Today's Tidbits

More on 1st Quarter GDP Update
From RBSGC: “Today's release included the first estimate of corporate profits for Q1. After back-to-back significant declines, corporate profits managed to squeak out a small rise in Q1, 0.3% not annualized. According to the BEA, the writedowns in the financial sector were stanched (the financial sector lost $3 billion in Q1, vs. $32.5 billion in Q3 and $74.4 billion in Q4), while nonfinancial corporations made money after losses in Q3 and Q4. There was some quirkiness in some of the profit measures associated with the depreciation bonus that was in the fiscal stimulus package passed in the first quarter, mainly affecting after-tax profits, but the headline figures quoted above were said to be unaffected.”
From JP Morgan: “Profits from domestic industries was unchanged, all of the $5 billion increase in profits came from earnings from the rest-of-the-world operations …Today’s release also contained information on the complete tabulation of wage and salary data for 4Q07. Compensation growth in that quarter was revised up to an annual rate of 4.6% from the previously reported 3.0%. Because of that revision, unit labor costs are now estimated to have increased 0.7% over a year-ago through 1Q08, up from the previously reported 0.2%.”
From Citi: “On a year/year basis, overall profits are up 1.7%, and have yet to show a
decline. Domestic industry profits were down 6.2%, while profits earned abroad rose 34.9% from a year ago. Domestic financial profits (again, ex-write downs of asset holdings) fell 12.2% from a year ago.”
From Deutsche Bank: “Troubling to us was the news on corporate profits, where we received the first glimpse for Q1. Total operating profits were up 1.3% in the quarter and 1.7% over the past four quarters. But domestic profits were essentially flat at +0.1% and they have declined 6.2% over the past year. Profits earned overseas remain robust, rising 5.1% but the momentum is slowing, as the year-over-year rate rose a much stronger 34.9%. The weakness in domestic profits is not just due to financials, which posted a 2.9% quarterly decline. Nonfinancial corporate profits rose only 1.7%. The strength in overseas growth is why net exports continue to provide a powerful support to the economy, contributing 0.8% to the quarter. Otherwise, GDP would have posted only a 0.1% increase in the quarter.”
From Lehman: “Overall, the report had a slightly healthier mix of growth, with more strength coming from final sales and less from inventory investment. With Q2 GDP now tracking well above zero (0.9% by our estimate), the report will likely intensify debate over whether the economy actually slid into recession in the first half of the year. Currently, employment growth and industrial production are sending recession-like signals, but sales growth and overall GDP continuing to indicate positive growth.”
Only Half Way Through Home Price Slide?
From Merrill Lynch: “Martin Feldstein weighed in on the US economy, and his conclusions were very dovish. Highlights of Feldstein's Remarks
1. Fed should not raise rates now.
2. Core inflation still relatively modest.
3. House Prices have another 15% to Fall.
4. Virtually every indicator is heading down.
5. Jobless rate could reach 7.0%.”
[Note - Martin Feldstein is President of the National Bureau of Economic Research which officially dates recessions.]
From Bank of America: “Since peaking in 1Q 2006, the S&P/Case-Shiller national home price index has declined 21.2% relative to owners’ equivalent rent. Note that this drop has involved a 15.6% decline in home prices (measured from 1Q 2006, rather than Q2) and a 7.0% rise in owners’ equivalent rent. In order for the ratio to return to its average level of 2000, an additional drop (in the ratio) of about 17% is needed. Assuming about a 2% (cumulative) rise in owners’ equivalent rent in the next few quarters, an additional 15% decline in national home prices would be expected.”

Dealers Question WSJ Analytics on LIBOR Mispricing
From Deutsche Bank: “The BBA is scheduled to announce any changes to its LIBOR-fixing mechanism tomorrow. We don't expect substantial changes that would warrant a significant change in the level of LIBOR rates. In our view, the WSJ article today, purporting to estimate the mispricing of the LIBOR rate submissions, has limited credibility, as it can be criticized for using 1Y CDS, itself a somewhat illiquid indicator, for projecting 3M LIBOR default premiums, and for a questionable method for calculating a risk-free LIBOR rate. Also, interbank markets to some extent are rationed by quantity rather than price, as counterparties would reduce the lines to a credit-impaired bank. We think the actual fixing has been little influenced in practice by individual bank submission errors, given the discarding of outlier submissions. But LIBOR is subject to systemic credit and liquidity concerns, and thus will continue to exhibit spread volatility. There are few transparent viable alternatives: OIS is commonly mentioned, but the underlying effective fed funds rate is subject to anomalies as well, depending on the success of the Fed's open market operations in reaching the funds target. It also doesn't accurately reflect actual borrowing costs among a wide variety of international banks.”
Reduced Immigration Likely to Slow US Economic Growth
From Goldman Sachs: “Immigration, legal and otherwise, has accounted for roughly half of the growth in the US labor force over the past decade. This represents a significant contribution to economic growth, approximately 1/2 percentage point annually. Over the next year or two, however, immigrants’ contribution to growth is apt to decline. Legal immigration ceilings remain unchanged, and recent policy efforts have focused on tightening border controls. Meanwhile, a weaker US labor market makes immigration less attractive economically. The drop in immigration is unfortunate—among other benefits, more legal immigration would help mitigate the housing bust by boosting the demand for housing. Although the long-term impact of immigration on the US economy will depend greatly on policy choices, immigrants’ role in labor force growth is likely to be larger, as the “baby boom” generation retires and the growth rate of the native-born population slows. One credible estimate has all of the growth in the US labor force between now and 2050 coming from new immigrants and their children… The composition of immigrant flows is fairly complementary to the US labor market. Immigrants are disproportionately represented at both ends of the skill distribution. Legal immigrants are more likely to have advanced degrees than native-born Americans, while undocumented immigrants are less likely to have completed high school than native-born workers. While competition for work obviously occurs in specific jobs, the “barbell” structure of immigrant skill distribution reduces this overlap. Immigrants also contribute to the tax base of the US economy. Because they are disproportionately of working age, immigrants tend to be net contributors to US federal government finances. This is even true of undocumented workers, many of whom pay withholding taxes on their income under others’ Social Security numbers but are unlikely to receive any Social Security benefits. (The situation for states and localities is different, as many of these incur expenses for services such as emergency room care and education and may not receive the corresponding tax revenue.)… The impact of immigrants on US wage levels is hotly debated, but most careful studies have found quite limited effects… if the limit for H1-B skilled worker visas were to return to 2002-2003 levels, this would represent an extra 130,000 people needing housing each year.!... The aging of the US population and retirement of the “baby boom” generation will result in significantly slower labor force growth, other things equal.”
Mortgage Rates Poised to Rise
From Bloomberg: “Rates for fixed mortgages, the loans used by nine out of 10 U.S. homebuyers, are poised to rise, and may extend a housing slump that's already in its third year. The yield on the 10-year U.S. Treasury note increased to the highest level of the year after the government said the world's largest economy grew at a faster pace in the first quarter than it originally estimated. Rates on home loans typically track long-term government debt and may soon follow suit… ``The outlook for housing and for the economy will grow even darker if credit gets costlier,”…``It will be a weight on home demand and will mean additional cuts in refinancings, which will crimp consumer spending.'' The 10-year note's yield rose 9 basis points, or 0.09 percentage point, to 4.09 percent … the highest since Dec. 28… ``Fixed rates may rise, but they won't rise as much as the underlying Treasuries,'' … ``The spread between government debt and fixed rate mortgages has been extraordinarily wide, and if lenders are interested in making loans some of that will disappear.'' The difference, or spread, between the average U.S. fixed mortgage rate and the 10-year Treasury yield is 1.97 percentage points today, down from the high of 2.82 percentage points on March 17. That was the widest since 1986, as banks that reported $382 billion in asset writedowns and credit losses since last year tried to rebuild their tattered balance sheets… So far, fixed home-loan rates have barely budged, according to Freddie Mac, the world's second-largest mortgage buyer. The average U.S. rate for a 30-year fixed mortgage is 6.08 percent this week, up from last week's 5.98 percent, it said in a report today.”
Signs Consumer Spending is Likely to Continue Slowing
From Deutsche Bank: “The May retail sales data are not reported for another two weeks, however, some recent evidence points to a weak performance this month… Tax rebates aside, the fundamentals for the medium-term outlook on consumer spending are becoming increasingly negative. As is often the case at turning points, the data on retail sales are not yet sending a clear signal of the new trajectory. Nevertheless, the evidence is starting to accumulate. Unit motor vehicle sales are a compelling leading indicator of private consumption and recently have sharply deteriorated. They fell to an annualized rate of 14.4 million units in April (compared to 16.2M one year earlier), which is the lowest reading in a decade… To be sure, the recent anecdotal evidence in the auto sector has been downbeat, particularly with respect to light truck and SUV sales. Another negative signal is coming from the weekly chain store sales figures, which while volatile, appear to be in a prolonged deceleration. They are up only 1.5% y/y, which is nearly 1% lower than last year at this time. By itself, this is not compelling evidence-the weekly chain store figures are not strongly correlated with the monthly retail sales data-however, they do provide one more piece of hard data which supports what the leading indicators (e.g. consumer confidence) and fundamentals (e.g. reduced buying power) have suggested for some time.”
GSE’s Prove They Are “The Mortgage Market”
From Merril Lynch: “If ever the US housing market needed the GSEs (Fannie and Freddie) it's NOW! Rising mortgage rates certainly isn't good for housing today. With Credit tighter than it's been in quite sometime and lenders requiring borrowers to verify just about everything, the "effective" demand for housing is poised to remain stagnant. Yeah prices are falling and some reports will tell you that housing demand will pick up soon. That new homes for sale should see a pop given that the demand from first time buyers is poised to rise this summer. Those same pundits seem to have forgotten that during the boom period of 2003-2005 nearly half of first time home buyers put NOTHING down and the other half put about 2% down. Today, that's a far stretch given the fickleness of most lenders. But the there's Fannie Mae and Freddie Mac, who have in the past been criticized for not supporting the lower-tail of the US housing market through strict affordable housing goals. To be sure, however, the GSE-model of home loan underwriting is pretty tight: lots of documentation and verification. When SubPrime died, the US Government quickly turned to both US housing giants to help ease liquidity bottlenecks in the US housing market. The GSEs have responded quite nicely, issuing Billions of MBS over the past several months: 30 year NET-fixed rate Fannie+Freddie issuance (gross issuance less liquidations) has totaled ~ $148 Billion this year and ~ $507 Billion over the past 12 months! These numbers are staggering and the Agencies are proving that they have come to the party ready to party. Both agencies have seen their debt (bullet and callable) trade extremely well too, with overseas buyers continuing to find these instruments an attractive alternative to the tiny after-tax/after-inflation returns given by the US Treasury market today… The GSEs should be applauded for the massive liquidity they are providing to the mortgage market. Agency debt investors should be mindful that this could lead to more issuance if they really ratchet up their net forward retained commitments (commitments to buy forward less commitments to sale) to purchase MBS like they did last month: Freddie issued ~ $40 Billion in PCs (their version of MBS) in April and committed to buy ~ $36 Billion (net) PCs in April.
Freddie's retained portfolio grew at an eye-popping annual rate of 42.2% in April. Their holdings of their own PCs jumped by ~ $29 Billion between March and April. Fannie on the other hand issued ~ $58.6 Billion Fannie MBS in April, that's nearly $100 Billion in MBS flow between the two GSEs! Fannie's retained grew at an annual rate of 9.8% in April. And finally some economists have suggested that the banks will be forced to ease lending, I don't agree. To be sure, the GSEs will drive a lot of that decision, as they are proving that they are the mortgage market.”
From Credit Suisse: “GSEs remain a backstop, which augurs well for the basis longer term. Over March and April, GSEs have entered into combined forward purchase commitments of $126B. Actual portfolio growth for Fannie Mae and Freddie Mac was $6B and $25B, respectively, during April. We estimate that their portfolios will grow by $20B and $25B, respectively, in May. Fannie Mae has raised $6B and Freddie Mac is to raise $5.5B once SEC registration is complete over the next couple of months. This will result in Fannie Mae and Freddie Mac having maximum additional capacity of $214B and $160B, respectively. However, we expect actual purchases to be around half of that.”
Oil Subsidies Distort Markets
From Credit Suisse: “Oil prices are capped in China, India, Indonesia, Malaysia and in the Middle East… Subsidies in 2008 could reach US$70 bn, 4x higher than in 2007. The shortfall (from fair market-determined prices) could top US$205 bn. Domestic gasoline prices need to go up between 25% (in India) to 70% (in China). Diesel prices need to go up 57- 160% to bring them up to parity with international prices… Oil subsidies are approaching 4% of GDP in Indonesia, 2.2% in Malaysia, 1.7% in India and 0.6% in China… In China, there is resistance to price hikes, as inflation is a primary concern… Subsidies are distorting demand. There is elasticity of demand where customer can feel the price. Globally, oil demand is falling across most free pricing regimes, with price-capped regions contributing inordinately to growth. Within India and China, demand for products with free pricing (naphtha and fuel oil) has slowed dramatically, and even declined. Paradoxically, efforts to shield customers from the oil shock could be sending oil prices higher.”

MISC
From Bank of America: “Dow Chemical's announcement of a 20% increase in prices further reinforced inflation as the dominant theme in financial markets. Inflation now appears to have replaced housing as the dominant macro driver of financial markets, and Dow's initiation of "difficult discussions with customers" regarding its pass-through of its substantial increase in oil-based feedstocks highlights a crucial feature of commodity price-based inflation: there are substantial lags in passing through that inflation. Mistaking that lag for a lack of pass-through may explain the so-far benign response in measures of inflation expectations either in TIPS or in long-term Treasury yields, yet today's bear flattener move in interest rates clearly signals the credit market's current concern lies with rising inflation.”
From Goldman Sachs: “The Help Wanted index remained extremely low at 19, in fact a record low. Though there is an element of secular decline as advertising shifts away from newspapers, the weakness this cycle has gone beyond that. There were declines in a number of regions, and no region showed an increase.”
From RBSGC: “Overall, delinquencies rose across all four ABX indices last month, with serious delinquencies (90-day plus, FCs, REOs and bankruptcies) increasing in the aggregate to 28.3% from 27.0%, an absolute change of 1.35% or a rate of change of 5.0%. Yet the increase in delinquencies was smaller than the previous month, both in absolute and percentage terms, further flattening out the delinquency curve (the increase in April's report was 1.61% in absolute terms or 6.3% as a rate of change).”
End-of-Day Market Update
From Merrill Lynch: “The MBS rate is now at 5.77%, up 47bps in six days. With FN 5.5s now well BELOW Par (98-28 in Jun, 98-10 in Aug) the huge FN 6 cohort is now Out-Of-The-Money. Prepays will slow, MBS will lengthen, but most importantly, convexity demand will weaken !!!”
From SunTrust: “Moves in financial markets today have been vicious. Oil has traded in a $7 range, settling down to a $4 loss on the day. The US dollar Index is on a tear, trading at a 2-week high against 6 major currencies. Heating oil and natural gas are off 4% on the day. Treasuries moved by 10-14 bp higher in yield before recovering partially. S&Ps rose 16 points, but have given back 1/3 of that going into the close… When the bond market could not trade higher on good news, sellers pounced quickly. The carnage started in Europe, where their government bonds collapsed. Treasuries had little option but to follow with supply piling up by the day. The 5 yr auction was an abject failure. The yield tailed back to 3.52, 40 bp higher on the week, and interest was still weak. Bid cover was low at 1.84 times with only 16% indirects vs 28% last month. Mercifully, Treasuries hit bottom with the auction. A flood of buyers emerged at the lows, erasing half the losses in 10's.”
From UBS: “Treasuries took a beating on the back of an upward revision to Q1 GDP and a lackluster 5-year note auction. The stage was actually set in the overseas markets as weak JGB and Eurozone debt markets dragged treasuries lower early. Treasuries opened through every single support level across the curve. Meanwhile, the dollar rallied strongly, stock indices were up across the board, and Crude plunged below $127/barrel intraday… Following these unimpressive auction results, Treasuries tanked all over the curve, led by the 5-year area, which at one point was nearly 18bps cheaper on the day before rallying late in the session. By 3pm, Treasuries had recovered a good portion of their losses and 2's almost made it back to unchanged… Today's volume was 146% of the 30-day average, with total ICAP volume coming in at its highest level since March 31st… Swaps saw another day of curve flattening trades, with spreads widening across the board. Agencies had a return of massive demand in 12-18 month paper with yields north of 3%, but still underperformed Libor by 0.5-1bp. Mortgages saw heavy servicer selling this morning to the tune of $4B. Coupled with another $1B in origination, this selling overwhelmed the $1B+ in buying, pushing mortgages 8 ticks wider to Treasuries and 5 wider to swaps. After the Treasury auction, however, real-money accounts came in buying $2B+ in mortgages, which are now only 4 wider to Treasuries and 2 to swaps.”
From Lehman: “the yield curve steepened quite a bit today, with almost the entire move coming between 2s and 5s. The 5 year sector traded as much as 4 basis points cheaper to 2s and 10s intraday, bringing the two week total to about 12 basis points.”
From Bloomberg: “The dollar reached a three-month high against the yen as U.S. stocks gained and crude oil tumbled, brightening the outlook for the world's biggest economy. The U.S. currency also advanced the most in three weeks against the euro as the government said gross domestic product was stronger last quarter than initially estimated. The rally started late yesterday after Federal Reserve Bank of Dallas President Richard Fisher said yesterday the central bank will raise interest rates should consumers expect faster inflation.”
From Bloomberg: “U.S. stocks rose for a third day, the dollar jumped to a three-month high against the yen and the 10- year Treasury note's yield climbed to the highest since December after a government report showed the U.S. economy grew more than estimated in the first quarter. Crude oil dropped the most in two months. The Standard & Poor's 500 Index capped its biggest three-day advance in six weeks after the Commerce Department said gross domestic product grew at a 0.9 percent pace last quarter. Oil lost as much as 3.8 percent on signs record prices will prompt consumers to reduce fuel purchases. ``We didn't have negative growth in the fourth quarter and it looks like we didn't in the first quarter,…``Growth is going to pick up in the second half of the year. We're running out of time to have a recession.'' The S&P 500 added 0.5 percent to 1,398.39 at 3:44 p.m. in New York. The dollar climbed to 105.71 yen from 104.69 yesterday. The yield on the 10-year note rose 0.08 point to 4.09 percent. Crude oil lost 3.3 percent to $126.75 a barrel. Faster-than-estimated economic growth bolstered speculation the Federal Reserve will increase interest rates. Futures on the Chicago Board of Trade show a 42 percent likelihood that the Fed will raise the target rate for overnight lending between banks by at least a quarter-percentage point in September, compared with 29 percent odds yesterday. The Fed cut the target lending rate seven times since mid-September, pushing it to 2 percent, and arranged lending programs to increase trading in the credit markets. Financial shares led the rally in U.S. stocks after MasterCard Inc. forecast faster profit growth and JPMorgan Chase & Co. predicted bank shares will rally as corporate borrowing costs fall. Bank of America Corp. and Wells Fargo & Co. helped send the KBW Bank Index higher after JPMorgan strategist Thomas Lee predicted the group will climb 21 percent as the cost of protecting their bonds from default declines. MasterCard's shares jumped to a record after saying consumers are using credit and debit cards more… Countrywide Financial Corp., the largest U.S. mortgage
lender, posted the steepest gain in the S&P 500 after setting June 25 as the date for shareholders to vote on the $4 billion takeover by Bank of America. A firm date for the special shareholders meeting may help quell investor concern that Bank of America will seek a lower price or cancel the deal. Countrywide rallied 8 percent to $5.38. Citigroup Inc., the largest U.S. bank by assets, climbed 2.7 percent to $22.18. Bank of America, the second-biggest, rose 2.2 percent to $34.60. JPMorgan, the No. 3, added 2.5 percent to $43.92. Wells Fargo increased 2.1 percent to $28.04. Financial stocks in the S&P 500 rose 1.8 percent, thesecond-most among 10 industries. The group has tumbled 33 percent over the past year after global banks and securities firms racked up $383 billion in asset writedowns and credit losses related to the collapse of the subprime mortgage market. The world's largest banks and securities firms have cut 83,000 jobs in the past 10 months. The KBW Bank Index of 24 companies rebounded from a six-week low, gaining 1.7 percent… ``There's a lot of concern about inflation, and you're seeing investors build more inflation premium in yields. There's a growing expectation the Fed's finished cutting rates.''”
Three month T-Bill yield rose 2 bp to 1.90%.
Two year T-Note yield rose 3 bp to 2.68%
Ten year T-Note yield rose 7 bp to 4.08%
Dow rose 52 to 12,646
S&P 500 rose 7.5 to 1398
Dollar index rose .20 to 72.54
Yen at 105.5 per dollar
Euro at 1.55
Gold fell $23 to $878
Oil fell $4.63 to $126.4
*All prices as of 4:40 PM