Chinese Growth Accelerating
From JP Morgan: “China’s economy boomed in 2Q and the June activity indicators suggest that the economy had strong momentum heading into the current quarter...The quarterly advance in real GDP, estimated by us to be 15.9% (q/q, saar), was the strongest since the early 1990s, with the exception of the 3Q03 increase that followed the SARS crisis…we estimate that China’s manufacturing output advanced at a 29% annual rate in 2Q, the fastest of the 2000s expansion.”
From Merrill Lynch: “China's surging growth is actually leading to growing "hard landing" concerns - real GDP expanded 11.9% y/y in 2Q on top of the 11% pace in the first quarter and inflation jumped to 4.4% (from 3.4% in May). Even non-food prices are now up 1.2% y/y. Fixed asset investment (FAI) also came in above market expectations, at 26.7% YoY for 1H07, up from 25.9% for January-May. This suggests that FAI rose 28.5% YoY in June alone. Finally, retail sales came in above market expectations, at 16.0% YoY in June, up from 15.9% YoY in May. We should add that Hong Kong's unemployment rate dropped to a 9-year low in June to 4.2% (down from 8.6% just four years ago). Bottom line is that the Chinese economy is starting to overheat and more aggressive tightening measures that will have to include more meaningful currency appreciation are likely in store - negative for the dollar; good for gold.”
MISC
From Morgan Stanley: “The Biggest Dollar Diversifiers Are American. US real money managers, not Asian central banks, are the biggest dollar diversifiers and have been steadily diversifying out of the US since 2003. I calculate that cumulative outflows may have totaled US$1.16 trillion in the past four years. This may help explain the USD’s downward drift in recent years, and why it is so weak now.”
From The Financial Times: “…the $200bn figure President George W. Bush cited is for the “unified” deficit that incorporates the surplus on Social Security. Without this accounting gimmick (which the Bush administration did not invent) the projected 2007 deficit would be more than twice as large…US federal spending on Medicare, Medicaid and Social Security, now about 8.5 percent of GDP…If there is a shorter-term Achilles heel to US government deficit policies, it is dependence on foreign financing. The US is borrowing at the rate of $800bn a year, more than 6 percent of GDP. Incredibly, US borrowing accounts for roughly two-thirds of total new saving of all the world’s surplus countries.”
From Fortune: “…the American middle class isn't really shrinking, so much as it is anxious. The median household income for workers aged 25 to 60 is nearly $62,000. If both spouses work, it's close to $82,000…There's not a lot of security in a fast-paced global economy where workers get ahead by chasing opportunities (not obediently following office rules), by constantly reinventing their careers (not relying on seniority), by self-investing their savings (not counting on company pensions). In other words, in the new economy, we all have to be entrepreneurs with our own lives - with all the rewards and risks and, yes, anxieties that entails. … middle-aged men are staying at the same job nearly half as long as they were just 20 years ago, and more than 60 percent of workers report they've actually had to switch the type of work they are doing.”
From JP Morgan: “The minutes to the June 28 FOMC meeting reveal a committee that is more comfortable about growth, not terribly anxious about inflation, and unlikely to do anything anytime soon.”
From Bank of America: “The pace of business activity in the Philadelphia area moderated somewhat in July. After posting its highest reading since April 2005, the index fell 8.8 percentage points in July to 9.2. While the new orders index, a key component for future business activity, posted a decline in July, the shipments index registered a solid increase. Also noteworthy in today’s report was the increase in optimism about future business activity.”
From Bloomberg: “The index of leading U.S. economic indicators fell more than forecast last month, pulled down by a drop in building permits and an increase in jobless claims. The Conference Board's gauge declined 0.3 percent after increasing a revised 0.2 percent in May, the New York-based research group said today. The index points to the direction of the economy over the next three to six months.”
From JP Morgan: “Japan’s department store sales boomed in June.”
From Dow Jones: “Federal Reserve Bank of Chicago President Michael Moskow said … he wants a key inflation measure, the core personal consumption expenditures price index, rising between 1% to 2% compared with year-ago levels… “on a sustained basis” to determine inflation trends were in the right range. In May the core PCE price index dipped to a 1.9% annual advance, but the Fed, at its most recent policy meeting, said an improvement in inflation had yet to be “convincingly demonstrated.””
From Dow Jones: “Highly-rated doesn’t necessarily mean safe anymore. If the last week has shown investors anything, it’s that securities - whether they be mortgage bonds or the more opaque collateralized debt obligations - that carry the stellar AAA stamp are not immune to the subprime woes roiling financial markets.”
End-of-Day Market Update
Treasuries remained relatively range-bound with yields closing close to unchanged across the curve. But, the 2/10 curve flattened by a basis point as 30 year rates fell half a bp and two year yields rose just under a bp.
Equities recovered around the world, with the Dow rallying 82 points to close at another record high closing level of exactly 14,000. The S&P rose 7 to settle at 1553 (2pts below recent closing high), and Nasdaq rose 20.5 to close at a high for the year of 2720.
The dollar traded within a narrower range than yesterday, and is settling close to unchanged.
Oil is continuing to surge to new highs, rallying another 87 cents today to close just shy of $76 based on the NY WTI futures. The high for this contract was $80.76 in July 2006.
Thursday, July 19, 2007
Wednesday, July 18, 2007
New Home Permits Indicate Further Housing Market Softness
Due to a large revision in the May housing starts, reducing new starts by 40k, June showed a monthly increase in housing starts. June housing starts actually came in 17k higher than anticipated. Housing starts rose 2.3% in June after falling -3.4% in May. All the strength in the housing starts in June was focused on multi-family which rose +12.5% MoM. Single family starts actually fell -.2% MoM.
May building permits on the other hand were revised higher by 19k. June's new housing permits were much weaker than expected, coming in 74k below consensus, and 114k lower versus the prior month, showing a decline of -7.5% MoM. All the weakness in permits were focused on the multi-family sector which declined -15.3% MoM. Over the last quarter, permits have fallen -23%, which indicates that the new home construction will remain weak. Permits tend to be less volatile than starts.
Houses under construction held steady in June, while housing completed fell -6% MoM.
May building permits on the other hand were revised higher by 19k. June's new housing permits were much weaker than expected, coming in 74k below consensus, and 114k lower versus the prior month, showing a decline of -7.5% MoM. All the weakness in permits were focused on the multi-family sector which declined -15.3% MoM. Over the last quarter, permits have fallen -23%, which indicates that the new home construction will remain weak. Permits tend to be less volatile than starts.
Houses under construction held steady in June, while housing completed fell -6% MoM.
CPI Gains Relatively Benign
Headline CPI rose +.2% MoM in June, slightly higher than expected, but still the smallest increase in five months. On an annual basis, headline CPI held steady at 2.7% YoY rather than softening to 2.6% as expected. Core CPI rose +.2% MoM, as expected, and also head steady at 2.2% YoY, which is a one year low. Year-to-date, headline prices are rising at a 5% annual rate, and core prices are rising at a 2.3% annual pace.
As expected, energy price gains halted in June after rising steadily over the prior months. This helped rein in the gains in headline inflation which grew +.7% MoM in May. Energy prices actually declined -.5% MoM in June after rising 5.4% in April. Gasoline prices fell -1.1% in June. Since June of last year, gasoline has risen +5% YoY (+25% in last three months annualized) and energy prices have increased +4.6% YoY.
In contrast, food prices continue to accelerate higher, rising +.5% MoM in June versus a gain of +.3% MoM in May. Poultry and dairy price hikes led the gain. Food has risen 4.1% YoY.
Owners' equivalent rent rose from last month's two year low, of +.1% MoM, to increase +.2% MoM in June. OER is expected to soften this year as higher vacancy rates depress rents. General housing costs also rose this month to a +.3% MoM gain versus +.2% MoM in May.
Medical care costs eased to +.2% MoM, continuing a moderating trend this year. Clothing costs continue to deflate, falling -.6% MoM in June after declining -.3% MoM the two prior months. Auto prices were unchanged as sales continue to soften, and are down -1.9% YoY. Continue the trend, computer prices fell another -2.7% MoM (-9.3% YoY) to be the biggest decliner over the past year.
The CPI index is the most watched index because it is the government's broadest measure of costs across goods and services based on a constant basket of items. About 60 percent of the index covers services.
Interest rates have barely moved on the data.
As expected, energy price gains halted in June after rising steadily over the prior months. This helped rein in the gains in headline inflation which grew +.7% MoM in May. Energy prices actually declined -.5% MoM in June after rising 5.4% in April. Gasoline prices fell -1.1% in June. Since June of last year, gasoline has risen +5% YoY (+25% in last three months annualized) and energy prices have increased +4.6% YoY.
In contrast, food prices continue to accelerate higher, rising +.5% MoM in June versus a gain of +.3% MoM in May. Poultry and dairy price hikes led the gain. Food has risen 4.1% YoY.
Owners' equivalent rent rose from last month's two year low, of +.1% MoM, to increase +.2% MoM in June. OER is expected to soften this year as higher vacancy rates depress rents. General housing costs also rose this month to a +.3% MoM gain versus +.2% MoM in May.
Medical care costs eased to +.2% MoM, continuing a moderating trend this year. Clothing costs continue to deflate, falling -.6% MoM in June after declining -.3% MoM the two prior months. Auto prices were unchanged as sales continue to soften, and are down -1.9% YoY. Continue the trend, computer prices fell another -2.7% MoM (-9.3% YoY) to be the biggest decliner over the past year.
The CPI index is the most watched index because it is the government's broadest measure of costs across goods and services based on a constant basket of items. About 60 percent of the index covers services.
Interest rates have barely moved on the data.
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.
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.
Tuesday, July 17, 2007
Homebuilder Confidence Falls to 16-Year Low (January, 1991)
In July, the National Association of Homebuilders' confidence index plummeted to a new low of 24 (consensus 27). The prior low for this cycle was set last month at 28. Sentiment has been declining for the last six months. Prior to that, the index dipped to 30 last September before rebounding to 39 in February. Any reading below 50 indicate poor selling conditions.
Single-family home sales fell to 24 from 29, prospective buyer traffic fell to 19 from 23, and expectations for the next six months dropped to 34 from 39 last month. Over the past year, the decline in the single-family homes sales has been the greatest, falling 19 points.
All regions of the country are showing weakness with the Midwest having the lowest reading at 19 (-1 from prior month), followed by the West and South at 25(-3) and 26(-5). The strongest area is the Northeast at 31 (-5).
Record high levels of inventory and increased cancellations are causing builders to halt new projects, and reduce prices, as losses mount. Higher interest rates and tighter credit conditions are also weighing on the housing market following the problems in subprime mortgages. Residential construction has been in decline for a year and half, cutting GDP growth. Today's survey does not indicate that housing is likely to rebound soon. Most economists expect housing starts to continue to decline through the rest of this year.
Single-family home sales fell to 24 from 29, prospective buyer traffic fell to 19 from 23, and expectations for the next six months dropped to 34 from 39 last month. Over the past year, the decline in the single-family homes sales has been the greatest, falling 19 points.
All regions of the country are showing weakness with the Midwest having the lowest reading at 19 (-1 from prior month), followed by the West and South at 25(-3) and 26(-5). The strongest area is the Northeast at 31 (-5).
Record high levels of inventory and increased cancellations are causing builders to halt new projects, and reduce prices, as losses mount. Higher interest rates and tighter credit conditions are also weighing on the housing market following the problems in subprime mortgages. Residential construction has been in decline for a year and half, cutting GDP growth. Today's survey does not indicate that housing is likely to rebound soon. Most economists expect housing starts to continue to decline through the rest of this year.
Industrial Production Rebounds, As Expected
Industrial production in June rose +.5% MoM, and right at consensus. This indicator has been bouncing from gain to loss over the past year as inventories have been pared back. Capacity utilization also rebounded to 81.7% (81.6% consensus), and a new high for the year in June.
Increases in industrial production were broadbased across industries. Manufacturing rose +.6% MoM. Motor vehicle output rose +2.5% MoM while machinery production fell -1.2% MoM. These were both countercyclical to their behavior over the past year when vehicle production fell -1.7% YoY and machinery grew +.9% YoY. As expected, utility demand grew +.3% MoM. Excluding motor vehicle production, factory output rose +.4% MoM.
By product groupings, home electronics(+2.6% MoM) saw the greatest rebound followed by construction supplies(+1% MoM).
Mining has the highest capacity utilization at 90.7% followed by utilities at 85.6%. Semiconductors had the lowest factory usage rate at 72.4% followed by manufacturing at 80.3%. The overall capacity utilization rate at 81.75 is still .6% below the level of a year ago.
Output in the second quarter accelerated to a 2.9% annualized pace from the 1.1% annualized pace in the first quarter.
Increases in industrial production were broadbased across industries. Manufacturing rose +.6% MoM. Motor vehicle output rose +2.5% MoM while machinery production fell -1.2% MoM. These were both countercyclical to their behavior over the past year when vehicle production fell -1.7% YoY and machinery grew +.9% YoY. As expected, utility demand grew +.3% MoM. Excluding motor vehicle production, factory output rose +.4% MoM.
By product groupings, home electronics(+2.6% MoM) saw the greatest rebound followed by construction supplies(+1% MoM).
Mining has the highest capacity utilization at 90.7% followed by utilities at 85.6%. Semiconductors had the lowest factory usage rate at 72.4% followed by manufacturing at 80.3%. The overall capacity utilization rate at 81.75 is still .6% below the level of a year ago.
Output in the second quarter accelerated to a 2.9% annualized pace from the 1.1% annualized pace in the first quarter.
International Demand for US Stocks and Bonds Rises to Record in May
Foreign purchases of long-term U.S. financial assets rose to a record $126.1 billion in May, an increase from the $80.3 billion purchased last month. The largest previous monthly long-term purchases were in August, 2006 at $120.9 billion. When net short-term purchases are included, the total increased to $105.9 billion in May, and April's purchases were revised down to $97.8 billion from the $111.8 billion originally reported. Purchases were focused on corporate bonds and stocks.
Private flows made up the total demand for total net flows into the U.S. in May as net foreign official flows actually were a negative -$2.8B. Private purchases more than doubled from the prior month to a record $152B in May. U.S. investors bought a net $37.3 billion of overseas assets, an increase of $20 billion over the prior month.
New record highs in the U.S. equity market helped fuel foreign demand for our stocks, which rose to $41.9 billion in May from a recent low of $8.7 billion in March. Demand for Treasury notes also rebounded, rising $21.6 billion from flat in April. Corporate bonds saw a more than doubling in demand to $72.6 billion in May from $33.5 billion in April, while agency debt and mortgages saw an almost $9 billion decline to $27.5 billion in May.
Foreign official holdings of Treasuries fell -$10 billion in May, fairly evenly split between T-Bills and T-Notes. The UK was the largest purchaser ($33B) by a large margin, followed by oil exporters at +$9B. China was a net seller of $6.6B, but this was swamped by hedge fund selling out of the Caribbean of -$28.5B. Japan is still the largest foreign holder of U.S. Treasury debt at $615B, followed by China at $407B. The UK trails in third place at $167B.
Foreign investor demand for U.S. assets continues to be sufficient to fund the trade deficit, which rose to $60B in May, even as the dollar weakens. The strong demand for long-term over short-term ( <1y) assets can be viewed as a sign of foreign faith in the U.S. economy.
Private flows made up the total demand for total net flows into the U.S. in May as net foreign official flows actually were a negative -$2.8B. Private purchases more than doubled from the prior month to a record $152B in May. U.S. investors bought a net $37.3 billion of overseas assets, an increase of $20 billion over the prior month.
New record highs in the U.S. equity market helped fuel foreign demand for our stocks, which rose to $41.9 billion in May from a recent low of $8.7 billion in March. Demand for Treasury notes also rebounded, rising $21.6 billion from flat in April. Corporate bonds saw a more than doubling in demand to $72.6 billion in May from $33.5 billion in April, while agency debt and mortgages saw an almost $9 billion decline to $27.5 billion in May.
Foreign official holdings of Treasuries fell -$10 billion in May, fairly evenly split between T-Bills and T-Notes. The UK was the largest purchaser ($33B) by a large margin, followed by oil exporters at +$9B. China was a net seller of $6.6B, but this was swamped by hedge fund selling out of the Caribbean of -$28.5B. Japan is still the largest foreign holder of U.S. Treasury debt at $615B, followed by China at $407B. The UK trails in third place at $167B.
Foreign investor demand for U.S. assets continues to be sufficient to fund the trade deficit, which rose to $60B in May, even as the dollar weakens. The strong demand for long-term over short-term ( <1y) assets can be viewed as a sign of foreign faith in the U.S. economy.
Core PPI Inflation Rises in June
June producer prices showed a substantial decline in headline inflation as energy price rises retreated, but core inflation rose more than expected. Pipeline pressures abated at the crude and intermediate levels.
Headline PPI fell -.2% MoM (consensus +.2%) versus an increase of +.9% MoM in May. This is the first negative monthly change since January. On an annual basis, headline inflation fell to +3.3% YoY in June versus +4.1% YoY in May. Over the past three months, headline PPI has risen at a 5.7% annualized basis.
Core inflation rose +.3% MoM (consensus +.2%), and the highest monthly gain since March. Over the past year, core inflation rose 1.8% versus June 2006 (consensus +1.7% YoY), a notable increase from the +1.6% YoY rate in May. Ex-food and energy, core PPI has risen at a 2% annualized basis over the past three months.
Gasoline prices fell -3.9% MoM and food prices fell -.8% MoM. Though the prices for gasoline and food fell this month, they have been trending higher over the past year, with gasoline rising +3.8% YoY and food rising +6.5% YoY. Energy prices overall fell -1.1% MoM but are up +4.7% YoY. This month's decline in food and energy prices is not likely to persist into next month's data.
Consumer goods prices fell -.4% MoM while capital equipment rose +.3% MoM, the biggest gain since February. Computers continue to fall in price, declining -3.4% MoM, and -22.5% YoY. Surprising strength was observed in auto prices which rose +1.4% MoM, and accounts for 17% of the core weighting. This is unlikely to continue based on the weak auto sales data, and should allow core PPI to subside in coming months.
Intermediate goods prices slowed to +.5% MoM from +1.1% MoM in May, and crude goods prices decelerated even more to +.3% MoM from +2% MoM in May. Food prices took over from energy prices as the major inflationary factor in intermediate prices, while they were about equally weighted in their impact at the crude level in June.
Over the first six months of 2007, finished goods prices have risen at a 6.4% seasonally adjusted annual rate. This compares with an unchanged reading during the last six months of 2006. The main reason for the change is energy prices which rose 18.4% this year, after declining 8.2% in the second half of 2006. Food prices accelerated in 2007, rising at a 7.8% for the year-to-date, after increasing 4.9% annualized in the second half of 2006. Excluding food and energy, the core PPI accelerated to 2.3% so far this year versus +1.3% annualized in the prior six months.
The Treasury market focused on the rise in core inflation, and has sold off slightly this morning, causing ten year yields to rise around 2bp.
Headline PPI fell -.2% MoM (consensus +.2%) versus an increase of +.9% MoM in May. This is the first negative monthly change since January. On an annual basis, headline inflation fell to +3.3% YoY in June versus +4.1% YoY in May. Over the past three months, headline PPI has risen at a 5.7% annualized basis.
Core inflation rose +.3% MoM (consensus +.2%), and the highest monthly gain since March. Over the past year, core inflation rose 1.8% versus June 2006 (consensus +1.7% YoY), a notable increase from the +1.6% YoY rate in May. Ex-food and energy, core PPI has risen at a 2% annualized basis over the past three months.
Gasoline prices fell -3.9% MoM and food prices fell -.8% MoM. Though the prices for gasoline and food fell this month, they have been trending higher over the past year, with gasoline rising +3.8% YoY and food rising +6.5% YoY. Energy prices overall fell -1.1% MoM but are up +4.7% YoY. This month's decline in food and energy prices is not likely to persist into next month's data.
Consumer goods prices fell -.4% MoM while capital equipment rose +.3% MoM, the biggest gain since February. Computers continue to fall in price, declining -3.4% MoM, and -22.5% YoY. Surprising strength was observed in auto prices which rose +1.4% MoM, and accounts for 17% of the core weighting. This is unlikely to continue based on the weak auto sales data, and should allow core PPI to subside in coming months.
Intermediate goods prices slowed to +.5% MoM from +1.1% MoM in May, and crude goods prices decelerated even more to +.3% MoM from +2% MoM in May. Food prices took over from energy prices as the major inflationary factor in intermediate prices, while they were about equally weighted in their impact at the crude level in June.
Over the first six months of 2007, finished goods prices have risen at a 6.4% seasonally adjusted annual rate. This compares with an unchanged reading during the last six months of 2006. The main reason for the change is energy prices which rose 18.4% this year, after declining 8.2% in the second half of 2006. Food prices accelerated in 2007, rising at a 7.8% for the year-to-date, after increasing 4.9% annualized in the second half of 2006. Excluding food and energy, the core PPI accelerated to 2.3% so far this year versus +1.3% annualized in the prior six months.
The Treasury market focused on the rise in core inflation, and has sold off slightly this morning, causing ten year yields to rise around 2bp.
Today's Tidbits
Subprime Contagion Fears
From Dow Jones: “The riskiest tranche of the subprime mortgage-based derivative index, the ABX, hit another low Tuesday. The BBB- tranche was quoted at 44 cents on the dollar early afternoon… Further downgrades of securities tied to the subprime mortgage meltdown will put pressure on public pension funds and insurance companies to sell off their holdings, but the rules under which they operate generally give them the flexibility to avoid a fire sale. That could provide some reassurance to Wall Street, which is concerned hasty sales could sharply lower market prices on mortgage bonds and the complex securities that banks have constructed based on them, so-called collateralized debt obligations. A sharp drop in prices could force other buyers to record big losses, spooking investors and causing a sharp spike in risk aversion - which could threaten the stability of the financial system.”
Private Equity Firms May Have to Utilize Bridge Loans to Fund Pipeline Purchases
From TheStreet.com: “…bankers financing big leveraged buyouts are fretting over …handing over billions of dollars in so-called bridge loan commitments to buyout-happy private-equity shops. Bridge loans are hardly lucrative for investment banks -- they are not usually even drawn down. Instead they serve to "bridge" the gap between the announcement of a buyout …and the receipt of permanent financing. But with the debt market having soured recently for leveraged buyouts, banks are starting to worry that private-equity shops might opt to actually draw upon these hefty loans -- possibly leaving the banks with billions of unwanted loans on their books, unless they can syndicate them out to buyers including hedge fund investors…Complicating the picture is growing resistance from hedge funds and managers of collateralized loan obligations, which pool and manage portfolios of commercial debt… one firm pushing back against banks and eschewing loans that lack the covenants that would protect investors if they tank. "Until recently there has been no organized consortium among managers to push back on poor covenant quality and credit agreement terms," …Although markedly different from CLOs, subprime has put a spotlight on loans made to borrowers with questionable credit. Excesses emerging there have caused buyers of loans to demand better underwriting standards. Highland has doubled the number of loans it rejects in structuring CLO assets from 25% to 35% to around 65%, …Such resistance has put a strain on banks and pushed bankers into the negotiating room with private-equity firms, which are trying to ensure that the buyout-friendly terms they received earlier don't change. But if they do, they are willing to consider asking the banks to fund these billion dollar bridges.”
From Dow Jones: “Private equity firms hoping to skimp on investor protection when they raise funds for their buyouts in the debt markets in the coming months could be in for a rude awakening. A particularly risky type of leveraged loan - debt that is sliced up and sold to investors - has borne the brunt of selling in the last three weeks as investors have grown less enamored with speculative debt. Covenant-lite loans - ones that carry
minimal protection for debt holders should a company run into trouble - have under-performed more traditional, safer loans as investors rethink risk. This doesn’t bode well for large deals looming, like First Data Corp.’s (FDC) expected $14 billion covenant-lite loan to finance its leveraged buyout. If sold as covenant-lite, it would be the largest ever deal of its kind in the market…. According to S&P’s data, about 17% of the loan universe is covenant-lite. First Data’s deal alone would grow that number to 20% if investors agree to a deal without such protections. But recent aversion to covenant-lite loans could have lasting repercussions in the market, which is expecting $200 billion of new supply in the next six to nine months to fund the massive amount of leveraged buyouts that have already been announced.”
Central Banks Becoming More Aggressive With Investment of Excess Reserves
From Bloomberg: “In a confidential poll, UBS surveyed its guests about several key issues, including predictions about where U.S. interest rates, bond yields and the dollar will be at year's end, and anticipated changes in asset allocation over the next decade. The reserve managers' responses made it clear that the world's biggest pool of cash will be invested more aggressively than in the past. That means they will buy fewer U.S. government securities, which is bad news for U.S. interest rates. What's more, the responses illustrate that regardless of their financial muscle, central banks are no better than the private sector when it comes to predicting market moves… Central banks traditionally have invested their reserves in highly liquid, low-yielding securities, such as U.S. Treasuries and equivalent German government bonds. The goal is to have quick
access to the funds to defend a currency under attack, cover short-term debt obligations, finance imports and counter any runs on domestic banks. Yet, having amassed reserves well in excess of prudential needs, central banks are under increasing pressure from
politicians and public-interest groups to earn higher returns on their hoards by investing in riskier assets. To that end, several countries, including China, Singapore, the United Arab Emirates, Kuwait, Norway and Russia, have established or announced their intention to set up sovereign wealth funds… The UBS survey asked the reserve managers what the biggest change would be in the way they allocated assets over the next 10 years. Thirty-six percent said they would invest more in so-called spread products, which include swaps, agency bonds andcorporate debt -- fixed-income securities that trade at a spread to government bonds… Eighteen percent of reserve managers responded with more equities, another 18 percent with fewer U.S. dollars and 12 percent said alternative investments. Bottom line: The more money that the countries with big reserves invest in corporate bonds, stocks and other risky investments, the less they will put into Treasuries. Asian central banks and oil exporters, which are large buyers of U.S. government securities, have helped restrain U.S. interest rates in recent years. ``The dominant story is more risk: People are looking for higher rates of return, and that will only come with more risk,''… One percent of the respondents voted for more gold, while 3 percent said less gold.”
From Morgan Stanley: “The composition of buying in May was geared towards riskier assets more so than safer assets. Increased risk appetite was definitely the name of the game as the data indicates that foreign accounts took major stakes in US corporations
during May. The majority of these flows were private based, but foreigners purchased both a record $41.9 billion in US stocks and $72.6 billion in US corporate bonds. This trend bears watching, given the prospects of excess official reserves flowing into sovereign wealth funds (which would be difficult to tag as official flows by the TIC system and would instead be viewed as private account transactions), which are mandated to seek higher returning assets …Granted, there was a rebound in foreign buying of safe assets as purchases of Treasuries rebounded in May up $21.6 billion. However, the majority of the flows into Treasuries were from private accounts (bulk UK and OPEC) as central banks actually sold $4.6 billion (the second time that FCBs have sold this year). In 2007, foreign official purchases of Treasuries have been diminutive at best (only $3 billion in 2007), as FCB purchases of US fixed income assets are now concentrated more in Agencies and MBS (up $63 billion in 2007).”
Concentration of Credit Derivatives Risk May Amplify Volatility Says Fitch Study
From Bloomberg: “Hedge fund borrowing to invest in credit derivatives may magnify volatility in a market slump, according to a Fitch Ratings survey of 65 banks and insurers. A ``dramatic'' increase in hedge funds' use of credit derivatives has pushed their share of trading to 60 percent of credit-default swaps, and about 33 percent of collateralized
debt obligations, Fitch said in the report today, citing data from Greenwich Associates. U.S. corporate bond risk premiums reached the highest in almost two years last week as hedge funds bought credit-default swaps to offset potential losses from the subprime mortgage rout… In a market slump, large deals financed with borrowed money, or leverage, may ``result in a number of hedge funds and banks attempting to close out positions with no potential takers of credit risk on the other side,''… Banks and money managers bought and sold about $50 trillion of credit derivatives in 2006, more than twice the total in the previous year, Fitch said. The market has grown 15-fold since
Fitch started the survey in 2003, the ratings company said. The contracts, based on bonds and loans, are used to speculate on the ability of companies to repay debt. ``Until all of this recent volatility, investors had been forced down the credit quality ladder, and up in leverage to meet investment targets,'' …``Now it appears hedge funds are deleveraging'' to meet demands from their lenders. Hedge funds typically leverage their assets by five to six times, Fitch said in a report in June. The funds' holdings of corporate debt reached more than $300 billion in 2005, Fitch said, citing International Monetary Fund data. In-depth, up-to-date data on hedge fund investment in corporate bonds, loans and their derivatives ``remains elusive,'' Fitch said in today's report. In credit-default swaps, the buyer pays an annual premium to guard against a borrower failing to pay its debts. In a default, the buyer gets paid the full amount insured, and hands over defaulted loans or bonds to the swap seller. Morgan Stanley was cited as the most frequent trader of the contracts, followed by Deutsche Bank AG, Goldman Sachs Group Inc. and JPMorgan Chase & Co., Fitch said. The top 10 firms accounted for 89 percent of credit derivatives bought and sold in 2006, up from 86 percent in the previous year, Fitch said. ``For better or worse, counterparty concentration appears to remain a feature of this market,'' Fitch analysts wrote. Credit-default swaps based on the debt of General Motors Corp., the largest U.S. automaker, were the most frequently traded single-name contracts last year, … Prices of the derivatives typically decline when creditworthiness improves, and rise when it worsens.”
MISC
From Merrill Lynch: “…real consumer spending was depressed by the surge in food and energy prices in 2Q-07 (growing just +1.31% SAAR)…We expect substantial price discounting from general merchandisers in the ‘back-to-school’ sales period in August and September.”
From Barclays: “On a regional basis, Asia preferred US agency debt to Treasuries, with net purchases of $22.5bn of the former versus net sales of $0.8bn of the latter. [Based on May TIC data]”
From Dow Jones: “…recent figures from the Chicago Mercantile Exchange show that short speculative positions in the U.S. currency have risen back to their highest level in nearly three years…”
From Merrill Lynch: “The NAHB index is now just 5 points shy of making a new all-time low. The last time it was this low in January 1991, housing starts were 798,000 units (vs. 1.5 million now) and new home sales were 401,000 (vs. 915,000 now).”
From Time: “The average U.S. home size was 2,434 square feet in 2005, up from 983 square feet in 1950, according to the National Association of Home Builders.”
End-of-Day Market Update
Treasuries fell for the first time in three days, pushing up interest rates 2bp across the curve. The ten year Treasury is finishing the day at 5.06% after rising to 5.10% earlier in the day.
Stocks rose, pushing the Dow to another new high of 14,021 intraday, before closing up 21 at 13,971. The S&P remained confined within yesterday’s range, and closed essentially unchanged. The NASDAQ closed up 15 at 2712.
The dollar is closing unchanged after trading in a tight range all day.
Oil shot up above $75 a barrel during the morning, to an 11-month high in an outside trading day, but closed 13 cents lower at $74.02. Most other energy prices fell as well, with gasoline falling to a 34 day low.
Commodity prices were lower, with soybeans settling near limit down for the second day in a row.
From Dow Jones: “The riskiest tranche of the subprime mortgage-based derivative index, the ABX, hit another low Tuesday. The BBB- tranche was quoted at 44 cents on the dollar early afternoon… Further downgrades of securities tied to the subprime mortgage meltdown will put pressure on public pension funds and insurance companies to sell off their holdings, but the rules under which they operate generally give them the flexibility to avoid a fire sale. That could provide some reassurance to Wall Street, which is concerned hasty sales could sharply lower market prices on mortgage bonds and the complex securities that banks have constructed based on them, so-called collateralized debt obligations. A sharp drop in prices could force other buyers to record big losses, spooking investors and causing a sharp spike in risk aversion - which could threaten the stability of the financial system.”
Private Equity Firms May Have to Utilize Bridge Loans to Fund Pipeline Purchases
From TheStreet.com: “…bankers financing big leveraged buyouts are fretting over …handing over billions of dollars in so-called bridge loan commitments to buyout-happy private-equity shops. Bridge loans are hardly lucrative for investment banks -- they are not usually even drawn down. Instead they serve to "bridge" the gap between the announcement of a buyout …and the receipt of permanent financing. But with the debt market having soured recently for leveraged buyouts, banks are starting to worry that private-equity shops might opt to actually draw upon these hefty loans -- possibly leaving the banks with billions of unwanted loans on their books, unless they can syndicate them out to buyers including hedge fund investors…Complicating the picture is growing resistance from hedge funds and managers of collateralized loan obligations, which pool and manage portfolios of commercial debt… one firm pushing back against banks and eschewing loans that lack the covenants that would protect investors if they tank. "Until recently there has been no organized consortium among managers to push back on poor covenant quality and credit agreement terms," …Although markedly different from CLOs, subprime has put a spotlight on loans made to borrowers with questionable credit. Excesses emerging there have caused buyers of loans to demand better underwriting standards. Highland has doubled the number of loans it rejects in structuring CLO assets from 25% to 35% to around 65%, …Such resistance has put a strain on banks and pushed bankers into the negotiating room with private-equity firms, which are trying to ensure that the buyout-friendly terms they received earlier don't change. But if they do, they are willing to consider asking the banks to fund these billion dollar bridges.”
From Dow Jones: “Private equity firms hoping to skimp on investor protection when they raise funds for their buyouts in the debt markets in the coming months could be in for a rude awakening. A particularly risky type of leveraged loan - debt that is sliced up and sold to investors - has borne the brunt of selling in the last three weeks as investors have grown less enamored with speculative debt. Covenant-lite loans - ones that carry
minimal protection for debt holders should a company run into trouble - have under-performed more traditional, safer loans as investors rethink risk. This doesn’t bode well for large deals looming, like First Data Corp.’s (FDC) expected $14 billion covenant-lite loan to finance its leveraged buyout. If sold as covenant-lite, it would be the largest ever deal of its kind in the market…. According to S&P’s data, about 17% of the loan universe is covenant-lite. First Data’s deal alone would grow that number to 20% if investors agree to a deal without such protections. But recent aversion to covenant-lite loans could have lasting repercussions in the market, which is expecting $200 billion of new supply in the next six to nine months to fund the massive amount of leveraged buyouts that have already been announced.”
Central Banks Becoming More Aggressive With Investment of Excess Reserves
From Bloomberg: “In a confidential poll, UBS surveyed its guests about several key issues, including predictions about where U.S. interest rates, bond yields and the dollar will be at year's end, and anticipated changes in asset allocation over the next decade. The reserve managers' responses made it clear that the world's biggest pool of cash will be invested more aggressively than in the past. That means they will buy fewer U.S. government securities, which is bad news for U.S. interest rates. What's more, the responses illustrate that regardless of their financial muscle, central banks are no better than the private sector when it comes to predicting market moves… Central banks traditionally have invested their reserves in highly liquid, low-yielding securities, such as U.S. Treasuries and equivalent German government bonds. The goal is to have quick
access to the funds to defend a currency under attack, cover short-term debt obligations, finance imports and counter any runs on domestic banks. Yet, having amassed reserves well in excess of prudential needs, central banks are under increasing pressure from
politicians and public-interest groups to earn higher returns on their hoards by investing in riskier assets. To that end, several countries, including China, Singapore, the United Arab Emirates, Kuwait, Norway and Russia, have established or announced their intention to set up sovereign wealth funds… The UBS survey asked the reserve managers what the biggest change would be in the way they allocated assets over the next 10 years. Thirty-six percent said they would invest more in so-called spread products, which include swaps, agency bonds andcorporate debt -- fixed-income securities that trade at a spread to government bonds… Eighteen percent of reserve managers responded with more equities, another 18 percent with fewer U.S. dollars and 12 percent said alternative investments. Bottom line: The more money that the countries with big reserves invest in corporate bonds, stocks and other risky investments, the less they will put into Treasuries. Asian central banks and oil exporters, which are large buyers of U.S. government securities, have helped restrain U.S. interest rates in recent years. ``The dominant story is more risk: People are looking for higher rates of return, and that will only come with more risk,''… One percent of the respondents voted for more gold, while 3 percent said less gold.”
From Morgan Stanley: “The composition of buying in May was geared towards riskier assets more so than safer assets. Increased risk appetite was definitely the name of the game as the data indicates that foreign accounts took major stakes in US corporations
during May. The majority of these flows were private based, but foreigners purchased both a record $41.9 billion in US stocks and $72.6 billion in US corporate bonds. This trend bears watching, given the prospects of excess official reserves flowing into sovereign wealth funds (which would be difficult to tag as official flows by the TIC system and would instead be viewed as private account transactions), which are mandated to seek higher returning assets …Granted, there was a rebound in foreign buying of safe assets as purchases of Treasuries rebounded in May up $21.6 billion. However, the majority of the flows into Treasuries were from private accounts (bulk UK and OPEC) as central banks actually sold $4.6 billion (the second time that FCBs have sold this year). In 2007, foreign official purchases of Treasuries have been diminutive at best (only $3 billion in 2007), as FCB purchases of US fixed income assets are now concentrated more in Agencies and MBS (up $63 billion in 2007).”
Concentration of Credit Derivatives Risk May Amplify Volatility Says Fitch Study
From Bloomberg: “Hedge fund borrowing to invest in credit derivatives may magnify volatility in a market slump, according to a Fitch Ratings survey of 65 banks and insurers. A ``dramatic'' increase in hedge funds' use of credit derivatives has pushed their share of trading to 60 percent of credit-default swaps, and about 33 percent of collateralized
debt obligations, Fitch said in the report today, citing data from Greenwich Associates. U.S. corporate bond risk premiums reached the highest in almost two years last week as hedge funds bought credit-default swaps to offset potential losses from the subprime mortgage rout… In a market slump, large deals financed with borrowed money, or leverage, may ``result in a number of hedge funds and banks attempting to close out positions with no potential takers of credit risk on the other side,''… Banks and money managers bought and sold about $50 trillion of credit derivatives in 2006, more than twice the total in the previous year, Fitch said. The market has grown 15-fold since
Fitch started the survey in 2003, the ratings company said. The contracts, based on bonds and loans, are used to speculate on the ability of companies to repay debt. ``Until all of this recent volatility, investors had been forced down the credit quality ladder, and up in leverage to meet investment targets,'' …``Now it appears hedge funds are deleveraging'' to meet demands from their lenders. Hedge funds typically leverage their assets by five to six times, Fitch said in a report in June. The funds' holdings of corporate debt reached more than $300 billion in 2005, Fitch said, citing International Monetary Fund data. In-depth, up-to-date data on hedge fund investment in corporate bonds, loans and their derivatives ``remains elusive,'' Fitch said in today's report. In credit-default swaps, the buyer pays an annual premium to guard against a borrower failing to pay its debts. In a default, the buyer gets paid the full amount insured, and hands over defaulted loans or bonds to the swap seller. Morgan Stanley was cited as the most frequent trader of the contracts, followed by Deutsche Bank AG, Goldman Sachs Group Inc. and JPMorgan Chase & Co., Fitch said. The top 10 firms accounted for 89 percent of credit derivatives bought and sold in 2006, up from 86 percent in the previous year, Fitch said. ``For better or worse, counterparty concentration appears to remain a feature of this market,'' Fitch analysts wrote. Credit-default swaps based on the debt of General Motors Corp., the largest U.S. automaker, were the most frequently traded single-name contracts last year, … Prices of the derivatives typically decline when creditworthiness improves, and rise when it worsens.”
MISC
From Merrill Lynch: “…real consumer spending was depressed by the surge in food and energy prices in 2Q-07 (growing just +1.31% SAAR)…We expect substantial price discounting from general merchandisers in the ‘back-to-school’ sales period in August and September.”
From Barclays: “On a regional basis, Asia preferred US agency debt to Treasuries, with net purchases of $22.5bn of the former versus net sales of $0.8bn of the latter. [Based on May TIC data]”
From Dow Jones: “…recent figures from the Chicago Mercantile Exchange show that short speculative positions in the U.S. currency have risen back to their highest level in nearly three years…”
From Merrill Lynch: “The NAHB index is now just 5 points shy of making a new all-time low. The last time it was this low in January 1991, housing starts were 798,000 units (vs. 1.5 million now) and new home sales were 401,000 (vs. 915,000 now).”
From Time: “The average U.S. home size was 2,434 square feet in 2005, up from 983 square feet in 1950, according to the National Association of Home Builders.”
End-of-Day Market Update
Treasuries fell for the first time in three days, pushing up interest rates 2bp across the curve. The ten year Treasury is finishing the day at 5.06% after rising to 5.10% earlier in the day.
Stocks rose, pushing the Dow to another new high of 14,021 intraday, before closing up 21 at 13,971. The S&P remained confined within yesterday’s range, and closed essentially unchanged. The NASDAQ closed up 15 at 2712.
The dollar is closing unchanged after trading in a tight range all day.
Oil shot up above $75 a barrel during the morning, to an 11-month high in an outside trading day, but closed 13 cents lower at $74.02. Most other energy prices fell as well, with gasoline falling to a 34 day low.
Commodity prices were lower, with soybeans settling near limit down for the second day in a row.
Monday, July 16, 2007
Today's Tidbits
Annual Federal Budget Deficit Shrinks in 2007
From Deutsche Bank: “Over the last year, federal spending is down 0.7%, but some of this reflects a large 7.4% decline in defense spending in Q1 that is unlikely to be repeated going forward. Still, we do not see federal spending growing much more than 2% in
inflation-adjusted terms, because we do not anticipate any major new legislative initiatives that would sharply lift appropriations.”
From JP Morgan: “The forecast looks for the federal budget deficit to narrow by nearly $100 billion this year to $150 billion, or 1.1% of GDP…Through the first nine months of the fiscal year, the federal budget shows an improvement of $85.5 billion. The trend in growth of receipts has slowed over the past few months, partly reflecting the sharp slowdown in corporate income taxes.”
From Bloomberg: “Just as international investors are reducing purchases of Treasuries, the U.S. government will be selling fewer of them thanks to a surge in tax receipts. The projected 7 percent increase in tax revenue will help the U.S. budget deficit shrink by 17 percent to about $205 billion for the fiscal year ending Sept. 30, the Bush administration said last week. As a result, the Treasury Department sold less securities from January through June than matured, the first time that has happened since 2000. A drop in supply is good news for a market that in the second quarter lost 0.4 percent when including reinvested interest, the biggest decline in more than a year, as an accelerating economy drew investors away from fixed-income assets, according to New York-based Merrill Lynch & Co.'s U.S. Treasury Master index. In fact, the fiscal outlook is so good that investors and strategists are beginning to handicap which maturities the government may stop selling or even buy back for the first time in five years.”
Surprising Strength in Construction Employment Has Many Questioning Data
From The New York Post: “The numbers are too amazing to believe. In fact, the figures are so unbelievable - as in, "not to be believed" - that even an economist working at the Labor Department hedged on their veracity by admitting that there may be a "lag time" before job losses start to appear. You decide for yourself if the government is snowing us. According to the Labor Department, there were 185,000 more construction jobs in June than there were in May before the government makes seasonal adjustments to the statistics. Even after adjusting for the season, the number of construction jobs increased by a still inconceivable 12,000. Harder to believe is what the government says happened in the residential construction market. Before the zany seasonal adjustment the government says 126,000 new residential construction jobs were created in June. After being seasonally adjusted, there were still 2,000 extra people putting up houses around the country - at least the way Washington counts them.”
From Lehman: “Macroeconomic Advisers finds that payrolls as of June this year were between 68,000 and 139,000 lower than what the BLS says [based on ADP data of 17% of employers]…if the company's estimates are correct and the BLS is wrong, the likeliest reason is that the BLS's own birth/death model may be overstating jobs created at small firms (a major share of employment in construction). If so, the eventual release of more comprehensive, quarterly data based on state unemployment insurance records could eventually lead to a downward revision to the BLS's monthly estimates…Automatic Data Processing doesn't supply data for the BLS's monthly payroll count, but does for the quarterly comprehensive count, because the firm processes unemployment insurance premium payments for its payroll clients. But that still leaves a mystery. Based on Macroeconomic Advisers's own econometric analysis, construction payrolls ought to be about 500,000 lower than the BLS now reports them to be; the new analysis explains at most a quarter of that gap. A recent report by Deutsche Bank argues that the unemployment stats have failed to capture layoffs of about 500,000 illegal Hispanic workers…On the other hand, Ken Simonson, chief economist of the Associated General Contractors of America, argues that the gap can be explained entirely by small firms moving from residential to commercial work -- an explanation the Deutsche Bank researchers rejected.”
Impact of Weaker Dollar on US Companies and Foreign Countries
From JP Morgan: “The weaker currency has an immediate effect in lifting the dollar value of foreign earnings [for US companies], a plus for stock prices and for corporate financial health. The lower dollar will also support growth in trade-sensitive industries over time. The amount of help that the economy will get from a weaker dollar depends on both the rate of depreciation and the level of the dollar. Significant stimulus is likely on both counts. The real trade-weighted dollar has dropped a hefty 5% since the beginning of March, and the trade-weighted value of the dollar is now down to its lowest level in decades…
…fx reserves in the EM [emerging market countries] group rose $586 billion in 1H07 to $3.7 trillion by the end of June, a gain almost as much as in all of 2006. These inflows have only partially been sterilized, most recently demonstrated by reports of continued double-digit money supply growth in China and Korea—a development that is common throughout the EM group. Although inflation rates remain quite low in most EM countries, the rapid growth of credit is raising concerns about incipient wage and price pressures alongside longer-standing worries about overheated asset markets. In response, some countries have tried easing restrictions on capital outflows from residents to stimulate foreign currency demand. For example, some Latin American countries (e.g.,
Chile, Colombia, and Peru) have introduced regulatory changes allowing pension funds to invest a higher proportion of their portfolios overseas. These market-based measures
have tended to fail, however, because of the expectation of higher returns in local currency investments. This has led a handful of countries (most recently Columbia) to introduce capital controls in an effort to cap net inflows. But the potential cost is that choosing this option sends a negative signal to the private sector and distorts capital mobility.”
Has Servicing Private Equity Debt Reduced Capex Expenditures and Productivity?
From BMO: “The sky became the limit for the amount of money investors were willing
to give PE [private equity] investors in subordinated paper and collateralized bank loans, so there was no apparent limit on the market capitalization of mid-cap companies waiting to be removed from the nuisances of Sarbanes-Oxley, and the constraints on management vision from quarterly earnings reporting. The most obvious effect of the torrent of privatizations was on the S&P 400…. Collectively, the mid-caps who remain public (apart from the commodity producers) probably have lesser investment merit than those acquired by the PE companies, who can be presumed to be great stock selectors. Meanwhile, another trend was emerging. US business capital spending was not sharing in the otherwise strong economic recovery. As each new year dawned, forecasters assured us that “the long overdue recovery in capex is coming this year.”… The acquired companies once had modest debt loads which were incurred primarily for capital spending. Now they have debt loads many times their cash flow financing payouts to the owners—with nothing to show for those payouts but the debts. Instead of managing for growth, the companies have to be managed for servicing the debts. The capex budgets are the most obvious candidate for cuts… Remember that the best of the small and mid-size non-financial American companies have been responsible for a disproportionate share of American economic growth. That means they have probably been responsible for a disproportionate share of American productivity gains. Result: It is hard to imagine that American productivity growth in the future will be as strong as in the relatively recent past.”
Higher Food Prices Cutting Into Aid for the Poor
From The Financial Times: “Rising prices for food have led the United Nations…to warn that it can no longer afford to feed the 90m people it has helped for each of the past five years…The World Food Programme…said its purchasing costs had risen ‘almost 50 per cent in the last five years’. It said the price it paid for maize had risen up to 120 per cent in the past six months…Global what stocks have fallen to the lowest level in 25 years, according to the US Department of Agriculture…’We are no longer in a surplus world.’”
From BMO: “Consumers across most of the economic world will be spending significantly more on food this year and next…The world’s carryover of grains and oilseeds at the end of the crop year in September will probably be the lowest (in relation to consumption) on record…The US…average corn production per acre has risen by two bushels a year over the past 26 years…the major contributor has been genetically modified seeds…Many climatologists also attribute the sustained gains to rises in CO2, which, of course contributes to faster growth in plants and thereby to the lowering of food costs across the globe…Last week’s FAO and OECD report on the food outlook predicted a decade of higher food prices. The CEO of Nestle predicts ‘significant and long-lasting food-price inflation.”
MISC
From Dow Jones: “Even with the absence of negative subprime-related headlines that have roiled the markets in the past few weeks, the index based on subprime mortgages is hitting new lows. The riskiest tranche of the current index, the BBB- of the ABX.HE 07-1, touched 45 cents on the dollar in morning trade, according to … a trader at UBS. “The stuff is a lot softer,” … “Sellers want to offset risk and sell the stuff.””
From JP Morgan: “Real consumer spending downshifted from two consecutive quarters of 4.2% growth to an estimated 1.4% growth pace in 2Q07…The most important influence on spending is real labor income. The payroll proxy of labor income (hours worked times hourly earnings) has been getting stronger, accelerating to a 6.1% growth pace in 2Q.”
From Mauldin: “The Chinese yuan is up against the dollar from 8.28 to 7.57 to the dollar over the last two years. That is an increase of almost 9%. The movement in the last month has been particularly fast.”
From The Financial Times: “In the last few quarters, wage rises have started to outstrip rises in productivity for the first time in years [in China]”
From AFP: “China's economy grew so rapidly in the first half of 2007 that it is likely to overtake Germany as the world's third-largest by the end of this year, analysts say.”
From RBSGC: “MBS holdings were down $9 bn since the end of June. Deposits…were up $48 bn since June.Commercial and industrial loans… increased $9 bn since June. Whole loan holdings decreased by $11 bn over the week, and were up by $9 bn since June.”
From The New York Times: “…last year it [solar power] provided less than 0.01 percent of the country’s electricity supply…Even a quarter century from now, says the Energy Department official in charge of renewable energy, solar power might account for, at best, 2 or 3 percent of the grid electricity in the United States…there are few major programs looking for ways to drastically reduce the cost of converting sunlight to energy and — of equal if not more importance — of efficiently storing it for when the sun is not shining…Scientists are hoping to expand the range of sunlight’s wavelengths that can be absorbed, and to cut the amount of energy the cells lose to heat.”
From Deutsche Bank: “The economy has been growing below trend for the last four quarters, and while growth is expected to pick up in the second half of the year, the trajectory is likely to be modest because of a projected slowdown in consumer spending. This should limit the economy's ability to get back to trend growth on a sustained basis. However, the economy is unlikely to be weak enough to engender a meaningful rise in the unemployment rate which would be necessary to bring the Fed into play.”
From Mauldin: “Wal-Mart sales were up a higher than expected 2.4%. They noted that home goods and apparel sales were weak but that grocery sales surged. No kidding. With food inflation at almost 7%, grocery sales are clearly going to increase if we just eat the same food…”
End-of-Day Market Update
Treasuries rallied causing yields to fall 5bp across the curve on flight-to-quality buying as ABX fell further. 10y Treasury yield is closing at 5.04%. The 2/10 curve is at 17.
Equities are mixed with the Down closing up 44 to another new record nominal high, and the S&P 500 closing down 3. NASDAQ is also closing down 10 points. The dollar continues to slowly weaken, with the dollar index falling .05 to 80.52, but slid sharply versus the Canadian Dollar to approach a 30 year high. Oil futures rose 23 cents, but slid in after hours trading. Oil futures are still $4 below the $78 high reached last summer.
From Deutsche Bank: “Over the last year, federal spending is down 0.7%, but some of this reflects a large 7.4% decline in defense spending in Q1 that is unlikely to be repeated going forward. Still, we do not see federal spending growing much more than 2% in
inflation-adjusted terms, because we do not anticipate any major new legislative initiatives that would sharply lift appropriations.”
From JP Morgan: “The forecast looks for the federal budget deficit to narrow by nearly $100 billion this year to $150 billion, or 1.1% of GDP…Through the first nine months of the fiscal year, the federal budget shows an improvement of $85.5 billion. The trend in growth of receipts has slowed over the past few months, partly reflecting the sharp slowdown in corporate income taxes.”
From Bloomberg: “Just as international investors are reducing purchases of Treasuries, the U.S. government will be selling fewer of them thanks to a surge in tax receipts. The projected 7 percent increase in tax revenue will help the U.S. budget deficit shrink by 17 percent to about $205 billion for the fiscal year ending Sept. 30, the Bush administration said last week. As a result, the Treasury Department sold less securities from January through June than matured, the first time that has happened since 2000. A drop in supply is good news for a market that in the second quarter lost 0.4 percent when including reinvested interest, the biggest decline in more than a year, as an accelerating economy drew investors away from fixed-income assets, according to New York-based Merrill Lynch & Co.'s U.S. Treasury Master index. In fact, the fiscal outlook is so good that investors and strategists are beginning to handicap which maturities the government may stop selling or even buy back for the first time in five years.”
Surprising Strength in Construction Employment Has Many Questioning Data
From The New York Post: “The numbers are too amazing to believe. In fact, the figures are so unbelievable - as in, "not to be believed" - that even an economist working at the Labor Department hedged on their veracity by admitting that there may be a "lag time" before job losses start to appear. You decide for yourself if the government is snowing us. According to the Labor Department, there were 185,000 more construction jobs in June than there were in May before the government makes seasonal adjustments to the statistics. Even after adjusting for the season, the number of construction jobs increased by a still inconceivable 12,000. Harder to believe is what the government says happened in the residential construction market. Before the zany seasonal adjustment the government says 126,000 new residential construction jobs were created in June. After being seasonally adjusted, there were still 2,000 extra people putting up houses around the country - at least the way Washington counts them.”
From Lehman: “Macroeconomic Advisers finds that payrolls as of June this year were between 68,000 and 139,000 lower than what the BLS says [based on ADP data of 17% of employers]…if the company's estimates are correct and the BLS is wrong, the likeliest reason is that the BLS's own birth/death model may be overstating jobs created at small firms (a major share of employment in construction). If so, the eventual release of more comprehensive, quarterly data based on state unemployment insurance records could eventually lead to a downward revision to the BLS's monthly estimates…Automatic Data Processing doesn't supply data for the BLS's monthly payroll count, but does for the quarterly comprehensive count, because the firm processes unemployment insurance premium payments for its payroll clients. But that still leaves a mystery. Based on Macroeconomic Advisers's own econometric analysis, construction payrolls ought to be about 500,000 lower than the BLS now reports them to be; the new analysis explains at most a quarter of that gap. A recent report by Deutsche Bank argues that the unemployment stats have failed to capture layoffs of about 500,000 illegal Hispanic workers…On the other hand, Ken Simonson, chief economist of the Associated General Contractors of America, argues that the gap can be explained entirely by small firms moving from residential to commercial work -- an explanation the Deutsche Bank researchers rejected.”
Impact of Weaker Dollar on US Companies and Foreign Countries
From JP Morgan: “The weaker currency has an immediate effect in lifting the dollar value of foreign earnings [for US companies], a plus for stock prices and for corporate financial health. The lower dollar will also support growth in trade-sensitive industries over time. The amount of help that the economy will get from a weaker dollar depends on both the rate of depreciation and the level of the dollar. Significant stimulus is likely on both counts. The real trade-weighted dollar has dropped a hefty 5% since the beginning of March, and the trade-weighted value of the dollar is now down to its lowest level in decades…
…fx reserves in the EM [emerging market countries] group rose $586 billion in 1H07 to $3.7 trillion by the end of June, a gain almost as much as in all of 2006. These inflows have only partially been sterilized, most recently demonstrated by reports of continued double-digit money supply growth in China and Korea—a development that is common throughout the EM group. Although inflation rates remain quite low in most EM countries, the rapid growth of credit is raising concerns about incipient wage and price pressures alongside longer-standing worries about overheated asset markets. In response, some countries have tried easing restrictions on capital outflows from residents to stimulate foreign currency demand. For example, some Latin American countries (e.g.,
Chile, Colombia, and Peru) have introduced regulatory changes allowing pension funds to invest a higher proportion of their portfolios overseas. These market-based measures
have tended to fail, however, because of the expectation of higher returns in local currency investments. This has led a handful of countries (most recently Columbia) to introduce capital controls in an effort to cap net inflows. But the potential cost is that choosing this option sends a negative signal to the private sector and distorts capital mobility.”
Has Servicing Private Equity Debt Reduced Capex Expenditures and Productivity?
From BMO: “The sky became the limit for the amount of money investors were willing
to give PE [private equity] investors in subordinated paper and collateralized bank loans, so there was no apparent limit on the market capitalization of mid-cap companies waiting to be removed from the nuisances of Sarbanes-Oxley, and the constraints on management vision from quarterly earnings reporting. The most obvious effect of the torrent of privatizations was on the S&P 400…. Collectively, the mid-caps who remain public (apart from the commodity producers) probably have lesser investment merit than those acquired by the PE companies, who can be presumed to be great stock selectors. Meanwhile, another trend was emerging. US business capital spending was not sharing in the otherwise strong economic recovery. As each new year dawned, forecasters assured us that “the long overdue recovery in capex is coming this year.”… The acquired companies once had modest debt loads which were incurred primarily for capital spending. Now they have debt loads many times their cash flow financing payouts to the owners—with nothing to show for those payouts but the debts. Instead of managing for growth, the companies have to be managed for servicing the debts. The capex budgets are the most obvious candidate for cuts… Remember that the best of the small and mid-size non-financial American companies have been responsible for a disproportionate share of American economic growth. That means they have probably been responsible for a disproportionate share of American productivity gains. Result: It is hard to imagine that American productivity growth in the future will be as strong as in the relatively recent past.”
Higher Food Prices Cutting Into Aid for the Poor
From The Financial Times: “Rising prices for food have led the United Nations…to warn that it can no longer afford to feed the 90m people it has helped for each of the past five years…The World Food Programme…said its purchasing costs had risen ‘almost 50 per cent in the last five years’. It said the price it paid for maize had risen up to 120 per cent in the past six months…Global what stocks have fallen to the lowest level in 25 years, according to the US Department of Agriculture…’We are no longer in a surplus world.’”
From BMO: “Consumers across most of the economic world will be spending significantly more on food this year and next…The world’s carryover of grains and oilseeds at the end of the crop year in September will probably be the lowest (in relation to consumption) on record…The US…average corn production per acre has risen by two bushels a year over the past 26 years…the major contributor has been genetically modified seeds…Many climatologists also attribute the sustained gains to rises in CO2, which, of course contributes to faster growth in plants and thereby to the lowering of food costs across the globe…Last week’s FAO and OECD report on the food outlook predicted a decade of higher food prices. The CEO of Nestle predicts ‘significant and long-lasting food-price inflation.”
MISC
From Dow Jones: “Even with the absence of negative subprime-related headlines that have roiled the markets in the past few weeks, the index based on subprime mortgages is hitting new lows. The riskiest tranche of the current index, the BBB- of the ABX.HE 07-1, touched 45 cents on the dollar in morning trade, according to … a trader at UBS. “The stuff is a lot softer,” … “Sellers want to offset risk and sell the stuff.””
From JP Morgan: “Real consumer spending downshifted from two consecutive quarters of 4.2% growth to an estimated 1.4% growth pace in 2Q07…The most important influence on spending is real labor income. The payroll proxy of labor income (hours worked times hourly earnings) has been getting stronger, accelerating to a 6.1% growth pace in 2Q.”
From Mauldin: “The Chinese yuan is up against the dollar from 8.28 to 7.57 to the dollar over the last two years. That is an increase of almost 9%. The movement in the last month has been particularly fast.”
From The Financial Times: “In the last few quarters, wage rises have started to outstrip rises in productivity for the first time in years [in China]”
From AFP: “China's economy grew so rapidly in the first half of 2007 that it is likely to overtake Germany as the world's third-largest by the end of this year, analysts say.”
From RBSGC: “MBS holdings were down $9 bn since the end of June. Deposits…were up $48 bn since June.Commercial and industrial loans… increased $9 bn since June. Whole loan holdings decreased by $11 bn over the week, and were up by $9 bn since June.”
From The New York Times: “…last year it [solar power] provided less than 0.01 percent of the country’s electricity supply…Even a quarter century from now, says the Energy Department official in charge of renewable energy, solar power might account for, at best, 2 or 3 percent of the grid electricity in the United States…there are few major programs looking for ways to drastically reduce the cost of converting sunlight to energy and — of equal if not more importance — of efficiently storing it for when the sun is not shining…Scientists are hoping to expand the range of sunlight’s wavelengths that can be absorbed, and to cut the amount of energy the cells lose to heat.”
From Deutsche Bank: “The economy has been growing below trend for the last four quarters, and while growth is expected to pick up in the second half of the year, the trajectory is likely to be modest because of a projected slowdown in consumer spending. This should limit the economy's ability to get back to trend growth on a sustained basis. However, the economy is unlikely to be weak enough to engender a meaningful rise in the unemployment rate which would be necessary to bring the Fed into play.”
From Mauldin: “Wal-Mart sales were up a higher than expected 2.4%. They noted that home goods and apparel sales were weak but that grocery sales surged. No kidding. With food inflation at almost 7%, grocery sales are clearly going to increase if we just eat the same food…”
End-of-Day Market Update
Treasuries rallied causing yields to fall 5bp across the curve on flight-to-quality buying as ABX fell further. 10y Treasury yield is closing at 5.04%. The 2/10 curve is at 17.
Equities are mixed with the Down closing up 44 to another new record nominal high, and the S&P 500 closing down 3. NASDAQ is also closing down 10 points. The dollar continues to slowly weaken, with the dollar index falling .05 to 80.52, but slid sharply versus the Canadian Dollar to approach a 30 year high. Oil futures rose 23 cents, but slid in after hours trading. Oil futures are still $4 below the $78 high reached last summer.
New York Manufacturing Unexpectedly Improves Further to One Year High
Empire manufacturing unexpectedly continued to improve in July, rising to 26.5 (consensus 18) from 25.8 in June, to a new one year high. The expansion in factory activity in the New York region showed up as an almost ten point jump in new orders to 26.5. New orders have been improving for the last four months, and set a new one year high. There was also a significant decline in inventories of over 20 points to -20. Employment shot 8 points higher. Prices paid fell notably, but remain elevated at 34.6, while shipments fell modestly to 29.2. The six month outlook also improved, rising to 48.2 from 44.1. 40% of respondents indicated that they are increasing production plans for the rest of this year. The New York region is more tied to high-tech industries compared to the Midwest's continued emphasis on autos.
The past two months have shown the best two month levels since 2004, as most of the subcomponents show strength. The figures indicate strength in the ISM, and support for the employment, figures for July.
The past two months have shown the best two month levels since 2004, as most of the subcomponents show strength. The figures indicate strength in the ISM, and support for the employment, figures for July.
Subscribe to:
Posts (Atom)