Comments on Bernanke’s JEC Testimony
From Morgan Stanley: “In sum, it does not appear that Bernanke was looking to send any important new signals in today’s testimony.”
From Citi: “Federal Reserve Chairman Bernanke's testimony this morning in front of the Joint Economic Committee (JEC) largely steered clear of providing forward-looking interest rate guidance. The Chairman's statement fleshed out some of the details surrounding prior policy actions and noted that the FOMC expected near-term economic growth to ease from its recent pace. The testimony also touched on the importance of financial conditions to the outlook, an especially relevant issue given market developments since policymakers last convened on October 31.”
From JP Morgan: “Chairman Bernanke’s testimony reaffirmed that the Fed sees both downside risks to growth and upside risks to inflation. The economy is forecast to slow sharply this quarter and remain sluggish during the first part of next year, followed by a strengthening later next year "as the effects of credit tightening and the housing correction begin to wane." Downside risks are centered on effects of credit market tightening and declining house prices. Upside inflation risk stems from higher commodity prices and the weaker dollar, which will raise headline inflation and possibly inflation expectations.”
From Merrill Lynch: “Fed Chairman Bernanke reiterated recent comments by other Fed speakers in his testimony before the Joint Economic Committee (JEC) this morning. He noted that the strong growth in the third quarter showed "scant evidence of spillovers from housing" to the broader economy, but said that such a strong rate of growth is unlikely to be sustained in the near-term. He said household spending is likely to decelerate and that "indicators of overall consumer sentiment suggested that household spending would grow more slowly, a reading consistent with the expected effects of higher energy prices, tighter credit, and continuing weakness in housing"… We believe Bernanke has left the door open for more rate cuts saying the Fed will "act as needed" to shelter the economy from the current credit market turmoil. Bernanke did however repeat the Fed's concern on building inflation pressures from oil, commodities and the weak dollar. He was a bit more forceful than other Fed speakers this week, saying that "the inflation outlook was also seen as subject to important upside risks". He went a bit further, saying that the current risk factors could potentially "increase overall inflation in the short run and, should inflation expectations become unmoored, had the potential to boost inflation in the longer run as well".”
From Deutsche Bank: “With five central banks in play the past week (if we include Bernanke's testimony) it struck us how data dependant central banking has become. The Fed Chairman underscored this when he noted that "we are going to follow the data, and we're going to see what's happening in financial markets". While central banks have always benchmarked their views and assumptions against the steady flow of real and financial market data, the ascendancy of the backward looking central banker is new. While totally understandable in the current environment we can't help but wonder whether it marks the end of a very successful period for central bankers, a period we would argue that was based in no small part on their pre-emptive approach.”
Banks Reconsidering Earlier Enthusiasm For Bankruptcy Reform
From Bloomberg: “Washington Mutual Inc. got what it wanted in 2005: A revised bankruptcy code that no longer lets people walk away from credit card bills. The largest U.S. savings and loan didn't count on a housing recession. The new bankruptcy laws are helping drive foreclosures to a record as homeowners default on mortgages and struggle to pay credit card debts that might have been wiped out under the old code… ``Be careful what you wish for,'' Westbrook said. ``They wanted to make sure that people kept paying their credit cards, and what they're getting is more foreclosures.'' Washington Mutual, Bank of America Corp., JPMorgan Chase & Co. and Citigroup Inc. spent $25 million in 2004 and 2005 lobbying for a legislative agenda that included changes in bankruptcy laws to protect credit card profits… The banks are still paying for that decision. The surge in foreclosures has cut the value of securities backed by mortgages and led to more than $40 billion of writedowns for U.S. financial institutions. It also reached to the top echelons of the financial services industry…. Even as losses have mounted, banks have seen their credit card businesses improve. The amount of money owed on U.S. credit cards with payments more than 30 days late fell to $7.04 billion in the second quarter from $8.37 billion two years earlier, according to data compiled by Federal Deposit Insurance Corp. In the same period, the dollar volume of repossessed homes owned by insured banks doubled to $4.2 billion, the federal agency said. New foreclosures rose to a record in the second quarter, led by defaults in subprime adjustable-rate mortgages, according to the Mortgage Bankers Association in Washington. People are putting their credit card payments ahead of their mortgages, said Richard Fairbank, chief executive officer of Capital One Financial Corp., the largest independent U.S. credit card issuer. Of customers who are at least three months late on their mortgage payments, 70 percent are current on their credit cards, he said… The new bankruptcy code makes it harder for debtors to qualify for Chapter 7, the section that erases non-mortgage debt. It shifted people who get paychecks higher than the median income for their area to Chapter 13, giving them up to five years to pay off non-housing creditors… ``We have people walking away from homes because they can't afford them even post bankruptcy,'' said Sommer, a Philadelphia- based bankruptcy attorney. ``Their mortgage rates are resetting at levels that are completely unaffordable, and there's nothing the bankruptcy process can do for them as it now stands.'' Four million subprime borrowers with limited or tainted credit histories will see their mortgage bills increase by an average 40 percent in the next 18 months, according to the National Association of Consumer Advocates in Washington. About 1.45 million of those will end up in foreclosure by the end of 2008, said Mark Zandi, chief economist at Moody's Economy.com, a research firm and unit of Moody's Corp. in New York. Lenders began the process of seizing properties on 0.65 percent of U.S. mortgages in the second quarter, a record in a 35-year-old Mortgage Bankers study. The percentage of subprime borrowers making late payments increased to 14.82, a five-year high, from 13.77… Personal bankruptcies rose 48 percent to 391,105 in the first half of 2007 from a year earlier and Chapter 13 filings accounted for more than one-third of those, according to the American Bankruptcy Institute. In the first half of 2005, they were just 24 percent of the total. Bad mortgages slashed Washington Mutual's profit by 75 percent in the third quarter from a year earlier, the Seattle- based thrift said Oct. 5. Income from credit card interest rose 8.8 percent to $689 million in the same period… Citigroup's third-quarter earnings fell 57 percent on mortgage losses. Bank of America stopped so-called warehouse lending to mortgage brokers after its profit declined 32 percent in the same period…. ``The law had an unintended consequence of taking away a
relief valve that mortgage borrowers used to have,'' said Rod Dubitsky, head of asset-backed research for Credit Suisse Holdings USA Inc. in New York. ``It's bad for the mortgage borrowers and bad for subprime investors because it means more losses.'' The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was the biggest overhaul to the code in more than a quarter of a century. The old law, the Bankruptcy Reform Act of 1978 that was signed by President Jimmy Carter, had loosened requirements for debt forgiveness. Financial companies began a coordinated lobbying campaign for bankruptcy reform in 1998 when the American Financial Services Association, a trade group representing credit card companies, joined the American Bankers Association to form the National Consumer Bankruptcy Coalition… Countrywide Financial Corp., the largest U.S. lender, said last month that it will modify $16 billion worth of adjustable- rate mortgages. Washington Mutual said in April that it will spend $2 billion giving discounted rates to help customers with subprime loans refinance at better terms. So far, most lenders have been reluctant to change loan agreements. About 1 percent of mortgages that reset in January, April and July were modified, according to a Sept. 21 Moody's Investors Service report that surveyed 16 subprime lenders that account for 80 percent of the market. Congress probably will approve at least a limited measure to permit loan modifications, said Westbrook, the University of Texas law professor. ``They are going to have to figure out some way to address the problem,'' Westbrook said. ``I don't think our economy or our consciences can handle the number of foreclosures we'll see if they do nothing.''”
Foreign Official Reserves Growing Rapidly
From Morgan Stanley: “The world’s total reserves breached US$6.0 trillion in August, having been US$4.2 trillion at end-2005 and US$5.0 trillion at end-2006. At this pace, total global official reserves are on track to be US$6.50 trillion by end-2007. This implies a monthly increase of US$120 billion a month, significantly higher than the average of around US$80 billion a month in 2006. Asia is the region with the largest reserve holdings. Asia has a total of US$3.7 trillion (about two-thirds of the world’s total reserve holdings). Excluding Japan, China and the rest of Asia (AXJC) each has around US$1.3-1.4 trillion. Thus, while there is a lot of focus on China’s official reserves, it is important to keep in mind that AXJC, collectively, has the same amount of reserves as China does. Further, oil exporting countries have around US$850 billion in reserves, with the OPEC having some US$360 billion. Russia’s US$310 billion in reserves ranks it number three in the world, after China (US$1.43 trillion) and Japan (US$923 billion). Asia’s reserves grew by three times as much as those of oil exporters. In the past 12 months (September 2006 to August 2007), total official reserves grew by US$1.2 trillion, with Asia accounting for US$700 billion of this increase, and oil exporters accounting for US$220 billion. Russia accounted for another US$129 billion, which we find remarkable. The single-largest reserve accumulator, in the past 12 months, was China, with US$446 billion, or close to 40% of the world’s increase in reserves. For the past 12 months, most of the reserve increases have reflected genuine interventions. We have tried to decompose the returns on the underlying assets, currency valuation changes, interventions and errors and omissions. Through this decomposition, we find that, while the depreciation of the dollar has led to some valuation gains of EUR, GBP and other currencies, in dollar terms, most of the increases in the official reserves reflected actual interventions. Thus, the dollar has indeed weakened this year, but the size of the interventions conducted by the emerging market central banks is rather extraordinary. China slowed down its pace of intervention in September…We find it remarkable that, first, the stock of China’s foreign reserves increased by ‘only’ US$25 billion. Of this increase, US$18.7 billion may have arisen from valuation changes associated with China’s holdings of EUR and GBP. This implies that actual interventions in September may have totaled only US$1.5 billion. Accelerated intervention activities in the GCC countries. .. we see that Saudi Arabia has drastically accelerated its pace of currency intervention, leading to a 50% expansion in its stock of reserves, from US$23 billion in the previous month to US$32 billion in the latest reporting month. The rest of the GCC have more dated data, but we suspect that the same trend will be revealed with the next round of data releases. Bottom Line Total world reserves exceeded the US$6.0 trillion threshold, and are on track to reach US$6.5 trillion by year-end. This reflects a 50% acceleration in the average monthly pace of reserve accumulation compared to 2006. Asia accounts for two-thirds of the stock of reserves, with China and AXJC – collectively – having roughly the same amount. While China’s cumulative reserve accumulation in the past 12 months was huge (US$446 billion), its pace of intervention may have slowed dramatically to only US$1.6 billion, if we strip out valuation changes and earnings on the underlying assets.”
U.S. Investors Increasing Demand for Foreign Investments as Dollar Weakens
From JP Morgan: “…US equity investors: looking at US equity mutual fund holdings, the percentage of total holdings dedicated to “world” equities has risen from around 16% in 1997 to around 25% today…The dollar’s relatively lower yield (2-year US bond yields have fallen nearly 80bps over 2007 to date) and expectations for even lower yields ahead (rates markets looking for about 50bps of additional easing by early 2008) have only added to the attraction of funding overseas’ trades with dollars. Such US capital outflows exacerbate the US’ financing needs (reflected in the current account deficit) and leave the dollar even more vulnerable. Importantly, rising oil prices in recent years have added to downside worries for US growth via the potential hit on consumers, and hence have helped weigh on US yields, and in turn, the dollar (more than oil has created upside worries for inflation as it did in the past).”
Rapid Money Supply Growth Due to Concerned Investors Moving Cash to Banks
From Merrill Lynch: “Is MZM telling the full story? This money metric has risen at a 21% annual rate since the beginning of August and one would ordinarily associate that with booming liquidity conditions and a rampant bull market in equities. Normally, that would be true - but these are hardly normal times. As a valued hedge fund client pointed out to us, fully 80% of the runup in MZM in the past three months stems from the huge increases seen in institutional money market funds. This isn't about new sources of liquidity - it's due to direct holders of conduit ABCP and SIV CP refusing to roll at maturity and shifting their investments to money market funds that had little or no exposure to "toxic" CP. The runup in MZM is actually reflective of dire risk-averse capital market conditions - as asset-backed CP has still not had a "build" week for an unprecedented 12 weeks running.”
Measuring Equity Market Weakness
From The Financial Times: “Equities bore the brunt of another turbulent session yesterday as the dollar fell to record lows, oil set a fresh record high and gold prices surged higher…The VIX index, a measure of volatility in US equity markets and often referred to as Wall Street's "fear gauge", rose 18 per cent.”
From The Financial Times: “A "correction" occurs when a market falls 10 per cent. The S&P Financials index has done that in the past week alone. A "bear market" starts once an index falls 20 per cent. The S&P Financials has done that since February. So the US financial sector is now officially in a bear market…The broader S&P 500 is down only 5.7 per cent from its peak. It is up 4 per cent for the year. The Nasdaq is up 14 per cent. Apart from financials, and the consumer discretionary sector, which includes homebuilders, all the S&P's sectors are up for the year.”
From The Financial Times: “Wall Street analysts are rapidly losing faith in US companies' ability to rekindle profit growth before the end of the year, raising the prospect of the first "earnings recession" - two consecutive quarters of falling profits - in more than five years. Mounting troubles in the financial sector have led analysts to reduce sharply their forecasts for earnings growth in the final quarter of the year. In the past month, fourth quarter earnings expectations for companies in the S&P 500 have fallen by nearly half, according to Thomson Financial. Wall Street now expects earnings in the fourth quarter to increase 6.1 per cent over a year earlier, down from 11.9 per cent at the start of October. The downgraded expectations have confounded hopes that, after a disappointing third quarter, companies would exploit a weak dollar and solid global growth to record strong earnings in the last three months of 2007. Analysts warn that prolonged earnings weakness could undermine the confidence of the stock market, whose current resilience has largely been attributed to expectations of strong profits.”
From Natixis: “…when I called up INDUDES on Bloomberg today to see what the new P/E ratio is for the Dow after incorporating the real-but-non-cash GM charge, I was flabbergasted to find that it hadn’t moved. I contacted Bloomberg to find out when new earnings are incorporated into the P/E; they insisted that the P/E had been updated last night. After briefly running through the math with them, they checked again. Here was their answer, verbatim: “09:42:29 BLOOMBERG HELP DESK: Hello, the GM equity EPS is negative and it’s [sic] impact on the INDU EPS was substantial. It went from 837.27 to 224.52, and it broke our index EPS throttle in our task, I have now corrected it and INDUP/E is now updated. Sorry for the delay.” The real DJIA P/E is about 59. There are some who will look at the P/E ratio of the index and discount it because of the GM hit, arguing that is a “non-recurring item.” But as Bob Arnott has pointed out, what is non-recurring for any particular company is routine, on average, for a group of companies. That is, the one thing you can say for almost absolute certain is that while GM may not have another “non-recurring” item next year, some companies in the index will…perhaps more, perhaps less, but you can’t simply exclude items that are individually non-recurring but collectively recurring. High prices, declining earnings, diminishing liquidity, and a weak dollar (which requires that expected asset returns in the U.S. rise relative to foreign asset returns – implying lower prices) should pack a wallop on equity indices, although they were mixed today after a weak open. This is counterbalanced by the fact that even people who should want lower prices (those who will be net investors over the next ten years, for example) don’t want to see the stock market decline. As in the last bear market, everyone who has any power to do so is reaching into the old bag of tricks. For example, a large west-coast financial institution yesterday announced a big share buyback program. It is always easier to announce such things than to actually spend real cash to buy back expensive equity and to effectively lever up into one of the more dangerous periods of our financial lives, but this was a very popular gambit in the early ‘Aughts. You may recall that several companies announced large share buybacks in the aftermath of September 11th, 2001, to show support for the market before it reopened. Only a fraction of those announcements were ultimately effected; and, anyway, such cavalier expenditure of shareholders’ cash didn’t after do more than modestly delay much lower lows in the stock market. And so is past prologue, again.”
Heating Oil Prices Substantially Higher This Year
From Merrill Lynch: “The Department of Energy (DoE), in their weekly energy report noted that residential heating fuel prices have been increasing sharply. Rising energy prices are going to test the US consumer in a way we haven’t seen – and with the price spikes coming this close to the holiday shopping season, expect this holiday shopping season to be one of the worst in years. To quote the DoE report, “Residential heating oil prices attained greater heights during the period ending November 5, 2007. The average residential heating oil price jumped 15.7 cents last week to reach 311.0 cents per gallon, an increase of 72.8 cents from this time last year. Wholesale heating oil prices increased by 13.9 cents, reaching 263.5 cents per gallon, an increase of 87.6 cents compared to the same period last year.”
MISC
From Citi: “US ABCP yields rose by 21bp yesterday while T-bills dropped by 23bp sending the spread to 126bp. While we have had similar spikes in the past, this could be an indication that we are in for another bout of more severe risk aversion…3M USD Libors have ticked up slightly as concerns on bank capital adequacy continue. Euro and sterling Libors remain at elevated levels and are likely to remain there as long as there is no clarity on the extent of losses in the money and credit markets. Effective Fed funds remains volatile as injections from the Fed appear to have pushed it significantly below the 4.5% target.”
From Reuters: “Ford CFO says company will cut equity weight in Pension investment from 50% to 30%.”
From Dow Jones: “Retailers reported weak October sales, setting the stage for a lackluster holiday season as shoppers grapple with a swooning housing market, stiff energy prices and lurking worries about jobs…Saks Inc. was among the few bright spots in October, reporting an 11% comparable sales gain as tourists lured by a weak U.S. dollar mobbed its Saks Fifth Avenue flagship in New York City. But October reports from most big chains - including Wal-Mart Stores Inc., Macy’s Inc., Nordstrom Inc., Kohl’s Corp. and J.C. Penney Co. - all missed Wall Street’s modest expectations.”
From Merrill Lynch: “…more Americans think a recession is likely, pegging the odds at 60%. In a telephone survey for Reuters conducted by America’s Research Group, 45.7% of respondents said recession was somewhat likely and 14.3% said “very likely.” Hardly comforting news weeks ahead of the holiday shopping season – which many have already said could turn out to be a dud. One hopeful takeaway from the survey was that the wealthy are intent on spending more this season no matter what.”
From Handelsbank: “Another round of sub-prime-related write downs by financial services companies has pushed swap spreads back towards their summer highs of 75-80 basis points. This back up in the interest rate swap market appears to be less about the supply and demand for hedging and more to do with perceived credit quality.”
End-of-Day Market Update
From Lehman: “…the yield curve did steepen another 12 bp as financial market carnage continued, as did the flight to quality trade… Credit was soft and, term markets for G/C were hard to come by…”
From RBSGC: “The influence of the equity market gains the most creditability in the context that it is the remaining driver of the wealth-effect -- as housing is now underwater. The major U.S. equity indices are still higher on the year, with the Dow up 6.5%, the S&P500 +4% and the NASDAQ 11.5% better -- not as concerning in that context, but considering the sharpness of the recent declines, the potential consumption impact from the perception of decreasing wealth is surely a factor for the Fed. Thursday's volumes were strong… Friday's early close, limited data, and lack of any major events to bias the direction, has us uncomfortable doing anything except going with the bullish steepener. The curve has reached the 81 bps channel top and a decisive break points to the triple digits -- especially if the Fed is unable to avoid having to ease an addition 25 bps in December -- the Fed Funds futures market is currently pricing in 90% chance of a quarter-point ease. We expect that stocks will remain the primary story and while the intra-day moves have been choppy, there is clearly a direction emerging -- pointing to lower yields into the end of the year. Seasonals are strong for the market, with 10-year yields dropping 20 basis points on average into year-end…Headlines continue to show stress in a variety of sectors and the theme has shifted to a risk-reduction mode -- selling riskier assets in favor of Treasuries.”
Three month T-Bill yield fell 4bp to 3.40%.
Two year T-Note yield fell 7bp to 3.48%
Ten year T-Note yield fell 3.5bp to 4.29%
Dow fell 34 to 13,266
S&P 500 fell 1 to 1475
Dollar index unchanged at 75.41
Yen unchanged at 112.7 per dollar
Euro rose .004 to 1.467, a new record high close
Gold unchanged at $831
Oil fell .65 to $95.68
*All prices as of 4:30pm
To show how volatile markets have been today, see charts below –
From Morgan Stanley: “In sum, it does not appear that Bernanke was looking to send any important new signals in today’s testimony.”
From Citi: “Federal Reserve Chairman Bernanke's testimony this morning in front of the Joint Economic Committee (JEC) largely steered clear of providing forward-looking interest rate guidance. The Chairman's statement fleshed out some of the details surrounding prior policy actions and noted that the FOMC expected near-term economic growth to ease from its recent pace. The testimony also touched on the importance of financial conditions to the outlook, an especially relevant issue given market developments since policymakers last convened on October 31.”
From JP Morgan: “Chairman Bernanke’s testimony reaffirmed that the Fed sees both downside risks to growth and upside risks to inflation. The economy is forecast to slow sharply this quarter and remain sluggish during the first part of next year, followed by a strengthening later next year "as the effects of credit tightening and the housing correction begin to wane." Downside risks are centered on effects of credit market tightening and declining house prices. Upside inflation risk stems from higher commodity prices and the weaker dollar, which will raise headline inflation and possibly inflation expectations.”
From Merrill Lynch: “Fed Chairman Bernanke reiterated recent comments by other Fed speakers in his testimony before the Joint Economic Committee (JEC) this morning. He noted that the strong growth in the third quarter showed "scant evidence of spillovers from housing" to the broader economy, but said that such a strong rate of growth is unlikely to be sustained in the near-term. He said household spending is likely to decelerate and that "indicators of overall consumer sentiment suggested that household spending would grow more slowly, a reading consistent with the expected effects of higher energy prices, tighter credit, and continuing weakness in housing"… We believe Bernanke has left the door open for more rate cuts saying the Fed will "act as needed" to shelter the economy from the current credit market turmoil. Bernanke did however repeat the Fed's concern on building inflation pressures from oil, commodities and the weak dollar. He was a bit more forceful than other Fed speakers this week, saying that "the inflation outlook was also seen as subject to important upside risks". He went a bit further, saying that the current risk factors could potentially "increase overall inflation in the short run and, should inflation expectations become unmoored, had the potential to boost inflation in the longer run as well".”
From Deutsche Bank: “With five central banks in play the past week (if we include Bernanke's testimony) it struck us how data dependant central banking has become. The Fed Chairman underscored this when he noted that "we are going to follow the data, and we're going to see what's happening in financial markets". While central banks have always benchmarked their views and assumptions against the steady flow of real and financial market data, the ascendancy of the backward looking central banker is new. While totally understandable in the current environment we can't help but wonder whether it marks the end of a very successful period for central bankers, a period we would argue that was based in no small part on their pre-emptive approach.”
Banks Reconsidering Earlier Enthusiasm For Bankruptcy Reform
From Bloomberg: “Washington Mutual Inc. got what it wanted in 2005: A revised bankruptcy code that no longer lets people walk away from credit card bills. The largest U.S. savings and loan didn't count on a housing recession. The new bankruptcy laws are helping drive foreclosures to a record as homeowners default on mortgages and struggle to pay credit card debts that might have been wiped out under the old code… ``Be careful what you wish for,'' Westbrook said. ``They wanted to make sure that people kept paying their credit cards, and what they're getting is more foreclosures.'' Washington Mutual, Bank of America Corp., JPMorgan Chase & Co. and Citigroup Inc. spent $25 million in 2004 and 2005 lobbying for a legislative agenda that included changes in bankruptcy laws to protect credit card profits… The banks are still paying for that decision. The surge in foreclosures has cut the value of securities backed by mortgages and led to more than $40 billion of writedowns for U.S. financial institutions. It also reached to the top echelons of the financial services industry…. Even as losses have mounted, banks have seen their credit card businesses improve. The amount of money owed on U.S. credit cards with payments more than 30 days late fell to $7.04 billion in the second quarter from $8.37 billion two years earlier, according to data compiled by Federal Deposit Insurance Corp. In the same period, the dollar volume of repossessed homes owned by insured banks doubled to $4.2 billion, the federal agency said. New foreclosures rose to a record in the second quarter, led by defaults in subprime adjustable-rate mortgages, according to the Mortgage Bankers Association in Washington. People are putting their credit card payments ahead of their mortgages, said Richard Fairbank, chief executive officer of Capital One Financial Corp., the largest independent U.S. credit card issuer. Of customers who are at least three months late on their mortgage payments, 70 percent are current on their credit cards, he said… The new bankruptcy code makes it harder for debtors to qualify for Chapter 7, the section that erases non-mortgage debt. It shifted people who get paychecks higher than the median income for their area to Chapter 13, giving them up to five years to pay off non-housing creditors… ``We have people walking away from homes because they can't afford them even post bankruptcy,'' said Sommer, a Philadelphia- based bankruptcy attorney. ``Their mortgage rates are resetting at levels that are completely unaffordable, and there's nothing the bankruptcy process can do for them as it now stands.'' Four million subprime borrowers with limited or tainted credit histories will see their mortgage bills increase by an average 40 percent in the next 18 months, according to the National Association of Consumer Advocates in Washington. About 1.45 million of those will end up in foreclosure by the end of 2008, said Mark Zandi, chief economist at Moody's Economy.com, a research firm and unit of Moody's Corp. in New York. Lenders began the process of seizing properties on 0.65 percent of U.S. mortgages in the second quarter, a record in a 35-year-old Mortgage Bankers study. The percentage of subprime borrowers making late payments increased to 14.82, a five-year high, from 13.77… Personal bankruptcies rose 48 percent to 391,105 in the first half of 2007 from a year earlier and Chapter 13 filings accounted for more than one-third of those, according to the American Bankruptcy Institute. In the first half of 2005, they were just 24 percent of the total. Bad mortgages slashed Washington Mutual's profit by 75 percent in the third quarter from a year earlier, the Seattle- based thrift said Oct. 5. Income from credit card interest rose 8.8 percent to $689 million in the same period… Citigroup's third-quarter earnings fell 57 percent on mortgage losses. Bank of America stopped so-called warehouse lending to mortgage brokers after its profit declined 32 percent in the same period…. ``The law had an unintended consequence of taking away a
relief valve that mortgage borrowers used to have,'' said Rod Dubitsky, head of asset-backed research for Credit Suisse Holdings USA Inc. in New York. ``It's bad for the mortgage borrowers and bad for subprime investors because it means more losses.'' The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was the biggest overhaul to the code in more than a quarter of a century. The old law, the Bankruptcy Reform Act of 1978 that was signed by President Jimmy Carter, had loosened requirements for debt forgiveness. Financial companies began a coordinated lobbying campaign for bankruptcy reform in 1998 when the American Financial Services Association, a trade group representing credit card companies, joined the American Bankers Association to form the National Consumer Bankruptcy Coalition… Countrywide Financial Corp., the largest U.S. lender, said last month that it will modify $16 billion worth of adjustable- rate mortgages. Washington Mutual said in April that it will spend $2 billion giving discounted rates to help customers with subprime loans refinance at better terms. So far, most lenders have been reluctant to change loan agreements. About 1 percent of mortgages that reset in January, April and July were modified, according to a Sept. 21 Moody's Investors Service report that surveyed 16 subprime lenders that account for 80 percent of the market. Congress probably will approve at least a limited measure to permit loan modifications, said Westbrook, the University of Texas law professor. ``They are going to have to figure out some way to address the problem,'' Westbrook said. ``I don't think our economy or our consciences can handle the number of foreclosures we'll see if they do nothing.''”
Foreign Official Reserves Growing Rapidly
From Morgan Stanley: “The world’s total reserves breached US$6.0 trillion in August, having been US$4.2 trillion at end-2005 and US$5.0 trillion at end-2006. At this pace, total global official reserves are on track to be US$6.50 trillion by end-2007. This implies a monthly increase of US$120 billion a month, significantly higher than the average of around US$80 billion a month in 2006. Asia is the region with the largest reserve holdings. Asia has a total of US$3.7 trillion (about two-thirds of the world’s total reserve holdings). Excluding Japan, China and the rest of Asia (AXJC) each has around US$1.3-1.4 trillion. Thus, while there is a lot of focus on China’s official reserves, it is important to keep in mind that AXJC, collectively, has the same amount of reserves as China does. Further, oil exporting countries have around US$850 billion in reserves, with the OPEC having some US$360 billion. Russia’s US$310 billion in reserves ranks it number three in the world, after China (US$1.43 trillion) and Japan (US$923 billion). Asia’s reserves grew by three times as much as those of oil exporters. In the past 12 months (September 2006 to August 2007), total official reserves grew by US$1.2 trillion, with Asia accounting for US$700 billion of this increase, and oil exporters accounting for US$220 billion. Russia accounted for another US$129 billion, which we find remarkable. The single-largest reserve accumulator, in the past 12 months, was China, with US$446 billion, or close to 40% of the world’s increase in reserves. For the past 12 months, most of the reserve increases have reflected genuine interventions. We have tried to decompose the returns on the underlying assets, currency valuation changes, interventions and errors and omissions. Through this decomposition, we find that, while the depreciation of the dollar has led to some valuation gains of EUR, GBP and other currencies, in dollar terms, most of the increases in the official reserves reflected actual interventions. Thus, the dollar has indeed weakened this year, but the size of the interventions conducted by the emerging market central banks is rather extraordinary. China slowed down its pace of intervention in September…We find it remarkable that, first, the stock of China’s foreign reserves increased by ‘only’ US$25 billion. Of this increase, US$18.7 billion may have arisen from valuation changes associated with China’s holdings of EUR and GBP. This implies that actual interventions in September may have totaled only US$1.5 billion. Accelerated intervention activities in the GCC countries. .. we see that Saudi Arabia has drastically accelerated its pace of currency intervention, leading to a 50% expansion in its stock of reserves, from US$23 billion in the previous month to US$32 billion in the latest reporting month. The rest of the GCC have more dated data, but we suspect that the same trend will be revealed with the next round of data releases. Bottom Line Total world reserves exceeded the US$6.0 trillion threshold, and are on track to reach US$6.5 trillion by year-end. This reflects a 50% acceleration in the average monthly pace of reserve accumulation compared to 2006. Asia accounts for two-thirds of the stock of reserves, with China and AXJC – collectively – having roughly the same amount. While China’s cumulative reserve accumulation in the past 12 months was huge (US$446 billion), its pace of intervention may have slowed dramatically to only US$1.6 billion, if we strip out valuation changes and earnings on the underlying assets.”
U.S. Investors Increasing Demand for Foreign Investments as Dollar Weakens
From JP Morgan: “…US equity investors: looking at US equity mutual fund holdings, the percentage of total holdings dedicated to “world” equities has risen from around 16% in 1997 to around 25% today…The dollar’s relatively lower yield (2-year US bond yields have fallen nearly 80bps over 2007 to date) and expectations for even lower yields ahead (rates markets looking for about 50bps of additional easing by early 2008) have only added to the attraction of funding overseas’ trades with dollars. Such US capital outflows exacerbate the US’ financing needs (reflected in the current account deficit) and leave the dollar even more vulnerable. Importantly, rising oil prices in recent years have added to downside worries for US growth via the potential hit on consumers, and hence have helped weigh on US yields, and in turn, the dollar (more than oil has created upside worries for inflation as it did in the past).”
Rapid Money Supply Growth Due to Concerned Investors Moving Cash to Banks
From Merrill Lynch: “Is MZM telling the full story? This money metric has risen at a 21% annual rate since the beginning of August and one would ordinarily associate that with booming liquidity conditions and a rampant bull market in equities. Normally, that would be true - but these are hardly normal times. As a valued hedge fund client pointed out to us, fully 80% of the runup in MZM in the past three months stems from the huge increases seen in institutional money market funds. This isn't about new sources of liquidity - it's due to direct holders of conduit ABCP and SIV CP refusing to roll at maturity and shifting their investments to money market funds that had little or no exposure to "toxic" CP. The runup in MZM is actually reflective of dire risk-averse capital market conditions - as asset-backed CP has still not had a "build" week for an unprecedented 12 weeks running.”
Measuring Equity Market Weakness
From The Financial Times: “Equities bore the brunt of another turbulent session yesterday as the dollar fell to record lows, oil set a fresh record high and gold prices surged higher…The VIX index, a measure of volatility in US equity markets and often referred to as Wall Street's "fear gauge", rose 18 per cent.”
From The Financial Times: “A "correction" occurs when a market falls 10 per cent. The S&P Financials index has done that in the past week alone. A "bear market" starts once an index falls 20 per cent. The S&P Financials has done that since February. So the US financial sector is now officially in a bear market…The broader S&P 500 is down only 5.7 per cent from its peak. It is up 4 per cent for the year. The Nasdaq is up 14 per cent. Apart from financials, and the consumer discretionary sector, which includes homebuilders, all the S&P's sectors are up for the year.”
From The Financial Times: “Wall Street analysts are rapidly losing faith in US companies' ability to rekindle profit growth before the end of the year, raising the prospect of the first "earnings recession" - two consecutive quarters of falling profits - in more than five years. Mounting troubles in the financial sector have led analysts to reduce sharply their forecasts for earnings growth in the final quarter of the year. In the past month, fourth quarter earnings expectations for companies in the S&P 500 have fallen by nearly half, according to Thomson Financial. Wall Street now expects earnings in the fourth quarter to increase 6.1 per cent over a year earlier, down from 11.9 per cent at the start of October. The downgraded expectations have confounded hopes that, after a disappointing third quarter, companies would exploit a weak dollar and solid global growth to record strong earnings in the last three months of 2007. Analysts warn that prolonged earnings weakness could undermine the confidence of the stock market, whose current resilience has largely been attributed to expectations of strong profits.”
From Natixis: “…when I called up INDU
Heating Oil Prices Substantially Higher This Year
From Merrill Lynch: “The Department of Energy (DoE), in their weekly energy report noted that residential heating fuel prices have been increasing sharply. Rising energy prices are going to test the US consumer in a way we haven’t seen – and with the price spikes coming this close to the holiday shopping season, expect this holiday shopping season to be one of the worst in years. To quote the DoE report, “Residential heating oil prices attained greater heights during the period ending November 5, 2007. The average residential heating oil price jumped 15.7 cents last week to reach 311.0 cents per gallon, an increase of 72.8 cents from this time last year. Wholesale heating oil prices increased by 13.9 cents, reaching 263.5 cents per gallon, an increase of 87.6 cents compared to the same period last year.”
MISC
From Citi: “US ABCP yields rose by 21bp yesterday while T-bills dropped by 23bp sending the spread to 126bp. While we have had similar spikes in the past, this could be an indication that we are in for another bout of more severe risk aversion…3M USD Libors have ticked up slightly as concerns on bank capital adequacy continue. Euro and sterling Libors remain at elevated levels and are likely to remain there as long as there is no clarity on the extent of losses in the money and credit markets. Effective Fed funds remains volatile as injections from the Fed appear to have pushed it significantly below the 4.5% target.”
From Reuters: “Ford CFO says company will cut equity weight in Pension investment from 50% to 30%.”
From Dow Jones: “Retailers reported weak October sales, setting the stage for a lackluster holiday season as shoppers grapple with a swooning housing market, stiff energy prices and lurking worries about jobs…Saks Inc. was among the few bright spots in October, reporting an 11% comparable sales gain as tourists lured by a weak U.S. dollar mobbed its Saks Fifth Avenue flagship in New York City. But October reports from most big chains - including Wal-Mart Stores Inc., Macy’s Inc., Nordstrom Inc., Kohl’s Corp. and J.C. Penney Co. - all missed Wall Street’s modest expectations.”
From Merrill Lynch: “…more Americans think a recession is likely, pegging the odds at 60%. In a telephone survey for Reuters conducted by America’s Research Group, 45.7% of respondents said recession was somewhat likely and 14.3% said “very likely.” Hardly comforting news weeks ahead of the holiday shopping season – which many have already said could turn out to be a dud. One hopeful takeaway from the survey was that the wealthy are intent on spending more this season no matter what.”
From Handelsbank: “Another round of sub-prime-related write downs by financial services companies has pushed swap spreads back towards their summer highs of 75-80 basis points. This back up in the interest rate swap market appears to be less about the supply and demand for hedging and more to do with perceived credit quality.”
End-of-Day Market Update
From Lehman: “…the yield curve did steepen another 12 bp as financial market carnage continued, as did the flight to quality trade… Credit was soft and, term markets for G/C were hard to come by…”
From RBSGC: “The influence of the equity market gains the most creditability in the context that it is the remaining driver of the wealth-effect -- as housing is now underwater. The major U.S. equity indices are still higher on the year, with the Dow up 6.5%, the S&P500 +4% and the NASDAQ 11.5% better -- not as concerning in that context, but considering the sharpness of the recent declines, the potential consumption impact from the perception of decreasing wealth is surely a factor for the Fed. Thursday's volumes were strong… Friday's early close, limited data, and lack of any major events to bias the direction, has us uncomfortable doing anything except going with the bullish steepener. The curve has reached the 81 bps channel top and a decisive break points to the triple digits -- especially if the Fed is unable to avoid having to ease an addition 25 bps in December -- the Fed Funds futures market is currently pricing in 90% chance of a quarter-point ease. We expect that stocks will remain the primary story and while the intra-day moves have been choppy, there is clearly a direction emerging -- pointing to lower yields into the end of the year. Seasonals are strong for the market, with 10-year yields dropping 20 basis points on average into year-end…Headlines continue to show stress in a variety of sectors and the theme has shifted to a risk-reduction mode -- selling riskier assets in favor of Treasuries.”
Three month T-Bill yield fell 4bp to 3.40%.
Two year T-Note yield fell 7bp to 3.48%
Ten year T-Note yield fell 3.5bp to 4.29%
Dow fell 34 to 13,266
S&P 500 fell 1 to 1475
Dollar index unchanged at 75.41
Yen unchanged at 112.7 per dollar
Euro rose .004 to 1.467, a new record high close
Gold unchanged at $831
Oil fell .65 to $95.68
*All prices as of 4:30pm
To show how volatile markets have been today, see charts below –
Dow
Oil
Five Year Treasury Note Yields
Gold
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