Today's Tidbits

Banks Most Likely Saviors For Financial Guarantors
From The Financial Times: “Leading private equity firms are unlikely to participate in any recapitalisation of Ambac and MBIA, increasing the pressure on banks to come up with a rescue package for the troubled US bond insurers. A number of firms, including Bain Capital, Carlyle Group, Kohlberg Kravis Roberts and TPG, have looked at investing in the cash-strapped groups, which guarantee the value of everything from municipal bonds to the most complicated mortgage securities. These investors have all concluded that the risks are too great, according to people familiar with their thinking. This puts more pressure on the banks to provide rescue financing for Ambac and MBIA. Some large banks and securities firms could face large writedowns on mortgage securities, as well as derivatives, if the bond insurers lose their triple-A credit ratings…."The financial guarantors pass neither the shadow test nor the ability-to-understand test." The next two to four weeks will be vital for the bond insurers because the biggest ratings agencies have made it clear they are very close to cutting their ratings.”
From Morgan Stanley: “Most critical event this week…is monoline "bailout"
From Deutsche Bank: “At the risk of sounding repetitive, our focus continues to be the monoline bond insurers. If the monoline bond insurers can effectively maintain their AAA debt status, then the probability of another credit related markdown in debt is minimized. This would be good news for the beleaguered financial sector as well as the overall stock market. By default this would take some pressure off of the Fed to reduce interest rates significantly further in an attempt to arrest the negative investor psychology which could have adverse implications for the real economy. To be sure, the stock market is worried about a credit crunch induced slowdown in economic growth, which means the health of the financial sector needs to be taken into account when forecasting the macro-economy, and for good reason.”
Economic Weakness Likely to Persist into 2009
From Goldman Sachs: “Weakness in hours worked and several other indicators suggests that real GDP is already contracting in the current quarter. However, the bigger-than-expected fiscal stimulus and the more front-loaded monetary easing have led us to boost our second-half growth forecasts. Since the fiscal stimulus is temporary, this upgrade comes at the expense of growth in early 2009, where we expect a renewed slowdown. Meanwhile, there are no signs of improvement in terms of the root cause of the economy’s troubles, namely the downturn in the housing and mortgage markets. Data released this week show that the drop in both homeownership and house prices accelerated in late 2007. This is pushing more and more households into negative equity. As a result, we expect total mortgage credit losses of around $400 billion, as well as substantial losses on commercial real estate and other debt. House price declines and credit losses will continue to weigh on the balance sheets of both private households and financial institutions. Although the direct effect of the housing downturn on construction activity and GDP should abate over time, this means that the indirect drag on credit growth and economic activity will persist well into 2009.”
From Morgan Stanley: “Aggressive monetary and fiscal stimulus will ultimately promote economic recovery. But the summer boost to growth from tax rebates will fizzle in the fall, casting doubt on the rebound. In our view, investors and policymakers should look through the erratic pattern of growth to a more sustainable, stronger 2009. And the focus then may return to inflation rather than growth… Incoming data point to recession. Most important, weakening job and income growth will reinforce the downturn… Tax rebates and business investment incentives will add significant, short-term stimulus to growth in 2H08, followed by a payback early in 2009. Large swings in both income and spending will obscure their underlying pattern.”
From Bank of America: “We expect that businesses will further curtail capital spending plans this year. With continued substantial declines in residential construction and efforts by business to control rising inventory-to-sales ratios, we expect a modest decline in real GDP this quarter, and well below-trend growth for most of the year…A proposed fiscal stimulus package will likely add substantially to the federal budget deficit for FY2008 and provide relief to some households. However, we doubt that temporary tax rebates, driven by the pressures of election-year politics, will have a substantial macroeconomic impact. Moreover, the package will not be designed to impact the particular issues created by the housing price declines and rising foreclosures.”
From The Washington Post: “Public views of the national economy are now more negative than at any point in nearly 15 years, and few people believe that the kind of stimulus plan being devised by President Bush and Congress is enough to stave off or soften a recession, according to a new Washington Post-ABC News poll. More than eight in 10 Americans describe the economy as "not so good" or "poor," and nearly six in 10 believe the United States is already in a recession. While voters appear more sanguine about their own circumstances, three in 10 are now pessimistic about their financial prospects over the coming year, double the percentage holding a dour outlook in December 2006… Only 19 percent of Americans now rate the nation's economy positively, the fewest to say so since June 1993.”
If US in Recession, Probably Too Early to Look for Bargains
From Merrill Lynch: “It's amazing what 125bps in eight days can accomplish. All of a sudden, the bears have gone into hibernation. The Dow is up 1,000 points from the low, the VIX index has collapsed 23% over the last two weeks, and everyone seems to believe that our monetary and fiscal policymakers are going to be able to put Humpty Dumpty together again. Some analysts are now talking about how vital it is now to start building positions in the early cyclicals to take advantage of what some are talking about a V-shaped recovery in the second half of the year, and of course, the mantra on the financials now is that the worst is priced in especially with a bailout plan in train for the monolines. As if to put an exclamation point on the recent bullish sentiment, the Saturday WSJ declared "some money managers are starting to look ahead to a rebound in the second half of the year". We are more than happy to take the other side of that debate. Here's a little bit of history - keeping in mind that nothing moves in a straight line. We seem to recall that in the 2001-02 bear market there were no fewer than six rallies of 5% or more lasting roughly 30 days on average. The NASDAQ, which saw an 80% peak to trough collapse, posted 35 five percent or more bouncebacks, and in fact, in that entire bear market we saw the index turn in a cumulative 17,884 rally points. These are called bear market rallies. In our view, that is what we have on our hands right now. Let's not lose sight that even though we averted the worst start to any year on record, the 6% January decline in the S&P 500 was the poorest showing since 1990 (a recession year if memory serves us correctly)…Remember - recessions usually last 10 months, not six months, and the time to start pricing in the recovery is usually in the sixth month, not the first month. The stock market is indeed a discounting mechanism, but let's keep in mind that during economic recessions, peak-to-trough decline is typically closer to 30%. And, more than half of that 30% slide tends to take place before the recession, and the last leg down takes place about two-thirds into the economic downturn. So by our estimation that leaves us no better than 1,200 on the S&P 500 around June. Nothing moves in a straight line, but that is the end point and that assumes this turns out to be a 'plain vanilla' recession. Let's hope.”

Banks Most Likely Saviors For Financial Guarantors
From The Financial Times: “Leading private equity firms are unlikely to participate in any recapitalisation of Ambac and MBIA, increasing the pressure on banks to come up with a rescue package for the troubled US bond insurers. A number of firms, including Bain Capital, Carlyle Group, Kohlberg Kravis Roberts and TPG, have looked at investing in the cash-strapped groups, which guarantee the value of everything from municipal bonds to the most complicated mortgage securities. These investors have all concluded that the risks are too great, according to people familiar with their thinking. This puts more pressure on the banks to provide rescue financing for Ambac and MBIA. Some large banks and securities firms could face large writedowns on mortgage securities, as well as derivatives, if the bond insurers lose their triple-A credit ratings…."The financial guarantors pass neither the shadow test nor the ability-to-understand test." The next two to four weeks will be vital for the bond insurers because the biggest ratings agencies have made it clear they are very close to cutting their ratings.”
From Morgan Stanley: “Most critical event this week…is monoline "bailout"
From Deutsche Bank: “At the risk of sounding repetitive, our focus continues to be the monoline bond insurers. If the monoline bond insurers can effectively maintain their AAA debt status, then the probability of another credit related markdown in debt is minimized. This would be good news for the beleaguered financial sector as well as the overall stock market. By default this would take some pressure off of the Fed to reduce interest rates significantly further in an attempt to arrest the negative investor psychology which could have adverse implications for the real economy. To be sure, the stock market is worried about a credit crunch induced slowdown in economic growth, which means the health of the financial sector needs to be taken into account when forecasting the macro-economy, and for good reason.”

Economic Weakness Likely to Persist into 2009
From Goldman Sachs: “Weakness in hours worked and several other indicators suggests that real GDP is already contracting in the current quarter. However, the bigger-than-expected fiscal stimulus and the more front-loaded monetary easing have led us to boost our second-half growth forecasts. Since the fiscal stimulus is temporary, this upgrade comes at the expense of growth in early 2009, where we expect a renewed slowdown. Meanwhile, there are no signs of improvement in terms of the root cause of the economy’s troubles, namely the downturn in the housing and mortgage markets. Data released this week show that the drop in both homeownership and house prices accelerated in late 2007. This is pushing more and more households into negative equity. As a result, we expect total mortgage credit losses of around $400 billion, as well as substantial losses on commercial real estate and other debt. House price declines and credit losses will continue to weigh on the balance sheets of both private households and financial institutions. Although the direct effect of the housing downturn on construction activity and GDP should abate over time, this means that the indirect drag on credit growth and economic activity will persist well into 2009.”
From Morgan Stanley: “Aggressive monetary and fiscal stimulus will ultimately promote economic recovery. But the summer boost to growth from tax rebates will fizzle in the fall, casting doubt on the rebound. In our view, investors and policymakers should look through the erratic pattern of growth to a more sustainable, stronger 2009. And the focus then may return to inflation rather than growth… Incoming data point to recession. Most important, weakening job and income growth will reinforce the downturn… Tax rebates and business investment incentives will add significant, short-term stimulus to growth in 2H08, followed by a payback early in 2009. Large swings in both income and spending will obscure their underlying pattern.”
From Bank of America: “We expect that businesses will further curtail capital spending plans this year. With continued substantial declines in residential construction and efforts by business to control rising inventory-to-sales ratios, we expect a modest decline in real GDP this quarter, and well below-trend growth for most of the year…A proposed fiscal stimulus package will likely add substantially to the federal budget deficit for FY2008 and provide relief to some households. However, we doubt that temporary tax rebates, driven by the pressures of election-year politics, will have a substantial macroeconomic impact. Moreover, the package will not be designed to impact the particular issues created by the housing price declines and rising foreclosures.”
From The Washington Post: “Public views of the national economy are now more negative than at any point in nearly 15 years, and few people believe that the kind of stimulus plan being devised by President Bush and Congress is enough to stave off or soften a recession, according to a new Washington Post-ABC News poll. More than eight in 10 Americans describe the economy as "not so good" or "poor," and nearly six in 10 believe the United States is already in a recession. While voters appear more sanguine about their own circumstances, three in 10 are now pessimistic about their financial prospects over the coming year, double the percentage holding a dour outlook in December 2006… Only 19 percent of Americans now rate the nation's economy positively, the fewest to say so since June 1993.”

If US in Recession, Probably Too Early to Look for Bargains
From Merrill Lynch: “It's amazing what 125bps in eight days can accomplish
All of a sudden, the bears have gone into hibernation. The Dow is up 1,000 points from the low, the VIX index has collapsed 23% over the last two weeks, and everyone seems to believe that our monetary and fiscal policymakers are going to be able to put Humpty Dumpty together again. Some analysts are now talking about how vital it is now to start building positions in the early cyclicals to take advantage of what some are talking about a V-shaped recovery in the second half of the year, and of course, the mantra on the financials now is that the worst is priced in especially with a bailout plan in train for the monolines. As if to put an exclamation point on the recent bullish sentiment, the Saturday WSJ declared "some money managers are starting to look ahead to a rebound in the second half of the year". We are more than happy to take the other side of that debate. Here's a little bit of history - keeping in mind that nothing moves in a straight line. We seem to recall that in the 2001-02 bear market there were no fewer than six rallies of 5% or more lasting roughly 30 days on average. The NASDAQ, which saw an 80% peak to trough collapse, posted 35 five percent or more bouncebacks, and in fact, in that entire bear market we saw the index turn in a cumulative 17,884 rally points. These are called bear market rallies. In our view, that is what we have on our hands right now. Let's not lose sight that even though we averted the worst start to any year on record, the 6% January decline in the S&P 500 was the poorest showing since 1990 (a recession year if memory serves us correctly)…Remember - recessions usually last 10 months, not six months, and the time to start pricing in the recovery is usually in the sixth month, not the first month. The stock market is indeed a discounting mechanism, but let's keep in mind that during economic recessions, peak-to-trough decline is typically closer to 30%. And, more than half of that 30% slide tends to take place before the recession, and the last leg down takes place about two-thirds into the economic downturn. So by our estimation that leaves us no better than 1,200 on the S&P 500 around June. Nothing moves in a straight line, but that is the end point and that assumes this turns out to be a 'plain vanilla' recession. Let's hope.”

Treasury Auctions This Week May Cause Higher Interest Rates
From UBS: “The Treasury market finds itself at an interesting crossroads this week. Recession fears and credit stress has the investor crowd cowering in the relative safety of Treasury securities just at the time when the Treasury has begun to flood the market with new issues. This week's 10yr and 30yr auctions will be a good test of the market's mettle at a time when Japanese investors typically divest themselves of Treasury debt in preparation for Japan's fiscal year-end on March 31st. We still see great risk in owning long Treasury debt as 30yr Treasury yields gyrate just bp away from the all-time lows in Treasury 30yr yields.”
From RBSGC: “We expect that as the economic data trickles in over the next several weeks and the hard-landing thesis struggles to find definitive support, the recent market strength will be challenged and we will see a backup in rates. Layering on top of this fundamental backdrop are the bearish seasonals -- 10-year yields tend to increase between roughly 30-40 bps between the February and May Refunding auctions. Moreover, this dynamic has held true even during Hard-Landing scenarios -- yields increasing 11 to 19 bps during 2001-2003, and 1991-1992, respectively… The February Refunding this week will surely provide some selling pressure -- with $13 bn 10s and $9 bn 30s -- a total of $22 bn of new supply to take down in a relatively data-free environment. If the lackluster reception to last week's supply is any indication (record low 2-year Indirect bidding award and 1.1 bp tail on the 5-year), expectations might be modest.”

Historic Studies Question Impact of Stimulus Checks
From Citi: “In 1975, 2001 and 2003, the Federal Government sent households rebate checks of varying sizes in an attempt to lift economic activity…this year's potential stimulus is larger in inflation-adjusted terms and as a percent of consumer spending than any of the three prior events. There is a lack of consensus surrounding the effect of prior rebates. Macroadvisers, for instance, report that about 40% of the 1975, 2001 and 2003 rebate checks were spent on average and that spending occurred within four months of the monies being sent to taxpayers. On the other hand, research by University of Michigan economists Matthew Shapiro and Joel Slemrod suggests a considerably smaller impact, at least for the 2001 episode. Their study estimates that only 22% of households spent the bulk of the 2001 rebate…Shapiro and Slemrod's 2001 results are somewhat surprising since these rebates were a down payment on a 10-year (presumably a long enough period to be viewed as permanent) reduction in marginal tax rates. Theory and historical evidence suggests that a permanent change in tax rates -- not a one-time windfall -- produces a notably larger change in spending. The dynamic on this front is
straightforward: Lower permanent tax rates increase a consumer's expected long-run income and those heightened income expectations tend to fuel stronger personal consumption. In this context, it may be that the 2001 rebates were viewed primarily as a temporary, not permanent, income gain. These results are a cautionary note regarding the potential effectiveness of current stimulus plans.”
From Washington Post: ““Only about three in 10 think government checks of several hundred dollars to most workers and new corporate incentives will be enough to avoid or mitigate a recession; two-thirds doubt it will work. About three-quarters of Democrats and independents are skeptical that such a stimulus package would soften the slowdown. Republicans divide evenly -- 47 percent think it would, 47 percent think it would not. Asked what they would do with the extra money, 27 percent said they would put it in the bank, 26 percent would pay bills, 20 percent would spend it and 5 percent would pay down debt.”
From Deutsche Bank: “Investors have reason to be concerned that the source of the current negative shock to the global economy, the bursting of a housing bubble and an ensuing credit crunch, has significantly impaired the ability of monetary policy stimulus to offset the contractionary effects of the shock on economic activity. Our analysis suggests that some of the channels of transmission of monetary policy have indeed been weakened, but we conclude that such policy is still far from impotent.”
From JP Morgan: “The amount of fiscal and monetary stimulus aimed at the US economy is substantial. In a January 25 research note, we estimated that the proposed tax rebates would boost annualized GDP growth by anywhere from 0.5% to 2% in the second half of this year, depending on how much of it is spent. With respect to monetary policy, the Fed’s model suggests that with normal transmission through the financial system (e.g., bond yields, equities, the dollar), every 100bp of Fed ease should raise GDP by 0.6% pts after 1 year and 1.7% pts after two years. The Fed has cut 225bp in the past six months and according to the model this should raise GDP by 1.4% pts after a year. Half of that has come in the past week, so the effect should be focused in the second half. Of course this is when the fiscal stimulus will be maximized too.”

Credit Spreads Remain Elevated as Market Stress Continues
From Merrill Lynch: “The stress in the financial markets and tightening in credit availability is a serious concern for the Fed since these are the channels by which easier monetary policy is to be transmitted to the real economy. In other words, a lower Fed funds rate should translate into lower borrowing rates for consumers and businesses and the amount of lending and credit creation increases to meet the rising demand. However, instead what is happening is that the Fed has lowered the funds rate by 225bps and even indicated they will likely lower rates much further, but due to the stress in the financial markets, credit spreads have widened and remain well above their norm and consistent with a deteriorating credit environment and economic recession. Let me go through a few key spreads: Libor rates have fallen sharply following the year-end, aided by the Fed's special TAF auctions that have injected some needed liquidity into the interbank money markets. However, LIBOR rates versus Treasury bill rates, the difference called the TED spread remain alarmingly high. While the rates on 3-month and 1-month LIBOR have fallen to 3.15% and 3.19%, respectively, the rate on 3-month T-bill has fallen to 2.19%, while the 1-month bill as of Friday gripped at a 1% handle at 1.81%. This leaves the 3-month TED spread nearly at 100bps, where normally this would be around 15bps, so almost 7 times its norm. The 1-month TED spread is even wider at 110bps. Also, what you can see in the LIBOR market is that due to continued uncertainty and stress in the banking system, the LIBOR curve remains inverted, despite the steepening in Uncle Sam's yield curve.”

Renewed Frugality of Wealthy Negatively Impacts Service Providers Incomes
From AP: “…economists say that recent signs of cutting back by the affluent could hurt the economy and deliver even more pain to lower-income workers, who are dependent on their business and fat tips….Cutbacks by the wealthy have a ripple effect across all consumer spending, said Michael P. Niemira, chief economist at the International Council of Shopping Centers. That's because American households in the top 20 percent by income – those making at least $150,000 a year – account for about 40 percent of overall consumer spending, which makes up two-thirds of economic activity. Niemira expects the retail sector, whose growth was fueled in part by strong gains at luxury chains, will struggle to eke out a 1 percentage sales increase in stores opened at least a year during the next few months. That's below the 2.1 percent average for 2007 and 3.7 percent for 2006…cutbacks also included canceling the services of a cleaning woman and a lawn care company. She also plans to trade in her BMW for a Ford when her lease expires in about a month. "This is a time to have cash, not to spend. So, I'm cutting wherever I can,"… Soaring home values had made upper-middle class shoppers feel wealthy in recent years, causing them to trade up to $500 Coach handbags and $1,000 espresso makers, but a housing slump has wiped away their paper wealth. The woes are creeping into even the high-end luxury sector, as affluent shoppers are rattled by the turbulence in the financial markets. American Express Co., whose customers are generally affluent, said it expects slower spending and more missed payments on credit cards throughout 2008. The economy needs affluent shoppers to spend with enthusiasm. According to the government's latest survey of consumer expenditures, the top 20 percent of households spend about $94,000 annually, almost five times the bottom 20 percent and more per year than the bottom sixty percent combined. Then there's also the multiplier effect. When shoppers splurge on $1,000 dinners and $300 limousine rides, that means fatter tips for the waiter and the driver. Sales clerks at upscale stores, who typically earn sales commissions, also depend on spending sprees of mink coats and jewelry. But the trickling down is starting to dry up, threatening to hurt a broad base of low-paid workers…While its corporate business remains the same, individuals are hiring the limo company less for weddings, birthdays and bachelor and bachelorette parties, he said.
"People are holding onto their money or maybe they don't have the funds like they used to,"…”

Rising Defaults and Falling Home Prices Cut Off Access to Home Equity Loans
From Fortune: “…it looks like a lot of ready cash is getting taken away from homeowners, at least in California. Coupled with rising unemployment, this could pose a major headache for already strapped homeowners. To head off more defaults, Countywide sent out letters to 122,000 homeowners last week informing them that their home equity credit lines were shut down since their estimated home values had dropped below their loan amounts. Right behind Countrywide was Chase Home Lending, which notified borrowers in Los Angeles, Imperial and Orange Counties that they could tap their credit lines for no more than 70% of the value of their house. Previously, the limit had been 90%. The Calculated Risk blog, which specializes in real estate and mortgage finance issues, has estimated that mortgage equity withdrawals for the fourth quarter totaled $145 billion. If tightening lending standards are put rapidly into place for home equity loans, it is not inconceivable that $50 billion or more of spending power is instantly removed from the economy. In other words, at least one-third of the recently passed $150 billion stimulus package is already canceled out.”

Random Comments on Inflation
From Bear Stearns: “…we think the Fed’s monetary policy has become increasingly biased toward longer-term inflation. While the U.S. claims a moderate inflation rate, overall CPI inflation hit 4.1% in 2007, after 2.5% in 2006 and 3.4% in 2005. The revised core PCE deflator has been above the Fed’s 2% ceiling consistently since mid-2004…”
From Deutsche Bank: “Over the last 12 months, the core CPI has risen by 2.4%, and the recent momentum has been tilting upward as evidenced by the three- and six-month annualized changes of 2.7% and 2.6%, respectively. If nominal fed funds are cut to 2.5% by the end of March, the real fed funds rate will either be zero or slightly negative. This typically does not happen until the economy is exiting recession, because monetary policymakers are cutting the nominal fed funds rate to assure a sustained economic recovery. Inflation also begins to decline in traditional lagged response to the negative output gap from the past expansion. In the present environment, the real fed funds rate will be negative much sooner, testament to the

Fed's desire to front load easing and minimize recession risk.”
From Dow Jones: “Higher inflation rates reduce the value of money received in the future, and money received in the future is at the core of long-term investing. Inflation, therefore, reduces the value of future interest and principal payments to bondholders. Price/earnings ratios on stocks suffer because investors become less willing to pay high multiples for future earnings whose value is being eroded by inflation.”
From The Wall Street Journal: “Perhaps the biggest disadvantage of price controls, however, is that they short-circuit potential changes in behavior by producers and consumers that might damp the underlying causes of inflation. If price controls are kept in place too long, economists say, odds increase for a precipitous and destabilizing jump in prices later on.”
From Dow Jones: “Treasury inflation-protected securities, or TIPS, which are offered at an adjusted rate of interest based on changes in the consumer price index…are redeemable at maturity at their inflation-adjusted principal or their face value, whichever is greater. They give up some yield in return for the protection they offer from inflation, and the inflation adjustment is subject to federal taxes each year, though not paid out until maturity. This tax inefficiency makes tax-deferred retirement accounts [IRAs or 401k] a logical place to house these securities.”
From Deutsche: “Just as an aside, my local bagel shop just raised prices 35%, my ferry to work went up 7% and my Eli Manning Super Jersey was $76. Milk is like $100. The signs of inflation out there are getting harder to ignore.”
[Note: CPI +4.1% YoY and PCE Deflator +3.5% YoY.]

MISC
From The New York Times: “As Congress and the public focus on more than $600 billion already approved in supplemental budgets to pay for the wars in Iraq and Afghanistan and for counterterrorism operations, the Bush administration has with little notice approached a landmark in military spending. The Pentagon today will unveil its proposed 2009 budget of $515.4 billion, which, if approved, will mean annual military spending, when adjusted for inflation, will have reached its highest level since World War II.”
From Bear Stearns: “Nearly half the increase in unemployment since March 2007 is due to the 16-24 age group, perhaps impacted by the increase in the minimum wage in July.”
From Lehman: “Challenger announced that layoffs jumped to 74,986 in January. Financial services jobs led the job cuts, with 15,789 positions eliminated according to company announcements…The data are consistent with a weakening, but not collapsing, labor market.”
From JP Morgan: “In 2008, the payment increases in the prime and Alt-A markets are relatively insignificant (between 0 and 5%), owing to the Fed ease. Most borrowers (over 90%) are resetting to rates lower than they can refinance into…Nearly half of the conventional mortgages originated in the past two years have experienced negative HPA, putting more than a third of these originations above 80% LTV. The amount of “clean” refinance-able universe is only about 30% of the ‘06/'07 vintages. We expect these factors to tame speeds even as rates fall to historic lows.”
From Merrill Lynch: “…homebuilding stocks…have rallied 63% from the lows to their best levels since September 2007.”
From Handelsbanken: “The best performing stocks over the past few weeks have been financials, which are up 5.8% over the past month, while consumer discretionary stocks are up almost 5% over the same period. Energy, telecommunication and information technology stocks have performed the worst, declining by 9.5%, 8.3% and 6.6%, respectively.”
From Morgan Stanley: [Last week]”… 2’s-10’s steepened another 14 bp to 151.5 bp and 2’s-30’s 15 bp to 223 bp, highs since the fall of 2004. These spreads have now steepened every week this year for cumulative moves of 55 bp and 84 bp, respectively, since the close on December 31.”
From BMO: “Reported late Friday, auto sales fell a much larger-than-expected 6.3% in January to an annualized 15.2 million units, versus 16.2 million in 2007. The sharp decline in sales, alongside a dip in employment, suggests consumer spending could retrench in Q1.”
From The Wall Street Journal: “…it is starting to look as if smaller banks might be catching on to the wave of risk aversion that is tightening credit around the nation. Nervous regulators, worried about lax lending standards, could amplify all of this.”
From Fed’s Senior Loan Officer Survey: “"In the January survey, domestic and foreign institutions reported having tightened their lending standards and terms for a broad range of loan types over the past three months. Demand for bank loans reportedly had weakened, on net, for both businesses and households over the same period."
From RBSGC: “MBS holdings by US banks increased $2 bn, evenly split between pass-through holdings and CMO holdings. Since the beginning of 2008, total MBS positions were virtually unchanged. Deposits increased $90 bn over the past week. Since the start of 2008, deposits have risen by $96 bn. Commercial and industrial loans decreased $4 bn for all banks over the week. Since the start this year, C&I loans grew $13 bn. Whole loan holdings increased $10 bn over the week. Since the beginning of 2008, whole loan holdings have risen by $16 bn.”
From Deutsche: “There has been limited focus in the past couple of weeks about the upcoming G7 meeting (scheduled for Tokyo on Saturday). In many ways this is somewhat surprising, given the global nature of the current financial shock would seem to warrant a multi-lateral approach to its resolution.”
From Goldman Sachs: “The curtain is coming down on the [Japanese] economic recovery that began in early 2002. Production trended up until October but is turning down due to export slowdown. The supply/demand gap started to widen in mid-2007 and unemployment has started rising. Recession is the message from most quarters.”
From MNI: “Japan and China are considering evenly dividing profits from joint development of natural gas fields in the East China Sea…”
From Bloomberg: “China's benchmark stock index rose by a record 8.3 percent after the government allowed the sale of new stock funds and increased efforts to restore power supplies and transport links after the worst snowstorm in more than 50 years.”
From Forbes: “High-speed train service between Paris and Strasbourg, which state-owned railway SNCF began in mid-2007, built up to a 60 pct market share at the expense of air transport by the end of October, much faster than forecast… Air traffic between the cities fell 25 pct in 2007, the Strasbourg airport said.”
End-of-Day Market Update
From RBSGC: “The bond market lost some marginal ground, with the curve steepening in the process… trading volume was barely 55% of the recent norm…”
From JP Morgan: “The Treasury curve steadily steepened throughout the session, and the 2s30s curve finished the day nearly 8bps steeper. The front end held tight to Friday's closing levels while long Treasury yields ground higher. The onset of new 10y and 30y Treasury supply (and quieter markets) weighed on the back end today… TIPS breakevens were 1-2 bps tighter on the day… Swaps saw very light flows, with front end spreads widening … Mortgages had a quiet day with about $1B in origination and $500M in 2-way flow. MBS are 2-3 ticks wider on the day versus Treasuries and swaps.”
From Bloomberg: “U.S. stocks declined for the first time in three days after analysts told investors to sell American Express Co., Wells Fargo & Co. and Wachovia Corp. on concern a recession will worsen defaults among consumers… The Standard & Poor's 500 Index fell 14.6, or 1.1 percent, to 1,380.82 after rallying 4.9 percent last week. The Dow Jones Industrial Average decreased 108.03, or 0.9 percent, to 12,635.16. The Nasdaq Composite Index retreated 30.51, or 1.3 percent, to 2,382.85. Almost seven stocks declined for every four that advanced on the New York Stock Exchange.”
Three month T-Bill yield rose 13 bp to 2.22%.
Two year T-Note yield fell 1.5 bp to 2.05%
Ten year T-Note yield rose 5 bp to 3.65%
Dow fell 108 to 12,635
S&P 500 fell 14.5 to 1381
Dollar index fell .09 to 75.36
Yen at 106.7 per dollar
Euro at 1.483
Gold fell $2 at $903.5
Oil rose $.93 to $89.89
*All prices as of 4:30pmfears and credit stress has the investor crowd cowering in the relative safety of Treasury securities just at the time when the Treasury has begun to flood the market with new issues. This week's 10yr and 30yr auctions will be a good test of the market's mettle at a time when Japanese investors typically divest themselves of Treasury debt in preparation for Japan's fiscal year-end on March 31st. We still see great risk in owning long Treasury debt as 30yr Treasury yields gyrate just bp away from the all-time lows in Treasury 30yr yields.”
From RBSGC: “We expect that as the economic data trickles in over the next several weeks and the hard-landing thesis struggles to find definitive support, the recent market strength will be challenged and we will see a backup in rates. Layering on top of this fundamental backdrop are the bearish seasonals -- 10-year yields tend to increase between roughly 30-40 bps between the February and May Refunding auctions. Moreover, this dynamic has held true even during Hard-Landing scenarios -- yields increasing 11 to 19 bps during 2001-2003, and 1991-1992, respectively… The February Refunding this week will surely provide some selling pressure -- with $13 bn 10s and $9 bn 30s -- a total of $22 bn of new supply to take down in a relatively data-free environment. If the lackluster reception to last week's supply is any indication (record low 2-year Indirect bidding award and 1.1 bp tail on the 5-year), expectations might be modest.”
Historic Studies Question Impact of Stimulus Checks
From Citi: “In 1975, 2001 and 2003, the Federal Government sent households rebate checks of varying sizes in an attempt to lift economic activity…this year's potential stimulus is larger in inflation-adjusted terms and as a percent of consumer spending than any of the three prior events. There is a lack of consensus surrounding the effect of prior rebates. Macroadvisers, for instance, report that about 40% of the 1975, 2001 and 2003
rebate checks were spent on average and that spending occurred within four months of the monies being sent to taxpayers. On the other hand, research by University of Michigan economists Matthew Shapiro and Joel Slemrod suggests a considerably smaller impact, at least for the 2001 episode. Their study estimates that only 22% of households spent the bulk of the 2001 rebate…Shapiro and Slemrod's 2001 results are somewhat surprising since these rebates were a down payment on a 10-year (presumably a long enough period to be viewed as permanent) reduction in marginal tax rates. Theory and historical evidence suggests that a permanent change in tax rates -- not a one-time windfall -- produces a notably larger change in spending. The dynamic on this front is
straightforward: Lower permanent tax rates increase a consumer's expected long-run income and those heightened income expectations tend to fuel stronger personal consumption. In this context, it may be that the 2001 rebates were viewed primarily as a
temporary, not permanent, income gain. These results are a cautionary note regarding the potential effectiveness of current stimulus plans.”
From Washington Post: ““Only about three in 10 think government checks of several hundred dollars to most workers and new corporate incentives will be enough to avoid or mitigate a recession; two-thirds doubt it will work. About three-quarters of Democrats and independents are skeptical that such a stimulus package would soften the slowdown. Republicans divide evenly -- 47 percent think it would, 47 percent think it would not. Asked what they would do with the extra money, 27 percent said they would put it in the bank, 26 percent would pay bills, 20 percent would spend it and 5 percent would pay down debt.”
From Deutsche Bank: “Investors have reason to be concerned that the source of the current negative shock to the global economy, the bursting of a housing bubble and an ensuing credit crunch, has significantly impaired the ability of monetary policy stimulus to offset the contractionary effects of the shock on economic activity. Our analysis suggests that some of the channels of transmission of monetary policy have indeed been weakened, but we conclude that such policy is still far from impotent.”
From JP Morgan: “The amount of fiscal and monetary stimulus aimed at the US economy is substantial. In a January 25 research note, we estimated that the proposed tax rebates would boost annualized GDP growth by anywhere from 0.5% to 2% in the second half of this year, depending on how much of it is spent. With respect to monetary policy, the Fed’s model suggests that with normal transmission through the financial system (e.g., bond yields, equities, the dollar), every 100bp of Fed ease should raise GDP by 0.6% pts after 1 year and 1.7% pts after two years. The Fed has cut 225bp in the past six months and according to the model this should raise GDP by 1.4% pts after a year. Half of that has come in the past week, so the effect should be focused in the second half. Of course this is when the fiscal stimulus will be maximized too.”
Credit Spreads Remain Elevated as Market Stress Continues
From Merrill Lynch: “The stress in the financial markets and tightening in credit availability is a serious concern for the Fed since these are the channels by which easier monetary policy is to be transmitted to the real economy. In other words, a lower Fed funds rate should translate into lower borrowing rates for consumers and businesses and the amount of lending and credit creation increases to meet the rising demand. However, instead what is happening is that the Fed has lowered the funds rate by 225bps and even indicated they will likely lower rates much further, but due to the stress in the financial markets, credit spreads have widened and remain well above their norm and consistent with a deteriorating credit environment and economic recession. Let me go through a few key spreads: Libor rates have fallen sharply following the year-end, aided by the Fed's special TAF auctions that have injected some needed liquidity into the interbank money markets. However, LIBOR rates versus Treasury bill rates, the difference called the TED spread remain alarmingly high. While the rates on 3-month and 1-month LIBOR have fallen to 3.15% and 3.19%, respectively, the rate on 3-month T-bill has fallen to 2.19%, while the 1-month bill as of Friday gripped at a 1% handle at 1.81%. This leaves the 3-month TED spread nearly at 100bps, where normally this would be around 15bps, so almost 7 times its norm. The 1-month TED spread is even wider at 110bps. Also, what you can see in the LIBOR market is that due to continued uncertainty and stress in the banking system, the LIBOR curve remains inverted, despite the steepening in Uncle Sam's yield curve.”
Renewed Frugality of Wealthy Negatively Impacts Service Providers Incomes
From AP: “…economists say that recent signs of cutting back by the affluent could hurt the economy and deliver even more pain to lower-income workers, who are dependent on their business and fat tips….Cutbacks by the wealthy have a ripple effect across all consumer spending, said Michael P. Niemira, chief economist at the International Council of Shopping Centers. That's because American households in the top 20 percent by income – those making at least $150,000 a year – account for about 40 percent of overall consumer spending, which makes up two-thirds of economic activity. Niemira expects the retail sector, whose growth was fueled in part by strong gains at luxury chains, will struggle to eke out a 1 percentage sales increase in stores opened at least a year during the next few months. That's below the 2.1 percent average for 2007 and 3.7 percent for 2006…cutbacks also included canceling the services of a cleaning woman and a lawn care company. She also plans to trade in her BMW for a Ford when her lease expires in about a month. "This is a time to have cash, not to spend. So, I'm cutting wherever I can,"… Soaring home values had made upper-middle class shoppers feel wealthy in recent years, causing them to trade up to $500 Coach handbags and $1,000 espresso makers, but a housing slump has wiped away their paper wealth. The woes are creeping into even the high-end luxury sector, as affluent shoppers are rattled by the turbulence in the financial markets. American Express Co., whose customers are generally affluent, said it expects slower spending and more missed payments on credit cards throughout 2008. The economy needs affluent shoppers to spend with enthusiasm. According to the government's latest survey of consumer expenditures, the top 20 percent of households spend about $94,000 annually, almost five times the bottom 20 percent and more per year than the bottom sixty percent combined. Then there's also the multiplier effect. When shoppers splurge on $1,000 dinners and $300 limousine rides, that means fatter tips for the waiter and the driver. Sales clerks at upscale stores, who typically earn sales commissions, also depend on spending sprees of mink coats and jewelry. But the trickling down is starting to dry up, threatening to hurt a broad base of low-paid workers…While its corporate business remains the same, individuals are hiring the limo company less for weddings, birthdays and bachelor and bachelorette parties, he said.
"People are holding onto their money or maybe they don't have the funds like they used to,"…”
Rising Defaults and Falling Home Prices Cut Off Access to Home Equity Loans
From Fortune: “…it looks like a lot of ready cash is getting taken away from homeowners, at least in California. Coupled with rising unemployment, this could pose a major headache for already strapped homeowners. To head off more defaults, Countywide sent out letters to 122,000 homeowners last week informing them that their home equity credit lines were shut down since their estimated home values had dropped below their loan amounts. Right behind Countrywide was Chase Home Lending, which notified borrowers in Los Angeles, Imperial and Orange Counties that they could tap their credit lines for no more than 70% of the value of their house. Previously, the limit had been 90%. The Calculated Risk blog, which specializes in real estate and mortgage finance issues, has estimated that mortgage equity withdrawals for the fourth quarter totaled $145 billion. If tightening lending standards are put rapidly into place for home equity loans, it is not inconceivable that $50 billion or more of spending power is instantly removed from the economy. In other words, at least one-third of the recently passed $150 billion stimulus package is already canceled out.”
Random Comments on Inflation
From Bear Stearns: “…we think the Fed’s monetary policy has become increasingly biased toward longer-term inflation. While the U.S. claims a moderate inflation rate, overall CPI inflation hit 4.1% in 2007, after 2.5% in 2006 and 3.4% in 2005. The revised core PCE deflator has been above the Fed’s 2% ceiling consistently since mid-2004…”
From Deutsche Bank: “Over the last 12 months, the core CPI has risen by 2.4%, and the recent momentum has been tilting upward as evidenced by the three- and six-month annualized changes of 2.7% and 2.6%, respectively. If nominal fed funds are cut to 2.5% by the end of March, the real fed funds rate will either be zero or slightly negative. This typically does not happen until the economy is exiting recession, because monetary policymakers are cutting the nominal fed funds rate to assure a sustained economic recovery. Inflation also begins to decline in traditional lagged response to the negative output gap from the past expansion. In the present environment, the real fed funds rate will be negative much sooner, testament to the Fed's desire to front load easing and minimize recession risk.”
From Dow Jones: “Higher inflation rates reduce the value of money received in the future, and money received in the future is at the core of long-term investing. Inflation, therefore, reduces the value of future interest and principal payments to bondholders. Price/earnings ratios on stocks suffer because investors become less willing to pay high multiples for future earnings whose value is being eroded by inflation.”
From The Wall Street Journal: “Perhaps the biggest disadvantage of price controls, however, is that they short-circuit potential changes in behavior by producers and consumers that might damp the underlying causes of inflation. If price controls are kept in place too long, economists say, odds increase for a precipitous and destabilizing jump in prices later on.”
From Dow Jones: “Treasury inflation-protected securities, or TIPS, which are offered at an adjusted rate of interest based on changes in the consumer price index…are redeemable at maturity at their inflation-adjusted principal or their face value, whichever is greater. They give up some yield in return for the protection they offer from inflation, and the inflation adjustment is subject to federal taxes each year, though not paid out until maturity. This tax inefficiency makes tax-deferred retirement accounts [IRAs or 401k] a logical place to house these securities.”
From Deutsche: “Just as an aside, my local bagel shop just raised prices 35%, my ferry to work went up 7% and my Eli Manning Super Jersey was $76. Milk is like $100. The signs of inflation out there are getting harder to ignore.”
[Note: Many employees have requested data on the inflation rate this past week. Here are the most recent indications - CPI +4.1% YoY and PCE Deflator +3.5% YoY.]
MISC
From The New York Times: “As Congress and the public focus on more than $600 billion already approved in supplemental budgets to pay for the wars in Iraq and
Afghanistan and for counterterrorism operations, the Bush administration has with little notice approached a landmark in military spending. The Pentagon today will unveil its proposed 2009 budget of $515.4 billion, which, if approved, will mean annual military spending, when adjusted for inflation, will have reached its highest level since World War II.”
From Bear Stearns: “Nearly half the increase in unemployment since March 2007 is due to the 16-24 age group, perhaps impacted by the increase in the minimum wage in July.”
From Lehman: “Challenger announced that layoffs jumped to 74,986 in January. Financial services jobs led the job cuts, with 15,789 positions eliminated according to company announcements…The data are consistent with a weakening, but not collapsing, labor market.”
From JP Morgan: “In 2008, the payment increases in the prime and Alt-A markets are relatively insignificant (between 0 and 5%), owing to the Fed ease. Most borrowers (over 90%) are resetting to rates lower than they can refinance into…Nearly half of the conventional mortgages originated in the past two years have experienced negative HPA, putting more than a third of these originations above 80% LTV. The amount of “clean” refinance-able universe is only about 30% of the ‘06/'07 vintages. We expect these factors to tame speeds even as rates fall to historic lows.”
From Merrill Lynch: “…homebuilding stocks…have rallied 63% from the lows to their best levels since September 2007.”
From Handelsbanken: “The best performing stocks over the past few weeks have been financials, which are up 5.8% over the past month, while consumer discretionary stocks are up almost 5% over the same period. Energy, telecommunication and information technology stocks have performed the worst, declining by 9.5%, 8.3% and 6.6%, respectively.”
From Morgan Stanley: [Last week]”… 2’s-10’s steepened another 14 bp to 151.5 bp and 2’s-30’s 15 bp to 223 bp, highs since the fall of 2004. These spreads have now steepened every week this year for cumulative moves of 55 bp and 84 bp, respectively, since the close on December 31.”
From BMO: “Reported late Friday, auto sales fell a much larger-than-expected 6.3% in January to an annualized 15.2 million units, versus 16.2 million in 2007. The sharp decline in sales, alongside a dip in employment, suggests consumer spending could retrench in Q1.”
From The Wall Street Journal: “…it is starting to look as if smaller banks might be catching on to the wave of risk aversion that is tightening credit around the nation. Nervous regulators, worried about lax lending standards, could amplify all of this.”
From Fed’s Senior Loan Officer Survey: “"In the January survey, domestic and foreign institutions reported having tightened their lending standards and terms for a broad range of loan types over the past three months. Demand for bank loans reportedly had weakened, on net, for both businesses and households over the same period."
From RBSGC: “MBS holdings by US banks increased $2 bn, evenly split between pass-through holdings and CMO holdings. Since the beginning of 2008, total MBS positions were virtually unchanged. Deposits increased $90 bn over the past week. Since the start of 2008, deposits have risen by $96 bn. Commercial and industrial loans decreased $4 bn for all banks over the week. Since the start this year, C&I loans grew $13 bn. Whole loan holdings increased $10 bn over the week. Since the beginning of 2008, whole loan holdings have risen by $16 bn.”
From Deutsche: “There has been limited focus in the past couple of weeks about the upcoming G7 meeting (scheduled for Tokyo on Saturday). In many ways this is somewhat surprising, given the global nature of the current financial shock would seem to warrant a multi-lateral approach to its resolution.”
From Goldman Sachs: “The curtain is coming down on the [Japanese] economic recovery that began in early 2002. Production trended up until October but is turning down due to export slowdown. The supply/demand gap started to widen in mid-2007 and unemployment has started rising. Recession is the message from most quarters.”
From MNI: “Japan and China are considering evenly dividing profits from joint development of natural gas fields in the East China Sea…”
From Bloomberg: “China's benchmark stock index rose by a record 8.3 percent after the government allowed the sale of new stock funds and increased efforts to restore power supplies and transport links after the worst snowstorm in more than 50 years.”
From Forbes: “High-speed train service between Paris and Strasbourg, which state-owned railway SNCF began in mid-2007, built up to a 60 pct market share at the expense of air transport by the end of October, much faster than forecast… Air traffic between the cities fell 25 pct in 2007, the Strasbourg airport said.”

End-of-Day Market Update
From RBSGC: “The bond market lost some marginal ground, with the curve steepening in the process… trading volume was barely 55% of the recent norm…”
From JP Morgan: “The Treasury curve steadily steepened throughout the session, and the 2s30s curve finished the day nearly 8bps steeper. The front end held tight to Friday's closing levels while long Treasury yields ground higher. The onset of new 10y and 30y Treasury supply (and quieter markets) weighed on the back end today… TIPS breakevens were 1-2 bps tighter on the day… Swaps saw very light flows, with front end spreads widening … Mortgages had a quiet day with about $1B in origination and $500M in 2-way flow. MBS are 2-3 ticks wider on the day versus Treasuries and swaps.”
From Bloomberg: “U.S. stocks declined for the first time in three days after analysts told investors to sell American Express Co., Wells Fargo & Co. and Wachovia Corp. on concern a recession will worsen defaults among consumers… The Standard & Poor's 500 Index fell 14.6, or 1.1 percent, to 1,380.82 after rallying 4.9 percent last week. The Dow Jones Industrial Average decreased 108.03, or 0.9 percent, to 12,635.16. The Nasdaq Composite Index retreated 30.51, or 1.3 percent, to 2,382.85. Almost seven stocks declined for every four that advanced on the New York Stock Exchange.”
Three month T-Bill yield rose 13 bp to 2.22%.
Two year T-Note yield fell 1.5 bp to 2.05%
Ten year T-Note yield rose 5 bp to 3.65%
Dow fell 108 to 12,635
S&P 500 fell 14.5 to 1381
Dollar index fell .09 to 75.36
Yen at 106.7 per dollar
Euro at 1.483
Gold fell $2 at $903.5
Oil rose $.93 to $89.89
*All prices as of 4:30pm