Today's Tidbits

Global Manufacturing Contracts for 1st Time in 5 Years
From JPMorgan: “JPMorgan’s global manufacturing PMI fell 0.9 points to 49.5 in June. This was the first sub-50 reading since June 2003, when the global economy was hit by the twin shocks from the SARS epidemic and the US invasion of Iraq. Each of the major PMI’s components fell below the breakeven mark last month—including new orders, output and employment, with the exception of input prices, which set a new series high of 80.1. In addition to pointing to a significant deterioration in the global manufacturing sector in June, the PMI suggests that conditions may worsen even further in coming months…When combined, the ratio of new orders to inventory, which is the best barometer of underlying momentum in the manufacturing sector, fell to 0.98. This is the second lowest reading on record and is a signal that global manufacturing production is poised to contract. When viewed from a regional perspective, most national PMIs fell last month, including in the Euro area, the United Kingdom, Japan and China. The US was the key exception…However, the main driver behind the increase in the ISM survey was an increase in the inventory index, which is hardly a positive…demand growth is weakening across the globe, rather than being focused in the United States, as before.
Indeed, there is little reason to look for any improvement in global manufacturing activity in the near-term. Final demand growth is weakening in the major economies, and is likely in the emerging world as well, in response to tighter credit conditions, weaker housing markets, and higher food and energy prices. This will maintain the downward pressure on industrial activity, which is highly sensitive to movements in demand.”
Global Corporate Earnings Weaken
From FinancialWeek: “The multinational play was based on a combination of strong global growth and a weak U.S. dollar. But now with Europe slowing sharply, a cyclical economic slowdown in emerging markets and inflation rearing its head across the world economy, continued strong global demand is anything but certain. “Disappointing guidance from U.S. multinationals regarding global earnings could be the next shoe to drop on the U.S. equity markets,” Joseph Quinlan, chief market strategist of global wealth and investment management at Bank of America, wrote in a note to clients. “While there remains an investor bias toward large-cap U.S. equities, this asset class could be in for some difficult times ahead if the global economic slowdown ... gathers pace in the second half of this year,” he added. Earnings estimates for the S&P 500 are already falling fast. For the second quarter, analysts polled by Thomson Reuters now expect earnings to fall by 11.1% -- compared with expectations of a fall of 2% at the beginning of April. The biggest contributor to that drop in earnings expectations are financials and consumer discretionaries. But analysts are also beginning to scale back expectations for some of the sectors which have been doing relatively well. Earnings growth expectations for industrial companies have been cut nearly in half – to 5% from 9%, according to Thomson Reuters data…While U.S. domestic profits declined 3% in 2007, overseas earnings rose 17%, making up the only real strength in corporate profits over the past year, said Bank of America’s Quinlan. But that may be about to change. The global economy only expanded by a 3 percent annual rate in the first half of 2008 compared to a 5 percent rate a year ago, according to Bank of America. U.S. foreign affiliate income, a proxy for global earnings, declined 4.5% year-over-year in the first quarter, the bank’s data showed. This deceleration in growth will ultimately take some wind out of the sails for U.S. global earnings, Quinlan wrote.”
Vehicle Sales Plunged in June
From Bloomberg: “General Motors Corp., Toyota Motor Corp. and Ford Motor Co., the biggest auto retailers in the U.S., said June sales plunged as fuel prices above $4 a gallon drove consumers away from gas-guzzling trucks. GM sales fell 19 percent, Ford was down 28 percent and Toyota dropped 21 percent. Honda Motor Co. and Volkswagen AG, which rely on cars for the bulk of their sales, each rose about 1 percent…For the second straight month, Ford's F-Series large pickup, perennially the best-selling vehicle in the U.S., was outsold by four cars: Toyota's Corolla and Camry and Honda's Civic and Accord. Nissan Motor Co. reported an 18 percent total decline.”
Southwest Airlines Has Profited From Fuel Hedges
From San Diego Union-Tribune: “In the first quarter of this year, Southwest paid $1.98 per gallon for fuel. American Airlines paid $2.73, and United paid $2.83 per gallon in the same period. Since 1999, hedging has saved Southwest $3.5 billion. It has sometimes meant the difference between profit and loss. In the first quarter, hedging gains of $291 million dwarfed Southwest's $34 million profit… The transactions carry a price tag. Southwest spent $52 million on hedging premiums last year and $14 million in the first three months of this year. As a result mostly of trades made years ago, Southwest has hedged 70 percent of this year's fuel needs at $51 per barrel instead of the current price of more than $140 per barrel. But hedging premiums rise and fall with the price of the underlying commodity, making new trades very expensive. Southwest has not done much trading in the last several months. Airline executives say hedging is not a bet on the direction of oil prices. “We view our program as insurance,” said Paul Jacobson, the treasurer of Delta Air Lines Inc. “Our goal is to minimize the volatility of fuel expenses. To do that, you've got to be in the market actively without an opinion as to what energy prices will do.” But hedging carries risks. Airlines can lose money if oil prices turn down and their options expire. In 2006, Delta won approval from a bankruptcy court and creditors to get into hedging. But the airline got squeezed when oil prices dropped in midyear, and it reported a loss of $108 million from the trading. Continental Airlines Inc. reported a loss of $18 million from hedging in the first quarter of 2007. But like Delta, Continental is still hedging… At one time in the 1990s, most major U.S. airlines hedged some of their fuel costs – even hiring experts from the oil industry to show them the ropes …That changed after the recession and terror attacks of 2001, which plunged airlines into huge losses. Banks and energy companies that make hedging trades with airlines grew nervous. “The problem was that most carriers had terrible creditworthiness and couldn't hedge,” … “Counter-parties feared the carriers would renege on their trades.” Southwest was the only large U.S. carrier to remain profitable through the downturn. It benefited from higher labor productivity and lower ticket-sales costs. That, and a healthy balance sheet, allowed it to keep hedging when oil was a bargain, compared to today's prices. Now, Southwest is the only big carrier that has most of its fuel expenses hedged at below-market prices. And analysts say it will be the only one to earn a profit this year. While other carriers plan to slash flights later this year – some contracting by more than 10 percent – Southwest expects to grow…The bulk of Southwest's hedges expire gradually by 2012. Replacing them would be very expensive and risky. One plan under study is to go back to hedging only against catastrophically higher oil prices – say, $200 per barrel. Unless oil prices stabilize or even decline, the airline could face a crisis covering higher fuel costs in just a few years. “It's starting to have an impact on their operating plan,” said Betsy Snyder, an analyst for the debt-rating service Standard & Poor's. “They're cutting back growth plans for the first time ever and exiting some unprofitable routes.” Chairman and Chief Executive Gary Kelly said the fuel hedges have bought his airline time to adjust to higher energy costs. Now he wants to find $1.5 billion in new revenue to make up for shrinking fuel hedges. ”
Fast Money Makes Managing Growth and Inflation Tough for China
From the Economist: “…although China’s trade surplus has started to shrink this year, its foreign-exchange reserves are growing at an ever faster pace. The bulk of its net foreign-currency receipts now comes from capital inflows, not the current-account surplus. According to leaked official figures, China’s foreign-exchange reserves jumped by $115 billion during April and May, to $1.8 trillion. In the five months to May, reported reserves swelled by $269 billion, 20% more than in the same period of last year. But even this understates the true rate at which the People’s Bank of China (PBOC) has been piling up foreign exchange.. speculative inflows during that period were perhaps well over $200 billion, because hot money also comes into China through companies overstating FDI and over-invoicing exports. Foreign firms are bringing in more capital than they need for investment: the net inflow of FDI is 60% higher than a year ago, yet the actual use of this money for fixed investment has fallen by 6%. Some of it has been diverted elsewhere. It is one thing to deduce how much money is coming in. It is another to work out where it is going and how it gets past China’s strict capital controls. The stockmarket, which continues to plunge (see article), is no home for hot money. Some has gone into property. The lion’s share is in bog-standard bank deposits. An interest rate of just over 4% on yuan deposits compared with 2% on dollars, combined with an expected appreciation in the yuan, offers a seemingly risk-free profit for those who can get money into China. It comes in via various circuitous routes. Big Western investment funds which care about liquidity would find it hard to move money into China... Massive hot-money inflows present two dangers to China’s economy. One is that capital could suddenly flow out, as it did from other East Asian countries during the financial crisis a decade ago and Vietnam this year. China’s economy is protected by its current-account surplus and vast reserves, but its banking system would be hurt by an abrupt withdrawal. A more immediate concern is that capital inflows will fuel inflation. The more foreign capital that flows in, the more dollars the central bank must buy to hold down the yuan, which, in effect, means printing money. It then mops up this excess liquidity by issuing bills (as “sterilisation”) or by lifting banks’ reserve requirements. But all this complicates monetary policy. China’s interest rates are below the inflation rate, but the PBOC fears that higher rates would attract yet more hot money and so end up adding to inflationary pressures. The central bank has instead tried to curb inflation by allowing the yuan to rise at a faster pace against the dollar—by an annual rate of 18% in the first quarter of this year. But this encouraged investors to bet on future appreciation, exacerbating capital inflows. Since April the pace of appreciation has been much reduced, in a vain effort to discourage speculators… money-supply growth would explode without sterilisation, which is now close to its limit. It is becoming very costly for the central bank to mop up liquidity by selling bills, so it is now relying more heavily on raising banks’ reserve requirements (the PBOC pays banks only 1.9% on their reserves, against over 4% on bills). Since January 2007 the minimum reserve ratio has been raised 16 times, from 9% to 17.5%. But it cannot climb much higher without hurting banks’ profits. To curb future inflation, China therefore needs to stem the flood of capital. One solution would be a large one-off appreciation of the yuan so that investors no longer see it as a one-way bet. This, in turn, would give the PBOC room to raise interest rates. The snag is that the yuan would probably have to be wrenched perhaps 20% higher to alter investors’ expectations, and this is unacceptable to Chinese leaders, especially when global demand has slowed and some exporters are already being squeezed. This implies that monetary policy will remain too loose. The longer that the torrent of hot money continues and interest rates remain too low, the bigger the risk that underlying inflation will creep up.”
From MNI: “Chinese policymakers are reorienting their approach to the economy, moving away from an obsession with preventing overheating and instead bracing for a climate in which slowing global demand and rising inflationary pressure place growth risks firmly on the downside.”
MISC
From Citi: “Fed Minutes released last week indicate that JPMorgan has been granted an 18 month exemption which would allow it to exclude the assets and exposures of Bear Stearns from its regulatory capital requirements.”
From Merrill Lynch: “The addition of Elizabeth Duke to the Federal Reserve Board makes it less likely that Bernanke will have to compromise with the more hawkish Presidents as it should allow him more freedom in making policy decisions. We believe this addition further increases the probability of easier monetary policy in early 2009.”
From Bloomberg: “Moody's Corp. ousted the head of its structured finance unit and said employees violated internal rules in assigning ratings to last year's worst performing
securities….Moody's, the world's second largest credit-rating company, said today that employees, not the company's practices, were to blame. ``Moody's have lost a lot of credibility,''…”
From The New York Times: “Another strain on the economy and markets is the rapidly rising prices for energy, food and other commodities. Crude oil prices are up about 51 percent this year and corn prices are up 55 percent. That surge in raw materials is one reason that fast-growing markets like China and India — which are increasingly dependent on energy imports — have taken a beating in recent months. The Shanghai stock market is down 48 percent for the year, and the Nifty index in India is down 34 percent. By contrast, markets in Russia and Brazil, which are big exporters of commodities, are essentially flat for the year. “The emerging markets are associated with higher commodity prices, but not all emerging markets are beneficiaries,” said Simon Hallett, chief investment officer of Harding Loevner Management, an investment firm based in Somerville, N.J. “Russia and Brazil are commodity producers, but China and India are commodity consumers.””
From Bank of America: “[ISM] Prices paid is the highest since 1979.”
From RBSGC: “…the Census Bureau revised the entire private residential series going back to 1993 due to methodological changes (expenditures on private residential improvements to rental, vacant, and seasonal properties are now being excluded from the data, but improvements on owner-occupied structures will remain).”
From Merrill Lynch: “The sharp declines in the equity market have meant that $2.1 trillion of 'paper wealth' has evaporated so far this year - 70% of that loss occurring in June alone.”
From The New York Times: “Lehman Brothers, which has been struggling to persuade investors that it can survive as an independent firm, fell 11 percent Monday, bringing its loss for the year to nearly 70 percent.”
From Bloomberg: “Legg Mason has lined up $2.15 billion in financing since November to cushion its money funds from potential losses. The funds bought debt from structured investment vehicles, or SIVs, that held securities backed by subprime mortgages. In the three months ended March 31, Legg Mason posted a $255 million net loss, its first as a public company.”
From The LA Times: “Battling rumors that it may collapse, Pasadena-based IndyMac Bancorp acknowledged Monday that its financial position had deteriorated but described the fears as overblown and said it was working with regulators to improve its "safety and soundness."… The shares are down 90% this year… More than 96% of IndyMac's deposits are safe because they are insured by the FDIC, IndyMac said. The agency covers up to $100,000 per depositor. Retirement accounts are insured separately for up to $250,000.”
From Bloomberg: “Starbucks Corp., the world's largest chain of coffee shops, plans to close 600 ``underperforming'' stores in the U.S.”
End-of-Day Market Update
From RBSGC: “The market did little more than trade off of movements in domestic equities -- but in the wake of quarter-end, we see this as overall supportive, despite the fickleness of the strength. In fact, it is equally constructive that 2-year yields dipped to 2.52% even with a better-than-expected ISM report and smaller than forecast decline in construction spending. And with volumes heavy, we see this as setting the pre-Employment Report range. From a technical perspective, Tuesday's price action has broken the upward sloping channel in 2s -- much the same as the previous channel in 10s. Now through the 2.65% channel bottom, a projection to 2.35% seems achievable in this environment. That said, while momentum remains bullish, its waning somewhat as the strengthening slows. The selloff in equities and upside in Treasuries have edged the bar higher for a post-Employment Report rally on consensus data. Also of note from Tuesday's session, was the JPM survey, showing investors at a very flat 75% -- that's tied with early-June as the second flattest on record (since '97) behind the Sept '00 78% level..Volumes were very strong, with cash trading at 129% of the 10-day moving-average.”
From Lehman: “The treasury market took a roller coaster ride on Tuesday, rallying as much as 10 basis points in the 5 year sector as stocks got clobbered early, and then falling quickly when the equity market rebounded in the afternoon. The yield curve steepened a few basis points during the morning rally, and the 5 year sector had a particularly good bid, but the curve finished only marginally steeper as long bonds recovered from selling on the back of some large steepening trades in the afternoon selloff. Tuesday's trading volumes were high, with over 1.1 mm ten year contracts trading, and the market had a bit of a panicked feel about for much of the morning session.”
From JPMorgan: “Wild day. UST's were bid all day, particularly in the 5y sector, as equities tested their March low. The price action was similar to that of the last few days where MBS, swaps, and other spread product would not participate in the UST bid and spreads widened into uptrades. After ISM we saw a significant amount of duration shedding out of the servicing community in the long end of the curve. This also dragged in some rate paying in 10s from a few bank portfolios and rate lockers who had been sitting on the sidelines looking for a level to sell. … Today's reversal will set the resistance for the short term across the curve and will be the basis of stops for shorts set today.”
From SunTrust: “It appears that equities averted the trip to Hades for one more day… Nonetheless, the ISM was enough to turn stocks around and pressure Treasuries lower…Dollar weakness does have one advantage, exports are cheap. Also of some cheer to equities is weaker oil this afternoon, a real bargain at "only" $140 per barrel. CIT, Lehman and GM all managed to trade higher today, albeit small gains. 2 yrs managed to eke out 2.52 before yields turned higher. 10 yrs touched 3.90. Both issues are going into the close 10 bp higher as stocks lift up. The next hurdle for markets will be employment.”
From UBS: “Treasuries kicked off the session with a head of steam, with the front end richer by double-digit basis points, before a stronger-than-expected ISM Mfg. number put the kibosh on the rally. Subsequently, Treasuries simply mirrored stocks the rest of the way, leaving us little changed on the day as of 3pm. After stocks came back from heavy losses to close up (slightly) on the day. There was real money buying in intermediates helping the belly outperform on the day. We saw buying of 20-year TIPS, which continued to outperform nominals. Breakevens widened across the board, and the January 2009 breakeven was out by more than 17bps… With GM announcing better-than-feared sales today, total light vehicle sales for June appear on track to hit about 14.0M. This is in line with forecasts but still down from May's 14.3M in sales…Mortgages see origination again, get smoked on the day:
Swaps saw 2-way flow on curve trades, and back end spreads widened modestly. Agencies saw buying of 5- and 10-year paper, trading in line with Libor across the board. Mortgages had about $1.5B in origination, the most we've seen in about 2 weeks. With buyers seemingly on strike, mortgages went as much as 11 ticks wider to Treasuries and 8 to swaps, before coming back in to "only" 8+ wider to Treasuries and 6 to swaps.”
From Bloomberg: “U.S. stocks rose, helping the market rebound from its worst month in six years, after better-than- forecast sales at General Motors Corp. overshadowed concern that rising energy costs will damp corporate profits. GM, the largest U.S. automaker, jumped the most in more than two weeks and led the Dow Jones Industrial Average's rebound from an almost 167-point drop earlier in the day. American Express Co. posted its best gain since May on UBS AG's upgrade of the biggest U.S. credit-card company, while CIT Group Inc. jumped the most since March after selling its mortgage businesses to Lone Star Funds and Berkshire Hathaway Inc. Rising oil prices sent shares of FedEx Corp. to a four-year low, limiting gains in benchmark indexes. The Dow Jones Industrial Average climbed 32.25 points, or 0.3 percent, to 11,382.26, erasing earlier declines that sent the 30-stock gauge into a bear market for a third day. The Standard & Poor's 500 Index added 4.91, or 0.4 percent, to 1,284.91. The Nasdaq Composite Index advanced 11.99, or 0.5 percent, to 2,304.97…The Dow pared its retreat from an October record to 19.6 percent, less than the 20 percent decline that signals the start of a so-called bear market. The S&P 500 has lost 18 percent since its October peak after the biggest quarterly increase in oil prices since 1999 led analysts to cut forecasts for S&P 500
profit growth this year in half to 5.9 percent. The benchmark for U.S. equities tumbled 8.6 percent in June, its worst month since 2002…CIT Group gained the most in the S&P 500 and led financial shares to their first advance in four days, rising $2.02, or 30 percent, to $8.83. The business lender that's lost money for four straight quarters agreed to sell its manufactured housing and home-loan businesses for $1.8 billion as it exits consumer lending. Other mortgage-related companies rallied as CIT gained the most since March. MGIC Investment Corp., the largest U.S. mortgage insurer, rose 43 cents, or 7 percent, to $6.54. Washington Mutual Inc., the biggest U.S. savings and loan, increased 32 cents, or 6.5 percent, to $5.25. Lehman Brothers Holdings Inc. advanced $1.15, or 5.8 percent, to $20.96. Morgan Stanley said the fourth-largest U.S. securities firm has sufficient cash and rated the stock ``overweight'' in new coverage…The S&P 500 swung between gains and losses at least 25 times as a report showing unexpected growth in manufacturing was offset by a jump in oil prices of as much as $3.33 a barrel…il extended this year's gain to 47 percent after the International Energy Agency said supplies may not keep up with demand through 2013 and ABC News reported Israel is increasingly likely to attack Iran this year, starting a conflict that would cut crude supplies from the second-largest producer of theOrganization of Petroleum Exporting Countries. Iran's government dismissed the report as propaganda, while Israeli government officials declined to comment. Pentagon spokesmen Bryan Whitman declined to address the report and State Department spokesman Tom Casey said he had ``no information that would substantiate'' the ABC report, which cited an unidentified Pentagon official. Crude oil for August delivery rose 97 cents, or 0.7 percent, to settle at $140.97 a barrel in New York. Futures have doubled from a year ago…Home Depot Inc., the biggest home-improvement retailer, slid 21 cents to $23.21. Lowe's Cos., the second-largest, dropped 14 cents to $20.61. Merrill recommended investors sell shares of the two chains and other retailers whose earnings are being hurt by the housing slump. ``We see the difficult housing environment worsening throughout 2008,'' Merrill analyst …”
Three month T-Bill yield unchanged at 1.86%.
Two year T-Note yield rose 3 bp to 2.65%
Ten year T-Note yield rose3bp to 4%
Dow rose 32 points to 11,382
S&P 500 rose 5 to 1285
Dollar index fell .10 to 72.36
Yen at 106.1 per dollar
Euro at 1.579
Gold rose $14 to $940
Oil frose$1.42 $141.4
*All prices as of 5 PM