Today's Tidbits

Recession Updates
From Bloomberg: “Feldstein Says Recession Odds Now Higher Than 50%: Harvard University economist Martin Feldstein, head of the group that dates economic cycles in the U.S., said the odds of a recession are more than 50 percent after a report showing the unemployment rate jumped.”
From JP Morgan: “Atlanta Fed President Lockhart delivered a brief overview of the economic outlook. His projection for 2008 was definitely downbeat but not panicked: "My base case outlook see a weak first half of 2008 -- but one of modest growth -- with gradual improvement beginning in the year's second half and continuing into 2009." However, Lockhart's subsequent remarks make clear that the risks on growth are clearly tilted to the downside. The "pivotal question" for his outlook is the extent of spillover from the housing correction: first, through the influence of weaker house prices on consumer spending and second, through the effect of financial market distress on credit availability. With regard to the latter question, Lockhart observed that financial markets are "still far from settled and orderly," and that the coming weeks will be informative as to the extent of healing in financial markets. Lockhart made only passing reference to the rise in the unemployment rate. On inflation, Lockhart remarked that he's "troubled by the elevated level of inflation." While he expects inflation to moderate in 2008, Lockhart noted some upside risks due to the behavior of oil prices. Summing up, Lockhart intoned the now-familiar appeal to uncertainty: "At this juncture, the times present even greater uncertainty than usual." He then went on to observe: "The negatives in our economy may be gaining momentum. I think these circumstances call for policymakers to be prepared to respond pragmatically to whatever developments arise." Lockhart's speech is the first of many from Fed speakers this week -- the highlight being Bernanke's talk on Thursday. If Lockhart's speech is any guide, we are not in for a repeat of last November when Fed speakers pushed against market pricing of Fed easing. To the contrary, Lockhart's remarks do nothing to upset the view that the Fed will provide further policy accommodation.”
From Merrill Lynch: “At no time in the past sixty years has the unemployment rate risen 60 basis points (50 bps is the actual cutoff) from the cycle low without the economy slipping into recession, and here we now have the jobless rate hitting 5% in December versus the March/07 trough of 4.4%. Aggregate hours worked in the economy contracted at a 0.4% annual rate in 4Q, and this comes on the heels of a 0.6% decline in 3Q. Back-to-back declines in total hours worked have always been associated with recession. The breadth of the report was also very poor with the diffusion index slipping below the 50 cutoff mark, just like ISM, to 48.4% from 52.2% in November. A number below 50 indicates that a plurality of industries are now in the process of cutting jobs outright - heading into the last recession, this index fell below 50 in February 2001 and the recession began ... exactly one month later. The level of unemployment is up 13% YoY, again a development that has always been consistent with past recessions. The YoY rate of change in the level of the unemployed who have been idle for at least 15 weeks is particularly ominous - +20%, which is a pace that prevailed in the early stages of prior economic downturns (hitting this trend in April/01 and in Aug/90 when the recessions were one-month old). And we have Household Employment contracting 49,000 in 4Q and the YoY trend slowing to +0.2% in December from +2.2% a year ago, another classic recession signal. Consider for a second that in March of 2001 that trend was running at +0.8%, and in July of 1990 the pace was +1.1% - those two months represented the onset of a technical recession and yet the trend in Household jobs is weaker now than it was then. In sum, Friday's employment report strongly suggests that an official recession has arrived. The recession dating committee at the National Bureau of Economic Research (NBER) will be the final arbiters, but since it waits for conclusive evidence, including benchmark revisions, it may be at least two years before we are notified.”
From Bear Stearns: “We expect a material two-quarter slowdown extending through March from housing weakness and financial market turbulence. We’re maintaining our view that the economy will skirt a recession, helped by global growth, a proactive Fed, and the brimming reservoirs of Greenspan dollars roaming the world…We disagree with the long-standing recession arguments based on consumption, debt, the personal savings rate, and negative wealth effects from housing. GDP is created by labor, capital, production and innovation, not consumption. Consumption didn’t bulge in the housing and mortgage boom of 2004, and didn’t slow in the bust of 2006-2007. Debt has gone up less than assets and is much more correlated to net flows to financial assets than it is to consumption. When mortgage rates got low, mortgage debt went up as did net flows into financial assets, but consumption growth has held steady in line with the labor environment…With the dollar weak and oil and gold prices correspondingly high, we think inflation will remain problematic during 2008. The Fed may cut interest rates further in January, but we think it will have to hike later in 2008 due to persistently high core inflation. ”
From Goldman: “The US economy slowed sharply in December. Purchasing managers saw a drop in manufacturing activity, with a plunge in both the domestic and foreign orders indexes. More importantly, the labor market appears to be giving way, with substantial increases in initial and (especially) continuing jobless claims, weaker payroll employment growth, and a big increase in the unemployment rate. The increase in the unemployment rate is particularly worrisome. On a three-month moving average basis, it has now climbed by more than the 0.3-percentage-point threshold that has invariably been associated with recession in the past. The economy’s greater stability may imply that the economy will skirt a technical recession, but in many respects this distinction may feel like an academic one. Given these data, we expect the FOMC to cut its federal funds rate target by 50 basis points at the January 30-31 meeting, with an outside chance of a move before the meeting if the data remain as weak as they have been recently. Our fed funds forecast for midyear remains at 3% for now. The economic slowdown is also likely to trigger increased talk about of a fiscal stimulus package in coming weeks. Although the hurdles are high, there is some chance of such a package taking effect in late 2008. But this would be too late to keep the economy out of any recession—so the Fed still needs to ease policy aggressively in the near term.”
From Deutsche Bank: “The bond market is pricing in a recessionary scenario, with nearly 6 fed funds rate cuts priced into the curve, and the rate moving below 3%. In addition, the market is pricing in nearly a 60% chance of a 50 bp cut at the January FOMC meeting. While the high probability of a recession that is priced into the market might be debatable, the divergence between the bond market and strong commodity markets is notable. We are skeptical of the ability of the global economy to decouple from the effects of a US recession; strong global demand has in turn been supporting commodity prices. The correlation of the US and global economies is an argument for the Fed to focus more on growth rather than inflation.”
From Merrill Lynch: “In our opinion, the US consumer is heading for its first downturn since 1990-91 and at this point the debate should not really be about whether there is going to be a recession or not, but the debate should now move to how prolonged and deep the recession is going to be.”
From Barclays: “We have changed our Fed call in response to weak recent economic data; we now look for the FOMC to cut the federal funds rate 50 bp at this month's meeting and 25 bp in March. We view recent data as consistent with a period of slow growth, rather than recession, but we believe the risks of recession have risen.”
From Morgan Stanley: “We reiterate our US recession call for the first half of 2008. The question now is how deep it will be and how long it will last. We think it will be mild and short; recessions abroad are unlikely, US excesses are modest away from housing, and peaking inflation should give the Fed latitude to ease monetary policy further… The Fed will ease monetary policy further, and the yield curve will continue to steepen, but much of the recession news is now in the price. Not so for US equities; our strategy team expects a 10% decline from start-of-year prices. Nor is our expectation for slower growth abroad in the price, and we expect that eventually the dollar will strengthen…”
From BMO: “One of the cleanest measures in the U.S. household survey is the employment ratio — the share of people 16 and over who have a job. This ratio has dropped 0.7 percentage points in the past year from a cycle high of 63.4% to 62.7%. In each of the 10 prior post-war cycles, by the time the employment ratio had deteriorated this much, the economy was either embarking on recession or was already knee-deep into one. The 0.6 ppt rise in the jobless rate to 5.0% sends a similar story.”

Not Much Upside Profit Left in Owning Two Year Treasuries
From Bloomberg: “The last time Fed rates were so much higher than two-year [Treasury] notes was in 1989, when the gap reached 1.66 percentage points, the data show. The spread was greater than 1 percentage point twice since then. Once was in September and October 1998 following the collapse of hedge fund Long-Term Capital Management LP. The other started in November 2000 when policy makers were on the way to cutting the target rate to 1 percent…The [2 year] notes returned 7.5 percent in 2007 when yields fell as low as 2.79 percent on Dec. 4 from the year’s high of 5.13 percent on June 13…Investors buying two-year notes today would earn 0.8 percent if yields rise to 3.24 percent by June 30, as economists in the Bloomberg survey predict. Buyers would get a 2.6 percent return if yields drop to 2 percent by June…’We don’t see a great deal of value in Treasuries at these levels’…’All the gains have been achieved already’…” [Note that the return is likely to be even worse for foreign buyers if the dollar continues to weaken.]

Equity Markets Start 2008 on a Very Weak Note
From Merrill Lynch: “In the broader market, we have the S&P 500 off to its third worst start ever (-3.9% — taking back all of last year's gain) and the worst start since 1932 for the Dow (-3.5% — taking back half of last year's gain). The Dow is now down 9.6% from the peak, or just 40 basis points shy of an official correction; small caps, like the Russell 2000, are down 16%, so are already there but now just 400 basis point away from a technical bear market (not to mention down six sessions in a row and coming off its worst week since late July — off 6.5%). The problems from Friday's developments were: (i) the market closed at the lows; and, (ii) the selling was on progressively higher volume — in fact, volume soared across the board. Meanwhile, the Transports were crushed again on Friday (YRC down 28.7…But utilities are advancing, and so the plunge in transports/utilities is a bullish sign at least for bonds and defensive areas of the stock market like staples … All in, the drop in the stock market (as per the Wilshire 5000) has triggered a $471 bln loss in equity wealth so far this year.” [Note- Technical factors also indicate continuing weakness, with head-and-shoulder tops in many equity markets as well as declining RSIs and moving averages moving above current market levels.]
From Bank of America: “Redemptions continued for domestic equity mutual funds (open-end) at the turn of the New Year, continuing the trend in place over much of the past year. For 2007, it appears that net redemptions amounted to -$30.6 billion (the worst year for domestic equity flows since 2002). Much of this cash appears to have been redirected to equity funds investing outside the US; funds in this category enjoyed net inflows of +$100 billion last year, practically matching the 2006 take…Bond funds were more popular than stock funds in 2007. In contrast to the pattern seen in 2006 when equity funds of all types received about double the inflows directed towards bond funds, this year the roles were reversed. The +$70b that equity funds received in 2007 was dwarfed by the +$140b that was invested in taxable bond funds, mostly investment grade corporate bonds.”
From Goldman Sachs: “Nikkei broke below the long term bull trend from the 2003 lows (currently 15136) signaling further declines…The Russell 2000 is breaking key double top support at 736 to give a measured move target at 615.”

Living Within the Means of the World’s Resources
From The New York Times: “The average rates at which people consume resources like oil and metals, and produce wastes like plastics and greenhouse gases, are about 32 times higher in North America, Western Europe, Japan and Australia than they are in the developing world…Per capita consumption rates in China are still about 11 times below ours, but let’s suppose they rise to our level… China’s catching up alone would roughly double world consumption rates. Oil consumption would increase by 106 percent, for instance, and world metal consumption by 94 percent. If India as well as China were to catch up, world consumption rates would triple. If the whole developing world were suddenly to catch up, world rates would increase elevenfold. It would be as if the world population ballooned to 72 billion people (retaining present consumption rates). Some optimists claim that we could support a world with nine billion people. But I haven’t met anyone crazy enough to claim that we could support 72 billion…Much American consumption is wasteful and contributes little or nothing to quality of life. For example, per capita oil consumption in Western Europe is about half of ours, yet Western Europe’s standard of living is higher by any reasonable criterion, including life expectancy, health, infant mortality, access to medical care, financial security after retirement, vacation time, quality of public schools and support for the arts. Ask yourself whether Americans’ wasteful use of gasoline contributes positively to any of those measures. Other aspects of our consumption are wasteful, too. Most of the world’s fisheries are still operated non-sustainably, and many have already collapsed or fallen to low yields — even though we know how to manage them in such a way as to preserve the environment and the fish supply.…Just as it is certain that within most of our lifetimes we’ll be consuming less than we do now, it is also certain that per capita consumption rates in many developing countries will one day be more nearly equal to ours…The world has serious consumption problems, but we can solve them if we choose to do so.” [By Jared Diamond, author of “Collapse”.]

Deutsche Expects House Prices to Continue Declining for at Least the Next 2 Years
From Deutsche Bank: “…using a fundamentals-based framework where home prices are driven by mortgage rates, income, inflation, vacancy rate, and subprime foreclosures, and assuming that 20% of all subprime borrowers will be forced to leave their home, we estimate that house prices as measured by the OFHEO house price index are going to decline 5% over the coming two years, i.e. about 2.5% per year …The drop in the Case-Shiller index could be twice as large. Under our worse case scenario, where the number of subprime foreclosures increases to 40%, we see house prices declining 15-20% over the coming two years, or 7.5- 10% in 2008 and in 2009. For the Case-Shiller index house price inflation is already negative and, as can be seen, the futures market for the Case-Shiller index continues to expect negative house price inflation until 2010… Notably, despite this negative outlook, the expectations from the futures market are that house price inflation will trough at around 7% during 2008. Overall, futures markets combined with our own forecast lead to the tentative conclusion that we are likely to reach the trough in nationwide house price inflation in 2008, but that inflation could well remain negative for another year or more beyond.”

MISC

From Credit Suisse: “For the 1st time since '04 we did not have a bond deal during the first week of the year. '04 was only a '1-day' week. The last '3-day' week w/0 issuance was '00.”

From Merrill Lynch: “PIMCO's Bill Gross tells Bloomberg News that there is no value left in Treasuries and he is buying [GSE backed] MBS.”

From Citi: “3-month Libor (attached chart) is down to 4.54313%; below the TAF auction levels, just 29 bps over target, dropping steadily, and well within normal long- term historical parameters. The days of 12.5 bps over funds are gone for a while…”

From Deutsche Bank: “US LIBOR basis spreads have come in. Whilst still more than 50bps wider than they were in July, they are around 40bps tighter than a month earlier (essentially where they were in the two months after immediately the Fed's first federal funds rate cut in September). ..yields on ABCP (in this case 90-day A1+ rated) have continued to decline, perhaps reflecting last week's confirmation that outstanding US ABCP rose by $26bn in the week ended last Wednesday - the first rise in ABCP since early August. Swap spreads at the 10-year tenor are at 2 month lows so that 10-year swap rates have hit new lows at just 4.45%. However… the broader credit environment remains difficult further out the credit spectrum.”

From Barclays: “The current state of the US economy almost merits the term “stagflation,” in the sense that growth is a long way below trend, while inflation is a long way above trend.”

From US Treasury Secretary Paulson: “After years of unsustainable price appreciation and lax lending practices, a housing correction was inevitable and necessary. That correction is underway. Over the next two years, we also face an unprecedented wave of 1.8 million subprime mortgage resets, raising the potential of a market failure. Because the industry does not have the capacity to manage this volume, without action, unnecessary foreclosures would result. To meet this challenge, this Administration – without committing any taxpayer money – helped foster an industry-wide effort to prevent this market failure. By preventing avoidable foreclosures, we will safeguard neighborhoods and communities, and fulfill our primary responsibility of protecting the broader U.S. economy. However, let me be clear: there is no single or simple solution that will undo the excesses of the last few years.”

From Bear Stearns: “At the end of 2007, Congress extended inflation-indexing for the alternative minimum tax without raising other taxes, a good precedent for the larger Bush tax-cut expirations in 2010. Though not foremost in current U.S. market worries, procedural techniques to stop the massive tax increases (on personal income, dividends, capital gains and inheritance) scheduled for January 2011 will be a major issue in equity market performance once the slowdown-or-recession uncertainty is resolved.”

From Merrill Lynch: “The S&P 500 retailing index has declined to a three-year low after the last week's 7.6% falloff; and is in official bear market terrain with a 30% peak-to-trough decline (Macy's and JCPenney both down more than 10% so far this year).”

From The Wall Street Journal: “Office Vacancy Rate Rises For First Time in 4 Years: For the first time in four years, the national vacancy rate for office buildings rose in the fourth quarter, as an unusually large amount of new space came on the market and tenants shied way from signing new leases.”

From Citi: “Government forecasts overseas investment in India may double in 2008 for a second straight year to reach $30 billion.”

From RBSGC: “MBS holdings by US banks decreased $3 bn, with a split between pass-through holdings down $1 bn and CMO holdings down $2 bn. Since the beginning of 2007, total MBS positions declined by $49 bn. Deposits increased $73 bn over the past week. Since the start of 2007, deposits have risen by $536 bn. Commercial and industrial loans increased $12 bn for all banks over the week. Since the start of 2007, C&I loans grew $254 bn. Whole loan holdings increased $9 bn over the week. Since the beginning of 2007, whole loan holdings have risen by $223 bn. The most recently available data from the Fed covers the week ending December 26, 2007 and shows total increases in both deposits (+$73 bn) and asset holdings (+$42 bn). All numbers are seasonally adjusted.”

From JP Morgan: “In addition to the United States, the economy we are most concerned about is Japan, where GDP contracted in 2Q and the rebound in 3Q proved anemic.”

From Barclays: “Commodities have started the year on a strong footing with the CRB index rallying to new all-time highs in the first week of trading.”

End-of-Day Market Update

From Deutsche Bank: “US equities pare early gain even as crude slide continues. Lifts US front end modestly although very front yields lower as LIBOR spreads continue to decline. Dollar modestly stronger.”

From Bloomberg: “Crude oil fell more than $2 a barrel, the most since November, on concern slowing economies in the U.S. and Europe and warm weather in the Northeast will crimp fuel use.”

From Lehman: “The yield curve finally flattened Monday… after last week's 25 basis steeping from 2 year notes to bonds… The yield curve flattened, but almost all of the move came between 2s and 5s which tightened about 5 bp. More than a few accounts have pointed out the negative carry for owning 2 year notes right now, so it is quite possible that accounts are moving out of 2s and into 5s in their steepening positions.”

Three month T-Bill yield rose 5bp to 3.24%.
Two year T-Note yield unchanged at 2.74%
Ten year T-Note yield fell 3.5 bp to 3.83%
2/10 Treasury curve flattened 3.5bp to 109bp
Dow rose 27 to 12,827
S&P 500 rose 4.5 to 1416
Dollar index rose .36 to 76.16
Gold fell $1.50 to $858
Oil fell $2.74 to $95.17
*All prices as of 4:20pm