Friday, February 1, 2008
UM Consumer Sentiment Survey
As expected, the final reading for the University of Michigan consumer sentiment survey retreated lower to 78.4 (consensus 79) from the earlier reported level of 80.5 for January. Still, this is an improvement from the 75.5 reading of December, which was the second lowest reading since the early 90s. Both current conditions and future expectations eased from their preliminary January readings, but both are higher versus December. Current economic conditions finished at 94.4 (vs Dec at 91), and the economic outlook finished at 68.1 (vs Dec at 65.6). Inflation expectations held constant from the preliminary reading at +3.4% over the next year and +3% annually over the next five years. In December the five year inflation expectation was slightly higher at+3.1%.
January ISM Manufacturing Rebounds into Positive Territory
Manufacturing ISM unexpectedly rebounded in January to 50.7 from a revised higher 48.4 in December. Consensus had been looking for a decline to 47.3 from the originally reported 47.7 level. Any figure above 50 indicates expansion, while falling below the level indicates contraction. January's stronger performance pulls the indicator back into moderate growth territory. Over the past six months, the average has been 50.2. (FYI - The ISM manufacturing index used a new weighting for the headline figure this month giving equal weight to five of the major components.) The strength in January is due to a rebound in the production index which rose 6.6 points to 55.2. New orders rose 2.6 points to 49.5, but remain below breakeven. New export orders were especially strong at 58.5 vs 52.5 the prior month. Inflation remains an issue, as prices paid jumped to the highest level in over six months at 76, versus 68 in December. Also, the rise in inventories (49.1 vs. 45.4) is a concern. The inventory index gained more weight in the January index. The employment index eased back to 47.1 from 48.7. this is the lowest employment reading since 2003, and provides further support for this morning's decline in national employment in January. Historically, January's 50.7 reading equates to about a 3% real GDP growth rate.
Construction Spending Falls -1.1% MoM, -2.3% YoY
Total construction spending fell -1.1% MoM in December. The decline was totally attributable to residential spending which fell -2.7% MoM while non-residential spending was unchanged. Private residential spending fell -2.8% MoM and private non-residential spending fell -1.5% MoM. Public spending for non-residential structures, such as schools and hospitals, rose +14.5% MoM in December. Overall though, Federal government spending declined -1.3% MoM and state and local spending fell even more at -1.5% MoM. On a three month annualized basis, total construction has fallen -4.9%, indicating the pace of decline is accelerating. Again, all of the decline can be attributed to residential housing, which fell -29% annualized over the past three months, while non-residential construction rose 19% annualized. Over the past year, total construction spending has fallen -2.3% YoY, with residential down -20% YoY and non-residential growing +15.7% YoY. In the past twelve months, public spending has risen over 10%, mainly funded at the state and local level. Private investment has declined -6% YoY.
Economy sheds jobs in January
Non-farm payrolls unexpectedly tumbled into decline in January, as the economy lost 17k jobs. This was the first outright decline in combined private sector and government sector job growth in over four years. The market had been looking for a gain of 70k. Last month's anemic growth was revised higher to 82k from the originally reported 18k figure. The unemployment rate did ease back slightly to 4.925% after jumping +.3% last month to 5%. Big picture, it is clear that job growth has slowed dramatically. Manufacturing employment fell -28k MoM, the largest decline since last August. Large declines were seen in goods-producing jobs, which fell by -51k, and construction, which lost another 27k jobs. Business services had its first job losses in many months, falling -11k MoM after rising 70k in December. Government jobs also tumbled for the first time in 6 months, shedding -18k jobs. The largest job gains in January were in leisure and hospitality at +19k and retail trade at +11k. But both these figures are subject to question, due to the fact that the seasonal might be overestimating growth because fewer people were added last fall, so fewer were laid off this winter in these categories as businesses were hesitant to expand due to the weak economy. In total, service industries added 34k jobs in January versus expanding by 143k in December. Average weekly earnings fell -.1% MoM, as the aggregate hours worked fell -.3% MoM. Hours worked eased back to 33.7 from 33.8, where it has been since July. The manufacturing workweek held steady at 41.1 hours with overtime holding constant at 4 hours, down from 4.2 hours in September. Over the past year, average hourly earnings have risen +3.7% YoY and average weekly earnings have grown +3.4% YoY. The Labor Department announced its annual revisions, based on tax data, to adjust seasonal data for the past year. The revision subtracted 376k jobs from what was originally reported as job growth for 2007. This means the economy added 1.137 million jobs last year, or an average of 95k jobs a month. This is below the growth in the work force, which is estimated to add 120-150k new workers each month. So, it is not surprising the unemployment rate is rising.
Thursday, January 31, 2008
Employment Cost Index Steady, as Expected
The employment cost index rose +.8% QoQ in the fourth quarter of 2007. This was the consensus expectation, and the same pace as the prior two quarters. The breakdown was as expected as well. Wages and salary growth was constant at +.8% QoQ, while benefits edged up slightly to +.9% QoQ, versus +.8% the prior quarter. Over the past year, the employment cost index has risen +3.3%, with wages and salaries rising +3.4% YoY and benefits rising +3.1% YoY. This was the fastest annual growth pace since 2001. In 2006, the ECI rose +3.2% YoY. Benefits costs have been in a downtrend the past few years, since peaking at +6.7% YoY in 2004. Benefits costs rose +3.6% in 2006.
Personal Spending Slows in December as Income Grows, Inflation Steady at Elevated Levels
December personal income rose +.5% MoM (consensus +.4%, prior +.4%). Personal spending fell to a six month low in December, growing only +.2% MoM (consensus +.1%, prior +1%). The PCE deflator of total inflation eased back slightly to 3.5% YoY from 3.6% in November. Core PCE held steady at 2.2% YoY. The monthly change in core PCE also remained constant at +.2% MoM. The savings rate improved slightly to +.2% from zero, due to the fact that spending grew more slowly than incomes. Last month, inflation adjusted spending fell -.3% MoM for durable goods and -.2% MoM for non-durable goods, but services spending grew +.1% MoM. Disposable income, after taxes, rose +.5% MoM, but only rose +.2% when further adjusted for inflation. But this is an improvement over the declines of the prior two months. The slowdown in spending is going to be a concern for the economy. For all of 2007, personal spending rose only 5.7% YoY, the smallest increase in four years. When adjusted for inflation, spending barely grew last year. Personal income grew a tenth faster than spending in 2007 at +5.8% YoY, with wages and salaries growing +4.8% YoY. Over the past year, disposable income rose +5.6% YoY, but only +2.1% when adjusted for inflation. The PCE deflator remains elevated at +3.5% YoY. It has only been higher three months in the past 15 years. Core PCE, which excludes food and energy, spent the last quarter of 2007 at 2% or higher. The actual figure for December was 2.24% before rounding. This is above the Fed's desired range of 1-2%. Core PCE recently peaked at 2.5% in February of 2007.
Initial Jobless Claims Leap +69k to 375k
Initial jobless claims rose to over a two year high. This was the largest weekly jump in claims since Katrina. With the large moves in claims in recent weeks, both higher and lower than expected, many are blaming poor seasonals for the volatility. The market had been looking for initial claims to rise to 319k. The four week average rose 11k to 326k. Continuing claims also rose more than expected.
Wednesday, January 30, 2008
Today's Tidbits
From JP Morgan: “The Fed delivered 50bp as we expected, but the statement looks more dovish than we anticipated. Even after 125bp in easing in just over one week the FOMC notes: "Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," and "downside risks to growth remain." Finally, as we expected, Fisher dissented on this action and voted for no ease. Overall, even though the Fed notes that this ease combined with the cumulative easing prior to this should balance growth risks, they are still worried about the downside risks to growth.”
From UBS: “Overall, the tone suggests a willingness to continue easing if growth data continue to weaken—particularly if a recession has now begun, as we believe. We still forecast 25 bp rate cuts at each of the next three FOMC meetings (March 18, April 29/30, and June 24/25), with the funds rate down to 2.25% by mid-year. After that, we expect policy to go on hold as the economy starts to pull out of recession in the second half of the year.”
From Market Watch: “Five months ago, U.S. rates were the fourth-highest in the developed world and now they are the third-lowest… meaning the dollar is "yielding only 25 basis points more than Switzerland which means that once the Fed lowers rates again in March, and we expect them to, the U.S. dollar will be tied with the [Swiss] franc as second-lowest yielding currency in the developed world," above only Japan's rock-bottom 0.5%.”
From Bloomberg: “Banks may have to post additional writedowns of as much as $70 billion if credit ratings for bond insurers are downgraded, according to Oppenheimer & Co.'s Meredith Whitney. Citigroup Inc., Merrill Lynch & Co. and UBS AG hold 45 percent of the ``entire market risk,'' Whitney wrote in a note to clients dated yesterday. ``The fate of the monoline insurers is of paramount importance to financial stocks,'' Whitney wrote. ``When it becomes clear, as we expect it will, that more charges are on the horizon, we believe the market will take another turn for the worse.'' MBIA Inc., the largest bond insurer, and Ambac Financial Group Inc., the second-biggest so-called monoline insurer, are on review for possible downgrades by Moody's Investors Service and Standard & Poor's.”
From Reuters: “Recession fears are weighing heavily on U.S. corporate finance chiefs, pushing optimism down to a fresh three-year low, according to a survey on Wednesday. The quarterly survey from Financial Executives International (FEI) and Baruch College showed its optimism index sank 6.6 points, as nearly every chief financial officer polled said they were as concerned or more concerned about recession than they were in the previous quarter… Of the 361 CFOs polled, 73 percent said they were more concerned about a recession in the United States in the next 12 months. Economic growth ranked as their companies' top economic worry, followed by concerns about consumer spending, inflation and oil costs. Weakness in the dollar was also a worry, with nearly 46 percent of CFOs saying the decline would have a negative impact on their business.”
From Goldman Sachs: “Following this morning's ADP report, we are changing our estimate for January's payrolls to +125,000 and the unemployment rate to 4.9%. An outcome along these lines, while firmer than we first thought, would not alter our view that the labor market is in a longer-term trend of deterioration symptomatic of recession.”
From Deutsche Bank: “Housing affordability has improved fairly dramatically given the drop in conventional mortgage rates and declines in home prices relative to income.”
From Reuters: “Applications for home mortgages jumped to their highest level in nearly four years as low interest rates led more homeowners to seek refinancing… The MBA seasonally adjusted index of refinancing applications soared 22.1 percent to … the highest since July 2003. But the index measuring applications for home purchases declined 17.7 percent …Refinancing activity rose to 73 percent of all applications, up from 66 percent in the previous week…Fixed 30-year mortgage rates rose 0.11 percentage point last week to 5.6 percent, the MBA said. The previous week's rate was the lowest since late June 2005.”
From Realtytrac: “…more than 1 percent of all U.S. households were in some stage of foreclosure during the year, up from 0.58 percent in 2006.”
From Bloomberg: “UBS AG posted the biggest loss ever by a bank after raising fourth-quarter writedowns on securities infected by U.S. subprime mortgages to $14 billion.”
From The Financial Times: “The risk of bankruptcies among the big US homebuilders has risen sharply as the economy has weakened and an end to the housing slump remains distant. Credit default swaps on homebuilders, which act as insurance on corporate debt, suggest some of the biggest are at risk of failing to keep up debt payments… the most exposed are Standard Pacific, Hovnanian, Beazer and Meritage. All are among the top 15 publicly listed US homebuilders…. Homebuilders have been frantically trying to sell off properties and raise cash to remain liquid, offering heavy discounts and making large losses.”
From Bloomberg: “Merrill Lynch & Co., the world's largest brokerage, will cut back on packaging home loans and consumer debts into securities after the collapse of the subprime mortgage market eroded demand for the products. ``Opportunities in many areas'' of structured finance and so-called collateralized debt obligations ``will be minimal for the foreseeable future and our activities will be reduced accordingly,'' New York-based Merrill said in an e-mailed statement. The firm will continue packaging corporate loans and derivatives into securities… ``We are not going to be in the CDO and structured-credit types of businesses,'' which generated 15 percent of the firm's fixed-income revenue…”
From The Street.com: “The FBI has launched a criminal probe of 14 companies as part of a larger investigation in the wake of the subprime mortgage and resultant credit crisis, according to The Wall Street Journal. Citing the head of the FBI's economic crimes bureau in Washington, D.C., the Journal said the probe would look at possible accounting fraud, loan securitization and insider trading. The investigation will look at all stages of the securitization process, from companies that bundled loans to those that ultimately held them, the paper said. The FBI declined to identify any of the 14 companies, the Journal said.
From Bloomberg: “Goldman Sachs Group and Morgan Stanley, the two biggest securities firms, said they were responding to requests from regulators for information on subprime-mortgage securities.”
From Morgan Stanley: “Junk bond issuance is evaporating: through yesterday $850mm in high-yield debt had been issued for the month compared with $8.5bn for all of January last year.”
From The Financial Times: “An influential US official on Tuesday hit out at his country’s “addiction to debt”, warning that the federal budget was on an “imprudent and unsustainable path” due to ballooning healthcare costs… Moody’s Investor Services, the credit rating agency, last month warned that a lack of reform to Medicare – the government-administered healthcare plan – and the social security system threatened the US’s long-term fiscal outlook, and, thus, its AAA bond rating. Mr Walker said the root of the problem was the government’s continuing pledge to fund the gap between promised and funded social security and Medicare benefits and other commitments. In a report released to coincide with the hearing, the Government Accountability Office – which Mr Walker heads – put the total US public debt at $9,000bn …including the debt held by social security funds. That was almost double the $5,000bn headline figure for public debt, which excludes such funds’ debt. Including the gap between future promised and funded social security and Medicare benefits, the GAO put the total debt burden in present dollar value at $53,000bn – about four times the size of the US economy.”
From Market News: “Chinese consumer confidence inched down in January for the fourth month in a row, as a deterioration in the long-term outlook for business conditions more than offset a modest improvement in current conditions…Growth in consumption accounted for the largest share of GDP growth in 2007, the first time consumption has been in this position since 2001…”
From Bloomberg: “The Baltic Dry Index, a measure of shipping costs for commodities, surged 5.1 percent in London, its biggest gain in almost two years.”
From The Financial Times: “Andrew Liveris, chairman of Dow Chemical told the Davos meeting that: “Water is ... the oil of the 21st century.””
End-of-Day Market Update
From UBS: “Treasury yields meandered upwards again prior to the Fed decision. After the rate cut announcement, front end yields plunged while long end rates spiked upwards, and the 2s30s curve steepened roughly 10bps by 3pm… Agencies were very weak, trading 1-1.5bps cheaper to Libor most of the day before tightening marginally by the 3pm close… Mortgages traded tighter to swaps throughout the day…”
From Bloomberg: “U.S. stocks fell for the first time this week after concern that bond insurers guaranteeing $2.4 trillion in securities will lose their AAA credit ratings erased
a rally spurred by the Federal Reserve's interest-rate cut. Ambac Financial Group Inc. and MBIA Inc., the largest U.S. bond guarantors, led declines after Fitch Ratings revoked its top ranking on Financial Guaranty Insurance Co. The Standard & Poor's 500 Index had climbed as much as 1.7 percent after the Fed lowered its benchmark lending rate to 3 percent from 3.5 percent to help the economy avert a recession. `The Fed's trying to do what it can, and it looked like it excited people for a little while,'' … ``But things keep coming back in to show things are definitely weakening.'' The S&P 500 retreated 6.49, or 0.5 percent, to 1,355.81 and is down 7.7 percent this year. The Dow Jones Industrial Average lost 37.47, or 0.3 percent, to 12,442.83. The Nasdaq Composite Index decreased 9.06, or 0.4 percent, to 2,349. About two stocks fell for every one that rose on the New York Stock Exchange.”
From Market Watch: “The dollar weakened against its major counterparts Wednesday, after the U.S. Federal Reserve decided to cut interest rates by a half-point and signaled that more cuts could lie ahead.”
From AP: “Gold jumped in aftermarket trading Wednesday after the Federal Reserve slashed its key interest rate—an inflationary move that boosted the metal's appeal as a stable investment.”
From Market Watch: “Crude-oil futures rose for a fifth day… However, crude's rise was limited by a government report that showed U.S. oil inventories have risen more than expected.”
Three month T-Bill yield fell 13 bp to 2.15%.
Two year T-Note yield fell 9 bp to 2.20%
Ten year T-Note yield unchanged at 3.68%
Dow fell 37.5 to 12,443
S&P 500 fell 6.5 to 1356
Dollar index fell .47 to 75.08
Yen at 106.45 per dollar
Euro at 1.487
Gold rose $5.50 to $929
Oil rose .32 to $91.96
*All prices as of 4:40pm
From UBS: “Overall, the tone suggests a willingness to continue easing if growth data continue to weaken—particularly if a recession has now begun, as we believe. We still forecast 25 bp rate cuts at each of the next three FOMC meetings (March 18, April 29/30, and June 24/25), with the funds rate down to 2.25% by mid-year. After that, we expect policy to go on hold as the economy starts to pull out of recession in the second half of the year.”
From Market Watch: “Five months ago, U.S. rates were the fourth-highest in the developed world and now they are the third-lowest… meaning the dollar is "yielding only 25 basis points more than Switzerland which means that once the Fed lowers rates again in March, and we expect them to, the U.S. dollar will be tied with the [Swiss] franc as second-lowest yielding currency in the developed world," above only Japan's rock-bottom 0.5%.”
From Bloomberg: “Banks may have to post additional writedowns of as much as $70 billion if credit ratings for bond insurers are downgraded, according to Oppenheimer & Co.'s Meredith Whitney. Citigroup Inc., Merrill Lynch & Co. and UBS AG hold 45 percent of the ``entire market risk,'' Whitney wrote in a note to clients dated yesterday. ``The fate of the monoline insurers is of paramount importance to financial stocks,'' Whitney wrote. ``When it becomes clear, as we expect it will, that more charges are on the horizon, we believe the market will take another turn for the worse.'' MBIA Inc., the largest bond insurer, and Ambac Financial Group Inc., the second-biggest so-called monoline insurer, are on review for possible downgrades by Moody's Investors Service and Standard & Poor's.”
From Reuters: “Recession fears are weighing heavily on U.S. corporate finance chiefs, pushing optimism down to a fresh three-year low, according to a survey on Wednesday. The quarterly survey from Financial Executives International (FEI) and Baruch College showed its optimism index sank 6.6 points, as nearly every chief financial officer polled said they were as concerned or more concerned about recession than they were in the previous quarter… Of the 361 CFOs polled, 73 percent said they were more concerned about a recession in the United States in the next 12 months. Economic growth ranked as their companies' top economic worry, followed by concerns about consumer spending, inflation and oil costs. Weakness in the dollar was also a worry, with nearly 46 percent of CFOs saying the decline would have a negative impact on their business.”
From Goldman Sachs: “Following this morning's ADP report, we are changing our estimate for January's payrolls to +125,000 and the unemployment rate to 4.9%. An outcome along these lines, while firmer than we first thought, would not alter our view that the labor market is in a longer-term trend of deterioration symptomatic of recession.”
From Deutsche Bank: “Housing affordability has improved fairly dramatically given the drop in conventional mortgage rates and declines in home prices relative to income.”
From Reuters: “Applications for home mortgages jumped to their highest level in nearly four years as low interest rates led more homeowners to seek refinancing… The MBA seasonally adjusted index of refinancing applications soared 22.1 percent to … the highest since July 2003. But the index measuring applications for home purchases declined 17.7 percent …Refinancing activity rose to 73 percent of all applications, up from 66 percent in the previous week…Fixed 30-year mortgage rates rose 0.11 percentage point last week to 5.6 percent, the MBA said. The previous week's rate was the lowest since late June 2005.”
From Realtytrac: “…more than 1 percent of all U.S. households were in some stage of foreclosure during the year, up from 0.58 percent in 2006.”
From Bloomberg: “UBS AG posted the biggest loss ever by a bank after raising fourth-quarter writedowns on securities infected by U.S. subprime mortgages to $14 billion.”
From The Financial Times: “The risk of bankruptcies among the big US homebuilders has risen sharply as the economy has weakened and an end to the housing slump remains distant. Credit default swaps on homebuilders, which act as insurance on corporate debt, suggest some of the biggest are at risk of failing to keep up debt payments… the most exposed are Standard Pacific, Hovnanian, Beazer and Meritage. All are among the top 15 publicly listed US homebuilders…. Homebuilders have been frantically trying to sell off properties and raise cash to remain liquid, offering heavy discounts and making large losses.”
From Bloomberg: “Merrill Lynch & Co., the world's largest brokerage, will cut back on packaging home loans and consumer debts into securities after the collapse of the subprime mortgage market eroded demand for the products. ``Opportunities in many areas'' of structured finance and so-called collateralized debt obligations ``will be minimal for the foreseeable future and our activities will be reduced accordingly,'' New York-based Merrill said in an e-mailed statement. The firm will continue packaging corporate loans and derivatives into securities… ``We are not going to be in the CDO and structured-credit types of businesses,'' which generated 15 percent of the firm's fixed-income revenue…”
From The Street.com: “The FBI has launched a criminal probe of 14 companies as part of a larger investigation in the wake of the subprime mortgage and resultant credit crisis, according to The Wall Street Journal. Citing the head of the FBI's economic crimes bureau in Washington, D.C., the Journal said the probe would look at possible accounting fraud, loan securitization and insider trading. The investigation will look at all stages of the securitization process, from companies that bundled loans to those that ultimately held them, the paper said. The FBI declined to identify any of the 14 companies, the Journal said.
From Bloomberg: “Goldman Sachs Group and Morgan Stanley, the two biggest securities firms, said they were responding to requests from regulators for information on subprime-mortgage securities.”
From Morgan Stanley: “Junk bond issuance is evaporating: through yesterday $850mm in high-yield debt had been issued for the month compared with $8.5bn for all of January last year.”
From The Financial Times: “An influential US official on Tuesday hit out at his country’s “addiction to debt”, warning that the federal budget was on an “imprudent and unsustainable path” due to ballooning healthcare costs… Moody’s Investor Services, the credit rating agency, last month warned that a lack of reform to Medicare – the government-administered healthcare plan – and the social security system threatened the US’s long-term fiscal outlook, and, thus, its AAA bond rating. Mr Walker said the root of the problem was the government’s continuing pledge to fund the gap between promised and funded social security and Medicare benefits and other commitments. In a report released to coincide with the hearing, the Government Accountability Office – which Mr Walker heads – put the total US public debt at $9,000bn …including the debt held by social security funds. That was almost double the $5,000bn headline figure for public debt, which excludes such funds’ debt. Including the gap between future promised and funded social security and Medicare benefits, the GAO put the total debt burden in present dollar value at $53,000bn – about four times the size of the US economy.”
From Market News: “Chinese consumer confidence inched down in January for the fourth month in a row, as a deterioration in the long-term outlook for business conditions more than offset a modest improvement in current conditions…Growth in consumption accounted for the largest share of GDP growth in 2007, the first time consumption has been in this position since 2001…”
From Bloomberg: “The Baltic Dry Index, a measure of shipping costs for commodities, surged 5.1 percent in London, its biggest gain in almost two years.”
From The Financial Times: “Andrew Liveris, chairman of Dow Chemical told the Davos meeting that: “Water is ... the oil of the 21st century.””
End-of-Day Market Update
From UBS: “Treasury yields meandered upwards again prior to the Fed decision. After the rate cut announcement, front end yields plunged while long end rates spiked upwards, and the 2s30s curve steepened roughly 10bps by 3pm… Agencies were very weak, trading 1-1.5bps cheaper to Libor most of the day before tightening marginally by the 3pm close… Mortgages traded tighter to swaps throughout the day…”
From Bloomberg: “U.S. stocks fell for the first time this week after concern that bond insurers guaranteeing $2.4 trillion in securities will lose their AAA credit ratings erased
a rally spurred by the Federal Reserve's interest-rate cut. Ambac Financial Group Inc. and MBIA Inc., the largest U.S. bond guarantors, led declines after Fitch Ratings revoked its top ranking on Financial Guaranty Insurance Co. The Standard & Poor's 500 Index had climbed as much as 1.7 percent after the Fed lowered its benchmark lending rate to 3 percent from 3.5 percent to help the economy avert a recession. `The Fed's trying to do what it can, and it looked like it excited people for a little while,'' … ``But things keep coming back in to show things are definitely weakening.'' The S&P 500 retreated 6.49, or 0.5 percent, to 1,355.81 and is down 7.7 percent this year. The Dow Jones Industrial Average lost 37.47, or 0.3 percent, to 12,442.83. The Nasdaq Composite Index decreased 9.06, or 0.4 percent, to 2,349. About two stocks fell for every one that rose on the New York Stock Exchange.”
From Market Watch: “The dollar weakened against its major counterparts Wednesday, after the U.S. Federal Reserve decided to cut interest rates by a half-point and signaled that more cuts could lie ahead.”
From AP: “Gold jumped in aftermarket trading Wednesday after the Federal Reserve slashed its key interest rate—an inflationary move that boosted the metal's appeal as a stable investment.”
From Market Watch: “Crude-oil futures rose for a fifth day… However, crude's rise was limited by a government report that showed U.S. oil inventories have risen more than expected.”
Three month T-Bill yield fell 13 bp to 2.15%.
Two year T-Note yield fell 9 bp to 2.20%
Ten year T-Note yield unchanged at 3.68%
Dow fell 37.5 to 12,443
S&P 500 fell 6.5 to 1356
Dollar index fell .47 to 75.08
Yen at 106.45 per dollar
Euro at 1.487
Gold rose $5.50 to $929
Oil rose .32 to $91.96
*All prices as of 4:40pm
Preliminary 4th Qtr Real GDP Decelerated More than Expected to +.6% Annualized Growth
Real GDP growth, excluding inflation, slowed sharply in the fourth quarter of 2007 to +.6% annualized from the strong 4.9% annualized pace of the 3rd qtr. Consensus had been looking for +1.2% annualized growth. The huge drop in residential construction (-24% quarterly annualized) took 1.2% off of the 4th qtr growth rate, and was the largest quarterly decline since 1981, as the pace of decline accelerated its 8th straight quarterly decline. Inventories suffered their largest decline in almost 6 years in the 4th qtr. Reduced inventories subtracted -1.25% from GDP growth. A drop in inventories is healthy for the economy long term, but a drag on GDP for the 4th qtr. Auto production remained a drag in the fourth quarter as production fell -27% annualized, which was primarily responsible for the reduced stockpiles of inventory. Auto inventory declines subtracted -.9% from the quarter's GDP growth. Excluding autos, the economy grew +1.6% annualized. Real final sales (GDP less inventories) rose a better than expected +1.9%. Consumer spending, which accounts for over 70% of total consumption, fell to 2% in the fourth quarter, while helping GDP growth by +1.4%. Real disposable income rose only +.3% annualized in the third quarter versus an increase of +4.5% in the third quarter. Savings from current income are near zero, to slightly negative. Government growth was OK at +2.6% annualized, and capital expenditure was decent at +7.5%. A bright spot remains export growth, which grew +3.9% annualized in the 4th qtr after rising +19% in the 3rd qtr.. The shrinking trade deficit added the most to GDP growth last year since 1991 (+.55% YoY). For all of 2007, the economy grew +2.2% YoY, which was the slowest pace in five years since the last recession. Real GDP grew at a 2.9% YoY pace in 2006. Spending grew at +2.9% YoY, the slowest pace in four years. Rising energy and food prices helped push up headline inflation to 2.6% from 1% the prior quarter. Core PCE inflation rose slightly more than expected to +2.7% annualized from +2% in the prior quarter, and was the highest since the 2nd qtr of 2006. The PCE deflator rose 3.4% in 2007, while the core PCE was up 2.1% YoY. Net, the economy slowed substantially in the fourth quarter, but the large reduction in inventories should allow the economy to recover more quickly than otherwise as large inventory overhangs should be less of an issue to work through this year. First quarter 2008 GDP estimates are likely to be revised higher following this report.
FOMC Statement - Cuts 50bp
U.S. Federal Open Market Committee Statement: Text2008-01-30 14:14 (New York)
Jan. 30 (Bloomberg) -- The following is the full textof the statement released today by the Federal Reserve: The Federal Open Market Committee decided today tolower its target for the federal funds rate 50 basis pointsto 3 percent. Financial markets remain under considerable stress, andcredit has tightened further for some businesses andhouseholds. Moreover, recent information indicates adeepening of the housing contraction as well as somesoftening in labor markets. The Committee expects inflation to moderate in comingquarters, but it will be necessary to continue to monitorinflation developments carefully. Today's policy action, combined with those takenearlier, should help to promote moderate growth over timeand to mitigate the risks to economic activity. However,downside risks to growth remain. The Committee will continueto assess the effects of financial and other developments oneconomic prospects and will act in a timely manner as neededto address those risks. Voting for the FOMC monetary policy action were: Ben S.Bernanke, Chairman; Timothy F. Geithner, Vice Chairman;Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin;Sandra Pianalto; Charles I. Plosser; Gary H. Stern; andKevin M. Warsh. Voting against was Richard W. Fisher, whopreferred no change in the target for the federal funds rateat this meeting. In a related action, the Board of Governors unanimouslyapproved a 50-basis-point decrease in the discount rate to 31/2 percent. In taking this action, the Board approved therequests submitted by the Boards of Directors of the FederalReserve Banks of Boston, New York, Philadelphia, Cleveland,Atlanta, Chicago, St. Louis, Kansas City and San Francisco. --Washington newsroom +1-202-624-1820. Editor: Chris Anstey
Jan. 30 (Bloomberg) -- The following is the full textof the statement released today by the Federal Reserve: The Federal Open Market Committee decided today tolower its target for the federal funds rate 50 basis pointsto 3 percent. Financial markets remain under considerable stress, andcredit has tightened further for some businesses andhouseholds. Moreover, recent information indicates adeepening of the housing contraction as well as somesoftening in labor markets. The Committee expects inflation to moderate in comingquarters, but it will be necessary to continue to monitorinflation developments carefully. Today's policy action, combined with those takenearlier, should help to promote moderate growth over timeand to mitigate the risks to economic activity. However,downside risks to growth remain. The Committee will continueto assess the effects of financial and other developments oneconomic prospects and will act in a timely manner as neededto address those risks. Voting for the FOMC monetary policy action were: Ben S.Bernanke, Chairman; Timothy F. Geithner, Vice Chairman;Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin;Sandra Pianalto; Charles I. Plosser; Gary H. Stern; andKevin M. Warsh. Voting against was Richard W. Fisher, whopreferred no change in the target for the federal funds rateat this meeting. In a related action, the Board of Governors unanimouslyapproved a 50-basis-point decrease in the discount rate to 31/2 percent. In taking this action, the Board approved therequests submitted by the Boards of Directors of the FederalReserve Banks of Boston, New York, Philadelphia, Cleveland,Atlanta, Chicago, St. Louis, Kansas City and San Francisco. --Washington newsroom +1-202-624-1820. Editor: Chris Anstey
Today's Tidbits
From JP Morgan: “The Fed delivered 50bp as we expected, but the statement looks more dovish than we anticipated. Even after 125bp in easing in just over one week the FOMC notes: "Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," and "downside risks to growth remain." Finally, as we expected, Fisher dissented on this action and voted for no ease. Overall, even though the Fed notes that this ease combined with the cumulative easing prior to this should balance growth risks, they are still worried about the downside risks to growth.”
From UBS: “Overall, the tone suggests a willingness to continue easing if growth data continue to weaken—particularly if a recession has now begun, as we believe. We still forecast 25 bp rate cuts at each of the next three FOMC meetings (March 18, April 29/30, and June 24/25), with the funds rate down to 2.25% by mid-year. After that, we expect policy to go on hold as the economy starts to pull out of recession in the second half of the year.”
From Market Watch: “Five months ago, U.S. rates were the fourth-highest in the developed world and now they are the third-lowest… meaning the dollar is "yielding only 25 basis points more than Switzerland which means that once the Fed lowers rates again in March, and we expect them to, the U.S. dollar will be tied with the [Swiss] franc as second-lowest yielding currency in the developed world," above only Japan's rock-bottom 0.5%.”
From Bloomberg: “Banks may have to post additional writedowns of as much as $70 billion if credit ratings for bond insurers are downgraded, according to Oppenheimer & Co.'s Meredith Whitney. Citigroup Inc., Merrill Lynch & Co. and UBS AG hold 45 percent of the ``entire market risk,'' Whitney wrote in a note to clients dated yesterday. ``The fate of the monoline insurers is of paramount importance to financial stocks,'' Whitney wrote. ``When it becomes clear, as we expect it will, that more charges are on the horizon, we believe the market will take another turn for the worse.'' MBIA Inc., the largest bond insurer, and Ambac Financial Group Inc., the second-biggest so-called monoline insurer, are on review for possible downgrades by Moody's Investors Service and Standard & Poor's.”
From Reuters: “Recession fears are weighing heavily on U.S. corporate finance chiefs, pushing optimism down to a fresh three-year low, according to a survey on Wednesday. The quarterly survey from Financial Executives International (FEI) and Baruch College showed its optimism index sank 6.6 points, as nearly every chief financial officer polled said they were as concerned or more concerned about recession than they were in the previous quarter… Of the 361 CFOs polled, 73 percent said they were more concerned about a recession in the United States in the next 12 months. Economic growth ranked as their companies' top economic worry, followed by concerns about consumer spending, inflation and oil costs. Weakness in the dollar was also a worry, with nearly 46 percent of CFOs saying the decline would have a negative impact on their business.”
From Goldman Sachs: “Following this morning's ADP report, we are changing our estimate for January's payrolls to +125,000 and the unemployment rate to 4.9%. An outcome along these lines, while firmer than we first thought, would not alter our view that the labor market is in a longer-term trend of deterioration symptomatic of recession.”
From Deutsche Bank: “Housing affordability has improved fairly dramatically given the drop in conventional mortgage rates and declines in home prices relative to income.”
From Reuters: “Applications for home mortgages jumped to their highest level in nearly four years as low interest rates led more homeowners to seek refinancing… The MBA seasonally adjusted index of refinancing applications soared 22.1 percent to … the highest since July 2003. But the index measuring applications for home purchases declined 17.7 percent …Refinancing activity rose to 73 percent of all applications, up from 66 percent in the previous week…Fixed 30-year mortgage rates rose 0.11 percentage point last week to 5.6 percent, the MBA said. The previous week's rate was the lowest since late June 2005.”
From Realtytrac: “…more than 1 percent of all U.S. households were in some stage of foreclosure during the year, up from 0.58 percent in 2006.”
From Bloomberg: “UBS AG posted the biggest loss ever by a bank after raising fourth-quarter writedowns on securities infected by U.S. subprime mortgages to $14 billion.”
From The Financial Times: “The risk of bankruptcies among the big US homebuilders has risen sharply as the economy has weakened and an end to the housing slump remains distant. Credit default swaps on homebuilders, which act as insurance on corporate debt, suggest some of the biggest are at risk of failing to keep up debt payments… the most exposed are Standard Pacific, Hovnanian, Beazer and Meritage. All are among the top 15 publicly listed US homebuilders…. Homebuilders have been frantically trying to sell off properties and raise cash to remain liquid, offering heavy discounts and making large losses.”
From Bloomberg: “Merrill Lynch & Co., the world's largest brokerage, will cut back on packaging home loans and consumer debts into securities after the collapse of the subprime mortgage market eroded demand for the products. ``Opportunities in many areas'' of structured finance and so-called collateralized debt obligations ``will be minimal for the foreseeable future and our activities will be reduced accordingly,'' New York-based Merrill said in an e-mailed statement. The firm will continue packaging corporate loans and derivatives into securities… ``We are not going to be in the CDO and structured-credit types of businesses,'' which generated 15 percent of the firm's fixed-income revenue…”
From The Street.com: “The FBI has launched a criminal probe of 14 companies as part of a larger investigation in the wake of the subprime mortgage and resultant credit crisis, according to The Wall Street Journal. Citing the head of the FBI's economic crimes bureau in Washington, D.C., the Journal said the probe would look at possible accounting fraud, loan securitization and insider trading. The investigation will look at all stages of the securitization process, from companies that bundled loans to those that ultimately held them, the paper said. The FBI declined to identify any of the 14 companies, the Journal said.
From Bloomberg: “Goldman Sachs Group and Morgan Stanley, the two biggest securities firms, said they were responding to requests from regulators for information on subprime-mortgage securities.”
From Morgan Stanley: “Junk bond issuance is evaporating: through yesterday $850mm in high-yield debt had been issued for the month compared with $8.5bn for all of January last year.”
From The Financial Times: “An influential US official on Tuesday hit out at his country’s “addiction to debt”, warning that the federal budget was on an “imprudent and unsustainable path” due to ballooning healthcare costs… Moody’s Investor Services, the credit rating agency, last month warned that a lack of reform to Medicare – the government-administered healthcare plan – and the social security system threatened the US’s long-term fiscal outlook, and, thus, its AAA bond rating. Mr Walker said the root of the problem was the government’s continuing pledge to fund the gap between promised and funded social security and Medicare benefits and other commitments. In a report released to coincide with the hearing, the Government Accountability Office – which Mr Walker heads – put the total US public debt at $9,000bn …including the debt held by social security funds. That was almost double the $5,000bn headline figure for public debt, which excludes such funds’ debt. Including the gap between future promised and funded social security and Medicare benefits, the GAO put the total debt burden in present dollar value at $53,000bn – about four times the size of the US economy.”
From Market News: “Chinese consumer confidence inched down in January for the fourth month in a row, as a deterioration in the long-term outlook for business conditions more than offset a modest improvement in current conditions…Growth in consumption accounted for the largest share of GDP growth in 2007, the first time consumption has been in this position since 2001…”
From Bloomberg: “The Baltic Dry Index, a measure of shipping costs for commodities, surged 5.1 percent in London, its biggest gain in almost two years.”
From The Financial Times: “Andrew Liveris, chairman of Dow Chemical told the Davos meeting that: “Water is ... the oil of the 21st century.””
End-of-Day Market Update
From UBS: “Treasury yields meandered upwards again prior to the Fed decision. After the rate cut announcement, front end yields plunged while long end rates spiked upwards, and the 2s30s curve steepened roughly 10bps by 3pm… Agencies were very weak, trading 1-1.5bps cheaper to Libor most of the day before tightening marginally by the 3pm close… Mortgages traded tighter to swaps throughout the day…”
From Bloomberg: “U.S. stocks fell for the first time this week after concern that bond insurers guaranteeing $2.4 trillion in securities will lose their AAA credit ratings erased
a rally spurred by the Federal Reserve's interest-rate cut. Ambac Financial Group Inc. and MBIA Inc., the largest U.S. bond guarantors, led declines after Fitch Ratings revoked its top ranking on Financial Guaranty Insurance Co. The Standard & Poor's 500 Index had climbed as much as 1.7 percent after the Fed lowered its benchmark lending rate to 3 percent from 3.5 percent to help the economy avert a recession. `The Fed's trying to do what it can, and it looked like it excited people for a little while,'' … ``But things keep coming back in to show things are definitely weakening.'' The S&P 500 retreated 6.49, or 0.5 percent, to 1,355.81 and is down 7.7 percent this year. The Dow Jones Industrial Average lost 37.47, or 0.3 percent, to 12,442.83. The Nasdaq Composite Index decreased 9.06, or 0.4 percent, to 2,349. About two stocks fell for every one that rose on the New York Stock Exchange.”
From Market Watch: “The dollar weakened against its major counterparts Wednesday, after the U.S. Federal Reserve decided to cut interest rates by a half-point and signaled that more cuts could lie ahead.”
From AP: “Gold jumped in aftermarket trading Wednesday after the Federal Reserve slashed its key interest rate—an inflationary move that boosted the metal's appeal as a stable investment.”
From Market Watch: “Crude-oil futures rose for a fifth day… However, crude's rise was limited by a government report that showed U.S. oil inventories have risen more than expected.”
Three month T-Bill yield fell 13 bp to 2.15%.
Two year T-Note yield fell 9 bp to 2.20%
Ten year T-Note yield unchanged at 3.68%
Dow fell 37.5 to 12,443
S&P 500 fell 6.5 to 1356
Dollar index fell .47 to 75.08
Yen at 106.45 per dollar
Euro at 1.487
Gold rose $5.50 to $929
Oil rose .32 to $91.96
*All prices as of 4:40pm
From UBS: “Overall, the tone suggests a willingness to continue easing if growth data continue to weaken—particularly if a recession has now begun, as we believe. We still forecast 25 bp rate cuts at each of the next three FOMC meetings (March 18, April 29/30, and June 24/25), with the funds rate down to 2.25% by mid-year. After that, we expect policy to go on hold as the economy starts to pull out of recession in the second half of the year.”
From Market Watch: “Five months ago, U.S. rates were the fourth-highest in the developed world and now they are the third-lowest… meaning the dollar is "yielding only 25 basis points more than Switzerland which means that once the Fed lowers rates again in March, and we expect them to, the U.S. dollar will be tied with the [Swiss] franc as second-lowest yielding currency in the developed world," above only Japan's rock-bottom 0.5%.”
From Bloomberg: “Banks may have to post additional writedowns of as much as $70 billion if credit ratings for bond insurers are downgraded, according to Oppenheimer & Co.'s Meredith Whitney. Citigroup Inc., Merrill Lynch & Co. and UBS AG hold 45 percent of the ``entire market risk,'' Whitney wrote in a note to clients dated yesterday. ``The fate of the monoline insurers is of paramount importance to financial stocks,'' Whitney wrote. ``When it becomes clear, as we expect it will, that more charges are on the horizon, we believe the market will take another turn for the worse.'' MBIA Inc., the largest bond insurer, and Ambac Financial Group Inc., the second-biggest so-called monoline insurer, are on review for possible downgrades by Moody's Investors Service and Standard & Poor's.”
From Reuters: “Recession fears are weighing heavily on U.S. corporate finance chiefs, pushing optimism down to a fresh three-year low, according to a survey on Wednesday. The quarterly survey from Financial Executives International (FEI) and Baruch College showed its optimism index sank 6.6 points, as nearly every chief financial officer polled said they were as concerned or more concerned about recession than they were in the previous quarter… Of the 361 CFOs polled, 73 percent said they were more concerned about a recession in the United States in the next 12 months. Economic growth ranked as their companies' top economic worry, followed by concerns about consumer spending, inflation and oil costs. Weakness in the dollar was also a worry, with nearly 46 percent of CFOs saying the decline would have a negative impact on their business.”
From Goldman Sachs: “Following this morning's ADP report, we are changing our estimate for January's payrolls to +125,000 and the unemployment rate to 4.9%. An outcome along these lines, while firmer than we first thought, would not alter our view that the labor market is in a longer-term trend of deterioration symptomatic of recession.”
From Deutsche Bank: “Housing affordability has improved fairly dramatically given the drop in conventional mortgage rates and declines in home prices relative to income.”
From Reuters: “Applications for home mortgages jumped to their highest level in nearly four years as low interest rates led more homeowners to seek refinancing… The MBA seasonally adjusted index of refinancing applications soared 22.1 percent to … the highest since July 2003. But the index measuring applications for home purchases declined 17.7 percent …Refinancing activity rose to 73 percent of all applications, up from 66 percent in the previous week…Fixed 30-year mortgage rates rose 0.11 percentage point last week to 5.6 percent, the MBA said. The previous week's rate was the lowest since late June 2005.”
From Realtytrac: “…more than 1 percent of all U.S. households were in some stage of foreclosure during the year, up from 0.58 percent in 2006.”
From Bloomberg: “UBS AG posted the biggest loss ever by a bank after raising fourth-quarter writedowns on securities infected by U.S. subprime mortgages to $14 billion.”
From The Financial Times: “The risk of bankruptcies among the big US homebuilders has risen sharply as the economy has weakened and an end to the housing slump remains distant. Credit default swaps on homebuilders, which act as insurance on corporate debt, suggest some of the biggest are at risk of failing to keep up debt payments… the most exposed are Standard Pacific, Hovnanian, Beazer and Meritage. All are among the top 15 publicly listed US homebuilders…. Homebuilders have been frantically trying to sell off properties and raise cash to remain liquid, offering heavy discounts and making large losses.”
From Bloomberg: “Merrill Lynch & Co., the world's largest brokerage, will cut back on packaging home loans and consumer debts into securities after the collapse of the subprime mortgage market eroded demand for the products. ``Opportunities in many areas'' of structured finance and so-called collateralized debt obligations ``will be minimal for the foreseeable future and our activities will be reduced accordingly,'' New York-based Merrill said in an e-mailed statement. The firm will continue packaging corporate loans and derivatives into securities… ``We are not going to be in the CDO and structured-credit types of businesses,'' which generated 15 percent of the firm's fixed-income revenue…”
From The Street.com: “The FBI has launched a criminal probe of 14 companies as part of a larger investigation in the wake of the subprime mortgage and resultant credit crisis, according to The Wall Street Journal. Citing the head of the FBI's economic crimes bureau in Washington, D.C., the Journal said the probe would look at possible accounting fraud, loan securitization and insider trading. The investigation will look at all stages of the securitization process, from companies that bundled loans to those that ultimately held them, the paper said. The FBI declined to identify any of the 14 companies, the Journal said.
From Bloomberg: “Goldman Sachs Group and Morgan Stanley, the two biggest securities firms, said they were responding to requests from regulators for information on subprime-mortgage securities.”
From Morgan Stanley: “Junk bond issuance is evaporating: through yesterday $850mm in high-yield debt had been issued for the month compared with $8.5bn for all of January last year.”
From The Financial Times: “An influential US official on Tuesday hit out at his country’s “addiction to debt”, warning that the federal budget was on an “imprudent and unsustainable path” due to ballooning healthcare costs… Moody’s Investor Services, the credit rating agency, last month warned that a lack of reform to Medicare – the government-administered healthcare plan – and the social security system threatened the US’s long-term fiscal outlook, and, thus, its AAA bond rating. Mr Walker said the root of the problem was the government’s continuing pledge to fund the gap between promised and funded social security and Medicare benefits and other commitments. In a report released to coincide with the hearing, the Government Accountability Office – which Mr Walker heads – put the total US public debt at $9,000bn …including the debt held by social security funds. That was almost double the $5,000bn headline figure for public debt, which excludes such funds’ debt. Including the gap between future promised and funded social security and Medicare benefits, the GAO put the total debt burden in present dollar value at $53,000bn – about four times the size of the US economy.”
From Market News: “Chinese consumer confidence inched down in January for the fourth month in a row, as a deterioration in the long-term outlook for business conditions more than offset a modest improvement in current conditions…Growth in consumption accounted for the largest share of GDP growth in 2007, the first time consumption has been in this position since 2001…”
From Bloomberg: “The Baltic Dry Index, a measure of shipping costs for commodities, surged 5.1 percent in London, its biggest gain in almost two years.”
From The Financial Times: “Andrew Liveris, chairman of Dow Chemical told the Davos meeting that: “Water is ... the oil of the 21st century.””
End-of-Day Market Update
From UBS: “Treasury yields meandered upwards again prior to the Fed decision. After the rate cut announcement, front end yields plunged while long end rates spiked upwards, and the 2s30s curve steepened roughly 10bps by 3pm… Agencies were very weak, trading 1-1.5bps cheaper to Libor most of the day before tightening marginally by the 3pm close… Mortgages traded tighter to swaps throughout the day…”
From Bloomberg: “U.S. stocks fell for the first time this week after concern that bond insurers guaranteeing $2.4 trillion in securities will lose their AAA credit ratings erased
a rally spurred by the Federal Reserve's interest-rate cut. Ambac Financial Group Inc. and MBIA Inc., the largest U.S. bond guarantors, led declines after Fitch Ratings revoked its top ranking on Financial Guaranty Insurance Co. The Standard & Poor's 500 Index had climbed as much as 1.7 percent after the Fed lowered its benchmark lending rate to 3 percent from 3.5 percent to help the economy avert a recession. `The Fed's trying to do what it can, and it looked like it excited people for a little while,'' … ``But things keep coming back in to show things are definitely weakening.'' The S&P 500 retreated 6.49, or 0.5 percent, to 1,355.81 and is down 7.7 percent this year. The Dow Jones Industrial Average lost 37.47, or 0.3 percent, to 12,442.83. The Nasdaq Composite Index decreased 9.06, or 0.4 percent, to 2,349. About two stocks fell for every one that rose on the New York Stock Exchange.”
From Market Watch: “The dollar weakened against its major counterparts Wednesday, after the U.S. Federal Reserve decided to cut interest rates by a half-point and signaled that more cuts could lie ahead.”
From AP: “Gold jumped in aftermarket trading Wednesday after the Federal Reserve slashed its key interest rate—an inflationary move that boosted the metal's appeal as a stable investment.”
From Market Watch: “Crude-oil futures rose for a fifth day… However, crude's rise was limited by a government report that showed U.S. oil inventories have risen more than expected.”
Three month T-Bill yield fell 13 bp to 2.15%.
Two year T-Note yield fell 9 bp to 2.20%
Ten year T-Note yield unchanged at 3.68%
Dow fell 37.5 to 12,443
S&P 500 fell 6.5 to 1356
Dollar index fell .47 to 75.08
Yen at 106.45 per dollar
Euro at 1.487
Gold rose $5.50 to $929
Oil rose .32 to $91.96
*All prices as of 4:40pm
ADP Report Suggests Employment Rebound in January
The January ADP survey of private employers surprised on the upside, saying non-government jobs grew 130k this month. Consensus had been looking for +40k.
The growth in new jobs in the ADP survey was focused on services, which added 141k new jobs in January. Goods producing jobs declined 11k, continuing a 14 month string of negative job growth in this category. Construction employment fell by 13k, also the fourteenth straight monthly drop. Since the peak in 2006, over 200k construction jobs have been eliminated. A bright spot is that manufacturing job growth was steady after falling for 18 months in a row. Also, financial jobs showed a small rebound, growing by 1k.
Most of the job growth was also found in companies employing less than 500 people, which added 122k new jobs. Larger employers only added 8k new jobs.
Government jobs have been growing between 20-35k monthly, so this data implies non-farm payroll growth on Friday of 150-165k. This is substantially higher than the 65k current consensus. Last year, the ADP figures had only a 41% correlation with non-farm payroll results.
Tuesday, January 29, 2008
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January 23, 2008
TIDBITS
Record Rate Cut by Fed
From the Financial Times: “World markets are running out of superlatives. Tuesday saw the biggest cut by the Federal Reserve to its target Fed Funds rate in 26 years, and the biggest emergency cut it had ever made between scheduled meetings.”
From JP Morgan: “The Fed has not eased this much in a short period of time during the "modern" era of setting policy through fed funds rate changes. Indeed, the Greenspan Fed never eased by more than 50bp in one step. And the move by the Bernanke Fed over the past four months -- to a likely sub- 1% real funds rate next week (deflated by the core PCE), represents an unusually aggressive cumulative policy adjustment. During the past two cycles the funds rate reached this level only about six months after the economy had slid into recession… The Fed's action this week, signalling a likely 125bp move down in the funds rate over ten days, is unprecedented.” [Note that the author presumes the Fed will cut another 50bp at the FOMC meeting next week. This appears to be the consensus view.]
T-Bond Yields Touch Record Low
From Bloomberg: “U.S. Treasury notes gained, pushing two-year yields to the lowest since April 2004, on speculation the Federal Reserve will keep cutting interest rates to avert a recession in the world's largest economy. Benchmark 10-year yields dropped to the lowest since June 2003 as European stocks and futures on U.S. stock indexes
declined, prompting investors to seek safety in government debt. The Fed's decision yesterday to slash the target for overnight loans between banks to 3.5 percent pushed notes to the biggest rally since the aftermath of the Sept. 11, 2001, terrorist attacks… Benchmark 30-year yields touched 4.101 percent, the lowest since regular sales began in 1977… Two- year notes yielded 1.45 percentage points less than 10-year securities, close to the biggest gap since 2004. The steeper yield curve indicates investors favor shorter-maturity debt in anticipation of lower interest rates.”
Equity Markets Continue to Decline
From Bloomberg: “U.S. stocks dropped for a sixth day, the longest losing streak since April 2002…The Standard & Poor's 500 Index, which is off to its worst-ever start to a year… The Nasdaq Composite Index … is in a so-called bear market, marked by a more-than 20 percent drop from its almost seven-year high in October.”
Fed Rate Cut Helps Banks, But Risks Increasing Mal-Investment
From Citi: “It is also worth noting that, while the move has helped stabilise financial conditions (for now) and steepen the yield curve thereby helping the beleaguered banking sector, the underlying imbalances in the real economy remain and this may take a prolonged period of sub-trend growth to be addressed. Furthermore, the director of the US's CBO said yesterday that any planned fiscal stimulus would not have much impact on the US economy till the end of the year.”
From RBSGC: “So what do we think about the Fed's emergency intra-meeting 75bp rate cut? First and foremost, it's not a very encouraging sing when the Federal Reserve is forced to make such a move. Yes, it provides monetary stimulus, helps the earnings power of leveraged financial institutions and stops global equity markets from cratering (at least for the moment). But it also reeks of desperation, justifies investor fears about underlying economic conditions and validates criticism that the Fed has been late to provide help. However we certainly appreciate the positive impact of a sharp decline in market interest rates for credit worthy consumers and businesses. The drop in rates is consistent with our theme from last week: when all else fails, refi and inflate-away debt problems.”
From The Washington Post: “Looked at from a certain angle, the Fed's dramatic (though not unexpected) rate cut yesterday morning is a bit screwy. After all, what got us into this mess in the first place was too much cheap credit that was used to buy houses, finance corporate takeovers and commercial real estate and speculate in commodities, driving up the price of said houses, takeover targets, office buildings and commodities to levels unsupported by the economic fundamentals. Now the bubble has burst and the prices of those assets are beginning to fall back to more reasonable levels. Why would anyone want to interrupt that process by bringing back the cheap credit? The short and oversimplified answer can be summed up in three words: the Great Depression. For that was very much the attitude of the Federal Reserve and other central banks after the stock market crash of 1929. To a lesser extent, it is also the lesson of Japan’s's bungled policy response to the bursting of its real estate and stock market bubble in the early 1990s. As USA Today’s David J. Lynch pointed out in a timely piece yesterday, the leading academic expert on both failures is none other than the current chairman of the Federal Reserve, Ben S. Bernanke…At the moment, the Fed's big fear isn't a mild U.S. recession. It is a market meltdown in which the failure of one bank or hedge fund or insurance company triggers another and another as panicked investors and lenders all head for the exits at the same time. That's what the Fed and other central banks confronted last summer when they flooded markets with short-term credit to overcome the reluctance of banks to lend to one another. And it was what central bankers confronted again this week with the sharp sell-off on nearly all of the world's stock markets, where mounting concerns about a U.S. recession and banks failures and stock market bubbles in developing markets suddenly converged. Although Fed officials will claim in public that their three-quarter point rate cut was justified by risk to the economic fundamentals, simple logic tells you it ain't so. There's been nothing that has happened to the real economy in the past few weeks to justify an emergency meeting, let alone the biggest rate cut in more than two decades. Rather, the Fed's goal was to calm financial markets and take pressure off the balance sheets of troubled banks and insurance companies that benefit when borrowing costs are reduced…So is the Fed bailing out the big banks? Of course. It always does in these situations, even as it denies it… And it doesn't mean that the banks won't be required to come clean about their losses, even if shareholders wind up losing most of their money. But no matter how great the banks' folly, and no matter how much the Fed itself failed in its role as bank regulator during the bubble, the Fed will never allow them to collapse because the consequences to the financial system and the global economy would be too severe. Let's face it: When bubbles burst -- particularly ones as big and broad as this one -- there aren't any great outcomes or good policy options. There are only bad and less bad options. And so far, the Bernanke Fed -- drawing on the lessons of the Great Depression and Japan's "lost decade" -- seems to have chosen the less bad options. That's about all you can ask.”
From Bloomberg: “The Federal Reserve, which yesterday announced its first emergency rate cut since 2001, is ignoring history's lessons and risks re-igniting more asset bubbles, economists at the World Economic Forum annual meeting said… The central bank has drawn fire for paying too much attention to economic growth and not enough to asset prices, fueling unsustainable booms in stocks, property and derivatives… ``It's good for a central bank to ease when the risks are of a crash in the global economy, but that means you have to have a more systematic approach to asset bubbles,'' said Nouriel Roubini, founder of New York-based Roubini Global Economics LLC. ``If we have a `Greenspan put' or a `Bernanke put,' then we will create over and over again a distortion of excessive debt and leverage.''”
From CITI: “The Fed's surprise move yesterday has lowered USD Libors further but not by as much as the Fed's 75bp cut. While money markets had previously attained a degree of normality with the Libor-OIS spread fairly close to its pre-crisis levels, it remains to be seen if the Fed's aggressive easing will have the desired effect. The key to the dislocations in the financial markets still appear to still lie with the extent of balance sheet reconstruction by the major banks. The equity injections from SWFs have helped to shore up bank balance sheets but they may have to contract further, especially if weakness in the real economy starts to feed through.”
Still More Losses Expected from Banks and GSEs
From Deutsche Bank: “We think the market will continue to be subject to event shocks, particularly from bank/GSE earnings and the monoline situation. In addition, the sell-off in the dollar that is a result of the Fed ease will also likely put pressure on Asian economies and stock markets. Commodity prices in turn will be a function of the health of the global economy. One consistent theme of the recent bank earnings data is that there has been no more than modest efforts to reduce exposures to subprime, credit, or CMBS. Thus, Q4 2007 earnings do not seem to be the last of the bank losses, but rather could extend into 2008 if super senior CDO prices decline further. The immediate focus of the market is the monoline insurers, particularly their exposure to collateral calls from their CDS positions. Our impression is that counterparties will be loathe to make the mistake of others earlier in the crisis, when aggressive collateral calls worsened the crisis.”
From Citywire: “Senior executives at Fidelity Investments have identified three big risks for the banking sector from the problems being experienced by US monoline insurers. Firms such as Ambac, MBIA and ACA, which insure the credit worthiness of many of the structured bonds arranged by investment banks, are struggling to survive the credit crunch as downgrades by ratings agencies and slumping share prices call into question their business models…. fears of the potential impact this could have were a factor in yesterday's worldwide sell-off in markets as investors worried about the renewed threat of financial contagion arising from the sub-prime lending disaster… leading members of Fidelity's investment team said specific dangers to banks' balance sheets could quickly emerge if the bond insurers' cover is called into question, they said.
Investment banks could be forced to stand behind certain bonds if the credit ratings of these securities falls from the top AAA to AA. Structured investment vehicles (SIVs), which have already been badly hit by the sub-prime crisis, could suffer further losses from investments in monoline covered bonds and require greater support from banks.
Money market 'cash' funds run by banks could be forced sellers of vast quantities of monoline insured securities should they lose their AAA rating. This last factor is seen as particularly insidious as it would create a downward spiral in these assets, hurting insurers and other institutions which have also widely invested in them. This latest phase of the credit crunch increases the risk that what has so far been a financial crisis will spill over into the wider economy, sparking a recession.”
From Informa Global Markets: “Rumors galore are fueling the ferocious Treasury bid. Aside from the one reported about huge losses to come from a large French Bank, there is chatter that a German bank will have to write down E15bln, as well as one reporting a European bank of undetermined provenance losing credit lines with other banks.”
From Bloomberg: “New York State's insurance regulators met today with U.S. banks to discuss raising new capital for bond insurers, said a department spokesman. Talks in New York with the unnamed banks are part of Insurance Superintendent Eric Dinallo's effort to stabilize the bond guarantors and bolster the market's financial condition, said agency spokesman Andrew Mais in an interview. New capital may help preserve the top credit ratings for the bond guarantors such as MBIA Inc., the industry's largest, and halt any erosion of investor confidence in the $2 trillion of assets they guarantee. Ambac Financial Group Inc., MBIA's biggest rival, lost its AAA grade from Fitch Ratings this month on concern about rising defaults tied to subprime mortgages.”
Health of Mortgage Insurers Raises Concern Over Fannie Mae’s Business
The Street.com: “The private mortgage insurance industry is under severe pressure from rising delinquencies and mounting losses. Now questions are swirling about how a potential blow-up in that sector will affect Fannie Mae. As the largest purchaser of U.S. mortgages, Fannie Mae provides an essential backstop to the housing market. The government-sponsored entity…purchases mostly standard 80% loan-to-value mortgages -- those for which the homebuyer puts down 20% equity. Due to a quirk in its charter, Fannie Mae is allowed to purchase mortgages with loan-to-value, or LTV, ratios greater than 80% -- and as high as 100%. Generally, these are allowed only if the homeowner purchases mortgage insurance to cover the amount of the loan above 80%. This business model works fine as long as Fannie Mae believes it can be reimbursed from the private mortgage insurers. But as housing prices fall, borrowers are defaulting at a faster pace on high-LTV mortgages. In turn, private mortgage insurers -- who cover these risky loans -- have had their stocks crushed…as investors worry about whether the companies can fund their payments to lenders as mortgage defaults rise. There are a few looming questions regarding Fannie Mae's exposure to the private mortgage insurers. One is whether Fannie Mae has adequately reserved for possible losses, because the company operates with the understanding that the insurers will pay it back. The other issue is that if one of these insurers takes a massive hit, then Fannie Mae's underwriting standards may come under scrutiny, and the firm may be forced into buying fewer high-LTV mortgages in the future…Fannie Mae has $227 billion of exposure to mortgage loans in which the LTV ratios are greater than 90%. Overall, about 19% of the company's $2.4 trillion single-family mortgage book of business has private mortgage insurance or some other form of credit enhancement. Troubles among bond insurers may provide a clue about how Fannie Mae would be forced to act if mortgage insurers' troubles grow…In its most recent quarterly filing, Fannie Mae said it had $130.3 billion of recoveries from private mortgage insurance policies and other credit enhancements. However, if the firm decides that portions of its mortgage insurance are useless, then increased default reserves -- and thus larger writedowns -- may be looming. Fannie Mae has just $39.9 billion of shareholder equity to absorb these losses. So far, Wall Street sell-side analysts have not expressed much concern about the issue. In a November 2007 research note, Lehman Brothers analyst Bruce Harting said Fannie Mae and Freddie Mac were "reasonably well insulated vis-à-vis the mortgage insurance industry in total."…"It looks to us like a lot of the mortgage issuers will not survive if any kind of really bleak outcome comes to pass," Narayanan told Fannie officials on the firm's last earnings call in November. "To the extent that some of their risks may not be insurable by them if they're not in existence, it comes back on your books," he said. "So there's clearly a much more complicated interlinked relationship you have with a number of other providers, which are all possibly at risk in this situation." In response, Fannie Mae's chief risk officer Enrico Dallavecchia said the company believes that the mortgage insurance industry "will manage its capital position to meet the claims obligations that they have." "I feel comfortable with the exposure that we have to the MI (mortgage insurance industry) at this stage," Dallavecchia said. While the write-offs of existing mortgage insurance could be looming for Fannie Mae, another worry is that these increased losses will cause Fannie to curtail use of the insurance product in the future. Fannie Mae continues to use mortgage insurance to buy loans at a maximum LTV of 95% these days, mortgage brokers say. "What happens if Fannie realizes that mortgage insurance guarantees are worthless and decided not to take mortgage insurance-wrapped mortgages anymore?" says an analyst at a hedge fund that is shorting Fannie Mae and several mortgage insurance firms. "The whole mortgage world will be turned upside down," the analyst says. "This is the real problem."”
From Bloomberg: “Fannie Mae and Freddie Mac, the two largest sources of money for U.S. home loans, may need to recognize $16 billion in losses in fourth-quarter earnings and capital levels because of declines in the value of subprime- mortgage bonds, according to Credit Suisse Group… With other financial companies this quarter already reporting ``other than temporary impairments'' of mortgage- related holdings that they wouldn't normally need to report under accounting rules, Fannie Mae and Freddie Mac may need to follow suit, the analysts wrote in a report today. ``We believe that this will likely spur the GSEs' regulator to compel similar actions,'' they wrote, referring to the Office of Federal Housing Enterprise Oversight, regulator to the so- called government-sponsored enterprises. McLean, Virginia-based Freddie Mac's subprime securities may be worth $8 billion to $11 billion less than the prices at which the company is carrying them on its books, while Washington-based Fannie Mae's bonds may be worth $2.25 billion to $5 billion less, according to Credit Suisse. Without ``other than temporary'' impairments, or declines in the value of the securities unlikely to be recovered, the losses don't affect the companies' earnings or capital, the analysts wrote. The losses would affect the book values, or their assets minus liabilities, the companies reported, they wrote. Through September of last year, the companies had only reported 1.5 percent declines in their value of their subprime securities, through adjustments to their book values, they wrote.
The potential losses don't reflect the companies' holdings of securities backed by Alt A mortgages, or loans considered between subprime and prime in terms of default risks, the analysts wrote. Non-agency mortgage securities are ones not guaranteed by the two companies or federal agency Ginnie Mae.”
Good Profits in Municipal Bond Insurance Before Diversifying into MI
From Bloomberg: “Municipal bond insurers such as MBIA Inc. and Ambac Financial Group Inc. had a good thing going. For years, they earned some of the highest profit margins in any industry -- by writing coverage for securities sold by states and cities to build roads, schools and firehouses. During the past five years, MBIA's average profit margin was 39 percent, more than four times the average of the Standard & Poor's 500 Index, according to data compiled by Bloomberg. Ambac's average profit margin was 48 percent. The good times are over, and the culprit isn't municipal bonds; it's subprime debt, a market the insurers waded into in pursuit of even greater profits. Some of the biggest bond insurers are facing potential claims that may deplete their capital. Their share prices have plunged, and credit rating companies are scrutinizing their AAA status. Ambac became the first insurer to lose its triple-A rating, when Fitch Ratings downgraded the company to AA on Jan. 18… ACA founder Fraser says the bond insurance industry needs to do more than raise capital: It needs to restore faith in its unquestioned ability to assess credit risk… By chasing the higher profits of CDOs while underestimating the risks, the bond insurers jeopardized their basic business: insuring municipalities against default. In practice, cities and states rarely default. That's because they can raise taxes to meet obligations or refinance their debts. The designers of CDOs don't have those options.”
Increased Debt Helped Fuel Boom & Will Likely Retard Recovery as Its Paid Back
From NATIXIS: “…US Non-Federal Debt per capita, as a multiple of real output per capita (the “per capitas” cancel, but it is helpful to think about the debt in terms of how much more an average person owes than he produces in a year). In the middle of the “Me Decade” of the 1980s, debt was some 65% higher than output; today, it is 120% higher. To be sure, the numerator is a stock figure and the denominator is a flow figure, but so is a person’s debt compared to their income. If the average person owes more than twice what he makes in a year, where does the money come “from the sidelines” this time? All of the money is in the market now; some of it is also trapped in housing where the tightening of credit conditions and the decline in the value of the housing stock has made it difficult to extract. No one has saved for a rainy day.”
From The New York Times: “The recent financial turmoil has many causes, but they are tied to a basic fear that some of the economic successes of the last generation may yet turn out to be a mirage…The great moderation now seems to have depended — in part — on a huge speculative bubble, first in stocks and then real estate, that hid the economy’s rough edges. Everyone from first-time home buyers to Wall Street chief executives made bets they did not fully understand, and then spent money as if those bets couldn’t go bad. For the past 16 years, American consumers have increased their overall spending every single quarter, which is almost twice as long as any previous streak. Now, some worry, comes the payback. Martin Feldstein, the éminence grise of Republican economists, says he is concerned that the economy “could slip into a recession and that the recession could be a long, deep, severe one.”…[Bank] are facing real losses, which will almost certainly curtail lending, and economic growth, this year. The second problem is that real estate and stocks remain fairly expensive. This shows just how big the bubbles were: despite the recent declines, stock prices and home values have still not returned to historical norms. David Rosenberg, a Merrill Lynch economist, says that the stock market is overvalued by 10 percent relative to corporate earnings and interest rates. And remember that stocks usually fall more than they should during a bear market, much as they rise more than they should during a bull market. The situation with house prices looks worse. Until 2000, the relationship between house prices and rents remained fairly steady. The same could be said about house prices relative to household incomes and mortgage rates. But the boom of the last decade changed this entirely. For prices to return to the old norm, they would still need to fall 30 percent across much of Florida, California and the Southwest and about 20 percent in the Northeast. This could happen quickly, or prices could remain stagnant for years while incomes and rents caught up. Cheaper stocks and houses will benefit many people — namely those who don’t yet own a home and still have most of their 401(k) investing in front of them. But the price declines will also lead directly to the third big economic problem. Consumer spending kept on rising for the last 16 years largely because families tapped into their newfound wealth, often taking out loans to supplement their income. This increase in debt — as a recent study co-written by the vice chairman of the Fed dryly put it — “is not likely to be repeated.” So just as rising asset values cushioned the last two downturns, falling values could aggravate the next one. “What people have done is make an assumption that these prices could continue rising at the rate they had been,” said Ed McKelvey, an economist at Goldman Sachs. “And that does seem to have been an unreasonable assumption.””
From Minneapolis Star Tribune: “Many U.S. consumers are tapped out -- over-mortgaged and over-borrowed with no savings to fall back on. The homes that helped finance their spending sprees are now falling in value, and higher food and energy costs are digging deeper into their wallets daily. Increasingly, they're falling behind on mortgage and car payments as well as credit card bills. But there's something more, and it's new, said Jerrold Peterson, economics professor emeritus at the University of Minnesota at Duluth. It's fear. "For every one mortgage foreclosure there are four of us saying, 'There but for the grace of God go I,'" Peterson said. "As I see houses repossessed, and home values go down and down, am I really going to want to buy an automobile, or even a whole lot of new clothes?"… The interest rate drop could encourage spending because the rates of many consumer loans are tied to it, including most credit cards. The president's hope is that Americans will go out and spend any rebate check that comes their way. Both strategies have worked before, some economists said… "All of a rebate won't go to spending," … "There will be some, but others will put it in savings for a rainy day, or pay down bills they otherwise couldn't have." Indeed, more Americans -- some 34 percent -- intend to cut their spending, according to a national survey reported last week on Cardtrak.com, which tracks the credit card industry. That's up from 21 percent six months ago. Also, 57 percent said they will try to reduce their debt and save more money. That could be out of necessity. Delinquency rates for the major credit cards stood at 5.01 percent in December, up from 4.44 percent a year earlier…At the same time, average balances neared $10,000 last year, up nearly $400 in a year. Even Target Corp. has seen the problems. The Minneapolis-based discount retailer wrote off 6.84 percent of its charge receivables in December, a 20 percent increase since August.”
In a Recession, Merrill Lynch Sees Further Large Drops for Housing and Stocks
From Merrill Lynch: “We have concluded that the supply-demand backdrop in the residential real market is still so far out of equilibrium that average home prices nationwide have the potential to drop a further 25-30% over the next two to three years. This sounds dire (and it is - effectively wiping out three years of price appreciation) but would only reverse part of the unprecedented 130% price surge from 2000 to 2006…If in fact the economy is in a recession or on the precipice thereof, then the historical record shows that these setbacks in the real economy usher in an average 25% decline in the S&P 500. Because it is normal to have 70% of the prior bull market reversed in the cyclical bear market, such a re-occurrence this time around would imply a breach of 1,100 on the S&P 500 or a further 20-25% downside from here. Remember - these are just averages. So we have a situation where both house values and equity prices, having already fallen decisively from their peaks, have the potential to drop another 25% from here. And that is what we have built into our new assumptions for the GDP forecast, keeping in mind that both asset classes combined exceed $40 trillion on the household balance sheet and represent almost 70% of aggregate household net worth.”
Possible Impacts on Society from the End of Cheap Oil
From Bloomberg: “`This is what the end of the age of oil means,'' says Reinert, 60, who plans the vehicles Toyota will make in a quarter century as national manager for advanced technology at the U.S. sales unit in Torrance, California. ``The car-based culture, the business-as-usual of building cars and trucks, is going to change dramatically.'' … Today, the twin threats of $100-a-barrel oil and global warming are convulsing an industry addicted to cheap, abundant petroleum. Auto companies, already hurt in 2007 by the lowest U.S. demand in a decade, are struggling to perfect cars that run
on ethanol, diesel, natural gas, hydrogen and household electricity… Reinert says automakers are endangering themselves by basing sales and profits on the big, fast cars that many U.S. customers say they want in 2008. In five years, as oil shortages and global warming intensify, car companies may be out of step with drivers' demands for fuel-efficient vehicles. Even worse, degrading stretches of the planet like Fort McMurray will only delay -- not prevent -- the time when the world must function in a post-peak- petroleum economy… Shareholder ambivalence about clean cars is only one hurdle
to surviving the end of easy oil… There's no blueprint for the impact of increasingly scarce oil on a U.S. economy already laboring with a mortgage crisis and a dropping dollar. Add industrialization in China and India, and the number of cars and trucks worldwide may double to 2.1 billion by 2030, according to the Paris-based International Energy Agency. ``We don't have a past, a history or a database that allows us to explore the simultaneous impact of recessions, disruptions to the energy supply and climate change,'' says Reinert… Reinert defends Toyota's need for sport utility vehicles, minivans and pickups, which contributed 42 percent of its 2.6 million U.S. vehicle sales in 2007. The company earns about $6,000 before taxes in the U.S. on an SUV. That compares with a $1,000 profit on a Corolla and a small loss on a Prius… ``Without these profits, where does the investment capital come from for our research on plug-ins or fuel cells?'' Reinert asks… at Fort McMurray's pit mines, it takes 2 tons of sand, 250 gallons (947 liters) of water and 1,400 cubic feet (39.6 cubic meters) of natural gas to produce one barrel of synthetic crude…That's enough water for a day's use for a U.S. family of four and enough natural gas for 5.6 days. The gas is burned to power a process that extracts a tarry substance called bitumen from the sand and then refines it into synthetic crude….``When you're schlepping around two tons of sand for a barrel of crude, it shows that conventional oil is already well into depletion,'' says Jeffrey Rubin, chief economist at CIBC World Markets Inc. in Toronto. ``Price will ultimately ration demand. People won't be able to afford to drive.''… ``It's definitely true that the era of cheap and easy oil is over,'' says Brad Bellows, spokesman for Suncor Energy Inc., which opened Fort McMurray's first commercial oil sands mine in 1967. ``Industry is looking offshore and to unconventional sources like oil sands.'' Oil sands facility operators are working to minimize environmental harm by recycling water faster and using the refining process to produce heat that's now generated with gas, Stringham and Bellows say. They're also trying to sequester carbon dioxide emissions underground and quickly restore land to its original condition. Wells predicts world oil production will peak at about 100 million barrels a day in about a decade. By 2030, output will fall to today's level of 87 million barrels. Declining production will collide with rising demand, which could hit 118 million barrels a day by 2030 if trends were to continue, the U.S. Energy Information Administration forecasts. ``When production levels off, if the price is $200 or $300 a barrel, then that's what people will pay.'' Wells says. Reinert says that although oil may drop in price because of a global recession, it's likely to gyrate between $75 and $125 a barrel for the next five years… Cities must be redesigned too. People need to rely on mass transit and live closer to where they work. ``In a place like New York, there may not be a role for our traditional product -- I don't mean today but 20 or 30 years from now,''… Since 1950, the world has been blessed with an eightfold increase in oil production. Yet the peak discoveries for new oil came in 1962, petroleum consultant Wells says. Total production outside the former Soviet Union and the Organization of Petroleum Exporting Countries topped out two years ago, he says. Oil in the former Soviet Union will reach its highest level in about five years; OPEC will peak in about 10, he says. In the interim, nations will be more dependent on the Middle East, where getting oil is complicated by war, political turmoil and declining output from mature wells. ``After a series of incidents in the Persian Gulf, or a low-level nuclear exchange that shuts off oil supplies, you wouldn't have a short-term disruption like Katrina,'' Reinert
says. ``You would have a profound one- or two- or three-year period in which economies and governments fail.''
Return Assumptions for Pension Plans May Need to be Lowered
From NATIXIS: “Here’s something else to put on the worry list; it is something we haven’t worried about in a while. For some time now, bullish analysts have talked about the great condition of corporate balance sheets. For years, they have been ignoring the off-balance-sheet pension and OPEB liabilities, but in recent years the aggregate pension deficit had healed somewhat given the enormous rally in equities and the selloff in the bond market between 2003 and 2007. As a quick review, higher interest rates lower the pension liability by raising the discount rate, while higher equity prices increase the pension asset since most pensions are laden with far more equities than is prudent. But now, those pension gains have been significantly eroded. While equities are still dramatically above their 2003 lows, the pension surplus is considerably more sensitive to interest rates and the big rally we have had over the last six months will put a large liability on the pristine corporate balance sheets. And in fact, this will actually begin to show up on corporate balance sheets, and not just in the footnotes, due to FASB rules passed last year. This will become a big story unless bonds sell off appreciably and equities rally back. This would seem to be a good time to congratulate the folks at Ford, who on July 26th announced plans to change their pension allocation from 70%-30% (equities-fixed income) to 55%-45%. They probably saved their shareholders and/or pensioners billions of dollars with that move. The bad news about this about-face in the fortunes of corporate pension and OPEB plans is that it will make it more difficult for the pension fund managers to do what they should be doing, and that is to sell equities and buy long Treasuries or (in the case especially of an OPEB plan) TIPS. At this level of
real yields, it would be hard to stomach such a program in any event, but it will be even harder to buy TIPS at 1.40% real yields when you had a chance at 2.80% back in June (note that we argued strongly for buying them at that point). But what assets can a pension fund hold instead? Real estate? Gold, with no yield? Equities? However you slice it, one casualty of the recent market move is likely to be a change in the implausibly-high return assumptions used to calculate the pension plan’s funded status. At a 1.4% real yield, a 7% or 8% blended nominal return for a portfolio requires a willful act of disbelief. Without sharply higher inflation (and such does not appear to be on the horizon), nominal
returns averaging 5% over the next 10 years will be difficult to come by.” [Note – One bright spot may be that overseas equities have seen higher returns, so diversifying into foreign/emerging market stock markets may help improve total returns for retirement funds.]
MISC
From RBSGC: “The investment grade credit market has also seen financing rates drop, but it has not been as dramatic as the fall in mortgage rates. High Yield has seen an even tougher time, with yields in that sector crossing above 10.00% for the first time since 2003. The profits picture has soured, fears of defaults have grown, and pricing now reflects plenty of anxiety.”
From Citi: “Fed Funds/U.S. 2 year yield spread: Yesterday’s actions fail to put the fire out. Prior to yesterday’s Fed Funds cut this spread had moved to 226 bps Fed Funds over U.S. 2 year yields. This was a 2-decade plus extreme. While immediately afterwards the spread did narrow sharply with today’s move it is back to 165 basis points. By historic standards this is again back into extreme territory. This reminds us that while yesterday’s move is a step in the right direction, it currently appears significantly more is needed to quell market fears.”
From AP: “An economic activity index calculated by the Federal Reserve Bank of Chicago showed its lowest level in more than four years in December, dragged down by a sharp contraction in employment-related indicators, the bank said Tuesday…The three-month average, which the Chicago Fed says provides a more consistent picture of national economic growth than the volatile monthly readings, hit its lowest level since May 2003…The three-month average was below zero for every month in 2007, indicating below-average economic growth throughout the year. The data are in line with other recent indicators of economic weakness that have caused financial markets to swoon and led to several interest rate cuts by the Federal Reserve. In December, each of the four broad categories in the Chicago Fed Index were negative…”
From The Financial Times: “…the Baltic Dry index, which measures demand for shipping, has fallen more than 40 per cent since peaking late last year…”
From Morgan Stanley: “As a group, we think the US economy is in recession, that Europe is most vulnerable to spillovers from that downturn, but that many emerging market economies are much less exposed. Decoupling means simply that a US recession won't likely cripple EM as in the past. A US recession will help cool an overheated Chinese economy.”
From the Financial Times: “The mood of chief executives has darkened for the first time since 2003, according to a survey of corporate leaders released on the eve of the World Economic Forum. Fears of a recession have displaced concerns such as terrorism and regulation. The fall in business confidence was most pronounced in the US, where only 35 per cent of CEOs said they were “very confident” about growth – down from 53 per cent a year ago. The survey of 1,150 senior executives by PricewaterhouseCoopers was conducted late last year – before the latest fall in global markets.”
From AFP: “China on Wednesday issued an "urgent" call for the coal industry, electricity providers and government agencies to ensure adequate coal supplies as a nationwide power crisis loomed… The looming supply shortage had already caused 13 provincial power grids in central and southern China to impose restrictions on electricity use, it added. The report said the booming nation's stockpile of coal, which provides about 70 percent of China's power needs, had dwindled to a mere week's supply in recent days… China's electricity consumption has soared amid booming economic growth, putting the government in a quandary about how to meet that demand while simultaneously limiting consumption of heavily polluting coal and cutting down on the chronic deadly accidents in the coal mining industry. The situation has been worsened by several other factors including drought conditions that have hit hydroelectric output, the commission said.”
From Bloomberg: “European Central Bank President Jean- Claude Trichet said he's committed to fighting inflation, attempting to quash speculation he'll follow the U.S. Federal Reserve in cutting interest rates after stocks plunged. ``Particularly in demanding times of significant market correction and turbulences, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility,'' Trichet told the European Parliament in Brussels today. Bond investors dismissed his comments and raised bets on an ECB interest-rate cut. European two-year government notes rose the most since September 2001…”
End-of-Day Market Update
Five Day Chart of S&P 500 Showing Early New Low before the Afternoon Rally
Five Day Chart of 10-Year Treasury Yields (27bp high-low range today)
From Citi: “Yields moved 15 bps instantly on the news that NY state regulators meeting with banks to rescue bond insurers… the speed of the turn and reverse certainly tells you
that the short-term last-to-the-party bulls out there don't have deep pockets and are certainly nervous about owning bonds at these nose-bleed yield levels. It also tells you that a lot of the selling in equities of late is of similar fast-money type. Anyway, while I never believe that civil servants are going the save the day for the financial markets, this could have enough momentum to it to continue the correction for a couple of days. Oh, and if you think trading duration is tough on a day like today, how about Swap Spreads? Where they typically bounce around in a 1 or 2bp range (and even less pre-meltdown) … we've seen a NINE bps swing from low to high in 30yr spreads today. Impressive.”
From CNN: “Blue chips rallied Wednesday afternoon, with the Dow bouncing back from a more than 300-point loss earlier in the session, while the Nasdaq erased losses sparked by Apple's profit warning. The Dow Jones industrial added almost 300 points, after having fallen more than 300 points earlier in the session. The Standard & Poor's 500 index rose 2.1 percent. The Nasdaq composite gained 1 percent after sinking more than 3 percent earlier in the session.”
Three month T-Bill yield fell 13 bp to 2.19%.
Two year T-Note yield rose 11 bp to 2.11%
Ten year T-Note yield rose 13 bp to 3.56%
Dow rose 299 to 12,270
S&P 500 rose 28 to 1339
Dollar index steady at 76.32
Yen at 106.67 per dollar
Euro at 1.464
Gold down $2 at $890
Oil fell $1.50 to $87.72
*All prices as of 4:20pm
Five Day Chart of S&P 500 Showing Early New Low before the Afternoon Rally
Five Day Chart of 10-Year Treasury Yields (27bp high-low range today)
From Citi: “Yields moved 15 bps instantly on the news that NY state regulators meeting with banks to rescue bond insurers… the speed of the turn and reverse certainly tells you
that the short-term last-to-the-party bulls out there don't have deep pockets and are certainly nervous about owning bonds at these nose-bleed yield levels. It also tells you that a lot of the selling in equities of late is of similar fast-money type. Anyway, while I never believe that civil servants are going the save the day for the financial markets, this could have enough momentum to it to continue the correction for a couple of days. Oh, and if you think trading duration is tough on a day like today, how about Swap Spreads? Where they typically bounce around in a 1 or 2bp range (and even less pre-meltdown) … we've seen a NINE bps swing from low to high in 30yr spreads today. Impressive.”
From CNN: “Blue chips rallied Wednesday afternoon, with the Dow bouncing back from a more than 300-point loss earlier in the session, while the Nasdaq erased losses sparked by Apple's profit warning. The Dow Jones industrial added almost 300 points, after having fallen more than 300 points earlier in the session. The Standard & Poor's 500 index rose 2.1 percent. The Nasdaq composite gained 1 percent after sinking more than 3 percent earlier in the session.”
Three month T-Bill yield fell 13 bp to 2.19%.
Two year T-Note yield rose 11 bp to 2.11%
Ten year T-Note yield rose 13 bp to 3.56%
Dow rose 299 to 12,270
S&P 500 rose 28 to 1339
Dollar index steady at 76.32
Yen at 106.67 per dollar
Euro at 1.464
Gold down $2 at $890
Oil fell $1.50 to $87.72
*All prices as of 4:20pm
Homeowner Vacancy Rate Rises as Homeownership Rate Slips in 4th Qtr 2007
Homeownership fell by an extremely large -.4% QoQ, to 67.7%, in the fourth quarter of 2007. A year ago, the homeownership rate was 68.8%. Today's data shows accelerating errosion in the ability of families to afford their homes as defaults rise. The trend is expected to continue as home prices continue to fall and credit remains tight. The homeowner vacancy rate edged up to a record high 2.8% in the 4th quarter, from 2.7% the prior quarter. A 2.8% vacancy rate equates to about 1 million vacant homes for sale. This elevated excess supply will probably keep home prices under pressure. Rental vacancy eased back to 9.6% from 9.8%, but still remains historically elevated. The move by homeowners back to renting is likely to take some of this supply off of the market in coming months.
Case-Shiller20-City Home Price Index Accelerates Decline Faster Than Expected to a Record Annual Drop
In November, the S&P Case Shiller index for 20 major cities indicates that home price declines fell -7.74% YoY (consensus -7.1%YoY, prior -6.1% YoY). The three month annualized decline rate has now risen to -16.2% for the 20-city index which goes back to 2000. The smaller ten city index, which has a longer history going back to 1987, fell -8.42% YoY. The largest monthly declines in November were in the West. Los Angeles fell the most at -3.64% MoM, while the average for the twenty cities fell -2.14% MoM. All cities saw declines in prices on a monthly basis in November, with Portland falling the least at -.78% MoM. Over the past year, Miami had the largest drop of -15% YoY. Other cities with annual double-digit declines are Tampa, Detroit, Phoenix, Las Vegas, San Diego, and Los Angeles. Three cities are still showing house price appreciation over the past year, as of November 2007. They are Charlotte (+2.9% YoY), Seattle (+1.77% YoY), and Portland (+1.27% YoY). The major concern in the report is that house price declines are accelerating, and all regions are now feeling the pain. Also, Washington home prices fell -1.74% MoM and -7.77% YoY. The decline of the past three months, when annualized, was -11.24%.
Consumer confidence softens, but employment figures look brighter than expected
Consumer confidence fell close to a two year low in January. The Conference Board's confidence survey fell to 87.9 (consensus 87). The decline was less than expected, and the prior month's drop was revised notably higher to 90.6 from the originally reported 88.6. These figures compare to an average of 103.2 for all of 2007. This survey is known to place a higher weight on employment indicators than other surveys. Present conditions rose to 115.3 in January from 112.9 in December. Another positive was that jobs hard to get fell to 20.1, the lowest in five months, while jobs plentiful rose to 23.9. But, future expectations for the next six months fell to 69.6 from 75.8, and the percentage of people expecting their incomes to rise over the next six months fell to 17.6 from 20.2. All age groups saw a decline in confidence, with middle-aged consumers showing the most pessimism. The highest and lowest income ranges experienced reduced confidence. Those earning between $15-35,000 saw increases. Regionally, the Pacific and northern Midwest regions saw the largest declines in optimism, while the Southeast saw the biggest improvements. Big picture, the survey indicates that employment may rebound more than expected in Friday's payroll report, but consumption is likely to remain weak. Confidence continues to weaken.
December Durable Goods Orders Much Stronger than Expected
Durable goods orders rose +5.2% MoM (consensus +1.6%, prior revised higher to +.5%) in December. Ex-transportation orders, which tend to be volatile, were also much stronger than expected, rising +2.6% MoM (consensus +.1%, prior revised up to -.4%). Record aircraft sales were expected to boost sales, but other areas were expected to remain weak. It appears that export orders were much stronger than anticipated at the end of 2007. This was the best monthly gain since last July. Over the past year, new durable goods orders have risen +5% YoY, with ex-transportation rising +2.5% YoY and ex-defense increasing +3.1% YoY. Defense capital goods orders have risen a stunning +50% YoY as the war increases replacement demand. Capital goods orders rose a strong +11.2% MoM. Demand for non-defense capital goods excluding aircraft rose a solid +4.4% MoM, the best gain since last March. In fact this area stagnated during most of 2007, and is viewed as a good proxy for future business investment. Renewed strength in capital goods excluding defense and aircraft is an encouraging sign for future economic growth. Shipments of this same category rose +2% MoM, the largest rise since March 2006. The Fed will be glad to see that capital expenditure demand has not collapsed. Defense orders surged an unusually large 81% MoM, mainly due to increased aircraft orders. Ex-defense equipment orders rose +2.9% MoM, as machinery orders rose the most in a year. Computer and electronic orders remain robust at +4.6% MoM, but electrical equipment fell -1.4% MoM. Aircraft orders rose 11.7% MoM (+33% YoY), as overseas demand for airliners increased aircraft new books to 287 new orders in December versus 177 in November. Other vehicle sales fell -2.3% MoM, meaning that all of the +11.3% MoM gain in transportation orders was due to aircraft demand. Domestic demand showed continued signs of slowing. Orders for appliances and motor vehicles fell again in December. The most recent ISM manufacturing readings showed manufacturing contracting at the fastest pace in four years, and new orders falling the most since the 2001 recession. Shipments of durable goods fell -.1% MoM, and are down -.6% YoY. Capital goods defense shipments fell -4.9% MoM, and are down -2.2% YoY. Transportation shipments fell -1.4% MoM and -6.9% YoY, perhaps due to problems with the new Dreamliners at Boeing. Non-defense capital goods unfilled orders rose +2.8% MoM, while ex-aircraft only rose +.6% MoM. The large backlog of unfilled orders should help keep employment supported until demand is met. Inventories rose +1.1% MoM (+3.7% YoY) with non-defense capital goods inventories also rising +1.1% MoM, but +7% YoY. The inventory to shipments ratio popped back up to 1.51 from 1.42 last summer. The one major negative out of this report is that inventories have risen +3.7% YoY while shipments have slowed -.6% YoY. This data will cause fourth quarter GDP to be revised higher.
Monday, January 28, 2008
Today's Tidbits
Recently Retired Top Fed Economist Expects 50bp from FOMC
From MarketWatch: “The Federal Open Market Committee is likely to cut rates again by a half-point on Wednesday, according to former top Fed staffer Vincent Reinhart. Fed watchers pay attention to Reinhart because he has the distinction of being the last man who has come in from the cold, having left the Fed's marble temple last year for the private sector. Reinhart worked at the Fed for twenty-five years, rising to become the top staffer on monetary policy. In an interview with MarketWatch, Reinhart said the Bernanke Fed "clearly has to ease" on Wednesday. A half-point cut is the "most likely" action, but a quarter-point cut shouldn't be ruled out, he said. Fed officials would like nothing better than to hold rates steady and show independence from the market, but this is not the time for such action, Reinhart said, as financial markets are so volatile and skittish. "They are not in a situation where they can disappoint market participants," Reinhart said in an interview at the American Enterprise Institute, the conservative think-tank he has joined as a research scholar. Traders are pricing in about an 86% chance of a half-point rate cut on Wednesday.”
Loan Limit Changes
From American Banker: “A deal to include Federal Housing Administration reform and let Fannie Mae and Freddie Mac have a slice of the jumbo loan market in the economic stimulus package was on the rocks Monday, according to sources. A Hill aide said House lawmakers - under pressure from Treasury Secretary Henry Paulson - were poised to scrap FHA reform from the stimulus package. A Treasury spokeswoman said Mr. Paulson wants Congress to handle FHA reform separately to avoid slowing down the legislation, which is intended to provide a quick boost to the economy. "Treasury continues to support FHA modernization and believes it should be completed as soon as possible on a separate track from the stimulus package," the spokeswoman said. Another provision of the bill, which would temporarily raise the conforming loan limit, was also in jeopardy, sources said. House Financial Services Committee Chairman Barney Frank first announced last week a deal with the White House that included a one-year increase in the loan limits of Fannie and Freddie to 125% of the local median house cost, with a cap of $729,750. But one source said the White House and House were still debating the scope of a conforming loan limit increase. The White House would like to limit the increase only to new loans, while House leadership would like it to also apply to existing mortgages. It was unclear if policymakers can work out their differences before the House is expected to vote on the stimulus plan Tuesday. Mr. Paulson made no secret last week that he was not pleased lawmakers had included a temporary conforming loan limit increase in the stimulus bill. The conventional wisdom in Washington is that raising the conforming loan limit saps momentum for a broader GSE regulatory reform package. Mr. Paulson said last week he was run down by a "bipartisan steamroller" over the issue, but said he ultimately supported the stimulus package. Removal of the FHA reform package from the stimulus bill, however, is more of a surprise. President Bush has personally urged Congress several times to pass the bill, which would allow the FHA to insure more loans. Lawmakers, however, were still trying to hammer out differences last week between the House and Senate versions of reform. The Senate bill would reduce FHA downpayment requirements to 1.5%, while the House bill would allow the program to insure loans with no downpayment.”
From RBSGC: “By our estimates, 67% of the $2.5 trillion Jumbo market would be refinancible at a loan size limit of $625 K. The impact on the Alt-A sector would be minimal. The SIFMA call this afternoon provided little clarity regarding the TBA eligibility of these loans.”
From Deutsche Bank: “We estimate between $250-$300 bn in additional agency MBS supply due to the higher conforming loan limit.”
Increased Eligibility for FHA Mortgages
From LEHC: “While most of the stories written about loan limits and last week’s economic stimulus package have focused on the “conforming” loan limit that applies to loans purchased or securitized by Fannie and Freddie, the real “eye-popper” is the proposal to increase permanently the FHA loan limit – either to as much as $729,250 depending on local housing costs, or to $625,000. FHA financing has traditionally been focused on “low-to-moderate income” lending, and FHA insurance is a government guarantee. The maximum front-end (mortgage payment) and back-end (all debt payments) debt-to-income underwriting ratios for FHA-insured loans approved via manual underwriting are 31% and 43%, respectively. Ratios can be higher if loans go through an automated underwriting engine and there are “compensating factors”, but 31%/43% are the standards. Those ratios focus on total payments including escrow for taxes and insurance (and any condo/HOA fees), and full documentation of income and assets is required. If one just focuses on the front-end ratio, let’s consider a borrower that has a 30-year fixed-rate FHA mortgage with a 6% rate (included the MI premium), and that annual T&I/other expenses are a (conservative) 1.5% of the value of the home. Let’s assume that the borrower puts down just 3% (though at least one version of the FHA modernization act would put the minimum down payment down to 1.5% -- a scary proposal given that home prices are declining in so many parts of the country). And, to be conservative, let’s assume that no MI/other closing costs are financed. For someone taking out a $625,000 FHA-insured mortgage to buy a home “priced” at $644,330, the income needed to have a front end ratio of 31% would be $176,229.80! And for someone taking out a $729,750 FHA-insured mortgage to buy a home “priced” at $752,320, the income needed to have a front-end ratio of 31% would be $205,765.91!!!!! About 95% of US households have incomes below $176,230, and about 95% of California households have incomes below $205,766!!!! So these new loan limits would “open up” government-insured mortgage financing to folks with a high debt-to-income ratio and low down payment to almost everyone, including households with incomes about 3.6 times the US median, and 2.7 times the US average!!!! According to the FY 2007 MMI Fund Analysis Actuarial Review, the FHA share of the mortgage-financed home purchase market declined from around 18% in 1990 to around 4% in 2006 and 2007 (fiscal, not calendar year).”
Value-At-Risk No Longer Considered Sufficient Risk Metric
From Bloomberg: “The risk-taking model that emboldened Wall Street to trade with impunity is broken and everyone from Merrill Lynch & Co. Chief Executive Officer John Thain to Morgan Stanley Chief Financial Officer Colm Kelleher is coming to the realization that no algorithm or triple-A rating can substitute for old-fashioned due diligence. Value at risk, the measure banks use to calculate the maximum their trades can lose each day, failed to detect the scope of the U.S. subprime mortgage market's …The past six months have exposed the flaws of a financial measure based on historical prices that securities firms use idiosyncratically and that doesn't anticipate every potential disaster, such as the mistaken credit ratings on defaulted subprime debt. ``Finance is an area that's dominated by rare events,'' said Nassim Taleb, a research professor at London Business School and former options trader. ``The tools we have in quantitative finance do not work in what I call the `Black Swan' domain.'' Taleb's book ``The Black Swan”… describes how people underestimate the impact of infrequent occurrences. Just as it was assumed that all swans were white until the first black species was spotted in Australia during the 17th century, historical analysis is an inadequate way to judge risk, he said. Executives at Merrill, Morgan Stanley and UBS took steps in the past six weeks to overhaul their risk-management groups after internal models failed to foresee the first annual decline in house prices since the Great Depression that eroded five years of trading gains… Thain, who replaced the ousted Stan O'Neal last month at Merrill, said Jan. 17 that the largest U.S. brokerage should stop making trades that have the potential to wipe out profits…UBS CEO Marcel Rohner told employees two weeks ago that Europe's biggest bank will scale back risk taking after reporting a $15 billion writedown last year for subprime- infected investments…At New York-based Morgan Stanley, which disclosed a $3.56 billion fourth-quarter loss after writing down mortgage-related and other securities by $9.4 billion, the risk department will now report directly to Kelleher instead of to the trading heads. The firm said it plans to hire more risk managers… Hiring risk managers and giving them more power won't alter the mistake that led to last year's slump and that was Wall Street's dependence on statistics to quantify risks, Taleb said. ``We have had dismal failures in quantitative finance in measuring these risks, yet people hire quants and hire risk managers simply to back up their desire to take these risks,'' he said. ``There are some probabilities that you cannot compute.''… All the New York-based firms base their calculations at a confidence level of 95 percent, meaning they don't expect one- day drops to exceed the reported amount more than 5 percent of the time. The amounts differ in part because every firm uses their own methodology and data. For instance, Lehman uses four years of historical data to calculate VaR, with a higher weighting given to more recent time periods, while Morgan Stanley provides VaR calculations using both four years and one year of market data. ``If you compare what peoples' values at risk are versus what their losses were in the third quarter or fourth quarter, the numbers are astounding,'' said David Einhorn, president and co-founder of hedge fund Greenlight Capital LLC in New York. ``There are a lot of things that probably the value-at-risk model said would have trivial losses 95 percent of the time or 99 percent of the time but are now having a huge loss.'' Merrill's highest one-day value at risk in the third quarter was $92 million, indicating that the firm's maximum expected cost during the 63-trading day period would be $5.8 billion. In fact, the firm wrote down $8.4 billion from the value of collateralized debt obligations, subprime mortgages and leveraged finance commitments, 45 percent more than the worst- case scenario. All of the risk-measurement tools failed to prepare Merrill for the unforeseen declines on triple-A rated securities backed by subprime mortgages, according to the company's third-quarter filing with the U.S. Securities and Exchange Commission. The firm's writedowns related to the highest-rated portions of CDOs backed by pools of home loans, which plunged in value as defaults on the underlying mortgages soared. ``VaR, stress tests and other risk measures significantly underestimated the magnitude of actual loss from the unprecedented credit market environment,'' Merrill's filing said. ``In the past, these AAA ABS CDO securities had never experienced a significant loss in value.'' Securities firms developed statistical models during the early 1990s to better quantify risks as the trading of bonds, stocks, currencies and derivatives increased. J.P. Morgan & Co., now part of JPMorgan Chase & Co., helped popularize the use of value at risk as the primary measurement tool in 1994 when it published its so-called RiskMetrics system. Four years later, two events helped demonstrate the drawbacks in using statistical analysis based on historical market movements to measure risk. Russia's bond default sent fixed-income markets into a tailspin and Long-Term Capital Management LP, the Greenwich, Connecticut-based hedge fund run by former Salomon Brothers trader John W. Meriwether, had to be bailed out after $4 billion of trading declines. Russia's default risk was underestimated because value-at- risk computations used by investment banks depended on market events of the preceding two to three years, when nothing similar had occurred…Long-Term Capital Management, which amplified its risk by relying on borrowed money for most of its trading bets, blew up in part because it didn't anticipate that investor panic after the Russian default would cut the value of any risky debt, whether it was issued by a country, sold by a company, or backed by mortgages…``In a market stress event, some individual sectors that previously appeared unrelated do move together, and as a result, the organization could take losses on both of them or even on positions that were previously deemed to be a hedge,…The other risk tool commonly used by securities firms, known as stress testing or scenario analysis, also failed to prepare the industry for the plummeting value of AAA-rated securities that had previously been deemed the most creditworthy…``Stress tests are only as good or as predictive as the scenarios used and in many cases the scenarios that played out were much more severe than people anticipated,'' … ``One lesson learned is that these stress tests should be broader, should consider more scenarios.'' … VaR provides a service if used every day because it can pick up fluctuations in the risk that the firm is taking in some distant region or an arcane product that might not otherwise be noticed. Investment banks will continue to take unsafe risks as long as traders are rewarded for making profits, leaving shareholders, bondholders and sometimes taxpayers to shoulder the consequences, Taleb said.”
Japan’s Economy Slowing
From Bloomberg: “Japan's economy is particularly at risk. Its housing market is slumping as stricter building-permit rules drag home starts to a four-decade low. A drop in construction demand led Tokyo Steel Manufacturing Co., the nation's biggest maker of steel girders, to lower its profit forecast Jan. 22. It's ``highly likely'' Japan is already in a recession or will enter one this quarter, Tetsufumi Yamakawa, chief Japan economist at Goldman in Tokyo, wrote in a report published today. The yen's 13 percent rise versus the dollar in the last six months is also taking a toll. The Japanese currency reached a 2 1/2-year high of 104.97 to the dollar last week. That is near the break-even point for Japan's exporters, who say they can remain profitable as long as the currency is weaker than 106.6, according to a government survey. Kozo Yamamoto, head of the ruling Liberal Democratic Party's monetary policy panel, urged the Bank of Japan to cut its benchmark interest rate, already the lowest in the industrialized world at 0.5 percent. ``Concerns over a recession are emerging not only in the U.S., but in Japan as well,'' Yamamoto said in a Jan. 23 interview. ``The BOJ should cut rates back to zero immediately.''”
Study Indicates Credit Derivatives Increase Company Bankruptcy
From The Financial Times: “A boom in the use of derivatives is giving creditors strong incentives to push troubled companies into bankruptcy rather than help rescue them, according to new research and industry experts. A study by academics Henry Hu and Bernard Black concludes that, thanks to explosive growth in credit derivatives, debt-holders such as banks and hedge funds have often more to gain if companies fail than if they survive. The study suggests this development could endanger the stability of the financial system. The findings highlight a crucial problem in corporate restructuring when more and more companies are facing financial difficulties as a result of the credit crunch and US economic slowdown. According to the research and industry practitioners, creditors have a strong interest in voting against a restructuring plan if they have bought credit or loan default swaps, which trigger payments when a company fails…. “[investor’s] financial interests may be best served by forcing a default if they are on the right side of a CDS position.” The problem is compounded by creditors not having to disclose derivatives positions, making it very difficult for companies and regulators to find out their real intentions. The study by the two University of Texas academics warns that the breakdown in the relationship between creditors and debtors, which traditionally worked together to keep solvent companies out of bankruptcy, lowers the system’s ability to deal with a credit crunch. “Spread across the economy, the ‘freezing’ of debtor-creditor relationships can increase systemic financial risk,” says the paper, which has been sent to the Securities and Exchange Commission. “[It] can also increase the economy’s exposure to liquidity shocks”.”
Lower Interest Rates Risk Dollar Decline
From Jim Grant: “In finance, to borrow from the economist Hyman Minsky, nothing is so destabilizing as stability. The paradox is easily explained. Profit-seeking people will take more financial risk when they believe the coast is clear. By taking bigger chances, however, they unwittingly make the world unsafe all over again. Anxious people don’t ordinarily get in over their heads; it’s the confident ones who do. And nothing builds confidence like the belief that a greater power has conquered the business cycle and laid inflation low. In such happy circumstances, a calculating human will take out a bigger mortgage, build a bigger hedge fund or attempt a gaudier corporate buyout. That is, he or she will borrow more money, or, as they say on Wall Street, lay on more leverage. So Americans proceeded to borrow. Over the past decade, household indebtedness, expressed as a percentage of the value of household assets, has shot up into record territory… To lubricate the machinery of lending and borrowing, Mr. Bernanke is likely to make dollars increasingly plentiful. The trouble is that, while the Fed is America’s central bank, the dollar is the world’s currency. It lines the vaults of central banks of America’s creditors, especially the up-and-coming states of Asia and the oil-soaked principalities of the Middle East. Such institutions hold dollars by choice, and not a few of them chafe at the greenback’s steady loss of purchasing power. For some, Tuesday’s hasty rate cut might be the last straw. As just about nobody predicted the present troubles, humility is what becomes today’s forecaster the most. So I will offer up a humble forecast. Inflation will, at length, make its way up from the bottom of the Fed’s worry list to the very top. Not for years has it seemed to matter that the dollar is only a piece of paper. But, before very long, that homely fact will push itself back to the fore.”
MISC
From Merrill Lynch: “All in all, we are off to the worst start to any year for the equity market (S&P 500 down 9.4% YTD) in over a century, and that is despite 175 basis points of rate cuts out of the Fed and a raft of policy proposals from Super SIV to FHA Secure to Hope Now to renewed fiscal largesse. In a sign of the times, we see on Bloomberg that so far in January, 24 IPOs have been pulled - the most in a decade…this was one oversold stock market - to be suffering these losses in December AND January? These are usually the two best months of the year, so if you were to "seasonally adjust" the market as you do for the economic data, it would suggest the bear market is even worse than it looks on the surface.”
From Wachovia: “There is little wonder why economics is known as the dismal science. Pessimistic views on the economy almost always seem to garner far more headlines and attention than supposedly optimistic predictions of moderating economic growth. Judging from today's headlines you would think that virtually every economist believes the U.S. economy is either heading for or is already in a recession. In fact, the latest Blue Chip Consensus shows economists rate the odds of a recession beginning in the next 12 months at just shy of 50 percent.”
From Morgan Stanley: “Subprime remittance deteriorated in November, supporting our underweight view. Deterioration in subprime loan pools suggests possibility of further CDO write-downs and higher losses and reserves against subprime loans.…We are underweight Large Cap Banks, expecting significant deterioration in loan quality throughout the year as housing values decline. We expect peak losses in first and second lien loans to be more than double prior recession cycle peaks and all other loan categories to generate losses in-line with prior recession cycle peaks. Banks are entering into this cycle with low reserves (we expect will have to double, eating into earnings) and thin capital. We don’t think the Fed rate cuts will sufficiently reliquify the banks.”
From Merrill Lynch: “Not only do the banks still have $230 billion of leveraged loans on their books, but according to the Investor’s Business Daily, regulators may force them to raise as much as $143 billion in fresh capital if the rating agencies sharply downgrade the monolines… Counterparty risk is the new theme in this credit mess – subprime was several chapters ago.”
From JP Morgan: “These actions justly mark the Bernanke Fed as “activist”: the central bank is willing to move policy aggressively in response to changes in its macroeconomic forecasts and perception of risks.”
From Merrill Lynch: “We look for national homeprices to be down at least 10.0% y/y in 2008 - and that implies a NEGATIVE wealth effect to the consumer of -$105.0 bln, or more. If a portion of the Bush $100.0 bln tax rebate is saved, then the negative housing wealth effect will dominate the stimulus package, calling forth ADDITIONAL Fed rate cuts.”
From Citi: “…large sales declines, price declines, and a hint of help from lower mortgage rates, have pushed affordability measures back above 20-year averages.”
From RBSGC: “Clearly, the steep cutbacks in housing starts have allowed significant progress in slowing the amount of supply in the pipeline. However, as long as new home sales are falling, builders will not be able to pare stocks, especially of finished homes, to desired levels very quickly. As a result, expect housing construction to keep falling for all of 2008 and stay focused on the sales data, which will provide the first evidence of a bottom.”
From BMO: “This will be the first real estate contraction since after World War I, which
begins at a time of a shrinkage in the numbers of twenty-somethings—the traditional first-time homebuyers. The demographic collapse that began 35 years ago will be a major factor in residential real estate pricing for many decades to come.”
From AFP: “"When folks buy a home they expect to die in it, I guess," she said as she stood outside in the cold. "I had my American Dream but it became a nightmare."”
From Wachovia: “The most direct way that an American recession would spread to the rest of the world is via the weaker exports to the United States. In that regard, Canada and Mexico stand out as being the most susceptible to an American downturn, especially a severe one. Although the European Union is the least exposed nation to exports to the United States, at least as measured as a percentage of local GDP, Europe does not have much cushion due to its relatively low overall GDP growth rate. Contrary to popular perceptions, the Chinese economy would not collapse if the United States experiences recession. Small open Asian economies, such as Singapore and Taiwan, might feel more of an impact, but these economies are better able to withstand an American downturn than they were during the last cycle. Most Latin economies probably would not fall apart either.”
From Citi: “ABCP yields remain slightly below Fed Funds at 3.44% while the spread to T-bills is at 140bp. Fed data shows a fourth consecutive weekly rise ($8.2bn) in US ABCP outstanding to $813bn in the week to 23 Jan. While the stock of ABCP is unlikely to return to its August highs ($1.2tr) just yet, its current level is a healthy improvement from the lows of $747bn at the start of the year.”
From BMO: “…quality corporates are too rare—with 71% of corporate debt junk-rated.”
From Deutsche Bank: “While US high yield credit spreads have widened to reflect an 11% default rate over the next year (vs. current default rate of <1%), the non-financial sector has not been increasing leverage to any meaningful amount. After repairing their balance sheets post the 2001 recession, the increase in leverage for the non-financials over the past few years has been minimal. The prime reason for the increase in leverage for the S&P500 over the past three years has been the marked increase in debt/book ratios amongst the financials (primarily brokers and money center banks), which are now paying the price. Conversely, the nonfinancials are in good financial shape to weather any slowdown/recession.”
From Thompson Financial: “Mining giant Rio Tinto projects that China's booming economy will consume more than half of the world's key resources within a decade, potentially leading to clashes with other countries over resources. Rio Tinto last week said China already accounted for 47% of all iron ore consumption, 32% of aluminum, and 25% of copper.”
End-of-Day Market Update
From UBS: “Relative to the roller coaster sessions we've seen last week, Treasuries had an absolute yawner of a day today. Richer early in the morning, Treasury yields gradually meandered upwards during the session, finishing little changed from yesterday's close… Swaps …spreads tightened modestly across the board…Versus Libor, 3-year agencies cheapened slightly, while the rest of the curve held in to swaps. Mortgages had a very quiet day, with the 5.5 coupon trading 3.5 ticks better to Treasuries and 2.5 to swaps, and 6's outperforming Treasuries by 1.5 ticks and swaps by a plus.”
From JP Morgan: “Indirect bidders were allotted just 19.3% of the auction, the lowest ever…This was a weak [2 year Treasury] auction and consistent with the (lack of) demand we saw.”
From RBSGC: “The 2s/10s curve steepened slightly during Monday's downtrade -- a dynamic which reflects the front-end's continued anchor to policy expectations. The Fed funds futures market is pricing in a 86% probability of a 50 bps ease -- as a half point becomes the consensus.”
Three month T-Bill yield rose 1 bp to 2.26%.
Two year T-Note yield rose 1.5 bp to 2.20%
Ten year T-Note yield rose 4 bp to 3.59%
Dow rose 177 to 12,384
S&P 500 rose 23 to 154
Dollar index fell .40 to 75.58
Yen at 106.9 per dollar Euro at 1.479 Gold rose $15 at $929. another record high
Oil rose $.37 to $91.08
*All prices as of 4:27pm
From MarketWatch: “The Federal Open Market Committee is likely to cut rates again by a half-point on Wednesday, according to former top Fed staffer Vincent Reinhart. Fed watchers pay attention to Reinhart because he has the distinction of being the last man who has come in from the cold, having left the Fed's marble temple last year for the private sector. Reinhart worked at the Fed for twenty-five years, rising to become the top staffer on monetary policy. In an interview with MarketWatch, Reinhart said the Bernanke Fed "clearly has to ease" on Wednesday. A half-point cut is the "most likely" action, but a quarter-point cut shouldn't be ruled out, he said. Fed officials would like nothing better than to hold rates steady and show independence from the market, but this is not the time for such action, Reinhart said, as financial markets are so volatile and skittish. "They are not in a situation where they can disappoint market participants," Reinhart said in an interview at the American Enterprise Institute, the conservative think-tank he has joined as a research scholar. Traders are pricing in about an 86% chance of a half-point rate cut on Wednesday.”
Loan Limit Changes
From American Banker: “A deal to include Federal Housing Administration reform and let Fannie Mae and Freddie Mac have a slice of the jumbo loan market in the economic stimulus package was on the rocks Monday, according to sources. A Hill aide said House lawmakers - under pressure from Treasury Secretary Henry Paulson - were poised to scrap FHA reform from the stimulus package. A Treasury spokeswoman said Mr. Paulson wants Congress to handle FHA reform separately to avoid slowing down the legislation, which is intended to provide a quick boost to the economy. "Treasury continues to support FHA modernization and believes it should be completed as soon as possible on a separate track from the stimulus package," the spokeswoman said. Another provision of the bill, which would temporarily raise the conforming loan limit, was also in jeopardy, sources said. House Financial Services Committee Chairman Barney Frank first announced last week a deal with the White House that included a one-year increase in the loan limits of Fannie and Freddie to 125% of the local median house cost, with a cap of $729,750. But one source said the White House and House were still debating the scope of a conforming loan limit increase. The White House would like to limit the increase only to new loans, while House leadership would like it to also apply to existing mortgages. It was unclear if policymakers can work out their differences before the House is expected to vote on the stimulus plan Tuesday. Mr. Paulson made no secret last week that he was not pleased lawmakers had included a temporary conforming loan limit increase in the stimulus bill. The conventional wisdom in Washington is that raising the conforming loan limit saps momentum for a broader GSE regulatory reform package. Mr. Paulson said last week he was run down by a "bipartisan steamroller" over the issue, but said he ultimately supported the stimulus package. Removal of the FHA reform package from the stimulus bill, however, is more of a surprise. President Bush has personally urged Congress several times to pass the bill, which would allow the FHA to insure more loans. Lawmakers, however, were still trying to hammer out differences last week between the House and Senate versions of reform. The Senate bill would reduce FHA downpayment requirements to 1.5%, while the House bill would allow the program to insure loans with no downpayment.”
From RBSGC: “By our estimates, 67% of the $2.5 trillion Jumbo market would be refinancible at a loan size limit of $625 K. The impact on the Alt-A sector would be minimal. The SIFMA call this afternoon provided little clarity regarding the TBA eligibility of these loans.”
From Deutsche Bank: “We estimate between $250-$300 bn in additional agency MBS supply due to the higher conforming loan limit.”
Increased Eligibility for FHA Mortgages
From LEHC: “While most of the stories written about loan limits and last week’s economic stimulus package have focused on the “conforming” loan limit that applies to loans purchased or securitized by Fannie and Freddie, the real “eye-popper” is the proposal to increase permanently the FHA loan limit – either to as much as $729,250 depending on local housing costs, or to $625,000. FHA financing has traditionally been focused on “low-to-moderate income” lending, and FHA insurance is a government guarantee. The maximum front-end (mortgage payment) and back-end (all debt payments) debt-to-income underwriting ratios for FHA-insured loans approved via manual underwriting are 31% and 43%, respectively. Ratios can be higher if loans go through an automated underwriting engine and there are “compensating factors”, but 31%/43% are the standards. Those ratios focus on total payments including escrow for taxes and insurance (and any condo/HOA fees), and full documentation of income and assets is required. If one just focuses on the front-end ratio, let’s consider a borrower that has a 30-year fixed-rate FHA mortgage with a 6% rate (included the MI premium), and that annual T&I/other expenses are a (conservative) 1.5% of the value of the home. Let’s assume that the borrower puts down just 3% (though at least one version of the FHA modernization act would put the minimum down payment down to 1.5% -- a scary proposal given that home prices are declining in so many parts of the country). And, to be conservative, let’s assume that no MI/other closing costs are financed. For someone taking out a $625,000 FHA-insured mortgage to buy a home “priced” at $644,330, the income needed to have a front end ratio of 31% would be $176,229.80! And for someone taking out a $729,750 FHA-insured mortgage to buy a home “priced” at $752,320, the income needed to have a front-end ratio of 31% would be $205,765.91!!!!! About 95% of US households have incomes below $176,230, and about 95% of California households have incomes below $205,766!!!! So these new loan limits would “open up” government-insured mortgage financing to folks with a high debt-to-income ratio and low down payment to almost everyone, including households with incomes about 3.6 times the US median, and 2.7 times the US average!!!! According to the FY 2007 MMI Fund Analysis Actuarial Review, the FHA share of the mortgage-financed home purchase market declined from around 18% in 1990 to around 4% in 2006 and 2007 (fiscal, not calendar year).”
Value-At-Risk No Longer Considered Sufficient Risk Metric
From Bloomberg: “The risk-taking model that emboldened Wall Street to trade with impunity is broken and everyone from Merrill Lynch & Co. Chief Executive Officer John Thain to Morgan Stanley Chief Financial Officer Colm Kelleher is coming to the realization that no algorithm or triple-A rating can substitute for old-fashioned due diligence. Value at risk, the measure banks use to calculate the maximum their trades can lose each day, failed to detect the scope of the U.S. subprime mortgage market's …The past six months have exposed the flaws of a financial measure based on historical prices that securities firms use idiosyncratically and that doesn't anticipate every potential disaster, such as the mistaken credit ratings on defaulted subprime debt. ``Finance is an area that's dominated by rare events,'' said Nassim Taleb, a research professor at London Business School and former options trader. ``The tools we have in quantitative finance do not work in what I call the `Black Swan' domain.'' Taleb's book ``The Black Swan”… describes how people underestimate the impact of infrequent occurrences. Just as it was assumed that all swans were white until the first black species was spotted in Australia during the 17th century, historical analysis is an inadequate way to judge risk, he said. Executives at Merrill, Morgan Stanley and UBS took steps in the past six weeks to overhaul their risk-management groups after internal models failed to foresee the first annual decline in house prices since the Great Depression that eroded five years of trading gains… Thain, who replaced the ousted Stan O'Neal last month at Merrill, said Jan. 17 that the largest U.S. brokerage should stop making trades that have the potential to wipe out profits…UBS CEO Marcel Rohner told employees two weeks ago that Europe's biggest bank will scale back risk taking after reporting a $15 billion writedown last year for subprime- infected investments…At New York-based Morgan Stanley, which disclosed a $3.56 billion fourth-quarter loss after writing down mortgage-related and other securities by $9.4 billion, the risk department will now report directly to Kelleher instead of to the trading heads. The firm said it plans to hire more risk managers… Hiring risk managers and giving them more power won't alter the mistake that led to last year's slump and that was Wall Street's dependence on statistics to quantify risks, Taleb said. ``We have had dismal failures in quantitative finance in measuring these risks, yet people hire quants and hire risk managers simply to back up their desire to take these risks,'' he said. ``There are some probabilities that you cannot compute.''… All the New York-based firms base their calculations at a confidence level of 95 percent, meaning they don't expect one- day drops to exceed the reported amount more than 5 percent of the time. The amounts differ in part because every firm uses their own methodology and data. For instance, Lehman uses four years of historical data to calculate VaR, with a higher weighting given to more recent time periods, while Morgan Stanley provides VaR calculations using both four years and one year of market data. ``If you compare what peoples' values at risk are versus what their losses were in the third quarter or fourth quarter, the numbers are astounding,'' said David Einhorn, president and co-founder of hedge fund Greenlight Capital LLC in New York. ``There are a lot of things that probably the value-at-risk model said would have trivial losses 95 percent of the time or 99 percent of the time but are now having a huge loss.'' Merrill's highest one-day value at risk in the third quarter was $92 million, indicating that the firm's maximum expected cost during the 63-trading day period would be $5.8 billion. In fact, the firm wrote down $8.4 billion from the value of collateralized debt obligations, subprime mortgages and leveraged finance commitments, 45 percent more than the worst- case scenario. All of the risk-measurement tools failed to prepare Merrill for the unforeseen declines on triple-A rated securities backed by subprime mortgages, according to the company's third-quarter filing with the U.S. Securities and Exchange Commission. The firm's writedowns related to the highest-rated portions of CDOs backed by pools of home loans, which plunged in value as defaults on the underlying mortgages soared. ``VaR, stress tests and other risk measures significantly underestimated the magnitude of actual loss from the unprecedented credit market environment,'' Merrill's filing said. ``In the past, these AAA ABS CDO securities had never experienced a significant loss in value.'' Securities firms developed statistical models during the early 1990s to better quantify risks as the trading of bonds, stocks, currencies and derivatives increased. J.P. Morgan & Co., now part of JPMorgan Chase & Co., helped popularize the use of value at risk as the primary measurement tool in 1994 when it published its so-called RiskMetrics system. Four years later, two events helped demonstrate the drawbacks in using statistical analysis based on historical market movements to measure risk. Russia's bond default sent fixed-income markets into a tailspin and Long-Term Capital Management LP, the Greenwich, Connecticut-based hedge fund run by former Salomon Brothers trader John W. Meriwether, had to be bailed out after $4 billion of trading declines. Russia's default risk was underestimated because value-at- risk computations used by investment banks depended on market events of the preceding two to three years, when nothing similar had occurred…Long-Term Capital Management, which amplified its risk by relying on borrowed money for most of its trading bets, blew up in part because it didn't anticipate that investor panic after the Russian default would cut the value of any risky debt, whether it was issued by a country, sold by a company, or backed by mortgages…``In a market stress event, some individual sectors that previously appeared unrelated do move together, and as a result, the organization could take losses on both of them or even on positions that were previously deemed to be a hedge,…The other risk tool commonly used by securities firms, known as stress testing or scenario analysis, also failed to prepare the industry for the plummeting value of AAA-rated securities that had previously been deemed the most creditworthy…``Stress tests are only as good or as predictive as the scenarios used and in many cases the scenarios that played out were much more severe than people anticipated,'' … ``One lesson learned is that these stress tests should be broader, should consider more scenarios.'' … VaR provides a service if used every day because it can pick up fluctuations in the risk that the firm is taking in some distant region or an arcane product that might not otherwise be noticed. Investment banks will continue to take unsafe risks as long as traders are rewarded for making profits, leaving shareholders, bondholders and sometimes taxpayers to shoulder the consequences, Taleb said.”
Japan’s Economy Slowing
From Bloomberg: “Japan's economy is particularly at risk. Its housing market is slumping as stricter building-permit rules drag home starts to a four-decade low. A drop in construction demand led Tokyo Steel Manufacturing Co., the nation's biggest maker of steel girders, to lower its profit forecast Jan. 22. It's ``highly likely'' Japan is already in a recession or will enter one this quarter, Tetsufumi Yamakawa, chief Japan economist at Goldman in Tokyo, wrote in a report published today. The yen's 13 percent rise versus the dollar in the last six months is also taking a toll. The Japanese currency reached a 2 1/2-year high of 104.97 to the dollar last week. That is near the break-even point for Japan's exporters, who say they can remain profitable as long as the currency is weaker than 106.6, according to a government survey. Kozo Yamamoto, head of the ruling Liberal Democratic Party's monetary policy panel, urged the Bank of Japan to cut its benchmark interest rate, already the lowest in the industrialized world at 0.5 percent. ``Concerns over a recession are emerging not only in the U.S., but in Japan as well,'' Yamamoto said in a Jan. 23 interview. ``The BOJ should cut rates back to zero immediately.''”
Study Indicates Credit Derivatives Increase Company Bankruptcy
From The Financial Times: “A boom in the use of derivatives is giving creditors strong incentives to push troubled companies into bankruptcy rather than help rescue them, according to new research and industry experts. A study by academics Henry Hu and Bernard Black concludes that, thanks to explosive growth in credit derivatives, debt-holders such as banks and hedge funds have often more to gain if companies fail than if they survive. The study suggests this development could endanger the stability of the financial system. The findings highlight a crucial problem in corporate restructuring when more and more companies are facing financial difficulties as a result of the credit crunch and US economic slowdown. According to the research and industry practitioners, creditors have a strong interest in voting against a restructuring plan if they have bought credit or loan default swaps, which trigger payments when a company fails…. “[investor’s] financial interests may be best served by forcing a default if they are on the right side of a CDS position.” The problem is compounded by creditors not having to disclose derivatives positions, making it very difficult for companies and regulators to find out their real intentions. The study by the two University of Texas academics warns that the breakdown in the relationship between creditors and debtors, which traditionally worked together to keep solvent companies out of bankruptcy, lowers the system’s ability to deal with a credit crunch. “Spread across the economy, the ‘freezing’ of debtor-creditor relationships can increase systemic financial risk,” says the paper, which has been sent to the Securities and Exchange Commission. “[It] can also increase the economy’s exposure to liquidity shocks”.”
Lower Interest Rates Risk Dollar Decline
From Jim Grant: “In finance, to borrow from the economist Hyman Minsky, nothing is so destabilizing as stability. The paradox is easily explained. Profit-seeking people will take more financial risk when they believe the coast is clear. By taking bigger chances, however, they unwittingly make the world unsafe all over again. Anxious people don’t ordinarily get in over their heads; it’s the confident ones who do. And nothing builds confidence like the belief that a greater power has conquered the business cycle and laid inflation low. In such happy circumstances, a calculating human will take out a bigger mortgage, build a bigger hedge fund or attempt a gaudier corporate buyout. That is, he or she will borrow more money, or, as they say on Wall Street, lay on more leverage. So Americans proceeded to borrow. Over the past decade, household indebtedness, expressed as a percentage of the value of household assets, has shot up into record territory… To lubricate the machinery of lending and borrowing, Mr. Bernanke is likely to make dollars increasingly plentiful. The trouble is that, while the Fed is America’s central bank, the dollar is the world’s currency. It lines the vaults of central banks of America’s creditors, especially the up-and-coming states of Asia and the oil-soaked principalities of the Middle East. Such institutions hold dollars by choice, and not a few of them chafe at the greenback’s steady loss of purchasing power. For some, Tuesday’s hasty rate cut might be the last straw. As just about nobody predicted the present troubles, humility is what becomes today’s forecaster the most. So I will offer up a humble forecast. Inflation will, at length, make its way up from the bottom of the Fed’s worry list to the very top. Not for years has it seemed to matter that the dollar is only a piece of paper. But, before very long, that homely fact will push itself back to the fore.”
MISC
From Merrill Lynch: “All in all, we are off to the worst start to any year for the equity market (S&P 500 down 9.4% YTD) in over a century, and that is despite 175 basis points of rate cuts out of the Fed and a raft of policy proposals from Super SIV to FHA Secure to Hope Now to renewed fiscal largesse. In a sign of the times, we see on Bloomberg that so far in January, 24 IPOs have been pulled - the most in a decade…this was one oversold stock market - to be suffering these losses in December AND January? These are usually the two best months of the year, so if you were to "seasonally adjust" the market as you do for the economic data, it would suggest the bear market is even worse than it looks on the surface.”
From Wachovia: “There is little wonder why economics is known as the dismal science. Pessimistic views on the economy almost always seem to garner far more headlines and attention than supposedly optimistic predictions of moderating economic growth. Judging from today's headlines you would think that virtually every economist believes the U.S. economy is either heading for or is already in a recession. In fact, the latest Blue Chip Consensus shows economists rate the odds of a recession beginning in the next 12 months at just shy of 50 percent.”
From Morgan Stanley: “Subprime remittance deteriorated in November, supporting our underweight view. Deterioration in subprime loan pools suggests possibility of further CDO write-downs and higher losses and reserves against subprime loans.…We are underweight Large Cap Banks, expecting significant deterioration in loan quality throughout the year as housing values decline. We expect peak losses in first and second lien loans to be more than double prior recession cycle peaks and all other loan categories to generate losses in-line with prior recession cycle peaks. Banks are entering into this cycle with low reserves (we expect will have to double, eating into earnings) and thin capital. We don’t think the Fed rate cuts will sufficiently reliquify the banks.”
From Merrill Lynch: “Not only do the banks still have $230 billion of leveraged loans on their books, but according to the Investor’s Business Daily, regulators may force them to raise as much as $143 billion in fresh capital if the rating agencies sharply downgrade the monolines… Counterparty risk is the new theme in this credit mess – subprime was several chapters ago.”
From JP Morgan: “These actions justly mark the Bernanke Fed as “activist”: the central bank is willing to move policy aggressively in response to changes in its macroeconomic forecasts and perception of risks.”
From Merrill Lynch: “We look for national homeprices to be down at least 10.0% y/y in 2008 - and that implies a NEGATIVE wealth effect to the consumer of -$105.0 bln, or more. If a portion of the Bush $100.0 bln tax rebate is saved, then the negative housing wealth effect will dominate the stimulus package, calling forth ADDITIONAL Fed rate cuts.”
From Citi: “…large sales declines, price declines, and a hint of help from lower mortgage rates, have pushed affordability measures back above 20-year averages.”
From RBSGC: “Clearly, the steep cutbacks in housing starts have allowed significant progress in slowing the amount of supply in the pipeline. However, as long as new home sales are falling, builders will not be able to pare stocks, especially of finished homes, to desired levels very quickly. As a result, expect housing construction to keep falling for all of 2008 and stay focused on the sales data, which will provide the first evidence of a bottom.”
From BMO: “This will be the first real estate contraction since after World War I, which
begins at a time of a shrinkage in the numbers of twenty-somethings—the traditional first-time homebuyers. The demographic collapse that began 35 years ago will be a major factor in residential real estate pricing for many decades to come.”
From AFP: “"When folks buy a home they expect to die in it, I guess," she said as she stood outside in the cold. "I had my American Dream but it became a nightmare."”
From Wachovia: “The most direct way that an American recession would spread to the rest of the world is via the weaker exports to the United States. In that regard, Canada and Mexico stand out as being the most susceptible to an American downturn, especially a severe one. Although the European Union is the least exposed nation to exports to the United States, at least as measured as a percentage of local GDP, Europe does not have much cushion due to its relatively low overall GDP growth rate. Contrary to popular perceptions, the Chinese economy would not collapse if the United States experiences recession. Small open Asian economies, such as Singapore and Taiwan, might feel more of an impact, but these economies are better able to withstand an American downturn than they were during the last cycle. Most Latin economies probably would not fall apart either.”
From Citi: “ABCP yields remain slightly below Fed Funds at 3.44% while the spread to T-bills is at 140bp. Fed data shows a fourth consecutive weekly rise ($8.2bn) in US ABCP outstanding to $813bn in the week to 23 Jan. While the stock of ABCP is unlikely to return to its August highs ($1.2tr) just yet, its current level is a healthy improvement from the lows of $747bn at the start of the year.”
From BMO: “…quality corporates are too rare—with 71% of corporate debt junk-rated.”
From Deutsche Bank: “While US high yield credit spreads have widened to reflect an 11% default rate over the next year (vs. current default rate of <1%), the non-financial sector has not been increasing leverage to any meaningful amount. After repairing their balance sheets post the 2001 recession, the increase in leverage for the non-financials over the past few years has been minimal. The prime reason for the increase in leverage for the S&P500 over the past three years has been the marked increase in debt/book ratios amongst the financials (primarily brokers and money center banks), which are now paying the price. Conversely, the nonfinancials are in good financial shape to weather any slowdown/recession.”
From Thompson Financial: “Mining giant Rio Tinto projects that China's booming economy will consume more than half of the world's key resources within a decade, potentially leading to clashes with other countries over resources. Rio Tinto last week said China already accounted for 47% of all iron ore consumption, 32% of aluminum, and 25% of copper.”
End-of-Day Market Update
From UBS: “Relative to the roller coaster sessions we've seen last week, Treasuries had an absolute yawner of a day today. Richer early in the morning, Treasury yields gradually meandered upwards during the session, finishing little changed from yesterday's close… Swaps …spreads tightened modestly across the board…Versus Libor, 3-year agencies cheapened slightly, while the rest of the curve held in to swaps. Mortgages had a very quiet day, with the 5.5 coupon trading 3.5 ticks better to Treasuries and 2.5 to swaps, and 6's outperforming Treasuries by 1.5 ticks and swaps by a plus.”
From JP Morgan: “Indirect bidders were allotted just 19.3% of the auction, the lowest ever…This was a weak [2 year Treasury] auction and consistent with the (lack of) demand we saw.”
From RBSGC: “The 2s/10s curve steepened slightly during Monday's downtrade -- a dynamic which reflects the front-end's continued anchor to policy expectations. The Fed funds futures market is pricing in a 86% probability of a 50 bps ease -- as a half point becomes the consensus.”
Three month T-Bill yield rose 1 bp to 2.26%.
Two year T-Note yield rose 1.5 bp to 2.20%
Ten year T-Note yield rose 4 bp to 3.59%
Dow rose 177 to 12,384
S&P 500 rose 23 to 154
Dollar index fell .40 to 75.58
Yen at 106.9 per dollar Euro at 1.479 Gold rose $15 at $929. another record high
Oil rose $.37 to $91.08
*All prices as of 4:27pm
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