Construction spending rose +.2% MoM in August (consensus -.3%) after falling a larger than originally reported -.5% MoM in July. The improvement was in non-residential construction of factories, hotels and offices (+1.6% MoM, +15% YoY) - with private non-residential construction rising to a six month high. Private residential construction fell for the 18th straight month, declining -1.5% MoM in August.
Over the past year, total construction spending has fallen -1.7% YoY due to the housing slowdown pulling down residential construction spending by -16% YoY. Non-residential construction has grown 14.7% YoY. Another source of growth over the past year has been government spending with has grown almost 15% YoY, with Federal spending rising +21.5% YoY and state and local growing +14% YoY.
In the second quarter, commercial construction grew 26%, the fastest rate since 1981, and continues to help offset the slump in the housing market. Forward looking indicators indicate that non-residential construction may begin slowing from the record levels of earlier this year. The Architectural Billings Index, which tracks building intentions over the next six to nine months, fell for the first time in six months in August as credit tightens for more industries. Residential building permits have been falling for a while.
*********************
The University of Michigan Consumer Confidence Survey eased lower in the final September reading, falling to 83.4 from 83.8 to the lowest level in a year. Both current and future conditions eased slightly, and five year inflation expectations fell by a tenth to 2.9%.
Friday, September 28, 2007
Personal Spending Grew Faster than Expected, But Income Growth Lagged
Spending (+.6% MoM) grew twice as fast as personal income (+.3% MoM) in August. Both were expected to increase by +.4% MoM. Total inflation fell less than expected to +1.8% YoY (consensus +1.7%) from +2.1% in July. Core PCE inflation, as expected, also fell to +1.8% YoY, and rose +.1% MoM. Since spending grew faster than incomes, the savings rate fell back to +.7% from +.9% in July, and is down -.1% YoY.
Over the past year, personal income has risen +6.8% YoY and personal spending has risen +5.2% YoY. Disposable income has risen at the slightly slower pace of +6.2% YoY.
Continued strength in consumer spending indicates that the weaker job market and tighter credit markets had not yet negatively impacted a major component of GDP growth in August, though it is expected to slow growth later this year. The +.6% MoM rise in personal spending was the largest increase in four months. Lower gas prices and larger incentives from car dealers appear to have helped fuel the boom. Consumer spending currently accounts for around 70% of the U.S. economy. Adjusted for inflation, spending rose +.6%, the most since October 2006. Inflation-adjusted spending on durable goods jumped +2.8% MoM while non-durable goods purchases held steady. Spending on services rose +.6% MoM.
Income growth slowed to +.3% from +.5% in July. Actual salary growth was only +.2%. Disposable income, or what is left over after taxes, rose +.4% in August, down from a gain of +.6% in July. Most of the gain in wages was in service producing industries. The majority of the income data supports the recent payroll data showing a slowdown in the economy. Non-farm income only rose +.1% last month, and unemployment payments jumped +2.2%. Reflecting higher agricultural (food) prices, farm incomes have risen over 100% YoY.
Core inflation rose +.1% MoM for the sixth month in a row, indicating that excluding food and energy inflation growth has been steady and moderate most of this year. Core inflation, at +1.8% YoY, is at its lowest level since early 2004, and the annualized rate for the past six months has fallen to +1.3%. With both headline and core inflation falling below 2% YoY, the Fed has greater latitude to reduce their inflation concerns.
Interest rates fell slightly following the announcement.
Over the past year, personal income has risen +6.8% YoY and personal spending has risen +5.2% YoY. Disposable income has risen at the slightly slower pace of +6.2% YoY.
Continued strength in consumer spending indicates that the weaker job market and tighter credit markets had not yet negatively impacted a major component of GDP growth in August, though it is expected to slow growth later this year. The +.6% MoM rise in personal spending was the largest increase in four months. Lower gas prices and larger incentives from car dealers appear to have helped fuel the boom. Consumer spending currently accounts for around 70% of the U.S. economy. Adjusted for inflation, spending rose +.6%, the most since October 2006. Inflation-adjusted spending on durable goods jumped +2.8% MoM while non-durable goods purchases held steady. Spending on services rose +.6% MoM.
Income growth slowed to +.3% from +.5% in July. Actual salary growth was only +.2%. Disposable income, or what is left over after taxes, rose +.4% in August, down from a gain of +.6% in July. Most of the gain in wages was in service producing industries. The majority of the income data supports the recent payroll data showing a slowdown in the economy. Non-farm income only rose +.1% last month, and unemployment payments jumped +2.2%. Reflecting higher agricultural (food) prices, farm incomes have risen over 100% YoY.
Core inflation rose +.1% MoM for the sixth month in a row, indicating that excluding food and energy inflation growth has been steady and moderate most of this year. Core inflation, at +1.8% YoY, is at its lowest level since early 2004, and the annualized rate for the past six months has fallen to +1.3%. With both headline and core inflation falling below 2% YoY, the Fed has greater latitude to reduce their inflation concerns.
Interest rates fell slightly following the announcement.
Thursday, September 27, 2007
August New Home Sales Tumble -8.3% MoM
New home sales fell to the lowest rate in seven years, declining -8.3% MoM (consensus -5.2%) in August, and have fallen 21% YoY. Sales declined in the South (-21% MoM) and West(-15% MoM), but rose in the Northeast (+42% MoM) and Midwest (+21% MoM). The strength of sales in the Northeast is being attributed to a special sale by a New Jersey homebuilder.
Inventory rose to 8.2 months supply (from 7.6 months), at the current sales pace. The recent high was 8.3 months in March. One positive is that the absolute number of new homes for sale has fallen -7% YoY. The inventory of completed homes held constant in August.
The median price of new homes fell -7.5% YoY, as builders increased incentives. This was the largest decline in median home prices since 1970! The mean price fell a slightly larger -8% YoY to $292k. For comparison, the mean price in March was $329k.
New home sales, representing about 15% of monthly home sales, are considered to be a more timely indicator of home demand than existing home sales, which lag contract signing by one to two months. Home builders have also indicated that cancellations have been rising. This morning KB Homes said third quarter cancellations had risen to 50% from 34% in the second quarter, indicating that even today's poor data may be overstating true demand.
Rising inventories, tightening credit conditions, and falling home prices mean that the end of the housing slump is probably not just around the corner.
The regions of the country very greatly in market size. The Northeast region is the smallest, and had new home sales of 74k in August. The South is the largest region, with new home sales of 407k in August. The net increase in the Northeast was +22k homes versus a decline -70k in the South. This is the reason that the total number was negative, even though the Northeast had a huge improvement.
Inventory rose to 8.2 months supply (from 7.6 months), at the current sales pace. The recent high was 8.3 months in March. One positive is that the absolute number of new homes for sale has fallen -7% YoY. The inventory of completed homes held constant in August.
The median price of new homes fell -7.5% YoY, as builders increased incentives. This was the largest decline in median home prices since 1970! The mean price fell a slightly larger -8% YoY to $292k. For comparison, the mean price in March was $329k.
New home sales, representing about 15% of monthly home sales, are considered to be a more timely indicator of home demand than existing home sales, which lag contract signing by one to two months. Home builders have also indicated that cancellations have been rising. This morning KB Homes said third quarter cancellations had risen to 50% from 34% in the second quarter, indicating that even today's poor data may be overstating true demand.
Rising inventories, tightening credit conditions, and falling home prices mean that the end of the housing slump is probably not just around the corner.
The regions of the country very greatly in market size. The Northeast region is the smallest, and had new home sales of 74k in August. The South is the largest region, with new home sales of 407k in August. The net increase in the Northeast was +22k homes versus a decline -70k in the South. This is the reason that the total number was negative, even though the Northeast had a huge improvement.
GDP Revisions as Expected, Jobless Claims Fall More Than Expected
As expected, second quarter GDP was revised slightly lower to 3.8% annualized (from 4%) in the final revision. This is still the fastest quarterly pace in the last year, and a considerable improvement from the +.6% annualized gain in the first quarter, but it is also likely to be the fastest quarter for a while. Most economists are looking for the growth of GDP for the next year to average closer to 2% annualized. Most of the growth in the second quarter has been attributed to a growth in export demand as overseas economies grow robustly and the declining dollar helps make US goods and services more competitive globally. Exports made the best contribution to GDP since 1996.
Personal consumption held steady at 1.4%.
Total PCE inflation eased down to 2.6% annualized (from 2.7%) while core PCE inflation unexpectedly rose to +1.4% from the previously reported 1.3% annualized rate. PCE inflation is the broadest measure of inflation, and is the Fed's preferred observation. Core PCE inflation, which excludes food and energy, rose 2% YoY when compared to the second quarter of 2006.
Citi now expecting third quarter GDP to slow to 2.5%, and fourth quarter to slow further to 1.7%, as the credit tightening and housing slowdown negatively impact growth prospects.
*****************
Initial unemployment claims fell more than expected, falling to 298k (consensus 316k), the lowest weekly number since May. Though hiring is slowing, it appears that layoffs (other than in the housing area) remain low. The four week average drops to 311k. Continuing claims were as expected, rising 7k.
Personal consumption held steady at 1.4%.
Total PCE inflation eased down to 2.6% annualized (from 2.7%) while core PCE inflation unexpectedly rose to +1.4% from the previously reported 1.3% annualized rate. PCE inflation is the broadest measure of inflation, and is the Fed's preferred observation. Core PCE inflation, which excludes food and energy, rose 2% YoY when compared to the second quarter of 2006.
Citi now expecting third quarter GDP to slow to 2.5%, and fourth quarter to slow further to 1.7%, as the credit tightening and housing slowdown negatively impact growth prospects.
*****************
Initial unemployment claims fell more than expected, falling to 298k (consensus 316k), the lowest weekly number since May. Though hiring is slowing, it appears that layoffs (other than in the housing area) remain low. The four week average drops to 311k. Continuing claims were as expected, rising 7k.
Wednesday, September 26, 2007
Today's Tidbits
August State Employment Date Differs From National Data –Seasonal Adjustments for Teachers is a Suspect
From The Wall Street Journal: “Many economists suspect the drop in August payrolls was exaggerated by a fluky fall in local government payrolls, and new data from the Bureau of Labor Statistics supports that. On Tuesday the BLS released state payroll data for August. If you sum up the changes across the 50 states and the District of Columbia, the total rose 159,000, compared to the decline of 4,000 in the national data…the difference is unusually large. In part that may simply be catchup, since the sum of the states total has lagged the national total for some time. But he says the principal source of divergence in August appears to be in government payrolls. The national tally of government jobs fell 28,000, while the sum-of-the-states tally rose 88,000…evidence that the national data have been distorted by quirky seasonal adjustment, which is made difficult by the timing issues surrounding academic years, and the inconsistency in how teachers are paid over the summer. Some get paid on a 12-month basis, others on a 9- or 10-month basis. Any shift from year to year in the relative incidence of months-paid will play havoc with the seasonally adjusted teacher payrolls. Still, even excluding government, the sum-of-the-states data shows a gain of 70,000 in private payrolls vs. 24,000 in the national payroll survey and 38,000 in the ADP/Macroeconomic Advisers report, notes Andrew Tilton of Goldman Sachs. Mr. Tilton notes that at the state level, the disparity between the payroll and household surveys persists. After dividing the country into 20 regions of about 5 million or more workers each, he finds payroll employment fell in only three, but household employment fell in 15. He attributes this both to higher job loss in the informal sector home contractors, real estate agents, day laborers, and so on who do not show up on anyone's payroll and among young people who are not even looking for work, a very typical feature of softening labor markets.”
Questioning the Validity of Birth/Death Adjustment in Employment Data
From Northern Trust: “Employment measures tend to be coincident rather than leading indicators of cyclical economic behavior. One relatively reliable employment measure is the employment-to-population ratio. This measures the number of people employed relative to the number of people who potentially could be in the labor force. Typically, when the trend in the employment-to-population ratio turns down, the economy already has entered a recession or is about to. It appears as though the employment-to-population ratio has recently entered a downtrend. While on the subject of employment indicators, we would like to discuss one that seems unreliable to us – nonfarm payrolls. The principal reason we find it unreliable is the so-called birth/death adjustment the bean counters at the Bureau of Labor Statistics (BLS) make each month. The birth/death adjustment is an attempt to account for the net new jobs created by businesses not yet reporting to the BLS… in the 12 months ended August 2007, there had been a net increase in nonfarm payrolls, including the birth/death adjustment, of 1.521 million. But when the birth/death adjustment was excluded, the net increase in nonfarm payrolls was only 407,000. Another way to look at this is to calculate the birth/death adjustment’s percentage contribution to the 12-month change in total nonfarm payrolls. … in the 12 months ended August 2007 the birth/death adjustment represent 73% of the increase in nonfarm payrolls compared to only 31% in March 2006. Enquiring minds want to know why the birth/death adjustment’s contribution has more than doubled since March 2006. With small businesses expressing reservations about expanding their operations, is it reasonable to expect that there has been a sharp increase in business start-ups whose hiring is not being captured in the BLS’s sample of establishments?”
Comparing Housing Data
From The Boston Globe: “The explosion in home foreclosures and a tightening in mortgage lending dragged down real estate prices in Massachusetts in August, a real estate research and publishing firm reported yesterday. Warren Group in Boston said median single-family home prices last month fell 4.9 percent, to $314,000, from August 2006 - the 16th consecutive month in which prices have declined. The number of sales in the period fell by 1.5 percent. But the Massachusetts Association of Realtors reported a starkly different view of the housing market, based on a smaller number of transactions than those recorded by Warren Group. The realtors group said home prices in creased 1.4 percent, to a median of $357,000, from August 2006, while the number of sales rose a robust 6.6 percent. The realtor group's report is based mostly on sales brokered by real estate agents, while the larger pool of housing transactions tracked by Warren Group includes sales made directly by homeowners and lenders' repossessions from borrowers and sales of foreclosed homes.”
Longer Lives May Push Retirees Back to Equities and Risk Taking
From Morgan Stanley: “On the one hand, it is thought that global ageing may raise the equity premium, as ageing households become less willing to warehouse risk. As a result, ageing could benefit bond markets relative to equity markets. (In most countries, bills and bonds still rank first in asset allocation, ranging from 50-95%.) This is, in fact, what most academicians contend should be the case. However, recent experience in Japan suggests an interesting alternative hypothesis. Fixed retirement age, coupled with ever improving life expectancy, has created a ‘longevity risk’, whereby retirees can no longer be confident of their ability to defend their lifestyle if they end up living much longer than they expect at the time of their retirement. In the case of Japan, this has led to more risk-taking, not less, as retirees try to enhance their expected investment returns by diversifying away from assets with low credit risk. In contrast to the first hypothesis, this alternative hypothesis suggests that retirees should have a bigger appetite for equities.
Data suggest that, while bills and bonds still account for the bulk of total pension holdings in the world, the share that is allocated to equities is rising. Between 1994 and 2005, there was indeed such an increase in exposure to equities. Incidentally, the recent decision by Norway’s Government Pension Fund, Global, to alter its bond-to-equity allocation from 60:40 to 40:60 is totally consistent with this global trend. What this means is that, on the margin, as the developed world ages, there could be a structural bias in favour of equities over bonds.”
LIBOR’s Validity Under Scrutiny
From The Financial Times: “As the credit squeeze has spread in recent months, the Libor benchmark has, at least until recently, risen relentlessly. Consequently, many observers have seized on these rates as a handy, visible litmus test of banking stress, not least because the rest of the interbank market tends to be very opaque and thus not easily monitored…[But] the recent turmoil is prompting suggestions that Libor is no longer offering such an accurate benchmark of borrowing costs as before…“The Libor rates are a bit of a fiction. The number on the screen doesn’t always match what we see now,” complains the treasurer of one of the largest City banks…One of these is a growing divergence in the rates that different banks have been quoting to borrow and lend money between themselves. For although the banks used to move in a pack, quoting rates that were almost identical, this pattern broke down a couple of months ago – and by the middle of this month the gap between these quotes had sometimes risen to almost 10 basis points for three … the second, more pernicious trend is that as banks have hoarded liquidity this summer, some have been refusing to conduct trades at all at the official, “posted” rates, even when these rates have been displayed on Reuters…Some observers think this is just a short-term reaction to the current crisis. However, it may also reflect a longer-term shift. This is because one key, albeit largely unnoticed, feature of the banking world in recent years is that many large banks have reduced their reliance on the interbank market by tapping cash-rich companies and pensions funds for finance instead. The recent crisis appears to have accelerated this trend. In particular, it appears that some large banks have in effect been abandoning the interbank sector in recent weeks, turning to corporate or pension clients for funding by using innovative repurchase agreements. This trend is bad news for smaller institutions, such as British mortgage lenders, because these, unlike large banks, generally do not have any alternative ways of raising funds outside the interbank world. Thus it is that these institutions appear to have suffered worse from the latest squeeze. Few observers expect this pattern to reverse soon…The BBA Libor benchmark first emerged in the 1980s, because of industry demand for an accurate measure of the rate at which banks would lend money to each other. As London’s status as an international financial centre subsequently grew, the role of BBA Libor also rose, and it is now used to calculate the interest rates for a range of financial instruments and derivatives around the world…The BBA calculates the rates together with Reuters each day, usually before noon UK time. It assembles the interbank borrowing rates from 16 contributor panel banks at 11am, looks at the middle 50 per cent of these rates and uses these to calculate an average. These are then posted on Reuters as the BBA Libor rate.”
Importance of Modeling Extreme Tail Risk
From Business Week: “The big credit-rating agencies, Standard & Poor's and Moody's Investors Service, aren't known for making rash moves when changing their grades on bonds and other securities. The odds are only about 1 in 10,000 that a bond will go from the highest grade, AAA, to the low-quality CCC level during a calendar year. So imagine investors' surprise on Aug. 21 when, in a single day, S&P slashed its ratings on two sets of AAA bonds backed by residential mortgage securities to CCC+ and CCC, instantly changing their status from top quality to pure junk… the very structure of the vehicles that issued the bonds heightened the risk of dramatic downgrades--and that the ratings agencies were aware of this risk, however remote, from the start. The agencies have long contended that they shouldn't be blamed for the subprime meltdown, even though they gave high grades to most of the mortgage-backed bonds whose values have since plunged. Investors consider two main variables when assessing a bond: its price and the interest payments it generates. The agencies say their ratings reflect only the latter. Ratings are judgments about whether a bond will pay interest on schedule until it matures--not indicators of how market forces might affect its price. "Unlike market prices, [bond ratings] do not fluctuate on the basis of market sentiment," wrote S&P Executive Vice-President Vickie A. Tillman in an Aug. 31 Wall Street Journal commentary. But the downgrades made 10 days earlier were indeed driven by market forces. Because of the particular way the vehicles were structured, the credit market plunge that began in June hindered their ability to pay interest on time… The ratings agencies stress that the CDOs were victims of a market storm that resulted in prices for mortgage-backed securities falling by a magnitude 10 to 15 times greater than any time on record. "We've never seen anything like it in structured finance," says Paul Kerlogue, senior credit officer at Moody's in London. "Things just behaved in a way that we were not able to predict." Says S&P's statement: "Our original ratings were based on the best available data at the time." It adds that the credit quality of the CDOs' underlying investments is still strong… S&P's original rating reports on the CDO pools warn that if the portfolios' market values were to fall below certain thresholds, the pools would be required to start selling. Given that the agencies were aware of that possibility, some investors are now skeptical of how closely the agencies were watching over the CDOs, says Alex Roever, a credit market strategist at JPMorgan Securities (JPM ). Mortgage bond prices had fallen steeply in July and early August, yet the agencies issued no warnings that market value triggers might be tripped… In retrospect it's clear that the agencies misread the market risk when they issued their ratings on Mainsail II and Golden Key. Roever says that's forgivable because no one could have known how extraordinary and precipitous the plunge might be. But some others say the agencies should have been more cautious. Recent mortgage bonds included many more adjustable-rate and subprime loans, which carry higher risk and which were backed by homes whose prices had run up sharply--an unsustainable trend. "They were looking at historical data in a brand new ball game with brand new products," says Janet Tavakoli, president of Tavakoli Structured Finance Inc., a Chicago-based consulting firm and longtime critic of the agencies. "You have to understand what you're modeling. That is Statistics 101, and they failed." S&P and Moody's say they did significant stress testing on their models to account for the risk. Another suspected problem: The agencies may have been focusing too narrowly on the price history of mortgage-backed securities, says Christian Stracke, a senior analyst at CreditSights Ltd., a rival bond research firm. In the last few years the volatility of mortgage bonds was low because money was gushing into the sector, and financiers were developing all sorts of new vehicles. "New technology can breed dynamics that artificially depress price volatility, which in turn gives false confidence," says Stracke. Given all of this, the drastic credit downgrades in August "should not have seemed all that implausible," says Stracke. "We know, over and over, that markets get into crises like this. Price volatility on even very safe assets can be high."”
Complex Securitizations Caused Loan Risks to Disconnect Over Time
From The Economist: “…it is hard to overstate the effect that securitisation has had on financial markets. Until the early 1980s, finance hewed to an “originate and hold” model. Banks generally held loans on their balance sheets to maturity; some debts were sold on loan-by-loan, but this market was small and lumpy. This began to give way to an “originate and distribute” model after America's government-sponsored mortgage giants issued the first bonds with payments tied to the cash flows from large pools of loans. Wall Street built on this innovation, and securitisation took off soon after, then paused before exploding in the 1990s. It was given a lift by America's savings-and-loan crisis, which encouraged mortgage lenders to jettison their riskier loans, and by new technologies, such as credit-scoring, that facilitated loan-pooling. Around 56% of America's outstanding residential mortgages were packaged in this way, including more than two-thirds of the subprime loans issued in 2006. Thanks largely to securitisation, global private-debt securities are now far bigger than stockmarkets. Banks have come to see securitisation as an indispensable tool. Global lenders use it to manage their balance sheets, since selling loans frees up capital for new business or for return to shareholders. Small regional banks benefit too. Gone are the days when they had no choice but to place concentrated bets on local housing markets or industry. Now they can offload credits to far-away investors such as insurers and hedge funds, which have an appetite for them. Michael Milken, of junk-bond fame, called securitisation the “democratisation of capital”. Studies suggest that the explosion of this “secondary” market for bank debt has helped to push down borrowing costs for consumers and companies alike. There are other “systemic” gains, too. Subjecting bank loans to valuation by capital markets encourages the efficient use of capital. And the broad distribution of credit risk reduces the risk of any one holder going bust. Even in the midst of turmoil, it is hard to find a banker, regulator or academic who wants to see the clock turned back. But the crisis has exposed cracks in the new model that were hidden or ignored during the credit bubble. The three most glaring are complexity and confusion, a fragmentation of responsibility and the gaming of the regulatory system. Take each in turn. The past few weeks have shown that financiers did not fully understand what they were trading. The boom in derivatives was one of those moments when financial engineering raced ahead of back offices and risk-management departments, leaving them struggling to value or account for their holdings. … it is not uncommon for investors to break their exotic purchases into smaller pieces in order to feed them into their risk-management systems. This brings new risks, particularly that the parts will behave differently from the whole under stress….In a recent paper* on credit derivatives, David Skeel and Frank Partnoy concluded that collateralised debt obligations (CDOs), one of the most common derivatives, are too clever by half. The transaction costs are high, the benefits questionable. They conclude that CDOs are being used to transform existing debt instruments that are accurately priced into new ones that are overvalued. Complexity confuses investors about the risks they are taking on…The lack of transparency plagues the bundling of loans into securities, too. These days, for instance, lenders are less likely to foreclose on defaulting borrowers: in America, less than a quarter of loans 90 days late or more are in foreclosure, compared with three-quarters in the late 1990s, points out Charles Calomiris, of Columbia University. When a late payer gets back on track his loan is once again labelled “current”, and his chequered history does not have to be fully disclosed when the loan goes into a securitised pool. So even the most diligent buyer would struggle to spot that some of the “prime” collateral of mortgage-backed bonds was, in fact, of questionable quality. Investors seeking redress have encountered unforeseen problems. Securitisations are generally structured as “true sales”: the seller wipes its hands of the risk. In practice buyers have some protection. Many contracts allow them to hand back loan pools that sour surprisingly quickly. Some have done just this with the most rancid subprime mortgages, requesting an injection of better-quality loans into the pool. But there were so many bad loans that originators could not oblige. “What we thought was an effective secondary-market punishment mechanism turns out to be faulty when the problem grows beyond a certain size,” …The second lesson of the past few weeks is that securitisation has warped financiers' incentives. It is sometimes portrayed as bank “disintermediation”, but in fact it replaces one middleman with several. In mortgage securitisation, for instance, the lender is supplanted by the broker, the loan originator, the servicer (who collects payments), the investor and the arranger, not to mention the rating agencies and mortgage-bond insurers. This creates what economists call a principal-agent problem. The loan originator has little incentive to vet borrowers carefully because it knows the risk will soon be off its books. The ultimate holder of the risk, the investor, has more reason to care but owns a complex product and is too far down the chain for monitoring to work. For all its flaws, the old bank model resolved the incentives in a simple way. Because loans were kept in-house, banks had every reason both to underwrite cautiously and also to keep tabs on the borrower after the money left the vault. Investors in loan-backed securities could have pushed for tougher monitoring. But most were too taken with the alluring yields on offer…Debt investors are usually sober types, but as the bubble grew, it was increasingly their urges, and not the creditworthiness of homeowners, that determined loan-underwriting standards. Wall Street took full advantage of this appetite. It was well known that investors such as Germany's IKB, a lender to small companies which was bailed out last month, had a weakness for exotic products. The securities firms peddling mortgage-backed bonds did little to disabuse them of the notion that a CDO with a high rating must be as safe as houses—after all, the buyers were sophisticated institutions, not widows or orphans. Moreover Wall Street has every reason to shovel securitised debt out as fast as it can. The loan-origination platform has high fixed costs, so it is a scale business. This can lead to trouble when there are not enough creditworthy new borrowers, as in subprime lending. Banks may be tempted to keep feeding the machine at the expense of laxer lending standards…Complexity and warped incentives foster the third cost of securitisation: gaming the regulations. Politicians are scrutinising the role of rating agencies, as they did with auditors after the dotcom bubble burst. Regulatory dependence on ratings has grown across the board. Banks can reduce the amount of capital they have to set aside if they hold highly rated paper, for instance, and some investors, such as money-market funds, must stick to AAA-rated securities. But not all top-rated paper is the same. The agencies appear to have been too free in giving out prized AAA badges to structured products, especially CDOs. This was partly because their models were faulty, failing to pick up correlations between different markets, and partly because of a conflict of interest: theirs is one of few businesses where the appraiser is paid by the seller, not the buyer. This made it easier for the banks securitising and further repackaging debt to create the greatest possible number of securities with the lowest regulatory cost (that is, highest rating). Investors restricted to investment-grade paper assumed (or at least hoped) that the rating was a guarantee of strength. It might have helped if the agencies had properly monitored their ratings after issuing them. But with low fees per security there is little incentive to stay on the case…. argues that securitisation has let banks (as regulated “holders” of credit risk, with the capacity to keep it through bad times) pass it on to unregulated “traders” of risk with smaller balance sheets, such as hedge funds, which sell when trouble strikes. As a result, he says, although the risk of bank runs has fallen, the risk of market runs has increased…If investors continue to shun the most complex products, Wall Street will have to offer simpler fare. Tom Zimmerman, head of asset-backed research at UBS, sees parallels between the CDO bust and the blow-up in collateralised mortgage obligations (CMOs) in the mid-1990s. CMOs, which pool prepayment risk, became so convoluted that investors could no longer see where the dangers lay. When they stopped buying, investment banks made the product more straightforward and it took off again…But do not expect a rush back to the ways of the 1960s. Securitisation has become far too important for that… the transformation of sticky debt into something more tradable, for all its imperfections, has forged hugely beneficial links between individual borrowers and vast capital markets that were previously out of reach.”
MISC
From The New York Times: “A majority of hedge fund managers say a U.S. recession is "very likely" in 2008, but fewer than one in five said an economic slowdown would be bad for their funds, a survey of several-hundred hedge fund managers released on Tuesday found… 66 percent suggesting a recession would bring investment opportunities… Another 87 percent of those interviewed predicted market volatility would continue or increase for the rest of 2007.”
From JP Morgan: “Sharp declines in aircraft and motor vehicle bookings exaggerated the weakness in August durable goods. But ex transportation orders also reversed a sizable portion of July’s gain. And both ISM and IP softened in August, confirming that the underlying trend in manufacturing activity indeed slipped. More telling has been the moderation in core capital goods orders and shipments, and the risk to our 3Q equipment investment forecast (6%) is clearly to the downside. However, consumer spending is tracking above the anticipated 2.8%. So for now we are leaving the 3Q GDP forecast unchanged at 3%.”
From MNI: “In the first eight months of the year, China had imports of 603.98 bln usd, up 19.6 pct year-on-year…China spending on pollution control was at a record… 1.23 pct of GDP, according to a report released by the environmental regulator, the State Environmental Protection Administration.”
From Morgan Stanley: “The declining birth rate initially yielded a ‘Demographic Dividend’, as the working population rose as a percentage of the total population. In fact, this effect is so dominant that half of the changes in US per capita income growth since 1960 can be explained by changes in this demographic composition of its population.”
From The International Herald Tribune: “Over the past five years alone, oil prices have risen 158 percent, to around $80, while the price of wheat has soared 126 percent. Costs for nickel, used to build … sinks, have shot up 415 percent.”
From Bloomberg: “Bear Stearns Cos. is in ``serious talks with several outside investors'' including Berkshire Hathaway Inc.'s Warren Buffett to sell as much as 20 percent of
the firm, the New York Times reported, citing unidentified people familiar with the matter.”
End-of-Day Market Update
From UBS: “The Treasury auctioned $18 billion in 2-year notes at a yield of 4%, 0.8bp through the 1pm level. The bid-to-cover ratio was solid at 3.29x, although lower than last month's record 3.97x, and indirect bidders accounted for an above-average 35.5%... Swap spreads narrowed about 1.5bps across the board. Agencies saw heavy buying in the front end, especially in maturities between 6 months and 1 year. There was also strong buying of callables, as redemptions forced accounts to reinvest. Coupled with Fannie and Freddie not issuing much lately, the buying interest led agencies to outperform swaps by 0.5bp. Mortgages saw about $1.5 billion in origination, which pushed MBS about 2+ wider on the day. After about $1 billion in buying late in the day, however, mortgages ended only 1 wider.”
From RBSGC: “The [Treasury] market ended the day with a slight bid, but not without trading softer throughout much of the session first… the market bounced on the announcement that Goldman reduced its earnings estimates for Merrill Lynch, attributing the revisions to a potential "multibillion dollar" loss associated with weakness in the mortgage market -- wow. The market gained and equities traded off their highs (although stocks came back). Positions have remained relatively flat throughout much of the recent strength -- somewhat to our surprise. Wednesday's release of the weekly Stone & McCarthy survey shows that this trend has continued -- the index printed at 100.7% of the duration-weighted benchmark, unchanged from last week… Volumes were modest.”
Two and ten year Treasury yields both down less than a basis point in yield today. Two year at 3.98%, ten year at 4.62%.
Equities higher on the day. The Dow is up 100 at 13,878.
Dollar index rebounds today to close up .2, at 78.51, after testing all-time low yesterday by trading at 78.21 vs record low of 78.19. Yen weakened to 115.55, euro remains near record high at 1.413. Gold fell $2.80 to $728.90 spot.
Oil recovered by a dollar to trade at $80.50 at 5pm.
From The Wall Street Journal: “Many economists suspect the drop in August payrolls was exaggerated by a fluky fall in local government payrolls, and new data from the Bureau of Labor Statistics supports that. On Tuesday the BLS released state payroll data for August. If you sum up the changes across the 50 states and the District of Columbia, the total rose 159,000, compared to the decline of 4,000 in the national data…the difference is unusually large. In part that may simply be catchup, since the sum of the states total has lagged the national total for some time. But he says the principal source of divergence in August appears to be in government payrolls. The national tally of government jobs fell 28,000, while the sum-of-the-states tally rose 88,000…evidence that the national data have been distorted by quirky seasonal adjustment, which is made difficult by the timing issues surrounding academic years, and the inconsistency in how teachers are paid over the summer. Some get paid on a 12-month basis, others on a 9- or 10-month basis. Any shift from year to year in the relative incidence of months-paid will play havoc with the seasonally adjusted teacher payrolls. Still, even excluding government, the sum-of-the-states data shows a gain of 70,000 in private payrolls vs. 24,000 in the national payroll survey and 38,000 in the ADP/Macroeconomic Advisers report, notes Andrew Tilton of Goldman Sachs. Mr. Tilton notes that at the state level, the disparity between the payroll and household surveys persists. After dividing the country into 20 regions of about 5 million or more workers each, he finds payroll employment fell in only three, but household employment fell in 15. He attributes this both to higher job loss in the informal sector home contractors, real estate agents, day laborers, and so on who do not show up on anyone's payroll and among young people who are not even looking for work, a very typical feature of softening labor markets.”
Questioning the Validity of Birth/Death Adjustment in Employment Data
From Northern Trust: “Employment measures tend to be coincident rather than leading indicators of cyclical economic behavior. One relatively reliable employment measure is the employment-to-population ratio. This measures the number of people employed relative to the number of people who potentially could be in the labor force. Typically, when the trend in the employment-to-population ratio turns down, the economy already has entered a recession or is about to. It appears as though the employment-to-population ratio has recently entered a downtrend. While on the subject of employment indicators, we would like to discuss one that seems unreliable to us – nonfarm payrolls. The principal reason we find it unreliable is the so-called birth/death adjustment the bean counters at the Bureau of Labor Statistics (BLS) make each month. The birth/death adjustment is an attempt to account for the net new jobs created by businesses not yet reporting to the BLS… in the 12 months ended August 2007, there had been a net increase in nonfarm payrolls, including the birth/death adjustment, of 1.521 million. But when the birth/death adjustment was excluded, the net increase in nonfarm payrolls was only 407,000. Another way to look at this is to calculate the birth/death adjustment’s percentage contribution to the 12-month change in total nonfarm payrolls. … in the 12 months ended August 2007 the birth/death adjustment represent 73% of the increase in nonfarm payrolls compared to only 31% in March 2006. Enquiring minds want to know why the birth/death adjustment’s contribution has more than doubled since March 2006. With small businesses expressing reservations about expanding their operations, is it reasonable to expect that there has been a sharp increase in business start-ups whose hiring is not being captured in the BLS’s sample of establishments?”
Comparing Housing Data
From The Boston Globe: “The explosion in home foreclosures and a tightening in mortgage lending dragged down real estate prices in Massachusetts in August, a real estate research and publishing firm reported yesterday. Warren Group in Boston said median single-family home prices last month fell 4.9 percent, to $314,000, from August 2006 - the 16th consecutive month in which prices have declined. The number of sales in the period fell by 1.5 percent. But the Massachusetts Association of Realtors reported a starkly different view of the housing market, based on a smaller number of transactions than those recorded by Warren Group. The realtors group said home prices in creased 1.4 percent, to a median of $357,000, from August 2006, while the number of sales rose a robust 6.6 percent. The realtor group's report is based mostly on sales brokered by real estate agents, while the larger pool of housing transactions tracked by Warren Group includes sales made directly by homeowners and lenders' repossessions from borrowers and sales of foreclosed homes.”
Longer Lives May Push Retirees Back to Equities and Risk Taking
From Morgan Stanley: “On the one hand, it is thought that global ageing may raise the equity premium, as ageing households become less willing to warehouse risk. As a result, ageing could benefit bond markets relative to equity markets. (In most countries, bills and bonds still rank first in asset allocation, ranging from 50-95%.) This is, in fact, what most academicians contend should be the case. However, recent experience in Japan suggests an interesting alternative hypothesis. Fixed retirement age, coupled with ever improving life expectancy, has created a ‘longevity risk’, whereby retirees can no longer be confident of their ability to defend their lifestyle if they end up living much longer than they expect at the time of their retirement. In the case of Japan, this has led to more risk-taking, not less, as retirees try to enhance their expected investment returns by diversifying away from assets with low credit risk. In contrast to the first hypothesis, this alternative hypothesis suggests that retirees should have a bigger appetite for equities.
Data suggest that, while bills and bonds still account for the bulk of total pension holdings in the world, the share that is allocated to equities is rising. Between 1994 and 2005, there was indeed such an increase in exposure to equities. Incidentally, the recent decision by Norway’s Government Pension Fund, Global, to alter its bond-to-equity allocation from 60:40 to 40:60 is totally consistent with this global trend. What this means is that, on the margin, as the developed world ages, there could be a structural bias in favour of equities over bonds.”
LIBOR’s Validity Under Scrutiny
From The Financial Times: “As the credit squeeze has spread in recent months, the Libor benchmark has, at least until recently, risen relentlessly. Consequently, many observers have seized on these rates as a handy, visible litmus test of banking stress, not least because the rest of the interbank market tends to be very opaque and thus not easily monitored…[But] the recent turmoil is prompting suggestions that Libor is no longer offering such an accurate benchmark of borrowing costs as before…“The Libor rates are a bit of a fiction. The number on the screen doesn’t always match what we see now,” complains the treasurer of one of the largest City banks…One of these is a growing divergence in the rates that different banks have been quoting to borrow and lend money between themselves. For although the banks used to move in a pack, quoting rates that were almost identical, this pattern broke down a couple of months ago – and by the middle of this month the gap between these quotes had sometimes risen to almost 10 basis points for three … the second, more pernicious trend is that as banks have hoarded liquidity this summer, some have been refusing to conduct trades at all at the official, “posted” rates, even when these rates have been displayed on Reuters…Some observers think this is just a short-term reaction to the current crisis. However, it may also reflect a longer-term shift. This is because one key, albeit largely unnoticed, feature of the banking world in recent years is that many large banks have reduced their reliance on the interbank market by tapping cash-rich companies and pensions funds for finance instead. The recent crisis appears to have accelerated this trend. In particular, it appears that some large banks have in effect been abandoning the interbank sector in recent weeks, turning to corporate or pension clients for funding by using innovative repurchase agreements. This trend is bad news for smaller institutions, such as British mortgage lenders, because these, unlike large banks, generally do not have any alternative ways of raising funds outside the interbank world. Thus it is that these institutions appear to have suffered worse from the latest squeeze. Few observers expect this pattern to reverse soon…The BBA Libor benchmark first emerged in the 1980s, because of industry demand for an accurate measure of the rate at which banks would lend money to each other. As London’s status as an international financial centre subsequently grew, the role of BBA Libor also rose, and it is now used to calculate the interest rates for a range of financial instruments and derivatives around the world…The BBA calculates the rates together with Reuters each day, usually before noon UK time. It assembles the interbank borrowing rates from 16 contributor panel banks at 11am, looks at the middle 50 per cent of these rates and uses these to calculate an average. These are then posted on Reuters as the BBA Libor rate.”
Importance of Modeling Extreme Tail Risk
From Business Week: “The big credit-rating agencies, Standard & Poor's and Moody's Investors Service, aren't known for making rash moves when changing their grades on bonds and other securities. The odds are only about 1 in 10,000 that a bond will go from the highest grade, AAA, to the low-quality CCC level during a calendar year. So imagine investors' surprise on Aug. 21 when, in a single day, S&P slashed its ratings on two sets of AAA bonds backed by residential mortgage securities to CCC+ and CCC, instantly changing their status from top quality to pure junk… the very structure of the vehicles that issued the bonds heightened the risk of dramatic downgrades--and that the ratings agencies were aware of this risk, however remote, from the start. The agencies have long contended that they shouldn't be blamed for the subprime meltdown, even though they gave high grades to most of the mortgage-backed bonds whose values have since plunged. Investors consider two main variables when assessing a bond: its price and the interest payments it generates. The agencies say their ratings reflect only the latter. Ratings are judgments about whether a bond will pay interest on schedule until it matures--not indicators of how market forces might affect its price. "Unlike market prices, [bond ratings] do not fluctuate on the basis of market sentiment," wrote S&P Executive Vice-President Vickie A. Tillman in an Aug. 31 Wall Street Journal commentary. But the downgrades made 10 days earlier were indeed driven by market forces. Because of the particular way the vehicles were structured, the credit market plunge that began in June hindered their ability to pay interest on time… The ratings agencies stress that the CDOs were victims of a market storm that resulted in prices for mortgage-backed securities falling by a magnitude 10 to 15 times greater than any time on record. "We've never seen anything like it in structured finance," says Paul Kerlogue, senior credit officer at Moody's in London. "Things just behaved in a way that we were not able to predict." Says S&P's statement: "Our original ratings were based on the best available data at the time." It adds that the credit quality of the CDOs' underlying investments is still strong… S&P's original rating reports on the CDO pools warn that if the portfolios' market values were to fall below certain thresholds, the pools would be required to start selling. Given that the agencies were aware of that possibility, some investors are now skeptical of how closely the agencies were watching over the CDOs, says Alex Roever, a credit market strategist at JPMorgan Securities (JPM ). Mortgage bond prices had fallen steeply in July and early August, yet the agencies issued no warnings that market value triggers might be tripped… In retrospect it's clear that the agencies misread the market risk when they issued their ratings on Mainsail II and Golden Key. Roever says that's forgivable because no one could have known how extraordinary and precipitous the plunge might be. But some others say the agencies should have been more cautious. Recent mortgage bonds included many more adjustable-rate and subprime loans, which carry higher risk and which were backed by homes whose prices had run up sharply--an unsustainable trend. "They were looking at historical data in a brand new ball game with brand new products," says Janet Tavakoli, president of Tavakoli Structured Finance Inc., a Chicago-based consulting firm and longtime critic of the agencies. "You have to understand what you're modeling. That is Statistics 101, and they failed." S&P and Moody's say they did significant stress testing on their models to account for the risk. Another suspected problem: The agencies may have been focusing too narrowly on the price history of mortgage-backed securities, says Christian Stracke, a senior analyst at CreditSights Ltd., a rival bond research firm. In the last few years the volatility of mortgage bonds was low because money was gushing into the sector, and financiers were developing all sorts of new vehicles. "New technology can breed dynamics that artificially depress price volatility, which in turn gives false confidence," says Stracke. Given all of this, the drastic credit downgrades in August "should not have seemed all that implausible," says Stracke. "We know, over and over, that markets get into crises like this. Price volatility on even very safe assets can be high."”
Complex Securitizations Caused Loan Risks to Disconnect Over Time
From The Economist: “…it is hard to overstate the effect that securitisation has had on financial markets. Until the early 1980s, finance hewed to an “originate and hold” model. Banks generally held loans on their balance sheets to maturity; some debts were sold on loan-by-loan, but this market was small and lumpy. This began to give way to an “originate and distribute” model after America's government-sponsored mortgage giants issued the first bonds with payments tied to the cash flows from large pools of loans. Wall Street built on this innovation, and securitisation took off soon after, then paused before exploding in the 1990s. It was given a lift by America's savings-and-loan crisis, which encouraged mortgage lenders to jettison their riskier loans, and by new technologies, such as credit-scoring, that facilitated loan-pooling. Around 56% of America's outstanding residential mortgages were packaged in this way, including more than two-thirds of the subprime loans issued in 2006. Thanks largely to securitisation, global private-debt securities are now far bigger than stockmarkets. Banks have come to see securitisation as an indispensable tool. Global lenders use it to manage their balance sheets, since selling loans frees up capital for new business or for return to shareholders. Small regional banks benefit too. Gone are the days when they had no choice but to place concentrated bets on local housing markets or industry. Now they can offload credits to far-away investors such as insurers and hedge funds, which have an appetite for them. Michael Milken, of junk-bond fame, called securitisation the “democratisation of capital”. Studies suggest that the explosion of this “secondary” market for bank debt has helped to push down borrowing costs for consumers and companies alike. There are other “systemic” gains, too. Subjecting bank loans to valuation by capital markets encourages the efficient use of capital. And the broad distribution of credit risk reduces the risk of any one holder going bust. Even in the midst of turmoil, it is hard to find a banker, regulator or academic who wants to see the clock turned back. But the crisis has exposed cracks in the new model that were hidden or ignored during the credit bubble. The three most glaring are complexity and confusion, a fragmentation of responsibility and the gaming of the regulatory system. Take each in turn. The past few weeks have shown that financiers did not fully understand what they were trading. The boom in derivatives was one of those moments when financial engineering raced ahead of back offices and risk-management departments, leaving them struggling to value or account for their holdings. … it is not uncommon for investors to break their exotic purchases into smaller pieces in order to feed them into their risk-management systems. This brings new risks, particularly that the parts will behave differently from the whole under stress….In a recent paper* on credit derivatives, David Skeel and Frank Partnoy concluded that collateralised debt obligations (CDOs), one of the most common derivatives, are too clever by half. The transaction costs are high, the benefits questionable. They conclude that CDOs are being used to transform existing debt instruments that are accurately priced into new ones that are overvalued. Complexity confuses investors about the risks they are taking on…The lack of transparency plagues the bundling of loans into securities, too. These days, for instance, lenders are less likely to foreclose on defaulting borrowers: in America, less than a quarter of loans 90 days late or more are in foreclosure, compared with three-quarters in the late 1990s, points out Charles Calomiris, of Columbia University. When a late payer gets back on track his loan is once again labelled “current”, and his chequered history does not have to be fully disclosed when the loan goes into a securitised pool. So even the most diligent buyer would struggle to spot that some of the “prime” collateral of mortgage-backed bonds was, in fact, of questionable quality. Investors seeking redress have encountered unforeseen problems. Securitisations are generally structured as “true sales”: the seller wipes its hands of the risk. In practice buyers have some protection. Many contracts allow them to hand back loan pools that sour surprisingly quickly. Some have done just this with the most rancid subprime mortgages, requesting an injection of better-quality loans into the pool. But there were so many bad loans that originators could not oblige. “What we thought was an effective secondary-market punishment mechanism turns out to be faulty when the problem grows beyond a certain size,” …The second lesson of the past few weeks is that securitisation has warped financiers' incentives. It is sometimes portrayed as bank “disintermediation”, but in fact it replaces one middleman with several. In mortgage securitisation, for instance, the lender is supplanted by the broker, the loan originator, the servicer (who collects payments), the investor and the arranger, not to mention the rating agencies and mortgage-bond insurers. This creates what economists call a principal-agent problem. The loan originator has little incentive to vet borrowers carefully because it knows the risk will soon be off its books. The ultimate holder of the risk, the investor, has more reason to care but owns a complex product and is too far down the chain for monitoring to work. For all its flaws, the old bank model resolved the incentives in a simple way. Because loans were kept in-house, banks had every reason both to underwrite cautiously and also to keep tabs on the borrower after the money left the vault. Investors in loan-backed securities could have pushed for tougher monitoring. But most were too taken with the alluring yields on offer…Debt investors are usually sober types, but as the bubble grew, it was increasingly their urges, and not the creditworthiness of homeowners, that determined loan-underwriting standards. Wall Street took full advantage of this appetite. It was well known that investors such as Germany's IKB, a lender to small companies which was bailed out last month, had a weakness for exotic products. The securities firms peddling mortgage-backed bonds did little to disabuse them of the notion that a CDO with a high rating must be as safe as houses—after all, the buyers were sophisticated institutions, not widows or orphans. Moreover Wall Street has every reason to shovel securitised debt out as fast as it can. The loan-origination platform has high fixed costs, so it is a scale business. This can lead to trouble when there are not enough creditworthy new borrowers, as in subprime lending. Banks may be tempted to keep feeding the machine at the expense of laxer lending standards…Complexity and warped incentives foster the third cost of securitisation: gaming the regulations. Politicians are scrutinising the role of rating agencies, as they did with auditors after the dotcom bubble burst. Regulatory dependence on ratings has grown across the board. Banks can reduce the amount of capital they have to set aside if they hold highly rated paper, for instance, and some investors, such as money-market funds, must stick to AAA-rated securities. But not all top-rated paper is the same. The agencies appear to have been too free in giving out prized AAA badges to structured products, especially CDOs. This was partly because their models were faulty, failing to pick up correlations between different markets, and partly because of a conflict of interest: theirs is one of few businesses where the appraiser is paid by the seller, not the buyer. This made it easier for the banks securitising and further repackaging debt to create the greatest possible number of securities with the lowest regulatory cost (that is, highest rating). Investors restricted to investment-grade paper assumed (or at least hoped) that the rating was a guarantee of strength. It might have helped if the agencies had properly monitored their ratings after issuing them. But with low fees per security there is little incentive to stay on the case…. argues that securitisation has let banks (as regulated “holders” of credit risk, with the capacity to keep it through bad times) pass it on to unregulated “traders” of risk with smaller balance sheets, such as hedge funds, which sell when trouble strikes. As a result, he says, although the risk of bank runs has fallen, the risk of market runs has increased…If investors continue to shun the most complex products, Wall Street will have to offer simpler fare. Tom Zimmerman, head of asset-backed research at UBS, sees parallels between the CDO bust and the blow-up in collateralised mortgage obligations (CMOs) in the mid-1990s. CMOs, which pool prepayment risk, became so convoluted that investors could no longer see where the dangers lay. When they stopped buying, investment banks made the product more straightforward and it took off again…But do not expect a rush back to the ways of the 1960s. Securitisation has become far too important for that… the transformation of sticky debt into something more tradable, for all its imperfections, has forged hugely beneficial links between individual borrowers and vast capital markets that were previously out of reach.”
MISC
From The New York Times: “A majority of hedge fund managers say a U.S. recession is "very likely" in 2008, but fewer than one in five said an economic slowdown would be bad for their funds, a survey of several-hundred hedge fund managers released on Tuesday found… 66 percent suggesting a recession would bring investment opportunities… Another 87 percent of those interviewed predicted market volatility would continue or increase for the rest of 2007.”
From JP Morgan: “Sharp declines in aircraft and motor vehicle bookings exaggerated the weakness in August durable goods. But ex transportation orders also reversed a sizable portion of July’s gain. And both ISM and IP softened in August, confirming that the underlying trend in manufacturing activity indeed slipped. More telling has been the moderation in core capital goods orders and shipments, and the risk to our 3Q equipment investment forecast (6%) is clearly to the downside. However, consumer spending is tracking above the anticipated 2.8%. So for now we are leaving the 3Q GDP forecast unchanged at 3%.”
From MNI: “In the first eight months of the year, China had imports of 603.98 bln usd, up 19.6 pct year-on-year…China spending on pollution control was at a record… 1.23 pct of GDP, according to a report released by the environmental regulator, the State Environmental Protection Administration.”
From Morgan Stanley: “The declining birth rate initially yielded a ‘Demographic Dividend’, as the working population rose as a percentage of the total population. In fact, this effect is so dominant that half of the changes in US per capita income growth since 1960 can be explained by changes in this demographic composition of its population.”
From The International Herald Tribune: “Over the past five years alone, oil prices have risen 158 percent, to around $80, while the price of wheat has soared 126 percent. Costs for nickel, used to build … sinks, have shot up 415 percent.”
From Bloomberg: “Bear Stearns Cos. is in ``serious talks with several outside investors'' including Berkshire Hathaway Inc.'s Warren Buffett to sell as much as 20 percent of
the firm, the New York Times reported, citing unidentified people familiar with the matter.”
End-of-Day Market Update
From UBS: “The Treasury auctioned $18 billion in 2-year notes at a yield of 4%, 0.8bp through the 1pm level. The bid-to-cover ratio was solid at 3.29x, although lower than last month's record 3.97x, and indirect bidders accounted for an above-average 35.5%... Swap spreads narrowed about 1.5bps across the board. Agencies saw heavy buying in the front end, especially in maturities between 6 months and 1 year. There was also strong buying of callables, as redemptions forced accounts to reinvest. Coupled with Fannie and Freddie not issuing much lately, the buying interest led agencies to outperform swaps by 0.5bp. Mortgages saw about $1.5 billion in origination, which pushed MBS about 2+ wider on the day. After about $1 billion in buying late in the day, however, mortgages ended only 1 wider.”
From RBSGC: “The [Treasury] market ended the day with a slight bid, but not without trading softer throughout much of the session first… the market bounced on the announcement that Goldman reduced its earnings estimates for Merrill Lynch, attributing the revisions to a potential "multibillion dollar" loss associated with weakness in the mortgage market -- wow. The market gained and equities traded off their highs (although stocks came back). Positions have remained relatively flat throughout much of the recent strength -- somewhat to our surprise. Wednesday's release of the weekly Stone & McCarthy survey shows that this trend has continued -- the index printed at 100.7% of the duration-weighted benchmark, unchanged from last week… Volumes were modest.”
Two and ten year Treasury yields both down less than a basis point in yield today. Two year at 3.98%, ten year at 4.62%.
Equities higher on the day. The Dow is up 100 at 13,878.
Dollar index rebounds today to close up .2, at 78.51, after testing all-time low yesterday by trading at 78.21 vs record low of 78.19. Yen weakened to 115.55, euro remains near record high at 1.413. Gold fell $2.80 to $728.90 spot.
Oil recovered by a dollar to trade at $80.50 at 5pm.
Tuesday, September 25, 2007
Today's Tidbits
September 25, 2007 TIDBITS
Steve Roach Sees Weakening Dollar as Sign of Rising U.S. Economic Problems
From The New York Times: “Currencies are first and foremost relative prices — in essence, they are measures of the intrinsic value of one economy versus another. On that basis, the world has had no compunction in writing down the value of the United States over the past several years… Sadly, none of this is surprising. Because Americans haven’t been saving in sufficient amounts, the United States must import surplus savings from abroad in order to grow. And it has to run record balance of payments and trade deficits in order to attract that foreign capital. The United States current account deficit — the broadest gauge of America’s imbalance in relation to the rest of the world — hit a record 6.2 percent of gross domestic product in 2006 before receding slightly this year. America must still attract some $3 billion of foreign capital each business day in order to keep its economy growing. Economic science is very clear on the implications of such huge imbalances: foreign lenders need to be compensated for sending scarce capital to any country with a deficit. The bigger the deficit, the greater the compensation. The currency of the deficit nation usually bears the brunt of that compensation. As long as the United States fails to address its saving problem, its large balance of payments deficit will persist and the dollar will keep dropping… the American consumer is now at risk. Consumption expenditures currently account for a record 72 percent of the gross domestic product — a number unmatched in the annals of modern history for any nation.
This buying binge has been increasingly supported by housing and lending bubbles. Yet home prices are now headed lower — probably for years — and the fallout from the subprime crisis has seriously crimped home mortgage refinancing. With weaker employment growth also putting pressure on income, the days of open-ended American consumption are likely to finally come to an end. That will make it hard to avoid a recession. Fearful of that possibility, foreign investors are becoming increasingly skittish over buying dollar-based assets… Foreign appetite for United States financial instruments is likely to be sharply reduced for years to come. That would choke off an important avenue of capital inflows, putting more downward pressure on the dollar… the more the Fed under Ben Bernanke follows the easy-money Alan Greenspan script, the greater the risk to the dollar. Why worry about a weaker dollar? The United States imported $2.2 trillion of goods and services in 2006. A sharp drop in the dollar makes those items considerably more expensive — the functional equivalent of a tax hike on consumers. It could also stoke fears of inflation — driving up long-term interest rates and putting more pressure on financial markets and the economy, exacerbating recession risks. Optimists may draw comfort from the vision of an export-led renewal arising from a more competitive dollar. Yet history is clear: no nation has ever devalued its way into prosperity.”
Slowing Sales at Target Hint at Consumer Spending Slowdown For Holidays
From The Wall Street Journal: “Two retailers that have been strong performers in recent years said late yesterday that they are facing softer-than-expected sales, raising concerns about whether once-exuberant consumers are finally starting to snap their wallets shut. Target Corp. yesterday evening cut its forecast for September sales at stores
open more than a year to an increase of just 1.5% to 2.5%, down from its previous forecast of 4% to 6%.... said customer traffic was weaker than expected, and that sales in the Northeast were particularly slow…At the same time however, retailers are predicting one of the slowest Christmas selling seasons in years, as the slump in the housing market worsens. Consumers also are being pressured by higher food and gasoline prices. These new suggestions that consumer spending is slowing are likely to add to worries that the combination of a worsening housing market, credit-market turmoil and a weakening job market (if last month's disappointing hiring is repeated) could push the U.S. close to or into recession -- despite the Federal Reserve's recent interest-rate cut. Consumer spending accounts for more than two-thirds of total output in the U.S. Higher energy and food prices have been pinching sales of some other retailers recently. Separately, home-improvement retailer Lowe's Cos. …said sales are trending below previous expectations because of drought in the mid-Atlantic, Southeastern and Western regions of the U.S. The drought hurt sales of outdoor-related merchandise such as plants… the retailer has been consistently overly optimistic about the housing market's problems, which has led it to lower earnings forecasts for three of the past four quarters.”
Case-Shiller Housing Index Probably a Better Indicator Than OFHEO Index
From JP Morgan: “The largest decline ever in the 10-metro area index, which goes back to 1987, was 6.3%oya in April 1991. Many of the cities experiencing the sharpest declines—mainly along the coasts and in the Southwest—are the same cities that experienced the sharpest price increases during the housing boom. The Case-Shiller house price indices, like the OFHEO, track price changes for constant-quality existing homes and also control for regional shifts in the mix of homes sold. However, unlike the OFHEO, the Case-Shiller indices include nonconforming mortgages (mortgages over $417,000 in 2006 and 2007). In addition, subprime activity is underrepresented in the OFHEO, but likely not in Case-Shiller metrics. These differences explain greater appreciation in the national Case-Shiller index during the boom years but also more rapid deceleration subsequently. Thus, in 2Q07, the national S&P Case Shiller index was down 3.2%oya, while the OFHEO purchase-only index was up 2.6%oya. These differences probably make the Case Shiller indexes more reliable measures of house price changes at this time than the OFHEO indices.”
Home Equity Extraction Likely to Slow to 3.9% of Disposable Income This Year
From Lehman: “Homeowners have continued to extract equity from their homes, but at a slowing pace. Net equity extraction (less closing costs) fell to $494bn saar from an upwardly revised $639bn in Q1 [Based on Fed data]…Given falling home prices and tighter lending standards in the mortgage market, equity extraction is likely to continue to decline. If we assume extraction falls at roughly double the rate in Q2 over the next two quarters, extraction will total about $400bn this year. This equates to roughly 3.9% of disposable income, which is less than half the amount in 2005…”
Petro-Dollar Risks and Politics
From Lehman: “By holding onto massive dollar reserves and pricing oil in dollars, Saudi Arabia is sitting on two assets that threaten to depreciate in value. By pegging the Riyal to the dollar, the kingdom also risks importing inflation and damaging the Saudi economy. Riyadh’s predicament has increased both macroeconomic and geopolitical risks to the price of oil. The US dollar has long been a key mechanism tying together the two most important players in the global oil market – the US and Saudi Arabia. The “dollar alliance” between Riyadh and Washington dates back to the aftermath of the oil crisis of 1973, when then US Secretary of State Henry Kissinger and US Secretary of Treasury William Simon negotiated a bilateral agreement with the Saudis to assure petrodollar recycling. Since then, Riyadh has accumulated over $800 billion in dollar reserves, a large part of the $3.5 trillion in total dollar reserves thought to be held by the Gulf countries (GCC). Likely contributing to the recent pop in oil prices, speculation has increased that the dollar alliance between Washington and Riyadh is ending. With the US and Saudi business cycles appearing increasingly out of sync, it may become more difficult for Riyadh to maintain its currency peg to the dollar without causing inflation… While a Saudi currency peg may be broken as the Fed continues to ease monetary policy
in the US, we do not expect Saudi Arabia to make any rash decisions to break the dollar
alliance that has prevailed for a generation. Often referred to as the “central banker” of
the oil market, the kingdom has proven on multiple occasions that it is focused on
protecting the buoyant outlook for the global economy, as much to assure itself of a
buyer as to preserve its political alliance with the United States. That usually means ensuring enough oil is supplied to the market and holding spare capacity for use in the
event of a supply disruption. Today, however, given mushrooming dollar reserves and
the fragility of the US economy, it also means holding off on significant reserve
diversification or doing anything that would initiate an attack on the US dollar… We do not doubt that the kingdom’s increased leverage due to higher oil prices and a declining dollar will be put to use. It is difficult to imagine exactly how that leverage over Washington will manifest itself, but it may include higher technology weapons at greater discounts or greater consideration of Riyadh’s concerns in other areas, including regional security. Thus, while the world might actually never witness the Kingdom using its enhanced leverage, the fact that speculators perceive it to exist may push up the price of oil. The kingdom is also not alone in its recently improved bargaining position. Other large dollar reserve holders may also attempt to extract rents from Washington, and it is certainly possible that one or more of these countries could set off an attack on the dollar by diversifying its reserves or de-linking its currency. It is clear that after a generation on the sidelines, the dollar has re-emerged as an upside risk to oil prices.”
From Reuters: “Iran is receiving more than 70 percent of its income from crude oil exports in currencies other than the U.S. dollar…Nippon Oil and several other Japanese refiners have started paying for crude in yen at Iran’s request…”
Rate Resets for Subprime ARMS Will Get Little Help From Lower Fed Funds Rate
From LEHC: “Numerous Wall Street firms noted this week that the recent surprise move by the FOMC to cut the funds rate by 50 bp will have very little impact on subprime mortgages facing their first rate reset over the next few months. The reason? Incredibly high margins, and rate reset caps.
From Merrill Lynch: “Over the next several months, billions of adjustable-rate mortgage loans will reset in the US. Housing economists estimate that ~ $685.5 billion adjustable-rate loans will reset between q4'07 and Dec.'08. Estimates show that ~ 68.9% of these resetting arms are SubPrime with 2-3yr prepayment penalties (painful), which are normally pegged to 6- or 12-month LIBOR plus some enormous spread - 500-600bps (painful).”
From Barclays: "Prepays for all index series continue to decline, a trend that bodes ill for future delinquency and loss performance of subprime RMBS, given the large amount of first interest rate resets rapidly approaching."
Second Largest Homebuilder Plans to Increase Discounting to Reduce Inventories
From LEHC: “Lennar Corp., the nation’s second largest home builder (by deliveries) in 2006, reported a huge loss for the quarter ended 8/31/07, mainly resulting from write-offs of land options and write-downs of property. The company also reported declining margins and increased sales incentives, but the numbers on net new home orders showed that the company had been too timid in slashing prices so far this summer. For the quarter ended 8/31/07, Lennar reported net home orders of just 5,804, down a startling 47.5% from the comparable quarter of 2006…The company’s sales cancellation rate (expressed as a % of gross orders) was 32% in the latest quarter. The company noted that its average sales price on home deliveries in the latest quarter was $296,000, down 6.3% from a year ago, and noted that most of the decline was the result of increased sales incentives (an average of $46,000 per home this quarter compared to $35,900 per home a year ago). As the company’s CEO noted today, the housing market continued to deteriorate this summer in a manner that the company didn’t anticipate, and that as a result the company will become much more aggressive in discounting home prices to reduce inventories.”
Estimating China’s Exposure to a U.S. Economic Slowdown
From Citi: “Exports already account for 36% of China’s GDP, while the US market makes up 22% of China’s total exports… a slowdown of US GDP growth by 0.8ppt could cut Chinese growth by 1.1ppt. These imply an elasticity of 1.4.1 In a recession scenario, US growth could fall by 3ppts from our 2008 forecast of 2.5%. This would directly drag down Chinese growth from the expected 11% to 6.9%. This OEF model, however, probably ignores two important mechanisms. One, the model does not automatically take into account likely policy responses by the Chinese government. During the East Asian financial crisis, China maintained 7.8% growth through expansionary policies. The authorities would probably act again to prevent significant slowing of the economy given their strong belief of 8% minimum growth. Two, the model does not effectively capture changes in capital flows. In a world with rising risks and slowing growth, capital is likely to leave emerging market economies. But China could be an exception this time around, as many investors have begun to view China as a safe haven. Plus, while world interest rates start to fall, Chinese interest rates are probably still on an uptrend. This could mean increased capital flows to China in the event of a US recession. On balance, the Chinese economy would slow, but expansionary policies and capital inflows could support its GDP growth at 8-9%. In this hypothetical scenario, the trade and current account surpluses would narrow sharply; profit margins might collapse; growth would become even more dependent on investment activities; and inflationary pressure could ease.”
Health Care Insurance Premiums Growing Three Times Faster Than Inflation Rate
From Dow Jones: “A study shows that health-care cost increases are down to their lowest level in nearly a decade, but they’re forecast to rise at a much faster rate again in 2008. The study from Hewitt Associates says total health-care costs to employees will jump by double digits next year, and that point-of-service and preferred-provider-organization coverage - which have seen growth rates in the low single digits during 2007 - will jump by a high-single-digit percentage. Those increases will be more in line with health maintenance organizations and traditional indemnity plans. Hewitt researchers say that this year’s price increase was artificially low since many employers have been socking away extra cash for health care of late. “In ‘06 and ‘05, employers were budgeting too much so they had overall surpluses in the plan…“They didn’t have to budget so much [this year].”… insurers also will be upping their price increases by a percentage point or so, to about a 9% gain - roughly triple the rate of inflation. Employers generally already have lined up their health-care plans for the coming year and are feeling the extra pinch…the average cost per employee for major companies will hit $8,676 next year, up from $7,982 this year, an 8.7 increase. Rate increases were up 5.3% this year, down from last year’s level of 7.9%. Employee contributions to health insurance will rise at a faster rate, going to $1,859 a year from $1,690, for an increase of 10%. Including out-of-pocket charges such as co-payments and deductibles, total health-care costs for employees should average $3,597 next year, up 10.1% from $3,266. During 2007, traditional indemnity plans rose 9.1% while HMOs were up 8.7%. Point-of-service and preferred-provider costs, however, rose more modestly, up 3.9% and 2.4%, respectively.”
Second Quarter Personal Income Growth Remained Solid Nationally
From Wachovia: “Income growth moderated to a 4.9 percent pace in the second quarter, reflecting a payback from a 10.3 percent first quarter spike caused by bonus payments occurring in the first quarter. Nominal personal income grew in 49 states and the District of Columbia. New York saw the lone drop, a contraction of 0.1 percent for the quarter. Even with a slight second quarter dip, New York shows the second largest gain in income over the past year, trailing only California. Texas is the clear up-and-comer, with personal income up nearly 8 percent. The fastest growth continues to be in the Rocky Mountains, where mining activity is providing a sizable boost to income… Wages and salaries accounted for just over half the growth, while interest, dividends and rents accounted for more than a third of the rise… The industrial heartland in the Midwest posted modest income gains during the second quarter, as manufacturing activity has revived somewhat in recent months. Michigan, which has had the weakest major economy in the nation for most of this decade, saw personal income rise solidly for the second consecutive quarter. Weaker growth in earlier periods, however, has held year-to-year income gains to an anemic 3.6 percent. Surrounding states have faired slightly better, but most of the Midwest remains in the lowest or second lowest quintiles for income growth over the past year. Ohio and Michigan have both seen poor income growth mirroring their employment losses over the past year, 0.15 and 1.25 percent, respectively … Utah continued to post exceptionally strong income growth, leading the nation with an annualized growth rate of 8.2 percent in the second quarter and 9.3 percent growth over the past year. Utah also led the nation in nonfarm employment gains over the same period with growth of 4.85 percent… Texas saw the third fastest rate of personal income growth, up 7.99 percent over past year. The state’s economy has been booming, which also saw the largest gain in nonfarm jobs over the same period. Gains are evident across the board”
More Bank Loan Write-Downs Coming
From Dow Jones: “The nation’s three biggest banks are likely to suffer major third-quarter writedowns, possibly topping $1 billion apiece, to reflect the eroded value of loans to highly indebted companies. The expected hits stem in large part from loans the banks made, or committed to make, to finance the leveraged buyout boom that ground to a halt this summer. Banks traditionally farmed out the loans to an array of investors - other banks, hedge funds and vehicles called collateralized loan obligations - but risk-averse buyers are now balking. That’s forcing banks to either offer the loans at bargain prices or to hold them on their books at discounted values. Analysts and investors have been trying to forecast the fallout for banks ever since the credit crunch hit, forcing them to guess at banks’ exposures and then the level of discount. Wall Street brokerage firms made the task somewhat easier last week when they reported third-quarter results and said they had cut the value of their leveraged loan books by some 4% to 6%. Analysts expect Citigroup Inc., J.P. Morgan Chase & Co. and Bank of America Corp. to take similar haircuts when they report quarterly earnings next month, assuming the credit markets neither dramatically improve nor deteriorate before then.”
Rating Agencies To Defend Practices Before Congress Tomorrow
From CNN: “Since the subprime crisis erupted, plenty of blame has been pinned on the big credit rating agencies. Just what went wrong at these firms - and what can be done to stave off another disaster - will be the topic of hearings on Capitol Hill this week. Lawmakers are expected to grill executives from Moody's and Standard & Poor's, two of the biggest agencies, before the Senate Banking Committee on Wednesday. Securities and Exchange Chairman Christopher Cox is also scheduled to testify. The House Financial Services Committee will follow with a hearing on Thursday… many say there is little Congress can do to overhaul the rating system, and in turn, restore confidence in the complex debt products that have exploded on Wall Street in recent years… The rating agencies have responded to the criticism by contending that they only issue opinions about creditworthiness - and investors can choose to ignore their ratings. "Ratings are not recommendations to buy, sell or hold a particular security. They simply provide a tool for investors to assess risk and differentiate credit quality,"… There is recognition that the conflicts of interest in the rating industry are problematic, but reform won't come easily,… Under legislation passed last year, the SEC has the authority to inspect credit rating agencies…doubtful there will be a significant increase in regulatory oversight, largely due to the heavy costs that would incur. "The SEC and other regulators aren't prepared to come in and police the opinions issued by rating firms,"…”
MISC
From Morgan Stanley: “Commodities continued their outperformance and posted the highest weekly, month-to date and year-to-date returns of 3.6%, 10% and 18% respectively. The market witnessed reversal of risk appetite after the Fed cut the target rate by 50bps. Equities rallied 2.8% during the week and posted second highest returns of 3.5% and 7.6% on a month-to-date and year-to-date basis respectively.”
From Lehman: “The stabilization in money markets persisted through Monday. The Fed reported that rates on asset-backed commercial paper (ABCP) continued to retreat, though spreads remain historically wide to the funds rate. The weighted average maturity of new issues continued to climb as investors become willing to purchase longer maturity paper. LIBOR rates, though lower over the course of the past week, remain elevated to Treasuries and the funds rate. Finally, volatility of the funds rate itself has fallen to normal levels: in the last four days the effective funds rate has varied no more than 2bp from target.”
From Morgan Stanley: “…preemptive actions do not come without a cost, and in our view the Fed is swapping systematic / liquidity risk, for longer term inflation risk. As a result we think the curve will continue to steepen and volatility will continue to rise…”
From JP Morgan: “In the current environment, characterized by tight bank balance sheets, it appears highly likely that any near term lending that spans year-end will be priced at a premium. The 1999-2000 experience, when the year-end turn premium skyrocketed to levels never seen before or after, provides some (albeit wide) bounds and some guidance…the current turn premium is well below Y2K levels…the Y2K pattern appears likely to repeat itself - i.e., the implied turn premium will drift wider from current levels for another week or two.”
From Citi: “…we've seen the expectations of future Fed cuts actually decline. We've gone from pretty much fully pricing an eventual move to 4.0% to now pricing in only a move to 4.25% in both Fed Fund Futures as well as Eurodollar's.”
From RBSGC: “What the data can not tell us is how many of those for sale signs represent motivated sellers who will deal at any price (foreclosed properties, speculators who waited far too long to get out, etc.) vs. those homeowners who were just hoping to sell closer to the highs in prices.”
From Wachovia: “With closings across the country delayed or even canceled by financing trouble, the credit crunch showed up in full force in August's home sales data.”
From Macroeconomic Advisors: “Q3-2007 Current Quarter GDP Tracking 2.5 percent…”
From Credit Suisse: “The mild slowdown we project for global economic growth (from a 5.2% rate estimated this year to 5% next year) should keep a lid on inflation pressures, by increasing economic slack. And that’s despite the sharp rises seen in commodity prices (oil, metals, softs). To be sure, the inflation outlook remains largely unchanged for developed countries, while that for Non-Japan Asia looks less favorable, especially for China. That said, the contagion effect from the worsening Chinese inflation outlook should be limited: Rising inflation in China is largely driven by soaring food prices…”
From Deutsche Bank: “Today's economic data are a prime example of why we expect the Fed to make a 25bps insurance-cut at the October FOMC meeting-souring housing market conditions will take a toll on consumer attitudes, and hence spending, in the coming months and quarters. Given the paltry 2% year-over-year rate of growth in the economy and tame core inflation, we think the Fed will be forced to further lower rates in order to fend off a recession.”
From Citi: “While sales indications, including autos, are far from falling off a cliff
(beware of potential new strike distortions), the third quarter appears to be ending on a soft note. The earliest signs from fundamental data suggest the Fed's policy stance prior to September 18 was relatively tight for a decelerating economy, already carrying a heavy burden from contracting housing. This should be kept in mind by those speculating on inflationary impact.”
From FTN: “There are already close to a hundred thousand newly unemployed mortgage company employees looking for work on top of several hundred thousand unemployed residential construction workers.”
From JP Morgan: “…the deterioration in the labor market differential (jobs – plentiful less jobs-hard-to-get) in today’s confidence report…we have only seen a two-month drop this large (7.8 points) during or in the immediate aftermath of recessions…Sept, Oct, and Nov 2001 were the last time we saw 2-month cumulative declines, and prior to that only in Oct and Nov 1991 was the drop greater than 7.9 since 1990.”
From GaveKal Research: “Since 1970, most cuts by the Fed (1970, 1974, 1985, 1989, 2001) were followed for at least two years by massive declines in the inflation rate. There were, however, exceptions: 1980 (which was quickly taken back by Mr Volcker) and 1998 (which was also quickly taken back). Which leaves us with the following question: Will the recent Fed cut prove to be right? Or will it be, like 1980 and 1998, a mistake quickly taken back?... In recent years, the Fed has been more broadly right than wrong (five out of seven). Better yet, when it has been wrong, it was quick to change its course and adjust to the underlying realities… there are three things that a central bank can control: the growth rate of its money supply, its interest rate, or the value of its currency. Unfortunately, as the Chinese central bankers are now discovering, it cannot control all three at the same time.”
From Dow Jones: “Freddie Mac increased its retained portfolio 1.6% from July to August to a record $732.2 billion. This is the largest monthly increase since the company
agreed to limit its portfolio growth in mid-2006.”
From Natixis: “…there are some investors who are anxious to believe the incredible argument that equities are “looking past the valley” and that it is the right time to invest, even though I can’t recall them ever “looking past the peak.””
End-of-Day Market Update
From RBSGC: “Prices firmed up over the course of Tuesday with the curve quite a bit steeper, and with most of those gains lost into the close… volume over the course of the day came off from what started as a pretty active session to one that was merely average.”
From SunTrust: “Considering how active the overnight session was, today's trade has been a complete fizzle. Prices bubbled up, reached their highs just before the economic releases, only to spend the rest of the day heading south. The news on the economy was weak…It is hard to say what caused the sell-off, other than the news was already discounted. Equities recovered their losses, which took a bit of steam out of bonds too. The short end of the market held most of its gains, but the long bond is now in the red on the day. Dollar weakness is hurting there.”
From UBS: “The 2y-10y yield curve steepened by nearly 5bp in treasuries today--continuing its run to new steeps for the move. Much of the steepening came late day as 10yrs backed up and 2's stayed right around 3.99%... TIPS had better overall selling in the long end as 20y Breakevens cheapened by 1.5bp on the day. Agencies saw another day where short Agencies richened to Swaps and cheapened to treasuries as 2yr spreads have gone 6.5 wider in the past 2 days. We had early extension flows in Agencies…there was very little outright rate activity in swaps today.”
From Bloomberg: “The dollar fell to a record low against the euro as declines in consumer confidence and home resales increased expectations that the Federal Reserve will cut borrowing costs for a second time this year. The U.S. currency weakened to a 15-year low against a basket of six major peers on speculation another decrease in lending rates will make U.S. assets less attractive to international investors…The dollar … touched $1.4154, the weakest since the euro's debut in January 1999. The U.S. currency decreased 0.27 percent to 114.56 per yen…The New York Board of Trade's dollar index that measures its value against six major currencies touched 78.213, the lowest since September 1992. The Fed's trade-weighted dollar index against major currencies fell on Sept. 20 to the weakest since its inception in 1971. U.S. Treasuries rallied on the consumer and housing data, pushing the two-year note's yield down to 3.97 percent. The comparable-maturity German bund yielded 4.01 percent, increasing its advantage over the Treasury note to 0.04 percentage point, near the widest since September 2004.”
From UBS: “Equity markets were mixed, with the S&P500 about unchanged but the Nasdaq up 0.6%. 10-year Treasury yields were steady at 4.63%; 2-year yields fell 5bp to 4.00%. Oil prices fell $1.27 to $81.38.”
Steve Roach Sees Weakening Dollar as Sign of Rising U.S. Economic Problems
From The New York Times: “Currencies are first and foremost relative prices — in essence, they are measures of the intrinsic value of one economy versus another. On that basis, the world has had no compunction in writing down the value of the United States over the past several years… Sadly, none of this is surprising. Because Americans haven’t been saving in sufficient amounts, the United States must import surplus savings from abroad in order to grow. And it has to run record balance of payments and trade deficits in order to attract that foreign capital. The United States current account deficit — the broadest gauge of America’s imbalance in relation to the rest of the world — hit a record 6.2 percent of gross domestic product in 2006 before receding slightly this year. America must still attract some $3 billion of foreign capital each business day in order to keep its economy growing. Economic science is very clear on the implications of such huge imbalances: foreign lenders need to be compensated for sending scarce capital to any country with a deficit. The bigger the deficit, the greater the compensation. The currency of the deficit nation usually bears the brunt of that compensation. As long as the United States fails to address its saving problem, its large balance of payments deficit will persist and the dollar will keep dropping… the American consumer is now at risk. Consumption expenditures currently account for a record 72 percent of the gross domestic product — a number unmatched in the annals of modern history for any nation.
This buying binge has been increasingly supported by housing and lending bubbles. Yet home prices are now headed lower — probably for years — and the fallout from the subprime crisis has seriously crimped home mortgage refinancing. With weaker employment growth also putting pressure on income, the days of open-ended American consumption are likely to finally come to an end. That will make it hard to avoid a recession. Fearful of that possibility, foreign investors are becoming increasingly skittish over buying dollar-based assets… Foreign appetite for United States financial instruments is likely to be sharply reduced for years to come. That would choke off an important avenue of capital inflows, putting more downward pressure on the dollar… the more the Fed under Ben Bernanke follows the easy-money Alan Greenspan script, the greater the risk to the dollar. Why worry about a weaker dollar? The United States imported $2.2 trillion of goods and services in 2006. A sharp drop in the dollar makes those items considerably more expensive — the functional equivalent of a tax hike on consumers. It could also stoke fears of inflation — driving up long-term interest rates and putting more pressure on financial markets and the economy, exacerbating recession risks. Optimists may draw comfort from the vision of an export-led renewal arising from a more competitive dollar. Yet history is clear: no nation has ever devalued its way into prosperity.”
Slowing Sales at Target Hint at Consumer Spending Slowdown For Holidays
From The Wall Street Journal: “Two retailers that have been strong performers in recent years said late yesterday that they are facing softer-than-expected sales, raising concerns about whether once-exuberant consumers are finally starting to snap their wallets shut. Target Corp. yesterday evening cut its forecast for September sales at stores
open more than a year to an increase of just 1.5% to 2.5%, down from its previous forecast of 4% to 6%.... said customer traffic was weaker than expected, and that sales in the Northeast were particularly slow…At the same time however, retailers are predicting one of the slowest Christmas selling seasons in years, as the slump in the housing market worsens. Consumers also are being pressured by higher food and gasoline prices. These new suggestions that consumer spending is slowing are likely to add to worries that the combination of a worsening housing market, credit-market turmoil and a weakening job market (if last month's disappointing hiring is repeated) could push the U.S. close to or into recession -- despite the Federal Reserve's recent interest-rate cut. Consumer spending accounts for more than two-thirds of total output in the U.S. Higher energy and food prices have been pinching sales of some other retailers recently. Separately, home-improvement retailer Lowe's Cos. …said sales are trending below previous expectations because of drought in the mid-Atlantic, Southeastern and Western regions of the U.S. The drought hurt sales of outdoor-related merchandise such as plants… the retailer has been consistently overly optimistic about the housing market's problems, which has led it to lower earnings forecasts for three of the past four quarters.”
Case-Shiller Housing Index Probably a Better Indicator Than OFHEO Index
From JP Morgan: “The largest decline ever in the 10-metro area index, which goes back to 1987, was 6.3%oya in April 1991. Many of the cities experiencing the sharpest declines—mainly along the coasts and in the Southwest—are the same cities that experienced the sharpest price increases during the housing boom. The Case-Shiller house price indices, like the OFHEO, track price changes for constant-quality existing homes and also control for regional shifts in the mix of homes sold. However, unlike the OFHEO, the Case-Shiller indices include nonconforming mortgages (mortgages over $417,000 in 2006 and 2007). In addition, subprime activity is underrepresented in the OFHEO, but likely not in Case-Shiller metrics. These differences explain greater appreciation in the national Case-Shiller index during the boom years but also more rapid deceleration subsequently. Thus, in 2Q07, the national S&P Case Shiller index was down 3.2%oya, while the OFHEO purchase-only index was up 2.6%oya. These differences probably make the Case Shiller indexes more reliable measures of house price changes at this time than the OFHEO indices.”
Home Equity Extraction Likely to Slow to 3.9% of Disposable Income This Year
From Lehman: “Homeowners have continued to extract equity from their homes, but at a slowing pace. Net equity extraction (less closing costs) fell to $494bn saar from an upwardly revised $639bn in Q1 [Based on Fed data]…Given falling home prices and tighter lending standards in the mortgage market, equity extraction is likely to continue to decline. If we assume extraction falls at roughly double the rate in Q2 over the next two quarters, extraction will total about $400bn this year. This equates to roughly 3.9% of disposable income, which is less than half the amount in 2005…”
Petro-Dollar Risks and Politics
From Lehman: “By holding onto massive dollar reserves and pricing oil in dollars, Saudi Arabia is sitting on two assets that threaten to depreciate in value. By pegging the Riyal to the dollar, the kingdom also risks importing inflation and damaging the Saudi economy. Riyadh’s predicament has increased both macroeconomic and geopolitical risks to the price of oil. The US dollar has long been a key mechanism tying together the two most important players in the global oil market – the US and Saudi Arabia. The “dollar alliance” between Riyadh and Washington dates back to the aftermath of the oil crisis of 1973, when then US Secretary of State Henry Kissinger and US Secretary of Treasury William Simon negotiated a bilateral agreement with the Saudis to assure petrodollar recycling. Since then, Riyadh has accumulated over $800 billion in dollar reserves, a large part of the $3.5 trillion in total dollar reserves thought to be held by the Gulf countries (GCC). Likely contributing to the recent pop in oil prices, speculation has increased that the dollar alliance between Washington and Riyadh is ending. With the US and Saudi business cycles appearing increasingly out of sync, it may become more difficult for Riyadh to maintain its currency peg to the dollar without causing inflation… While a Saudi currency peg may be broken as the Fed continues to ease monetary policy
in the US, we do not expect Saudi Arabia to make any rash decisions to break the dollar
alliance that has prevailed for a generation. Often referred to as the “central banker” of
the oil market, the kingdom has proven on multiple occasions that it is focused on
protecting the buoyant outlook for the global economy, as much to assure itself of a
buyer as to preserve its political alliance with the United States. That usually means ensuring enough oil is supplied to the market and holding spare capacity for use in the
event of a supply disruption. Today, however, given mushrooming dollar reserves and
the fragility of the US economy, it also means holding off on significant reserve
diversification or doing anything that would initiate an attack on the US dollar… We do not doubt that the kingdom’s increased leverage due to higher oil prices and a declining dollar will be put to use. It is difficult to imagine exactly how that leverage over Washington will manifest itself, but it may include higher technology weapons at greater discounts or greater consideration of Riyadh’s concerns in other areas, including regional security. Thus, while the world might actually never witness the Kingdom using its enhanced leverage, the fact that speculators perceive it to exist may push up the price of oil. The kingdom is also not alone in its recently improved bargaining position. Other large dollar reserve holders may also attempt to extract rents from Washington, and it is certainly possible that one or more of these countries could set off an attack on the dollar by diversifying its reserves or de-linking its currency. It is clear that after a generation on the sidelines, the dollar has re-emerged as an upside risk to oil prices.”
From Reuters: “Iran is receiving more than 70 percent of its income from crude oil exports in currencies other than the U.S. dollar…Nippon Oil and several other Japanese refiners have started paying for crude in yen at Iran’s request…”
Rate Resets for Subprime ARMS Will Get Little Help From Lower Fed Funds Rate
From LEHC: “Numerous Wall Street firms noted this week that the recent surprise move by the FOMC to cut the funds rate by 50 bp will have very little impact on subprime mortgages facing their first rate reset over the next few months. The reason? Incredibly high margins, and rate reset caps.
From Merrill Lynch: “Over the next several months, billions of adjustable-rate mortgage loans will reset in the US. Housing economists estimate that ~ $685.5 billion adjustable-rate loans will reset between q4'07 and Dec.'08. Estimates show that ~ 68.9% of these resetting arms are SubPrime with 2-3yr prepayment penalties (painful), which are normally pegged to 6- or 12-month LIBOR plus some enormous spread - 500-600bps (painful).”
From Barclays: "Prepays for all index series continue to decline, a trend that bodes ill for future delinquency and loss performance of subprime RMBS, given the large amount of first interest rate resets rapidly approaching."
Second Largest Homebuilder Plans to Increase Discounting to Reduce Inventories
From LEHC: “Lennar Corp., the nation’s second largest home builder (by deliveries) in 2006, reported a huge loss for the quarter ended 8/31/07, mainly resulting from write-offs of land options and write-downs of property. The company also reported declining margins and increased sales incentives, but the numbers on net new home orders showed that the company had been too timid in slashing prices so far this summer. For the quarter ended 8/31/07, Lennar reported net home orders of just 5,804, down a startling 47.5% from the comparable quarter of 2006…The company’s sales cancellation rate (expressed as a % of gross orders) was 32% in the latest quarter. The company noted that its average sales price on home deliveries in the latest quarter was $296,000, down 6.3% from a year ago, and noted that most of the decline was the result of increased sales incentives (an average of $46,000 per home this quarter compared to $35,900 per home a year ago). As the company’s CEO noted today, the housing market continued to deteriorate this summer in a manner that the company didn’t anticipate, and that as a result the company will become much more aggressive in discounting home prices to reduce inventories.”
Estimating China’s Exposure to a U.S. Economic Slowdown
From Citi: “Exports already account for 36% of China’s GDP, while the US market makes up 22% of China’s total exports… a slowdown of US GDP growth by 0.8ppt could cut Chinese growth by 1.1ppt. These imply an elasticity of 1.4.1 In a recession scenario, US growth could fall by 3ppts from our 2008 forecast of 2.5%. This would directly drag down Chinese growth from the expected 11% to 6.9%. This OEF model, however, probably ignores two important mechanisms. One, the model does not automatically take into account likely policy responses by the Chinese government. During the East Asian financial crisis, China maintained 7.8% growth through expansionary policies. The authorities would probably act again to prevent significant slowing of the economy given their strong belief of 8% minimum growth. Two, the model does not effectively capture changes in capital flows. In a world with rising risks and slowing growth, capital is likely to leave emerging market economies. But China could be an exception this time around, as many investors have begun to view China as a safe haven. Plus, while world interest rates start to fall, Chinese interest rates are probably still on an uptrend. This could mean increased capital flows to China in the event of a US recession. On balance, the Chinese economy would slow, but expansionary policies and capital inflows could support its GDP growth at 8-9%. In this hypothetical scenario, the trade and current account surpluses would narrow sharply; profit margins might collapse; growth would become even more dependent on investment activities; and inflationary pressure could ease.”
Health Care Insurance Premiums Growing Three Times Faster Than Inflation Rate
From Dow Jones: “A study shows that health-care cost increases are down to their lowest level in nearly a decade, but they’re forecast to rise at a much faster rate again in 2008. The study from Hewitt Associates says total health-care costs to employees will jump by double digits next year, and that point-of-service and preferred-provider-organization coverage - which have seen growth rates in the low single digits during 2007 - will jump by a high-single-digit percentage. Those increases will be more in line with health maintenance organizations and traditional indemnity plans. Hewitt researchers say that this year’s price increase was artificially low since many employers have been socking away extra cash for health care of late. “In ‘06 and ‘05, employers were budgeting too much so they had overall surpluses in the plan…“They didn’t have to budget so much [this year].”… insurers also will be upping their price increases by a percentage point or so, to about a 9% gain - roughly triple the rate of inflation. Employers generally already have lined up their health-care plans for the coming year and are feeling the extra pinch…the average cost per employee for major companies will hit $8,676 next year, up from $7,982 this year, an 8.7 increase. Rate increases were up 5.3% this year, down from last year’s level of 7.9%. Employee contributions to health insurance will rise at a faster rate, going to $1,859 a year from $1,690, for an increase of 10%. Including out-of-pocket charges such as co-payments and deductibles, total health-care costs for employees should average $3,597 next year, up 10.1% from $3,266. During 2007, traditional indemnity plans rose 9.1% while HMOs were up 8.7%. Point-of-service and preferred-provider costs, however, rose more modestly, up 3.9% and 2.4%, respectively.”
Second Quarter Personal Income Growth Remained Solid Nationally
From Wachovia: “Income growth moderated to a 4.9 percent pace in the second quarter, reflecting a payback from a 10.3 percent first quarter spike caused by bonus payments occurring in the first quarter. Nominal personal income grew in 49 states and the District of Columbia. New York saw the lone drop, a contraction of 0.1 percent for the quarter. Even with a slight second quarter dip, New York shows the second largest gain in income over the past year, trailing only California. Texas is the clear up-and-comer, with personal income up nearly 8 percent. The fastest growth continues to be in the Rocky Mountains, where mining activity is providing a sizable boost to income… Wages and salaries accounted for just over half the growth, while interest, dividends and rents accounted for more than a third of the rise… The industrial heartland in the Midwest posted modest income gains during the second quarter, as manufacturing activity has revived somewhat in recent months. Michigan, which has had the weakest major economy in the nation for most of this decade, saw personal income rise solidly for the second consecutive quarter. Weaker growth in earlier periods, however, has held year-to-year income gains to an anemic 3.6 percent. Surrounding states have faired slightly better, but most of the Midwest remains in the lowest or second lowest quintiles for income growth over the past year. Ohio and Michigan have both seen poor income growth mirroring their employment losses over the past year, 0.15 and 1.25 percent, respectively … Utah continued to post exceptionally strong income growth, leading the nation with an annualized growth rate of 8.2 percent in the second quarter and 9.3 percent growth over the past year. Utah also led the nation in nonfarm employment gains over the same period with growth of 4.85 percent… Texas saw the third fastest rate of personal income growth, up 7.99 percent over past year. The state’s economy has been booming, which also saw the largest gain in nonfarm jobs over the same period. Gains are evident across the board”
More Bank Loan Write-Downs Coming
From Dow Jones: “The nation’s three biggest banks are likely to suffer major third-quarter writedowns, possibly topping $1 billion apiece, to reflect the eroded value of loans to highly indebted companies. The expected hits stem in large part from loans the banks made, or committed to make, to finance the leveraged buyout boom that ground to a halt this summer. Banks traditionally farmed out the loans to an array of investors - other banks, hedge funds and vehicles called collateralized loan obligations - but risk-averse buyers are now balking. That’s forcing banks to either offer the loans at bargain prices or to hold them on their books at discounted values. Analysts and investors have been trying to forecast the fallout for banks ever since the credit crunch hit, forcing them to guess at banks’ exposures and then the level of discount. Wall Street brokerage firms made the task somewhat easier last week when they reported third-quarter results and said they had cut the value of their leveraged loan books by some 4% to 6%. Analysts expect Citigroup Inc., J.P. Morgan Chase & Co. and Bank of America Corp. to take similar haircuts when they report quarterly earnings next month, assuming the credit markets neither dramatically improve nor deteriorate before then.”
Rating Agencies To Defend Practices Before Congress Tomorrow
From CNN: “Since the subprime crisis erupted, plenty of blame has been pinned on the big credit rating agencies. Just what went wrong at these firms - and what can be done to stave off another disaster - will be the topic of hearings on Capitol Hill this week. Lawmakers are expected to grill executives from Moody's and Standard & Poor's, two of the biggest agencies, before the Senate Banking Committee on Wednesday. Securities and Exchange Chairman Christopher Cox is also scheduled to testify. The House Financial Services Committee will follow with a hearing on Thursday… many say there is little Congress can do to overhaul the rating system, and in turn, restore confidence in the complex debt products that have exploded on Wall Street in recent years… The rating agencies have responded to the criticism by contending that they only issue opinions about creditworthiness - and investors can choose to ignore their ratings. "Ratings are not recommendations to buy, sell or hold a particular security. They simply provide a tool for investors to assess risk and differentiate credit quality,"… There is recognition that the conflicts of interest in the rating industry are problematic, but reform won't come easily,… Under legislation passed last year, the SEC has the authority to inspect credit rating agencies…doubtful there will be a significant increase in regulatory oversight, largely due to the heavy costs that would incur. "The SEC and other regulators aren't prepared to come in and police the opinions issued by rating firms,"…”
MISC
From Morgan Stanley: “Commodities continued their outperformance and posted the highest weekly, month-to date and year-to-date returns of 3.6%, 10% and 18% respectively. The market witnessed reversal of risk appetite after the Fed cut the target rate by 50bps. Equities rallied 2.8% during the week and posted second highest returns of 3.5% and 7.6% on a month-to-date and year-to-date basis respectively.”
From Lehman: “The stabilization in money markets persisted through Monday. The Fed reported that rates on asset-backed commercial paper (ABCP) continued to retreat, though spreads remain historically wide to the funds rate. The weighted average maturity of new issues continued to climb as investors become willing to purchase longer maturity paper. LIBOR rates, though lower over the course of the past week, remain elevated to Treasuries and the funds rate. Finally, volatility of the funds rate itself has fallen to normal levels: in the last four days the effective funds rate has varied no more than 2bp from target.”
From Morgan Stanley: “…preemptive actions do not come without a cost, and in our view the Fed is swapping systematic / liquidity risk, for longer term inflation risk. As a result we think the curve will continue to steepen and volatility will continue to rise…”
From JP Morgan: “In the current environment, characterized by tight bank balance sheets, it appears highly likely that any near term lending that spans year-end will be priced at a premium. The 1999-2000 experience, when the year-end turn premium skyrocketed to levels never seen before or after, provides some (albeit wide) bounds and some guidance…the current turn premium is well below Y2K levels…the Y2K pattern appears likely to repeat itself - i.e., the implied turn premium will drift wider from current levels for another week or two.”
From Citi: “…we've seen the expectations of future Fed cuts actually decline. We've gone from pretty much fully pricing an eventual move to 4.0% to now pricing in only a move to 4.25% in both Fed Fund Futures as well as Eurodollar's.”
From RBSGC: “What the data can not tell us is how many of those for sale signs represent motivated sellers who will deal at any price (foreclosed properties, speculators who waited far too long to get out, etc.) vs. those homeowners who were just hoping to sell closer to the highs in prices.”
From Wachovia: “With closings across the country delayed or even canceled by financing trouble, the credit crunch showed up in full force in August's home sales data.”
From Macroeconomic Advisors: “Q3-2007 Current Quarter GDP Tracking 2.5 percent…”
From Credit Suisse: “The mild slowdown we project for global economic growth (from a 5.2% rate estimated this year to 5% next year) should keep a lid on inflation pressures, by increasing economic slack. And that’s despite the sharp rises seen in commodity prices (oil, metals, softs). To be sure, the inflation outlook remains largely unchanged for developed countries, while that for Non-Japan Asia looks less favorable, especially for China. That said, the contagion effect from the worsening Chinese inflation outlook should be limited: Rising inflation in China is largely driven by soaring food prices…”
From Deutsche Bank: “Today's economic data are a prime example of why we expect the Fed to make a 25bps insurance-cut at the October FOMC meeting-souring housing market conditions will take a toll on consumer attitudes, and hence spending, in the coming months and quarters. Given the paltry 2% year-over-year rate of growth in the economy and tame core inflation, we think the Fed will be forced to further lower rates in order to fend off a recession.”
From Citi: “While sales indications, including autos, are far from falling off a cliff
(beware of potential new strike distortions), the third quarter appears to be ending on a soft note. The earliest signs from fundamental data suggest the Fed's policy stance prior to September 18 was relatively tight for a decelerating economy, already carrying a heavy burden from contracting housing. This should be kept in mind by those speculating on inflationary impact.”
From FTN: “There are already close to a hundred thousand newly unemployed mortgage company employees looking for work on top of several hundred thousand unemployed residential construction workers.”
From JP Morgan: “…the deterioration in the labor market differential (jobs – plentiful less jobs-hard-to-get) in today’s confidence report…we have only seen a two-month drop this large (7.8 points) during or in the immediate aftermath of recessions…Sept, Oct, and Nov 2001 were the last time we saw 2-month cumulative declines, and prior to that only in Oct and Nov 1991 was the drop greater than 7.9 since 1990.”
From GaveKal Research: “Since 1970, most cuts by the Fed (1970, 1974, 1985, 1989, 2001) were followed for at least two years by massive declines in the inflation rate. There were, however, exceptions: 1980 (which was quickly taken back by Mr Volcker) and 1998 (which was also quickly taken back). Which leaves us with the following question: Will the recent Fed cut prove to be right? Or will it be, like 1980 and 1998, a mistake quickly taken back?... In recent years, the Fed has been more broadly right than wrong (five out of seven). Better yet, when it has been wrong, it was quick to change its course and adjust to the underlying realities… there are three things that a central bank can control: the growth rate of its money supply, its interest rate, or the value of its currency. Unfortunately, as the Chinese central bankers are now discovering, it cannot control all three at the same time.”
From Dow Jones: “Freddie Mac increased its retained portfolio 1.6% from July to August to a record $732.2 billion. This is the largest monthly increase since the company
agreed to limit its portfolio growth in mid-2006.”
From Natixis: “…there are some investors who are anxious to believe the incredible argument that equities are “looking past the valley” and that it is the right time to invest, even though I can’t recall them ever “looking past the peak.””
End-of-Day Market Update
From RBSGC: “Prices firmed up over the course of Tuesday with the curve quite a bit steeper, and with most of those gains lost into the close… volume over the course of the day came off from what started as a pretty active session to one that was merely average.”
From SunTrust: “Considering how active the overnight session was, today's trade has been a complete fizzle. Prices bubbled up, reached their highs just before the economic releases, only to spend the rest of the day heading south. The news on the economy was weak…It is hard to say what caused the sell-off, other than the news was already discounted. Equities recovered their losses, which took a bit of steam out of bonds too. The short end of the market held most of its gains, but the long bond is now in the red on the day. Dollar weakness is hurting there.”
From UBS: “The 2y-10y yield curve steepened by nearly 5bp in treasuries today--continuing its run to new steeps for the move. Much of the steepening came late day as 10yrs backed up and 2's stayed right around 3.99%... TIPS had better overall selling in the long end as 20y Breakevens cheapened by 1.5bp on the day. Agencies saw another day where short Agencies richened to Swaps and cheapened to treasuries as 2yr spreads have gone 6.5 wider in the past 2 days. We had early extension flows in Agencies…there was very little outright rate activity in swaps today.”
From Bloomberg: “The dollar fell to a record low against the euro as declines in consumer confidence and home resales increased expectations that the Federal Reserve will cut borrowing costs for a second time this year. The U.S. currency weakened to a 15-year low against a basket of six major peers on speculation another decrease in lending rates will make U.S. assets less attractive to international investors…The dollar … touched $1.4154, the weakest since the euro's debut in January 1999. The U.S. currency decreased 0.27 percent to 114.56 per yen…The New York Board of Trade's dollar index that measures its value against six major currencies touched 78.213, the lowest since September 1992. The Fed's trade-weighted dollar index against major currencies fell on Sept. 20 to the weakest since its inception in 1971. U.S. Treasuries rallied on the consumer and housing data, pushing the two-year note's yield down to 3.97 percent. The comparable-maturity German bund yielded 4.01 percent, increasing its advantage over the Treasury note to 0.04 percentage point, near the widest since September 2004.”
From UBS: “Equity markets were mixed, with the S&P500 about unchanged but the Nasdaq up 0.6%. 10-year Treasury yields were steady at 4.63%; 2-year yields fell 5bp to 4.00%. Oil prices fell $1.27 to $81.38.”
Consumer Confidence Plummeted in September to Almost a 2 Year Low
Consumer confidence fell more than expected to 99.8 (consensus 104.3) in September. This follows a revised improvement to 105.6 for August. Both current conditions and future expectations fell as more people viewed jobs as hard to get (22%). (Note - This survey was taken before the Fed rate cuts this month.)
Inflation expectations fell as participants expect interest rates to fall. An equal percentage - 29% - expect stock prices to rise and fall from here. This compares to 40% looking for higher prices in May versus 20% looking for lower prices.
Those under 35 saw a rise in confidence, while those over 35 were more pessimistic. All income levels saw a drop in confidence, with the largest drop coming in the highest income category.
New England saw the largest erosion in confidence, followed by the Northeast Central and Pacific regions. The Southeast central and Mid Atlantic saw the largest improvements in sentiment. The South Atlantic, which includes the DC area, experienced a modest weakening in consumer confidence- with expectations falling more than perceptions of current conditions.
Inflation expectations fell as participants expect interest rates to fall. An equal percentage - 29% - expect stock prices to rise and fall from here. This compares to 40% looking for higher prices in May versus 20% looking for lower prices.
Those under 35 saw a rise in confidence, while those over 35 were more pessimistic. All income levels saw a drop in confidence, with the largest drop coming in the highest income category.
New England saw the largest erosion in confidence, followed by the Northeast Central and Pacific regions. The Southeast central and Mid Atlantic saw the largest improvements in sentiment. The South Atlantic, which includes the DC area, experienced a modest weakening in consumer confidence- with expectations falling more than perceptions of current conditions.
Existing Home Sales Fall to Five Year Low in August
Existing home sales slipped an addition -4.3% MoM in August, but declined less than the -4.6% drop that had been expected. Over the past year, existing home sales, which represent about 85% of annual home sales, have fallen 13%. Inventories rose +.4% MoM, to a new record high of ten months in August.
Single family home sales fell -3.8% MoM (-13% YoY) while condo sales fell -8% MoM (-11.7% YoY). Inventories for condos remain more elevated at 11.5 months, versus 9.8 months for single family homes, based on the current sales pace.
Median house prices rose +.2% YoY to $224,500 according the the National Association of Realtor's data. By category, median single family home prices were unchanged over the past year while condo prices rose +2.1%. Median prices indicate that half of homes sold for more while half sold for less.
Purchases dropped in all four regions in August, with the West leading the way at -9.8% MoM. The Northeast had the smallest drop at -2% MoM.
Single family home sales fell -3.8% MoM (-13% YoY) while condo sales fell -8% MoM (-11.7% YoY). Inventories for condos remain more elevated at 11.5 months, versus 9.8 months for single family homes, based on the current sales pace.
Median house prices rose +.2% YoY to $224,500 according the the National Association of Realtor's data. By category, median single family home prices were unchanged over the past year while condo prices rose +2.1%. Median prices indicate that half of homes sold for more while half sold for less.
Purchases dropped in all four regions in August, with the West leading the way at -9.8% MoM. The Northeast had the smallest drop at -2% MoM.
S&P Case-Shiller Home Prices Fall -3.9% YoY in July, a New Record Decline!
The twenty city Case-Shiller home price index fell slightly less than expected at -3.9% YoY in July (consensus -4.1%). The smaller ten city index fell -4.5% YoY in July. Annualizing the pace of the past three months shows a faster decline of -4.2% for the 20-city index and -5.5% for the 10-city index.
Over the past year, Detroit remains the largest loser, down -9.7% YoY (but up 1.3% MoM), followed by San Diego and Tampa around -7.75% YoY, then Washington, DC and Phoenix around -7.25% YoY. A total of 15 of the 20 cities are currently showing home price declines versus a year ago. Seattle remains the powerhouse at +6.9% YoY, followed by Charlotte, NC at +6% YoY. Chicago, Dallas and Denver are all within 1% of unchanged YoY. Miami saw the fastest monthly deterioration, falling -1.7% MoM and -6.5% YoY.
Over the past year, Detroit remains the largest loser, down -9.7% YoY (but up 1.3% MoM), followed by San Diego and Tampa around -7.75% YoY, then Washington, DC and Phoenix around -7.25% YoY. A total of 15 of the 20 cities are currently showing home price declines versus a year ago. Seattle remains the powerhouse at +6.9% YoY, followed by Charlotte, NC at +6% YoY. Chicago, Dallas and Denver are all within 1% of unchanged YoY. Miami saw the fastest monthly deterioration, falling -1.7% MoM and -6.5% YoY.
Monday, September 24, 2007
Economic Calendar - September 24 – 28, 2007
Monday, 9/24
No Data
Dallas Fed President Fisher speaks on Benefits of Higher Education
Chicago Fed President Evans speaks on the Role of R&D in Agriculture
Fed Chairman Bernanke speaks on Impact of Education on U.S. Economy
Tuesday, 9/25
July S&P/ Case-Shiller 20-City Home Price Index
Consensus YoY -4% Prior -3.5%
Ten city index expected to fall -4.6% YoY, largest decline since 1991
Lehman looking for cumulative national decline of 15% by YE2008
September Consumer Confidence
Consensus 104.5 Prior 105
Expectations expected to continue dropping, following sharp decline in August
Negative employment growth in August will weigh heavy at 40% of index
September Richmond Fed Manufacturing Index
Consensus 4 Prior 7
August Existing Home Sales
Consensus 5.49M Prior 5.75M
Expected to re-accelerate lower, falling -4.5% MoM
Pending home sales fell -12.2% in July
This would be the sixth month in a row of declines
UofM survey shows 40% think now is a bad time to buy a home
Philadelphia Fed President Plosser speaks on “Invention, Productivity and the Economy”
Wednesday, 9/26
August Durable Goods Orders
Consensus MoM -3% Prior +5.9%
Ex-transportation
Consensus MoM -.7% Prior +3.7%
Expected to give back some of the surge higher in July
Boeing had 74 fewer new plane orders in August than July
Weakness in other areas expected to be broad-based, with construction equipment demand especially weak
St. Louis Fed President Poole speaks to small business owners
Thursday, 9/27
Final 2nd Quarter GDP
Consensus Annualized +3.9% Prior +4%
Downward revisions to spending, construction, inventories, exports likely to cause small revision lower
Expected to be viewed as old news
Next four quarters, at least, expected to show weaker growth
Final 2nd Quarter Personal Consumption
Consensus Annualized +1.4% Prior +1.4%
Final 2nd Quarter GDP Price Index
Consensus Annualized +2.7% Prior +2.7%
Final 2nd Quarter Core PCE
Consensus QoQ +1.3% Prior +1.3%
Initial Jobless Claims
Consensus 320k Prior 311k
Continuing Claims
Consensus 2560k Prior 2544k
August New Home Sales
Consensus 830k Prior 870k
Further deterioration expected, falling -4.6% MoM, after surprise increase of +2.8% in July
Homebuilder sentiment at record low keeping them as motivated sellers
Expect larger price declines than for existing home sales
The South has shown signs of stabilizing, but the Midwest and West remain weak
Recall that cancellations aren’t included, so data likely overstates sales and understates inventory
August Help Wanted Index
Consensus 24 Prior 25
Boston Fed President Rosengren speaks on behavioral economics and economic policy
Chicago Fed President Evans speaks on Globalization and Systemic Risk
Fed Chairman Bernanke speaks on “Domestic Prices in an Integrated World Economy”
Fed Governor Mishkin speaks on “Globalization, Macroeconomic Performance and Monetary Policy”
Friday, 9/28
August Personal Income
Consensus +.4% Prior +.5%
Hours worked held constant, and hourly wages grew +.3%
August Personal Spending
Consensus +.4% Prior +.4%
Lower gas prices helped spur improved vehicle sales in August
Non-auto consumption expected to be relatively weak
July figure likely to be revised higher on stronger retail sales data
August PCE Deflator
Consensus YoY Prior +2.1%
August Core PCE
Consensus MoM +0.2% Prior +0.1%
Consensus YoY +1.8% Prior +1.9%
Annual change expected to soften modestly to +1.8% YoY
Core inflation has remained tame this summer, as goods and services prices, including rents, have been decelerating
September Chicago Purchasing Manager
Consensus 53.1 Prior 53.8
Expected to hold steady, near middle of range for this year, indicating continued moderate growth
August Construction Spending
Consensus MoM -.2% Prior -.4%
Looks like non-residential growth is no longer fully offsetting residential weakness
Housing construction expected to decline -.7% MoM
Public spending expected to grow 1%, but only accounts for 20% of total
Final September U of Mich Consumer Confidence
Consensus 84 Prior 83.8
Fed easing and stock market rally may give small lift
Half of respondents expect bad financial times in year ahead
Atlanta Fed President Lockhart speaks on economic outlook
San Francisco Fed President Yellen and Fed Governor Mishkin speak at Fed conference on behavioral economics and economic policy
St. Louis Fed President Poole speaks on “Thinking Like a Central Banker”
No Data
Dallas Fed President Fisher speaks on Benefits of Higher Education
Chicago Fed President Evans speaks on the Role of R&D in Agriculture
Fed Chairman Bernanke speaks on Impact of Education on U.S. Economy
Tuesday, 9/25
July S&P/ Case-Shiller 20-City Home Price Index
Consensus YoY -4% Prior -3.5%
Ten city index expected to fall -4.6% YoY, largest decline since 1991
Lehman looking for cumulative national decline of 15% by YE2008
September Consumer Confidence
Consensus 104.5 Prior 105
Expectations expected to continue dropping, following sharp decline in August
Negative employment growth in August will weigh heavy at 40% of index
September Richmond Fed Manufacturing Index
Consensus 4 Prior 7
August Existing Home Sales
Consensus 5.49M Prior 5.75M
Expected to re-accelerate lower, falling -4.5% MoM
Pending home sales fell -12.2% in July
This would be the sixth month in a row of declines
UofM survey shows 40% think now is a bad time to buy a home
Philadelphia Fed President Plosser speaks on “Invention, Productivity and the Economy”
Wednesday, 9/26
August Durable Goods Orders
Consensus MoM -3% Prior +5.9%
Ex-transportation
Consensus MoM -.7% Prior +3.7%
Expected to give back some of the surge higher in July
Boeing had 74 fewer new plane orders in August than July
Weakness in other areas expected to be broad-based, with construction equipment demand especially weak
St. Louis Fed President Poole speaks to small business owners
Thursday, 9/27
Final 2nd Quarter GDP
Consensus Annualized +3.9% Prior +4%
Downward revisions to spending, construction, inventories, exports likely to cause small revision lower
Expected to be viewed as old news
Next four quarters, at least, expected to show weaker growth
Final 2nd Quarter Personal Consumption
Consensus Annualized +1.4% Prior +1.4%
Final 2nd Quarter GDP Price Index
Consensus Annualized +2.7% Prior +2.7%
Final 2nd Quarter Core PCE
Consensus QoQ +1.3% Prior +1.3%
Initial Jobless Claims
Consensus 320k Prior 311k
Continuing Claims
Consensus 2560k Prior 2544k
August New Home Sales
Consensus 830k Prior 870k
Further deterioration expected, falling -4.6% MoM, after surprise increase of +2.8% in July
Homebuilder sentiment at record low keeping them as motivated sellers
Expect larger price declines than for existing home sales
The South has shown signs of stabilizing, but the Midwest and West remain weak
Recall that cancellations aren’t included, so data likely overstates sales and understates inventory
August Help Wanted Index
Consensus 24 Prior 25
Boston Fed President Rosengren speaks on behavioral economics and economic policy
Chicago Fed President Evans speaks on Globalization and Systemic Risk
Fed Chairman Bernanke speaks on “Domestic Prices in an Integrated World Economy”
Fed Governor Mishkin speaks on “Globalization, Macroeconomic Performance and Monetary Policy”
Friday, 9/28
August Personal Income
Consensus +.4% Prior +.5%
Hours worked held constant, and hourly wages grew +.3%
August Personal Spending
Consensus +.4% Prior +.4%
Lower gas prices helped spur improved vehicle sales in August
Non-auto consumption expected to be relatively weak
July figure likely to be revised higher on stronger retail sales data
August PCE Deflator
Consensus YoY Prior +2.1%
August Core PCE
Consensus MoM +0.2% Prior +0.1%
Consensus YoY +1.8% Prior +1.9%
Annual change expected to soften modestly to +1.8% YoY
Core inflation has remained tame this summer, as goods and services prices, including rents, have been decelerating
September Chicago Purchasing Manager
Consensus 53.1 Prior 53.8
Expected to hold steady, near middle of range for this year, indicating continued moderate growth
August Construction Spending
Consensus MoM -.2% Prior -.4%
Looks like non-residential growth is no longer fully offsetting residential weakness
Housing construction expected to decline -.7% MoM
Public spending expected to grow 1%, but only accounts for 20% of total
Final September U of Mich Consumer Confidence
Consensus 84 Prior 83.8
Fed easing and stock market rally may give small lift
Half of respondents expect bad financial times in year ahead
Atlanta Fed President Lockhart speaks on economic outlook
San Francisco Fed President Yellen and Fed Governor Mishkin speak at Fed conference on behavioral economics and economic policy
St. Louis Fed President Poole speaks on “Thinking Like a Central Banker”
Subscribe to:
Posts (Atom)