Today's Tidbits

Cost of Not Taking The “Punchbowl” Away Quickly Enough
From MNI: Dallas Fed President “Fisher… the Fed has been acting aggressively to alleviate the credit crisis and the economic downturn, but said there are limits to what the Fed can do. He called for unspecified fiscal action to complement the Fed's efforts. Pointing to the aggressive lending which the Fed has done to resolve the credit crisis and rescue large financial firms, Fisher observed, "You can see the size and breadth of the Fed's efforts to counter the collapse of the credit mechanism in our balance sheet." Noting that the Fed's assets have more than doubled from $890 billion at the start of the year to more than $1.9 trillion, Fisher said he "would not be surprised to see them aggregate to $3 trillion -- roughly 20% of GDP -- by the time we ring in the New Year." Fisher also observed that "the composition of our holdings has shifted considerably. Previously, almost 100 percent of our holdings were in the form of core holdings of U.S. Treasuries; today, less than a third are. The remainder consists of claims deriving from our new facilities."… Because of the Fed's "limited role," Fisher said "Complementary action must now be undertaken by the fiscal authorities." He did not say what kind of fiscal stimulus he would like to see. The U.S. is "experiencing the conesquences of the failure to take away the punch bowl and of allowing the exuberant 'animal spirits' of
our economy to get out of hand," Fisher said, adding, "We must never allow this to happen again."”

Why Has The Dollar Been Rallying?
From Dr. Ronald Solberg: “What has caused this abrupt appreciation of the US dollar during the past quarter…First, the seven-year decline in the US dollar’s value through July 2008 improved US competitiveness and… has led to an acceleration of export revenue. Slower GDP growth is also allowing imports to decline. These two effects have begun to stabilize the US trade deficit in nominal terms and allowed net exports in real terms to contribute 1.1% to Q3 2008 GDP growth. The shrinking trade deficit has also contributed to the narrowing of the current account deficit. By pumping fewer US dollars to our foreign suppliers, this narrowing is shrinking global liquidity and creating further support for the dollar. A second fundamental reason for US dollar strength has been an improvement in US terms-of-trade: the ratio of export prices over import prices. Since the United States is a net energy importer and this cost represents a significant portion of total import expenditures, the recent decline in crude oil prices has been a boon to our terms-of-trade. The improvement in US terms-of-trade has also supported the US dollar. Thirdly, it is suggested from viewing the highly unusual negative break-even yields for inflation-linked bonds (TIPs) that investors believe the US will suffer deflation, not inflation, for the foreseeable future. This expectation for a declining price level, as a corollary, also creates the expectation for US dollar appreciation…Perhaps the most important driver of the US dollar’s recent appreciation is not a fundamental but a technical factor. The meltdown of prices in the commodity complex, particularly energy, has generated a very strong impulse for US dollar strength. Whilst many commodity end-users were outright cash buyers, other buyers that were investing or speculating in commodities as a newfound asset class over the past five years would typically fund their position with US dollar-denominated credit, in effect, creating a US dollar short position. Now that these commodity carry trades are being unwound, it exacerbates commodity weakness and contributes to US dollar strength. In addition, US investments in foreign markets, particularly equities, were primarily un-hedged and large amounts of those monies are now being repatriated which holds similar bullish US dollar effects.

Huge Drop In New Mortgage Insurance Contracts
From LEHC: “The Mortgage Insurance Companies of America reported that primary new mortgage insurance written by members totaled a measly $8.1 billion in September, down almost 72% from last September’s pace. “Bulk” insurance written was “virtually zero” for the third straight month, compared to $5.8 billion last September…Private mortgage insurance companies, battered by rising mortgage defaults and soaring claims, have tightened underwriting and raised pricing considerably over the past year. As a result, an increasing number of borrowers have turned to the FHA SF program, which saw total SF mortgage endorsements surge from about $6 billion last September to about $25 billion this September. Current FHA pricing is massively below any private alternative for loans where the borrower makes the minimum down payment, and that is especially true for borrowers with less than perfect credit, and for borrowers in areas where home prices have been falling and foreclosures rising. The huge increase in the FHA loan limit in many parts of the country earlier this year has made government-subsidized low-down-payment mortgage financing available to the vast bulk of the US population – both for owner-occupied home purchase loans and for refinance loans – including folks who are pretty well off! Private mortgage lenders, stung not simply by much higher than expected home price declines but also by much higher default rates than “models” had predicted given observed home price declines, have reassessed both the pricing of and the logic of making low- or no-down payment mortgage loans.”

Concerns Rising China’s Growth Could Fall Below Stability Enhancing 8%
From the FT: “Wen Jiabao, China's prime minister, warned that high growth was needed to maintain social stability as fresh evidence emerged yesterday that China's economy was slowing quickly. In an article in a Communist party magazine, Mr Wen said 2008 was "the most difficult year in recent years" and maintaining high growth was the priority. "We must be crystal-clear that without a certain pace of economic growth, there will be difficulties with employment, fiscal revenues and social development . . . and factors damaging social stability will grow," he wrote in the magazine…The decision to relax lending quotas is the latest in a series of steps to prevent a hard landing in the economy, including three cuts in interest rates and a fiscal stimulus plan that includes a Rmb2,000bn ($292bn, €231bn) investment in railway infrastructure. Stephen Roach, chairman of Morgan Stanley Asia, said the flurry of recent announcements could indicate that Chinese authorities knew growth had already dipped below 8 per cent, sometimes considered an important benchmark. "The way the Chinese are reacting now is either visionary and proactive or they are panicking," he said. Many economists believe the economy can still expand by around 8 per cent next year. "There is no reason to panic," said Andy Rothman, economist at CLSA. But several have reduced their forecasts over the last few weeks. Dong Tao, at Credit Suisse, said yesterday that growth in the fourth quarter of this year could fall as low as 5.8 per cent.”

MISC
From Bloomberg: “U.S. auto sales plummeted 32 percent in October to the lowest monthly total since January 1991, led by General Motors Corp's 45 percent slide, as reduced access to loans and a weaker economy kept consumers off dealer lots. Ford Motor Co. reported a 30 percent drop in car and light- truck sales from a year earlier and Toyota Motor Corp.'s declined 23 percent. Honda Motor Co.'s slid 25 percent, Nissan Motor Co.'s were down 33 percent and Chrysler LLC's fell 35 percent. ``If you adjust for population growth, it's the worst sales month in the post-World War II era'' for the industry, said Mike DiGiovanni, GM's chief sales analyst, on a conference call. ``Clearly we're in a dire situation.'' Industrywide U.S. auto sales fell for the 12th straight month, extending the longest slide in 17 years.”
From Citi: “The Fed's Senior Loan Officer survey was also very tight. In October, a net 47% of all banks pulled back from lending to consumers, according to a series with the longest history in the report. Other than the net 79% pulling back from consumer lending in 1Q 1980, this was the most severe tightening event measured in the survey's history… The net percentage of banks tightening standards for commercial real estate loans rose to a record high 87% from 80.7% in 3Q. This points to outright declines in non-residential construction activity looking forward.”
From Bloomberg: “The cost of borrowing dollars for one month in London fell to the lowest level in almost four years as central-bank cash injections and interest-rate cuts worldwide showed signs of thawing the freeze in lending. The London interbank offered rate, or Libor, that banks charge each other for such loans slid 18 basis points to 2.18 percent today, the lowest level since November 2004, and the 17th straight decline, according to British Bankers' Association data. The three-month rate dropped 15 basis points to 2.71 percent, the lowest level since June 9, according to BBA figures. Interbank rates have tumbled worldwide as central banks slashed interest rates and governments pledged as much as $3 trillion of emergency funds to kickstart lending.”
From the Treasury: “Over the October – December 2008 quarter, the Treasury expects to borrow $550 billion of marketable debt, assuming an end-of-December cash balance of $300 billion, which includes $260 billion for the Supplementary Financing Program (SFP). Without the SFP, the end-of-December cash balance is expected to be $40 billion. This borrowing estimate is $408 billion higher than announced in July 2008. The increase in borrowing is primarily due to higher outlays related to economic assistance programs, lower receipts, and lower net issuances of State and Local Government Series securities.”
From Bloomberg: “The broadest set of data yet on the credit-default swaps market will be released today as traders in the market say concerns about potential losses from the more than $47 trillion in outstanding contracts are overblown. The Depository Trust & Clearing Corp., which operates a central registry of credit swaps trades, will publish details including the top 1,000 contracts on its Web site after 5 p.m. New York time. The data is being released after pressure from regulators for more transparency about risks in the market after trading exploded the past decade. The data will for the first time offer a clearer picture of the amount wagered on the creditworthiness of the world's companies and governments.”
From Bloomberg: “New York City commercial real estate transactions plunged 61 percent in 2008 through October as the global credit crisis roiled lending and sidelined buyers.”
From Merrill Lynch: “The Baltic Dry Index, a measure of commodity shipping costs, has plunged 21 days in a row. The index is now at its lowest level since February 1999. In fact, the index is off a staggering 90% from its peak seen back in May of this year.”
From MNI: “Taiwan and China began historic talks here aimed at bringing the two sides closer economically…the discussions that are expected to ink deals potentially worth billions of dollars to each side…China and Taiwan have agreed to open direct sea, air and postal links at the morning session of talks in Taipei…”
End-of-Day Market Update
From Bloomberg: “U.S. stocks advanced in the biggest presidential Election Day rally in 24 years, led by energy and banking shares, on rebounding commodity prices and speculation the Treasury will bail out more financial companies. General Electric Co. added 7.6 percent while CIT Group Inc. and Principal Financial Group Inc. climbed more than 22 percent after people briefed on the matter said the government may broaden the focus of its rescue program. Exxon Mobil Corp. and Chevron Corp. led all 40 energy shares in the Standard & Poor's 500 Index higher as oil gained. Archer Daniels Midland Co. rose 15 percent after profit more than doubled at the world's largest grain processor. ``The market has come to the conclusion that Armageddon is off the table,'' said Philip Orlando, who helps manage $330 billion as chief equity strategist at Federated Investors Inc. in New York. ``The elimination of the uncertainty of the campaign typically results in an end-of-year rally and you're starting to see that today.'' The S&P 500 added 39.42 points, or 4.1 percent, to 1,005.72, its first close above 1,000 since Oct. 13. The Dow Jones Industrial Average rose 305.45 points, or 3.3 percent, to 9,625.28. The Nasdaq Composite Index advanced 53.79, or 3.1 percent, to 1,780.12. Gains in Europe and Asia sent the MSCI World Index to a sixth straight advance. Today's advance in the S&P 500 and Dow average are the biggest for a presidential Election Day since the NYSE first opened for trading during a vote in 1984. The S&P 500 rose on four and fell on two of the previous presidential election days since then, averaging a 0.3 percent gain. The winner between Democrat Barack Obama, who leads in national polls, and Republican John McCain will contend with an economy crippled by declining profits and the highest unemployment in five years… Concern economic growth is slowing sent the S&P 500 down 17 percent in October, the steepest monthly loss since 1987. The month's sell-off erased more than $9.5 trillion from the value of stocks worldwide, almost one-third of the total value wiped out this year, as credit-related losses and writedowns by financial firms approached $700 billion. The S&P 500 has rebounded 18 percent since reaching a five-year low on Oct. 27 as global interest-rate cuts and government attempts to shore up banks spurred a 23 percent gain in the index's financial shares.”
From Bloomberg: “The dollar fell the most against the euro since the 15-nation currency's 1999 debut as the thaw in money markets reduced demand for the safety of U.S. assets. Brazil's real and South Africa's rand advanced versus the dollar on revived investor interest in emerging markets. The yen dropped against the dollar, the euro, the Australian dollar and New Zealand's currency as a global rally in stocks encouraged investors to buy higher-yielding assets financed by low-cost loans in Japan's currency. ``It's a broad setback for the dollar,'' … The dollar depreciated 2.7 percent to $1.2999 per euro … The euro climbed 3.5 percent to 129.71 yen from 125.33. The yen fell 0.6 percent to 99.76 per dollar from 99.12.”
From UBS: “Another quiet data day with a seeming decline in risk aversion. UST rallied smartly in the early afternoon, led by the intermediate sector. UST were responsive to movements in other sectors, as the Swap and MBS desks reported good real money buying, while the Treasury desk noted the out-performance of futures relative to cash. UST 2- year and UST 10- year approached our short term resistance levels of 1.375% and 3.75% respectively. The UST2Y10Y flattened -8 bps to 238 bps. In addition to the lower Libor sets of recent days, our anecdotal sense is that UST fails in the repo market continue to decline. It is hard to characterize the price moves in the various markets in a manner that makes sense. UST, equities, and commodities rallied in an asset grabathon. The dollar weakened presumably because there was a flight from quality (?) which conflicts with the UST rally theme.... Let's chalk this all up to thin markets and position squaring in anticipation of election results. Hopefully when we start the day tomorrow everything will make more sense. The Dow was up 305 points to 9,625. The CRB was 278.11, +14.11. Oil closed at $70.30/bbl, +6.22. UST volume was -34.5% below the 30 day trading average…. Spreads Narrow as Vol Seems Perched to Fall:
Let's lead with Vol. As noted yesterday, implied Vol is at very high levels which need to be justified by high realized price action. The market has seen subdued volumes and somewhat less intraday price volatility. Volatilities have been moving lower since mid-month and have now reached a support point. Further declines start to probe levels last seen in early September, before the world "changed." If the "repair" trade is on, then volatility is probably too high. MBS were very well bid today. Purchasing MBS can be a play on declining volatility. Our desk saw better real money buying and we heard the same away. The supply pipeline is thin and price movements can therefore be exaggerated. We see the current coupon MBS at 170 bps over a 50/50 weight of 5- year and 10- year swaps, -16 bps today. The swap desk reported better receiving across the curve as well as rate curve flatteners. The 2Y10Y swap box trade improved by about 8 bps, with 2- year spreads narrowing by -11.25 bps. Agency spreads joined the party as benchmark 2- years fell by -15 bps to 131, 5- years fell by -10 to 125 bps, and 10- years fell by -3 bps to 124 bps (Bloomberg).”

Prices as of 5PM (Based on Bloomberg)
Three month T-Bill yield fell 1 bp to 0.48%
Two year T-Note fell 6 bp to 1.37%
Ten year T-Note yield fell 19 bp to 3.72%
30-year FNMA current coupon fell 38 bp to 5.60%
Dow rose 305 points to9625
S&P rose 39 points to 106
Dollar index fell 1.57 points to 84.78
Yen at 99.7
Euro at 1.298
Gold rose $40 to $763
Oil rose $6 to $70