Today's Tidbits

Indicators of Economic Health
From Deutsche Bank: “Right now there are three indicators which we are watching closely to gauge recession risks: jobless claims, consumer confidence and the ISM. Jobless claims have been very low despite softer job gains and slowing GDP growth. The reason claims have stayed low is because most of the slowdown in GDP growth has been due to lower productivity. Corporations have hoarded labor even while economic activity slowed. As a result, the labor market has remained tight and income growth has stayed solid, running between 6%-7%. Incidentally, this is corroborated by the employee tax receipt data, which after looking soft in August, have since rebounded. Tax receipts suggest that robust income growth will continue, at least in the very near-term. In this environment, consumer confidence should hold up. We prefer the University of Michigan sentiment survey because its questions change from month to month, making it less static than the Conference Board's consumer confidence survey. Despite strong income growth, consumer sentiment has been stuck in the low 80s over the last few months. While consumer attitudes are a notoriously unreliable gauge of consumer spending, large moves in the former tend to correlate well with meaningful changes in the latter. As long as sentiment stays in the mid-to-high 80s and does not crack on the continued drumbeat of negative housing news, the economy should be okay. If this is the case, then business confidence, which is proxied quite well by the ISM survey, should hold up well. We will start to worry about the economic outlook if any of the following data thresholds are breached: jobless claims rise above 350k, consumer sentiment falls below 75, or the ISM survey prints in sub-50 territory.”

Fed Remains Focused on Risk Management
From JP Morgan: “Chairman Bernanke did not break any new ground on the outlook in his two speeches last week. But in both speeches he emphasized the Fed's role as a risk manager. His talk in St. Louis was perhaps the more enlightening one in this regard. His topic was somewhat academic with a central focus on the "Brainard uncertainly principle." This principle holds that it is optimal for monetary policy to move cautiously under uncertainty -- as it is appropriate to walk slowly when in a dark room. Bernanke noted that theoretical developments over the past ten years suggest that this principle may not always hold and there are circumstances where "intuition suggests that stronger action by the central bank may be warranted to prevent particularly costly outcomes." While these comments were partly designed to justify the Fed's September action, he did not frame the speech to limit this point to past actions. It is worth noting that other Fed speakers -- including Chicago Fed President Evans in his first speech in this role -- have also highlighted that the Fed's role as a risk manager warrants preemptive action. In a related development, Governor Mishkin delivered a speech defending the Fed's focus on core inflation in a world in which food and energy prices are rising. The message coming from Chairman Bernanke and others is that the Fed's risk management strategy warrants a further ease in October.”

Fed Adds Substantial Liquidity to Markets This Week
From Dow Jones: “The Federal Reserve has added a fairly substantial amount of liquidity to the financial system over the last three days. While the size of Fed operations is highly variable and driven by diverse factors, operations on Monday, Tuesday and Wednesday were nevertheless hefty. And because of their sizes, the interventions raised the specter of continued troubles in short-term funding markets, although that possibility was complicated by the fact the central bank’s overnight target rate has been sticking fairly close to where it should be, around 4.75%. That suggests at least in the fed funds market, borrowing and lending are functioning as they should. Still, on Monday the Fed took in a substantial $10.5 billion in collateral overnight. Tuesday saw a two-day operation that injected $8.5 billion in fresh cash, followed by Wednesday’s $6.5 billion overnight operation.”

China Faces Growing Energy Demands for Industry and Citizens
From Barclays: “…benchmark coal prices in China hit all-time highs…The real problem for China… is that despite rapid increases in coal production this decade, surging domestic demand is outpacing local primary energy supply, leading to a rapidly widening energy gap… For the first nine months of this year, China’s coal imports have risen by 48% Y/Y… China’s oil imports have continued to soar, driven by rapid growth in demand for transport fuel. Its oil imports hit an all-time high in July of 3.49mn bpd and are up 16% in the year to September. Chinese officials may be complaining that oil prices are too high, but that is not the case for local consumers, who have seen retail prices frozen since May 2007 and hence have little incentive to economise. Strong oil demand growth is contributing to the widening energy gap that China is facing and which has trebled since the start of this decade to the equivalent of almost 3.3mn bpd of oil in 2006. The difficult consequences of this energy gap are recognised by central government, which has started to make life much harder for energy intensive industries, recently reducing electricity price subsidies for ferro-alloy and primary aluminium producers, many of which are big exporters of their products. Nevertheless, with Chinese energy consumption per capita currently at the equivalent of just 9 barrels of oil per head per year (the equivalent figure for the US is 59), the nation faces a big struggle to prevent a further widening of its energy gap in the years to come.”

MISC

From Citi: “…With 2s trading at 3.81%, the lowest yield seen in 2yrs, and still 69bp below the 4.50% Funds rate …it will be difficult to rally much further unless we start to see the very front end start pricing in the possibility of the Fed eventually going beyond 4%.”

From Goldman Sachs: “Manufacturing activity appears to have decelerated further over the past month. Three reports released over the past week have suggested that orders and shipments of manufactured goods are growing more slowly than before…”

From Merrill Lynch: “The National Retail Federation expects that holiday sales could be the slowest in five years at just 3.7%. On top of this, yesterday UPS lowered guidance for 4Q, citing concerns about weak retail sales. And we don’t see much momentum going into the holiday season – the latest chain store sales are anemic, running at just above 2%.”

From Deutsche Bank: “We are worried that the housing market slide may be accelerating. There was evidence of this in last week's figures on new residential construction starts; the 6-month rate of change (-36%) showed a steeper decline than the year-on-year rate (-31%), and the 3-month rate of decline was even lower (-57%). There is a 10 month supply of inventory in the new construction market, which is a record high and over twice as large it was during 2004 and 2005.”

From RBSGC: “As we have discussed many times, we are not big fans of the price numbers in this release[existing homes] because the price composition of homes sold in any given month tends to fluctuate wildly. The disruptions seen in the financing markets this summer probably distorted the price numbers down in September (the median sales price plunged by nearly 6% in the month) because the jumbo market -- by definition, expensive homes -- dried up for a time. Undoubtedly, prices are falling in a variety of regions, as they need to for those markets to clear, but this particular reading should be viewed skeptically.”

From Dow Jones: ““There’s no question that housing is the area we’re most concerned about,” Al Hubbard, director of the White House’s National Economic Council, told CNBC. “There’s significant softness in housing and to be perfectly frank...it’s not going to turn around quickly.” Edward Lazear, chairman of the Council of Economic Advisers, said declines in the housing market haven’t had much of an impact yet on consumption, largely because the market’s problems followed a big appreciation in home prices.”

From Morgan Stanley: “Stripping out the China gap still leaves a US trade deficit of over $600 billion in 2006 – a number nearly three times as large as the shortfall with China… If America wants to fix its trade deficit and relieve the concomitant pressures that are bearing down on middle-class workers, it must address its seemingly chronic saving deficit.”

From SunTrust: “Merrill's Q3 earnings are not pretty. Merrill reported its first quarterly loss in 6 years and increased their writedown for sub-prime and asset- backed bonds to $7.9 bln, over $2 bln more than expected. The additional loss was written down after "additional analysis and price verification". Now the concern is there will be more to come in Q4 as further "price discovery" unfolds.”

From Deutsche Bank: Observations from a recent conference] “A sharp contrast was noted on the US outlook between relatively benign views outlined by the main opinion makers and a rather alarmed tone detected among investors. This, however, seems to reflect unusually asymmetric downside risks and their associated effect on asset pricing.”


End-of-Day Market Update

From RBSGC: “Bonds had a strong rally and attempted technical break, with 3s the best performer, as 'bad' information proved even worse than expectations. Existing Home Sls fell a whopping 8% with inventory at the highest level in 22 years and prices fell sharply -- led by single family units. Single family home prices fell 4.9% -- most on record. And while rumors were around on Tuesday that Merrill had deeper Q3 writedowns coming, the 7.9 bn amount announced today along with EPS at -$2.85 were worse than expectations (-$0.45 was expected for EPS). The move up came on decent volume and accelerated post the Existing Home Sls report pointing to new buyers and some momentum coming to the market. In accord, Fed Fund futures for November have moved fully to the 25 bp camp AND added some odds towards either a 50 bp move (either 14% for next week, or somewhat less for sometime in Nov in what would be an inter-meeting event). This action reeks of a bit of panic (and stock charts look particularly ugly) with some covering afoot.”

From UBS: “The 2s30s curve steepened nearly 5 more basis points on increased expectations of a rate cut next week … Spreads were wider intraday, but ended the session little changed. Agencies saw overseas selling of 3- and 10-year notes, and lagged swaps by 0.5bp across the board…Mortgages saw decent 2-way flow, trading in line to a plus wider on the day.”

From Deutsche Bank: “…all recent resistant points taken by 11:00. real money types particularly engaged buying often and early across mbs and trsy space. 2yr raffle on the screws but little fanfare. afternoon equity reversal almost surreal with a third probe of recent lows finding massive buy interest. number of large mutual funds have oct year end so not overly shocked to see some committment to defend 15%ish yoy gains in the dow.”

From SunTrust: “Equites have cut their losses from -205 points to -22 points, but Treasuries are still hanging around the highs of the day. One reason the bond market will not release on its relentless bid is expectation that another investment bank is about to announce a horrendous writedown. Rumor is Lehman, the amount is for a loss of $9 bln. Lehman has denied any such loss.”

From JP Morgan: “Rumor of possible discount rate cut helped stocks bounce”

Three month T-Bill yield fell 12.5bp to 3.85%.
Two year T-Note yield fell 8.5bp to 3.73%
Ten year T-Note yield fell 7bp to 4.33%
Dow fell 1 to 13,675
S&P 500 fell 4 to 1516
Dollar index fell -.07 to 77.51
Yen improved to .5 yen to 114.25 per dollar
Euro closed unchanged at 1.427
Gold rallied $3.60 to $763.5
Oil rose $2.33 to $87.59 (all prices as of 4:45)