Wholesale Inventories Growing as Sales Shrink

A sharp drop in sales caused a larger inventory build than expected in December of +1.1% MoM (consensus +.3%). This was the largest monthly jump in inventories in a year and a half. In addition, November's figure was revised higher to +.8% from +.6% originally. Over the past year, inventory levels have expanded by +6.1% YoY. Sales fell -.7% MoM, the largest decline in almost a year. Steep declines were seen in auto sales (-2.2% MoM, -8.1% YoY). and computers (-4% MoM). Overall, durable goods sales fell -2% MoM (+1.6% YoY) and non-durable goods sales rose +.4% MoM (+19.3% YoY). Auto inventories grew a substantial +3.5% MoM, following a +2.6% gain the prior month, and the largest monthly increase since April 2006. Over the past year, auto inventories are up +5% YoY. The only category seeing a decline in inventories was computers (-1.2% MoM, +2.7% YoY). Non-durable goods inventories rose +1.6% MoM (+13.6% YoY). Non-durables include food and drugs. Stockpiles of oil rose +9.2% MoM. The inventory to sales ratio rose to 1.09 months, which is not far above the recent low of 1.07 months in November. The durable goods I/S ratio rose the most, to 1.48 months. Excess inventories indicate that demand is declining, and production will need to slow down to accommodate reduced consumption. This data is likely to slightly boost 4th quarter 2007 GDP estimates, and further reduce 1st quarter 2008 GDP forecasts. Manufacturing ISM, factory orders, and industrial production are all likely to weaken this winter.

Today's Tidbits

End-of-Day Market Update

From Bloomberg: "U.S. stocks rose for the first time this week as improved earnings prospects at retailers and banks overshadowed a bigger-than-forecast drop in home sales and slowing demand for computer equipment...The S&P 500 added 10.46 points, or 0.8 percent, to 1,336.91. The Dow rose 46.9, or 0.4 percent, to 12,247. The Nasdaq Composite Index increased 14.28, or 0.6 percent, to 2,293.03. About five stocks gained for every two that declined on the New York Stock Exchange...The forecasts from J.C. Penney and Gap spurred speculation that the nation's chain stores will rebound from a lower-than-expected 0.5 percent gain in sales last month, the worst January since 1970, according to the International Council of Shopping Centers. Treasury notes tumbled, pushing the 30-year yield down by the most since 2004, as investors concluded that bond yields were too low given the Federal Reserve's determination to cut interest rates."
From RBSGC: "The cold reception to the 30-yr auction took the edge off of what had been a relatively firm market and broke the very recent range support. The weakness was not solely a bond affair as 2s, too, cracked behind 2%. Still, the curve steepened..." From Deutsche Bank: "US equity markets consolidate whilst Tsy yields rise sharply after poor 30Y auction, curve steepens...Fed's Lockhart says Fed’s main focus remains on economy, says ‘very concerned’ about house price moves.... Fed's Fisher says facing unprecedented inflationary forces from commodity prices, says Fed has to be careful not to stir up inflation." From Deutsche Bank: "With a complete lack of indirect bidders(10.7%), the street unwillingly underwrote the largest portion of any issue since the bond was reintroduced. As the tender level hit the tape 4.5bps cheaper than expected, the bids disappeared leaving the bond in a 2.5pt freefall to the lows...Interestingly, the curve has flattened since 1pm with the 5yr point leading the move."
From JP Morgan: "It sounds like the Senate is on the verge of passing the stimulus package ...their version of the bill will not include the net operating loss provisions (this would've been a windfall for otherwise struggling home builders) or the renewable energy tax credits. It will, however, include the GSE loan limit increases and rebate checks as well as the addition of payments to social security recipients and veteran disability payments. The market has obviously been exceedingly choppy this afternoon, w/ a round of spec selling and mtge-related paying in swaps taking us lower as well as smaller gyrations around what is happening in eqs." From UBS: "Treasury bond auction flops, Bonds lead a sharp decline: The Treasury today sold $9 billion of 30-year bonds at a yield of 4.449% in a disastrous auction, tailing the 1pm level by roughly 4bps. Indirect bidders accounted for a meager 10.7% of the auction (compares to 32.4% on average for the past 6 bond auctions) while the bid-to-cover ratio was a weak 1.82x as well. The poor demand almost certainly stems from long-end yields trading near historic lows and concerns that the Fed's actions may raise inflation prospects. Long term inflation expectations have exploded higher since the Fed's inter-meeting 75bp rate cut. Treasury bond yields spiked up sharply after the auction (bonds fell by >2 1/2 points on the day), and the 2s30s curve steepened 9.4bps as bonds sagged. We did see heavy long end Treasury buying as 30yr yields broke above 4.50%-- though the buyers were eventually overwhelmed by sellers by the close. TIPS breakevens widened across the board, and Treasury volume was 144% of the 30-day average...ICSC chain store sales measure was up 0.5% year over year in January. Finally, Dallas Fed president Fisher, who voted to leave rates unchanged at the last meeting, said that although the credit crunch has damaged growth, he still fears that aggressive easing would "juice up" inflation...Mortgages saw $4 billion in origination and about $2 billion in real money buying across the coupon stack. Lower coupons, particularly 5's, got hammered during the selloff, and MBS widened 3 ticks to Treasuries and 1 to swaps."
Three month T-Bill yield rose 10 bp to 2.19%.
Two year T-Note yield rose 14 bp to 2.06%
Ten year T-Note yield rose 17bp to 3.77%
Dow rose 47to 12,247
S&P 500 rose 10.5 to 1337
Dollar index rose .71 to 76.85
Yen at 107.49 per dollar
Euro at 1.448
Gold rose $10 to $910
Oil rose $1.21 to $88.35
*All prices as of 4:55pm

Pending Home Sales Continue Decline

December pending home sales fell -1.5% MoM (consensus -1%). In addition, November's decline grew to -3% MoM, from the previously reported drop of -2.6%. Only the Midwest saw an increase in sales (+3.4%), while the other regions saw monthly declines of of -3 and -3.1% for the West and South, and the Northeast fell -1.7% MoM. Over the past year, pending home sales have declined -23.9% nationally. Regionally, in descending order, the Northeast experienced a decline of -27.3%, followed by the South at -26.5%, the West at -23.3%, and the Midwest at -17.4% YoY. Pending home sales represent signed contracts to purchase existing homes. The actual conclusion of the sale appears in the existing home sales data 1-2 months later.

Jobless Claims Data Worse Than Expected

First time jobless claims remain high at 356k (consensus 342k). Last week, initial jobless claims rose to a 27 month high of 375k, which was revised higher to 378k this week. The four week moving average of initial claims rose 8.5k to 335k. Over the past year, new jobless claims have averaged 324k a week. The recent high in initial claims was 345k in December. Continuing claims shot higher this week, rising to 2785k (consensus 2715k). This is the highest level for continuing claims since 2005. But to put it in perspective, continuing claims are still significantly below the five year peak of 3770k in May 2003. Net, this week's data reinforces that labor market conditions have begun a modest deterioration.

End-of-Day Market Update

From Bloomberg:  "U.S. stocks rose for the first time this week as improved earnings prospects at retailers and banks overshadowed a bigger-than-forecast drop in home sales and slowing demand for computer equipment...The S&P 500 added 10.46 points, or 0.8 percent, to 1,336.91. The Dow rose 46.9, or 0.4 percent, to 12,247. The Nasdaq Composite Index increased 14.28, or 0.6 percent, to 2,293.03. About five stocks gained for every two that declined on the New York Stock Exchange...The forecasts from J.C. Penney and Gap spurred speculation that the nation's chain stores will rebound from a lower-than-expected 0.5 percent gain in sales last month, the worst January since 1970, according to the International Council of Shopping Centers.  Treasury notes tumbled, pushing the 30-year yield down by the most since 2004, as investors concluded that bond yields were too low given the Federal Reserve's determination to cut interest rates."

 

From RBSGC:  "The cold reception to the 30-yr auction took the edge off of what had been a relatively firm market and broke the very recent range support. The weakness was not solely a bond affair as 2s, too, cracked behind 2%. Still, the curve steepened..."

 

From Deutsche Bank:  "US equity markets consolidate whilst Tsy yields rise sharply after poor 30Y auction, curve steepens...Fed's Lockhart says Fed’s main focus remains on economy, says ‘very concerned’ about house price moves.... Fed's Fisher says facing unprecedented inflationary forces from commodity prices, says Fed has to be careful not to stir up inflation."

 

From Deutsche Bank:  "With a complete lack of indirect bidders(10.7%), the street unwillingly underwrote the largest portion of any issue since the bond was reintroduced. As the tender level hit the tape 4.5bps cheaper than expected, the bids disappeared leaving the bond in a 2.5pt freefall to the lows...Interestingly, the curve has flattened since 1pm with the 5yr point leading the move."

 

From JP Morgan:  "It sounds like the Senate is on the verge of passing the stimulus package ...their version of the bill will not include the net operating loss provisions (this would've been a windfall for otherwise struggling home builders) or the renewable energy tax credits. It will, however, include the GSE loan limit increases and rebate checks as well as the addition of payments to social security recipients and veteran disability payments.  The market has obviously been exceedingly choppy this afternoon, w/ a round of spec selling and mtge-related paying in swaps taking us lower as well as smaller gyrations around what is happening in eqs."

From UBS:  "Treasury bond auction flops, Bonds lead a sharp decline: The Treasury today sold $9 billion of 30-year bonds at a yield of 4.449% in a disastrous auction, tailing the 1pm level by roughly 4bps. Indirect bidders accounted for a meager 10.7% of the auction (compares to 32.4% on average for the past 6 bond auctions) while the bid-to-cover ratio was a weak 1.82x as well. The poor demand almost certainly stems from long-end yields trading near historic lows and concerns that the Fed's actions may raise inflation prospects. Long term inflation expectations have exploded higher since the Fed's inter-meeting 75bp rate cut. Treasury bond yields spiked up sharply after the auction (bonds fell by >2 1/2 points on the day), and the 2s30s curve steepened 9.4bps as bonds sagged. We did see heavy long end Treasury buying as 30yr yields broke above 4.50%-- though the buyers were eventually overwhelmed by sellers by the close. TIPS breakevens widened across the board, and Treasury volume was 144% of the 30-day average...ICSC chain store sales measure was up 0.5% year over year in January. Finally, Dallas Fed president Fisher, who voted to leave rates unchanged at the last meeting, said that although the credit crunch has damaged growth, he still fears that aggressive easing would "juice up" inflation...Mortgages saw $4 billion in origination and about $2 billion in real money buying across the coupon stack. Lower coupons, particularly 5's, got hammered during the selloff, and MBS widened 3 ticks to Treasuries and 1 to swaps."

Three month T-Bill yield rose 10 bp to 2.19%.

Two year T-Note yield rose 14 bp to 2.06%

Ten year T-Note yield rose 17bp to 3.77%

Dow rose 47to 12,247

S&P 500 rose 10.5 to 1337

Dollar index rose .71 to 76.85

Yen at 107.49 per dollar

Euro at 1.448

Gold rose $10 to $910

Oil rose $1.21 to $88.35

*All prices as of 4:55pm

Today's Tidbits

U.S. May be “Teetering on Edge” of Recession that is More Severe Than Last Two
From Reuters: “"If we do go into recession, it's going to be more severe and long-lasting than the last one," said Jeffrey Frankel, a Harvard professor and member of the private-sector panel that dates U.S. recessions. The nation's last two recessions, in 1990-1991 and 2001, each lasted for just eight months. But the two downturns that ended in 1975 and 1982, when economic conditions bore some similarities to today, each lasted 16 months, making them the longest recessions since the Great Depression of the 1930s, according to the National Bureau of Economic Research, the accepted arbiter of U.S. recessions. The U.S. economy entered the recessions of 1975 and 1982 saddled with huge government budget deficits from spending on social programs and the Vietnam war, and was suffering double-digit consumer price inflation. Frankel said members of NBER's business-cycle dating panel have been in contact with each other over the prospect of a recession through e-mails, but it would likely take months, or perhaps even more than a year, for the panel to determine whether the economy had turned down. Even though the latest data showed a loss of jobs in January, and the largest monthly decline on record in an index of service-sector activity, Frankel thinks a recession is not yet at hand. "My description is that we are teetering on the edge," he said…The last time the economy moved into recession, in 2001, there was a budget surplus, providing an opportunity for extra government spending to boost economic growth. In addition, consumers were not as heavily in debt and credit was more freely available. Consumer spending represents for roughly two-thirds of total U.S. economic output and for the 2007 year consumer spending grew at the slowest pace since 2003. "My biggest concern right now is the consumer. The consumer is highly levered and when the economy faces a credit crunch on in a highly levered scenario, then you have trouble”…”
Homeowners Increasingly Abandoning Mortgages
From CNN: “Homeowners are abandoning their homes and, more importantly, their mortgages, rather than trying to keep up with rising payments on deteriorating assets. So many people are handing their keys back to lenders that a new term has been coined for it: jingle mail….Current lending practices have created an environment where a measure as extreme as abandoning a home actually makes sense to some people. Many buyers put little or no money down, so they don't have much invested in them. That leaves them with little incentive to keep making payments when a home's market value dips below the balance of the mortgage. The most serious consequence is a tremendous hit to credit scores. For some, that's better than throwing away money they'll never recover by selling their home. And while a mortgage default can savage a person's credit record, trying to pay off a loan they can't afford could be worse for borrowers if it leads to bankruptcy, said Craig Watts, a spokesman for the credit reporting firm Fair Isaac. Credit scores are hurt much more by missing multiple payments - on credit cards, cars and so on - than by a single foreclosure. "The time it takes to regain your credit score [after foreclosure] can be shorter than after bankruptcy," said Watts. It typically takes three years of a spotless payment record after a bankruptcy before credit scores recover enough for someone to think about buying a home again, he said. After abandoning a mortgage, a person may be able to buy a new house in two years or less. And now skipping out on a home is easier, thanks to the Mortgage Debt Relief Act of 2007. Previously, if a bank sold a foreclosed home for less than the mortgage balance and it forgave the difference, the borrower had to pay tax on that difference as if it were income. Now the IRS will ignore it…The trend of walking away is most pronounced among real estate investors, according to Jay Brinkman, an economist with the Mortgage Bankers Association (MBA). But families are doing it too…Beyond anecdotes, some statistics indicate that hard-pressed owners are deliberately courting foreclosure. An analysis by the consumer credit rating agency Experian last spring found that many borrowers were choosing to pay off credit card and other consumer debt before making mortgage payments. They were electing to put their mortgage at risk rather than their credit cards or auto loans. Similarly, Richard DeKaser, chief economist for National City Corp., notes that while all credit metrics are deteriorating, mortgage delinquencies are rising disproportionately. "That makes sense if people are choosing to walk away," he said. And now reports are emerging of homeowners skipping out on mortgages even though they can still afford to pay them.
Wachovia CEO Ken Thompson described these people on an earnings call last month."[These are] people that have otherwise had the capacity to pay, but have basically just decided not to, because they feel like they've lost equity, value in their properties."
Lenders are afraid that borrowers may find it's worth the hit to their credit scores, if they can drastically reduce their housing expenses. Someone with good credit and a $600,000 home in a town with cratering real estate prices could buy a similar house nearby for $450,000, and then let the other $600,000 mortgage go into foreclosure. The stage is set for this kind of thing particularly in California, where huge numbers of buyers used low or no-down deals to buy homes. The trend has even spawned at least one new business, San Diego-based YouWalkAway.com, which for a fee of $1,000 purports to guide clients through the process of ditching their mortgages. It launched in early January, and says it has already signed up 180 clients. California is a bit of a safe haven for these borrowers, since banks that repossess and then sell a foreclosed property for less than the mortgage that was owed on it cannot come after borrowers for the difference - as long as it's the initial mortgage, one that has not been refinanced. So if a borrower owes $200,000 and the bank sells the house for $170,000, the borrower comes out of it debt-free. And for many homeowners, the prospect of becoming debt-free is growing increasingly alluring.”
From FTN: “The WSJ reports that as many as one in four home sales were speculative at the height of the boom rather than the 10% people previously believed. Frankly, we’re not sure who “people” are in this case. Other sources have put the number as high as 30% since 2005.”

Increased Capital May Not Stop Rating Downgrades for Bond Insurers
From Reuters: “Fitch Ratings on Tuesday said it may cut its top "AAA" rating on MBIA Inc's insurance unit and bond insurers as a whole are likely to face larger losses than previously expected, which may lead to more downgrades. Fitch also said it may cut its "AAA" ratings on bond insurer CIFG, part of French bank Natixis, due to changes in its loss assumptions. Losses by bond insurers are likely to increase due to continuing deterioration in the mortgage and housing markets, Fitch said. "The need to update loss assumptions at this time reflects the highly dynamic nature of the real estate markets in the U.S., and the speed with which adverse information on underlying mortgage performance is becoming available," Fitch said in a statement. If losses increase, the ratings of bond insurers Ambac Financial Group, Financial Guaranty Insurance Co, and Security Capital Assurance Ltd, which operates XL Capital Assurance Inc, are also likely to come under pressure due to their exposures to subprime mortgages, Fitch said.
Bond insurers, including industry leader MBIA, are scrambling to raise capital that rating agencies have said is required for "AAA" ratings. Fitch, however, said on Tuesday that an increase in capital may not be enough to hold the ratings, as an increase in claims in itself would be inconsistent with the top ratings. "A material increase in claim payments would be inconsistent with 'AAA' rating standards for financial guarantors, and could potentially call into question the appropriateness of 'AAA' ratings for those affected companies, regardless of their ultimate capital levels," the rating agency said. MBIA has already raised $1.5 billion in new capital, however this may not be sufficient, Fitch said.
Fitch expects that losses taken by MBIA are likely to increase materially due to the company's significant portfolios of CDOs backed by assets, which includes mortgage-backed securities. This portfolio was around $30.6 billion as of September 30, 2007, Fitch said. CIFG's exposure to CDOs of asset backed securities stood at $9.2 billion at September 30, 2007. "Fitch believes that a sharp increase in expected losses would be especially problematic for the ratings of financial guarantors exposed to this asset class, including MBIA -- even more problematic than previously discussed increases in 'AAA' capital guidelines," the rating agency said.”
From Barclays: “Credit headlines also remain grim, with Fitch warning that updates to its assumptions for losses on subprime MBS may lead to a downgrade of the bond insurers. A downgrade of financial guarantors would be very problematic for banks, in our view, and likely spur another round of writedowns, potentially necessitating further capital infusions or balance sheet delivering.”
From Bloomberg: [Breaking News] “MBIA TO ISSUE $750 MILLION IN COMMON STOCK”

Rising Unemployment For Self-Employed May Explain Data Discrepancies
From Bloomberg: “The increase in U.S. unemployment …is being driven by a drop in
the number of people working for themselves, government figures indicate. Hours worked by the self-employed dropped at a 15.5 percent annual pace in the last three months of 2007, the biggest decrease in 15 years, according to data provided …by the Labor Department. The decline ``is probably related to the housing downturn, since one in six workers in construction is self-employed, twice the average for all industries,”… The figures may be another indication of how the deepest real-estate slump in a quarter century is filtering through the economic statistics…The number of people running their own businesses dropped by 365,000 last quarter, compared with the same period in 2006, according to separate Labor Department numbers. The decline in the number of hours worked by the self- employed last quarter reflected a 9 percent annualized drop in employment combined with a 7 percent decrease in average weekly hours for those still with work, the department said. The issue may also help resolve some discrepancies among various labor statistics, economists said. The unemployment rate, calculated from the household survey that covers the self-employed, jumped 0.3 percentage point in December. The increase prompted some economists to predict the U.S. was already, or would soon be, in a recession. Even as the jobless rate rose, revised figures from the
survey of businesses, which doesn't track single-employee companies, showed hiring accelerated on average from the third quarter to the last three months of the year. Payrolls dropped in January for the first time in more than four years…Many mortgage brokers involved in the subprime industry work for themselves…Self-employment may also help explain why first-time applications for jobless benefits have yet to reach levels normally associated with a weakening labor market…Self-employed Americans, although they may file claims, are not eligible for benefits under the unemployment insurance system, according to the Labor Department. ``This could really help explain a lot of the conflicting signals in the data,''…”

MISC

From Merrill Lynch: “After yesterday’s bond rally in the front end, Fed funds futures are now more than 100% priced for a 50 bps ease on 18 March (114% in fact, up from 68% on Tuesday). The market is now close to fully pricing in a 2% Fed funds rate by August.”

From Deutsche Bank: “Given the mounting concerns of an economic recession, the stronger-than-expected productivity figures have a somewhat hollow ring because they came as the result of declining aggregate hours, as opposed to strong output growth. We see the decline in aggregate hours as a negative omen for the labor market, which is worrisome news following a surprisingly weak January employment report and some potential red flags being raised by jobless claims. In fact, aggregate hours were unchanged from year-ago levels…We believe the productivity data further justify the Fed's bias toward downside risks to growth”
From Goldman Sachs: “As helpful as this figure [ULC] is for our contention that labor cost pressures are abating, it's a bit premature to uncork the champagne. The labor cost figures have been subject to enormous revisions in recent years as government officials belatedly discover sharp changes in exercises of stock options, which are counted as part of labor costs. However, with the market going the way it has been lately, maybe the revisions will be more down than up. How's that for a day brightener?”
From Merrill Lynch: “According to the weekly ABC/Washington Post Survey News, the consumer comfort index fell to -33, down six points from the previous week. During the past month, this measure is down 13 points – very recessionary in fact, if you consider that right before the 1990-91 recession the index fell 13 points in four weeks, and slumped by 14 points in the four weeks leading up to the 2001 recession. And keep in mind that this time around the index has slumped in the aftermath of the Fed’s 125 bp rate cut.”

From Deutsche Bank: “Yesterday, the International Council of Shopping Centers reported that total January sales, to be reported tomorrow, are likely to show the worst January performance on record. This new information, in addition to news that January motor vehicle sales fell 6% to 15.2M units, means that we are likely to see negative January retail sales, the second consecutive monthly decline.”
From Lehman: “After surging for the past month, demand for refinancing applications cooled in the week ending February 1. The index of refinancing applications slipped 1%, but given the increase over the previous few weeks, the four-week moving average rose a solid 45% and the y-o-y rate rose 130%. The boom in refinancing has been spurred by lower mortgage rates. The average rate on a 30-yr fixed-rate mortgage fell to a low of 5.50% in mid-January, more than a full percentage point lower than in the summer. However, rates have started to edge higher, reaching 5.61% in the latest week.
The index of purchase applications rose 12%, offsetting part of the decline over the past two weeks. Purchase applications have been little changed over the past year and a half while home sales have fallen sharply, suggesting that applications are a poor indicator of future home sales.”
From Merrill Lynch: “Capital flows have become more significant relative to trade flows in cyclical currency determination. This suggests that currency cycles will be longer, and quite probably of greater amplitude than in the past. We also think that the moves when cycles come to a close could be more violent than in the past…Concern surrounding the upcoming G7 has been affecting FX markets in recent days. We do not believe that any meaningful change to the statement is likely; however the history of these meetings ensure some market nervousness in the lead up.”
From Reuters: “Oil fell to $87 on Wednesday after a larger-than-expected build in U.S. crude stocks and growing fears of a U.S. recession.”
From Bloomberg: “Wheat surged to a record in Chicago, leading other grains and oilseeds higher, on shrinking U.S. and Canadian supplies of high-protein varieties used for bread and pasta. Canada, the largest wheat exporter after the U.S., said yesterday its inventories of the grain plunged by almost a third after adverse weather hurt crops. U.S. spring-wheat inventories will total 88 million bushels on May 31, down 25 percent from a year earlier, according to government forecasts. The jump in grain prices may increase costs for food producers, including Kellogg Co. and General Mills Inc., the largest U.S. cereal makers. It also risks stoking inflation and making it more difficult for central bankers around the world to stave off recession by cutting interest rates.”
From FTN: “Edward Altman, the guru of junk bond analysis, says defaults this year will reach 4.64%, a significant increase over last year’s 0.51% rate. For the most part his analysis consists of tallying up companies already in trouble, meaning the figure is fairly certain to be close to the mark. He says difficulty refinancing is a major issue this year. Or, perhaps it was the ease of refinancing last year which is the problem, because it means trouble was pushed out a year.”
From Bank of America: “The ECB decision to wind down USD liquidity provision to European banks during the month of February (with auctions rolling off February 14 and 28) and subsequent rise in the LIBOR-OIS spread may be contributing to the recent rebound of the USD.”
From JP Morgan: “Charles Plosser, the President of the Philadelphia Fed, defended the Fed's recent rate cuts … while still emphasizing the ultimate importance of price stability for the Fed's macroeconomic mandate….and the importance of anchored inflation expectations….Plosser's forecast: growth in the first half of around 1%, thereafter gradually returning to trend, which he sees as 2.7%. The below trend growth should lift the unemployment rate to 5-1/4%.... On inflation, Plosser expects "little progress to be made in reducing core inflation this year or next, and I am skeptical that slower economic growth will help." He forecasts core inflation to remain in the 2-2.5% range in 2008, "above the range I consider to be consistent with price stability."… On the policy outlook, Plosser did not go as far as Lacker and say that further easing may be warranted. Instead, he noted that policy rates should be lowered only when data is weaker than expected, and his outlook has already factored in weak data.”
From Handelsbanken: “Positive earnings surprises have started to outnumber negative reports, and if you exclude financial companies, a full 66.4% of the companies already reported have beat analyst expectations prior to the beginning of reporting season. This constructive earnings result is even more surprising in that a healthy cross section of sectors and industries have contributed to the positive earnings developments.”

End-of-Day Market Update
From RBSGC: “[Treasury] Prices didn't do much of anything on Wednesday, but rather held to the middle of a fairly tight range. The takeaway is that the recent strength is undergoing consolidation, not rejection, which tempers our bearishness and puts us more in a range-trading frame of mind. That said, within the boundaries of a range the market has an somewhat improving tone raising the risk of a move higher… Softer stocks certainly contributed to the bond market's hold/bounce of the intra-day lows.”
From Bloomberg: “Treasuries fell as the government sold $13 billion of 10-year notes at the lowest yield since regular quarterly auctions of the securities began 30 years ago. Ten-year Treasuries reversed most of a rally from yesterday as traders bet that interest-rate cuts by the Federal Reserve will revive growth and spark inflation later this year. Two-year note yields were the furthest below 10-year note yields since 2004, indicating traders expect the central bank to add to its five rate reductions since September to support the economy. ``As the next few cuts come, long-term rates will rise as opposed to falling,'' … ``The steepness of the yield curve shows you the market is concerned about inflation.''”
From Bloomberg: “U.S. stocks fell for a third day, led by energy producers and retailers, after oil prices dropped and a reduced earnings forecast at Macy's Inc. spurred concern the housing slump is spreading through the economy. The Standard & Poor's 500 Index erased a gain of as much as 1.2 percent after Macy's said it will cut 2,300 jobs, sending chain-store shares to their steepest three-day drop in five years. Chevron Corp., the second-biggest U.S. oil company, retreated to a nine-month low as oil declined by more than $1 a barrel. Micron Technology Inc., the largest U.S. maker of memory chips, fell the most since October 2006 after an analyst said computer companies have stockpiles of unused parts. The S&P 500 lost 10.19 points, or 0.8 percent, to 1,326.45. The Dow Jones Industrial Average declined 65.03, or 0.5 percent, to 12,200.1. The Nasdaq Composite Index decreased 30.82, or 1.3 percent, to 2,278.75. More than two stocks fell for every one that rose on the New York Stock Exchange.”
Three month T-Bill yield fell 7 bp to 2.08%.
Two year T-Note yield rose 2 bp to 1.94%
Ten year T-Note yield rose 2.5 bp to 3.60%
Dow fell 65 to 12,200
S&P 500 fell 10 to 1326.5
Dollar index rose .05 to 76.16
Yen at 106.7 per dollar
Euro at 1.462
Gold rose 12 to $900
Oil fell $1.34 to $87.07
*All prices as of 4:37pm

S&P500

10Yr-Treasury Note

3m T-Bill Yield

Much Better than Expected Productivity and ULC Figures for the 4th Quarter

Fourth quarter productivity rose more than expected at +1.8% annualized (consensus +.5%), and ULC gains were slower than expected at +2.1% annualized (consensus +3.5%). The increased worker efficiency was due to the largest drop in hours worked (-1.5%) in five years. Unit labor costs are adjusted for efficiency gains, so even though compensation growth held almost steady at 3.9%, ULC fell on due the increased output per worker. Labor costs represent about 2/3rds of the production cost of most goods and services. For the year as a whole, productivity improved to 1.6% in 2007 versus only 1% in 2006. ULC though rose to a seven year high of 3.1%. Compared to the fourth quarter a year ago, productivity is up +2.6%, and ULC are only up +1% YoY. Net, these are good figures. ULC remaining below 3% will ease inflation concerns, and productivity is slowing its deceleration from the higher pace of the 90s

Today's Tidbits

End-of-Day Market Update
From UBS: "The whole story today was the plunge in the January Non-Mfg. ISM to a recessionesque 44.6 reading. Equally worrisome was the drop in the Employment Index to 43.9 from 51.8. As such, the winter of discontent (in the economy and in credit) looks to have some legs yet. S&P also published a report today that warned that downgrades of the bond insurers like MBIA and Ambac Financial group could cause knock-on downgrades among US banks with monoline exposure. Fitch then chimed in late day with a more bearish view about subprime collateral losses and put MBIA back on review for downgrade--just 3 weeks after being taken off the Review list. To say that things are fluid in the monoline space is a grand understatement."
From Bloomberg: "U.S. stocks tumbled the most in 11 months after the first contraction in service industries since2002 reinforced concern the economy is in a recession. Exxon Mobil Corp. and General Electric Co. led declines inNew York trading and all 10 industry groups in the S&P 500 retreated...Citigroup Inc. led 91 of 92 financial shares in theS&P 500 lower after Fitch Ratings said it may downgrade the AAA insurance rating on MBIA Inc., the largest bond guarantor.The S&P 500 lost 44.18, or 3.2 percent, to 1,336.64. The Dow Jones Industrial Average decreased 370.03, or 2.9 percent,to 12,265.13. The Nasdaq Composite Index slipped 73.28, or 3.1 percent, to 2,309.57. Shares also retreated in Asia and Europe.Almost 11 stocks fell for every one that rose on the New York Stock Exchange...Fourth-quarter profits at the 311 companies in the S&P 500 that reported results so far declined 23 percent on average, according to data compiled today by Bloomberg...Shares also declined on signs the U.S. slowdown is spreading to Europe and Asia. Europe's service industries grew at the slowest pace in more than four years and retail sales dropped the most since 1995."
From RBSGC: "...propelled the curve steeper and yields lower, but still kept yields within the most recent extremes."
From UBS: "Flows were decent today in treasuries...We must mention T-Bills which continue to fall to ever lower yields even as the Treasury steps up issuance. The 3mo Bill auction tailed yesterday when it came at 2.23 and they went out today 8bp richer. The demand for Bills is insatiable. Today's Treasury volume was a solid 135% of the 30 day average...MBS from 2 wider to swaps in the AM to a tick tighter at the close."
From Deutsche Bank: "...nikkei currently looking for a down 4.6% open."
Three month T-Bill yield fell 9 bp to 2.16%.
Two year T-Note yield fell 15 bp to 1.91%
Ten year T-Note yield fell 8 bp to 3.56%
Dow fell 370 to 12,265
S&P 500 fell 44 to 1337
Dollar index rose .79 to 76.17
Yen at 106.77 per dollar
Euro at 1.464
Gold fell $15 at $888
Oil fell $1.85 to $88.17
*All prices as of 4:38pm

Massive Economic Slowdown Apparent in January's Non-Manufacturing ISM Decline

National Non-Manufacturing ISM, which measures the larger service sector of the economy (88% of economy), unexpectedly plummeted in January to 44.6. The market had been looking for a reading of 52.4. This much lower level will clearly renew concerns about a recession! The index was redesigned for this month to fall more in line with the ISM manufacturing index which is a composite of the underlying indicators. The new ISM non-manufacturing index moves away from focusing on business activity, or production, for the headline indicator. Now this indicator is given equal weight with employment, new orders, and supplier deliveries. In truth, there has been a high correlation between the business activity index and the new composite index, so switching to the new index is not the cause of the large drop this month. The report was released early today because of concerns about a security breach. The January contraction was the first in almost five years for non-manufacturing ISM. Business activity, the old headline number, fell to 41.9 from 54.4 in December. New orders fell to 43.5%, from 53.9 the prior month.This was the first contraction for new orders since March 2003 and the lowest level since October 2001. Employment fell to 43.9%, the lowest since February 2002. Prices only eased slightly to 70.7, indicating only a modest slowdown in price gains. One bright spot was new export orders rising to 52 from 50 in December. Only three industries reported growth in January, indicating the slowdown was widespread as consumers and business grow increasingly cautious. The three industries showing growth were utilities, professional, scientific and technical services, and education. Fourteen industries showed contraction including construction, transportation, health care, finance, retail, hotel and food, etc.

End-of-Day Market Update

From UBS:  "The whole story today was the plunge in the January Non-Mfg. ISM to a recessionesque 44.6 reading. Equally worrisome was the drop in the Employment Index to 43.9 from 51.8. As such, the winter of discontent (in the economy and in credit) looks to have some legs yet. S&P also published a report today that warned that downgrades of the bond insurers like MBIA and Ambac Financial group could cause knock-on downgrades among US banks with monoline exposure. Fitch then chimed in late day with a more bearish view about subprime collateral losses and put MBIA back on review for downgrade--just 3 weeks after being taken off the Review list. To say that things are fluid in the monoline space is a grand understatement."

 

From Bloomberg:  "U.S. stocks tumbled the most in 11 months after the first contraction in service industries since 2002 reinforced concern the economy is in a recession.  Exxon Mobil Corp. and General Electric Co. led declines in New York trading and all 10 industry groups in the S&P 500 retreated...Citigroup Inc. led 91 of 92 financial shares in the
S&P 500 lower after Fitch Ratings said it may downgrade the AAA insurance rating on MBIA Inc., the largest bond guarantor.
The S&P 500 lost 44.18, or 3.2 percent, to 1,336.64. The Dow Jones Industrial Average decreased 370.03, or 2.9 percent, to 12,265.13. The Nasdaq Composite Index slipped 73.28, or 3.1 percent, to 2,309.57. Shares also retreated in Asia and Europe.
Almost 11 stocks fell for every one that rose on the New York Stock Exchange...Fourth-quarter profits at the 311 companies in the S&P 500 that reported results so far declined 23 percent on average, according to data compiled today by Bloomberg...

Shares also declined on signs the U.S. slowdown is spreading to Europe and Asia. Europe's service industries grew at the slowest pace in more than four years and retail sales dropped the most since 1995."

 

From RBSGC:  "...propelled the curve steeper and yields lower, but still kept yields within the most recent extremes."

 

From UBS:  "Flows were decent today in treasuries...We must mention T-Bills which continue to fall to ever lower yields even as the Treasury steps up issuance. The 3mo Bill auction tailed yesterday when it came at 2.23 and they went out today 8bp richer. The demand for Bills is insatiable. Today's Treasury volume was a solid 135% of the 30 day average...MBS from 2 wider to swaps in the AM to a tick tighter at the close."

 

From Deutsche Bank:  "...nikkei currently looking for a down 4.6% open."

 

Three month T-Bill yield fell 9 bp to 2.16%.

Two year T-Note yield fell 15 bp to 1.91%

Ten year T-Note yield fell 8 bp to 3.56%

Dow fell 370 to 12,265

S&P 500 fell 44 to 1337

Dollar index rose .79 to 76.17

Yen at 106.77 per dollar 

Euro at 1.464 

Gold fell $15 at $888

Oil fell $1.85 to $88.17

*All prices as of 4:38pm

Today's Tidbits

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

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

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

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

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

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

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

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

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

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

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

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

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