Economic Calendar
August 6 – 10, 2007
Consensus Prior
Monday, 8/6
No Data
Tuesday, 8/7
2nd Quarter Non-Farm Productivity QoQ Annualized +2% +1%
YoY +1%
2nd Quarter Unit Labor Costs QoQ Annualized +1.8% +1.8%
YoY +2.2%
Business output rose 4.2% and hours worked probably rose 2.2% causing productivity to rise 2%
Benchmark revisions for last three years will be included
Productivity is expected to be lowered while ULC’s are increased
YoY Productivity expectations range between +.7% to +1.2%
YoY Unit labor cost expectations accelerating toward +3.3% to +4.4%
Suggests economy’s non-inflationary output will be lower
FOMC Meeting
Expected to leave rates unchanged
June Consumer Credit +$6B +$12.9B
If expectations occur, growth will have slowed from an annualized rate of $110B annualized in the first quarter to +$85B in the second quarter
Wednesday, 8/8
June Wholesale Inventories +.4% +.5%
Wholesale inventories are lean
The inventory to sales ratio hit a new record low of 1.11 months in May
Minneapolis Fed President Stern Speaks on Economic Education/Policy Making
Thursday, 8/9
Initial Jobless Claims 310k 307k
Four week average has dropped to 305.5k
Friday, 8/10
July Import Prices MoM +1% +1%
YoY +2.5% +2.3%
Import prices have risen steadily for the past five months
Higher energy costs and a declining dollar are primary drivers
China no longer exporting deflation
July Monthly Budget Statement -$34B -$33.2B
Consistent with year earlier deficit
Friday, August 3, 2007
Service Sector of Economy Slowing
Non-Manufacturing ISM, which basically covers the service industries, unexpectedly weakened more than expected in July, falling to 55.8 (consensus 59) from 60.7 in June. This brings this series in line with other indicators. Since inception, the index has averaged 57.5, so it is now below the long-term average.
The slowing in services, which was also apparent in this morning's employment report, is not a healthy sign for the economy as services now make up the majority of GDP, and have been the main driver of employment growth this year. It appears that the third quarter may be getting off to a slow start as tightening credit, weak housing, and consumer spending declines lead to contracting GDP growth prospects.
The sub-indexes were also weak. New orders fell to the lowest level in over four years, and the employment component slipped by over 3 points to a relatively neutral 51.7 for non-manufacturing industries. Inventories rose to 55. One hopeful factor for growth is that backlogs rose from 46.5 to 53. On the positive side for inflation, prices paid declined four points to a still elevated 61.3.
The slowing in services, which was also apparent in this morning's employment report, is not a healthy sign for the economy as services now make up the majority of GDP, and have been the main driver of employment growth this year. It appears that the third quarter may be getting off to a slow start as tightening credit, weak housing, and consumer spending declines lead to contracting GDP growth prospects.
The sub-indexes were also weak. New orders fell to the lowest level in over four years, and the employment component slipped by over 3 points to a relatively neutral 51.7 for non-manufacturing industries. Inventories rose to 55. One hopeful factor for growth is that backlogs rose from 46.5 to 53. On the positive side for inflation, prices paid declined four points to a still elevated 61.3.
Employment Growth Slows
Employment growth in July was slower than expected with only 92k new jobs added (consensus 127k). In addition the increase in June was revised down by 6k to 126k. Other than the 90k number in February, this was the slowest growth since 2004, and suggests that the labor market may be cooling. The household survey showed employment declining by 30k.
Government hiring declined for the first time since January 2006, falling by 28k jobs in July. Service hiring growth, which has been the main creator of new jobs this year, slowed to +104k in July, half the pace of just two months ago. Construction payrolls fell by 12k. Retail job growth was also flat at -1k.
Manufacturing payrolls only declined by 2k, the smallest decline since January, and the manufacturing workweek held steady at a relatively high 41.3 hours. Overtime also remained constant at 4.2 hours.
The unemployment rate inched up in July to 4.647%, the top end of the range for the past 11 months. The low for this cycle was 4.4% in March, which was also the lowest unemployment rate since 2001. The unemployment rate has held below 5% since December 2005. Fewer people entering the labor force has helped keep the unemployment rate from rising as job creation has slowed.
Average hourly earnings grew 6 cents, or +.3% MoM, and held steady at 3.9% YoY (consensus +3.8% YoY). Over the past 12 months, average hourly earnings have risen 4%, on average, versus 3% over the past five years. Average weekly earnings, which take into account the changing number of hours worked, rose slightly to $589.81 for production workers.
Hours worked unexpectedly fell to 33.8 (33.9 consensus). Other than one blip down to 33.7 hours in February, the workweek has varied between 33.8 or 33.9 hours for almost two years.
Interest rates fell following the employment report, but are slowly working back to unchanged versus yesterday's 5pm close.
Government hiring declined for the first time since January 2006, falling by 28k jobs in July. Service hiring growth, which has been the main creator of new jobs this year, slowed to +104k in July, half the pace of just two months ago. Construction payrolls fell by 12k. Retail job growth was also flat at -1k.
Manufacturing payrolls only declined by 2k, the smallest decline since January, and the manufacturing workweek held steady at a relatively high 41.3 hours. Overtime also remained constant at 4.2 hours.
The unemployment rate inched up in July to 4.647%, the top end of the range for the past 11 months. The low for this cycle was 4.4% in March, which was also the lowest unemployment rate since 2001. The unemployment rate has held below 5% since December 2005. Fewer people entering the labor force has helped keep the unemployment rate from rising as job creation has slowed.
Average hourly earnings grew 6 cents, or +.3% MoM, and held steady at 3.9% YoY (consensus +3.8% YoY). Over the past 12 months, average hourly earnings have risen 4%, on average, versus 3% over the past five years. Average weekly earnings, which take into account the changing number of hours worked, rose slightly to $589.81 for production workers.
Hours worked unexpectedly fell to 33.8 (33.9 consensus). Other than one blip down to 33.7 hours in February, the workweek has varied between 33.8 or 33.9 hours for almost two years.
Interest rates fell following the employment report, but are slowly working back to unchanged versus yesterday's 5pm close.
Thursday, August 2, 2007
Today's Tidbits
Tighter Credit Could Slow U.S. GDP Growth
From Reuters: “…tighter lending standards are starting to pinch consumer and business spending, threatening to slow already tepid U.S. economic growth… banks are increasingly leery of backing all sorts of risky loans, not just subprime mortgages for borrowers with shaky credit. "All the hoopla about subprime has created a sense among creditors and lenders that maybe they should rethink their easy terms,"… "It means that we have what is equivalent to a Fed (interest rate) tightening going on." Reduced spending stemming from the tighter credit terms could shave …off the U.S. economic growth rate… more sensible lending standards would be good for the economy in the long run… Business investment was a key factor behind the stronger-than-expected second-quarter gross domestic product figure issued last week. While consumer spending advanced at a slim 1.3 percent annual rate in the second quarter, business investment rose at an 8.1 percent pace. If companies pull back just as consumer spending is tapering off, it would hamstring the U.S. economy. Tighter credit is already stinging some smaller retail trade companies that supply goods to stores… If terms stay tight through the critical holiday shopping season and into next year, suppliers will have little choice but to cut back on shipments… Another subtle side effect of tightening credit is the decline in corporate share repurchases. As borrowing costs rise, companies have less incentive to ramp up debt to fund major stock buybacks, which typically push up share prices.”
Central Banks Appreciate Seeing Market Risks Re-Evaluated Higher
From Lehman: “ECB President Jean-Claude Trichet announced “strong vigilance”, and therefore signalled that a rate hike in September is very likely…The ECB president also addressed financial market developments. He recalled that “there had been some underpricing of risks” in the past, and that we are “now seeing the process of a progressive risk reappreciation”. He also mentioned a “period of nervosity (nervousness)” in the markets which deserves “particular attention”. To us, this means that the ECB is welcoming some of the repricing, but also that it is ready to act should financial market conditions deteriorate significantly.”
U.S. Less Dependent on Bank Lending Than Other Countries
From Wachovia: “Private debt securities comprise about 40% of total financing in the U.S. economy, and adding in the stock market brings total U.S. financing via the capital markets to 80%. No other major economy comes close to that percentage…the financial systems of the Euro-zone and the United Kingdom are much more dependent on bank lending than the United States. The same statement applies to most developing countries. The Canadian and Japanese economies are roughly as dependent on capital markets financing as they are on bank financing…in the third quarter of 1998, when U.S. capital markets essentially ground to a halt, new issuance in the corporate bond market plummeted 67%. Total U.S. bank lending was down only 5% during that quarter. Therefore, in the current environment, economies that are more dependent on financing via capital markets may be more adversely affected by widespread credit restriction than economies that are financed primarily via bank lending. In other words, the United States appears to be the economy that would be most negatively impacted by the direct financial effects of a credit crunch centered in the bond markets.”
Month-End Valuations Getting a Lot of Scrutiny and Disagreements
From The Financial Times: “Bitter disputes are developing behind the scenes in the hedge fund industry about the way funds are valuing some assets for their end-of-month performance reports…“There is a lot of wrangling going on behind the scenes, because it’s getting hard to agree [about] how to value a lot of stuff,” says one US banking official. “The bid-offer spreads can be incredibly wide – and that can really affect the NAV.”
The issue of valuation is particularly critical at present because many hedge funds typically give their investors a NAV report at the end of every month. The data on funds’ NAV for the end of July is currently awaited with particular eagerness by many credit funds, since some are believed to have suffered painful losses as a result of the recent market turmoil – not only in the subprime sector but corporate credit markets in general.
Indeed, many bankers assume there will be further hedge fund implosions during coming weeks, adding to the list of those already forced to close their doors, or to take extreme measures such as banning investor redemptions…However, although these pressures make July’s NAV data particularly important, it is often difficult to ascribe precise values to many complex financial instruments even in calm markets, because these markets are illiquid. As a result, funds have often relied on models to value these instruments. However, there is growing unease these days about the quality of some of these models, given that conditions in the subprime sector, for example, are turning out to be much worse than models have assumed. Worse still, the sharp swings in credit prices now also make it hard to value instruments according to market or broker quotes. “Illiquidity is making those month-end [valuation] marks look atrocious,” …in the mainstream credit default swaps sector the bid-offer spread can now now be “as high as 20 basis points” (or between 5 and 20 per cent of the actual spread). Some hedge fund managers yesterday suggested that the largest, best-capitalised funds will now seek to take a very conservative approach to valuations in an effort to build credibility with investors.
However, with banks now raising margin calls, some weaker funds are scrambling for survival – raising the pressure for accounting tricks…“You are getting a distressed subprime asset which one person values at 20 cents in the dollar, and someone else values at 40 cents. “There is a lot of scope for argument,” said one banker.”
Evaporating Liquidity Hurts Investors
From The Financial Times: “When an ordinary sounding Australian mutual fund run by Macquarie Bank’s asset management division warned investors they could lose up to 25 per cent of their money this week it was shocking for two reasons. First, it was a retail fund, so the investors were everyday people. Second, their money had not been anywhere near US subprime mortgages, which have been at the centre of recent market turmoil.
The fund was actually invested in senior secured corporate loans, which are mainly the leveraged debt used in private equity-backed buy-outs – and these assets were fundamentally sound and performing well, the fund insisted. What caused the embarrassing loss was “supply-demand imbalances” in the market – which in plain English means many need to sell but few want to buy. The saga illustrates an ominous point, namely that as market turmoil rises, financial problems are no longer simply confined to a risky corner of the US mortgage market. This stems from another key theme now haunting the markets: namely that liquidity is evaporating from numerous corners of the financial world, as both investors in hedge funds and the banks that lend to them try to cut and run from recent losses.””
From The Los Angeles Times: “Some hedge funds that have suffered losses on investments are closing the gate on clients who want to pull money out, a move that could further undermine confidence in already shaky financial markets. Temporarily barring withdrawals, though legal, also could damage the image of the hedge fund industry, which in recent years has attracted hordes of well-heeled investors seeking high returns. The industry has mushroomed to 9,700 funds with $1.7 trillion in assets…Fund managers say that withdrawal limits protect their investors by preventing sales of securities at deeply depressed prices. But some analysts say news of unexpected hedge fund suspensions could prompt nervous investors in other funds to demand their money back, fearing that the exit door could slam shut on them in the next few months should stock and bond market losses deepen. Such a run-on-the-bank scenario also could hurt investors who have no money in hedge funds because forced asset sales could drive markets overall lower.”
Rating Agencies and Investors Seldom Saw Investment Bank Due-Diligence Reports
From Reuters: “Investment banks that bundle and sell home mortgages often commissioned reports showing growing risks in subprime loans to less creditworthy borrowers but did not pass on much of the information to credit rating agencies or investors, according to some of those who prepared the reports. The mortgage consultants, known as due-diligence firms, were hired by investment banks to make sure blocks of mortgages conformed to the mortgage seller's own standards. The studies provided a first glimpse of loan quality for ratings agencies and investors who do not normally see the full reports… But due-diligence firms … are not empowered to release the reports… While subprime mortgage security prospectuses warned about the perils of such loans in recent years, they did not enumerate the findings of due-diligence reports… Moody's customarily receives summaries of due-diligence studies but not the full reports, which might have helped the ratings agency evaluate now-troubled mortgage securities, said Nicolas Weill, chief credit officer for Moody's asset finance team. "It's difficult to know what would have happened if we had gotten that information," he said… However, while due diligence reports may contain facts that ratings agencies seek, they might not be interested in seeing the reports…"The International Organization of Securities Commissions code of conduct requires that they use all available information in their ratings process," … "To require them to look at due diligence would move them to another level of responsibility."”
MISC
From Dow Jones: “Factory orders climbed during June on the strength of higher demand for airplanes, but the increase was smaller than expected as bookings weakened for cars, computers and electrical equipment…a yardstick for business investment demand - non-defense capital goods orders excluding aircraft - was flat in June, after dropping 1.5% in May.”From JP Morgan: “Livestock (+8.6%) was the best-performing [commodity] sector in July, followed by energy (+6.5%).”
From Goldman Sachs: “…we highlighted the disparity between strong US surveys of industrial activity and what appeared to be a significant slowdown in household demand. Discrepancies of this sort must be reconciled through a rebound in demand, cutbacks in production, or both. Early signs suggest that a good part of this adjustment is coming on the production side.”
From JP Morgan: “Movements in yield curves are closely linked to monetary policy cycles… yield curves tend to flatten when central banks tighten monetary policy and steepen when they ease.”
From Merrill Lynch: “…the trough in the CBOE Volatility Index (VIX) coincided almost perfectly with the BOJ's initial rate hike of this cycle back in February. The much-discussed yen carry trade (i.e., borrowing at low interest rates in Yen to invest in higher returning assets elsewhere in the world) becomes incrementally expensive if the yen appreciates and/or Japanese interest rates rise. Thus, this year's increase in financial market volatility might be reflecting the early stages of the unwinding of such carry trades. Along that line of reasoning, we have further argued that anything that might cause the yen to appreciate could foster still higher financial market volatility.”
From The U.S. Treasury: “The overall compliance rate achieved under the U.S. revenue system is quite high. For the 2001 tax year, the IRS estimates that over 86 percent of tax liabilities were collected, after factoring in late payments and recoveries from IRS enforcement activities. Nevertheless, an unacceptable amount of the tax that should be paid every year is not, short-changing the vast majority of Americans who pay their taxes accurately and giving rise to the tax gap. The gross tax gap was estimated to be $345 billion in 2001. After enforcement effects and late payments, this number was reduced to a net tax gap of approximately $290 billion.”
From Merrill Lynch: “We believe it will be difficult for the market to do well as Financials underperform amidst rising bond yields and sub prime worries. After all, they comprise around 20% of total market value. However, we do not believe that this sector needs to outperform in order for the market to rally. Keep in mind that Financials have been at best a market performer for almost all of the past five years, despite respectable market returns.”
From UBS: “The net slowing in employment growth this year has been despite no significant change in jobless claims. Implicitly, the slowing has come from reduced hiring rather than increased layoffs.”
End-of-Day Market Update
Two and ten year Treasury yields declined 2.5bp in quiet trade verses 5pm yesterday.
Equities rose for the third day this week. The Dow is closing up 101 to 13,463. S&P +6.
The dollar index slipped .19 to 80.68. Gold eased a dollar to $665.90.
Oil futures rallied 40 cents to $76.93, down from an intraday high yesterday of $78.77.
From Reuters: “…tighter lending standards are starting to pinch consumer and business spending, threatening to slow already tepid U.S. economic growth… banks are increasingly leery of backing all sorts of risky loans, not just subprime mortgages for borrowers with shaky credit. "All the hoopla about subprime has created a sense among creditors and lenders that maybe they should rethink their easy terms,"… "It means that we have what is equivalent to a Fed (interest rate) tightening going on." Reduced spending stemming from the tighter credit terms could shave …off the U.S. economic growth rate… more sensible lending standards would be good for the economy in the long run… Business investment was a key factor behind the stronger-than-expected second-quarter gross domestic product figure issued last week. While consumer spending advanced at a slim 1.3 percent annual rate in the second quarter, business investment rose at an 8.1 percent pace. If companies pull back just as consumer spending is tapering off, it would hamstring the U.S. economy. Tighter credit is already stinging some smaller retail trade companies that supply goods to stores… If terms stay tight through the critical holiday shopping season and into next year, suppliers will have little choice but to cut back on shipments… Another subtle side effect of tightening credit is the decline in corporate share repurchases. As borrowing costs rise, companies have less incentive to ramp up debt to fund major stock buybacks, which typically push up share prices.”
Central Banks Appreciate Seeing Market Risks Re-Evaluated Higher
From Lehman: “ECB President Jean-Claude Trichet announced “strong vigilance”, and therefore signalled that a rate hike in September is very likely…The ECB president also addressed financial market developments. He recalled that “there had been some underpricing of risks” in the past, and that we are “now seeing the process of a progressive risk reappreciation”. He also mentioned a “period of nervosity (nervousness)” in the markets which deserves “particular attention”. To us, this means that the ECB is welcoming some of the repricing, but also that it is ready to act should financial market conditions deteriorate significantly.”
U.S. Less Dependent on Bank Lending Than Other Countries
From Wachovia: “Private debt securities comprise about 40% of total financing in the U.S. economy, and adding in the stock market brings total U.S. financing via the capital markets to 80%. No other major economy comes close to that percentage…the financial systems of the Euro-zone and the United Kingdom are much more dependent on bank lending than the United States. The same statement applies to most developing countries. The Canadian and Japanese economies are roughly as dependent on capital markets financing as they are on bank financing…in the third quarter of 1998, when U.S. capital markets essentially ground to a halt, new issuance in the corporate bond market plummeted 67%. Total U.S. bank lending was down only 5% during that quarter. Therefore, in the current environment, economies that are more dependent on financing via capital markets may be more adversely affected by widespread credit restriction than economies that are financed primarily via bank lending. In other words, the United States appears to be the economy that would be most negatively impacted by the direct financial effects of a credit crunch centered in the bond markets.”
Month-End Valuations Getting a Lot of Scrutiny and Disagreements
From The Financial Times: “Bitter disputes are developing behind the scenes in the hedge fund industry about the way funds are valuing some assets for their end-of-month performance reports…“There is a lot of wrangling going on behind the scenes, because it’s getting hard to agree [about] how to value a lot of stuff,” says one US banking official. “The bid-offer spreads can be incredibly wide – and that can really affect the NAV.”
The issue of valuation is particularly critical at present because many hedge funds typically give their investors a NAV report at the end of every month. The data on funds’ NAV for the end of July is currently awaited with particular eagerness by many credit funds, since some are believed to have suffered painful losses as a result of the recent market turmoil – not only in the subprime sector but corporate credit markets in general.
Indeed, many bankers assume there will be further hedge fund implosions during coming weeks, adding to the list of those already forced to close their doors, or to take extreme measures such as banning investor redemptions…However, although these pressures make July’s NAV data particularly important, it is often difficult to ascribe precise values to many complex financial instruments even in calm markets, because these markets are illiquid. As a result, funds have often relied on models to value these instruments. However, there is growing unease these days about the quality of some of these models, given that conditions in the subprime sector, for example, are turning out to be much worse than models have assumed. Worse still, the sharp swings in credit prices now also make it hard to value instruments according to market or broker quotes. “Illiquidity is making those month-end [valuation] marks look atrocious,” …in the mainstream credit default swaps sector the bid-offer spread can now now be “as high as 20 basis points” (or between 5 and 20 per cent of the actual spread). Some hedge fund managers yesterday suggested that the largest, best-capitalised funds will now seek to take a very conservative approach to valuations in an effort to build credibility with investors.
However, with banks now raising margin calls, some weaker funds are scrambling for survival – raising the pressure for accounting tricks…“You are getting a distressed subprime asset which one person values at 20 cents in the dollar, and someone else values at 40 cents. “There is a lot of scope for argument,” said one banker.”
Evaporating Liquidity Hurts Investors
From The Financial Times: “When an ordinary sounding Australian mutual fund run by Macquarie Bank’s asset management division warned investors they could lose up to 25 per cent of their money this week it was shocking for two reasons. First, it was a retail fund, so the investors were everyday people. Second, their money had not been anywhere near US subprime mortgages, which have been at the centre of recent market turmoil.
The fund was actually invested in senior secured corporate loans, which are mainly the leveraged debt used in private equity-backed buy-outs – and these assets were fundamentally sound and performing well, the fund insisted. What caused the embarrassing loss was “supply-demand imbalances” in the market – which in plain English means many need to sell but few want to buy. The saga illustrates an ominous point, namely that as market turmoil rises, financial problems are no longer simply confined to a risky corner of the US mortgage market. This stems from another key theme now haunting the markets: namely that liquidity is evaporating from numerous corners of the financial world, as both investors in hedge funds and the banks that lend to them try to cut and run from recent losses.””
From The Los Angeles Times: “Some hedge funds that have suffered losses on investments are closing the gate on clients who want to pull money out, a move that could further undermine confidence in already shaky financial markets. Temporarily barring withdrawals, though legal, also could damage the image of the hedge fund industry, which in recent years has attracted hordes of well-heeled investors seeking high returns. The industry has mushroomed to 9,700 funds with $1.7 trillion in assets…Fund managers say that withdrawal limits protect their investors by preventing sales of securities at deeply depressed prices. But some analysts say news of unexpected hedge fund suspensions could prompt nervous investors in other funds to demand their money back, fearing that the exit door could slam shut on them in the next few months should stock and bond market losses deepen. Such a run-on-the-bank scenario also could hurt investors who have no money in hedge funds because forced asset sales could drive markets overall lower.”
Rating Agencies and Investors Seldom Saw Investment Bank Due-Diligence Reports
From Reuters: “Investment banks that bundle and sell home mortgages often commissioned reports showing growing risks in subprime loans to less creditworthy borrowers but did not pass on much of the information to credit rating agencies or investors, according to some of those who prepared the reports. The mortgage consultants, known as due-diligence firms, were hired by investment banks to make sure blocks of mortgages conformed to the mortgage seller's own standards. The studies provided a first glimpse of loan quality for ratings agencies and investors who do not normally see the full reports… But due-diligence firms … are not empowered to release the reports… While subprime mortgage security prospectuses warned about the perils of such loans in recent years, they did not enumerate the findings of due-diligence reports… Moody's customarily receives summaries of due-diligence studies but not the full reports, which might have helped the ratings agency evaluate now-troubled mortgage securities, said Nicolas Weill, chief credit officer for Moody's asset finance team. "It's difficult to know what would have happened if we had gotten that information," he said… However, while due diligence reports may contain facts that ratings agencies seek, they might not be interested in seeing the reports…"The International Organization of Securities Commissions code of conduct requires that they use all available information in their ratings process," … "To require them to look at due diligence would move them to another level of responsibility."”
MISC
From Dow Jones: “Factory orders climbed during June on the strength of higher demand for airplanes, but the increase was smaller than expected as bookings weakened for cars, computers and electrical equipment…a yardstick for business investment demand - non-defense capital goods orders excluding aircraft - was flat in June, after dropping 1.5% in May.”From JP Morgan: “Livestock (+8.6%) was the best-performing [commodity] sector in July, followed by energy (+6.5%).”
From Goldman Sachs: “…we highlighted the disparity between strong US surveys of industrial activity and what appeared to be a significant slowdown in household demand. Discrepancies of this sort must be reconciled through a rebound in demand, cutbacks in production, or both. Early signs suggest that a good part of this adjustment is coming on the production side.”
From JP Morgan: “Movements in yield curves are closely linked to monetary policy cycles… yield curves tend to flatten when central banks tighten monetary policy and steepen when they ease.”
From Merrill Lynch: “…the trough in the CBOE Volatility Index (VIX) coincided almost perfectly with the BOJ's initial rate hike of this cycle back in February. The much-discussed yen carry trade (i.e., borrowing at low interest rates in Yen to invest in higher returning assets elsewhere in the world) becomes incrementally expensive if the yen appreciates and/or Japanese interest rates rise. Thus, this year's increase in financial market volatility might be reflecting the early stages of the unwinding of such carry trades. Along that line of reasoning, we have further argued that anything that might cause the yen to appreciate could foster still higher financial market volatility.”
From The U.S. Treasury: “The overall compliance rate achieved under the U.S. revenue system is quite high. For the 2001 tax year, the IRS estimates that over 86 percent of tax liabilities were collected, after factoring in late payments and recoveries from IRS enforcement activities. Nevertheless, an unacceptable amount of the tax that should be paid every year is not, short-changing the vast majority of Americans who pay their taxes accurately and giving rise to the tax gap. The gross tax gap was estimated to be $345 billion in 2001. After enforcement effects and late payments, this number was reduced to a net tax gap of approximately $290 billion.”
From Merrill Lynch: “We believe it will be difficult for the market to do well as Financials underperform amidst rising bond yields and sub prime worries. After all, they comprise around 20% of total market value. However, we do not believe that this sector needs to outperform in order for the market to rally. Keep in mind that Financials have been at best a market performer for almost all of the past five years, despite respectable market returns.”
From UBS: “The net slowing in employment growth this year has been despite no significant change in jobless claims. Implicitly, the slowing has come from reduced hiring rather than increased layoffs.”
End-of-Day Market Update
Two and ten year Treasury yields declined 2.5bp in quiet trade verses 5pm yesterday.
Equities rose for the third day this week. The Dow is closing up 101 to 13,463. S&P +6.
The dollar index slipped .19 to 80.68. Gold eased a dollar to $665.90.
Oil futures rallied 40 cents to $76.93, down from an intraday high yesterday of $78.77.
Wednesday, August 1, 2007
Market pulse
As of 2:25pm, the 10y Treasury yield has risen 3.5bp to 4.77%, the Dow is up 14 points, the dollar index up .11, and oil futures are down $1.80.
Today's Tidbits
Risk Aversion May Cause Higher Volatility, Reduced Correlation & Steeper Curve
From Morgan Stanley: “The market is in a risk aversion mode and the steps it takes to reduce risk may cause volatility to rise and correlations to fall. It would be naïve to think that the market mean-reverts back to the way things were just prior to the meltdown in
subprime. In fact, we view the recent event in subprime as a big bang, of sorts, that catalyzes a reversal in excessive risk-taking over the past several years. This would lead to a breakdown in the current high levels of market correlations. We call this a ReNormalization…This is significant because it marks a reversal of risk dynamics that we have grown accustomed to over the past few years…Too much liquidity and leverage chasing too few assets creates not only an increase in asset inflation but also an increase in asset correlation. In a world of easy money, liquidity and leverage can be manufactured quite easily and viewed as commodities. In this world lenders of capital compete aggressively with one another. This competition drives lenders of capital further down the quality spectrum to make more risky loans to achieve incrementally less returns. In turn, investors also move down the quality spectrum as the supply of investible assets dwindles. Soon, neither borrower nor lender fully differentiates risks inter- and intra-asset class. Effectively, assets move more closely together and volatility declines. This drives correlations higher. But it cuts both ways. This is because the mechanism from lenders of capital (prime brokerage, credit lines, repos, etc.) starts to tighten lending standards for the users of capital. For example, larger ‘hair-cuts’ on collateral may be required today in reflection of the increase in volatility and market uncertainty. Effectively, this makes the ease of acquiring liquidity and leverage more difficult and more costly. In turn, investor demand for assets declines and investors become more discerning about the risk they are taking. Soon, both borrowers and lenders start to differentiate risks inter- and intra-asset class. Effectively, assets move less closely together and volatility rises. This drives correlations lower…We argue that the historically flat level of the yield curve remains as one of the greatest dislocations across the rates market…We think the timing is ripe to position for a steeper yield curve, higher volatility and a breakdown in correlations.”
Impact of VAR [Estimated Value-at-Risk] on Market Participants
From NATIXIS: “Ultimately, the market was able to hold the line for less than a day, with equities closing on 3.5 month lows and bonds reversing all of yesterday’s decline and then some. I wonder how much of the failure was due to tighter risk budgets. Readers who aren’t familiar with sell-side risk limits may not be aware of the tyranny of VAR-based risk budgeting. Value-at-risk (VAR) methodologies at their core involve certain assumptions about market volatilities and correlations. Some models use historical volatilities, some use model volatilities, but for all of them VAR rises when (a) volatility rises and (b) correlations increase. Not too unlike a CDO tranche, actually. So in times when market volatility is creating great opportunity, the sell-side loses some of its ability to take on risk since the same positions now consume more of the VAR budget. The buy side typically has looser constraints (which is why some of them blow up), which means that in times of volatility the “fast money” becomes more and more dominant over flows.
Dealers hate that, but there is nothing they can do about it. When volatilities and/or correlations recede, then risk budgets will be resuscitated but in the meantime, the market stabilizers are decidedly less stable.”
Credit Default Swaps Display Signs of Immaturity and Inefficiency
From The Financial Times: “Did the risk of default on US investment grade bonds really triple over the past month? And, having done so, did this risk really drop by a third over the ensuing 24 hours? Of course not. But movements in the prices of credit default swaps, which allow investors to buy protection against defaults, suggested exactly that. So we now know that the market for credit derivatives, which did not exist five years ago, is inefficient… The way the price of default swaps has ricocheted in the past few days appears to reflect a market in which there are only a few ultimate "sellers" (at the big investment banks), who, if they do not feel confident about their ability to hedge their exposures, can simply mark prices up to unrealistic levels. This is much less efficient than the markets for stocks or bonds. As for the fundamentals, moves in swaps prices have far outpaced moves in underlying bonds.”
MISC
From RBSGC: “As badly as investors want to believe that the worst of it is behind us, global financial markets remain in turmoil and certainly more pain exists on the horizon…Credit markets are seizing up as global markets reprice risk premiums across all asset classes. While pass-throughs are AAA and relatively liquid compared to some of the securities out there, the market appetite for risk is minimal and unlikely to change soon. Mortgages however are the tail, not the dog right now and valuations will simply be a function of treasuries, swaps and implied volatility until further notice. We are keeping our powder dry and waiting for friendlier price action before committing capital to a significant trade. Mortgages are very cheap but difficult to hedge. Bid/ask spreads are widening to reflect the illiquidity and only are going to get worse for the time being.”
From Merrill Lynch: “…just about every currency is losing ground to the yen…”
From UBS: “Agencies underperformed Treasuries and swaps across the curve over the past 2 weeks as the mortgage market, hedge funds and the equity market decline contributed to the suffering. During the past 3 trading sessions Agencies appear to be turning the corner, and spreads are inching back in…”
From Forbes: “Standard & Poor's said the U.S. corporate bond market was officially speculative grade. The big ratings agency said 50.7% of the corporate bond market is now rated speculative grade, the first time this has happened, marking a decade-long shift toward more aggressive finance strategies and the evolution of the leveraged finance market. S&P calls anything below BBB- "speculative," but most people just call it junk. These days, the market calls it scary.”
From Bloomberg: “Crude-oil supplies dropped 6.5 million barrels in the week ended July 27, the biggest decline this year, according to the department. Gasoline, diesel and heating-oil stockpiles rose as refiners bolstered operating rates to 93.6 percent of capacity, the highest in 13 months.”
From JP Morgan: “Pending home sales surged 5% in June, a surprising move given the rise in mortgage rates in that month and tightening lending standards. However, this rise should be viewed in the context of declines in the prior three months: a cumulative 11.1%. Moreover, mortgage interest rates were up measurably between May and June, while builder assessments of sales and new home sales pulled back sharply. These developments question the credibility of the 5% jump reported today.”
From JP Morgan: “The JPMorgan global manufacturing PMI suffered a setback in July, all but reversing the impressive uptrend since the turn of the year. The headline composite index sank 1.3 point to 53.1 in July, its largest fall since March of 2003. The sharp fall was broadly-based across the PMI’s components, including output, new orders, export orders, and employment. The particularly large fall in the output index was the second biggest decline in the history of the survey back to 1998, excluding the drop following the 9/11 terrorist attacks, and points to an easing in the growth of industrial activity last month. The level of the PMI remains solid, but the drop may indicate renewed concern among businesses regarding the pace of aggregate demand in the second half of this year.”
From Merrill Lynch: “…it is clear that: business capex and consumer spending growth, and inventory stockpiling have decelerated at the beginning of 3Q-07, and these are the factors behind the decelerating dynamic in real GDP growth and in ISM.”
From The Financial Times: “The spat between the US and China over contaminated food exports highlights a rapidly spreading battle line in the world economy: the use of product standards to regulate, and some would say stifle, international trade.”
The Financial Times: “The world's biggest oil prod-ucers have boosted their search for oil and gas to one of the highest levels in two decades as prices yesterday neared record highs of more than $78 a barrel. The Organisation of the Petroleum Exporting Countries, the cartel that controls three-quarters of global oil reserves, said yesterday that its members operated 336 oil rigs last year, an increase of 11.5 per cent since 2005, in response to strong demand from developing countries such as China and India… Saudi Arabia drilled 382 new wells last year, the highest number for any year since 1980.”
From Morgan Stanley: “The market is in a risk aversion mode and the steps it takes to reduce risk may cause volatility to rise and correlations to fall. It would be naïve to think that the market mean-reverts back to the way things were just prior to the meltdown in
subprime. In fact, we view the recent event in subprime as a big bang, of sorts, that catalyzes a reversal in excessive risk-taking over the past several years. This would lead to a breakdown in the current high levels of market correlations. We call this a ReNormalization…This is significant because it marks a reversal of risk dynamics that we have grown accustomed to over the past few years…Too much liquidity and leverage chasing too few assets creates not only an increase in asset inflation but also an increase in asset correlation. In a world of easy money, liquidity and leverage can be manufactured quite easily and viewed as commodities. In this world lenders of capital compete aggressively with one another. This competition drives lenders of capital further down the quality spectrum to make more risky loans to achieve incrementally less returns. In turn, investors also move down the quality spectrum as the supply of investible assets dwindles. Soon, neither borrower nor lender fully differentiates risks inter- and intra-asset class. Effectively, assets move more closely together and volatility declines. This drives correlations higher. But it cuts both ways. This is because the mechanism from lenders of capital (prime brokerage, credit lines, repos, etc.) starts to tighten lending standards for the users of capital. For example, larger ‘hair-cuts’ on collateral may be required today in reflection of the increase in volatility and market uncertainty. Effectively, this makes the ease of acquiring liquidity and leverage more difficult and more costly. In turn, investor demand for assets declines and investors become more discerning about the risk they are taking. Soon, both borrowers and lenders start to differentiate risks inter- and intra-asset class. Effectively, assets move less closely together and volatility rises. This drives correlations lower…We argue that the historically flat level of the yield curve remains as one of the greatest dislocations across the rates market…We think the timing is ripe to position for a steeper yield curve, higher volatility and a breakdown in correlations.”
Impact of VAR [Estimated Value-at-Risk] on Market Participants
From NATIXIS: “Ultimately, the market was able to hold the line for less than a day, with equities closing on 3.5 month lows and bonds reversing all of yesterday’s decline and then some. I wonder how much of the failure was due to tighter risk budgets. Readers who aren’t familiar with sell-side risk limits may not be aware of the tyranny of VAR-based risk budgeting. Value-at-risk (VAR) methodologies at their core involve certain assumptions about market volatilities and correlations. Some models use historical volatilities, some use model volatilities, but for all of them VAR rises when (a) volatility rises and (b) correlations increase. Not too unlike a CDO tranche, actually. So in times when market volatility is creating great opportunity, the sell-side loses some of its ability to take on risk since the same positions now consume more of the VAR budget. The buy side typically has looser constraints (which is why some of them blow up), which means that in times of volatility the “fast money” becomes more and more dominant over flows.
Dealers hate that, but there is nothing they can do about it. When volatilities and/or correlations recede, then risk budgets will be resuscitated but in the meantime, the market stabilizers are decidedly less stable.”
Credit Default Swaps Display Signs of Immaturity and Inefficiency
From The Financial Times: “Did the risk of default on US investment grade bonds really triple over the past month? And, having done so, did this risk really drop by a third over the ensuing 24 hours? Of course not. But movements in the prices of credit default swaps, which allow investors to buy protection against defaults, suggested exactly that. So we now know that the market for credit derivatives, which did not exist five years ago, is inefficient… The way the price of default swaps has ricocheted in the past few days appears to reflect a market in which there are only a few ultimate "sellers" (at the big investment banks), who, if they do not feel confident about their ability to hedge their exposures, can simply mark prices up to unrealistic levels. This is much less efficient than the markets for stocks or bonds. As for the fundamentals, moves in swaps prices have far outpaced moves in underlying bonds.”
MISC
From RBSGC: “As badly as investors want to believe that the worst of it is behind us, global financial markets remain in turmoil and certainly more pain exists on the horizon…Credit markets are seizing up as global markets reprice risk premiums across all asset classes. While pass-throughs are AAA and relatively liquid compared to some of the securities out there, the market appetite for risk is minimal and unlikely to change soon. Mortgages however are the tail, not the dog right now and valuations will simply be a function of treasuries, swaps and implied volatility until further notice. We are keeping our powder dry and waiting for friendlier price action before committing capital to a significant trade. Mortgages are very cheap but difficult to hedge. Bid/ask spreads are widening to reflect the illiquidity and only are going to get worse for the time being.”
From Merrill Lynch: “…just about every currency is losing ground to the yen…”
From UBS: “Agencies underperformed Treasuries and swaps across the curve over the past 2 weeks as the mortgage market, hedge funds and the equity market decline contributed to the suffering. During the past 3 trading sessions Agencies appear to be turning the corner, and spreads are inching back in…”
From Forbes: “Standard & Poor's said the U.S. corporate bond market was officially speculative grade. The big ratings agency said 50.7% of the corporate bond market is now rated speculative grade, the first time this has happened, marking a decade-long shift toward more aggressive finance strategies and the evolution of the leveraged finance market. S&P calls anything below BBB- "speculative," but most people just call it junk. These days, the market calls it scary.”
From Bloomberg: “Crude-oil supplies dropped 6.5 million barrels in the week ended July 27, the biggest decline this year, according to the department. Gasoline, diesel and heating-oil stockpiles rose as refiners bolstered operating rates to 93.6 percent of capacity, the highest in 13 months.”
From JP Morgan: “Pending home sales surged 5% in June, a surprising move given the rise in mortgage rates in that month and tightening lending standards. However, this rise should be viewed in the context of declines in the prior three months: a cumulative 11.1%. Moreover, mortgage interest rates were up measurably between May and June, while builder assessments of sales and new home sales pulled back sharply. These developments question the credibility of the 5% jump reported today.”
From JP Morgan: “The JPMorgan global manufacturing PMI suffered a setback in July, all but reversing the impressive uptrend since the turn of the year. The headline composite index sank 1.3 point to 53.1 in July, its largest fall since March of 2003. The sharp fall was broadly-based across the PMI’s components, including output, new orders, export orders, and employment. The particularly large fall in the output index was the second biggest decline in the history of the survey back to 1998, excluding the drop following the 9/11 terrorist attacks, and points to an easing in the growth of industrial activity last month. The level of the PMI remains solid, but the drop may indicate renewed concern among businesses regarding the pace of aggregate demand in the second half of this year.”
From Merrill Lynch: “…it is clear that: business capex and consumer spending growth, and inventory stockpiling have decelerated at the beginning of 3Q-07, and these are the factors behind the decelerating dynamic in real GDP growth and in ISM.”
From The Financial Times: “The spat between the US and China over contaminated food exports highlights a rapidly spreading battle line in the world economy: the use of product standards to regulate, and some would say stifle, international trade.”
The Financial Times: “The world's biggest oil prod-ucers have boosted their search for oil and gas to one of the highest levels in two decades as prices yesterday neared record highs of more than $78 a barrel. The Organisation of the Petroleum Exporting Countries, the cartel that controls three-quarters of global oil reserves, said yesterday that its members operated 336 oil rigs last year, an increase of 11.5 per cent since 2005, in response to strong demand from developing countries such as China and India… Saudi Arabia drilled 382 new wells last year, the highest number for any year since 1980.”
Manufacturing ISM Eases Back to Recent Trend Growth Rate
Manufacturing ISM slipped to 53.8 in July (consensus 55) from its recent high of 56 last month. This puts the index exactly at its monthly average level for the past 18 months, and indicates healthy growth. A reading above 50 indicates expansion. Prices paid fell a larger than expected amount, from 67 to 65. Prices paid remain elevated, but have fallen to the lowest level since January due to lower energy and metal prices.
New export orders were one of the few categories to show improvement in July, indicating that foreign demand is helping offset softening domestic retail demand. Unfortunately, production, new orders, and order backlogs all fell, with production down an unusually large -7 MoM, but all remain above 50. All inventory gauges showed higher readings, which is a concern following the recent efforts to reduce excess inventories. Employment weakened to a four month low, supporting the weakening manufacturing employment data reported by ADP this morning.
New export orders were one of the few categories to show improvement in July, indicating that foreign demand is helping offset softening domestic retail demand. Unfortunately, production, new orders, and order backlogs all fell, with production down an unusually large -7 MoM, but all remain above 50. All inventory gauges showed higher readings, which is a concern following the recent efforts to reduce excess inventories. Employment weakened to a four month low, supporting the weakening manufacturing employment data reported by ADP this morning.
Pending Home Sales Leap Higher in June
June pending home sales unexpectedly increased 5% MoM in June (consensus -.5% MoM). This is the first increase in this data series in four months, and is in stark contrast to other recent housing data. Pending home sales are based on initial sales contract data for existing (used) homes, and is considered a leading indicator of housing market health. Actual contract closings usually occur a month or two after the initial contract is agreed. Pending home sales for May were revised lower to -3.7% MoM. Existing homes account for about 80% of normal monthly home sales.
All regions of the country saw a rebound in pending home sales. The West saw the strongest gain at +8.6% MoM followed by the South at +4.7% MoM, then the Midwest at +3.5% and the Northeast at +3.1% MoM.
Versus a year ago, pending home sales are down -11.1% nationally. By region the South has seen the greatest decline falling -13.8% YoY. The Midwest has fallen -11.6% YoY, followed by the West at -9.4% YoY and the Northeast at -5.8% YoY.
No house price data was included in today's report.
All regions of the country saw a rebound in pending home sales. The West saw the strongest gain at +8.6% MoM followed by the South at +4.7% MoM, then the Midwest at +3.5% and the Northeast at +3.1% MoM.
Versus a year ago, pending home sales are down -11.1% nationally. By region the South has seen the greatest decline falling -13.8% YoY. The Midwest has fallen -11.6% YoY, followed by the West at -9.4% YoY and the Northeast at -5.8% YoY.
No house price data was included in today's report.
ADP Job Estimate Half Expected Growth for July
ADP's employment growth estimate, based on a survey of their customers, shows weak job creation in July. The survey indicates only 48k in non-government jobs were created last month, versus an estimate of 100k. Adding in 25k for government job growth, this implies national job growth of 75k, only 58% of the current consensus for employment growth in the Friday's non-farm payrolls report of 130k.
The ADP report shows manufacturing and construction companies shedding 41k jobs last month, while services added 89k. Large companies reduced employment while small and medium sized firms added employees.
The ADP survey covers 383k business and around 23 million workers.
Yesterday, Johnson and Johnson announced they are reducing their workforce by 4%. This morning's Challenger report showed job cuts are up 15% in July of 2007, versus July of last year(which was a six year low). Year-to-date, job cuts are only down 8%, as the unemployment rate remains low.
The ADP report shows manufacturing and construction companies shedding 41k jobs last month, while services added 89k. Large companies reduced employment while small and medium sized firms added employees.
The ADP survey covers 383k business and around 23 million workers.
Yesterday, Johnson and Johnson announced they are reducing their workforce by 4%. This morning's Challenger report showed job cuts are up 15% in July of 2007, versus July of last year(which was a six year low). Year-to-date, job cuts are only down 8%, as the unemployment rate remains low.
Tuesday, July 31, 2007
Today's Tidbits
Spike in July’s Consumer Confidence Unlikely to PersistFrom Lehman: “Consumer confidence jumped to 112.6 in July, the highest level since August 2001 when the index was at 114.0. The jump was the result of a 9.3 point increase in current conditions and a six point gain in expectations. Buying plans for autos and housing both increased with the latter rising to its highest level since March. Among the current conditions components, business conditions posted a modest improvement but net employment conditions surged - the percentage of consumers reporting that jobs are "plentiful" less the percentage reporting that jobs are "hard to get" rose to 12.1 from a 7.1 reported last month. Like the headline index, this is the highest level since August 2001 when the series was at 17.6. This data is consistent with recent employment readings and suggests that the "tightness" of the labor market is real and not the result of BLS adjustments….The report is yet more evidence of the overall health of the labor market despite the downturn in construction activity and supports the notion that, while consumer spending may slow, there are some reasons for optimism.”
From Deutsche Bank: “…the recent rise in the minimum wage could also have been a factor behind the increase in consumer confidence as lower income households reported a large increase in confidence this month. …confidence is a terrible predictor of future spending…”
Lower Stock Prices Will Hurt Consumer Spending as MEW Subsides
From HSBC: “Unlike the business sector, the household sector has had a growing financing gap in recent years. It reached a record USD600bn in 2006, even though households savagely reduced their investment in residential structures. In 2002-2004, the household financing gap was comfortably covered by mortgage equity withdrawal (MEW). But since 2005, consumers have had to also sell equities back to the corporate sector. For instance, MEW went from USD400bn in 2004 to virtually nothing by early 2007. In that same period, the net selling of equities by households went from about USD100bn to over USD500bn - virtually a perfect offset - which gave consumers the cash to keep plugging their large financing gap. But this game may be changing. If leveraged buyouts decrease and the pressure on firms generally to maintain their current level of buybacks is reduced, the implication is that consumers will have to find another willing buyer of equities (or corporate bonds and Treasuries, for that matter). Perhaps foreigners will step up to the plate, but that might require further declines in asset prices and/or a further decline in the dollar to entice them. Alternatively, and perhaps more likely, consumption has to slow so that the financing gap can narrow.”
Oil Prices Rising on International Demand Growth & Stagnate Reserve Gains
From Bloomberg: “Crude oil rose to a record close of $78.21 [+$1.38] a barrel in New York on speculation demand will outpace supply as refiners increase fuel production. Bets on rising prices by hedge funds and other speculators rose to a record earlier this month, according to U.S. Commodity Futures Trading Commission data. Global demand will climb 1.7 percent in 2008, showing no sign of slowing because of high prices, a Deutsche Bank AG report showed. A government report tomorrow may show U.S. oil supplies fell for a fourth week. ``There's significant growth in global energy demand and
production isn't keeping up,''…”
From JP Morgan: “The EIA revised May oil demand down by a whopping 822 kbd this month, with revisions distributed across all major product categories. This is the fourth straight month EIA has made downward revisions to its weekly data. As with previous months, the adjustments significantly changed the US demand story, changing the 2.5% yoy growth seen in weekly data to a 1.5% contraction…“
From Dow Jones: “…in an indication as to why it may be keeping a tight rope on future production capacity, the report [OPEC’s annual statistical review] showed OPEC’s base of economically recoverable oil reserves last year was flat if new, higher estimates from troubled OPEC producer Venezuela are stripped out, the worst growth in this key metric in recent years.”
MISC
From JP Morgan: “…the global upturn in manufacturing to date has been led by EM Asia excluding China…”
From Morgan Stanley: “the Chicago Fed announced that its current director of research, Charles Evans, will become the bank’s new president when Michael Moskow retires at the end of August, following in the footsteps of Richmond Fed President Lacker, who was also his bank’s research head before being promoted to president in 2004…He will be a voting member at his first FOMC meeting in September.”
From Merrill Lynch: “…the beginning of the rise in overall equity market volatility as measured by the CBOE Volatility Index (VIX) coincided with the Bank of Japan's initial interest rate increase in February. Not surprisingly, we also have suggested that the increase in financial market volatility is the prime symptom of a gradual unwinding of the so-called yen carry trade (i.e., borrowing in low Japanese interest rates to get higher rates of return in other markets). Debt markets generally sniffed out this unwinding before equity markets did. For example, although high yield bond spreads were widening during June, equity market participants didn't realize that their assumed takeover premiums were too high until late-July.”
From Bloomberg: “American Home Mortgage Investment Corp. shares plunged 89 percent after the lender said it doesn't have cash to fund new loans and may have to sell off assets. Investment banks cut off credit lines, leaving American Home without money yesterday for $300 million of mortgages it had already agreed to provide, the Melville, New York-based company said in a statement today. It anticipates $450 million to $500
million of loans probably won't get funded today. ``They can't function without access to capital,''…”
From Bloomberg: “On Wall Street, Bear Stearns Cos., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Goldman Sachs Group Inc., are as good as junk. Bonds of U.S. investment banks lost about $1.5 billion of their face value this month as the risk of owning the securities increased the most since at least October 2004, according to Merrill indexes. Prices of credit-default swaps based on the debt imply that their credit ratings are below investment grade, data compiled by Moody's Investors Service show… Credit-default swaps tied to $10 million of bonds sold by Bear Stearns, the second-largest underwriter of mortgage bonds, rose to about $110,000 on July 27, from $30,000 at the start of June, indicating growing investor concerns.”
From Bloomberg: “Moody's Investors Service described some so-called Alt A mortgages as no better than subprime home loans, saying it will change how it rates related securities after failing to predict how far delinquencies would rise. The ratings firm said today its expectations for losses on Alt A mortgages will rise between 10 percent and 100 percent, depending on whether a loan pool has a lot of debt extended to borrowers with low credit scores and little money for down payments. It's also raising loss expectations when borrowers don't fully document their incomes. ``Actual performance of weaker Alt-A loans has in many cases been comparable to stronger subprime performance, signaling that underwriting standards were likely closer to subprime guidelines,'' Marjan Riggi, Moody's senior credit officer, said in a statement. ``Absent strong compensating factors, we will model these loans as subprime loans.''”
End-of-Day Market Update
From RBSGC: “The [Treasury] market ended the day near the 4.76% [-6bp] low-yield close of last Friday. The reason for the late-session uptrade was multifaceted -- including a resurgence of credit-related concerns, month-end, weakness in stocks, and an emerging willingness to go-with uptrades. 4.75/76% does represent some resistance -- and we have now traded up here for the 4-th consecutive session, continuing to flirt with the highs, but yet to break. We expect another leg of serious credit concerns will need to precede a sustainable break of the highs.”
From UBS: “Swap spreads swung around from 3bps wider to 3bps tighter, finishing about 1bp tighter. Mortgages saw $1.5 billion in origination on the day, and $2.5 billion in selling, compared to $3 billion in buying. Considering the bad news from MGIC, Sowood, Indy Mac, Am Home, Oddo, Kfw and Macquarie... MBS did quite well until after 3pm when MBS went a + wider to Tsy and a tick wider to swaps…”
From CNN: “Wall Street [equities] could not sustain its early rally, slipping into negative territory Tuesday afternoon on higher oil prices and signs that recent credit market woes were not over. The Dow Jones industrial average eased… [closing down 146 points at 13,212] after climbing by as much as 138 points after the market open. [The S&P fell 18.6 points to 1455.]
The dollar weakened again today with the dollar index falling -.05 to 80.80.
From CNN: “Oil prices…neared its record [intraday] trading high of $78.40 hit a year ago, …. U.S. light crude for September jumped $1.41 to $78.24 a barrel on the New York Mercantile Exchange.”
From Deutsche Bank: “…the recent rise in the minimum wage could also have been a factor behind the increase in consumer confidence as lower income households reported a large increase in confidence this month. …confidence is a terrible predictor of future spending…”
Lower Stock Prices Will Hurt Consumer Spending as MEW Subsides
From HSBC: “Unlike the business sector, the household sector has had a growing financing gap in recent years. It reached a record USD600bn in 2006, even though households savagely reduced their investment in residential structures. In 2002-2004, the household financing gap was comfortably covered by mortgage equity withdrawal (MEW). But since 2005, consumers have had to also sell equities back to the corporate sector. For instance, MEW went from USD400bn in 2004 to virtually nothing by early 2007. In that same period, the net selling of equities by households went from about USD100bn to over USD500bn - virtually a perfect offset - which gave consumers the cash to keep plugging their large financing gap. But this game may be changing. If leveraged buyouts decrease and the pressure on firms generally to maintain their current level of buybacks is reduced, the implication is that consumers will have to find another willing buyer of equities (or corporate bonds and Treasuries, for that matter). Perhaps foreigners will step up to the plate, but that might require further declines in asset prices and/or a further decline in the dollar to entice them. Alternatively, and perhaps more likely, consumption has to slow so that the financing gap can narrow.”
Oil Prices Rising on International Demand Growth & Stagnate Reserve Gains
From Bloomberg: “Crude oil rose to a record close of $78.21 [+$1.38] a barrel in New York on speculation demand will outpace supply as refiners increase fuel production. Bets on rising prices by hedge funds and other speculators rose to a record earlier this month, according to U.S. Commodity Futures Trading Commission data. Global demand will climb 1.7 percent in 2008, showing no sign of slowing because of high prices, a Deutsche Bank AG report showed. A government report tomorrow may show U.S. oil supplies fell for a fourth week. ``There's significant growth in global energy demand and
production isn't keeping up,''…”
From JP Morgan: “The EIA revised May oil demand down by a whopping 822 kbd this month, with revisions distributed across all major product categories. This is the fourth straight month EIA has made downward revisions to its weekly data. As with previous months, the adjustments significantly changed the US demand story, changing the 2.5% yoy growth seen in weekly data to a 1.5% contraction…“
From Dow Jones: “…in an indication as to why it may be keeping a tight rope on future production capacity, the report [OPEC’s annual statistical review] showed OPEC’s base of economically recoverable oil reserves last year was flat if new, higher estimates from troubled OPEC producer Venezuela are stripped out, the worst growth in this key metric in recent years.”
MISC
From JP Morgan: “…the global upturn in manufacturing to date has been led by EM Asia excluding China…”
From Morgan Stanley: “the Chicago Fed announced that its current director of research, Charles Evans, will become the bank’s new president when Michael Moskow retires at the end of August, following in the footsteps of Richmond Fed President Lacker, who was also his bank’s research head before being promoted to president in 2004…He will be a voting member at his first FOMC meeting in September.”
From Merrill Lynch: “…the beginning of the rise in overall equity market volatility as measured by the CBOE Volatility Index (VIX) coincided with the Bank of Japan's initial interest rate increase in February. Not surprisingly, we also have suggested that the increase in financial market volatility is the prime symptom of a gradual unwinding of the so-called yen carry trade (i.e., borrowing in low Japanese interest rates to get higher rates of return in other markets). Debt markets generally sniffed out this unwinding before equity markets did. For example, although high yield bond spreads were widening during June, equity market participants didn't realize that their assumed takeover premiums were too high until late-July.”
From Bloomberg: “American Home Mortgage Investment Corp. shares plunged 89 percent after the lender said it doesn't have cash to fund new loans and may have to sell off assets. Investment banks cut off credit lines, leaving American Home without money yesterday for $300 million of mortgages it had already agreed to provide, the Melville, New York-based company said in a statement today. It anticipates $450 million to $500
million of loans probably won't get funded today. ``They can't function without access to capital,''…”
From Bloomberg: “On Wall Street, Bear Stearns Cos., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Goldman Sachs Group Inc., are as good as junk. Bonds of U.S. investment banks lost about $1.5 billion of their face value this month as the risk of owning the securities increased the most since at least October 2004, according to Merrill indexes. Prices of credit-default swaps based on the debt imply that their credit ratings are below investment grade, data compiled by Moody's Investors Service show… Credit-default swaps tied to $10 million of bonds sold by Bear Stearns, the second-largest underwriter of mortgage bonds, rose to about $110,000 on July 27, from $30,000 at the start of June, indicating growing investor concerns.”
From Bloomberg: “Moody's Investors Service described some so-called Alt A mortgages as no better than subprime home loans, saying it will change how it rates related securities after failing to predict how far delinquencies would rise. The ratings firm said today its expectations for losses on Alt A mortgages will rise between 10 percent and 100 percent, depending on whether a loan pool has a lot of debt extended to borrowers with low credit scores and little money for down payments. It's also raising loss expectations when borrowers don't fully document their incomes. ``Actual performance of weaker Alt-A loans has in many cases been comparable to stronger subprime performance, signaling that underwriting standards were likely closer to subprime guidelines,'' Marjan Riggi, Moody's senior credit officer, said in a statement. ``Absent strong compensating factors, we will model these loans as subprime loans.''”
End-of-Day Market Update
From RBSGC: “The [Treasury] market ended the day near the 4.76% [-6bp] low-yield close of last Friday. The reason for the late-session uptrade was multifaceted -- including a resurgence of credit-related concerns, month-end, weakness in stocks, and an emerging willingness to go-with uptrades. 4.75/76% does represent some resistance -- and we have now traded up here for the 4-th consecutive session, continuing to flirt with the highs, but yet to break. We expect another leg of serious credit concerns will need to precede a sustainable break of the highs.”
From UBS: “Swap spreads swung around from 3bps wider to 3bps tighter, finishing about 1bp tighter. Mortgages saw $1.5 billion in origination on the day, and $2.5 billion in selling, compared to $3 billion in buying. Considering the bad news from MGIC, Sowood, Indy Mac, Am Home, Oddo, Kfw and Macquarie... MBS did quite well until after 3pm when MBS went a + wider to Tsy and a tick wider to swaps…”
From CNN: “Wall Street [equities] could not sustain its early rally, slipping into negative territory Tuesday afternoon on higher oil prices and signs that recent credit market woes were not over. The Dow Jones industrial average eased… [closing down 146 points at 13,212] after climbing by as much as 138 points after the market open. [The S&P fell 18.6 points to 1455.]
The dollar weakened again today with the dollar index falling -.05 to 80.80.
From CNN: “Oil prices…neared its record [intraday] trading high of $78.40 hit a year ago, …. U.S. light crude for September jumped $1.41 to $78.24 a barrel on the New York Mercantile Exchange.”
Construction Spending Sinks in June
Construction spending unexpectedly fell -.3% MoM (consensus +.2% MoM) last month, for the first time since January, as non- residential spending rose less (+.1% MoM) than residential fell (-.7% MoM). Non-residential growth has been the support for construction spending this year, as the housing market has continued to weaken. Over the past year, non-residential construction has risen +14.1% YoY, while residential construction spending has fallen -16.1% YoY. Combined, construction has fallen -2.4% YoY.
The softness in construction investment in June appears to be due to government spending coming to a halt last month. Public investment was unchanged in June, with non-residential public development falling -.1% MoM, after growing 10.3% YoY. Non-residential public construction includes things like water-treatment plants and government office buildings. Public construction of hospitals has been quite strong this past quarter, but is slowing.
Private residential construction continues its 16 month slump, falling an additional -.7% MoM in June, for a cumulative loss of -16.1% YoY.
Slower construction spending will be a drag on GDP.
The softness in construction investment in June appears to be due to government spending coming to a halt last month. Public investment was unchanged in June, with non-residential public development falling -.1% MoM, after growing 10.3% YoY. Non-residential public construction includes things like water-treatment plants and government office buildings. Public construction of hospitals has been quite strong this past quarter, but is slowing.
Private residential construction continues its 16 month slump, falling an additional -.7% MoM in June, for a cumulative loss of -16.1% YoY.
Slower construction spending will be a drag on GDP.
July Chicago PMI Unexpectedly Weakens
The Chicago Purchasing Managers Index unexpectedly weakened more than expected in July, falling to 53.4 (consensus 58.4) from 60.2 in June. The index reached a two year high in May at 61.7. Any reading over 50 indicates growth.
Production, new orders, and order backlogs all declined in July, while prices paid, employment, and supplier deliveries rose.
Companies may be pulling back on production due to rising concerns about consumer consumption slowing.
Production, new orders, and order backlogs all declined in July, while prices paid, employment, and supplier deliveries rose.
Companies may be pulling back on production due to rising concerns about consumer consumption slowing.
S&P Case Shiller Home Price Index
Home prices depreciation continued to accelerate in May. The larger 20 city index fell -2.8% YoY (consensus -2.9%), and the more bubble focused 10 city index fell -3.4% YoY.
Regional variations remain sizeable. Detroit continues to be the weakest housing market with declines of -11.1% YoY, while Seattle remains the strongest at + 9.1% YoY. Washington, DC's home prices have eroded by -6.3% YoY, not much better than Tampa's -6.6% YoY decline or San Francisco's -6.9% YoY decline.
The Case-Shiller index is based on repeat home sales. Most dealers are predicting home prices will have declined nationally at least -5% YoY by the end of 2007.
Regional variations remain sizeable. Detroit continues to be the weakest housing market with declines of -11.1% YoY, while Seattle remains the strongest at + 9.1% YoY. Washington, DC's home prices have eroded by -6.3% YoY, not much better than Tampa's -6.6% YoY decline or San Francisco's -6.9% YoY decline.
The Case-Shiller index is based on repeat home sales. Most dealers are predicting home prices will have declined nationally at least -5% YoY by the end of 2007.
Income/Spending/Inflation data generally as expected
Personal Income growth was slightly weaker than expected at +.4% MoM (consensus +.5%), but spending was right on consensus at a very modest gain of +.1% MoM, down from an increase in personal spending of +.6% MoM in May.
June's +.1% MoM gain in spending was the smallest increase in nine months. This is important because consumer spending currently accounts for approx 70% of GDP, though this percentage, and the consumer's importance to the economy, may slip if domestic consumption declines and exports increase. Income growing four times faster than spending should help stabilize consumer spending,, even as higher gasoline prices reduce other discretionary spending. The slump in housing, and now equities, also puts consumers under greater strain. The impact of these factors can be seen in the slowdown in consumer spending which increased at the slowest pace last quarter in more than a year, and only rose at one-third the pace of the first quarter's growth. Auto sales were the lowest in two years last month. Durable goods spending fell -1.6% MoM while spending on services rose +.5% MoM, basically at trend.
Personal income is growing at a fairly decent pace when annualized, at just under 5%. Personal income when adjusted for taxes, otherwise known as disposable income, rose +.4% MoM for the second month in a row. Inflation-adjusted disposable income rose +.3% MoM.
Personal consumption expenditure inflation figures were unexpectedly revised higher in May, causing the June figures, which came in at expectations as unchanged from the originally released May figures, to show a decline in inflation. The PCE deflator for May was +2.3% YoY, and the core PCE was +1.9% YoY. Core PCE grew +.1% MoM (consensus +.2%). Core PCE is considered to be the Fed's preferred inflation measure. They are believed to desire inflation to range between 1-2%, which today's figure does. The three month annualized rate has fallen to +1.6%.
Revisions to GDP data last week improved the savings data back into positive territory from negative territory. Today's data for June shows the savings rate rising from +.4% last month to +.6% in June, as income grew faster than spending.
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Employment Cost Index for the the 2nd quarter grew +.9% QoQ, as expected, and a slight increase from the +.8% pace of the first quarter. Unexpectedly, benefits costs rose the most in two years as companies improved benefits to retain employees. On an annual basis, the ECI fell from 3.5% YoY in the first quarter to +3.3% YoY in the second quarter. Wages and salaries have risen +3.4% YoY. Benefits have also risen +3.4% YoY (up from +3.1% in the first quarter), but they fell -.3% QoQ in the first quarter before rising +1.1% QoQ in the second quarter.
The ECI includes wages, benefits, and employer contributions to Social Security and Medicare, but not bonuses and options. Eliminating the later enables this index to show more modest labor cost gains than other indicators. Benefits costs include severance pay, health insurance, and paid vacations.
June's +.1% MoM gain in spending was the smallest increase in nine months. This is important because consumer spending currently accounts for approx 70% of GDP, though this percentage, and the consumer's importance to the economy, may slip if domestic consumption declines and exports increase. Income growing four times faster than spending should help stabilize consumer spending,, even as higher gasoline prices reduce other discretionary spending. The slump in housing, and now equities, also puts consumers under greater strain. The impact of these factors can be seen in the slowdown in consumer spending which increased at the slowest pace last quarter in more than a year, and only rose at one-third the pace of the first quarter's growth. Auto sales were the lowest in two years last month. Durable goods spending fell -1.6% MoM while spending on services rose +.5% MoM, basically at trend.
Personal income is growing at a fairly decent pace when annualized, at just under 5%. Personal income when adjusted for taxes, otherwise known as disposable income, rose +.4% MoM for the second month in a row. Inflation-adjusted disposable income rose +.3% MoM.
Personal consumption expenditure inflation figures were unexpectedly revised higher in May, causing the June figures, which came in at expectations as unchanged from the originally released May figures, to show a decline in inflation. The PCE deflator for May was +2.3% YoY, and the core PCE was +1.9% YoY. Core PCE grew +.1% MoM (consensus +.2%). Core PCE is considered to be the Fed's preferred inflation measure. They are believed to desire inflation to range between 1-2%, which today's figure does. The three month annualized rate has fallen to +1.6%.
Revisions to GDP data last week improved the savings data back into positive territory from negative territory. Today's data for June shows the savings rate rising from +.4% last month to +.6% in June, as income grew faster than spending.
***************
Employment Cost Index for the the 2nd quarter grew +.9% QoQ, as expected, and a slight increase from the +.8% pace of the first quarter. Unexpectedly, benefits costs rose the most in two years as companies improved benefits to retain employees. On an annual basis, the ECI fell from 3.5% YoY in the first quarter to +3.3% YoY in the second quarter. Wages and salaries have risen +3.4% YoY. Benefits have also risen +3.4% YoY (up from +3.1% in the first quarter), but they fell -.3% QoQ in the first quarter before rising +1.1% QoQ in the second quarter.
The ECI includes wages, benefits, and employer contributions to Social Security and Medicare, but not bonuses and options. Eliminating the later enables this index to show more modest labor cost gains than other indicators. Benefits costs include severance pay, health insurance, and paid vacations.
Monday, July 30, 2007
Today's Tidbits
Corporate Profits Revised Substantially Lower in GDP Revisions
From UBS: “The GDP revisions included large shifts in income away from corporations and toward households. On a Q4/Q4 basis, personal income growth was revised up to: 6.0% (was 5.8%) in 2006 and 5.4% (was 4.6%) in 2005. Consequently, the personal savings rate was revised up to 0.4% in 2006 (was -0.9%) and 0.8% in 2005 (was -0.3%). Meanwhile, corporate profits were revised down: now reported up 8.4% (was 18.3%) in 2006 (Q4/Q4) and 9.1% in 2005 (was 12.8%). For Q1, they are now reported up just 2.1%y/y (was 6.5%)—well below the nearly 10% pace reported for S&P500 EPS (see chart). (Unlike the S&P 500, the national income accounts include all companies.) The weak pace in profits growth helps explain the slowing in business investment recently.”
Mortgage Market Relative to Other Markets and Hedging Implications
From Merrill Lynch: “…because of the headlines about the problems in the housing market, most investors are probably unaware that high quality mortgage backed securities issued by Fannie Mae and Freddie Mac have actually appreciated recently. From June 15 to Thursday of last week, high quality mortgage backed securities had a total return of +1.2%. That certainly compares well with High Yield debt's return of -4%, and Emerging Market Debt's return of -1.8%. 10-Year Treasuries, of course the highest quality long-term debt, returned 3.7%. Thus, high quality mortgage backed securities have not outperformed Treasuries, but they have certainly outperformed lower quality high yield or emerging markets debt.”
From Barclays: “Last week saw a massive bull steepening, driven by a bona fide flight to quality. 2s and 5s rallied 28 bp on the week, and 10s and 30s were 19 and 13 bp lower respectively… Mortgages got crushed last week, with the 30-year 4.5s to 6s losing between 6 to 16 ticks against swap duration hedges, led by the discounts. The spike in volatility was by far the reason, hurting returns by 10-14 ticks. The curve, on the other hand, actually added 4-5 ticks in returns as it steepened. Over the month, MBS have now lost 8 to 18 ticks duration hedged. 15s did far better last week, losing just 2-3 ticks duration hedged… Swap spreads widened 4-8 bp across the curve last week, amidst a decline in liquidity… Both short- and long-dated options spiked last week, especially once rates rallied through technical levels. They are now near two-year highs for most contracts.”
From RBSGC: “It was the 1998-1999 credit meltdown which forced the street to look at OAS versus less volatile swaps rather than Treasuries. As has been the case recently, during credit driven rallies, swap spreads tend to widen and MBS trade on a much shorten duration making them difficult to hedge. In fact, we have been recommending hedging MBS with less volatile swaps rather than treasuries for particularly this reason. Based on our hedge ratios we estimate that MBS have underperformed 10-year swaps by only 18 ticks this past months compared to almost 42 ticks versus Treasuries. Another notable exception to the 1998 episode has been that MBS have not benefited to the same extent from a flight to quality from corporates in 2007 compared to 1998.”
From RBSGC: “…so far this year, bank deposits have shrunk back to YE 2006 levels, MBS holdings are lower, yet C&I loan growth continues apace. This is somewhat negative for MBS, and we believe the "mortgage shedding" will continue until the banks perceive a Fed ease is imminent…Mortgages had a tough year last week, as markets other than U.S. Treasuries decoupled and literally stopped trading during Thursday's stock market drop. FNMA 5.5s underperformed the 10Y UST by 24+ ticks from 7/20 to 7/26.”
Housing Problems Spilling Into Weaker Consumer Spending Data
From Goldman Sachs: “ …recent news has significantly strengthened the notion of spillovers from housing to consumption: a) Real consumption grew only 1.3% annualized in Q2. Some of this was clearly due to gas prices…But even with that adjustment the numbers are pretty weak. Moreover, the news for early Q3 remains mostly soft, despite the fact that gas prices have fallen 25 cents since late May. Auto sales in July were probably only around 16.0 million SAAR, and the anecdotal news coming out of retail has remained on the weak side…Market is worried about consumption as well (this downtrend precedes the equity market drop). b) In today's GDP report, consumption for Q1 and prior quarters was revised down. Partly as a result of this revision, the personal saving rate now shows a modestly rising trend over the past 1-2 years. This strengthens the notion that the decline in mortgage equity withdrawal is weighing on consumer spending growth, as we have been expecting. (MEW isn't included in disposable income, so a MEW-driven consumption decline leaves income unchanged, driving up the saving rate.) This would come as a surprise to Fed officials, who have generally downplayed the housing/consumption link. c) If you look at sales tax revenue at the state level, you see a significant slowdown that is mostly due to outright revenue declines in housing boom/bust states such as Florida and California. Moreover, Florida provides some data that break out taxable retail sales into different categories (durables, nondurables, recreation, construction supplies, etc.). These data show a broad-based drop, which supports the idea that the unfolding Florida recession isn't just due to construction but has an important consumer element as well -- just as the MEW story would predict. All this is so important because it's clear that housing will remain weak for the foreseeable future. Our estimate of a 5% decline in house prices this year looks to be on track, and next year is likely to show another decline. In that environment, the squeeze on consumers is likely to get worse, not better, and that reinforces the idea that growth next year will again be below trend.”
Home Foreclosures Expected to Reach 2 Million This Year
From Reuters: “U.S. home foreclosure filings rose 58 percent from the same period a year earlier with the trend likely to increase by the end of the year, RealtyTrac said on Monday…showing a foreclosure rate of one foreclosure filing for every 134 U.S. households…"If the current pace were to continue, foreclosure filings would surpass two
million by the end of the year, which would represent a year-over-year increase
of more than 65 percent," …California's foreclosure filing total was the highest among all states in the first half of 2007, while Nevada posted the country's highest foreclosure
rate, with one foreclosure filing for every 40 households. Foreclosure filings include default notices, auction sales notices and bank repossessions.”
From JP Morgan: “…delinquency rates on agency guaranteed mortgages continued to decline through May and indeed were at new cycle-lows…”
Vacant Homes Rise 50% in 2 Years As New Construction Exceeds Demand
From JP Morgan: “Total vacant units for sale are now up nearly 50% over the last two years, but the year-over-year rate of growth slowed sharply between 1Q and 2Q… Whether vacancies can fall further will in part depend on the path of housing starts and new home sales. This is because while new homes make up only 15% of vacant single-family units, they have contributed 36% of the rise in vacancies over the last year… Data …suggest that the new home sales report is underestimating the inventory level of new homes. This is occurring because if a sales contract on a new home is canceled, the new home sales report does not add that unit back into inventory (nor does it revise sales figures). According to the housing vacancies report, completed new homes for sale rose from 158,000 in 2Q06 to 256,000 in 2Q07, while the new home sales report shows a rise from 131,000 to 179,000 over the same period. The homeowner vacancy rate fell to 2.6% in 2Q from 2.8% in 1Q but is above the 2.2% rate from 2Q06. The rental vacancy rate fell to 9.5% in 2Q from 10.1% in 1Q and 9.6% in 2Q06.”
Banks Raising Hedge Fund Margin Requirements
From The Financial Times: “Investment banks are responding to rising credit concerns by imposing tougher lending terms on hedge funds, in a move that threatens to exacerbate investor unease in the financial markets. Prime brokerage departments at several investment banks have raised their margin requirements for certain hedge fund clients as they seek to insure themselves against the possibility of new hedge fund collapses as a result of the recent market turmoil… Financing terms for hedge funds are being tightened and this is forcing a further deleveraging of risk across global markets," …"Recently we have broadened our stricter standards to funds beyond those with exposure to US mortgage market. I'd say this is now a pretty broad-based retreat from leverage." The move could raise the pressure on parts of the hedge fund sector, since it comes at a time when performance at some groups has slumped as a result of recent market swings. The average hedge fund, across all strategies, returned just 0.8 per cent in June… Fixed income-focused hedge funds were the worst affected, returning just 0.2 per cent in June. If a hedge fund's performance deteriorates sufficiently, its prime broker's bank can demand that it sells assets to repay loans.”
Jobless Claims Good Indicator of Employment Growth as Productivity Slows
From JP Morgan: “Even as growth has been lackluster over the past year, most indicators of the labor market have remained healthy. The simplest explanation is that productivity growth has slowed. Another explanation is that the payroll survey has
overcounted jobs, particularly in the residential construction industry. This week brought the release of the 4Q06 Quarterly Census of Employment and Wages (QCEW), a
comprehensive count of employment that covers 98% of all jobs—the closest thing to a hard number in economic data. Through the end of last year, the payroll survey tracked the change in actual employment, as measured by the QCEW, remarkably well, suggesting that forthcoming benchmark revisions to payrolls will be negligible. Over that period, jobless claims behaved in a manner consistent with the payroll survey, supporting the contention that the claims data are a very useful high-frequency gauge of the health of the labor market. And claims have moved down through July, which is a positive signal on growth. The notion that construction payrolls are being grossly mismeasured also received little support from the QCEW, as the benchmark data were very close to the monthly survey data. Some have argued that the decline in residential investment without a corresponding decline in residential construction employment augurs a fall in jobs in that category and a bounce in productivity. However, nonresidential investment relative to nonresidential construction employment has surged. Taking the earlier argument at face value, this would foretell a surge in hiring and a fall in productivity. A better story is that the demarcation between residential and nonresidential construction jobs is clearerin the data than it is in reality.”
Asian Growth Accelerating Outside of China
From JP Morgan: “Recent indicators point to a powerful acceleration in growth in EM Asia. Although China’s growth surge has dominated the headlines, Korea’s 2Q real GDP growth of 7.0%q/q, saar and Singapore’s 2Q double-digit growth were both well above their recent trends. Monthly data from Taiwan also show a turn towards much stronger growth, with IP reaching a 22.3% growth pace last quarter; the rise in July export orders
indicated that this momentum is carrying into the current quarter. In these tech-driven economies, inventory drawdowns that were drags on growth around the turn of the year
have faded, and solid global demand for electronics equipment is now lifting output.
These solid growth numbers should give Asian central bankers more comfort to nudge policy conditions tighter, though their motivation is often not around core inflation (which stays generally well contained around the region).”
Unusual Stock Market Divergences Urge Caution
From Forbes: “Since last month, the Dow Jones Industrial Average has hit nine new record closing highs… and breadth has taken a decisive turn for the worse. The DJIA has closed higher in five of the past eight trading days, but declining stocks outnumbered advancing stocks in seven of those eight sessions. That type of negative breadth divergence has occurred only 15 times in 75 years--the majority of which were in bear markets. On Monday of last week, the DJIA hit a record high while declining stocks overwhelmed advancing stocks by a two to one margin. That ominous divergence has never occurred in the past 75 years of market history. Divergences are also appearing in major indexes, as the headline-grabbing DJIA has risen over 1,000 points in the past five months--but the small-cap Russell 2000 Index has slipped lower. If that isn't a flight to quality, we don't know what is! As a consequence, we are moving to a full bear market defensive mode… When the DJIA scores a new record high by closing up over 40 points, yet there are twice as many stocks closing down for the day as closing up, then something is wrong. When the DJIA closes higher in seven out of eight days, but breadth is positive (advancing stocks outnumber declining stocks) on only one of those days, then something is wrong. The "wrong" confirms that fewer stocks are participating and investors become more selective in stock purchases. Historically, this is known as "a flight to quality"--and it is clearly underway.”
Tighter Credit Reduces Stock Buybacks and Mergers – Reduce Market Support
From The International Herald Tribune: “As stocks raced to new highs this year, many investors felt their prices were justified by robust corporate earnings. They were only partly right. Other powerful forces were at work as well: corporate buybacks and mergers, both of which require access to E-Z credit. For instance, the Standard & Poor's Index Services Group estimated that almost $118 billion was spent on stock buybacks during the first quarter of 2007, up 17.5 percent from the $100 billion registered during the first quarter of 2006. In the first quarter, S&P said, 101 companies reduced their actual share count by at least 4 percent, while 72 cut their average diluted shares, used to determine earnings per share, by at least 4 percent. That means that at least 4 percent of the growth at those companies came from share count reductions, not operating earnings. The S&P data also show that information technology companies were the biggest buyers of their own shares, accounting for almost 23 percent of the total buybacks and 15 percent of the market value of that stock during the first quarter. Consumer goods companies were another major player in the repurchase arena last quarter, accounting for almost 15 percent of stock buybacks and 10 percent of the market value.”
Financial Stocks Under Pressure
From Bloomberg: “Moody's shares have declined about 10 percent in the past two weeks, extending their loss for the year to almost 20 percent… After peaking at about 511 points on May 23, the Standard & Poor's index of 92 U.S. financial stocks declined more than 10 percent through July 26, while the S&P 500 index fell just 2.6 percent. In the five years through the end of 2006, the financial index posted a total return of more than 56 percent, outpacing the 34 percent delivered by the benchmark index. Here's a scorecard of some of the world's biggest banks, from wherever the shares reached their high for this year compared with closing prices on July 26. Bear Stearns Cos. is down almost 28 percent. Royal Bank of Scotland Group Plc is down 21 percent. Deutsche Bank AG is down 18 percent. JPMorgan Chase & Co. is down 17 percent. Goldman Sachs Group Inc. is down almost 17 percent. Citigroup Inc. is down almost 14 percent. So much for the golden age of finance. ”
MISC
From Goldman: “Fear is sweeping through the financial markets, with a tightening of credit conditions prompting a broad based repricing of risk (i.e. a widening of spreads). The equity market has been the highest profile victim of the pullback in credit markets. The S&P 500 index fell roughly 5% on the week, with financial intermediaries the hardest hit sector…A key feature of the current turmoil is that credit has become scarcer, rather than simply more expensive. This could affect the real economy in at least three ways. First, it could exacerbate the already large overhang of unoccupied housing. Second, it could curb consumer spending through a combination of negative wealth effects, constraints on those who require access to smooth spending through a combination of negative wealth effects, constraints on those who require access to credit to smooth spending, and potential labor market contraction. Finally, tougher credit conditions could constrain capital spending and hiring by firms that depend on external financing.”
From The Financial Times: “Global banks are well-placed to withstand the weakening in credit markets but could face a squeeze on revenues if the situation worsens, according to a report Monday by Standard & Poor's, the ratings agency… S&P says an upturn in defaults "cannot be far away". Banks could - if the situation worsens - see "sizeable losses" relative to earnings and capital. In terms of revenues, they will no longer receive such substantial underwriting fees from leveraged finance activity.
From Business Week: “…it's not the Fed's job to bail out stock and bond investors. The Fed takes notice of the financial markets only when conditions there threaten to cause a genuine credit crunch—that is, when even credit-worthy companies and families can't borrow money. We're still far from that scenario. In the mortgage market, for example, prime borrowers are getting, if anything, even more offers of credit because lenders need to make up for their lost subprime business.”
From JP Morgan: “The shock waves currently reverberating through financial markets are putting monetary authorities in a tight spot, balancing the risk of a full-blown credit crisis against the risk of a decisive move up in inflation. However, for some countries,
inflation risks are turning into inflation realities, leaving little option but for higher policy rates in the coming months.”
From JP Morgan: “Strong economic fundamentals and high commodity prices had until recently insulated financial assets in emerging markets from the troubles in US credit markets. However, this changed dramatically this week, as the subprime woes finally
hit equity markets and investors took profits in emerging markets to offset losses elsewhere. This led to a massive 42bp widening in the EM bond index (EMBIG) spread this week. Moreover, in EM countries where appreciating currencies have been a disinflationary force allowing central bank to ease, the spread of the US credit market anxiety to EM’s raises the possibility of currency depreciation.”
From Market News: “In an interview with the Sunday Telegraph, Lord George, former governor of the Bank of England, claimed criticisms of China's handling of its currency were often misplaced. "The Chinese I speak to understand that in the longer term a stronger renminbi is good for the welfare of the Chinese people as a whole," George said. "It's the same argument the Americans used to use - a strong dollar is good for the US. "But their immediate priority is not improving the overall welfare, in terms of the overseas purchasing power, of the Chinese people. Their priority is to create jobs for all those coming off the land. That's a good thing for the Chinese economy and for the rest of the world. "They've lifted millions out of poverty in the last few years and they have recognised these concerns through the increasing flexibility of the renminbi. But they recognise that you can't change things overnight."”
From ASPO: “China [total oil]… Imports were 19.7% higher than a year earlier… making Tehran the largest supplier of crude to Beijing… China plans to build four levels of crude oil reserves made up of two parts - the government reserve and “enterprise storage.” The government reserve will be at two levels, a strategic crude oil reserve base by the central government, and an oil reserve base by local governments. The enterprise storage will also be at two levels, commercial oil reserve by the largest oil companies and oil storage by the medium and small ones.”
From Market News: “Treasury says it expects to hit the statutory debt limit of $8.965 trillion in early October and Paulson sends letter to Congress requesting an increase ‘as soon as possible.’”
End-of-Day Market Update
Treasuries retreated as the flight-to-quality buying eased after the equity market rallied. As of 4pm, two year yields fell 9bp to 4.58% while ten year yields fell a more modest 5bp to 4.81%, causing the yield curve to flatten. Swap and other credit spreads stopped widening (worsening), and finished the day tighter.
Stocks bounced. The Dow closed up 93 to settle at 13,359 after trading up over 130 points in the early afternoon. The S&P finished up 15 at 1474, and the Nasdaq improved by 21 points. The S&P is 3.9% higher since the beginning of the year, but is down 5.3% from its recent new high.
The dollar weakened slightly in the afternoon after trading around unchanged overnight. Versus Friday’s close, the dollar index has fallen 15 points to 80.80.
WTI oil futures rallied to set a new contract high of $77.33 earlier in the day, exceeding last summer’s high of just over $77, before settling back to close down 19 cents at $76.72.
From UBS: “The GDP revisions included large shifts in income away from corporations and toward households. On a Q4/Q4 basis, personal income growth was revised up to: 6.0% (was 5.8%) in 2006 and 5.4% (was 4.6%) in 2005. Consequently, the personal savings rate was revised up to 0.4% in 2006 (was -0.9%) and 0.8% in 2005 (was -0.3%). Meanwhile, corporate profits were revised down: now reported up 8.4% (was 18.3%) in 2006 (Q4/Q4) and 9.1% in 2005 (was 12.8%). For Q1, they are now reported up just 2.1%y/y (was 6.5%)—well below the nearly 10% pace reported for S&P500 EPS (see chart). (Unlike the S&P 500, the national income accounts include all companies.) The weak pace in profits growth helps explain the slowing in business investment recently.”
Mortgage Market Relative to Other Markets and Hedging Implications
From Merrill Lynch: “…because of the headlines about the problems in the housing market, most investors are probably unaware that high quality mortgage backed securities issued by Fannie Mae and Freddie Mac have actually appreciated recently. From June 15 to Thursday of last week, high quality mortgage backed securities had a total return of +1.2%. That certainly compares well with High Yield debt's return of -4%, and Emerging Market Debt's return of -1.8%. 10-Year Treasuries, of course the highest quality long-term debt, returned 3.7%. Thus, high quality mortgage backed securities have not outperformed Treasuries, but they have certainly outperformed lower quality high yield or emerging markets debt.”
From Barclays: “Last week saw a massive bull steepening, driven by a bona fide flight to quality. 2s and 5s rallied 28 bp on the week, and 10s and 30s were 19 and 13 bp lower respectively… Mortgages got crushed last week, with the 30-year 4.5s to 6s losing between 6 to 16 ticks against swap duration hedges, led by the discounts. The spike in volatility was by far the reason, hurting returns by 10-14 ticks. The curve, on the other hand, actually added 4-5 ticks in returns as it steepened. Over the month, MBS have now lost 8 to 18 ticks duration hedged. 15s did far better last week, losing just 2-3 ticks duration hedged… Swap spreads widened 4-8 bp across the curve last week, amidst a decline in liquidity… Both short- and long-dated options spiked last week, especially once rates rallied through technical levels. They are now near two-year highs for most contracts.”
From RBSGC: “It was the 1998-1999 credit meltdown which forced the street to look at OAS versus less volatile swaps rather than Treasuries. As has been the case recently, during credit driven rallies, swap spreads tend to widen and MBS trade on a much shorten duration making them difficult to hedge. In fact, we have been recommending hedging MBS with less volatile swaps rather than treasuries for particularly this reason. Based on our hedge ratios we estimate that MBS have underperformed 10-year swaps by only 18 ticks this past months compared to almost 42 ticks versus Treasuries. Another notable exception to the 1998 episode has been that MBS have not benefited to the same extent from a flight to quality from corporates in 2007 compared to 1998.”
From RBSGC: “…so far this year, bank deposits have shrunk back to YE 2006 levels, MBS holdings are lower, yet C&I loan growth continues apace. This is somewhat negative for MBS, and we believe the "mortgage shedding" will continue until the banks perceive a Fed ease is imminent…Mortgages had a tough year last week, as markets other than U.S. Treasuries decoupled and literally stopped trading during Thursday's stock market drop. FNMA 5.5s underperformed the 10Y UST by 24+ ticks from 7/20 to 7/26.”
Housing Problems Spilling Into Weaker Consumer Spending Data
From Goldman Sachs: “ …recent news has significantly strengthened the notion of spillovers from housing to consumption: a) Real consumption grew only 1.3% annualized in Q2. Some of this was clearly due to gas prices…But even with that adjustment the numbers are pretty weak. Moreover, the news for early Q3 remains mostly soft, despite the fact that gas prices have fallen 25 cents since late May. Auto sales in July were probably only around 16.0 million SAAR, and the anecdotal news coming out of retail has remained on the weak side…Market is worried about consumption as well (this downtrend precedes the equity market drop). b) In today's GDP report, consumption for Q1 and prior quarters was revised down. Partly as a result of this revision, the personal saving rate now shows a modestly rising trend over the past 1-2 years. This strengthens the notion that the decline in mortgage equity withdrawal is weighing on consumer spending growth, as we have been expecting. (MEW isn't included in disposable income, so a MEW-driven consumption decline leaves income unchanged, driving up the saving rate.) This would come as a surprise to Fed officials, who have generally downplayed the housing/consumption link. c) If you look at sales tax revenue at the state level, you see a significant slowdown that is mostly due to outright revenue declines in housing boom/bust states such as Florida and California. Moreover, Florida provides some data that break out taxable retail sales into different categories (durables, nondurables, recreation, construction supplies, etc.). These data show a broad-based drop, which supports the idea that the unfolding Florida recession isn't just due to construction but has an important consumer element as well -- just as the MEW story would predict. All this is so important because it's clear that housing will remain weak for the foreseeable future. Our estimate of a 5% decline in house prices this year looks to be on track, and next year is likely to show another decline. In that environment, the squeeze on consumers is likely to get worse, not better, and that reinforces the idea that growth next year will again be below trend.”
Home Foreclosures Expected to Reach 2 Million This Year
From Reuters: “U.S. home foreclosure filings rose 58 percent from the same period a year earlier with the trend likely to increase by the end of the year, RealtyTrac said on Monday…showing a foreclosure rate of one foreclosure filing for every 134 U.S. households…"If the current pace were to continue, foreclosure filings would surpass two
million by the end of the year, which would represent a year-over-year increase
of more than 65 percent," …California's foreclosure filing total was the highest among all states in the first half of 2007, while Nevada posted the country's highest foreclosure
rate, with one foreclosure filing for every 40 households. Foreclosure filings include default notices, auction sales notices and bank repossessions.”
From JP Morgan: “…delinquency rates on agency guaranteed mortgages continued to decline through May and indeed were at new cycle-lows…”
Vacant Homes Rise 50% in 2 Years As New Construction Exceeds Demand
From JP Morgan: “Total vacant units for sale are now up nearly 50% over the last two years, but the year-over-year rate of growth slowed sharply between 1Q and 2Q… Whether vacancies can fall further will in part depend on the path of housing starts and new home sales. This is because while new homes make up only 15% of vacant single-family units, they have contributed 36% of the rise in vacancies over the last year… Data …suggest that the new home sales report is underestimating the inventory level of new homes. This is occurring because if a sales contract on a new home is canceled, the new home sales report does not add that unit back into inventory (nor does it revise sales figures). According to the housing vacancies report, completed new homes for sale rose from 158,000 in 2Q06 to 256,000 in 2Q07, while the new home sales report shows a rise from 131,000 to 179,000 over the same period. The homeowner vacancy rate fell to 2.6% in 2Q from 2.8% in 1Q but is above the 2.2% rate from 2Q06. The rental vacancy rate fell to 9.5% in 2Q from 10.1% in 1Q and 9.6% in 2Q06.”
Banks Raising Hedge Fund Margin Requirements
From The Financial Times: “Investment banks are responding to rising credit concerns by imposing tougher lending terms on hedge funds, in a move that threatens to exacerbate investor unease in the financial markets. Prime brokerage departments at several investment banks have raised their margin requirements for certain hedge fund clients as they seek to insure themselves against the possibility of new hedge fund collapses as a result of the recent market turmoil… Financing terms for hedge funds are being tightened and this is forcing a further deleveraging of risk across global markets," …"Recently we have broadened our stricter standards to funds beyond those with exposure to US mortgage market. I'd say this is now a pretty broad-based retreat from leverage." The move could raise the pressure on parts of the hedge fund sector, since it comes at a time when performance at some groups has slumped as a result of recent market swings. The average hedge fund, across all strategies, returned just 0.8 per cent in June… Fixed income-focused hedge funds were the worst affected, returning just 0.2 per cent in June. If a hedge fund's performance deteriorates sufficiently, its prime broker's bank can demand that it sells assets to repay loans.”
Jobless Claims Good Indicator of Employment Growth as Productivity Slows
From JP Morgan: “Even as growth has been lackluster over the past year, most indicators of the labor market have remained healthy. The simplest explanation is that productivity growth has slowed. Another explanation is that the payroll survey has
overcounted jobs, particularly in the residential construction industry. This week brought the release of the 4Q06 Quarterly Census of Employment and Wages (QCEW), a
comprehensive count of employment that covers 98% of all jobs—the closest thing to a hard number in economic data. Through the end of last year, the payroll survey tracked the change in actual employment, as measured by the QCEW, remarkably well, suggesting that forthcoming benchmark revisions to payrolls will be negligible. Over that period, jobless claims behaved in a manner consistent with the payroll survey, supporting the contention that the claims data are a very useful high-frequency gauge of the health of the labor market. And claims have moved down through July, which is a positive signal on growth. The notion that construction payrolls are being grossly mismeasured also received little support from the QCEW, as the benchmark data were very close to the monthly survey data. Some have argued that the decline in residential investment without a corresponding decline in residential construction employment augurs a fall in jobs in that category and a bounce in productivity. However, nonresidential investment relative to nonresidential construction employment has surged. Taking the earlier argument at face value, this would foretell a surge in hiring and a fall in productivity. A better story is that the demarcation between residential and nonresidential construction jobs is clearerin the data than it is in reality.”
Asian Growth Accelerating Outside of China
From JP Morgan: “Recent indicators point to a powerful acceleration in growth in EM Asia. Although China’s growth surge has dominated the headlines, Korea’s 2Q real GDP growth of 7.0%q/q, saar and Singapore’s 2Q double-digit growth were both well above their recent trends. Monthly data from Taiwan also show a turn towards much stronger growth, with IP reaching a 22.3% growth pace last quarter; the rise in July export orders
indicated that this momentum is carrying into the current quarter. In these tech-driven economies, inventory drawdowns that were drags on growth around the turn of the year
have faded, and solid global demand for electronics equipment is now lifting output.
These solid growth numbers should give Asian central bankers more comfort to nudge policy conditions tighter, though their motivation is often not around core inflation (which stays generally well contained around the region).”
Unusual Stock Market Divergences Urge Caution
From Forbes: “Since last month, the Dow Jones Industrial Average has hit nine new record closing highs… and breadth has taken a decisive turn for the worse. The DJIA has closed higher in five of the past eight trading days, but declining stocks outnumbered advancing stocks in seven of those eight sessions. That type of negative breadth divergence has occurred only 15 times in 75 years--the majority of which were in bear markets. On Monday of last week, the DJIA hit a record high while declining stocks overwhelmed advancing stocks by a two to one margin. That ominous divergence has never occurred in the past 75 years of market history. Divergences are also appearing in major indexes, as the headline-grabbing DJIA has risen over 1,000 points in the past five months--but the small-cap Russell 2000 Index has slipped lower. If that isn't a flight to quality, we don't know what is! As a consequence, we are moving to a full bear market defensive mode… When the DJIA scores a new record high by closing up over 40 points, yet there are twice as many stocks closing down for the day as closing up, then something is wrong. When the DJIA closes higher in seven out of eight days, but breadth is positive (advancing stocks outnumber declining stocks) on only one of those days, then something is wrong. The "wrong" confirms that fewer stocks are participating and investors become more selective in stock purchases. Historically, this is known as "a flight to quality"--and it is clearly underway.”
Tighter Credit Reduces Stock Buybacks and Mergers – Reduce Market Support
From The International Herald Tribune: “As stocks raced to new highs this year, many investors felt their prices were justified by robust corporate earnings. They were only partly right. Other powerful forces were at work as well: corporate buybacks and mergers, both of which require access to E-Z credit. For instance, the Standard & Poor's Index Services Group estimated that almost $118 billion was spent on stock buybacks during the first quarter of 2007, up 17.5 percent from the $100 billion registered during the first quarter of 2006. In the first quarter, S&P said, 101 companies reduced their actual share count by at least 4 percent, while 72 cut their average diluted shares, used to determine earnings per share, by at least 4 percent. That means that at least 4 percent of the growth at those companies came from share count reductions, not operating earnings. The S&P data also show that information technology companies were the biggest buyers of their own shares, accounting for almost 23 percent of the total buybacks and 15 percent of the market value of that stock during the first quarter. Consumer goods companies were another major player in the repurchase arena last quarter, accounting for almost 15 percent of stock buybacks and 10 percent of the market value.”
Financial Stocks Under Pressure
From Bloomberg: “Moody's shares have declined about 10 percent in the past two weeks, extending their loss for the year to almost 20 percent… After peaking at about 511 points on May 23, the Standard & Poor's index of 92 U.S. financial stocks declined more than 10 percent through July 26, while the S&P 500 index fell just 2.6 percent. In the five years through the end of 2006, the financial index posted a total return of more than 56 percent, outpacing the 34 percent delivered by the benchmark index. Here's a scorecard of some of the world's biggest banks, from wherever the shares reached their high for this year compared with closing prices on July 26. Bear Stearns Cos. is down almost 28 percent. Royal Bank of Scotland Group Plc is down 21 percent. Deutsche Bank AG is down 18 percent. JPMorgan Chase & Co. is down 17 percent. Goldman Sachs Group Inc. is down almost 17 percent. Citigroup Inc. is down almost 14 percent. So much for the golden age of finance. ”
MISC
From Goldman: “Fear is sweeping through the financial markets, with a tightening of credit conditions prompting a broad based repricing of risk (i.e. a widening of spreads). The equity market has been the highest profile victim of the pullback in credit markets. The S&P 500 index fell roughly 5% on the week, with financial intermediaries the hardest hit sector…A key feature of the current turmoil is that credit has become scarcer, rather than simply more expensive. This could affect the real economy in at least three ways. First, it could exacerbate the already large overhang of unoccupied housing. Second, it could curb consumer spending through a combination of negative wealth effects, constraints on those who require access to smooth spending through a combination of negative wealth effects, constraints on those who require access to credit to smooth spending, and potential labor market contraction. Finally, tougher credit conditions could constrain capital spending and hiring by firms that depend on external financing.”
From The Financial Times: “Global banks are well-placed to withstand the weakening in credit markets but could face a squeeze on revenues if the situation worsens, according to a report Monday by Standard & Poor's, the ratings agency… S&P says an upturn in defaults "cannot be far away". Banks could - if the situation worsens - see "sizeable losses" relative to earnings and capital. In terms of revenues, they will no longer receive such substantial underwriting fees from leveraged finance activity.
From Business Week: “…it's not the Fed's job to bail out stock and bond investors. The Fed takes notice of the financial markets only when conditions there threaten to cause a genuine credit crunch—that is, when even credit-worthy companies and families can't borrow money. We're still far from that scenario. In the mortgage market, for example, prime borrowers are getting, if anything, even more offers of credit because lenders need to make up for their lost subprime business.”
From JP Morgan: “The shock waves currently reverberating through financial markets are putting monetary authorities in a tight spot, balancing the risk of a full-blown credit crisis against the risk of a decisive move up in inflation. However, for some countries,
inflation risks are turning into inflation realities, leaving little option but for higher policy rates in the coming months.”
From JP Morgan: “Strong economic fundamentals and high commodity prices had until recently insulated financial assets in emerging markets from the troubles in US credit markets. However, this changed dramatically this week, as the subprime woes finally
hit equity markets and investors took profits in emerging markets to offset losses elsewhere. This led to a massive 42bp widening in the EM bond index (EMBIG) spread this week. Moreover, in EM countries where appreciating currencies have been a disinflationary force allowing central bank to ease, the spread of the US credit market anxiety to EM’s raises the possibility of currency depreciation.”
From Market News: “In an interview with the Sunday Telegraph, Lord George, former governor of the Bank of England, claimed criticisms of China's handling of its currency were often misplaced. "The Chinese I speak to understand that in the longer term a stronger renminbi is good for the welfare of the Chinese people as a whole," George said. "It's the same argument the Americans used to use - a strong dollar is good for the US. "But their immediate priority is not improving the overall welfare, in terms of the overseas purchasing power, of the Chinese people. Their priority is to create jobs for all those coming off the land. That's a good thing for the Chinese economy and for the rest of the world. "They've lifted millions out of poverty in the last few years and they have recognised these concerns through the increasing flexibility of the renminbi. But they recognise that you can't change things overnight."”
From ASPO: “China [total oil]… Imports were 19.7% higher than a year earlier… making Tehran the largest supplier of crude to Beijing… China plans to build four levels of crude oil reserves made up of two parts - the government reserve and “enterprise storage.” The government reserve will be at two levels, a strategic crude oil reserve base by the central government, and an oil reserve base by local governments. The enterprise storage will also be at two levels, commercial oil reserve by the largest oil companies and oil storage by the medium and small ones.”
From Market News: “Treasury says it expects to hit the statutory debt limit of $8.965 trillion in early October and Paulson sends letter to Congress requesting an increase ‘as soon as possible.’”
End-of-Day Market Update
Treasuries retreated as the flight-to-quality buying eased after the equity market rallied. As of 4pm, two year yields fell 9bp to 4.58% while ten year yields fell a more modest 5bp to 4.81%, causing the yield curve to flatten. Swap and other credit spreads stopped widening (worsening), and finished the day tighter.
Stocks bounced. The Dow closed up 93 to settle at 13,359 after trading up over 130 points in the early afternoon. The S&P finished up 15 at 1474, and the Nasdaq improved by 21 points. The S&P is 3.9% higher since the beginning of the year, but is down 5.3% from its recent new high.
The dollar weakened slightly in the afternoon after trading around unchanged overnight. Versus Friday’s close, the dollar index has fallen 15 points to 80.80.
WTI oil futures rallied to set a new contract high of $77.33 earlier in the day, exceeding last summer’s high of just over $77, before settling back to close down 19 cents at $76.72.
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