may be closing off some of the more aggressive rate cutting expectations by being preemptive here at the outset.”
From Wachovia: “Two and done?”
From FTN: “Looking ahead, the FOMC clearly wants to keep all options open. If calm returns in the credit markets, the Fed will likely raise rates. But if turmoil persists or the economy continues to deteriorate, they may cut further. We can’t remember the last time the Fed had both an easing and a tightening bias in place, but the Committee clearly feels it has insufficient information to commit to any course of action today.”
From Lehman: “The FOMC makes it sound like "one and done" as it cuts both the Fed funds and discount rate by 50 basis points but continues to note inflation risks. The statement noted that the "Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully." The "bias paragraph" (paragraph 4) suggests a balanced statement with the Fed noting that it will "assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth." As of this writing, we no longer look for the Fed to cut rates in October but that position, like the Fed's, remains data dependent.”
From Morgan Stanley: “We suspect that the references to inflation concerns in today’s statement may have been necessary to achieve a unanimous vote. We did not anticipate that there would be any dissents to a 25 bp move, but are a bit surprised that no dissenting votes were cast on the 50 bp outcome.”
From Credit Suisse: “Transparency is difficult to sustain when you are in significant doubt about what the future will bring or what you will do about it. The honest and forthcoming statement is "I don’t know." And that’s what the FOMC said today. Their statement highlights the "uncertainty surrounding the economic outlook."”
From Dow Jones: “U.S. interest rate futures prices soared Tuesday afternoon, reflecting increased expectations for the Federal Reserve to implement further cuts to its benchmark rate later this year…”
From RBSGC: “The Fed opted for the dramatic gesture today, cutting both the fed funds and discount rates by 50 BPs. We are very surprised, but we view this as a valuable data point on the Bernanke Fed's reaction function. For all of the talk of Bernanke being less inclined to respond to financial market difficulties than Greenspan, the reality is that this Fed has been very aggressive -- cutting the discount rate by 50 BP in August along with a number of administrative moves aimed at promoting liquidity, and giving the markets more than they expected on the funds rate today. If Greenspan's modus operandi was gradualism, then Bernanke's may be "a stitch in time saves nine." The key question is whether the Fed eased by 50 BP rather than 25 BP because 1) they wanted to get ahead of the curve and frontload whatever they were going to do (in which case, there may be less rate cutting going forward) or 2) they are more worried about the economy than they had let on (in which case, there may be more rate cutting going forward). This is the critical question for the outlook, and policymakers very skillfully kept their opinions to themselves. If the FOMC had wanted to send a signal either way, it would have been easy enough in the statement. Instead, the Fed failed to lean in either direction. I think this is a very shrewd and very intentional strategy. The Fed has just as much uncertainty as the rest of us, and officials did not want to lock in a forecast (I can certainly identify with that!) or to artificially govern market expectations (they probably view market expectations as a valuable read on the outlook and did not want to taint that signal).
If the Fed had hoped to ease by 50 BP today and be done, then the statement could have suggested something along the lines that "today's action should help to counteract the tightening of credit conditions" or to suggest that "the FOMC expects the economy to grow at a moderate pace in light of today's action." Instead, the FOMC said that the action was "intended to help forestall some of the adverse effects on the broader economy...and to promote moderate growth over time." What I find most interesting here is that there is no presumption of success. They tell us their intention, but there is no assertion that they think they will be successful. The other thing from the statement that, in my mind, points to the Fed being open to further easing is the wording of the forward-looking paragraph. Again, no sense of confidence from policymakers that they have their hands around the dimensions of the situation. Instead, the statement merely notes that "the Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth." That's a pretty open-ended promise that sounds like something that would come in the midst of financial market difficulties, not at the tail end of a crisis. So, despite the improving tone in recent days, the Fed does not presume that financial markets are out or nearly out of the woods yet.”

Fed’s Discount Rate is a Penalty Rate for Bank’s “Last Resort” Borrowing
From the Wall Street Journal: “Normally, banks pay a "penalty" to borrow from the Fed's discount window of one percentage point over the target for the federal-funds rate, at which banks lend to one another in a market heavily influenced by the Fed. Banks seldom borrow at the discount window because they can borrow federal funds more cheaply. The direct loans also have carried a stigma because they were often a last resort for troubled banks. On Aug. 17, in a bid to improve the flow of cash to clogged credit markets, the Fed cut the discount rate to 5.75%, a penalty of half a percentage point above the 5.25% federal-funds target. It also extended the term of such loans to as long as 30 days from one day, and declared that using them would be regarded as a sign of strength, not weakness. Its hope was that banks would use discount loans, or the knowledge that they were available, to finance customer holdings of hard-to-sell securities such as asset-backed commercial paper and jumbo mortgages. Many on Wall Street feel the Fed has yet to make the discount window attractive. The actual penalty, they note, is larger than the normal half point because the Fed has allowed the federal-funds rate to fall to 5%, a quarter point below its target. Many market participants recommend that the Fed cut the discount rate so it sits just a quarter point above the fed-funds rate or even matches it…Wall Street officials say they are still reluctant to borrow at the discount window because, if their identity became known, it could make counterparties skittish or hurt share prices. If the penalty were cut or eliminated, they say, banks could argue they were using the window because it was profitable…Officials also worry that cutting the discount rate too much would prompt many banks to fund all of their needs from the window instead of the money market. That could make it harder for the Fed to manage the fed-funds rate with open-market operations.”

Mortgage Defaults Double Over Past Year
From CNN: “The number of homes in some stage of default jumped 36 percent month-over-month in August, according to a regular monthly survey. Delinquencies and defaults more than doubled year over year to 243,947, according to August figures released Tuesday by RealtyTrac, a marketer of foreclosed properties…The jump in foreclosure filings this month might be the beginning of the next wave of increased foreclosure activity, as a large number of subprime adjustable rate loans are beginning to reset now," James Saccacio, chief executive of RealtyTrac, said in a statement. October is expected to be a peak month for hybrid adjustable rate mortgages (ARMs) to reset, with the interest rates on some $50 billion worth of loans poised to go up dramatically. In the past few months, the foreclosure story has become a tale of two regions. Some of the hardest hit states have traditionally been in the Midwest, where plant closings and job losses have hit the economy there hard. The other region is the Sun Belt, which is showing even more significant foreclosure growth as out-sized price increases in the first half of the decade led to virtually unchecked real estate speculation. Nevada led all the other states in the rate of August foreclosure filings: one for every 165 households for a total of 6,197. Other hard-hit, sun-belt states were California (one in 224), Florida (one in 243), Georgia (one in 271), Arizona (one in 289), Colorado (one in 312) and Texas (one in 532). Rust-belt states in the top 10 included Ohio (one in 281), Michigan (one in 288) and Indiana (one in 544). California placed six cities among the top 10 metro areas for the number of filings. Modesto led the way with one of every 79 households. Stockton, Merced, Vallejo-Fairfield, Riverside-San Bernardino and Sacramento also hit the top 10. Detroit, Cleveland, Ft. Lauderdale and Las Vegas rounded out the list of worst hit metro areas. California, by far the most populous state, also led the nation in the actual number of foreclosures. Some 57,975 households were in some stage of default during the month. Florida was next with 33,932 and Ohio, with 17,793, was third…When borrowers can't catch up on their mortgages, their homes are often sold before the actual foreclosure takes place. Even if they go on to the next step in the process - auction - they may not draw higher enough bids for lenders to accept the sales. In that event, they return to the banks as REO properties.”

Too Much Leverage Hurts Housing More Than ARM Resets as Prices Fall
From Barclays: “The worst-performing mortgages are those that were made in 2006 – their delinquency rates are very high and quite worrying. Yet, the vast majority of these loans have not yet reset. In other words, their credit performance is poor for other reasons… Leverage, not ARM resets, is the real problem with US housing. Many borrowers were allowed to take on too much leverage in the lax lending standards of 2005/06… The keen-eyed reader will also notice that loans made in 2005 and 2006 had roughly the same leverage. 40-45% of Alt-A first lien mortgages made in both years had second liens. Then why are 2006 loans doing so much less poorly than 2005 loans? The reason is that home prices were rising far more in 2005 than in 2006… It is possible that ARM resets could add to the pain being felt by mortgage borrowers. By our estimates, the payment shock due to mortgage resets is only about $25bn annually, and that is for all ARMs resetting, not just subprime. Subprime borrowers will foot $15bn of this $25bn. If that is the main problem, it is an easy one to solve. As a client of ours recently suggested, the government could simply subsidize the $15bn and help subprime borrowers; it seems a small price to pay for the health of the $10trn mortgage market.”

MISC

From Bloomberg: “Crude oil climbed to a record $81.90 a barrel in New York after the Federal Reserve reduced U.S. interest rates by more than expected… ``Lower interest rates are bullish for oil because they boost economic growth and energy demand, always have and always will,'' … ``It should also put pressure on the U.S. dollar. The dollar price of oil will to have to rise to keep the same value in other currencies.''…the highest since [futures] trading began in 1983. Prices are up 28 percent from a year ago.”

From FTN: “NAHB Housing Market Index continues to plummet, falling to 20 in September, matching the lowest level in the history of the index. Since 1985 it has touched 20 only once, in January 1991. The NAHB has fallen more than 50 points from its June 2005 peak. The survey has three components: Sales conditions, both present and future, fell in September, with prospective buyers’ traffic unchanged from August at 16. The survey is reported as a diffusion index measuring homebuilders’ assessments of market conditions for home sales. Looking at the trend, the question now is whether the index will continue lower or begin to consolidate near the record low. Right now, homebuilders’ confidence in a market recovery continues to deteriorate.”
From JP Morgan: “Compared to August, builders downgraded their assessments of present and future sales, but said buyer traffic held steady. The findings are consistent with the view that the tightening of credit terms and availability is producing further weakness in sales.”

From Lehman: “The Fed’s flow of funds report for the second quarter provides evidence of a substantial shift underway in borrowing patterns even before the latest blow-up in credit markets. Corporate sector borrowing continues to pick up, with borrowing requirements now at 1.7% of GDP. The profligate household sector maintained a steady pace of debt accumulation, while the federal government actually paid down debt in the second quarter. Third-quarter data are likely to show a sharp deceleration in borrowing as tighter credit standards took hold. Mortgage borrowing looks poised for an especially heavy hit, and as a result we have revised down our forecasts for mortgage equity withdrawal (MEW). We now expect total MEW to fall to just over $200 billion in 2008, from our previous forecast of roughly $300 billion and a 2006 level of $830 billion.”

From Dow Jones: “[Washington Mutual (Wamu)] … is unlikely to face the same kind of dire, life threatening problems as those its competitor Countrywide Financial Corp. CFC) battled recently. That is mainly because Washington Mutual, with more than 2,000 retail branches, has a much larger deposit base than Countrywide, meaning it is less dependent on short-term debt markets to raise financing for its operations. Also, because Washington Mutual originates its loans as thrift, it has much broader access to funds from the Federal Home Loan Bank.”

From CSFB: “…prices of manufacturing goods imported from EM countries ran at -6% yoy during 1998 easing, -2.1% during 2001/2002, but have risen +2.4% over the past year.”

From MNI: “China may impose more restrictions on mortgage lending as the industry grows rapidly, Lehman Brothers said. China's mortgage loans as a share of total loans outstanding have risen sharply to 9.4 pct in 2006 from 0.2 pct in 1997, and as a share of urban household income to 31 pct in 2006 from 0.6 pct in 1997.”

From MNI: “ China will require 3,400 new airplanes worth about 340 bln usd over the next 20 years, according to an updated annual forecast by Boeing. Boeing had previously forecast that China would need 2,900 new aircraft over the next two decades. “

End-of-Day Market Update

From UBS: “After the larger than expected cut, short-end yields immediately plunged, while 30-year yields spiked about 8bps. 10-year yields showed confusion at first as they plummeted, then shot upwards, then proceeded to solidify not too far from pre-Fed levels. On the day, the 2s10s curve steepened 9.5bps, and 2s30s is nearly 14bps steeper. In T-bills, 3-month paper rallied 13.5bps, while the 6-month bill richened 20bps. TIPS saw breakevens explode after the Fed announcement, going from narrower on the day to 4-5bps wider across the board… swap spreads ended the day significantly tighter across the board. Mortgages were trading about 2 ticks tighter to swaps early in the day on light flows, but screamed tighter post-Fed. On the day, the FNMA 5's and 5.5's tightened 6-7 ticks versus swaps and 10-13 to Treasuries, while the 6's and 6.5's tightened 3-4 ticks to swaps and 6-8 versus Treasuries. Agencies saw better buying across the curve pre-Fed, trading mixed to swaps and 4-5bps tighter to Treasuries.”

From Bloomberg: “U.S. stocks rallied the most in four years after the Federal Reserve cut its benchmark lending rate by half a percentage point to keep credit-market losses and the real estate slump from dragging down the economy… ``The markets were concerned that the risk of recession had increased, and these aggressive moves have reduced those risks.''… in the Standard & Poor's 500 Index. Consumer shares climbed the most since 2003… Four-hundred ninety stocks in the index gained the broadest advance since at least 1996. The S&P 500 climbed 43.13, or 2.9 percent, to 1,519.78. The Dow Jones Industrial Average advanced 335.97, or 2.5 percent, to 13,739.39. The Nasdaq Composite Index increased 70, or 2.7 percent, to 2,651.66.”

From Bloomberg: “The dollar fell to a record low against the euro… The Dollar Index against six other major currencies sank to the lowest since September 1992… The U.S. currency also fell to a 30-year low of 98.74 U.S. cents per Canadian dollar. The dollar has lost 5.5 percent this year versus the euro… The yen fell 1 percent to 116.21 per dollar and 1.7 percent to 162.36 per euro on speculation the rate cut will encourage investors to borrow in yen to finance a risky strategy known as the carry trade. In a sign investors added to risky wagers, U.S. stocks soared… ``Growth and interest-rate differentials are both turning against the dollar,''…”[Gold up $5.50]

Oil is finishing at the high of the day, and at another record all-time high of $82.38, up $1.81.