Consensus Prior
Monday, 7/30No Data
Tuesday, 7/31
June Personal Income +.5% +.4%
Hourly earnings and hours worked both rose
June Personal Spending +.2% +.5% Auto sales were weak
June PCE Deflator YoY 2.3% 2.3%
June Core PCE MoM +.2% +.1%
YoY +1.9% +1.9%
Slightly lower growth than CPI
Hotel price gains have less impact on this index
2nd Qtr Employment Cost Index +.9% +.8%
Wages and salaries expected to grow +.9%
Benefit costs likely to rise after decelerating last quarter
Strong equity market gains reduced pension plan contribution needs
Above trend medical cost gains decelerating
YoY growth expected to hold steady at 3.5%, with wages picking up and benefits costs slowing over the past year
May S&P Case-Shiller Home Price Change 20 City -2.1%
July Chicago Purchasing Manager 58 60.2
Domestic demand has been weak
Auto demand has been weak
July Consumer Confidence 105 103.9
Slight improvement expected as most participation is early in month, when stocks were rising and gas prices easing
June Construction Spending +.3% +.9%
Residential construction expected to decline for 16th straight month
Non-residential and government demand continue to carry the load
Non-residential growth exceptionally strong in second quarter, but concerns credit tightening will squash future growth
Wednesday, 8/1
ADP Employment Change 100k 150k
Add 25k for government jobs
June Pending Home Sales -.3% -3.5%
Down 11% in last three months
July ISM Manufacturing 55.5 56
Prices Paid 66.5 68 ISM manufacturing reached a 14-month high in June
New orders hit a 16-month high in June
Deliveries have been increasing, suggesting fewer bottlenecks and less inflationary pressures
Regional indexes mixed in July
July Total Vehicles Sold 16M 15.6M
Domestic 12.3M 11.8M
Thursday, 8/2
Initial Jobless Claims 310k 301k
4 week average 308.5k
June Factory Orders +1% -.5%
Friday, 8/3
July Change in Non-Farm Payrolls 129k 132k
Manufacturing -15k -18k
Over the past three months, growth has averaged 148k per month
Jobless claims remain relatively low
76% of new jobs in 2007 focused on education, health services, food services, and government
July Unemployment Rate 4.5% 4.5%
Has ranged between 4.4 – 4.6% since last September
If labor force participation holds steady, unemployment rate may rise to 4.6%
Continuing claims have trended higher
July Average Hourly Earnings MoM +.3% +.3%
YoY +3.9% +3.9%
Peaked at 4.3% YoY last December
July Average Weekly Hours 33.9 33.9
Index of aggregate hours worked expected to rise +.1% MoM
July Non-Manufacturing ISM 59 60.7
Beige Book indicates strong demand for professional services
New orders slipped last month
Saturday, July 28, 2007
Friday, July 27, 2007
University of Michigan Confidence Remains Elevated in Final July Reading
The final July University of Michigan Confidence Survey was able to maintain the majority of its improvement from June. The final July figure is 90.4, down from the preliminary estimate of 92.4, but considerably above the 85.3 final level for June. Lower future expectations were responsible for the softening in the July figure. Current conditions softened from 105.7 to 104.5 from the preliminary to the final reading, while the outlook fell to 81.5 from 83.9.
The number of consumers saying now is a bad time to buy a house rose the highest level since 1991.
Inflation expectations for the one-year outlook rose to 3.4% from 3.3%, while the 5-year reading held constant at 3.1% from the preliminary reading, which was an increase from the 2.9% level in June.
The number of consumers saying now is a bad time to buy a house rose the highest level since 1991.
Inflation expectations for the one-year outlook rose to 3.4% from 3.3%, while the 5-year reading held constant at 3.1% from the preliminary reading, which was an increase from the 2.9% level in June.
2nd Quarter GDP Close to Expectations Causing Little Market Reaction
Second quarter GDP figures show that growth rebounded from the weakness of the first quarter. GDP grew at a 3.4% annualized pace (consensus 3.2%), while the first quarter growth rate was revised slightly lower to +.6% annualized from +.7% previously reported. Versus the second quarter of 2006, GDP has grown +1.8% YoY, up from +1.5% in the first quarter of 2007, but down from the 3.2% pace of the second quarter of 2006.
Personal consumption fell dramatically to +1.3% annualized (consensus +1.5%) from 3.7% (revised down from +4.2%) in the first quarter. Durable goods demand rose +1.6% annualized while non-durable goods fell -.8% annualized in the second quarter. Services slowed to +2.2% annualized.
Gross private investment rebounded to positive territory for the first time since the second quarter of 2006, growing +3.1% annualized. Non-residential structures grew a huge 22% annualized, but the recent credit crackdown may slow this growth in the future. Residential construction fell for the sixth quarter in a row, falling an additional -9.3% annualized in the most recent quarter, which is a slowdown from the 16-20% pace seen in the prior three quarters.
Exports grew +6.4% annualized, relatively evenly divided between goods and services. The rise in exports was a major contributor to GDP this past quarter. Imports fell -2.6% annualized with services declining more than goods. Imports haven't fallen this much since the 2001 recession. Government consumption rebounded to the highest level in over a year, increasing +4.2% annualized. Defense spending rose +9.55 annualized.
Headline inflation moderated more than expected, falling to +2.7% annualized (consensus +3.4%) from 4.2% in the first quarter. Core inflation dropped to 1.4% in the second quarter, as expected, from 2.4% in the prior period.
Normally GDP numbers would be watched carefully by the market, but with all of the other uncertainty, they are not having much impact today. Ten year Treasury yields rose after the release, and are now up 2bp verus yesterday's close. On net, the numbers are a little better than expected and should support third quarter GDP growth, based on the smaller than expected increase in inventory growth, and larger than expected increase in fixed investment by businesses. The increase in exports and decrease in imports were also a boost, though the slowdown in consumer spending indicates the consumer may be weakening. The Fed is unlikely to react to this report.
Personal consumption fell dramatically to +1.3% annualized (consensus +1.5%) from 3.7% (revised down from +4.2%) in the first quarter. Durable goods demand rose +1.6% annualized while non-durable goods fell -.8% annualized in the second quarter. Services slowed to +2.2% annualized.
Gross private investment rebounded to positive territory for the first time since the second quarter of 2006, growing +3.1% annualized. Non-residential structures grew a huge 22% annualized, but the recent credit crackdown may slow this growth in the future. Residential construction fell for the sixth quarter in a row, falling an additional -9.3% annualized in the most recent quarter, which is a slowdown from the 16-20% pace seen in the prior three quarters.
Exports grew +6.4% annualized, relatively evenly divided between goods and services. The rise in exports was a major contributor to GDP this past quarter. Imports fell -2.6% annualized with services declining more than goods. Imports haven't fallen this much since the 2001 recession. Government consumption rebounded to the highest level in over a year, increasing +4.2% annualized. Defense spending rose +9.55 annualized.
Headline inflation moderated more than expected, falling to +2.7% annualized (consensus +3.4%) from 4.2% in the first quarter. Core inflation dropped to 1.4% in the second quarter, as expected, from 2.4% in the prior period.
Normally GDP numbers would be watched carefully by the market, but with all of the other uncertainty, they are not having much impact today. Ten year Treasury yields rose after the release, and are now up 2bp verus yesterday's close. On net, the numbers are a little better than expected and should support third quarter GDP growth, based on the smaller than expected increase in inventory growth, and larger than expected increase in fixed investment by businesses. The increase in exports and decrease in imports were also a boost, though the slowdown in consumer spending indicates the consumer may be weakening. The Fed is unlikely to react to this report.
GDP Revisions Show Economy Slowed Earlier Than Originally Reported
The government provided revised GDP figures for the past few years which indicate the economy grew considerably more slowly than originally reported. Every quarter going back through at least the fourth quarter of 2005 had revisions lower. The largest revision was a decrease of -.9% for the third quarter of 2006 which revised GDP for the quarter almost in half to +1.1% from +2% originally reported. GDP was revised lower based on less housing and business investment than anticipated, and slower consumer spending gains. Net, GDP for the years of 2004-2006 was actually .3% lower than initially reported, with 2006 seeing the largest revision lower (2.9% from 3.3%). The trend shows the economy began cooling in 2006 rather than 2007.
Note that the lower GDP also implies that productivity has deteriorated more than previously observed. Economists will be watching the employment figures for revisions to indicated whether hours worked also declined.
Headline inflation was revised slightly higher to 2.8% YoY over the three years, but core held steady at 2.2% YoY.
Note that the lower GDP also implies that productivity has deteriorated more than previously observed. Economists will be watching the employment figures for revisions to indicated whether hours worked also declined.
Headline inflation was revised slightly higher to 2.8% YoY over the three years, but core held steady at 2.2% YoY.
Thursday, July 26, 2007
Today's Tidbits
An Overview
From Handelsbanken: “Reports of an Australian hedge fund limiting redemptions, disappointing earnings news from two more home builders, and rumours of liquidity problems at a couple of broker dealers extended the flight to quality rally in Treasury bonds and sparked large downward adjustments in equities and a slid in the dollar against the yen. The principal result of this increase in the risk premium discounted in the markets was bullish steepening of the Treasury yield curve and a dip in equities below key resistance at 13500 and 1500 on the Dow and the S&P… Continued deterioration in the sub-prime market and the derivative securities bases on these assets has prompted a sharp widening in credit spreads, especially for high yield debt. The long over due rise in the risk premium discounted in the domestic bond markets has also spilled over into equities and into the foreign exchange markets developing a self supporting loop of bad news. The deleveraging of the financial markets carries important implications not only for investors but also for the broader economy. Specifically, the economies ability to weather the consolidation in residential investment experienced over the past two years with only a marginal cut back in the pace of employment reflects the fact that excess liquidity in the economy was simply channelled into unaffected areas of the economy by efficient markets. On the other hand, a narrowing of the credit channel associated with more cautions bank lending decisions and the recent financial market rationing of credit to the most risky borrowers will keep the economy from living up to the relatively upbeat consensus forecast… The dynamics of a new more academic leaning FOMC and a desire on the part of policy makers to distance themselves from the “Greenspan put” implies that an orderly widening of credit spreads is not likely force a rate cut. Only a bank funding cries is likely to force the Fed’s hands before inflation is back well within the Committee’s comfort zone. The ongoing normalization of risk premium will be allowed to run as long as a flow of liquidity though the economy is not unexpected chocked off. Three things that market participant should monitor to determine if financial conditions are spiralling out of control: 1) swap and CDS spreads, 2) the strength of the yen, and 3) the on-the-run/off-the-run spread in the Treasury market. The interest rate swap market and CDS markets are good measures of the perceived risk in the economy and, in particular, the financial sector. A rising yen will reduce the liquidity coming into the economy from overseas and is likely to accelerate the deleveraging of the markets. The on-the-run/off-the-run spread provides a window into the perceived risk among major financial market participants.”
From Deutsche: “…one day does not make a trend and while emotions ran high, feels as though none of the topical concerns are going away soon.”
From JP Morgan: “Agencies have been absolutely hammered w/ 10s 9bp wider on the
day and trading at ~L-9.75bp. Lost in all of the credit meltdown, EM has taken it on the chin, w/ the EMBI index 28bp wider. Interestingly, mtge pass-thrus have cheapened significantly on sprd to USTs and swaps over the past week and a half, but when adjusted for the move in vol they haven't cheapened nearly as much...at this point it looks like mtge sprd positions are largely a vol trade.”
Implied Volatility Rising as Concerned Investors Buy Insurance
From Lehman: “Treasury Vols SCREAMING HIGHER - have gapped/repriced higher multiple times throughout the day.”
From Bloomberg: “The benchmark for U.S. stock volatility surged to the highest in 13 months on concern that bond market turmoil triggered by the subprime loan crisis will lead to bigger price swings. The Chicago Board Options Exchange Volatility Index jumped as much as 29 percent to 23.36, the highest since June 2006. Higher readings in the so-called VIX, derived from prices paid for options on the Standard & Poor's 500 Index, indicate traders expect bigger stock-market swings in the next 30 days. ``When it shoots up that means there's a great deal of uncertainty,'' …The S&P 500's slide today of as much as 3.5 percent, which would be the biggest closing decline since 2003, is a ``pretty good jab to the ribs.'' Spikes in the VIX have coincided with stock-market declines. The index rose the most ever on Feb. 27, climbing 64 percent to 18.31, as the U.S. equity market suffered the worst rout in almost four years[ when the Chinese stock market sold-off]. The VIX has come within 2 points of 50 on only three occasions in the past decade. The first, on Oct. 8, 1998, came as losses mounted from Russia defaulting on its debt. It reached another peak 10 days after the terrorist attacks in September 2001, and again surged in July 2002 as fallout from Enron Corp.'s collapse drove down shares of its main lenders and former rivals. …``People are panicking,…Volatility usually rises when you have big moves in the market and moves down tend to be more violent than moves up.'' When the S&P 500 reached a record high on July 19, the VIX finished the day at 15.23. While the S&P 500 has gained four straight years, the VIX has fallen every year since 2002. In November, the index fell below 10 for the first time since 1994 and in December fell to a 13-year low of 9.39. The number of shares changing hands also increased, another sign of volatility. Some 2.28 billion shares traded on the New York Stock Exchange as of 3:27 p.m., 88 percent more than the same time a week ago. In the U.K., the London Stock Exchange said 798,800 trades were made today, the most ever at the bourse.”
From RBSGC: “…in this environment of credit panic and illiquidity, you have the few actually trying (or succeeding) to get out or buy protection having an exaggerated influence and confusing already opaque price discovery. Where are we on all this? After such a massive move we are more interested in where yields stall than if they can continue and therein lies the rub. It's largely about credit spreads and we see no recovery, let alone relief, in sight and we deem this an ongoing event and, most certainly, credit risk premium is a structural, not a temporary, restoration. Besides, as we look at market positions and harp on neutral exposure vis a vis duration, we know that the overweight is in credit. What makes this liquidity/credit crunch different from others is that the risk is embedded into so many different funds, investments, and not so concentrated as to reveal quickly if traumatically an Orange County or LTCM. The revelation will take longer, we suspect, and so support Treasuries for that period and then some.”
Increasing Worries About the Economy, But Fed Not Likely to Rush Bailout
From Merrill Lynch: “Today's durable goods orders data only looked good next to the home sales report. While we are going to very likely see a 3%+ GDP growth for 2Q tomorrow, the number seems inconsequential for a forward-looking financial market. Stocks and bonds had priced in the second quarter inventory-led bounce a while ago. Not only do we enter the third quarter with no momentum on the consumer spending side, but after today's durables report, we have no growth being built into capex either. At the same time, housing remains in a full-blown recession and the spike in the durable goods I/S ratio in June to 1.48x from 1.46x in May, should cloud the 3Q production outlook. We have taken our 3Q real GDP growth forecast down to 1.7% (from 1.9%) and believe risks are squarely to the downside…The economy is clearly softening and the weakness from housing is clearly spreading out. The Fed is probably going to have to at least shift to a de facto neutral posture at the coming FOMC meeting on August 7th, especially with the sharp widening in credit spreads, the downturn in the equity market and the general pullback in risk appetite and lending further clouding what's already been a subdued economic outlook.”
From Lehman: “Fears of subprime mortgage contagion and a deeper housing recession continue to rattle financial markets. Housing data were decidedly weak, with larger-than-expected declines in existing and new home sales. We see downside risks to our downbeat forecast:”
From Dow Jones: “Home builders set off new alarm bells on the distressed U.S. housing market, with D.R. Horton Inc. and Beazer Homes USA Inc. posting losses, while WCI Communities Inc. admitted it can’t find a buyer for the ailing company. Those weren’t the only signs of stress: Beazer got a new line of credit that’s half the size of its previous one, signaling a greater tightening of money available to the industry. All of this indicates the worst housing slump in years – one that has scared buyers and lenders as inventories and foreclosures mount - won’t end any time soon. And it’s at the root of
the concerns slamming the stock market.”
From Morgan Stanley: “The Fed will not cut rates until this repricing of risk becomes a systemic problem that impacts the market's access to liquidity and leverage. In other
words, a good old fashioned liquidity crunch. Furthermore, Bernanke is not going
to cut rates and reward investors who bought products with very little risk
premium. There is no Bernanke put, at least not yet.”
Chinese Economists Recommend China Discontinue Purchasing US Mortgages
From The Asia Times: “While China is eager to invest a portion of its US$1.33 trillion foreign-exchange reserve overseas, it is unlikely to take a chance on buying additional US mortgage-backed securities (MBS) as they are now considered too risky, Chinese economists said… Yi Xianrong, a senior economist and finance professor with the Chinese Academy of Social Sciences, a central government think-tank, attributed the previous surge of mortgage-backed securities bought by Chinese companies to inexperience in conducting risk assessments and their miscalculation of the US property market. "After seeing how the property prices in China kept soaring, these Chinese companies never thought of the US property market as having problems and they bought a lot of mortgage-backed securities, particularly in the past two years," Yi told Asia Times Online. "Apart from underestimating the level of risk, the better returns offered by MBS over US Treasury bonds also made the Chinese investors unable to judge the high risk of the US mortgage market."… Yi said some bond ratings agencies that advise investors, including Chinese, also purposely played down the MBS risk. "Some ratings agencies slapped investment-grade ratings on mortgage-backed bonds that they knew they were risky," he charged. Bond-rating agencies this month finally downgraded about $12 billion worth of subprime US mortgage securities, Yi said. Economist Shi Weigan echoed Yi's comments. "With a possible burst in the housing bubble in the US, it's not the right choice for Beijing to spend foreign-exchange reserve funds on the US mortgage-backed securities," Shi said.”
Federal Government Expected to Go On a Hiring Spree as Baby-Boomers Retire
From CNN: “193,000 jobs will open up between now and 2009, according to the report, which is based on a detailed survey of 34 agencies representing about 99% of the federal workforce. Most of the hiring is due to two big factors - the aging of the workforce and the war on terror. Nearly one-third of the government's 1.6 million full-time employees are expected to retire over the next few years, and they all need to be replaced. At the same time, more than 83,000 jobs are being added at agencies charged with protecting the United States, including 47,897 jobs at the Department of Homeland Security and 35,505 at the Department of Defense…About 86% of federal jobs are located outside the D.C. area, and more than 50,000 are overseas. Cities with the greatest concentration of federal employees include Norfolk-Virginia Beach, Baltimore, Philadelphia, Atlanta, San Diego, New York City, Chicago, Salt Lake City, Oklahoma City, and Los Angeles. Uncle Sam is willing to be generous to the right candidates, offering "recruitment bonuses, retention incentives, [and] relocation incentives," the report says. Some positions will pay new hires' graduate-school tuition, and many offer student-loan repayments - up to $10,000 per year for a total of $60,000 - in exchange for at least three years of government service.”
MISC
From Bloomberg: “The risk of owning bonds of Wall Street firms soared as concerns escalated that investment banks will be hurt by losses from subprime mortgages and corporate debt… confidence has been sapped after hedge funds run by at least seven firms reported or forecast losses after the rout in securities backed by subprime mortgages, some of which have lost at least half their value as defaults among the riskiest borrowers rise. Slumping demand for high-yield, high-risk debt forced almost 40 companies to rework or abandon bond offerings in the past three weeks.”
From Dow Jones: “Risk-averse investors have been increasingly balking at junk bond offerings meant to replace bridge loans, which are temporary leveraged buyout financing extended by the banks. This has fueled worries that Wall Street banks will find themselves on the hook for risky, longer-term financing.”
From Dow Jones: “The dollar’s month-long declines against the yen took a decisive turn for the worse Thursday as volatility in global markets had investors scrambling to unwind the popular yen centered carry trade strategy, sending the Japanese currency soaring against its major rivals. More rough weather in U.S. stocks and declines in U.S.
Treasury yields amid higher oil prices and weaker-than-expected economic reports pushed the dollar to as low as Y118.86 during the New York session. That’s its lowest level since April…”
From Citi: “Consensus forecasters have habitually overestimed advance US GDP readings in recent years. Actual outcomes have come in beneath consensus 10 of the last 12 times.”
From Dow Jones: “Wells Fargo & Co.’s, the nation’s second-largest home lender, said it will stop making subprime mortgages through brokers amid escalating late payments and defaults that have been plaguing the entire mortgage industry. The closing of the subprime “wholesale lending” business, which accounted for 1.6% of Wells Fargo’s total home mortgages of $397.6 billion last year, reflects “the turmoil” in the market for risky mortgages, said Michael Lepore, executive vice president for institutional lending at the San Francisco bank. The business’s returns, he added, “have been consistently
diminishing since the first quarter.” Wells Fargo will continue to offer subprime loans - or those to less-than-creditworthy borrowers - “in channels where the company has direct relationships with consumers,” the bank said.”
From USA Today: “States are taking the lead in trying to combat what the Federal Trade Commission reports is the biggest concern to American consumers — identity theft — by limiting the ways thieves can collect Social Security numbers and other personal data. Since January, at least 35 states have considered bills that would further restrict the use of Social Security numbers to identify individuals, some even calling to remove the number from documents such as paychecks and police reports, according to the National Conference of State Legislatures.”
From Dow Jones: “Ford Motor Co. surprised Wall Street in announcing its first
profit in two years…:
From Dow Jones: “The Chicago Fed Midwest Manufacturing Index - a measure of manufacturing output in Illinois, Indiana, Iowa, Michigan and Wisconsin - remained unchanged in June…”
From RBSGC: “…yesterday saw the mortgage servicer remittance reports come out and show further payment slowdowns on subprime -- no surprise, perhaps, but no relief either. And today has rating agencies downgrading more debt (S&P doing this to some more ABS).”
End-of-Day Market Update
Treasury prices soared on panic flight to quality buying initiated by speculative buying in the morning and joined by real money buying in the afternoon. The 2y Treasury yield has fallen 15.5bp to 4.56%, while the 10y yield has fallen 12bp to 4.78%, causing the curve to steepen.
Equities hit the skids on high volume selling. The Dow is closing down 312 at 13,474. The S&P 500 dropped 36 to 1489, and Nasdaq fell 49 to 2599.
The dollar gave back some of yesterday’s gains, which some are attributing to central bank buying yesterday. The dollar index slid .20 to 80.45. Gold fell a substantial $12, as investors sought liquid investments to sell for cash gains to cover margin calls.
NY Oil futures fell 93 cents after hitting new highs for the year earlier in the trading session. The high oil price is being used to explain some of the weakness in equities today.
From Handelsbanken: “Reports of an Australian hedge fund limiting redemptions, disappointing earnings news from two more home builders, and rumours of liquidity problems at a couple of broker dealers extended the flight to quality rally in Treasury bonds and sparked large downward adjustments in equities and a slid in the dollar against the yen. The principal result of this increase in the risk premium discounted in the markets was bullish steepening of the Treasury yield curve and a dip in equities below key resistance at 13500 and 1500 on the Dow and the S&P… Continued deterioration in the sub-prime market and the derivative securities bases on these assets has prompted a sharp widening in credit spreads, especially for high yield debt. The long over due rise in the risk premium discounted in the domestic bond markets has also spilled over into equities and into the foreign exchange markets developing a self supporting loop of bad news. The deleveraging of the financial markets carries important implications not only for investors but also for the broader economy. Specifically, the economies ability to weather the consolidation in residential investment experienced over the past two years with only a marginal cut back in the pace of employment reflects the fact that excess liquidity in the economy was simply channelled into unaffected areas of the economy by efficient markets. On the other hand, a narrowing of the credit channel associated with more cautions bank lending decisions and the recent financial market rationing of credit to the most risky borrowers will keep the economy from living up to the relatively upbeat consensus forecast… The dynamics of a new more academic leaning FOMC and a desire on the part of policy makers to distance themselves from the “Greenspan put” implies that an orderly widening of credit spreads is not likely force a rate cut. Only a bank funding cries is likely to force the Fed’s hands before inflation is back well within the Committee’s comfort zone. The ongoing normalization of risk premium will be allowed to run as long as a flow of liquidity though the economy is not unexpected chocked off. Three things that market participant should monitor to determine if financial conditions are spiralling out of control: 1) swap and CDS spreads, 2) the strength of the yen, and 3) the on-the-run/off-the-run spread in the Treasury market. The interest rate swap market and CDS markets are good measures of the perceived risk in the economy and, in particular, the financial sector. A rising yen will reduce the liquidity coming into the economy from overseas and is likely to accelerate the deleveraging of the markets. The on-the-run/off-the-run spread provides a window into the perceived risk among major financial market participants.”
From Deutsche: “…one day does not make a trend and while emotions ran high, feels as though none of the topical concerns are going away soon.”
From JP Morgan: “Agencies have been absolutely hammered w/ 10s 9bp wider on the
day and trading at ~L-9.75bp. Lost in all of the credit meltdown, EM has taken it on the chin, w/ the EMBI index 28bp wider. Interestingly, mtge pass-thrus have cheapened significantly on sprd to USTs and swaps over the past week and a half, but when adjusted for the move in vol they haven't cheapened nearly as much...at this point it looks like mtge sprd positions are largely a vol trade.”
Implied Volatility Rising as Concerned Investors Buy Insurance
From Lehman: “Treasury Vols SCREAMING HIGHER - have gapped/repriced higher multiple times throughout the day.”
From Bloomberg: “The benchmark for U.S. stock volatility surged to the highest in 13 months on concern that bond market turmoil triggered by the subprime loan crisis will lead to bigger price swings. The Chicago Board Options Exchange Volatility Index jumped as much as 29 percent to 23.36, the highest since June 2006. Higher readings in the so-called VIX, derived from prices paid for options on the Standard & Poor's 500 Index, indicate traders expect bigger stock-market swings in the next 30 days. ``When it shoots up that means there's a great deal of uncertainty,'' …The S&P 500's slide today of as much as 3.5 percent, which would be the biggest closing decline since 2003, is a ``pretty good jab to the ribs.'' Spikes in the VIX have coincided with stock-market declines. The index rose the most ever on Feb. 27, climbing 64 percent to 18.31, as the U.S. equity market suffered the worst rout in almost four years[ when the Chinese stock market sold-off]. The VIX has come within 2 points of 50 on only three occasions in the past decade. The first, on Oct. 8, 1998, came as losses mounted from Russia defaulting on its debt. It reached another peak 10 days after the terrorist attacks in September 2001, and again surged in July 2002 as fallout from Enron Corp.'s collapse drove down shares of its main lenders and former rivals. …``People are panicking,…Volatility usually rises when you have big moves in the market and moves down tend to be more violent than moves up.'' When the S&P 500 reached a record high on July 19, the VIX finished the day at 15.23. While the S&P 500 has gained four straight years, the VIX has fallen every year since 2002. In November, the index fell below 10 for the first time since 1994 and in December fell to a 13-year low of 9.39. The number of shares changing hands also increased, another sign of volatility. Some 2.28 billion shares traded on the New York Stock Exchange as of 3:27 p.m., 88 percent more than the same time a week ago. In the U.K., the London Stock Exchange said 798,800 trades were made today, the most ever at the bourse.”
From RBSGC: “…in this environment of credit panic and illiquidity, you have the few actually trying (or succeeding) to get out or buy protection having an exaggerated influence and confusing already opaque price discovery. Where are we on all this? After such a massive move we are more interested in where yields stall than if they can continue and therein lies the rub. It's largely about credit spreads and we see no recovery, let alone relief, in sight and we deem this an ongoing event and, most certainly, credit risk premium is a structural, not a temporary, restoration. Besides, as we look at market positions and harp on neutral exposure vis a vis duration, we know that the overweight is in credit. What makes this liquidity/credit crunch different from others is that the risk is embedded into so many different funds, investments, and not so concentrated as to reveal quickly if traumatically an Orange County or LTCM. The revelation will take longer, we suspect, and so support Treasuries for that period and then some.”
Increasing Worries About the Economy, But Fed Not Likely to Rush Bailout
From Merrill Lynch: “Today's durable goods orders data only looked good next to the home sales report. While we are going to very likely see a 3%+ GDP growth for 2Q tomorrow, the number seems inconsequential for a forward-looking financial market. Stocks and bonds had priced in the second quarter inventory-led bounce a while ago. Not only do we enter the third quarter with no momentum on the consumer spending side, but after today's durables report, we have no growth being built into capex either. At the same time, housing remains in a full-blown recession and the spike in the durable goods I/S ratio in June to 1.48x from 1.46x in May, should cloud the 3Q production outlook. We have taken our 3Q real GDP growth forecast down to 1.7% (from 1.9%) and believe risks are squarely to the downside…The economy is clearly softening and the weakness from housing is clearly spreading out. The Fed is probably going to have to at least shift to a de facto neutral posture at the coming FOMC meeting on August 7th, especially with the sharp widening in credit spreads, the downturn in the equity market and the general pullback in risk appetite and lending further clouding what's already been a subdued economic outlook.”
From Lehman: “Fears of subprime mortgage contagion and a deeper housing recession continue to rattle financial markets. Housing data were decidedly weak, with larger-than-expected declines in existing and new home sales. We see downside risks to our downbeat forecast:”
From Dow Jones: “Home builders set off new alarm bells on the distressed U.S. housing market, with D.R. Horton Inc. and Beazer Homes USA Inc. posting losses, while WCI Communities Inc. admitted it can’t find a buyer for the ailing company. Those weren’t the only signs of stress: Beazer got a new line of credit that’s half the size of its previous one, signaling a greater tightening of money available to the industry. All of this indicates the worst housing slump in years – one that has scared buyers and lenders as inventories and foreclosures mount - won’t end any time soon. And it’s at the root of
the concerns slamming the stock market.”
From Morgan Stanley: “The Fed will not cut rates until this repricing of risk becomes a systemic problem that impacts the market's access to liquidity and leverage. In other
words, a good old fashioned liquidity crunch. Furthermore, Bernanke is not going
to cut rates and reward investors who bought products with very little risk
premium. There is no Bernanke put, at least not yet.”
Chinese Economists Recommend China Discontinue Purchasing US Mortgages
From The Asia Times: “While China is eager to invest a portion of its US$1.33 trillion foreign-exchange reserve overseas, it is unlikely to take a chance on buying additional US mortgage-backed securities (MBS) as they are now considered too risky, Chinese economists said… Yi Xianrong, a senior economist and finance professor with the Chinese Academy of Social Sciences, a central government think-tank, attributed the previous surge of mortgage-backed securities bought by Chinese companies to inexperience in conducting risk assessments and their miscalculation of the US property market. "After seeing how the property prices in China kept soaring, these Chinese companies never thought of the US property market as having problems and they bought a lot of mortgage-backed securities, particularly in the past two years," Yi told Asia Times Online. "Apart from underestimating the level of risk, the better returns offered by MBS over US Treasury bonds also made the Chinese investors unable to judge the high risk of the US mortgage market."… Yi said some bond ratings agencies that advise investors, including Chinese, also purposely played down the MBS risk. "Some ratings agencies slapped investment-grade ratings on mortgage-backed bonds that they knew they were risky," he charged. Bond-rating agencies this month finally downgraded about $12 billion worth of subprime US mortgage securities, Yi said. Economist Shi Weigan echoed Yi's comments. "With a possible burst in the housing bubble in the US, it's not the right choice for Beijing to spend foreign-exchange reserve funds on the US mortgage-backed securities," Shi said.”
Federal Government Expected to Go On a Hiring Spree as Baby-Boomers Retire
From CNN: “193,000 jobs will open up between now and 2009, according to the report, which is based on a detailed survey of 34 agencies representing about 99% of the federal workforce. Most of the hiring is due to two big factors - the aging of the workforce and the war on terror. Nearly one-third of the government's 1.6 million full-time employees are expected to retire over the next few years, and they all need to be replaced. At the same time, more than 83,000 jobs are being added at agencies charged with protecting the United States, including 47,897 jobs at the Department of Homeland Security and 35,505 at the Department of Defense…About 86% of federal jobs are located outside the D.C. area, and more than 50,000 are overseas. Cities with the greatest concentration of federal employees include Norfolk-Virginia Beach, Baltimore, Philadelphia, Atlanta, San Diego, New York City, Chicago, Salt Lake City, Oklahoma City, and Los Angeles. Uncle Sam is willing to be generous to the right candidates, offering "recruitment bonuses, retention incentives, [and] relocation incentives," the report says. Some positions will pay new hires' graduate-school tuition, and many offer student-loan repayments - up to $10,000 per year for a total of $60,000 - in exchange for at least three years of government service.”
MISC
From Bloomberg: “The risk of owning bonds of Wall Street firms soared as concerns escalated that investment banks will be hurt by losses from subprime mortgages and corporate debt… confidence has been sapped after hedge funds run by at least seven firms reported or forecast losses after the rout in securities backed by subprime mortgages, some of which have lost at least half their value as defaults among the riskiest borrowers rise. Slumping demand for high-yield, high-risk debt forced almost 40 companies to rework or abandon bond offerings in the past three weeks.”
From Dow Jones: “Risk-averse investors have been increasingly balking at junk bond offerings meant to replace bridge loans, which are temporary leveraged buyout financing extended by the banks. This has fueled worries that Wall Street banks will find themselves on the hook for risky, longer-term financing.”
From Dow Jones: “The dollar’s month-long declines against the yen took a decisive turn for the worse Thursday as volatility in global markets had investors scrambling to unwind the popular yen centered carry trade strategy, sending the Japanese currency soaring against its major rivals. More rough weather in U.S. stocks and declines in U.S.
Treasury yields amid higher oil prices and weaker-than-expected economic reports pushed the dollar to as low as Y118.86 during the New York session. That’s its lowest level since April…”
From Citi: “Consensus forecasters have habitually overestimed advance US GDP readings in recent years. Actual outcomes have come in beneath consensus 10 of the last 12 times.”
From Dow Jones: “Wells Fargo & Co.’s, the nation’s second-largest home lender, said it will stop making subprime mortgages through brokers amid escalating late payments and defaults that have been plaguing the entire mortgage industry. The closing of the subprime “wholesale lending” business, which accounted for 1.6% of Wells Fargo’s total home mortgages of $397.6 billion last year, reflects “the turmoil” in the market for risky mortgages, said Michael Lepore, executive vice president for institutional lending at the San Francisco bank. The business’s returns, he added, “have been consistently
diminishing since the first quarter.” Wells Fargo will continue to offer subprime loans - or those to less-than-creditworthy borrowers - “in channels where the company has direct relationships with consumers,” the bank said.”
From USA Today: “States are taking the lead in trying to combat what the Federal Trade Commission reports is the biggest concern to American consumers — identity theft — by limiting the ways thieves can collect Social Security numbers and other personal data. Since January, at least 35 states have considered bills that would further restrict the use of Social Security numbers to identify individuals, some even calling to remove the number from documents such as paychecks and police reports, according to the National Conference of State Legislatures.”
From Dow Jones: “Ford Motor Co. surprised Wall Street in announcing its first
profit in two years…:
From Dow Jones: “The Chicago Fed Midwest Manufacturing Index - a measure of manufacturing output in Illinois, Indiana, Iowa, Michigan and Wisconsin - remained unchanged in June…”
From RBSGC: “…yesterday saw the mortgage servicer remittance reports come out and show further payment slowdowns on subprime -- no surprise, perhaps, but no relief either. And today has rating agencies downgrading more debt (S&P doing this to some more ABS).”
End-of-Day Market Update
Treasury prices soared on panic flight to quality buying initiated by speculative buying in the morning and joined by real money buying in the afternoon. The 2y Treasury yield has fallen 15.5bp to 4.56%, while the 10y yield has fallen 12bp to 4.78%, causing the curve to steepen.
Equities hit the skids on high volume selling. The Dow is closing down 312 at 13,474. The S&P 500 dropped 36 to 1489, and Nasdaq fell 49 to 2599.
The dollar gave back some of yesterday’s gains, which some are attributing to central bank buying yesterday. The dollar index slid .20 to 80.45. Gold fell a substantial $12, as investors sought liquid investments to sell for cash gains to cover margin calls.
NY Oil futures fell 93 cents after hitting new highs for the year earlier in the trading session. The high oil price is being used to explain some of the weakness in equities today.
Today's Tidbits
An Overview
From Handelsbanken: “Reports of an Australian hedge fund limiting redemptions, disappointing earnings news from two more home builders, and rumours of liquidity problems at a couple of broker dealers extended the flight to quality rally in Treasury bonds and sparked large downward adjustments in equities and a slid in the dollar against the yen. The principal result of this increase in the risk premium discounted in the markets was bullish steepening of the Treasury yield curve and a dip in equities below key resistance at 13500 and 1500 on the Dow and the S&P… Continued deterioration in the sub-prime market and the derivative securities bases on these assets has prompted a sharp widening in credit spreads, especially for high yield debt. The long over due rise in the risk premium discounted in the domestic bond markets has also spilled over into equities and into the foreign exchange markets developing a self supporting loop of bad news. The deleveraging of the financial markets carries important implications not only for investors but also for the broader economy. Specifically, the economies ability to weather the consolidation in residential investment experienced over the past two years with only a marginal cut back in the pace of employment reflects the fact that excess liquidity in the economy was simply channelled into unaffected areas of the economy by efficient markets. On the other hand, a narrowing of the credit channel associated with more cautions bank lending decisions and the recent financial market rationing of credit to the most risky borrowers will keep the economy from living up to the relatively upbeat consensus forecast… The dynamics of a new more academic leaning FOMC and a desire on the part of policy makers to distance themselves from the “Greenspan put” implies that an orderly widening of credit spreads is not likely force a rate cut. Only a bank funding cries is likely to force the Fed’s hands before inflation is back well within the Committee’s comfort zone. The ongoing normalization of risk premium will be allowed to run as long as a flow of liquidity though the economy is not unexpected chocked off. Three things that market participant should monitor to determine if financial conditions are spiralling out of control: 1) swap and CDS spreads, 2) the strength of the yen, and 3) the on-the-run/off-the-run spread in the Treasury market. The interest rate swap market and CDS markets are good measures of the perceived risk in the economy and, in particular, the financial sector. A rising yen will reduce the liquidity coming into the economy from overseas and is likely to accelerate the deleveraging of the markets. The on-the-run/off-the-run spread provides a window into the perceived risk among major financial market participants.”
From Deutsche: “…one day does not make a trend and while emotions ran high, feels as though none of the topical concerns are going away soon.”
From JP Morgan: “Agencies have been absolutely hammered w/ 10s 9bp wider on the
day and trading at ~L-9.75bp. Lost in all of the credit meltdown, EM has taken it on the chin, w/ the EMBI index 28bp wider. Interestingly, mtge pass-thrus have cheapened significantly on sprd to USTs and swaps over the past week and a half, but when adjusted for the move in vol they haven't cheapened nearly as much...at this point it looks like mtge sprd positions are largely a vol trade.”
Implied Volatility Rising as Concerned Investors Buy Insurance
From Lehman: “Treasury Vols SCREAMING HIGHER - have gapped/repriced higher multiple times throughout the day.”
From Bloomberg: “The benchmark for U.S. stock volatility surged to the highest in 13 months on concern that bond market turmoil triggered by the subprime loan crisis will lead to bigger price swings. The Chicago Board Options Exchange Volatility Index jumped as much as 29 percent to 23.36, the highest since June 2006. Higher readings in the so-called VIX, derived from prices paid for options on the Standard & Poor's 500 Index, indicate traders expect bigger stock-market swings in the next 30 days. ``When it shoots up that means there's a great deal of uncertainty,'' …The S&P 500's slide today of as much as 3.5 percent, which would be the biggest closing decline since 2003, is a ``pretty good jab to the ribs.'' Spikes in the VIX have coincided with stock-market declines. The index rose the most ever on Feb. 27, climbing 64 percent to 18.31, as the U.S. equity market suffered the worst rout in almost four years[ when the Chinese stock market sold-off]. The VIX has come within 2 points of 50 on only three occasions in the past decade. The first, on Oct. 8, 1998, came as losses mounted from Russia defaulting on its debt. It reached another peak 10 days after the terrorist attacks in September 2001, and again surged in July 2002 as fallout from Enron Corp.'s collapse drove down shares of its main lenders and former rivals. …``People are panicking,…Volatility usually rises when you have big moves in the market and moves down tend to be more violent than moves up.'' When the S&P 500 reached a record high on July 19, the VIX finished the day at 15.23. While the S&P 500 has gained four straight years, the VIX has fallen every year since 2002. In November, the index fell below 10 for the first time since 1994 and in December fell to a 13-year low of 9.39. The number of shares changing hands also increased, another sign of volatility. Some 2.28 billion shares traded on the New York Stock Exchange as of 3:27 p.m., 88 percent more than the same time a week ago. In the U.K., the London Stock Exchange said 798,800 trades were made today, the most ever at the bourse.”
From RBSGC: “…in this environment of credit panic and illiquidity, you have the few actually trying (or succeeding) to get out or buy protection having an exaggerated influence and confusing already opaque price discovery. Where are we on all this? After such a massive move we are more interested in where yields stall than if they can continue and therein lies the rub. It's largely about credit spreads and we see no recovery, let alone relief, in sight and we deem this an ongoing event and, most certainly, credit risk premium is a structural, not a temporary, restoration. Besides, as we look at market positions and harp on neutral exposure vis a vis duration, we know that the overweight is in credit. What makes this liquidity/credit crunch different from others is that the risk is embedded into so many different funds, investments, and not so concentrated as to reveal quickly if traumatically an Orange County or LTCM. The revelation will take longer, we suspect, and so support Treasuries for that period and then some.”
Increasing Worries About the Economy, But Fed Not Likely to Rush Bailout
From Merrill Lynch: “Today's durable goods orders data only looked good next to the home sales report. While we are going to very likely see a 3%+ GDP growth for 2Q tomorrow, the number seems inconsequential for a forward-looking financial market. Stocks and bonds had priced in the second quarter inventory-led bounce a while ago. Not only do we enter the third quarter with no momentum on the consumer spending side, but after today's durables report, we have no growth being built into capex either. At the same time, housing remains in a full-blown recession and the spike in the durable goods I/S ratio in June to 1.48x from 1.46x in May, should cloud the 3Q production outlook. We have taken our 3Q real GDP growth forecast down to 1.7% (from 1.9%) and believe risks are squarely to the downside…The economy is clearly softening and the weakness from housing is clearly spreading out. The Fed is probably going to have to at least shift to a de facto neutral posture at the coming FOMC meeting on August 7th, especially with the sharp widening in credit spreads, the downturn in the equity market and the general pullback in risk appetite and lending further clouding what's already been a subdued economic outlook.”
From Lehman: “Fears of subprime mortgage contagion and a deeper housing recession continue to rattle financial markets. Housing data were decidedly weak, with larger-than-expected declines in existing and new home sales. We see downside risks to our downbeat forecast:”
From Dow Jones: “Home builders set off new alarm bells on the distressed U.S. housing market, with D.R. Horton Inc. and Beazer Homes USA Inc. posting losses, while WCI Communities Inc. admitted it can’t find a buyer for the ailing company. Those weren’t the only signs of stress: Beazer got a new line of credit that’s half the size of its previous one, signaling a greater tightening of money available to the industry. All of this indicates the worst housing slump in years – one that has scared buyers and lenders as inventories and foreclosures mount - won’t end any time soon. And it’s at the root of
the concerns slamming the stock market.”
From Morgan Stanley: “The Fed will not cut rates until this repricing of risk becomes a systemic problem that impacts the market's access to liquidity and leverage. In other
words, a good old fashioned liquidity crunch. Furthermore, Bernanke is not going
to cut rates and reward investors who bought products with very little risk
premium. There is no Bernanke put, at least not yet.”
Chinese Economists Recommend China Discontinue Purchasing US Mortgages
From The Asia Times: “While China is eager to invest a portion of its US$1.33 trillion foreign-exchange reserve overseas, it is unlikely to take a chance on buying additional US mortgage-backed securities (MBS) as they are now considered too risky, Chinese economists said… Yi Xianrong, a senior economist and finance professor with the Chinese Academy of Social Sciences, a central government think-tank, attributed the previous surge of mortgage-backed securities bought by Chinese companies to inexperience in conducting risk assessments and their miscalculation of the US property market. "After seeing how the property prices in China kept soaring, these Chinese companies never thought of the US property market as having problems and they bought a lot of mortgage-backed securities, particularly in the past two years," Yi told Asia Times Online. "Apart from underestimating the level of risk, the better returns offered by MBS over US Treasury bonds also made the Chinese investors unable to judge the high risk of the US mortgage market."… Yi said some bond ratings agencies that advise investors, including Chinese, also purposely played down the MBS risk. "Some ratings agencies slapped investment-grade ratings on mortgage-backed bonds that they knew they were risky," he charged. Bond-rating agencies this month finally downgraded about $12 billion worth of subprime US mortgage securities, Yi said. Economist Shi Weigan echoed Yi's comments. "With a possible burst in the housing bubble in the US, it's not the right choice for Beijing to spend foreign-exchange reserve funds on the US mortgage-backed securities," Shi said.”
Federal Government Expected to Go On a Hiring Spree as Baby-Boomers Retire
From CNN: “193,000 jobs will open up between now and 2009, according to the report, which is based on a detailed survey of 34 agencies representing about 99% of the federal workforce. Most of the hiring is due to two big factors - the aging of the workforce and the war on terror. Nearly one-third of the government's 1.6 million full-time employees are expected to retire over the next few years, and they all need to be replaced. At the same time, more than 83,000 jobs are being added at agencies charged with protecting the United States, including 47,897 jobs at the Department of Homeland Security and 35,505 at the Department of Defense…About 86% of federal jobs are located outside the D.C. area, and more than 50,000 are overseas. Cities with the greatest concentration of federal employees include Norfolk-Virginia Beach, Baltimore, Philadelphia, Atlanta, San Diego, New York City, Chicago, Salt Lake City, Oklahoma City, and Los Angeles. Uncle Sam is willing to be generous to the right candidates, offering "recruitment bonuses, retention incentives, [and] relocation incentives," the report says. Some positions will pay new hires' graduate-school tuition, and many offer student-loan repayments - up to $10,000 per year for a total of $60,000 - in exchange for at least three years of government service.”
MISC
From Bloomberg: “The risk of owning bonds of Wall Street firms soared as concerns escalated that investment banks will be hurt by losses from subprime mortgages and corporate debt… confidence has been sapped after hedge funds run by at least seven firms reported or forecast losses after the rout in securities backed by subprime mortgages, some of which have lost at least half their value as defaults among the riskiest borrowers rise. Slumping demand for high-yield, high-risk debt forced almost 40 companies to rework or abandon bond offerings in the past three weeks.”
From Dow Jones: “Risk-averse investors have been increasingly balking at junk bond offerings meant to replace bridge loans, which are temporary leveraged buyout financing extended by the banks. This has fueled worries that Wall Street banks will find themselves on the hook for risky, longer-term financing.”
From Dow Jones: “The dollar’s month-long declines against the yen took a decisive turn for the worse Thursday as volatility in global markets had investors scrambling to unwind the popular yen centered carry trade strategy, sending the Japanese currency soaring against its major rivals. More rough weather in U.S. stocks and declines in U.S.
Treasury yields amid higher oil prices and weaker-than-expected economic reports pushed the dollar to as low as Y118.86 during the New York session. That’s its lowest level since April…”
From Citi: “Consensus forecasters have habitually overestimed advance US GDP readings in recent years. Actual outcomes have come in beneath consensus 10 of the last 12 times.”
From Dow Jones: “Wells Fargo & Co.’s, the nation’s second-largest home lender, said it will stop making subprime mortgages through brokers amid escalating late payments and defaults that have been plaguing the entire mortgage industry. The closing of the subprime “wholesale lending” business, which accounted for 1.6% of Wells Fargo’s total home mortgages of $397.6 billion last year, reflects “the turmoil” in the market for risky mortgages, said Michael Lepore, executive vice president for institutional lending at the San Francisco bank. The business’s returns, he added, “have been consistently
diminishing since the first quarter.” Wells Fargo will continue to offer subprime loans - or those to less-than-creditworthy borrowers - “in channels where the company has direct relationships with consumers,” the bank said.”
From USA Today: “States are taking the lead in trying to combat what the Federal Trade Commission reports is the biggest concern to American consumers — identity theft — by limiting the ways thieves can collect Social Security numbers and other personal data. Since January, at least 35 states have considered bills that would further restrict the use of Social Security numbers to identify individuals, some even calling to remove the number from documents such as paychecks and police reports, according to the National Conference of State Legislatures.”
From Dow Jones: “Ford Motor Co. surprised Wall Street in announcing its first
profit in two years…:
From Dow Jones: “The Chicago Fed Midwest Manufacturing Index - a measure of manufacturing output in Illinois, Indiana, Iowa, Michigan and Wisconsin - remained unchanged in June…”
From RBSGC: “…yesterday saw the mortgage servicer remittance reports come out and show further payment slowdowns on subprime -- no surprise, perhaps, but no relief either. And today has rating agencies downgrading more debt (S&P doing this to some more ABS).”
End-of-Day Market Update
Treasury prices soared on panic flight to quality buying initiated by speculative buying in the morning and joined by real money buying in the afternoon. The 2y Treasury yield has fallen 15.5bp to 4.56%, while the 10y yield has fallen 12bp to 4.78%, causing the curve to steepen.
Equities hit the skids on high volume selling. The Dow is closing down 312 at 13,474. The S&P 500 dropped 36 to 1489, and Nasdaq fell 49 to 2599.
The dollar gave back some of yesterday’s gains, which some are attributing to central bank buying yesterday. The dollar index slid .20 to 80.45. Gold fell a substantial $12, as investors sought liquid investments to sell for cash gains to cover margin calls.
NY Oil futures fell 93 cents after hitting new highs for the year earlier in the trading session. The high oil price is being used to explain some of the weakness in equities today.
From Handelsbanken: “Reports of an Australian hedge fund limiting redemptions, disappointing earnings news from two more home builders, and rumours of liquidity problems at a couple of broker dealers extended the flight to quality rally in Treasury bonds and sparked large downward adjustments in equities and a slid in the dollar against the yen. The principal result of this increase in the risk premium discounted in the markets was bullish steepening of the Treasury yield curve and a dip in equities below key resistance at 13500 and 1500 on the Dow and the S&P… Continued deterioration in the sub-prime market and the derivative securities bases on these assets has prompted a sharp widening in credit spreads, especially for high yield debt. The long over due rise in the risk premium discounted in the domestic bond markets has also spilled over into equities and into the foreign exchange markets developing a self supporting loop of bad news. The deleveraging of the financial markets carries important implications not only for investors but also for the broader economy. Specifically, the economies ability to weather the consolidation in residential investment experienced over the past two years with only a marginal cut back in the pace of employment reflects the fact that excess liquidity in the economy was simply channelled into unaffected areas of the economy by efficient markets. On the other hand, a narrowing of the credit channel associated with more cautions bank lending decisions and the recent financial market rationing of credit to the most risky borrowers will keep the economy from living up to the relatively upbeat consensus forecast… The dynamics of a new more academic leaning FOMC and a desire on the part of policy makers to distance themselves from the “Greenspan put” implies that an orderly widening of credit spreads is not likely force a rate cut. Only a bank funding cries is likely to force the Fed’s hands before inflation is back well within the Committee’s comfort zone. The ongoing normalization of risk premium will be allowed to run as long as a flow of liquidity though the economy is not unexpected chocked off. Three things that market participant should monitor to determine if financial conditions are spiralling out of control: 1) swap and CDS spreads, 2) the strength of the yen, and 3) the on-the-run/off-the-run spread in the Treasury market. The interest rate swap market and CDS markets are good measures of the perceived risk in the economy and, in particular, the financial sector. A rising yen will reduce the liquidity coming into the economy from overseas and is likely to accelerate the deleveraging of the markets. The on-the-run/off-the-run spread provides a window into the perceived risk among major financial market participants.”
From Deutsche: “…one day does not make a trend and while emotions ran high, feels as though none of the topical concerns are going away soon.”
From JP Morgan: “Agencies have been absolutely hammered w/ 10s 9bp wider on the
day and trading at ~L-9.75bp. Lost in all of the credit meltdown, EM has taken it on the chin, w/ the EMBI index 28bp wider. Interestingly, mtge pass-thrus have cheapened significantly on sprd to USTs and swaps over the past week and a half, but when adjusted for the move in vol they haven't cheapened nearly as much...at this point it looks like mtge sprd positions are largely a vol trade.”
Implied Volatility Rising as Concerned Investors Buy Insurance
From Lehman: “Treasury Vols SCREAMING HIGHER - have gapped/repriced higher multiple times throughout the day.”
From Bloomberg: “The benchmark for U.S. stock volatility surged to the highest in 13 months on concern that bond market turmoil triggered by the subprime loan crisis will lead to bigger price swings. The Chicago Board Options Exchange Volatility Index jumped as much as 29 percent to 23.36, the highest since June 2006. Higher readings in the so-called VIX, derived from prices paid for options on the Standard & Poor's 500 Index, indicate traders expect bigger stock-market swings in the next 30 days. ``When it shoots up that means there's a great deal of uncertainty,'' …The S&P 500's slide today of as much as 3.5 percent, which would be the biggest closing decline since 2003, is a ``pretty good jab to the ribs.'' Spikes in the VIX have coincided with stock-market declines. The index rose the most ever on Feb. 27, climbing 64 percent to 18.31, as the U.S. equity market suffered the worst rout in almost four years[ when the Chinese stock market sold-off]. The VIX has come within 2 points of 50 on only three occasions in the past decade. The first, on Oct. 8, 1998, came as losses mounted from Russia defaulting on its debt. It reached another peak 10 days after the terrorist attacks in September 2001, and again surged in July 2002 as fallout from Enron Corp.'s collapse drove down shares of its main lenders and former rivals. …``People are panicking,…Volatility usually rises when you have big moves in the market and moves down tend to be more violent than moves up.'' When the S&P 500 reached a record high on July 19, the VIX finished the day at 15.23. While the S&P 500 has gained four straight years, the VIX has fallen every year since 2002. In November, the index fell below 10 for the first time since 1994 and in December fell to a 13-year low of 9.39. The number of shares changing hands also increased, another sign of volatility. Some 2.28 billion shares traded on the New York Stock Exchange as of 3:27 p.m., 88 percent more than the same time a week ago. In the U.K., the London Stock Exchange said 798,800 trades were made today, the most ever at the bourse.”
From RBSGC: “…in this environment of credit panic and illiquidity, you have the few actually trying (or succeeding) to get out or buy protection having an exaggerated influence and confusing already opaque price discovery. Where are we on all this? After such a massive move we are more interested in where yields stall than if they can continue and therein lies the rub. It's largely about credit spreads and we see no recovery, let alone relief, in sight and we deem this an ongoing event and, most certainly, credit risk premium is a structural, not a temporary, restoration. Besides, as we look at market positions and harp on neutral exposure vis a vis duration, we know that the overweight is in credit. What makes this liquidity/credit crunch different from others is that the risk is embedded into so many different funds, investments, and not so concentrated as to reveal quickly if traumatically an Orange County or LTCM. The revelation will take longer, we suspect, and so support Treasuries for that period and then some.”
Increasing Worries About the Economy, But Fed Not Likely to Rush Bailout
From Merrill Lynch: “Today's durable goods orders data only looked good next to the home sales report. While we are going to very likely see a 3%+ GDP growth for 2Q tomorrow, the number seems inconsequential for a forward-looking financial market. Stocks and bonds had priced in the second quarter inventory-led bounce a while ago. Not only do we enter the third quarter with no momentum on the consumer spending side, but after today's durables report, we have no growth being built into capex either. At the same time, housing remains in a full-blown recession and the spike in the durable goods I/S ratio in June to 1.48x from 1.46x in May, should cloud the 3Q production outlook. We have taken our 3Q real GDP growth forecast down to 1.7% (from 1.9%) and believe risks are squarely to the downside…The economy is clearly softening and the weakness from housing is clearly spreading out. The Fed is probably going to have to at least shift to a de facto neutral posture at the coming FOMC meeting on August 7th, especially with the sharp widening in credit spreads, the downturn in the equity market and the general pullback in risk appetite and lending further clouding what's already been a subdued economic outlook.”
From Lehman: “Fears of subprime mortgage contagion and a deeper housing recession continue to rattle financial markets. Housing data were decidedly weak, with larger-than-expected declines in existing and new home sales. We see downside risks to our downbeat forecast:”
From Dow Jones: “Home builders set off new alarm bells on the distressed U.S. housing market, with D.R. Horton Inc. and Beazer Homes USA Inc. posting losses, while WCI Communities Inc. admitted it can’t find a buyer for the ailing company. Those weren’t the only signs of stress: Beazer got a new line of credit that’s half the size of its previous one, signaling a greater tightening of money available to the industry. All of this indicates the worst housing slump in years – one that has scared buyers and lenders as inventories and foreclosures mount - won’t end any time soon. And it’s at the root of
the concerns slamming the stock market.”
From Morgan Stanley: “The Fed will not cut rates until this repricing of risk becomes a systemic problem that impacts the market's access to liquidity and leverage. In other
words, a good old fashioned liquidity crunch. Furthermore, Bernanke is not going
to cut rates and reward investors who bought products with very little risk
premium. There is no Bernanke put, at least not yet.”
Chinese Economists Recommend China Discontinue Purchasing US Mortgages
From The Asia Times: “While China is eager to invest a portion of its US$1.33 trillion foreign-exchange reserve overseas, it is unlikely to take a chance on buying additional US mortgage-backed securities (MBS) as they are now considered too risky, Chinese economists said… Yi Xianrong, a senior economist and finance professor with the Chinese Academy of Social Sciences, a central government think-tank, attributed the previous surge of mortgage-backed securities bought by Chinese companies to inexperience in conducting risk assessments and their miscalculation of the US property market. "After seeing how the property prices in China kept soaring, these Chinese companies never thought of the US property market as having problems and they bought a lot of mortgage-backed securities, particularly in the past two years," Yi told Asia Times Online. "Apart from underestimating the level of risk, the better returns offered by MBS over US Treasury bonds also made the Chinese investors unable to judge the high risk of the US mortgage market."… Yi said some bond ratings agencies that advise investors, including Chinese, also purposely played down the MBS risk. "Some ratings agencies slapped investment-grade ratings on mortgage-backed bonds that they knew they were risky," he charged. Bond-rating agencies this month finally downgraded about $12 billion worth of subprime US mortgage securities, Yi said. Economist Shi Weigan echoed Yi's comments. "With a possible burst in the housing bubble in the US, it's not the right choice for Beijing to spend foreign-exchange reserve funds on the US mortgage-backed securities," Shi said.”
Federal Government Expected to Go On a Hiring Spree as Baby-Boomers Retire
From CNN: “193,000 jobs will open up between now and 2009, according to the report, which is based on a detailed survey of 34 agencies representing about 99% of the federal workforce. Most of the hiring is due to two big factors - the aging of the workforce and the war on terror. Nearly one-third of the government's 1.6 million full-time employees are expected to retire over the next few years, and they all need to be replaced. At the same time, more than 83,000 jobs are being added at agencies charged with protecting the United States, including 47,897 jobs at the Department of Homeland Security and 35,505 at the Department of Defense…About 86% of federal jobs are located outside the D.C. area, and more than 50,000 are overseas. Cities with the greatest concentration of federal employees include Norfolk-Virginia Beach, Baltimore, Philadelphia, Atlanta, San Diego, New York City, Chicago, Salt Lake City, Oklahoma City, and Los Angeles. Uncle Sam is willing to be generous to the right candidates, offering "recruitment bonuses, retention incentives, [and] relocation incentives," the report says. Some positions will pay new hires' graduate-school tuition, and many offer student-loan repayments - up to $10,000 per year for a total of $60,000 - in exchange for at least three years of government service.”
MISC
From Bloomberg: “The risk of owning bonds of Wall Street firms soared as concerns escalated that investment banks will be hurt by losses from subprime mortgages and corporate debt… confidence has been sapped after hedge funds run by at least seven firms reported or forecast losses after the rout in securities backed by subprime mortgages, some of which have lost at least half their value as defaults among the riskiest borrowers rise. Slumping demand for high-yield, high-risk debt forced almost 40 companies to rework or abandon bond offerings in the past three weeks.”
From Dow Jones: “Risk-averse investors have been increasingly balking at junk bond offerings meant to replace bridge loans, which are temporary leveraged buyout financing extended by the banks. This has fueled worries that Wall Street banks will find themselves on the hook for risky, longer-term financing.”
From Dow Jones: “The dollar’s month-long declines against the yen took a decisive turn for the worse Thursday as volatility in global markets had investors scrambling to unwind the popular yen centered carry trade strategy, sending the Japanese currency soaring against its major rivals. More rough weather in U.S. stocks and declines in U.S.
Treasury yields amid higher oil prices and weaker-than-expected economic reports pushed the dollar to as low as Y118.86 during the New York session. That’s its lowest level since April…”
From Citi: “Consensus forecasters have habitually overestimed advance US GDP readings in recent years. Actual outcomes have come in beneath consensus 10 of the last 12 times.”
From Dow Jones: “Wells Fargo & Co.’s, the nation’s second-largest home lender, said it will stop making subprime mortgages through brokers amid escalating late payments and defaults that have been plaguing the entire mortgage industry. The closing of the subprime “wholesale lending” business, which accounted for 1.6% of Wells Fargo’s total home mortgages of $397.6 billion last year, reflects “the turmoil” in the market for risky mortgages, said Michael Lepore, executive vice president for institutional lending at the San Francisco bank. The business’s returns, he added, “have been consistently
diminishing since the first quarter.” Wells Fargo will continue to offer subprime loans - or those to less-than-creditworthy borrowers - “in channels where the company has direct relationships with consumers,” the bank said.”
From USA Today: “States are taking the lead in trying to combat what the Federal Trade Commission reports is the biggest concern to American consumers — identity theft — by limiting the ways thieves can collect Social Security numbers and other personal data. Since January, at least 35 states have considered bills that would further restrict the use of Social Security numbers to identify individuals, some even calling to remove the number from documents such as paychecks and police reports, according to the National Conference of State Legislatures.”
From Dow Jones: “Ford Motor Co. surprised Wall Street in announcing its first
profit in two years…:
From Dow Jones: “The Chicago Fed Midwest Manufacturing Index - a measure of manufacturing output in Illinois, Indiana, Iowa, Michigan and Wisconsin - remained unchanged in June…”
From RBSGC: “…yesterday saw the mortgage servicer remittance reports come out and show further payment slowdowns on subprime -- no surprise, perhaps, but no relief either. And today has rating agencies downgrading more debt (S&P doing this to some more ABS).”
End-of-Day Market Update
Treasury prices soared on panic flight to quality buying initiated by speculative buying in the morning and joined by real money buying in the afternoon. The 2y Treasury yield has fallen 15.5bp to 4.56%, while the 10y yield has fallen 12bp to 4.78%, causing the curve to steepen.
Equities hit the skids on high volume selling. The Dow is closing down 312 at 13,474. The S&P 500 dropped 36 to 1489, and Nasdaq fell 49 to 2599.
The dollar gave back some of yesterday’s gains, which some are attributing to central bank buying yesterday. The dollar index slid .20 to 80.45. Gold fell a substantial $12, as investors sought liquid investments to sell for cash gains to cover margin calls.
NY Oil futures fell 93 cents after hitting new highs for the year earlier in the trading session. The high oil price is being used to explain some of the weakness in equities today.
New Home Sales Tumble
New home sales plummeted, dropping -6.6% MoM (consensus -2.7% MoM). This is the largest monthly drop since January, and puts monthly sales just above the 7 year low reached in March. New home sales have declined -22% versus a year ago.
Inventories rose to 7.8 months, based on the current sales pace, an increase from May's 7.4 months supply, but still below the 8.3 month high set in March. Homes completed and waiting for sale declined by 2,000 last month.
The South was the only region to see an increase in sales, rising 7.6% MoM. The other three regions saw substantial declines. New home purchases fell -27% in the Northeast, -23% in the West, and -17% in the Midwest.
Median new home prices fell -2.2% YoY.
New home sales normally account for about 15% of monthly home purchases.
Interest rates have fallen dramatically this morning. The 10y Treasury yield is down 10bp, to 4.80%, a level last seen in April. The 2y Treasury yield has fallen an even greater -14bp, causing the yield curve to steepen by 4bp.
Inventories rose to 7.8 months, based on the current sales pace, an increase from May's 7.4 months supply, but still below the 8.3 month high set in March. Homes completed and waiting for sale declined by 2,000 last month.
The South was the only region to see an increase in sales, rising 7.6% MoM. The other three regions saw substantial declines. New home purchases fell -27% in the Northeast, -23% in the West, and -17% in the Midwest.
Median new home prices fell -2.2% YoY.
New home sales normally account for about 15% of monthly home purchases.
Interest rates have fallen dramatically this morning. The 10y Treasury yield is down 10bp, to 4.80%, a level last seen in April. The 2y Treasury yield has fallen an even greater -14bp, causing the yield curve to steepen by 4bp.
Durable Goods Recovery Focused on Aircraft Demand
Total durable goods orders rose +1.4% MoM in June (consensus +1.9%), but this was offset by the reduction in May's decline to -2.3% MoM from the originally reported decrease of -2.8%. Most of the gain was tied to an increase in aircraft orders at Boeing (+29% MoM in June versus -21% MoM in May. +59% YoY), a normally volatile figure. Over the past year, new orders have fallen -1.3% YoY.
The more important issue today was the decline in durables excluding transportation which unexpectedly declined -.5% MoM (consensus +.6%). Ex-transportation orders have now fallen two months in a row, and raises concerns about the robustness of business investment, or capex. The good news here is that last month's decline in ex-transportation durable goods orders, for items meant to last several years, was revised to -.2% from -1% MoM. Versus a year ago, new orders ex-transportation have fallen -2.5% YoY. Transportation orders have risen +1.5% YoY, and they rose +6.1% MoM in June.
Capital goods orders +2.7% MoM while shipments fell -.5% MoM. Over the past year, capital goods orders have only risen +.3% YoY.
Non-defense capital goods orders excluding aircraft, which is viewed as a good proxy for future business investment, also fell again in June, declining -.7% MoM after falling an even larger -1.5% MoM in May. Shipments of this subgroup are used to calculate GDP, and they also fell in June, down -.4% MoM after rising +.7% MoM in May. Unfilled orders though grew +.7% MoM in June. The weakness in this category's growth in June is tied to lower demand for computers (-4.6% MoM), communications equipment, metals, and defense orders (-14% MoM). Ex-military demand grew 1.9% MoM in June after falling -2.7% MoM in May. The decline in defense spending still surprises (-38% YoY) me after many years of war. Isn't the government having to replace a lot of worn out and damaged equipment?
This report pulls into question the recent strength in manufacturing, and whether firms are investing in future growth. Weaker domestic consumer demand is being somewhat offset by rising export demand for U.S. durable goods. The decline in shipments (-1.1% MoM) after three months of gains is also something to watch as durable goods inventories rose a modest +.2% MoM. Factories appear to want to keep inventory growth contained after having to draw down excess inventories earlier this year. The good news is that unfilled orders are rising.
Second quarter GDP estimates are being left unchanged based on this data.
*****************
Jobless claims were lower than expected at 301k (310k consensus) and down slightly from last week's revised level of 303k.
The more important issue today was the decline in durables excluding transportation which unexpectedly declined -.5% MoM (consensus +.6%). Ex-transportation orders have now fallen two months in a row, and raises concerns about the robustness of business investment, or capex. The good news here is that last month's decline in ex-transportation durable goods orders, for items meant to last several years, was revised to -.2% from -1% MoM. Versus a year ago, new orders ex-transportation have fallen -2.5% YoY. Transportation orders have risen +1.5% YoY, and they rose +6.1% MoM in June.
Capital goods orders +2.7% MoM while shipments fell -.5% MoM. Over the past year, capital goods orders have only risen +.3% YoY.
Non-defense capital goods orders excluding aircraft, which is viewed as a good proxy for future business investment, also fell again in June, declining -.7% MoM after falling an even larger -1.5% MoM in May. Shipments of this subgroup are used to calculate GDP, and they also fell in June, down -.4% MoM after rising +.7% MoM in May. Unfilled orders though grew +.7% MoM in June. The weakness in this category's growth in June is tied to lower demand for computers (-4.6% MoM), communications equipment, metals, and defense orders (-14% MoM). Ex-military demand grew 1.9% MoM in June after falling -2.7% MoM in May. The decline in defense spending still surprises (-38% YoY) me after many years of war. Isn't the government having to replace a lot of worn out and damaged equipment?
This report pulls into question the recent strength in manufacturing, and whether firms are investing in future growth. Weaker domestic consumer demand is being somewhat offset by rising export demand for U.S. durable goods. The decline in shipments (-1.1% MoM) after three months of gains is also something to watch as durable goods inventories rose a modest +.2% MoM. Factories appear to want to keep inventory growth contained after having to draw down excess inventories earlier this year. The good news is that unfilled orders are rising.
Second quarter GDP estimates are being left unchanged based on this data.
*****************
Jobless claims were lower than expected at 301k (310k consensus) and down slightly from last week's revised level of 303k.
Wednesday, July 25, 2007
Today's Tidbits
IMF Says China Now World’s Engine of Growth, Not U.S.
From Dow Jones: “Global economic output is growing even faster than expected just a couple of months ago, fueled by demand in China, India and other developing countries, the International Monetary Fund said. The IMF slightly lowered its 2008 forecast for the U.S. economy, the engine of growth for the world for many years, to 2.0% this year, and 2.8% for 2007. China, whose economy should expand 11.2% this year and another 10.5% next, has for the first time become the largest contributor to global growth with output measured both in terms of purchasing power and at market exchange rates, the IMF said. These latest forecasts are about a percentage point higher for both years than the IMF had predicted in April. China alone will account for about a quarter of global growth this year, IMF officials said. China, Russia and India together are likely to contribute about half of world output growth, they said.”
Health Care Premiums Likely to Eat-Up Wage Gains in 2008
From CNN: “Compensation experts are predicting average base pay increases below 4 percent next year - and a lot of that may go to higher health insurance costs, according to early estimates. If you want to fatten your paycheck in 2008 without changing jobs, your best bet rides on the bonus….Base pay increases are expected to be modest at best, even for star players. Since base pay is one of a company's largest expenses, there's a big push to keep a lid on fixed costs…Hewitt and Mercer Human Resource Consulting each are surveying up to 1,000 companies, and their preliminary findings suggest base pay will increase by an average of 3.8 percent…Typically, Abosch sees bonuses ranging from 5 percent of pay up to 40 percent, and not just in sales jobs. The lower end of the range is usually reserved for entry-level employees, the mid-level range (15 percent to 20 percent) for middle managers and professionals, and the high end (30 percent to 40 percent) for upper-level management. Of course, not every company makes their bonus program transparent. They just announce what you got when they pay it out, as if they just discovered an extra pot of money and decided to dole it out. That doesn't do a very good job of communicating the tie between your performance and your pay. If at this point in the year, you're not clear what is expected of you to earn the maximum base pay increase and bonus, talk to your manager about it. If you need added incentive, consider this: Your share of health care costs at work very likely will rise and eat up a significant portion of your base pay bump. "In general we're still seeing double-digit increases in healthcare costs. And most employers are passing the majority of that increased cost directly to employees," Abosch said. Last year, for instance, premium costs grew at more than twice the level of wage growth and inflation - and that was the slowest rate of growth since 2000, according to the Kaiser Family Foundation. Looking ahead, a Hewitt analysis of HMO rates at 160 large companies found that initial 2008 rate increases for HMOs were averaging 14.1 percent …”
Leveraged Buy-Out Financing Under Stress
From Dow Jones: “The sale of $12 billion of loans to support the main auto division of Chrysler was delayed for a second time Wednesday in the biggest deal yet to stumble amid slackening investor demand for leveraged loans and high-yield debt.”
From Bloomberg: “Deutsche Bank AG, JPMorgan Chase & Co. and six more banks are stuck with …$10 billion) of loans for Kohlberg Kravis Roberts & Co.'s purchase of Alliance Boots Plc. The banks will keep the senior loans after failing to find investors to buy them…KKR, Blackstone Group LP and other private equity firms will need to make further concessions to borrow the $300 billion Bear Stearns Cos. says they need to pay for buyouts already agreed. ``It's certainly a bad signal to the market,'' said David Watts, a strategist in London at research firm CreditSights Inc. ``It not only makes private equity more reluctant to do deals but also the banks. Banks don't want to be stuck with the bridge loans. You're not going to want to stick your neck out.''”
From Merrill Lynch: “With the debt markets quickly moving to ration credit, the probability of companies being "taken out" is plummeting…”
From RBSGC: “For those who ponder the Fed, we have to note that a steady 5.25% funds rate for a year masks what else has been going on. To wit, with wider credit spreads the market has given the Fed a hike or two and that process is clearly having some repercussions; witness Expedia cutting back on its buyback and Chrysler's debt issuance postponed as bankers provide the loan themselves. These are the ripple effects of what started in the US housing market over a year ago and in its most basic form translates to rising risk premium… If it were only a story of the economic data, yields would be higher for sure…”
MISC
From Goldman Sachs: “No major surprises [in Fed’s Beige Book Report]--consumers slow, manufacturing activity firm, price and wage trends manageable despite commodity pressures on the price side and shortages of skilled workers on the wage side. Nothing here to change our view that Fed policy will remain on hold.”
From Dow Jones: “The lower-rated risky slices of the ABX index hit record lows as data on subprime loan performance were released by banks who hold the loans. The BBB- slice of the index based on loans made in the second half of 2006 was quoted at 40 cents on the dollar,…”
From The Financial Times: “Foreign earnings came to the rescue of a slew of US multinationals on Tuesday, offsetting weakness in the domestic economy and highlighting their growing reliance on the rest of the world… the results season has been characterised by the increased importance of US companies’ international operations, which have been helped by the weakness in the dollar and rapid growth in emerging markets.”
From The Wall Street Journal: “The freight slowdown that began last year is rippling through the second-quarter results of big transportation companies, whose largely disappointing profits indicate the weak housing and manufacturing markets, on top of high fuel prices, remain a drag on economic growth.
Growth in revenue and delivery volume continue to slow at United Parcel Service Inc., the world's largest package handler in terms of daily shipments. UPS reported its lowest profit growth in nearly three years -- 4% on net income -- and for the second quarter in a row showed essentially no volume growth.”
From The U.S. Treasury: “The vast majority of the Latin American population functions exclusively in a cash and barter economy. More than 70 percent of the residents of most Latin American economies do not use basic financial services such as deposit and transaction accounts, according to World Bank estimates.”
From Market News: “China's insurance regulator said insurers will be allowed to invest up to 15 pct of their total assets in overseas markets…the China Insurance Regulatory Commission (CIRC) said insurers will be able to invest in equities products, including options.”
From Bloomberg: “Japan's trade surplus …expanded 53.4 …from a year earlier… Exports climbed 16.2 percent…The yen fell to a record against the euro in June and 6.5 percent versus the dollar from a year earlier…Exports to the U.S. advanced 6.7 percent …in June… after barely rising in May and falling in April for the first time in two years…Shipments to China surged 22.6 percent to a record …and exports to Asia gained 15.8 percent…Exports to the European Union climbed 16.3 percent … the second highest on record…Half of Japan's exports were traded in dollars in the first half of 2007 compared with 38 percent in yen and 8.7 percent in euros…Export volumes, which don't take into account price and currency fluctuations, rose 6.1 percent in June.”
End-of-Day Market Update
Treasuries rallied a little more today, causing yields to decline by a basis point on the wings (2s and 30s) while better buying caused yields in the belly of the curve to drop 1.5bp (5s and 10s). Ten year Treasury yields are closing at 4.90% (down 1.2bp).
Equities rallied +.5%, recovering approx 30% of yesterday’s losses in the case of the Dow, which gained 68 points. The S&P is settling up 7 points, for a recovery of 17.5% of the prior day’s slump. The VIX index of equity volatility hit a new high, on the open this morning since the Chinese stock market panic of March, when it spiked to almost 19.5. Nervousness faded as equities rallied, and the index closed .5 lower at 18.1. Volatilities for most financial instruments have risen recently.
The Dollar rebounded strongly, from multi-year lows, in the overseas markets overnight. The dollar index opened 50bp higher in NY and held the gain throughout the day settling at 80.61.
Oil rallied over a dollar after government reports indicated inventories fell for the third straight week. Refinery utilization is at a ten month high, indicating rising demand for gasoline. The UK has also had a major refinery shut down.
From Dow Jones: “Global economic output is growing even faster than expected just a couple of months ago, fueled by demand in China, India and other developing countries, the International Monetary Fund said. The IMF slightly lowered its 2008 forecast for the U.S. economy, the engine of growth for the world for many years, to 2.0% this year, and 2.8% for 2007. China, whose economy should expand 11.2% this year and another 10.5% next, has for the first time become the largest contributor to global growth with output measured both in terms of purchasing power and at market exchange rates, the IMF said. These latest forecasts are about a percentage point higher for both years than the IMF had predicted in April. China alone will account for about a quarter of global growth this year, IMF officials said. China, Russia and India together are likely to contribute about half of world output growth, they said.”
Health Care Premiums Likely to Eat-Up Wage Gains in 2008
From CNN: “Compensation experts are predicting average base pay increases below 4 percent next year - and a lot of that may go to higher health insurance costs, according to early estimates. If you want to fatten your paycheck in 2008 without changing jobs, your best bet rides on the bonus….Base pay increases are expected to be modest at best, even for star players. Since base pay is one of a company's largest expenses, there's a big push to keep a lid on fixed costs…Hewitt and Mercer Human Resource Consulting each are surveying up to 1,000 companies, and their preliminary findings suggest base pay will increase by an average of 3.8 percent…Typically, Abosch sees bonuses ranging from 5 percent of pay up to 40 percent, and not just in sales jobs. The lower end of the range is usually reserved for entry-level employees, the mid-level range (15 percent to 20 percent) for middle managers and professionals, and the high end (30 percent to 40 percent) for upper-level management. Of course, not every company makes their bonus program transparent. They just announce what you got when they pay it out, as if they just discovered an extra pot of money and decided to dole it out. That doesn't do a very good job of communicating the tie between your performance and your pay. If at this point in the year, you're not clear what is expected of you to earn the maximum base pay increase and bonus, talk to your manager about it. If you need added incentive, consider this: Your share of health care costs at work very likely will rise and eat up a significant portion of your base pay bump. "In general we're still seeing double-digit increases in healthcare costs. And most employers are passing the majority of that increased cost directly to employees," Abosch said. Last year, for instance, premium costs grew at more than twice the level of wage growth and inflation - and that was the slowest rate of growth since 2000, according to the Kaiser Family Foundation. Looking ahead, a Hewitt analysis of HMO rates at 160 large companies found that initial 2008 rate increases for HMOs were averaging 14.1 percent …”
Leveraged Buy-Out Financing Under Stress
From Dow Jones: “The sale of $12 billion of loans to support the main auto division of Chrysler was delayed for a second time Wednesday in the biggest deal yet to stumble amid slackening investor demand for leveraged loans and high-yield debt.”
From Bloomberg: “Deutsche Bank AG, JPMorgan Chase & Co. and six more banks are stuck with …$10 billion) of loans for Kohlberg Kravis Roberts & Co.'s purchase of Alliance Boots Plc. The banks will keep the senior loans after failing to find investors to buy them…KKR, Blackstone Group LP and other private equity firms will need to make further concessions to borrow the $300 billion Bear Stearns Cos. says they need to pay for buyouts already agreed. ``It's certainly a bad signal to the market,'' said David Watts, a strategist in London at research firm CreditSights Inc. ``It not only makes private equity more reluctant to do deals but also the banks. Banks don't want to be stuck with the bridge loans. You're not going to want to stick your neck out.''”
From Merrill Lynch: “With the debt markets quickly moving to ration credit, the probability of companies being "taken out" is plummeting…”
From RBSGC: “For those who ponder the Fed, we have to note that a steady 5.25% funds rate for a year masks what else has been going on. To wit, with wider credit spreads the market has given the Fed a hike or two and that process is clearly having some repercussions; witness Expedia cutting back on its buyback and Chrysler's debt issuance postponed as bankers provide the loan themselves. These are the ripple effects of what started in the US housing market over a year ago and in its most basic form translates to rising risk premium… If it were only a story of the economic data, yields would be higher for sure…”
MISC
From Goldman Sachs: “No major surprises [in Fed’s Beige Book Report]--consumers slow, manufacturing activity firm, price and wage trends manageable despite commodity pressures on the price side and shortages of skilled workers on the wage side. Nothing here to change our view that Fed policy will remain on hold.”
From Dow Jones: “The lower-rated risky slices of the ABX index hit record lows as data on subprime loan performance were released by banks who hold the loans. The BBB- slice of the index based on loans made in the second half of 2006 was quoted at 40 cents on the dollar,…”
From The Financial Times: “Foreign earnings came to the rescue of a slew of US multinationals on Tuesday, offsetting weakness in the domestic economy and highlighting their growing reliance on the rest of the world… the results season has been characterised by the increased importance of US companies’ international operations, which have been helped by the weakness in the dollar and rapid growth in emerging markets.”
From The Wall Street Journal: “The freight slowdown that began last year is rippling through the second-quarter results of big transportation companies, whose largely disappointing profits indicate the weak housing and manufacturing markets, on top of high fuel prices, remain a drag on economic growth.
Growth in revenue and delivery volume continue to slow at United Parcel Service Inc., the world's largest package handler in terms of daily shipments. UPS reported its lowest profit growth in nearly three years -- 4% on net income -- and for the second quarter in a row showed essentially no volume growth.”
From The U.S. Treasury: “The vast majority of the Latin American population functions exclusively in a cash and barter economy. More than 70 percent of the residents of most Latin American economies do not use basic financial services such as deposit and transaction accounts, according to World Bank estimates.”
From Market News: “China's insurance regulator said insurers will be allowed to invest up to 15 pct of their total assets in overseas markets…the China Insurance Regulatory Commission (CIRC) said insurers will be able to invest in equities products, including options.”
From Bloomberg: “Japan's trade surplus …expanded 53.4 …from a year earlier… Exports climbed 16.2 percent…The yen fell to a record against the euro in June and 6.5 percent versus the dollar from a year earlier…Exports to the U.S. advanced 6.7 percent …in June… after barely rising in May and falling in April for the first time in two years…Shipments to China surged 22.6 percent to a record …and exports to Asia gained 15.8 percent…Exports to the European Union climbed 16.3 percent … the second highest on record…Half of Japan's exports were traded in dollars in the first half of 2007 compared with 38 percent in yen and 8.7 percent in euros…Export volumes, which don't take into account price and currency fluctuations, rose 6.1 percent in June.”
End-of-Day Market Update
Treasuries rallied a little more today, causing yields to decline by a basis point on the wings (2s and 30s) while better buying caused yields in the belly of the curve to drop 1.5bp (5s and 10s). Ten year Treasury yields are closing at 4.90% (down 1.2bp).
Equities rallied +.5%, recovering approx 30% of yesterday’s losses in the case of the Dow, which gained 68 points. The S&P is settling up 7 points, for a recovery of 17.5% of the prior day’s slump. The VIX index of equity volatility hit a new high, on the open this morning since the Chinese stock market panic of March, when it spiked to almost 19.5. Nervousness faded as equities rallied, and the index closed .5 lower at 18.1. Volatilities for most financial instruments have risen recently.
The Dollar rebounded strongly, from multi-year lows, in the overseas markets overnight. The dollar index opened 50bp higher in NY and held the gain throughout the day settling at 80.61.
Oil rallied over a dollar after government reports indicated inventories fell for the third straight week. Refinery utilization is at a ten month high, indicating rising demand for gasoline. The UK has also had a major refinery shut down.
Housing Slump Continues as Existing Home Sales Fall -3.8% MoM in June
Existing home sales fell a larger than expected -3.8% MoM (consensus -2.1%) in June. Existing home sales have dropped every month since February, and now stand at a pace last observed in 2002. In addition, last month's decline was revised slightly lower to -.5% MoM from the originally reported -.3%. The strength in condos seen last month eroded in June as condo sales fell almost twice as fast as single-family sales fell, declining at -6.3% MoM versus -3.5% MoM.
Versus a year ago, total sales have fallen -11.4% YoY, with single-family sales having fallen -12.1% MoM, and condos declining more slowly at -6.6% YoY.
Inventory held steady at 8.8 months supply, based on the current sales rate, and remains at the highest level of the year. By category, single-family inventory inched higher to 8.7 months, and condos fell by half a month to 9.2 months. The actual supply of homes available for resale fell 4.2% to 4.2 million in June.
Median home values rose +.3% YoY (+3.3% MoM) to $230,100 - the first year-over-year increase in 11 months. Most of the gain was again in condo prices which rose 2.6% YoY. Caution should be used in watching median home prices as the mix of sales between regions and home types can skew the results month-to-month. But, the increase in price may indicate that as subprime borrowers find loans more difficult to acquire, fewer lower priced homes are purchased, which is pushing the median price higher due to the mix of homes sold.
Regionally, the Northeast saw the biggest decline at -7.3% MoM, followed by the West at -6.8% MoM, then the Midwest at -2.8% MoM, trailed by the South at -1.7% MoM. Not seasonally adjusted median house prices gains showed gains of $6-8,000 in the Northeast, Midwest and South in June versus May. The West actually experienced a $2,000 decline in median home prices versus the prior month.
Existing home sales represent finalized sales of 'used' homes at contract closings. Pending home sales indicate initial purchase agreements, and usually lead existing home sales by 1-2 months. Pending home sales fell to a five year low in May as higher interest rates, tighter credit conditions, and falling home prices have discouraged purchases. Existing homes sales account for about 85% of total home sales.
The housing market has not yet bottomed.
Versus a year ago, total sales have fallen -11.4% YoY, with single-family sales having fallen -12.1% MoM, and condos declining more slowly at -6.6% YoY.
Inventory held steady at 8.8 months supply, based on the current sales rate, and remains at the highest level of the year. By category, single-family inventory inched higher to 8.7 months, and condos fell by half a month to 9.2 months. The actual supply of homes available for resale fell 4.2% to 4.2 million in June.
Median home values rose +.3% YoY (+3.3% MoM) to $230,100 - the first year-over-year increase in 11 months. Most of the gain was again in condo prices which rose 2.6% YoY. Caution should be used in watching median home prices as the mix of sales between regions and home types can skew the results month-to-month. But, the increase in price may indicate that as subprime borrowers find loans more difficult to acquire, fewer lower priced homes are purchased, which is pushing the median price higher due to the mix of homes sold.
Regionally, the Northeast saw the biggest decline at -7.3% MoM, followed by the West at -6.8% MoM, then the Midwest at -2.8% MoM, trailed by the South at -1.7% MoM. Not seasonally adjusted median house prices gains showed gains of $6-8,000 in the Northeast, Midwest and South in June versus May. The West actually experienced a $2,000 decline in median home prices versus the prior month.
Existing home sales represent finalized sales of 'used' homes at contract closings. Pending home sales indicate initial purchase agreements, and usually lead existing home sales by 1-2 months. Pending home sales fell to a five year low in May as higher interest rates, tighter credit conditions, and falling home prices have discouraged purchases. Existing homes sales account for about 85% of total home sales.
The housing market has not yet bottomed.
Tuesday, July 24, 2007
Today's Tidbits
Weak Dollar Reducing OPEC Profits and Europe’s Energy Costs From The Financial Times: “The falling US dollar is lowering the Organisation of the Petroleum Exporting Countries’ purchasing power by up to a third, making the powerful oil cartel more reluctant to increase production and cut prices. Although oil is trading near last August’s record $78.65 a barrel, Opec calculations show that, when adjusted for the weaker dollar and inflation, an average of the 12 Opec members’ crude oil prices has fallen in the past year…Growing trade between Opec members, especially in the Middle East and North Africa, and the European Union is aggravating the problem because the pound and the euro have risen… a Morgan Stanley economist, estimates that a 10 per cent drop in the dollar against major currencies cuts Opec’s Middle East members’ crude oil purchasing power by about 5 per cent…the refusal of the cartel to increase its production to force a drop in the oil price was “more understandable if the lower value of Opec’s spending power...is taken into account”. But the decline in the value of the dollar is insulating some countries from high oil prices, which provides Opec with strong demand even as oil prices soar above $75 a barrel.”
Weak Dollar Increasing Tourism to US and Pushing Inflation Higher
From Merrill Lynch: “The weaker dollar and solid income growth abroad are bolstering the US travel/tourism industry in a major way and this is one segment of the consumer group has no correlation with the housing market… hotels have big-time pricing power - up 7% year-on-year, but this masks what has happened in the past three months where pricing has soared at a 28% annual rate, which is the strongest pricing power the sector has posted since January 1991. Airlines are seeing some nice price increases too - up 0.9% sequentially in June and a 5.4% annual rate since over the six months to June. Restaurants are actually enjoying solid pricing growth at 3.5% on a year-over-year basis, which is above average for the economy as a whole. High-end stuff that tourists buy, such as jewelry, is also seeing strong pricing power - up in 6 of the past 8 months and the year-on-year trend solid at 6%… real (inflation adjusted) consumer spending on accommodation has risen a solid 4.4% y/y; airlines are seeing 1.5% volume growth; sightseeing expenditures, again in real terms, have risen nearly 2% in the past year and attendance at museums increased by 5.5%. Restaurants are seeing close to
3% year-over-year volume growth to go along with the decent pricing…What we do know with certainty is that US spending on travel abroad has declined 10% year-on-year (the weakest since mid-2003) while foreigner spending on travel/tourism in the USA is up 3.7%...”
Home Prices Likely to Continue Falling
From Bloomberg: “U.S. house prices may decline by as much as 15 percent in the next two to three years, reducing the value of the property market by a fifth since mid-2006 and prompting an increase in defaults and delinquencies, according to analysts at JPMorgan Chase & Co… JPMorgan sees scope for a total decline of as much as 20 percent ``from the June 2006 peak before this cycle hits bottom, potentially two or three years from now.''… ``Further declines in home prices will exacerbate the default problem, both by making it harder for borrowers to qualify for modifications and by reducing their incentive to continue making payments on homes that are worth less than the amount owed on the mortgage,'' the JPMorgan analysts wrote.”
From Wachovia: “…home prices may be far from bottoming…contrasts the home price decline in the current cycle with that between 1989 and 1994 for major metro areas. In percentage terms, the drop in home prices to date is only 40% to 50% of that during the ’89-‘94 cycle. In terms of time duration, the current decline has lasted only 25% of the ’89-94 cycle (70% if measured to the trough of the sharp initial drop). If we benchmark the current cycle with the last major housing market down turn, there would be significant room for additional weakness in terms of price depreciation and time duration.”
From CNN: “Countrywide Financial Corp. Chief Executive Angelo Mozilo said the U.S. housing market is unlikely to recover before 2009, as lenders and homeowners work through oversupply, stagnating home prices and the excesses of recent lax lending standards in much of the mortgage industry.”
MISC
From Merrill Lynch: “The year-over-year growth rate in headline consumer inflation (CPI) has bested the growth rate of the core CPI index 73.1% of the time in the decade of the 2000s (compared to just 26.7% of the time in the 1990s), the most persistent such out-performance since 1960…only the decade of the 1970s has headline consumer inflation persistently outperformed core inflation even close to the extent that it has in the decade of the 2000s…. The combination of lower potential GDP growth (our models point to +2.5% y/y in the current decade), along with the persistent out-performance of running headline inflation versus the core, means that the Fed must be vigilant against the risk that headline inflation creeps into core inflation via an unwelcome rise in inflation expectations (which the Fed assesses to be "imperfectly anchored").”
From Merrill Lynch: “… the monthly issuance of Collateralized Debt Obligations (CDOs), or packages of debt instruments bundled together to form a "portfolio" of debt, dropped from $42 billion to $3 billion in the latest month. That 93% drop represents a significant tightening of liquidity that is starting to ripple throughout the credit markets.
The fixed-income markets appear to be starting to understand that the days of free-flowing liquidity are likely to be behind us. Most credit spreads are widening. However, the equity markets seem to be clinging to the past and ignoring the debt markets' signals…Mergers and acquisitions have garnered a disproportionate amount of equity investors' attention. Today's New York Times, for example, has an article titled "Merger Activity Helps Shares Bounce Back." Unless such deals are going to be increasingly done for cash, we think equity investors better realize soon that the last days of the debt-financed M&A and LBO spree are probably not too far off.”
From Market News: The negative results from DuPont have added to concerns about the wider impact of the downturn in the US housing market and its potential impact on consumer sentiment…the 2% drop in US demand that has drawn focus from credit traders and analysts looking at wider housing sector contagion from sub-prime. Also slow car sales contributed to lower paint sales, yet another indication of possible consumer fatigue.”[Maker of Tyvek house wrap used in 40% of new homes]
From RBSGC: “Countrywide's earnings slumping 33% has set the negative tone for the mortgage market today, with broader questions being asked about Alt-A…”
From Barclays: “The extra interest investors demand to own junk-rated debt
rather than Treasuries of similar maturity has widened 103 basis
points to 344 basis points since touching the lowest on record on
June 5…”
From JP Morgan: “The Richmond Fed manufacturing survey was stable in July, with both the headline composite (4) and ISM-weighted composite (52.7) being exactly equal to their June values. Capital expenditure plans did rise sharply, from 13 to 25; capex plans in the other regional Fed surveys released so far this month have also improved. On the whole, the July Empire, Philadelphia, and Richmond Fed surveys have showed steady manufacturing growth this month.”
From Merrill Lynch: “Throughout Asia, industrial production (IP) has surprised on the upside. A simple average of Asian IP numbers for April and May exceeded consensus by 0.45 standard deviations. This is the highest meaningful figure since the very strong October/November 2005 showing (0.62 standard deviations above consensus), which was associated with strong FX performance in early 2006.”
From The US Treasury: “Treasury Secretary Henry M. Paulson, Jr. will travel to China at the end of this week to meet with government officials and discuss the U.S.-China Strategic Economic Dialogue (SED) launched by Presidents Bush and Hu last year. "This trip is part of an ongoing process to strengthen our strategic economic relationship – to address long term issues such as working with China to rebalance its growth and increase the flexibility of its currency, and also to address short term issues as they arise," said Paulson.”
End-of-Day Market Update
Treasuries rallied late in the day as the equity market tanked. The yield curve steepened as shorter maturities declined more in yield than long expiries. Two year Treasuries are closing down 3.5bp at 4.74% while thirty year bonds are down 1.5bp to 5.04%.
Today’s 20-year TIPS auction had the strongest bidding ever seen for a TIPS auction according to Morgan Stanley. Very little went to dealers.
Equities were under pressure all afternoon. The Dow closed down 227 points to finish near the low for the day. The S&P lost a substantial 50bp, or 2% in value. The homebuilders index fell to a four year low, and financial shares fell to a four month low, on concerns about mortgage defaults.
The dollar index reached a low of 80.016 on the US open, but recovered slightly to close down .25 at 80.10, another record low for this year. The 20 year low for the dollar index is 78, with the 80 level having been tested two times in the past 15 years.
Oil fell precipitously again today, declining almost $2 before bouncing back 50 cents. Oil is down over $3 from its 11-month high last week.
Weak Dollar Increasing Tourism to US and Pushing Inflation Higher
From Merrill Lynch: “The weaker dollar and solid income growth abroad are bolstering the US travel/tourism industry in a major way and this is one segment of the consumer group has no correlation with the housing market… hotels have big-time pricing power - up 7% year-on-year, but this masks what has happened in the past three months where pricing has soared at a 28% annual rate, which is the strongest pricing power the sector has posted since January 1991. Airlines are seeing some nice price increases too - up 0.9% sequentially in June and a 5.4% annual rate since over the six months to June. Restaurants are actually enjoying solid pricing growth at 3.5% on a year-over-year basis, which is above average for the economy as a whole. High-end stuff that tourists buy, such as jewelry, is also seeing strong pricing power - up in 6 of the past 8 months and the year-on-year trend solid at 6%… real (inflation adjusted) consumer spending on accommodation has risen a solid 4.4% y/y; airlines are seeing 1.5% volume growth; sightseeing expenditures, again in real terms, have risen nearly 2% in the past year and attendance at museums increased by 5.5%. Restaurants are seeing close to
3% year-over-year volume growth to go along with the decent pricing…What we do know with certainty is that US spending on travel abroad has declined 10% year-on-year (the weakest since mid-2003) while foreigner spending on travel/tourism in the USA is up 3.7%...”
Home Prices Likely to Continue Falling
From Bloomberg: “U.S. house prices may decline by as much as 15 percent in the next two to three years, reducing the value of the property market by a fifth since mid-2006 and prompting an increase in defaults and delinquencies, according to analysts at JPMorgan Chase & Co… JPMorgan sees scope for a total decline of as much as 20 percent ``from the June 2006 peak before this cycle hits bottom, potentially two or three years from now.''… ``Further declines in home prices will exacerbate the default problem, both by making it harder for borrowers to qualify for modifications and by reducing their incentive to continue making payments on homes that are worth less than the amount owed on the mortgage,'' the JPMorgan analysts wrote.”
From Wachovia: “…home prices may be far from bottoming…contrasts the home price decline in the current cycle with that between 1989 and 1994 for major metro areas. In percentage terms, the drop in home prices to date is only 40% to 50% of that during the ’89-‘94 cycle. In terms of time duration, the current decline has lasted only 25% of the ’89-94 cycle (70% if measured to the trough of the sharp initial drop). If we benchmark the current cycle with the last major housing market down turn, there would be significant room for additional weakness in terms of price depreciation and time duration.”
From CNN: “Countrywide Financial Corp. Chief Executive Angelo Mozilo said the U.S. housing market is unlikely to recover before 2009, as lenders and homeowners work through oversupply, stagnating home prices and the excesses of recent lax lending standards in much of the mortgage industry.”
MISC
From Merrill Lynch: “The year-over-year growth rate in headline consumer inflation (CPI) has bested the growth rate of the core CPI index 73.1% of the time in the decade of the 2000s (compared to just 26.7% of the time in the 1990s), the most persistent such out-performance since 1960…only the decade of the 1970s has headline consumer inflation persistently outperformed core inflation even close to the extent that it has in the decade of the 2000s…. The combination of lower potential GDP growth (our models point to +2.5% y/y in the current decade), along with the persistent out-performance of running headline inflation versus the core, means that the Fed must be vigilant against the risk that headline inflation creeps into core inflation via an unwelcome rise in inflation expectations (which the Fed assesses to be "imperfectly anchored").”
From Merrill Lynch: “… the monthly issuance of Collateralized Debt Obligations (CDOs), or packages of debt instruments bundled together to form a "portfolio" of debt, dropped from $42 billion to $3 billion in the latest month. That 93% drop represents a significant tightening of liquidity that is starting to ripple throughout the credit markets.
The fixed-income markets appear to be starting to understand that the days of free-flowing liquidity are likely to be behind us. Most credit spreads are widening. However, the equity markets seem to be clinging to the past and ignoring the debt markets' signals…Mergers and acquisitions have garnered a disproportionate amount of equity investors' attention. Today's New York Times, for example, has an article titled "Merger Activity Helps Shares Bounce Back." Unless such deals are going to be increasingly done for cash, we think equity investors better realize soon that the last days of the debt-financed M&A and LBO spree are probably not too far off.”
From Market News: The negative results from DuPont have added to concerns about the wider impact of the downturn in the US housing market and its potential impact on consumer sentiment…the 2% drop in US demand that has drawn focus from credit traders and analysts looking at wider housing sector contagion from sub-prime. Also slow car sales contributed to lower paint sales, yet another indication of possible consumer fatigue.”[Maker of Tyvek house wrap used in 40% of new homes]
From RBSGC: “Countrywide's earnings slumping 33% has set the negative tone for the mortgage market today, with broader questions being asked about Alt-A…”
From Barclays: “The extra interest investors demand to own junk-rated debt
rather than Treasuries of similar maturity has widened 103 basis
points to 344 basis points since touching the lowest on record on
June 5…”
From JP Morgan: “The Richmond Fed manufacturing survey was stable in July, with both the headline composite (4) and ISM-weighted composite (52.7) being exactly equal to their June values. Capital expenditure plans did rise sharply, from 13 to 25; capex plans in the other regional Fed surveys released so far this month have also improved. On the whole, the July Empire, Philadelphia, and Richmond Fed surveys have showed steady manufacturing growth this month.”
From Merrill Lynch: “Throughout Asia, industrial production (IP) has surprised on the upside. A simple average of Asian IP numbers for April and May exceeded consensus by 0.45 standard deviations. This is the highest meaningful figure since the very strong October/November 2005 showing (0.62 standard deviations above consensus), which was associated with strong FX performance in early 2006.”
From The US Treasury: “Treasury Secretary Henry M. Paulson, Jr. will travel to China at the end of this week to meet with government officials and discuss the U.S.-China Strategic Economic Dialogue (SED) launched by Presidents Bush and Hu last year. "This trip is part of an ongoing process to strengthen our strategic economic relationship – to address long term issues such as working with China to rebalance its growth and increase the flexibility of its currency, and also to address short term issues as they arise," said Paulson.”
End-of-Day Market Update
Treasuries rallied late in the day as the equity market tanked. The yield curve steepened as shorter maturities declined more in yield than long expiries. Two year Treasuries are closing down 3.5bp at 4.74% while thirty year bonds are down 1.5bp to 5.04%.
Today’s 20-year TIPS auction had the strongest bidding ever seen for a TIPS auction according to Morgan Stanley. Very little went to dealers.
Equities were under pressure all afternoon. The Dow closed down 227 points to finish near the low for the day. The S&P lost a substantial 50bp, or 2% in value. The homebuilders index fell to a four year low, and financial shares fell to a four month low, on concerns about mortgage defaults.
The dollar index reached a low of 80.016 on the US open, but recovered slightly to close down .25 at 80.10, another record low for this year. The 20 year low for the dollar index is 78, with the 80 level having been tested two times in the past 15 years.
Oil fell precipitously again today, declining almost $2 before bouncing back 50 cents. Oil is down over $3 from its 11-month high last week.
Monday, July 23, 2007
Today's Tidbits
Wider Impacts of Credit Tightening
From Bear Stearns: “Credit markets remain on alert as a wave of supply needs to be distributed in the days ahead. While sub-prime has been the lead story during the widening, focus in now shifting to corporate credit. Not only is the supply a major hurdle but the earnings outlook is being viewed through a more skeptical lens. The major underlying concern is that credit markets freeze up. A repricing of risk assets is not going to prompt the Fed to ease, but a credit lock down is a different story. With the focus moving toward traditional credit concerns the calendar of headline deals will take on added importance The Chrysler deal is reportedly due to trade this week. If this deal goes off, albeit at wider spreads, it could prove a turning point for credit markets. Conversely if the deal falters, look out.”
From Morgan Stanley: “The question that continues to loom over the market, is if the biggest catalyst for the equity market (LBOs) will be significantly affected by the recent credit shake up. So far 20 levered deals have been postponed or modified, and there are $220B in the pipe line in the US, with an additional $50B in Europe.”
From Deutsche Bank: “While we think that spreads in both subrpime and credit will continue to widen as part of repricing to a new level of risk premium, we don't think it will reach systemic proportions. Therefore there is little basis for a significant Treasury market rally to accompany the spread widening. Markets appear stable from Friday's close. Attention is shifting away from subprime and toward the credit markets, particularly in the knock-on effects on equities. Private equity has slowed down its pace of deals, with the more marginal ones being held up, and much of the large financings being delayed until September or October. Then there will be a battle between investors who need to put money to work and issuers who need to finance their deals. The only question is where the market will clear. We think that today's announcement that China Development Bank and Temasek are helping to finance Barclays' bid for ABN Amro might be significant in this regard. If Asia comes in with even modest flows into the credit markets, the balance of forces will shift toward the issuers, and bring spreads back down. Thus, credit spread widening is still an ongoing saga, unlike the subprime sector, where large losses in the underlying loans will continue to be an issue.”
From Market News: “Barclays is close to raising around 10 bln from the Chinese and Singaporean governments to help finance its takeover of the Dutch bank giant, ABN, the BBC reports. If it succeeds and if Barclays acquires ABN, the Chinese state would emerge with a shareholding of around 7% in the enlarged group. The Asian cash will be used to help Barclays increase its takeover for ABN to around 50 bln, the report says. A smaller stake of around 3% would be taken by Temasek Holdings, the Singapore government-owned investment firm.”
From JP Morgan: “July AAA spreads are now implying a default rate equivalent to the historical default rate for BBB-rated corporates...all lower rated indices are implying default rates of high yield debt. The fact that this is happening in credit during a period of historically low default rates (we've have the fewest defaults YTD in high yield since 1981) is some of the best evidence that this is largely about technicals in credit rather than a fundamental story (obviously different in this respect than what is happening in the ABS market).”
From Merrill Lynch: “Over the past 5 months, there have been many loss estimates published over the size of the sub-prime investment debacle, and our desk range runs at near $160.0 to $180.0 bln (conservatively speaking). As a percentage of GDP, that $160.0/$180.0 bln loss estimate is near +1.2% of GDP, versus the +2.5% share of GDP of the S&L crisis in the early 1990s. As a concentration of the investor base, we simply note that Anglo, Caribbean and Pacific-based hedge fund and institutional buying further
dilutes the US domiciled investor risk exposure. Hence, overall, we continue to expect that the Fed will not pre-empt the mortgage melt-down (Fed on hold well into 2008), and that the Fed will continue to urge private sector solutions to the problem - at the very
least to avoid moral hazard problems.”
From Bank of America: “Stocks are indeed pricing in higher risk premia evident in the bond market. Outperformance of the large caps over smaller companies has been noticeable since the market’s mid-February highs; record highs for the oft-cited Dow Jones Industrials reflect 1) higher international economy exposure; 2) more aggressive
payout policies; 3) unchallenging valuations in the context of the broad market; and 4) greater liquidity/visibility to foreign investors who are rapidly increasing their exposure to US stocks. A “flight to quality” in the bond market is also occurring among stocks, as the distribution of earnings yields has widened, reflecting a higher risk premium for slower-growing, cyclical companies.”
From The Financial Times: “The stricken US subprime mortgage market is likely to suffer further setbacks in coming months as $500bn of risky home loans sold with initial low "teaser" interest rates are reset at much higher levels, analysts warn… Over the next 18 months, adjustable-rate home loans sold at the peak of the high-risk lending boom in 2005 and 2006 will be reset. Given a recent tightening of lending standards as banks try to rein in their mortgage exposures, this raises the prospect of further serious losses. Christopher Flanagan, strategist at JPMorgan, estimates up to 45 per cent of borrowers facing resets will not meet criteria to refinance into new home loans. The mounting problems could force ratings agencies to downgrade billions of dollars of mortgage securities below investment grade, a move that would in turn force many investors to sell their holdings and exacerbate the spiral of losses. "The potential repercussions are quite serious," … Ratings agency downgrades of subprime-related securities have already gained momentum in recent weeks, helping to push a key derivatives index tracking such securities to record lows. The ABX index tracking 2006-issued subprime bonds rated BBB- fell to a low of 41 cents on the dollar on Friday, down more than 50 per cent since January. "There is a possibility that one or two money centre banks and dealers could be a casualty along with hedge funds and institutional investors,"… JPMorgan, Citigroup and Bank of America increased future loss provisions for bad loans in second-quarter earnings reports.”
From The Wall Street Journal: “Hoping to slow the quickening pace of home foreclosures, about a half-dozen state are setting up funds to help homeowners with high-risk subprime mortgages refinance to more-affordable loans. The States – which include Maryland, Massachusetts. New Jersey, New York, Ohio, and Pennsylvania – are expected to invest a total of more than $500 million in the effort. That isn’t much, given the size of the problem, but state officials hope it will be enough to keep some vulnerable low- and moderate- income neighborhoods from sliding into decline.”
Commodities Power African Growth
From Merrill Lynch: “According to the IMF, African growth has been outpacing world growth since the beginning of the commodity bull market in late 2001. Since that year, annual economic growth in Africa has averaged 5.0%, while overall world growth rose
only 4.2%....Almost two-thirds of African countries remain below the $2,000 level for per capita GDP, despite the commodity price boom we have witnessed for the last several years. Despite the rise in incomes in the region, even the wealthiest African countries are still far below developed-country standards, and only four are above the $2,400 threshold the UN sets as “middle income” status for a country. It is interesting to note that all four of those countries – Botswana, Mauritius, South Africa, and Namibia – are in the southern part of the continent. None of those four countries are oil exporters and only two, Botswana and Namibia, generate sizeable income from mining operations….In central Africa, the largest economy and one of the fastest growing is Nigeria. The country is an oil and agricultural products exporter and is also rapidly expanding its financial center.
Regionally, Northern Africa is very wealthy because many of those countries are oil
exporters. Libya, Algeria, and Egypt are major oil exporters, possessing 51% of
Africa’s proven oil reserves… In the North, real per capita GDP is almost four times that of the countries in the southern region. According to the World Bank, the five countries of the North (Algeria, Egypt, Libya, Morocco, and Tunisia) all boasted real per capita GDP above $1,000 in 2004…. The income disparities in Africa are stark and much higher than we see in the US or in the G-7 countries…. Even a fairly developed economy like that of South Africa has an income inequality measure of more than … twice that of the US and more than three times that of the G-7… One of the key sources of wealth in Africa is oil. The continent boasts 8% of the world’s proven oil reserves, putting it ahead of Asia and Latin America. While there are 12 oil exporting countries in Africa, the bulk of the reserves – almost 86% – are held by four countries: Libya, Nigeria, Algeria, and Angola… Other countries possess natural resources like gold, silver, platinum and various other commodities… Another source of economic growth is food as many African nations are agricultural exporters. In fact, agriculture is a main source of revenue for many African countries…. Foreign direct investment (FDI) into Africa has soared in the last few years and is expected to continue. The World Bank estimates that net inflows of FDI into Africa jumped to almost $40 billion in 2006 from less than $10 billion in 2000… As China and India continue their rapid expansion, commodity exporters will be the prime beneficiaries…. According to the UN, population growth in Africa through 2015 is expected to rise the fastest in the world at 2.2%. The result of this population explosion is that Africa is expected to house the largest youth population in the world. By 2015, according to the UN Human Development Report, Africa’s youth (those under the age of 15) is expected to rise to 42% of its total population. The next closest region is the Arab states where 33% of the population should be under 15. This presents some interesting possibilities because it will provide the nations of Africa with young workers who will want to earn, learn, and burn (their earnings). The challenges for the governments, in our view, will be to provide the healthcare, education, and business infrastructure so that they can become productive workers in the new African global economy…. Given the abundant natural resources available, we view Africa as a key complement to China’s growth needs. In mid-May China pledged $20 billion to Africa to help provide the capital necessary to build roads and other infrastructure. The funds are to be delivered in the next three years, and the $20 billion would go toward projects such as the rehabilitation of railway networks in Angola and Nigeria and the building of a hydroelectric dam in Ethiopia. According to the US Energy Information Administration, China accounted for 40% of total growth in oil demand in the last four years, and is now the second-largest consumer of oil globally (after the US). Africa’s five most resource-rich countries – Angola, South Africa, Sudan, Equatorial Guinea, and Congo – account for more than 80% of Africa’s exports to China….”
History Repeats
From The Financial Times: “The Jungle,… Upton Sinclair's 1906 novel… For many Americans watching the safety scandals that have engulfed Chinese exports to the US in recent months, Sinclair's book is something of a road map for contemporary China. In their own way, the tales about "filthy" catfish and poisonous toothpaste fit neatly into one of the grand narratives of our time, that China's booming economy is following a path similar to the US just over a century ago. Here is a continent-sized nation with new cities bursting with entrepreneurial energy and roads and railroads opening up once-isolated regions. Such rapid expansion has left the institutions of government scrabbling to keep up, opening space for unscrupulous businessmen to cut every imaginable corner. Copies of The Jungle are being dusted off because as well as illuminating the dark side of hasty industrialisation, it also provoked outrage that helped pave the way for the creation of the Food and Drug Administration. The uproar over Chinese products in the US is also an eye-opener about just how far globalisation has reached…. Whether we like it or not, China's problems are now everyone's problems. If food regulators in China cannot impose standards on the fish farms and vegetable producers they patrol, it is no longer just Chinese consumers at risk. The challenge facing regulators in Beijing is daunting, with hundreds of thousands of small companies operating in the industry, many with powerful connections to the local officials who should be keeping an eye on them… the more intriguing title of "China's Upton Sinclair". It included extracts from a book written in 2004 by a writer called Zhou Qing that describes in excruciating detail all the things residents of China have heard about the food supply but did not want to think about. At a factory making pickled vegetables, he watched workers pour in insecticides to get rid of bugs. Or there is the Shanghai shop that fumigated cakes with sulphur powder and added industrial bleach to make them look whiter. Or the Nanchang drinks company that scraped off the sell-by date that had expired and added a new one to the bottles. Corruption and powerful local vested interests are always in the background of his tales - all written in the very best muck-raking tradition. The big question is how quickly in China's one-party state, with its internet firewalls and media restrictions, such stories will translate into sustained pressure on the authorities. The other day I had a browse in some Shanghai bookshops and did manage to find The Jungle. But there were no copies of Zhou Qing's books.”
Oil Headed Higher?
From Morgan Stanley: “We think that oil producers are trying to offset the purchasing power lost to a weaker dollar by restraining crude supply, thus keeping prices high. They likely are also diversifying portfolios away from the dollar to hedge returns, and some worry about the possibility that USD assets might be frozen or confiscated… we can't rule out a further surge in crude quotes that could hurt both US consumers and global growth.”
From Bloomberg: “The $100-a-barrel oil that Goldman Sachs Group Inc. said would prevail by 2009 may be only a few months away. Jeffrey Currie, a London-based commodity analyst at the world's biggest securities firm says $95 crude is likely this
year unless OPEC unexpectedly increases production, and declining inventories are raising the chances for $100 oil. Jeff Rubin at CIBC World Markets predicts $100 a barrel as soon as next year. ``We're only a headline of significance away from $100
oil,'' said John Kilduff, an analyst in the New York office of futures broker Man Financial Inc… Currie, Goldman's global head of commodities research in London, is predicting that oil prices will probably touch a record and stay at unprecedented levels for months or years…``Ultimately, the key to the outlook going forward is when will Saudi Arabia ramp up production,'' he said… The cost of finding and pumping oil is rising steadily,
convincing analysts such as Rubin and Deutsche Bank AG chief energy economist Adam Sieminski that higher prices will last. Shortages of deepwater drilling ships and rigs has pushed daily rents to records, and the skilled workers needed to run rigs, weld pipes, pilot vessels, fix refineries and build oil-sands projects command ever-higher wages… A pullout from Iraq may be the event that pushes oil to $100 a barrel, according to Boone Pickens… `At face value this market is strikingly similar to a year ago,'' Currie said. ``What is different? Supply is down a million barrels a day, demand is up a million barrels a day. The market is in a deficit.''”
From UBS: “Once again, the price of energy topped investors’ concerns in July, followed by the federal budget deficit, and housing… in response to special questions related to consumer spending plans and high energy prices, 62% of investors said they plan on cutting back on nonenergy related spending. We view this as an important development, given that the UBS survey is a survey of investors and should mostly exclude the relatively non-affluent families who sometimes are thought to be main consumers adversely affected by higher energy prices. In fact, the detailed breakdown of the UBS survey showed 48% of “substantial investors” (those with more than $100,000 in invested assets) planned on cutting back other spending given energy and gasoline prices. And 70% of “average investors” (those with less than $100,000 in invested assets), expected to curtail other spending. Broken out by gender, females (70%) expect to cut back more than males (53%), and investors between the ages of 18-39 years (70%) planned to pare back more than any other age group”
From Dow Jones: “The Organization of Petroleum Exporting Countries’ head of research said that a fair price for crude oil was between $60 and $65 a barrel.”
Dollar at Record Lows
From The Financial Times: “The US currency has fallen 4.5 per cent against the euro this year and 4 per cent against sterling, hitting a new 26-year nadir against the pound last week. The trade-weighted dollar index dropped to its lowest since 1992. The dollar exchange rate is important because the US relies on hefty foreign purchases of securities and other assets to fund its current account deficit. "At some point, the fall in the dollar will translate into foreign investors no longer buying US assets and selling their existing holdings,"… The beleaguered US currency was hardly helped by Ben Bernanke, Federal Reserve chairman, last week. Questioned by Congress, he declined any chance to say the dollar was undervalued…. Official silence on the dollar's woes extends to Hank Paulson, US Treasury secretary. "You get the sense the administration wants a weaker dollar,"…”
From Bloomberg: “The currency [US dollar] has lost 13.2 percent since January 2001, when George W. Bush took office, the most under any president since at least Gerald Ford… The dollar set a new low of $1.3845 per euro today, and is the weakest in 26 years versus the British pound… Against the Canadian dollar, it's the lowest since 1977 and it's the weakest in seven years versus Brazil's real… The 13.2 percent tumble under Bush compares with a 18.3 percent gain under Bill Clinton and declines of 0.2 percent
under George H. W. Bush, 0.4 percent under Ronald Reagan, 3.0 percent under Carter and 2.3 percent during Ford's tenure, the Fed's U.S. Trade-Weighted Real Broad Dollar Index shows.”
MISC
From Deutsche Bank: “In the reported data on Friday, banks showed an increase in whole loan mortgage holdings and a decrease in short term assets. We would also point out that a crucial compromise has been made between the federal bank regulators and the banking industry that will enable Basel II to go forward, starting in January 2008, with 11 large banks likely to adopt the new analytic risk-based capital requirements. This will favor holding whole loans over MBS.
From Bank of America: “Foreign buying of U.S. stocks surged to a new record in May, according to data released last week by the U.S. Treasury. Net purchases of +$42B were half-again as large as the prior record (reached in February 2000 and nearly achieved again in April 2007).…While much of the incremental foreign demand for US equities represents recycled petrodollars, some major investors appear to be increasing equity allocations, because of the superior long-term expected returns for equity and its historic ability to behave as a natural hedge against dollar weakness.”
From The Financial Times: “Competition for investment is driving down corporate tax rates around the world, with average rates falling from 27.2 per cent to 26.8 percent over the past year…”
From The Wall Street Journal: “…a growing number of Japanese companies…are [now] pursuing woman workers with new vigor. That’s a big change from the past, when many companies viewed women primarily as a temporary source of labor…a growing labor shortage is spurring a change in attitude. The world’s second biggest economy is continuing to expand, and last year there were more jobs than job seekers for the first time in 14 years. The labor crunch is expected to get worse in the next few years …working-age population is expected to fall 15% between 2005 and 2025…Women in Japan hold only 10% of managerial posts…Only 23% of women who had a job a year before having a child were employed 18 months after giving birth…while women are supposed to receive equal pay under the law, in reality they earn only 67% of what men earn.”
From The Wall Street Journal: “Because the risks are spread so widely, regulators can do little but watch and try to reassure everybody it is all under control…it is hard to overstate how dramatically it has changed in the past decade…there are worrisome downsides to this financial architecture. The system hides risk and concentrates it in hedge funds that regulators and other investors don’t understand…’We don’t really know where the bodies are buried until after the fact”…A system designed to distribute risk also tends to breed it. At their core, subprime loans and other mortgage innovations – ‘piggyback’ loans, Alt-A mortgages, ‘no-doc’ loans – brought credit to people who wouldn’t otherwise have gotten it. Few of these products would have become so popular if they hadn’t been packaged into securities and sold widely to investors.”
From Bloomberg: “U.S. farmers this spring planted the most acreage with corn since 1944…”
From Dow Jones: “Assets controlled by hedge funds grew by about 36% over the past year to $1.74 trillion, Hedge Fund Research Inc. said , after investors poured $58.7 billion into these investments in the second quarter. HFR said the inflow was second only to the previous quarter, when investors poured $60 billion into hedge funds. The growth in assets is being driven in large part by institutional investment in hedge funds, including allocations to fundof- hedge-fund firms that select and monitor pools of hedge to diversify risk. In the second quarter, funds of hedge funds raised $17.4 billion of the net new assets, bringing their collective assets under management to $745 billion, or about 43% of the total hedge fund universe.”
End-of-Day Market Update
Treasuries traded in a relatively tight range on reduced volume. The curve flattened though with two year yields rising 2.5bp to close at 4.79%, and the ten year yields only rising .5bp to settle at 4.96%.
Equities recovered some of Friday’s sell-off. The Dow is closing up 92 at 13,943, and the S&P500 is closing up 5 at 1550.
The dollar index tested last week’s low in the overnight hours, but closed slightly firmer, rising .06 to 80.35.
Oil futures fell almost a dollar, after hitting a new 11-month high late last week. Gasoline prices fell six cents to a 3-month low.
From Bear Stearns: “Credit markets remain on alert as a wave of supply needs to be distributed in the days ahead. While sub-prime has been the lead story during the widening, focus in now shifting to corporate credit. Not only is the supply a major hurdle but the earnings outlook is being viewed through a more skeptical lens. The major underlying concern is that credit markets freeze up. A repricing of risk assets is not going to prompt the Fed to ease, but a credit lock down is a different story. With the focus moving toward traditional credit concerns the calendar of headline deals will take on added importance The Chrysler deal is reportedly due to trade this week. If this deal goes off, albeit at wider spreads, it could prove a turning point for credit markets. Conversely if the deal falters, look out.”
From Morgan Stanley: “The question that continues to loom over the market, is if the biggest catalyst for the equity market (LBOs) will be significantly affected by the recent credit shake up. So far 20 levered deals have been postponed or modified, and there are $220B in the pipe line in the US, with an additional $50B in Europe.”
From Deutsche Bank: “While we think that spreads in both subrpime and credit will continue to widen as part of repricing to a new level of risk premium, we don't think it will reach systemic proportions. Therefore there is little basis for a significant Treasury market rally to accompany the spread widening. Markets appear stable from Friday's close. Attention is shifting away from subprime and toward the credit markets, particularly in the knock-on effects on equities. Private equity has slowed down its pace of deals, with the more marginal ones being held up, and much of the large financings being delayed until September or October. Then there will be a battle between investors who need to put money to work and issuers who need to finance their deals. The only question is where the market will clear. We think that today's announcement that China Development Bank and Temasek are helping to finance Barclays' bid for ABN Amro might be significant in this regard. If Asia comes in with even modest flows into the credit markets, the balance of forces will shift toward the issuers, and bring spreads back down. Thus, credit spread widening is still an ongoing saga, unlike the subprime sector, where large losses in the underlying loans will continue to be an issue.”
From Market News: “Barclays is close to raising around 10 bln from the Chinese and Singaporean governments to help finance its takeover of the Dutch bank giant, ABN, the BBC reports. If it succeeds and if Barclays acquires ABN, the Chinese state would emerge with a shareholding of around 7% in the enlarged group. The Asian cash will be used to help Barclays increase its takeover for ABN to around 50 bln, the report says. A smaller stake of around 3% would be taken by Temasek Holdings, the Singapore government-owned investment firm.”
From JP Morgan: “July AAA spreads are now implying a default rate equivalent to the historical default rate for BBB-rated corporates...all lower rated indices are implying default rates of high yield debt. The fact that this is happening in credit during a period of historically low default rates (we've have the fewest defaults YTD in high yield since 1981) is some of the best evidence that this is largely about technicals in credit rather than a fundamental story (obviously different in this respect than what is happening in the ABS market).”
From Merrill Lynch: “Over the past 5 months, there have been many loss estimates published over the size of the sub-prime investment debacle, and our desk range runs at near $160.0 to $180.0 bln (conservatively speaking). As a percentage of GDP, that $160.0/$180.0 bln loss estimate is near +1.2% of GDP, versus the +2.5% share of GDP of the S&L crisis in the early 1990s. As a concentration of the investor base, we simply note that Anglo, Caribbean and Pacific-based hedge fund and institutional buying further
dilutes the US domiciled investor risk exposure. Hence, overall, we continue to expect that the Fed will not pre-empt the mortgage melt-down (Fed on hold well into 2008), and that the Fed will continue to urge private sector solutions to the problem - at the very
least to avoid moral hazard problems.”
From Bank of America: “Stocks are indeed pricing in higher risk premia evident in the bond market. Outperformance of the large caps over smaller companies has been noticeable since the market’s mid-February highs; record highs for the oft-cited Dow Jones Industrials reflect 1) higher international economy exposure; 2) more aggressive
payout policies; 3) unchallenging valuations in the context of the broad market; and 4) greater liquidity/visibility to foreign investors who are rapidly increasing their exposure to US stocks. A “flight to quality” in the bond market is also occurring among stocks, as the distribution of earnings yields has widened, reflecting a higher risk premium for slower-growing, cyclical companies.”
From The Financial Times: “The stricken US subprime mortgage market is likely to suffer further setbacks in coming months as $500bn of risky home loans sold with initial low "teaser" interest rates are reset at much higher levels, analysts warn… Over the next 18 months, adjustable-rate home loans sold at the peak of the high-risk lending boom in 2005 and 2006 will be reset. Given a recent tightening of lending standards as banks try to rein in their mortgage exposures, this raises the prospect of further serious losses. Christopher Flanagan, strategist at JPMorgan, estimates up to 45 per cent of borrowers facing resets will not meet criteria to refinance into new home loans. The mounting problems could force ratings agencies to downgrade billions of dollars of mortgage securities below investment grade, a move that would in turn force many investors to sell their holdings and exacerbate the spiral of losses. "The potential repercussions are quite serious," … Ratings agency downgrades of subprime-related securities have already gained momentum in recent weeks, helping to push a key derivatives index tracking such securities to record lows. The ABX index tracking 2006-issued subprime bonds rated BBB- fell to a low of 41 cents on the dollar on Friday, down more than 50 per cent since January. "There is a possibility that one or two money centre banks and dealers could be a casualty along with hedge funds and institutional investors,"… JPMorgan, Citigroup and Bank of America increased future loss provisions for bad loans in second-quarter earnings reports.”
From The Wall Street Journal: “Hoping to slow the quickening pace of home foreclosures, about a half-dozen state are setting up funds to help homeowners with high-risk subprime mortgages refinance to more-affordable loans. The States – which include Maryland, Massachusetts. New Jersey, New York, Ohio, and Pennsylvania – are expected to invest a total of more than $500 million in the effort. That isn’t much, given the size of the problem, but state officials hope it will be enough to keep some vulnerable low- and moderate- income neighborhoods from sliding into decline.”
Commodities Power African Growth
From Merrill Lynch: “According to the IMF, African growth has been outpacing world growth since the beginning of the commodity bull market in late 2001. Since that year, annual economic growth in Africa has averaged 5.0%, while overall world growth rose
only 4.2%....Almost two-thirds of African countries remain below the $2,000 level for per capita GDP, despite the commodity price boom we have witnessed for the last several years. Despite the rise in incomes in the region, even the wealthiest African countries are still far below developed-country standards, and only four are above the $2,400 threshold the UN sets as “middle income” status for a country. It is interesting to note that all four of those countries – Botswana, Mauritius, South Africa, and Namibia – are in the southern part of the continent. None of those four countries are oil exporters and only two, Botswana and Namibia, generate sizeable income from mining operations….In central Africa, the largest economy and one of the fastest growing is Nigeria. The country is an oil and agricultural products exporter and is also rapidly expanding its financial center.
Regionally, Northern Africa is very wealthy because many of those countries are oil
exporters. Libya, Algeria, and Egypt are major oil exporters, possessing 51% of
Africa’s proven oil reserves… In the North, real per capita GDP is almost four times that of the countries in the southern region. According to the World Bank, the five countries of the North (Algeria, Egypt, Libya, Morocco, and Tunisia) all boasted real per capita GDP above $1,000 in 2004…. The income disparities in Africa are stark and much higher than we see in the US or in the G-7 countries…. Even a fairly developed economy like that of South Africa has an income inequality measure of more than … twice that of the US and more than three times that of the G-7… One of the key sources of wealth in Africa is oil. The continent boasts 8% of the world’s proven oil reserves, putting it ahead of Asia and Latin America. While there are 12 oil exporting countries in Africa, the bulk of the reserves – almost 86% – are held by four countries: Libya, Nigeria, Algeria, and Angola… Other countries possess natural resources like gold, silver, platinum and various other commodities… Another source of economic growth is food as many African nations are agricultural exporters. In fact, agriculture is a main source of revenue for many African countries…. Foreign direct investment (FDI) into Africa has soared in the last few years and is expected to continue. The World Bank estimates that net inflows of FDI into Africa jumped to almost $40 billion in 2006 from less than $10 billion in 2000… As China and India continue their rapid expansion, commodity exporters will be the prime beneficiaries…. According to the UN, population growth in Africa through 2015 is expected to rise the fastest in the world at 2.2%. The result of this population explosion is that Africa is expected to house the largest youth population in the world. By 2015, according to the UN Human Development Report, Africa’s youth (those under the age of 15) is expected to rise to 42% of its total population. The next closest region is the Arab states where 33% of the population should be under 15. This presents some interesting possibilities because it will provide the nations of Africa with young workers who will want to earn, learn, and burn (their earnings). The challenges for the governments, in our view, will be to provide the healthcare, education, and business infrastructure so that they can become productive workers in the new African global economy…. Given the abundant natural resources available, we view Africa as a key complement to China’s growth needs. In mid-May China pledged $20 billion to Africa to help provide the capital necessary to build roads and other infrastructure. The funds are to be delivered in the next three years, and the $20 billion would go toward projects such as the rehabilitation of railway networks in Angola and Nigeria and the building of a hydroelectric dam in Ethiopia. According to the US Energy Information Administration, China accounted for 40% of total growth in oil demand in the last four years, and is now the second-largest consumer of oil globally (after the US). Africa’s five most resource-rich countries – Angola, South Africa, Sudan, Equatorial Guinea, and Congo – account for more than 80% of Africa’s exports to China….”
History Repeats
From The Financial Times: “The Jungle,… Upton Sinclair's 1906 novel… For many Americans watching the safety scandals that have engulfed Chinese exports to the US in recent months, Sinclair's book is something of a road map for contemporary China. In their own way, the tales about "filthy" catfish and poisonous toothpaste fit neatly into one of the grand narratives of our time, that China's booming economy is following a path similar to the US just over a century ago. Here is a continent-sized nation with new cities bursting with entrepreneurial energy and roads and railroads opening up once-isolated regions. Such rapid expansion has left the institutions of government scrabbling to keep up, opening space for unscrupulous businessmen to cut every imaginable corner. Copies of The Jungle are being dusted off because as well as illuminating the dark side of hasty industrialisation, it also provoked outrage that helped pave the way for the creation of the Food and Drug Administration. The uproar over Chinese products in the US is also an eye-opener about just how far globalisation has reached…. Whether we like it or not, China's problems are now everyone's problems. If food regulators in China cannot impose standards on the fish farms and vegetable producers they patrol, it is no longer just Chinese consumers at risk. The challenge facing regulators in Beijing is daunting, with hundreds of thousands of small companies operating in the industry, many with powerful connections to the local officials who should be keeping an eye on them… the more intriguing title of "China's Upton Sinclair". It included extracts from a book written in 2004 by a writer called Zhou Qing that describes in excruciating detail all the things residents of China have heard about the food supply but did not want to think about. At a factory making pickled vegetables, he watched workers pour in insecticides to get rid of bugs. Or there is the Shanghai shop that fumigated cakes with sulphur powder and added industrial bleach to make them look whiter. Or the Nanchang drinks company that scraped off the sell-by date that had expired and added a new one to the bottles. Corruption and powerful local vested interests are always in the background of his tales - all written in the very best muck-raking tradition. The big question is how quickly in China's one-party state, with its internet firewalls and media restrictions, such stories will translate into sustained pressure on the authorities. The other day I had a browse in some Shanghai bookshops and did manage to find The Jungle. But there were no copies of Zhou Qing's books.”
Oil Headed Higher?
From Morgan Stanley: “We think that oil producers are trying to offset the purchasing power lost to a weaker dollar by restraining crude supply, thus keeping prices high. They likely are also diversifying portfolios away from the dollar to hedge returns, and some worry about the possibility that USD assets might be frozen or confiscated… we can't rule out a further surge in crude quotes that could hurt both US consumers and global growth.”
From Bloomberg: “The $100-a-barrel oil that Goldman Sachs Group Inc. said would prevail by 2009 may be only a few months away. Jeffrey Currie, a London-based commodity analyst at the world's biggest securities firm says $95 crude is likely this
year unless OPEC unexpectedly increases production, and declining inventories are raising the chances for $100 oil. Jeff Rubin at CIBC World Markets predicts $100 a barrel as soon as next year. ``We're only a headline of significance away from $100
oil,'' said John Kilduff, an analyst in the New York office of futures broker Man Financial Inc… Currie, Goldman's global head of commodities research in London, is predicting that oil prices will probably touch a record and stay at unprecedented levels for months or years…``Ultimately, the key to the outlook going forward is when will Saudi Arabia ramp up production,'' he said… The cost of finding and pumping oil is rising steadily,
convincing analysts such as Rubin and Deutsche Bank AG chief energy economist Adam Sieminski that higher prices will last. Shortages of deepwater drilling ships and rigs has pushed daily rents to records, and the skilled workers needed to run rigs, weld pipes, pilot vessels, fix refineries and build oil-sands projects command ever-higher wages… A pullout from Iraq may be the event that pushes oil to $100 a barrel, according to Boone Pickens… `At face value this market is strikingly similar to a year ago,'' Currie said. ``What is different? Supply is down a million barrels a day, demand is up a million barrels a day. The market is in a deficit.''”
From UBS: “Once again, the price of energy topped investors’ concerns in July, followed by the federal budget deficit, and housing… in response to special questions related to consumer spending plans and high energy prices, 62% of investors said they plan on cutting back on nonenergy related spending. We view this as an important development, given that the UBS survey is a survey of investors and should mostly exclude the relatively non-affluent families who sometimes are thought to be main consumers adversely affected by higher energy prices. In fact, the detailed breakdown of the UBS survey showed 48% of “substantial investors” (those with more than $100,000 in invested assets) planned on cutting back other spending given energy and gasoline prices. And 70% of “average investors” (those with less than $100,000 in invested assets), expected to curtail other spending. Broken out by gender, females (70%) expect to cut back more than males (53%), and investors between the ages of 18-39 years (70%) planned to pare back more than any other age group”
From Dow Jones: “The Organization of Petroleum Exporting Countries’ head of research said that a fair price for crude oil was between $60 and $65 a barrel.”
Dollar at Record Lows
From The Financial Times: “The US currency has fallen 4.5 per cent against the euro this year and 4 per cent against sterling, hitting a new 26-year nadir against the pound last week. The trade-weighted dollar index dropped to its lowest since 1992. The dollar exchange rate is important because the US relies on hefty foreign purchases of securities and other assets to fund its current account deficit. "At some point, the fall in the dollar will translate into foreign investors no longer buying US assets and selling their existing holdings,"… The beleaguered US currency was hardly helped by Ben Bernanke, Federal Reserve chairman, last week. Questioned by Congress, he declined any chance to say the dollar was undervalued…. Official silence on the dollar's woes extends to Hank Paulson, US Treasury secretary. "You get the sense the administration wants a weaker dollar,"…”
From Bloomberg: “The currency [US dollar] has lost 13.2 percent since January 2001, when George W. Bush took office, the most under any president since at least Gerald Ford… The dollar set a new low of $1.3845 per euro today, and is the weakest in 26 years versus the British pound… Against the Canadian dollar, it's the lowest since 1977 and it's the weakest in seven years versus Brazil's real… The 13.2 percent tumble under Bush compares with a 18.3 percent gain under Bill Clinton and declines of 0.2 percent
under George H. W. Bush, 0.4 percent under Ronald Reagan, 3.0 percent under Carter and 2.3 percent during Ford's tenure, the Fed's U.S. Trade-Weighted Real Broad Dollar Index shows.”
MISC
From Deutsche Bank: “In the reported data on Friday, banks showed an increase in whole loan mortgage holdings and a decrease in short term assets. We would also point out that a crucial compromise has been made between the federal bank regulators and the banking industry that will enable Basel II to go forward, starting in January 2008, with 11 large banks likely to adopt the new analytic risk-based capital requirements. This will favor holding whole loans over MBS.
From Bank of America: “Foreign buying of U.S. stocks surged to a new record in May, according to data released last week by the U.S. Treasury. Net purchases of +$42B were half-again as large as the prior record (reached in February 2000 and nearly achieved again in April 2007).…While much of the incremental foreign demand for US equities represents recycled petrodollars, some major investors appear to be increasing equity allocations, because of the superior long-term expected returns for equity and its historic ability to behave as a natural hedge against dollar weakness.”
From The Financial Times: “Competition for investment is driving down corporate tax rates around the world, with average rates falling from 27.2 per cent to 26.8 percent over the past year…”
From The Wall Street Journal: “…a growing number of Japanese companies…are [now] pursuing woman workers with new vigor. That’s a big change from the past, when many companies viewed women primarily as a temporary source of labor…a growing labor shortage is spurring a change in attitude. The world’s second biggest economy is continuing to expand, and last year there were more jobs than job seekers for the first time in 14 years. The labor crunch is expected to get worse in the next few years …working-age population is expected to fall 15% between 2005 and 2025…Women in Japan hold only 10% of managerial posts…Only 23% of women who had a job a year before having a child were employed 18 months after giving birth…while women are supposed to receive equal pay under the law, in reality they earn only 67% of what men earn.”
From The Wall Street Journal: “Because the risks are spread so widely, regulators can do little but watch and try to reassure everybody it is all under control…it is hard to overstate how dramatically it has changed in the past decade…there are worrisome downsides to this financial architecture. The system hides risk and concentrates it in hedge funds that regulators and other investors don’t understand…’We don’t really know where the bodies are buried until after the fact”…A system designed to distribute risk also tends to breed it. At their core, subprime loans and other mortgage innovations – ‘piggyback’ loans, Alt-A mortgages, ‘no-doc’ loans – brought credit to people who wouldn’t otherwise have gotten it. Few of these products would have become so popular if they hadn’t been packaged into securities and sold widely to investors.”
From Bloomberg: “U.S. farmers this spring planted the most acreage with corn since 1944…”
From Dow Jones: “Assets controlled by hedge funds grew by about 36% over the past year to $1.74 trillion, Hedge Fund Research Inc. said , after investors poured $58.7 billion into these investments in the second quarter. HFR said the inflow was second only to the previous quarter, when investors poured $60 billion into hedge funds. The growth in assets is being driven in large part by institutional investment in hedge funds, including allocations to fundof- hedge-fund firms that select and monitor pools of hedge to diversify risk. In the second quarter, funds of hedge funds raised $17.4 billion of the net new assets, bringing their collective assets under management to $745 billion, or about 43% of the total hedge fund universe.”
End-of-Day Market Update
Treasuries traded in a relatively tight range on reduced volume. The curve flattened though with two year yields rising 2.5bp to close at 4.79%, and the ten year yields only rising .5bp to settle at 4.96%.
Equities recovered some of Friday’s sell-off. The Dow is closing up 92 at 13,943, and the S&P500 is closing up 5 at 1550.
The dollar index tested last week’s low in the overnight hours, but closed slightly firmer, rising .06 to 80.35.
Oil futures fell almost a dollar, after hitting a new 11-month high late last week. Gasoline prices fell six cents to a 3-month low.
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