Wednesday, July 2, 2008
Factory Orders
Factory orders rose slightly more than expected in May at +.6% MoM (consensus +.5%). This represents the third straight month of growth in factory orders. In addition, April's figure was revised up to +1.3% from +1.1%. As expected, defense spending and airline orders were responsible for most of the increase. Defense spending rose +12% MoM, while transportation orders rose +2.5% and computers rose +2.9% MoM. Excluding transportation, which tends to volatile month-to-month, factory orders rose +.4% MoM and excluding defense they rose +.3% MoM. Capital goods orders rose +1.9%, though when defense and aircraft are excluded, they actually fell -.4% MoM. Non-durable goods orders rose +1.2% MoM, probably due to higher energy prices (orders for petroleum and coal products rose +4% MoM), while durable goods orders were flat in May. Non-durable goods orders had jumped up +3.5% MoM in April. Raw materials prices are running at a 29-year high. Shipments of factory orders rose only +.1% MoM, though non-defense capital goods excluding aircraft rose +.5% MoM (used for calculating GDP). The slowdown in shipments caused inventories to pop up again in May, rising +.5% MoM after being unchanged in April. Unfilled orders continued to climb, and are likely to remain elevated as Boeing works through production problems with their new 787 airliner. The inventory to shipments ratio eased slightly higher to 1.23 months of supply from 1.22 last month. This is still down from the 1.26 high seen in late winter. Over the past year, new factory orders have risen +5% YoY, with ex-transportation rising +7.4% and ex-defense rising +4.4% YoY. Capital goods orders have risen +3.5% YoYmainly due to rising defense spending (+22% YoY) to replace depleted equipment from the wars. Ex-defense capital goods orders have risen a more modest +1.5% YoY. Durable goods orders have fallen -1.5% YoY. Excluding transportation, durable goods orders have fallen -8.7% YoY. Shipments have risen +4.7% YoY, with the important non-defense capital goods excluding aircraft rising a slower +2% YoY. Inventories are up +6.1% YoY and unfilled orders have grown by +16% YoY as of May. If not for growing defense spending and rising energy prices, plus continued export demand, factory goods orders would not look as strong. Domestic businesses are continuing to cut back on spending for new equipment as credit tightens
Mortgage Applications Rise Slightly from 6 Year Low
Mortgage applications improved to their second lowest level since 2002 after thirty year mortgage rates eased back 7bp to 6.33%. Mortgage rates remain substantially above the 5.5% level available at the beginning of the year, when we had the last refi surge. Total mortgage applications rose +3.6% versus the prior week last week, but remain down -23% YoY. Applications for new purchases rose +2.8% WoW, but also are down -22% YoY. Refinancing demand rose +4.7% WoW, but is down an even larger -25% YoY. This helped push the refinancing share up marginally to 36.8%, but is remains substantially below the 46% share of a month ago. ARM share of total loans held steady at 8.5% last week after 1y ARM rates rose 5bp to 7.14% according to the Mortgage Bankers Assoc.
More Jobs Shed in June by US Economy
ADP reports a much larger than expected drop in jobs of -79k in June versus a consensus of -20k. This indicator has lost its glitter over the past year as it has consistently overstated growth. The average for the past seven months has be 87k per month, growing to 110 since the beginning of this year. Today's decline, when adjusted for this error indicates a substantial drop is possible for non-farm payroll tomorrow. Remember that ADP does not include government jobs, only private sector jobs. Consensus is currently looking for a drop of -60k for non-farm payrolls, and the sixth straight monthly decline in job growth for the US economy. (Note some street economists think this month's large drop in ADP may indicate a catch-up figure). ADP also revised down their May job gain to 25k from 40k. The decline was seen across all categories in the ADP report, with service jobs dropping for the first time since 2002, by 3k. Goods producing jobs fell by -76k, with manufacturing jobs falling -44k in June. Both categories have been declining steadily for the past year and a half. Large companies shed 51k jobs, while companies employing between 50 to 500 lost 35k jobs in June. Small businesses added 7k workers. Construction jobs fell by 34k with the cumulative decline since the peak in August of 2006 totaling 349k. Financial services jobs fell by 3k. The Monster job index fell 3 points this morning, and the Challenger report showed 82k jobs were cut in June (+47% YoY), with 275k jobs lost over the past three months. This is the largest three month decline since the end of 2005.
Tuesday, July 1, 2008
Today's Tidbits
Global Manufacturing Contracts for 1st Time in 5 Years
From JPMorgan: “JPMorgan’s global manufacturing PMI fell 0.9 points to 49.5 in June. This was the first sub-50 reading since June 2003, when the global economy was hit by the twin shocks from the SARS epidemic and the US invasion of Iraq. Each of the major PMI’s components fell below the breakeven mark last month—including new orders, output and employment, with the exception of input prices, which set a new series high of 80.1. In addition to pointing to a significant deterioration in the global manufacturing sector in June, the PMI suggests that conditions may worsen even further in coming months…When combined, the ratio of new orders to inventory, which is the best barometer of underlying momentum in the manufacturing sector, fell to 0.98. This is the second lowest reading on record and is a signal that global manufacturing production is poised to contract. When viewed from a regional perspective, most national PMIs fell last month, including in the Euro area, the United Kingdom, Japan and China. The US was the key exception…However, the main driver behind the increase in the ISM survey was an increase in the inventory index, which is hardly a positive…demand growth is weakening across the globe, rather than being focused in the United States, as before.
Indeed, there is little reason to look for any improvement in global manufacturing activity in the near-term. Final demand growth is weakening in the major economies, and is likely in the emerging world as well, in response to tighter credit conditions, weaker housing markets, and higher food and energy prices. This will maintain the downward pressure on industrial activity, which is highly sensitive to movements in demand.”
Global Corporate Earnings Weaken
From FinancialWeek: “The multinational play was based on a combination of strong global growth and a weak U.S. dollar. But now with Europe slowing sharply, a cyclical economic slowdown in emerging markets and inflation rearing its head across the world economy, continued strong global demand is anything but certain. “Disappointing guidance from U.S. multinationals regarding global earnings could be the next shoe to drop on the U.S. equity markets,” Joseph Quinlan, chief market strategist of global wealth and investment management at Bank of America, wrote in a note to clients. “While there remains an investor bias toward large-cap U.S. equities, this asset class could be in for some difficult times ahead if the global economic slowdown ... gathers pace in the second half of this year,” he added. Earnings estimates for the S&P 500 are already falling fast. For the second quarter, analysts polled by Thomson Reuters now expect earnings to fall by 11.1% -- compared with expectations of a fall of 2% at the beginning of April. The biggest contributor to that drop in earnings expectations are financials and consumer discretionaries. But analysts are also beginning to scale back expectations for some of the sectors which have been doing relatively well. Earnings growth expectations for industrial companies have been cut nearly in half – to 5% from 9%, according to Thomson Reuters data…While U.S. domestic profits declined 3% in 2007, overseas earnings rose 17%, making up the only real strength in corporate profits over the past year, said Bank of America’s Quinlan. But that may be about to change. The global economy only expanded by a 3 percent annual rate in the first half of 2008 compared to a 5 percent rate a year ago, according to Bank of America. U.S. foreign affiliate income, a proxy for global earnings, declined 4.5% year-over-year in the first quarter, the bank’s data showed. This deceleration in growth will ultimately take some wind out of the sails for U.S. global earnings, Quinlan wrote.”
Vehicle Sales Plunged in June
From Bloomberg: “General Motors Corp., Toyota Motor Corp. and Ford Motor Co., the biggest auto retailers in the U.S., said June sales plunged as fuel prices above $4 a gallon drove consumers away from gas-guzzling trucks. GM sales fell 19 percent, Ford was down 28 percent and Toyota dropped 21 percent. Honda Motor Co. and Volkswagen AG, which rely on cars for the bulk of their sales, each rose about 1 percent…For the second straight month, Ford's F-Series large pickup, perennially the best-selling vehicle in the U.S., was outsold by four cars: Toyota's Corolla and Camry and Honda's Civic and Accord. Nissan Motor Co. reported an 18 percent total decline.”
Southwest Airlines Has Profited From Fuel Hedges
From San Diego Union-Tribune: “In the first quarter of this year, Southwest paid $1.98 per gallon for fuel. American Airlines paid $2.73, and United paid $2.83 per gallon in the same period. Since 1999, hedging has saved Southwest $3.5 billion. It has sometimes meant the difference between profit and loss. In the first quarter, hedging gains of $291 million dwarfed Southwest's $34 million profit… The transactions carry a price tag. Southwest spent $52 million on hedging premiums last year and $14 million in the first three months of this year. As a result mostly of trades made years ago, Southwest has hedged 70 percent of this year's fuel needs at $51 per barrel instead of the current price of more than $140 per barrel. But hedging premiums rise and fall with the price of the underlying commodity, making new trades very expensive. Southwest has not done much trading in the last several months. Airline executives say hedging is not a bet on the direction of oil prices. “We view our program as insurance,” said Paul Jacobson, the treasurer of Delta Air Lines Inc. “Our goal is to minimize the volatility of fuel expenses. To do that, you've got to be in the market actively without an opinion as to what energy prices will do.” But hedging carries risks. Airlines can lose money if oil prices turn down and their options expire. In 2006, Delta won approval from a bankruptcy court and creditors to get into hedging. But the airline got squeezed when oil prices dropped in midyear, and it reported a loss of $108 million from the trading. Continental Airlines Inc. reported a loss of $18 million from hedging in the first quarter of 2007. But like Delta, Continental is still hedging… At one time in the 1990s, most major U.S. airlines hedged some of their fuel costs – even hiring experts from the oil industry to show them the ropes …That changed after the recession and terror attacks of 2001, which plunged airlines into huge losses. Banks and energy companies that make hedging trades with airlines grew nervous. “The problem was that most carriers had terrible creditworthiness and couldn't hedge,” … “Counter-parties feared the carriers would renege on their trades.” Southwest was the only large U.S. carrier to remain profitable through the downturn. It benefited from higher labor productivity and lower ticket-sales costs. That, and a healthy balance sheet, allowed it to keep hedging when oil was a bargain, compared to today's prices. Now, Southwest is the only big carrier that has most of its fuel expenses hedged at below-market prices. And analysts say it will be the only one to earn a profit this year. While other carriers plan to slash flights later this year – some contracting by more than 10 percent – Southwest expects to grow…The bulk of Southwest's hedges expire gradually by 2012. Replacing them would be very expensive and risky. One plan under study is to go back to hedging only against catastrophically higher oil prices – say, $200 per barrel. Unless oil prices stabilize or even decline, the airline could face a crisis covering higher fuel costs in just a few years. “It's starting to have an impact on their operating plan,” said Betsy Snyder, an analyst for the debt-rating service Standard & Poor's. “They're cutting back growth plans for the first time ever and exiting some unprofitable routes.” Chairman and Chief Executive Gary Kelly said the fuel hedges have bought his airline time to adjust to higher energy costs. Now he wants to find $1.5 billion in new revenue to make up for shrinking fuel hedges. ”
Fast Money Makes Managing Growth and Inflation Tough for China
From the Economist: “…although China’s trade surplus has started to shrink this year, its foreign-exchange reserves are growing at an ever faster pace. The bulk of its net foreign-currency receipts now comes from capital inflows, not the current-account surplus. According to leaked official figures, China’s foreign-exchange reserves jumped by $115 billion during April and May, to $1.8 trillion. In the five months to May, reported reserves swelled by $269 billion, 20% more than in the same period of last year. But even this understates the true rate at which the People’s Bank of China (PBOC) has been piling up foreign exchange.. speculative inflows during that period were perhaps well over $200 billion, because hot money also comes into China through companies overstating FDI and over-invoicing exports. Foreign firms are bringing in more capital than they need for investment: the net inflow of FDI is 60% higher than a year ago, yet the actual use of this money for fixed investment has fallen by 6%. Some of it has been diverted elsewhere. It is one thing to deduce how much money is coming in. It is another to work out where it is going and how it gets past China’s strict capital controls. The stockmarket, which continues to plunge (see article), is no home for hot money. Some has gone into property. The lion’s share is in bog-standard bank deposits. An interest rate of just over 4% on yuan deposits compared with 2% on dollars, combined with an expected appreciation in the yuan, offers a seemingly risk-free profit for those who can get money into China. It comes in via various circuitous routes. Big Western investment funds which care about liquidity would find it hard to move money into China... Massive hot-money inflows present two dangers to China’s economy. One is that capital could suddenly flow out, as it did from other East Asian countries during the financial crisis a decade ago and Vietnam this year. China’s economy is protected by its current-account surplus and vast reserves, but its banking system would be hurt by an abrupt withdrawal. A more immediate concern is that capital inflows will fuel inflation. The more foreign capital that flows in, the more dollars the central bank must buy to hold down the yuan, which, in effect, means printing money. It then mops up this excess liquidity by issuing bills (as “sterilisation”) or by lifting banks’ reserve requirements. But all this complicates monetary policy. China’s interest rates are below the inflation rate, but the PBOC fears that higher rates would attract yet more hot money and so end up adding to inflationary pressures. The central bank has instead tried to curb inflation by allowing the yuan to rise at a faster pace against the dollar—by an annual rate of 18% in the first quarter of this year. But this encouraged investors to bet on future appreciation, exacerbating capital inflows. Since April the pace of appreciation has been much reduced, in a vain effort to discourage speculators… money-supply growth would explode without sterilisation, which is now close to its limit. It is becoming very costly for the central bank to mop up liquidity by selling bills, so it is now relying more heavily on raising banks’ reserve requirements (the PBOC pays banks only 1.9% on their reserves, against over 4% on bills). Since January 2007 the minimum reserve ratio has been raised 16 times, from 9% to 17.5%. But it cannot climb much higher without hurting banks’ profits. To curb future inflation, China therefore needs to stem the flood of capital. One solution would be a large one-off appreciation of the yuan so that investors no longer see it as a one-way bet. This, in turn, would give the PBOC room to raise interest rates. The snag is that the yuan would probably have to be wrenched perhaps 20% higher to alter investors’ expectations, and this is unacceptable to Chinese leaders, especially when global demand has slowed and some exporters are already being squeezed. This implies that monetary policy will remain too loose. The longer that the torrent of hot money continues and interest rates remain too low, the bigger the risk that underlying inflation will creep up.”
From MNI: “Chinese policymakers are reorienting their approach to the economy, moving away from an obsession with preventing overheating and instead bracing for a climate in which slowing global demand and rising inflationary pressure place growth risks firmly on the downside.”
MISC
From Citi: “Fed Minutes released last week indicate that JPMorgan has been granted an 18 month exemption which would allow it to exclude the assets and exposures of Bear Stearns from its regulatory capital requirements.”
From Merrill Lynch: “The addition of Elizabeth Duke to the Federal Reserve Board makes it less likely that Bernanke will have to compromise with the more hawkish Presidents as it should allow him more freedom in making policy decisions. We believe this addition further increases the probability of easier monetary policy in early 2009.”
From Bloomberg: “Moody's Corp. ousted the head of its structured finance unit and said employees violated internal rules in assigning ratings to last year's worst performing
securities….Moody's, the world's second largest credit-rating company, said today that employees, not the company's practices, were to blame. ``Moody's have lost a lot of credibility,''…”
From The New York Times: “Another strain on the economy and markets is the rapidly rising prices for energy, food and other commodities. Crude oil prices are up about 51 percent this year and corn prices are up 55 percent. That surge in raw materials is one reason that fast-growing markets like China and India — which are increasingly dependent on energy imports — have taken a beating in recent months. The Shanghai stock market is down 48 percent for the year, and the Nifty index in India is down 34 percent. By contrast, markets in Russia and Brazil, which are big exporters of commodities, are essentially flat for the year. “The emerging markets are associated with higher commodity prices, but not all emerging markets are beneficiaries,” said Simon Hallett, chief investment officer of Harding Loevner Management, an investment firm based in Somerville, N.J. “Russia and Brazil are commodity producers, but China and India are commodity consumers.””
From Bank of America: “[ISM] Prices paid is the highest since 1979.”
From RBSGC: “…the Census Bureau revised the entire private residential series going back to 1993 due to methodological changes (expenditures on private residential improvements to rental, vacant, and seasonal properties are now being excluded from the data, but improvements on owner-occupied structures will remain).”
From Merrill Lynch: “The sharp declines in the equity market have meant that $2.1 trillion of 'paper wealth' has evaporated so far this year - 70% of that loss occurring in June alone.”
From The New York Times: “Lehman Brothers, which has been struggling to persuade investors that it can survive as an independent firm, fell 11 percent Monday, bringing its loss for the year to nearly 70 percent.”
From Bloomberg: “Legg Mason has lined up $2.15 billion in financing since November to cushion its money funds from potential losses. The funds bought debt from structured investment vehicles, or SIVs, that held securities backed by subprime mortgages. In the three months ended March 31, Legg Mason posted a $255 million net loss, its first as a public company.”
From The LA Times: “Battling rumors that it may collapse, Pasadena-based IndyMac Bancorp acknowledged Monday that its financial position had deteriorated but described the fears as overblown and said it was working with regulators to improve its "safety and soundness."… The shares are down 90% this year… More than 96% of IndyMac's deposits are safe because they are insured by the FDIC, IndyMac said. The agency covers up to $100,000 per depositor. Retirement accounts are insured separately for up to $250,000.”
From Bloomberg: “Starbucks Corp., the world's largest chain of coffee shops, plans to close 600 ``underperforming'' stores in the U.S.”
End-of-Day Market Update
From RBSGC: “The market did little more than trade off of movements in domestic equities -- but in the wake of quarter-end, we see this as overall supportive, despite the fickleness of the strength. In fact, it is equally constructive that 2-year yields dipped to 2.52% even with a better-than-expected ISM report and smaller than forecast decline in construction spending. And with volumes heavy, we see this as setting the pre-Employment Report range. From a technical perspective, Tuesday's price action has broken the upward sloping channel in 2s -- much the same as the previous channel in 10s. Now through the 2.65% channel bottom, a projection to 2.35% seems achievable in this environment. That said, while momentum remains bullish, its waning somewhat as the strengthening slows. The selloff in equities and upside in Treasuries have edged the bar higher for a post-Employment Report rally on consensus data. Also of note from Tuesday's session, was the JPM survey, showing investors at a very flat 75% -- that's tied with early-June as the second flattest on record (since '97) behind the Sept '00 78% level..Volumes were very strong, with cash trading at 129% of the 10-day moving-average.”
From Lehman: “The treasury market took a roller coaster ride on Tuesday, rallying as much as 10 basis points in the 5 year sector as stocks got clobbered early, and then falling quickly when the equity market rebounded in the afternoon. The yield curve steepened a few basis points during the morning rally, and the 5 year sector had a particularly good bid, but the curve finished only marginally steeper as long bonds recovered from selling on the back of some large steepening trades in the afternoon selloff. Tuesday's trading volumes were high, with over 1.1 mm ten year contracts trading, and the market had a bit of a panicked feel about for much of the morning session.”
From JPMorgan: “Wild day. UST's were bid all day, particularly in the 5y sector, as equities tested their March low. The price action was similar to that of the last few days where MBS, swaps, and other spread product would not participate in the UST bid and spreads widened into uptrades. After ISM we saw a significant amount of duration shedding out of the servicing community in the long end of the curve. This also dragged in some rate paying in 10s from a few bank portfolios and rate lockers who had been sitting on the sidelines looking for a level to sell. … Today's reversal will set the resistance for the short term across the curve and will be the basis of stops for shorts set today.”
From SunTrust: “It appears that equities averted the trip to Hades for one more day… Nonetheless, the ISM was enough to turn stocks around and pressure Treasuries lower…Dollar weakness does have one advantage, exports are cheap. Also of some cheer to equities is weaker oil this afternoon, a real bargain at "only" $140 per barrel. CIT, Lehman and GM all managed to trade higher today, albeit small gains. 2 yrs managed to eke out 2.52 before yields turned higher. 10 yrs touched 3.90. Both issues are going into the close 10 bp higher as stocks lift up. The next hurdle for markets will be employment.”
From UBS: “Treasuries kicked off the session with a head of steam, with the front end richer by double-digit basis points, before a stronger-than-expected ISM Mfg. number put the kibosh on the rally. Subsequently, Treasuries simply mirrored stocks the rest of the way, leaving us little changed on the day as of 3pm. After stocks came back from heavy losses to close up (slightly) on the day. There was real money buying in intermediates helping the belly outperform on the day. We saw buying of 20-year TIPS, which continued to outperform nominals. Breakevens widened across the board, and the January 2009 breakeven was out by more than 17bps… With GM announcing better-than-feared sales today, total light vehicle sales for June appear on track to hit about 14.0M. This is in line with forecasts but still down from May's 14.3M in sales…Mortgages see origination again, get smoked on the day:
Swaps saw 2-way flow on curve trades, and back end spreads widened modestly. Agencies saw buying of 5- and 10-year paper, trading in line with Libor across the board. Mortgages had about $1.5B in origination, the most we've seen in about 2 weeks. With buyers seemingly on strike, mortgages went as much as 11 ticks wider to Treasuries and 8 to swaps, before coming back in to "only" 8+ wider to Treasuries and 6 to swaps.”
From Bloomberg: “U.S. stocks rose, helping the market rebound from its worst month in six years, after better-than- forecast sales at General Motors Corp. overshadowed concern that rising energy costs will damp corporate profits. GM, the largest U.S. automaker, jumped the most in more than two weeks and led the Dow Jones Industrial Average's rebound from an almost 167-point drop earlier in the day. American Express Co. posted its best gain since May on UBS AG's upgrade of the biggest U.S. credit-card company, while CIT Group Inc. jumped the most since March after selling its mortgage businesses to Lone Star Funds and Berkshire Hathaway Inc. Rising oil prices sent shares of FedEx Corp. to a four-year low, limiting gains in benchmark indexes. The Dow Jones Industrial Average climbed 32.25 points, or 0.3 percent, to 11,382.26, erasing earlier declines that sent the 30-stock gauge into a bear market for a third day. The Standard & Poor's 500 Index added 4.91, or 0.4 percent, to 1,284.91. The Nasdaq Composite Index advanced 11.99, or 0.5 percent, to 2,304.97…The Dow pared its retreat from an October record to 19.6 percent, less than the 20 percent decline that signals the start of a so-called bear market. The S&P 500 has lost 18 percent since its October peak after the biggest quarterly increase in oil prices since 1999 led analysts to cut forecasts for S&P 500
profit growth this year in half to 5.9 percent. The benchmark for U.S. equities tumbled 8.6 percent in June, its worst month since 2002…CIT Group gained the most in the S&P 500 and led financial shares to their first advance in four days, rising $2.02, or 30 percent, to $8.83. The business lender that's lost money for four straight quarters agreed to sell its manufactured housing and home-loan businesses for $1.8 billion as it exits consumer lending. Other mortgage-related companies rallied as CIT gained the most since March. MGIC Investment Corp., the largest U.S. mortgage insurer, rose 43 cents, or 7 percent, to $6.54. Washington Mutual Inc., the biggest U.S. savings and loan, increased 32 cents, or 6.5 percent, to $5.25. Lehman Brothers Holdings Inc. advanced $1.15, or 5.8 percent, to $20.96. Morgan Stanley said the fourth-largest U.S. securities firm has sufficient cash and rated the stock ``overweight'' in new coverage…The S&P 500 swung between gains and losses at least 25 times as a report showing unexpected growth in manufacturing was offset by a jump in oil prices of as much as $3.33 a barrel…il extended this year's gain to 47 percent after the International Energy Agency said supplies may not keep up with demand through 2013 and ABC News reported Israel is increasingly likely to attack Iran this year, starting a conflict that would cut crude supplies from the second-largest producer of theOrganization of Petroleum Exporting Countries. Iran's government dismissed the report as propaganda, while Israeli government officials declined to comment. Pentagon spokesmen Bryan Whitman declined to address the report and State Department spokesman Tom Casey said he had ``no information that would substantiate'' the ABC report, which cited an unidentified Pentagon official. Crude oil for August delivery rose 97 cents, or 0.7 percent, to settle at $140.97 a barrel in New York. Futures have doubled from a year ago…Home Depot Inc., the biggest home-improvement retailer, slid 21 cents to $23.21. Lowe's Cos., the second-largest, dropped 14 cents to $20.61. Merrill recommended investors sell shares of the two chains and other retailers whose earnings are being hurt by the housing slump. ``We see the difficult housing environment worsening throughout 2008,'' Merrill analyst …”
Three month T-Bill yield unchanged at 1.86%.
Two year T-Note yield rose 3 bp to 2.65%
Ten year T-Note yield rose3bp to 4%
Dow rose 32 points to 11,382
S&P 500 rose 5 to 1285
Dollar index fell .10 to 72.36
Yen at 106.1 per dollar
Euro at 1.579
Gold rose $14 to $940
Oil frose$1.42 $141.4
*All prices as of 5 PM
From JPMorgan: “JPMorgan’s global manufacturing PMI fell 0.9 points to 49.5 in June. This was the first sub-50 reading since June 2003, when the global economy was hit by the twin shocks from the SARS epidemic and the US invasion of Iraq. Each of the major PMI’s components fell below the breakeven mark last month—including new orders, output and employment, with the exception of input prices, which set a new series high of 80.1. In addition to pointing to a significant deterioration in the global manufacturing sector in June, the PMI suggests that conditions may worsen even further in coming months…When combined, the ratio of new orders to inventory, which is the best barometer of underlying momentum in the manufacturing sector, fell to 0.98. This is the second lowest reading on record and is a signal that global manufacturing production is poised to contract. When viewed from a regional perspective, most national PMIs fell last month, including in the Euro area, the United Kingdom, Japan and China. The US was the key exception…However, the main driver behind the increase in the ISM survey was an increase in the inventory index, which is hardly a positive…demand growth is weakening across the globe, rather than being focused in the United States, as before.
Indeed, there is little reason to look for any improvement in global manufacturing activity in the near-term. Final demand growth is weakening in the major economies, and is likely in the emerging world as well, in response to tighter credit conditions, weaker housing markets, and higher food and energy prices. This will maintain the downward pressure on industrial activity, which is highly sensitive to movements in demand.”
Global Corporate Earnings Weaken
From FinancialWeek: “The multinational play was based on a combination of strong global growth and a weak U.S. dollar. But now with Europe slowing sharply, a cyclical economic slowdown in emerging markets and inflation rearing its head across the world economy, continued strong global demand is anything but certain. “Disappointing guidance from U.S. multinationals regarding global earnings could be the next shoe to drop on the U.S. equity markets,” Joseph Quinlan, chief market strategist of global wealth and investment management at Bank of America, wrote in a note to clients. “While there remains an investor bias toward large-cap U.S. equities, this asset class could be in for some difficult times ahead if the global economic slowdown ... gathers pace in the second half of this year,” he added. Earnings estimates for the S&P 500 are already falling fast. For the second quarter, analysts polled by Thomson Reuters now expect earnings to fall by 11.1% -- compared with expectations of a fall of 2% at the beginning of April. The biggest contributor to that drop in earnings expectations are financials and consumer discretionaries. But analysts are also beginning to scale back expectations for some of the sectors which have been doing relatively well. Earnings growth expectations for industrial companies have been cut nearly in half – to 5% from 9%, according to Thomson Reuters data…While U.S. domestic profits declined 3% in 2007, overseas earnings rose 17%, making up the only real strength in corporate profits over the past year, said Bank of America’s Quinlan. But that may be about to change. The global economy only expanded by a 3 percent annual rate in the first half of 2008 compared to a 5 percent rate a year ago, according to Bank of America. U.S. foreign affiliate income, a proxy for global earnings, declined 4.5% year-over-year in the first quarter, the bank’s data showed. This deceleration in growth will ultimately take some wind out of the sails for U.S. global earnings, Quinlan wrote.”
Vehicle Sales Plunged in June
From Bloomberg: “General Motors Corp., Toyota Motor Corp. and Ford Motor Co., the biggest auto retailers in the U.S., said June sales plunged as fuel prices above $4 a gallon drove consumers away from gas-guzzling trucks. GM sales fell 19 percent, Ford was down 28 percent and Toyota dropped 21 percent. Honda Motor Co. and Volkswagen AG, which rely on cars for the bulk of their sales, each rose about 1 percent…For the second straight month, Ford's F-Series large pickup, perennially the best-selling vehicle in the U.S., was outsold by four cars: Toyota's Corolla and Camry and Honda's Civic and Accord. Nissan Motor Co. reported an 18 percent total decline.”
Southwest Airlines Has Profited From Fuel Hedges
From San Diego Union-Tribune: “In the first quarter of this year, Southwest paid $1.98 per gallon for fuel. American Airlines paid $2.73, and United paid $2.83 per gallon in the same period. Since 1999, hedging has saved Southwest $3.5 billion. It has sometimes meant the difference between profit and loss. In the first quarter, hedging gains of $291 million dwarfed Southwest's $34 million profit… The transactions carry a price tag. Southwest spent $52 million on hedging premiums last year and $14 million in the first three months of this year. As a result mostly of trades made years ago, Southwest has hedged 70 percent of this year's fuel needs at $51 per barrel instead of the current price of more than $140 per barrel. But hedging premiums rise and fall with the price of the underlying commodity, making new trades very expensive. Southwest has not done much trading in the last several months. Airline executives say hedging is not a bet on the direction of oil prices. “We view our program as insurance,” said Paul Jacobson, the treasurer of Delta Air Lines Inc. “Our goal is to minimize the volatility of fuel expenses. To do that, you've got to be in the market actively without an opinion as to what energy prices will do.” But hedging carries risks. Airlines can lose money if oil prices turn down and their options expire. In 2006, Delta won approval from a bankruptcy court and creditors to get into hedging. But the airline got squeezed when oil prices dropped in midyear, and it reported a loss of $108 million from the trading. Continental Airlines Inc. reported a loss of $18 million from hedging in the first quarter of 2007. But like Delta, Continental is still hedging… At one time in the 1990s, most major U.S. airlines hedged some of their fuel costs – even hiring experts from the oil industry to show them the ropes …That changed after the recession and terror attacks of 2001, which plunged airlines into huge losses. Banks and energy companies that make hedging trades with airlines grew nervous. “The problem was that most carriers had terrible creditworthiness and couldn't hedge,” … “Counter-parties feared the carriers would renege on their trades.” Southwest was the only large U.S. carrier to remain profitable through the downturn. It benefited from higher labor productivity and lower ticket-sales costs. That, and a healthy balance sheet, allowed it to keep hedging when oil was a bargain, compared to today's prices. Now, Southwest is the only big carrier that has most of its fuel expenses hedged at below-market prices. And analysts say it will be the only one to earn a profit this year. While other carriers plan to slash flights later this year – some contracting by more than 10 percent – Southwest expects to grow…The bulk of Southwest's hedges expire gradually by 2012. Replacing them would be very expensive and risky. One plan under study is to go back to hedging only against catastrophically higher oil prices – say, $200 per barrel. Unless oil prices stabilize or even decline, the airline could face a crisis covering higher fuel costs in just a few years. “It's starting to have an impact on their operating plan,” said Betsy Snyder, an analyst for the debt-rating service Standard & Poor's. “They're cutting back growth plans for the first time ever and exiting some unprofitable routes.” Chairman and Chief Executive Gary Kelly said the fuel hedges have bought his airline time to adjust to higher energy costs. Now he wants to find $1.5 billion in new revenue to make up for shrinking fuel hedges. ”
Fast Money Makes Managing Growth and Inflation Tough for China
From the Economist: “…although China’s trade surplus has started to shrink this year, its foreign-exchange reserves are growing at an ever faster pace. The bulk of its net foreign-currency receipts now comes from capital inflows, not the current-account surplus. According to leaked official figures, China’s foreign-exchange reserves jumped by $115 billion during April and May, to $1.8 trillion. In the five months to May, reported reserves swelled by $269 billion, 20% more than in the same period of last year. But even this understates the true rate at which the People’s Bank of China (PBOC) has been piling up foreign exchange.. speculative inflows during that period were perhaps well over $200 billion, because hot money also comes into China through companies overstating FDI and over-invoicing exports. Foreign firms are bringing in more capital than they need for investment: the net inflow of FDI is 60% higher than a year ago, yet the actual use of this money for fixed investment has fallen by 6%. Some of it has been diverted elsewhere. It is one thing to deduce how much money is coming in. It is another to work out where it is going and how it gets past China’s strict capital controls. The stockmarket, which continues to plunge (see article), is no home for hot money. Some has gone into property. The lion’s share is in bog-standard bank deposits. An interest rate of just over 4% on yuan deposits compared with 2% on dollars, combined with an expected appreciation in the yuan, offers a seemingly risk-free profit for those who can get money into China. It comes in via various circuitous routes. Big Western investment funds which care about liquidity would find it hard to move money into China... Massive hot-money inflows present two dangers to China’s economy. One is that capital could suddenly flow out, as it did from other East Asian countries during the financial crisis a decade ago and Vietnam this year. China’s economy is protected by its current-account surplus and vast reserves, but its banking system would be hurt by an abrupt withdrawal. A more immediate concern is that capital inflows will fuel inflation. The more foreign capital that flows in, the more dollars the central bank must buy to hold down the yuan, which, in effect, means printing money. It then mops up this excess liquidity by issuing bills (as “sterilisation”) or by lifting banks’ reserve requirements. But all this complicates monetary policy. China’s interest rates are below the inflation rate, but the PBOC fears that higher rates would attract yet more hot money and so end up adding to inflationary pressures. The central bank has instead tried to curb inflation by allowing the yuan to rise at a faster pace against the dollar—by an annual rate of 18% in the first quarter of this year. But this encouraged investors to bet on future appreciation, exacerbating capital inflows. Since April the pace of appreciation has been much reduced, in a vain effort to discourage speculators… money-supply growth would explode without sterilisation, which is now close to its limit. It is becoming very costly for the central bank to mop up liquidity by selling bills, so it is now relying more heavily on raising banks’ reserve requirements (the PBOC pays banks only 1.9% on their reserves, against over 4% on bills). Since January 2007 the minimum reserve ratio has been raised 16 times, from 9% to 17.5%. But it cannot climb much higher without hurting banks’ profits. To curb future inflation, China therefore needs to stem the flood of capital. One solution would be a large one-off appreciation of the yuan so that investors no longer see it as a one-way bet. This, in turn, would give the PBOC room to raise interest rates. The snag is that the yuan would probably have to be wrenched perhaps 20% higher to alter investors’ expectations, and this is unacceptable to Chinese leaders, especially when global demand has slowed and some exporters are already being squeezed. This implies that monetary policy will remain too loose. The longer that the torrent of hot money continues and interest rates remain too low, the bigger the risk that underlying inflation will creep up.”
From MNI: “Chinese policymakers are reorienting their approach to the economy, moving away from an obsession with preventing overheating and instead bracing for a climate in which slowing global demand and rising inflationary pressure place growth risks firmly on the downside.”
MISC
From Citi: “Fed Minutes released last week indicate that JPMorgan has been granted an 18 month exemption which would allow it to exclude the assets and exposures of Bear Stearns from its regulatory capital requirements.”
From Merrill Lynch: “The addition of Elizabeth Duke to the Federal Reserve Board makes it less likely that Bernanke will have to compromise with the more hawkish Presidents as it should allow him more freedom in making policy decisions. We believe this addition further increases the probability of easier monetary policy in early 2009.”
From Bloomberg: “Moody's Corp. ousted the head of its structured finance unit and said employees violated internal rules in assigning ratings to last year's worst performing
securities….Moody's, the world's second largest credit-rating company, said today that employees, not the company's practices, were to blame. ``Moody's have lost a lot of credibility,''…”
From The New York Times: “Another strain on the economy and markets is the rapidly rising prices for energy, food and other commodities. Crude oil prices are up about 51 percent this year and corn prices are up 55 percent. That surge in raw materials is one reason that fast-growing markets like China and India — which are increasingly dependent on energy imports — have taken a beating in recent months. The Shanghai stock market is down 48 percent for the year, and the Nifty index in India is down 34 percent. By contrast, markets in Russia and Brazil, which are big exporters of commodities, are essentially flat for the year. “The emerging markets are associated with higher commodity prices, but not all emerging markets are beneficiaries,” said Simon Hallett, chief investment officer of Harding Loevner Management, an investment firm based in Somerville, N.J. “Russia and Brazil are commodity producers, but China and India are commodity consumers.””
From Bank of America: “[ISM] Prices paid is the highest since 1979.”
From RBSGC: “…the Census Bureau revised the entire private residential series going back to 1993 due to methodological changes (expenditures on private residential improvements to rental, vacant, and seasonal properties are now being excluded from the data, but improvements on owner-occupied structures will remain).”
From Merrill Lynch: “The sharp declines in the equity market have meant that $2.1 trillion of 'paper wealth' has evaporated so far this year - 70% of that loss occurring in June alone.”
From The New York Times: “Lehman Brothers, which has been struggling to persuade investors that it can survive as an independent firm, fell 11 percent Monday, bringing its loss for the year to nearly 70 percent.”
From Bloomberg: “Legg Mason has lined up $2.15 billion in financing since November to cushion its money funds from potential losses. The funds bought debt from structured investment vehicles, or SIVs, that held securities backed by subprime mortgages. In the three months ended March 31, Legg Mason posted a $255 million net loss, its first as a public company.”
From The LA Times: “Battling rumors that it may collapse, Pasadena-based IndyMac Bancorp acknowledged Monday that its financial position had deteriorated but described the fears as overblown and said it was working with regulators to improve its "safety and soundness."… The shares are down 90% this year… More than 96% of IndyMac's deposits are safe because they are insured by the FDIC, IndyMac said. The agency covers up to $100,000 per depositor. Retirement accounts are insured separately for up to $250,000.”
From Bloomberg: “Starbucks Corp., the world's largest chain of coffee shops, plans to close 600 ``underperforming'' stores in the U.S.”
End-of-Day Market Update
From RBSGC: “The market did little more than trade off of movements in domestic equities -- but in the wake of quarter-end, we see this as overall supportive, despite the fickleness of the strength. In fact, it is equally constructive that 2-year yields dipped to 2.52% even with a better-than-expected ISM report and smaller than forecast decline in construction spending. And with volumes heavy, we see this as setting the pre-Employment Report range. From a technical perspective, Tuesday's price action has broken the upward sloping channel in 2s -- much the same as the previous channel in 10s. Now through the 2.65% channel bottom, a projection to 2.35% seems achievable in this environment. That said, while momentum remains bullish, its waning somewhat as the strengthening slows. The selloff in equities and upside in Treasuries have edged the bar higher for a post-Employment Report rally on consensus data. Also of note from Tuesday's session, was the JPM survey, showing investors at a very flat 75% -- that's tied with early-June as the second flattest on record (since '97) behind the Sept '00 78% level..Volumes were very strong, with cash trading at 129% of the 10-day moving-average.”
From Lehman: “The treasury market took a roller coaster ride on Tuesday, rallying as much as 10 basis points in the 5 year sector as stocks got clobbered early, and then falling quickly when the equity market rebounded in the afternoon. The yield curve steepened a few basis points during the morning rally, and the 5 year sector had a particularly good bid, but the curve finished only marginally steeper as long bonds recovered from selling on the back of some large steepening trades in the afternoon selloff. Tuesday's trading volumes were high, with over 1.1 mm ten year contracts trading, and the market had a bit of a panicked feel about for much of the morning session.”
From JPMorgan: “Wild day. UST's were bid all day, particularly in the 5y sector, as equities tested their March low. The price action was similar to that of the last few days where MBS, swaps, and other spread product would not participate in the UST bid and spreads widened into uptrades. After ISM we saw a significant amount of duration shedding out of the servicing community in the long end of the curve. This also dragged in some rate paying in 10s from a few bank portfolios and rate lockers who had been sitting on the sidelines looking for a level to sell. … Today's reversal will set the resistance for the short term across the curve and will be the basis of stops for shorts set today.”
From SunTrust: “It appears that equities averted the trip to Hades for one more day… Nonetheless, the ISM was enough to turn stocks around and pressure Treasuries lower…Dollar weakness does have one advantage, exports are cheap. Also of some cheer to equities is weaker oil this afternoon, a real bargain at "only" $140 per barrel. CIT, Lehman and GM all managed to trade higher today, albeit small gains. 2 yrs managed to eke out 2.52 before yields turned higher. 10 yrs touched 3.90. Both issues are going into the close 10 bp higher as stocks lift up. The next hurdle for markets will be employment.”
From UBS: “Treasuries kicked off the session with a head of steam, with the front end richer by double-digit basis points, before a stronger-than-expected ISM Mfg. number put the kibosh on the rally. Subsequently, Treasuries simply mirrored stocks the rest of the way, leaving us little changed on the day as of 3pm. After stocks came back from heavy losses to close up (slightly) on the day. There was real money buying in intermediates helping the belly outperform on the day. We saw buying of 20-year TIPS, which continued to outperform nominals. Breakevens widened across the board, and the January 2009 breakeven was out by more than 17bps… With GM announcing better-than-feared sales today, total light vehicle sales for June appear on track to hit about 14.0M. This is in line with forecasts but still down from May's 14.3M in sales…Mortgages see origination again, get smoked on the day:
Swaps saw 2-way flow on curve trades, and back end spreads widened modestly. Agencies saw buying of 5- and 10-year paper, trading in line with Libor across the board. Mortgages had about $1.5B in origination, the most we've seen in about 2 weeks. With buyers seemingly on strike, mortgages went as much as 11 ticks wider to Treasuries and 8 to swaps, before coming back in to "only" 8+ wider to Treasuries and 6 to swaps.”
From Bloomberg: “U.S. stocks rose, helping the market rebound from its worst month in six years, after better-than- forecast sales at General Motors Corp. overshadowed concern that rising energy costs will damp corporate profits. GM, the largest U.S. automaker, jumped the most in more than two weeks and led the Dow Jones Industrial Average's rebound from an almost 167-point drop earlier in the day. American Express Co. posted its best gain since May on UBS AG's upgrade of the biggest U.S. credit-card company, while CIT Group Inc. jumped the most since March after selling its mortgage businesses to Lone Star Funds and Berkshire Hathaway Inc. Rising oil prices sent shares of FedEx Corp. to a four-year low, limiting gains in benchmark indexes. The Dow Jones Industrial Average climbed 32.25 points, or 0.3 percent, to 11,382.26, erasing earlier declines that sent the 30-stock gauge into a bear market for a third day. The Standard & Poor's 500 Index added 4.91, or 0.4 percent, to 1,284.91. The Nasdaq Composite Index advanced 11.99, or 0.5 percent, to 2,304.97…The Dow pared its retreat from an October record to 19.6 percent, less than the 20 percent decline that signals the start of a so-called bear market. The S&P 500 has lost 18 percent since its October peak after the biggest quarterly increase in oil prices since 1999 led analysts to cut forecasts for S&P 500
profit growth this year in half to 5.9 percent. The benchmark for U.S. equities tumbled 8.6 percent in June, its worst month since 2002…CIT Group gained the most in the S&P 500 and led financial shares to their first advance in four days, rising $2.02, or 30 percent, to $8.83. The business lender that's lost money for four straight quarters agreed to sell its manufactured housing and home-loan businesses for $1.8 billion as it exits consumer lending. Other mortgage-related companies rallied as CIT gained the most since March. MGIC Investment Corp., the largest U.S. mortgage insurer, rose 43 cents, or 7 percent, to $6.54. Washington Mutual Inc., the biggest U.S. savings and loan, increased 32 cents, or 6.5 percent, to $5.25. Lehman Brothers Holdings Inc. advanced $1.15, or 5.8 percent, to $20.96. Morgan Stanley said the fourth-largest U.S. securities firm has sufficient cash and rated the stock ``overweight'' in new coverage…The S&P 500 swung between gains and losses at least 25 times as a report showing unexpected growth in manufacturing was offset by a jump in oil prices of as much as $3.33 a barrel…il extended this year's gain to 47 percent after the International Energy Agency said supplies may not keep up with demand through 2013 and ABC News reported Israel is increasingly likely to attack Iran this year, starting a conflict that would cut crude supplies from the second-largest producer of theOrganization of Petroleum Exporting Countries. Iran's government dismissed the report as propaganda, while Israeli government officials declined to comment. Pentagon spokesmen Bryan Whitman declined to address the report and State Department spokesman Tom Casey said he had ``no information that would substantiate'' the ABC report, which cited an unidentified Pentagon official. Crude oil for August delivery rose 97 cents, or 0.7 percent, to settle at $140.97 a barrel in New York. Futures have doubled from a year ago…Home Depot Inc., the biggest home-improvement retailer, slid 21 cents to $23.21. Lowe's Cos., the second-largest, dropped 14 cents to $20.61. Merrill recommended investors sell shares of the two chains and other retailers whose earnings are being hurt by the housing slump. ``We see the difficult housing environment worsening throughout 2008,'' Merrill analyst …”
Three month T-Bill yield unchanged at 1.86%.
Two year T-Note yield rose 3 bp to 2.65%
Ten year T-Note yield rose3bp to 4%
Dow rose 32 points to 11,382
S&P 500 rose 5 to 1285
Dollar index fell .10 to 72.36
Yen at 106.1 per dollar
Euro at 1.579
Gold rose $14 to $940
Oil frose$1.42 $141.4
*All prices as of 5 PM
June ISM Unexpectedly Expands for First Time in 5 Months
Surprise rebound in the ISM manufacturing number for June. The market had looked for a continued erosion to 48.5 from 49.6 in May. Instead the index rose to 50.2. This was the first reading above 50 , indicating expansion, since January. But along with the improvement in manufacturing is a strong indication that inflation continued to rise as the prices paid index jumped to a new high of 91.5 from the already elevated 87 reading of last month. Companies are saying it is getting easier to recover raw material costs, which may indicate that people are becoming more accepting of higher commodity costs. Looking at the components, the improvement doesn't look as impressive. Production improved slightly (51.5 vs 51.2) while new orders fell slightly (49.6 vs 49.7). The backlog of orders rose to 47.5, but remains in contraction. The improvement in new export orders stalled slightly in June, as the index didn't improve for the first timed since February, easing back to 58.5 from 59.5 the prior month. Supplier deliveries and inventories both rose, with inventories moving back above 50 to 51.2. Customer inventories also popped higher from 47 to 55. Employment weakened to 43.7 and imports also fell to 46. Economists expect that some of the improvement is tied to the transitory rebate checks. Industries seeing improved performance included computers, petroleum, food and furniture. Declining industries included wood, appliances, transportation apparel, plastics and machinery.
Demand for New Construction Continues to Decline
Overall construction spending continued to contract in May, falling -.4% MoM. This was a smaller than expected decline, and was further supported by the revision higher in April's data to only a -.1% MoM drop instead of the originally reported drop of -.4% MoM. Over the past year, total construction spending has fallen -6% YoY. Residential construction remains mired in a funk, falling -1.6% MoM for the second month in a row. Residential construction is down -27% YoY. Non-residential construction of schools, office buildings, hospitals and roads, rose +.3%, for the smallest increase since the beginning of the year. But, over the past year, non residential construction has grown by 12% YoY. Both public and private residential construction fell over 1% MoM. Non-residential construction grew twice as fast in the public sector as the private sector in May (+.2% vs +.4% MoM). Public construction projects are becoming increasingly important as the economy slows. Over the past year, private investment has fallen -10% YoY while public spending has grown +5% YoY. With gas taxes income falling on the decline in volume of gasoline burned, the government is currently considering raiding income taxes to cover the shortfall in funds needed to improve the nation's crumbling infrastructure. Federal spending on construction has risen +15% YoY while state and local spending has risen +4.5% YoY.
Monday, June 30, 2008
Today's Tidbits
Bank De-Levering Causes Lending to Contract at Fastest Pace Ever Recorded
From Goldman: “There are now also some troubling signals in the weekly bank lending data published by the Fed. Over the last 13 weeks, total bank credit -- which comprises all loans, leases, and securities holdings by commercial banks operating in the US -- has fallen by 9.1% (annualized) in seasonally adjusted terms. This is the fastest rate of decline in the history of the series, which stretches back to 1973. Unlike in 2007 H2, when strong credit extension by the banking sector partially offset the disruptions in the securitization markets, bank credit restraint has thus now started to reinforce the weakness elsewhere in the financial system. This could be the first hard evidence that our "leveraged losses" story -- i.e. banks curtailing lending in response to the depletion of their equity capital and a reduction in target leverage -- is really starting to bite.”
From Citi: “With bank balance sheets still under pressure there is increasing likelihood of the 'adverse feedback loop' between the financial system and the real economy gaining traction.”
From UBS: “…we have great fear that the historic pull-back by the banks from the loan markets will have serious, long-term ramifications for the US economy.”
BIS Warns of Risk of a Severe Slowdown in US
From The Wall Street Journal: “The global economy may be close to a "tipping point" that could see it enter a slowdown so severe that it transforms the current period of rising inflation into a period of falling prices, the Bank for International Settlements said Monday. In its annual report, the central bank for central banks said the impact of rising food and energy prices on consumers' incomes, combined with heavy household debts and a pullback in bank lending, may lead to a slowdown in global growth that "could prove to be much greater and longer-lasting than would be required to keep inflation under control." "Over time, this could potentially even lead to deflation," it said…The BIS said that in the early part of this decade, central banks had failed to set interest rates high enough to restrain an unsustainable credit boom…To be sure, the BIS regards a slide into deflation as an unlikely outcome, and for now rising inflation is a more imminent danger than a severe slowdown…While a severe slowdown is not inevitable, the BIS believes that the risks of a sharp downturn are very real, and centered on the financial system. It warned that the process of cutting back on borrowing after many years of accumulating debt could lead to "much slower growth than is generally expected." Within the financial sector, the BIS said the reduced availability of credit could force some institutions to sell assets at a time when buyers are hard to find -- an outcome that could lead to another round of price declines and losses at banks. "The impact of such fire sales on prices, and on the capital of financial institutions, could be substantial," it said. Tighter credit conditions could also hit non-financial companies and households hard, increasing defaults on bank loans and placing financial institutions in even greater difficulty. The BIS said the U.S. economy is most at risk from problems in the financial system. But it added that there are "suspicions that a number of other countries with low household savings rates might be similarly, if less significantly, affected." And it warned that while the U.S. dollar's depreciation against other major currencies has so far been "remarkably orderly," that might not continue to be the case. "Foreign investors in U.S. dollar assets have seen big losses," it said. "While unlikely ... a sudden rush for the exits cannot be ruled out completely."
Mortgage Demand Continues to Weaken as Banks Hoard Capital
From Bloomberg: “Subprime and Alt-A mortgage bonds, trading at or near record lows, may continue their declines as banks limit purchases of some securities and are forced to sell off what they hold, JPMorgan Chase & Co. analysts said. Prices for typical fixed-rate Alt-A bonds rated AAA have tumbled to near an all-time low of less than $84 per $100 of principal from about $87 in April, JPMorgan said. Subprime debt is also down, … AAA bonds lost 5.1 percent in three months, Lehman Brothers Holdings Inc. index data show. A year after the subprime meltdown roiled credit investors, the market for new non-agency mortgage bonds is no closer to reopening. Banks have a ``long way to go,'' after raising about $400 billion of capital, JPMorgan analyst Chris Flanagan said in a report. Banks will need about $115 billion simply to offset downgrades among the $1 trillion of AAA subprime and Alt-A bonds, he wrote, as lower quarter-end prices suggest new writedowns. ``In a world of insufficient capital, value no longer really matters,…A year after the collapse of two Bear Stearns Cos. edge funds began a global credit crisis, investors including Fannie Mae's Paul Norris see few signs of revival in the market for new non-agency mortgage bonds backed by even the safest home loans. ``It's maybe not going to be until the end of the year at least,'' Norris, who helps manage $106 billion of the debt as a director of mortgage portfolio investments at Washington-based Fannie Mae, said at a conference last week. On-agency bonds, once the most profitable home-loan debt for Wall Street, lack guarantees from government-chartered Fannie Mae and Freddie Mack or U.S. agency Ginnie Mae. Issuance of such bonds fell 92 percent to $37 billion this year through May…Other issuance was packaging meant to improve banks' capital ratios or financing options. More than $9 billion were repackagings of existing bonds meant to leave some of the debt less exposed to losses on the underlying loans. ...The drying up of lending facilitated by non-agency bond sales is boosting mortgage defaults by contributing to property- price declines and preventing refinancing, according to UBS analyst Laurie Goodman. Buyers have disappeared amid unprecedented U.S. home-price drops, foreclosure rates and bank losses. Bonds backed by subprime or second mortgages have cost holders an average of 15 percent so far this year, Lehman Brothers index data show. Top-rated bonds backed by Alt-A adjustable-rate mortgages may now fetch $5 to $10 less per $100 than their fixed-rate counterparts, according to JPMorgan. Some junior AAA securities tied to option ARMs, which allow borrowers to pay less than the interest they owe, may sell for $38, according to a June 27 report from Barclays Capital. The last-to-be-repaid of originally AAA rated subprime-mortgage bonds created in first half of 2007 fell last week to $45.89, a Markit ABX index suggests…Total issuance of U.S. mortgage securities may drop 34 percent to $1.4 trillion this year, according to UBS, with the non-agency segment accounting for 9 percent. In 2007, the share was 38 percent, down from a record 55 percent in 2005 and 2006. Non-agency bonds outstanding shrunk $70 billion in the first quarter to $2.13 trillion, after an almost five-fold rise since 2001 that fueled a record housing boom, according to the latest Federal Reserve data. This year, the market may fall by $385 billion, Bank of America Corp. estimates. hat's partly because borrowers are refinancing into fixed- rate loans packaged into agency mortgage securities, a market that may grow $613 billion, up from a record $505 billion last year…Selling bonds backed by even ``super clean'' jumbo loans -- with fixed rates, at least 25 percent down payments and high credit scores -- with interest rates needed to woo consumers is unprofitable at the bond yields now necessary to attract investors, according to a June 20 report from JPMorgan. Jumbo loans are larger than Fannie Mae and Freddie Mac limits, from $417,000 to $729,500 in certain areas.”
Rebate Checks Aren’t Being Spent on Durable Goods
From Merrill Lynch: “As we saw on Friday with that 1.9% bounce in personal income in May, the tax rebates are starting to percolate and the estimate was that the stimulus came to $48 billion during the month, but excluding government transfer payments, real incomes were actually down at a 0.3% annual rate in May. This was the third decline in a row, and is one of the four metrics the NBER uses in its recession methodology…So while the data are now being skewed by the tax rebates, beneath the surface what we see is that organic real wages remain under downward pressure, which is a huge signal that the buying power is going to fade away once the tax cuts run their course post-July. Now, consumer spending did rise a healthy 0.8% in nominal terms in May but fully 60% of that increase was absorbed by groceries, gasoline, utilities and transportation prices. Outside of that, the spending was centered in a select group of soft non-durables - the sort of things that you can stretch a $600 check towards: this included electronics, computers, hand tools, books and magazines, toys, sporting equipment, movies, which soared 25% in one month, restaurants, toiletries, and non-prescription drugs…As mentioned above, people also got caught up in their utility bills where payments surged 6%. And in a real sign of despair, a good chunk of the spending went into lotteries (+0.9%) and casino gambling (+3%). And, they must have been at the blackjack table all night because spending on hotel rooms actually declined 1.6%. In this sense, very little of the spending went into anything that would represent a long-term commitment to the economy - motor vehicles, home furnishings, major appliances, clothing and jewelry either lagged the overall spending gain or declined outright. My favorite indicator for travel plans is luggage sales, and in a month where after-tax income surged 5.3%, buying of suitcases and the like fell 0.4%.”
Reduced Credit Lines Pulling Down FICO Scores as Credit Gard Debt Grows Fast
From AP: “Just as Americans grow more reliant on credit cards to help pay monthly bills, they're being hit with a one-two punch: Card companies are reducing borrowing limits for tens of thousands of consumers, which then can lead to lower credit scores. Those facing this predicament might not even know it until they apply for a loan or another credit car, and then get denied because their credit score has dropped. This is an unintended consequence of the financial world's widespread ratcheting down of risk. Banks and other card lenders are trying to better protect themselves from more massive losses like those they've seen from subprime mortgages. As a result, they are looking for ways to reduce their exposure to cardholders more likely to default. That's why they are lowering credit limits, which means they are reducing the maximum amount of credit extended to an individual, along with boosting card interest rates and allowing fewer balance transfers…As the housing and mortgage markets have collapsed, lenders have also reduced the limits on what are known as home equity lines of credit, or HELOCs. Net home equity extraction fell nearly 60 percent from a year earlier to $205 billion in the first quarter, according to Merrill Lynch. The investment bank also notes that some $1.2 trillion in equity and housing wealth was wiped out in the first quarter alone because of plunging home values. At the same time, revolving credit usage – which includes credit cards – accelerated sharply to a year-over-year growth rate of about 8 percent in recent months. That's the fastest rate in seven years and well ahead of the 2 to 3 percent rate of growth from 2004 through 2006 when home equity lines of credit were a bigger source of cash for consumers, according to Merrill. But as credit cards are used more frequently, that often results in bigger balances left on the cards. What's worrisome is that consumers who are faced with a number of ugly economic scenarios hitting at once – falling home prices, surging commodities costs and a weak job outlook – won't be able to pay their bills….“Business conditions continue to weaken in the U.S. and so far this month we have seen credit indicators deteriorate beyond our expectations,” American Express' CEO Kenneth Chenault said in a statement. That's why card companies including Washington Mutual, HSBC and Wells Fargo are lowering their credit limits, according to data from the consulting firm Institutional Risk Analytics. Consumer advocates aren't saying that is bad news – in fact, they believe it helps prevent cardholders from overextending themselves and is preferred to having a sudden surge in card interest rates…A lower FICO score could make it more expensive for someone trying to borrow money. For instance, someone taking out a $25,000 36-month auto loan would see an interest rate of about 6.4 percent and a monthly payment of $765 if they were in the highest range of FICO scores of 720 to 850, according to Fair Isaac's Web site myFICO.com. That then jumps to an interest rate of 7.3 percent and a monthly payment of $776 for those with a score of 690 to 719 and as much as 15 percent or $866 a month for those with the lowest FICO range of 500 to 589. According to the Comptroller of the Currency, one of the government agencies that regulate U.S. banks, companies must notify cardholders at least 15 days in advance before making changes in the terms of their account, such as lowering the credit limit. But they don't have to explain how that could change an individual's credit score. That puts the burden on consumers to watch out for this. They better so they don't get blindsided.”
MISC
From Barron’s: "In the average bear market, the Dow Jones Industrial Average has fallen 30% and sometimes much, much more. The Dow decline of 2000 through 2003 involved a loss of 55%, the bear of '73-'74 caused a 50% loss and the 1929 market wiped out a full 85% of the Dow's value."
From Barron’s: “S&P500 investors are on the verge of experiencing something not seen for a very long time -- a losing decade. If markets continue their losing streak for a few more months, that is a realistic possibility. The S&P500 is now down 4.8% since June of 1999. To hit the decade mark, the SPX would need to be below the 1998 close of 1,229 -- less than 50 points below Friday's close of 1278.38 come December 31st. This has not occurred since the 1930s.”
From Barclays: “The aggressive sell-off in equities last week suggests the S&P500 is poised to retest its 2008 low, but oversold momentum implies the risk of a snap-back is growing. What is surprising is that the talk of a global slowdown and weaker equity markets is having no impact on commodities, which continue to surge higher. Most surprising of all, copper appears poised to retest its 2008 following the gains last week and the higher oil price. In some part, this could be explained by a weaker dollar but it suggests this is not going to be a straight forward week of trading. In FX markets, risk reduction is the theme with the carry trade under pressure…”
From UBS: “The BIS Annual Report came out earlier this morning and in that report the BIS warned that the unwind of the credit bubble could, after a period of temporary inflation, turn into a deflationary battle that would be hard for global central banks to fight.”
From Lehman: “We aren't going to see any refi driven prepayments for years.”
From PIMCO: “…gross private domestic investment (machines, houses, inventories) has declined by $200 billion since its peak in late 2006.”
From JPMorgan: “The growth/inflation trade-off is getting worse for developed economies. At the same time as inflation is reaching new highs in G3, the Euro area and Japanese economies are weakening into midyear, with the risks skewed to the downside to our already anaemic growth forecasts…How central banks will manage this mix of weakening growth and rising inflation remains unclear. Our calls anticipate a series of one-off moves by the ECB, the Fed and the BoE, but much will depend on exactly how the growth/inflation mix evolves over the next few months. The ECB is set to raise rates next week but it is far from certain what the Fed and the BoE will do. EM policy makers are facing a much more serious inflation problem, with signs of overheating and wage/price acceleration. Their reluctance to respond aggressively to the inflation threat now is eroding their credibility, raising the risk that they will have to move more abruptly next year, damaging their economies and local markets.”
From Lehman: “Stocks are as cheaply priced now as they were in 1974 or 1978, relative to 'risk-free' rates, which suggests that 'stagflation' is no longer viewed as a possibility, but a probability by equity investors.”
From Citi: “CDS spreads have been ticking up ominously in recent sessions as equities come under further pressure. The uptick has not been as dramatic as in previous bouts of 'risk aversion' but we are seeing movements in cross-JPY in FX space which is reminiscent of developments earlier in the year.”
From Merrill Lynch: “During the last week, NYMEX crude oil prices rose US$7.71 (+5.8%) to US$139.64/bbl. Natural gas prices rose US$0.24 (+1.9%) to US$13.11/mmbtu.”
From BMO: “The preliminary estimate for Eurozone CPI jumped 4.0% y/y in June, up 0.3 percentage points from May and the fastest increase since mid-1992.”
From JPMorgan: “…Russia which has become investors’ preferred country for commodity exposure. In contrast, Brazil continues to experience large outflows with $6bn withdrawn over the past month.”
From JPMorgan: “The bottom seems to have fallen out of the UK housing market this spring. UK mortgage purchase applications nosedived to 42,000 in May (consensus 51k), down almost 70% from the November 2006 peak. Recently, we downgraded our house price forecast to show a decline of 12%oya by the end of this year, but risks to this forecast are to the downside. Relatedly, UK consumer confidence declined in June to the lowest on record since the survey began in 1986.”
End-of-Day Market Update
From RBSGC: “Quarter-end, month-end, were the main constraints and motivations for lackluster trading Monday, which left yields little changed from Friday's robust closing levels, but the curve a tad flatter… Stocks managed a small bounce for an inside day. But if anything supported the interest rate market it was stocks -- selectively. Freddie and Fannie both lost about 6%, Lehman was off nearly 10%, but the headlines were merely about the price action itself vs. a new explanation for the price action. And weakness in these issues, the financials in general, are simply par for the course. We note that the S&P Banks and Brokerage indexes are now through their March lows… To underscore the subdued activity, volume amounted to 81% of average.”
From UBS: “Treasuries fell early from the overnight highs--dragged lower by the European debt markets--before grinding all the way back by the 3pm close… Swaps saw good interest in steepener trades, and swap spreads ended mixed on the day. Agencies saw large month-end extensions out of 1-year paper and into 2-3 year maturities. Agencies outperformed Libor by 2bps in the front end and stayed in line the rest of the way. Mortgages saw fast money short covering early in the morning, which pushed MBS 9 ticks tighter to Treasuries and 7 to swaps. Sellers then emerged at the tights and mortgages went back out to only 1 tighter against Treasuries and swaps. Despite the action, volume was fractions of the norm while liquidity was fleeting, at best. It seems summer has arrived.”
From Bloomberg: “Corn fell the maximum permitted by the Chicago Board of Trade and wheat dropped the most in 13 weeks after the government said U.S. farmers planted more of both crops than previously expected.”
From Bloomberg: “Most U.S. stocks fell for a third day, capping the market's worst month in six years, on concern that deepening mortgage losses will force more banks to cut dividends or sell shares at a discount. Wachovia Corp. tumbled to the lowest since 1992 after an analyst said the lender may cut its payout, while Merrill Lynch & Co. and Citigroup Inc. dropped as JPMorgan Chase & Co. said prices for some mortgage securities may sink further. Lehman Brothers Holdings Inc. plunged as traders speculated the fourth- largest U.S. securities firm may be sold for less than its market value. Devon Energy Corp. led gains in oil producers, which sent the Standard & Poor's 500 Index and Dow Jones Industrial Average higher, after analysts increased profit estimates through 2009. Three stocks dropped for every two that rose on the New York Stock Exchange. The S&P 500 increased 1.62 points, or 0.1 percent, to 1,280, paring its retreat this month to 8.6 percent. The Dow added 3.5 to 11,350.01. The Nasdaq Composite Index lost 22.65, or 1 percent, to 2,292.98… The Dow pared its monthly retreat to 10.2 percent, still the biggest June loss for the 30-stock gauge since 1930. The measure dropped 7.4 percent since the end of March for its third-straight quarterly slide, the longest stretch of declines since 1978. The S&P 500 slid 3.2 percent during the quarter, while the Nasdaq increased 0.6 percent… The Financial Select Sector SPDR Fund, a so-called exchange traded fund that tracks U.S. financial stocks, lost 1.5 percent to $20.26, the lowest since March 2003. The shares, known by their XLF ticker, were the second most-traded among stocks and ETFs in New York today… Newly delinquent homeowners outnumbered those who caught up on overdue payments for a 26th straight month in May, the Mortgage Insurance Companies of America, which tracks loans to people who put down less than 20 percent, said today. ``A lot of people are fearing with these financials, as we hear these second-quarter earnings, that there's going to be a lot more writedowns,''… More than $800 billion in announced buybacks last year helped the S&P 500 and Dow average climb to all-time highs in October. The pace has slowed as the U.S. housing slump spurred the longest steak of earnings declines for S&P 500 companies since 2002. U.S.
companies announced $197 billion in planned buybacks this year through June 26, 52 percent less than during the same period last year, according to Birinyi Associates Inc.”
Three month T-Bill yieldrose 7 bp to 1.73%.
Two year T-Note yield fell 1 bp to 2.62%
Ten year T-Note yield unchanged at 3.97%
Dow rose 3.5 points to 11,350
S&P 500 rose 1.5 to 1280
Dollar indexrose .16 to 72.52
Yen at 106.1 per dollar
Euro at 1.575
Gold fell $3 to $925
Oil fell $0.14 $140.1
*All prices as of 5:20 PM
From Goldman: “There are now also some troubling signals in the weekly bank lending data published by the Fed. Over the last 13 weeks, total bank credit -- which comprises all loans, leases, and securities holdings by commercial banks operating in the US -- has fallen by 9.1% (annualized) in seasonally adjusted terms. This is the fastest rate of decline in the history of the series, which stretches back to 1973. Unlike in 2007 H2, when strong credit extension by the banking sector partially offset the disruptions in the securitization markets, bank credit restraint has thus now started to reinforce the weakness elsewhere in the financial system. This could be the first hard evidence that our "leveraged losses" story -- i.e. banks curtailing lending in response to the depletion of their equity capital and a reduction in target leverage -- is really starting to bite.”
From Citi: “With bank balance sheets still under pressure there is increasing likelihood of the 'adverse feedback loop' between the financial system and the real economy gaining traction.”
From UBS: “…we have great fear that the historic pull-back by the banks from the loan markets will have serious, long-term ramifications for the US economy.”
BIS Warns of Risk of a Severe Slowdown in US
From The Wall Street Journal: “The global economy may be close to a "tipping point" that could see it enter a slowdown so severe that it transforms the current period of rising inflation into a period of falling prices, the Bank for International Settlements said Monday. In its annual report, the central bank for central banks said the impact of rising food and energy prices on consumers' incomes, combined with heavy household debts and a pullback in bank lending, may lead to a slowdown in global growth that "could prove to be much greater and longer-lasting than would be required to keep inflation under control." "Over time, this could potentially even lead to deflation," it said…The BIS said that in the early part of this decade, central banks had failed to set interest rates high enough to restrain an unsustainable credit boom…To be sure, the BIS regards a slide into deflation as an unlikely outcome, and for now rising inflation is a more imminent danger than a severe slowdown…While a severe slowdown is not inevitable, the BIS believes that the risks of a sharp downturn are very real, and centered on the financial system. It warned that the process of cutting back on borrowing after many years of accumulating debt could lead to "much slower growth than is generally expected." Within the financial sector, the BIS said the reduced availability of credit could force some institutions to sell assets at a time when buyers are hard to find -- an outcome that could lead to another round of price declines and losses at banks. "The impact of such fire sales on prices, and on the capital of financial institutions, could be substantial," it said. Tighter credit conditions could also hit non-financial companies and households hard, increasing defaults on bank loans and placing financial institutions in even greater difficulty. The BIS said the U.S. economy is most at risk from problems in the financial system. But it added that there are "suspicions that a number of other countries with low household savings rates might be similarly, if less significantly, affected." And it warned that while the U.S. dollar's depreciation against other major currencies has so far been "remarkably orderly," that might not continue to be the case. "Foreign investors in U.S. dollar assets have seen big losses," it said. "While unlikely ... a sudden rush for the exits cannot be ruled out completely."
Mortgage Demand Continues to Weaken as Banks Hoard Capital
From Bloomberg: “Subprime and Alt-A mortgage bonds, trading at or near record lows, may continue their declines as banks limit purchases of some securities and are forced to sell off what they hold, JPMorgan Chase & Co. analysts said. Prices for typical fixed-rate Alt-A bonds rated AAA have tumbled to near an all-time low of less than $84 per $100 of principal from about $87 in April, JPMorgan said. Subprime debt is also down, … AAA bonds lost 5.1 percent in three months, Lehman Brothers Holdings Inc. index data show. A year after the subprime meltdown roiled credit investors, the market for new non-agency mortgage bonds is no closer to reopening. Banks have a ``long way to go,'' after raising about $400 billion of capital, JPMorgan analyst Chris Flanagan said in a report. Banks will need about $115 billion simply to offset downgrades among the $1 trillion of AAA subprime and Alt-A bonds, he wrote, as lower quarter-end prices suggest new writedowns. ``In a world of insufficient capital, value no longer really matters,…A year after the collapse of two Bear Stearns Cos. edge funds began a global credit crisis, investors including Fannie Mae's Paul Norris see few signs of revival in the market for new non-agency mortgage bonds backed by even the safest home loans. ``It's maybe not going to be until the end of the year at least,'' Norris, who helps manage $106 billion of the debt as a director of mortgage portfolio investments at Washington-based Fannie Mae, said at a conference last week. On-agency bonds, once the most profitable home-loan debt for Wall Street, lack guarantees from government-chartered Fannie Mae and Freddie Mack or U.S. agency Ginnie Mae. Issuance of such bonds fell 92 percent to $37 billion this year through May…Other issuance was packaging meant to improve banks' capital ratios or financing options. More than $9 billion were repackagings of existing bonds meant to leave some of the debt less exposed to losses on the underlying loans. ...The drying up of lending facilitated by non-agency bond sales is boosting mortgage defaults by contributing to property- price declines and preventing refinancing, according to UBS analyst Laurie Goodman. Buyers have disappeared amid unprecedented U.S. home-price drops, foreclosure rates and bank losses. Bonds backed by subprime or second mortgages have cost holders an average of 15 percent so far this year, Lehman Brothers index data show. Top-rated bonds backed by Alt-A adjustable-rate mortgages may now fetch $5 to $10 less per $100 than their fixed-rate counterparts, according to JPMorgan. Some junior AAA securities tied to option ARMs, which allow borrowers to pay less than the interest they owe, may sell for $38, according to a June 27 report from Barclays Capital. The last-to-be-repaid of originally AAA rated subprime-mortgage bonds created in first half of 2007 fell last week to $45.89, a Markit ABX index suggests…Total issuance of U.S. mortgage securities may drop 34 percent to $1.4 trillion this year, according to UBS, with the non-agency segment accounting for 9 percent. In 2007, the share was 38 percent, down from a record 55 percent in 2005 and 2006. Non-agency bonds outstanding shrunk $70 billion in the first quarter to $2.13 trillion, after an almost five-fold rise since 2001 that fueled a record housing boom, according to the latest Federal Reserve data. This year, the market may fall by $385 billion, Bank of America Corp. estimates. hat's partly because borrowers are refinancing into fixed- rate loans packaged into agency mortgage securities, a market that may grow $613 billion, up from a record $505 billion last year…Selling bonds backed by even ``super clean'' jumbo loans -- with fixed rates, at least 25 percent down payments and high credit scores -- with interest rates needed to woo consumers is unprofitable at the bond yields now necessary to attract investors, according to a June 20 report from JPMorgan. Jumbo loans are larger than Fannie Mae and Freddie Mac limits, from $417,000 to $729,500 in certain areas.”
Rebate Checks Aren’t Being Spent on Durable Goods
From Merrill Lynch: “As we saw on Friday with that 1.9% bounce in personal income in May, the tax rebates are starting to percolate and the estimate was that the stimulus came to $48 billion during the month, but excluding government transfer payments, real incomes were actually down at a 0.3% annual rate in May. This was the third decline in a row, and is one of the four metrics the NBER uses in its recession methodology…So while the data are now being skewed by the tax rebates, beneath the surface what we see is that organic real wages remain under downward pressure, which is a huge signal that the buying power is going to fade away once the tax cuts run their course post-July. Now, consumer spending did rise a healthy 0.8% in nominal terms in May but fully 60% of that increase was absorbed by groceries, gasoline, utilities and transportation prices. Outside of that, the spending was centered in a select group of soft non-durables - the sort of things that you can stretch a $600 check towards: this included electronics, computers, hand tools, books and magazines, toys, sporting equipment, movies, which soared 25% in one month, restaurants, toiletries, and non-prescription drugs…As mentioned above, people also got caught up in their utility bills where payments surged 6%. And in a real sign of despair, a good chunk of the spending went into lotteries (+0.9%) and casino gambling (+3%). And, they must have been at the blackjack table all night because spending on hotel rooms actually declined 1.6%. In this sense, very little of the spending went into anything that would represent a long-term commitment to the economy - motor vehicles, home furnishings, major appliances, clothing and jewelry either lagged the overall spending gain or declined outright. My favorite indicator for travel plans is luggage sales, and in a month where after-tax income surged 5.3%, buying of suitcases and the like fell 0.4%.”
Reduced Credit Lines Pulling Down FICO Scores as Credit Gard Debt Grows Fast
From AP: “Just as Americans grow more reliant on credit cards to help pay monthly bills, they're being hit with a one-two punch: Card companies are reducing borrowing limits for tens of thousands of consumers, which then can lead to lower credit scores. Those facing this predicament might not even know it until they apply for a loan or another credit car, and then get denied because their credit score has dropped. This is an unintended consequence of the financial world's widespread ratcheting down of risk. Banks and other card lenders are trying to better protect themselves from more massive losses like those they've seen from subprime mortgages. As a result, they are looking for ways to reduce their exposure to cardholders more likely to default. That's why they are lowering credit limits, which means they are reducing the maximum amount of credit extended to an individual, along with boosting card interest rates and allowing fewer balance transfers…As the housing and mortgage markets have collapsed, lenders have also reduced the limits on what are known as home equity lines of credit, or HELOCs. Net home equity extraction fell nearly 60 percent from a year earlier to $205 billion in the first quarter, according to Merrill Lynch. The investment bank also notes that some $1.2 trillion in equity and housing wealth was wiped out in the first quarter alone because of plunging home values. At the same time, revolving credit usage – which includes credit cards – accelerated sharply to a year-over-year growth rate of about 8 percent in recent months. That's the fastest rate in seven years and well ahead of the 2 to 3 percent rate of growth from 2004 through 2006 when home equity lines of credit were a bigger source of cash for consumers, according to Merrill. But as credit cards are used more frequently, that often results in bigger balances left on the cards. What's worrisome is that consumers who are faced with a number of ugly economic scenarios hitting at once – falling home prices, surging commodities costs and a weak job outlook – won't be able to pay their bills….“Business conditions continue to weaken in the U.S. and so far this month we have seen credit indicators deteriorate beyond our expectations,” American Express' CEO Kenneth Chenault said in a statement. That's why card companies including Washington Mutual, HSBC and Wells Fargo are lowering their credit limits, according to data from the consulting firm Institutional Risk Analytics. Consumer advocates aren't saying that is bad news – in fact, they believe it helps prevent cardholders from overextending themselves and is preferred to having a sudden surge in card interest rates…A lower FICO score could make it more expensive for someone trying to borrow money. For instance, someone taking out a $25,000 36-month auto loan would see an interest rate of about 6.4 percent and a monthly payment of $765 if they were in the highest range of FICO scores of 720 to 850, according to Fair Isaac's Web site myFICO.com. That then jumps to an interest rate of 7.3 percent and a monthly payment of $776 for those with a score of 690 to 719 and as much as 15 percent or $866 a month for those with the lowest FICO range of 500 to 589. According to the Comptroller of the Currency, one of the government agencies that regulate U.S. banks, companies must notify cardholders at least 15 days in advance before making changes in the terms of their account, such as lowering the credit limit. But they don't have to explain how that could change an individual's credit score. That puts the burden on consumers to watch out for this. They better so they don't get blindsided.”
MISC
From Barron’s: "In the average bear market, the Dow Jones Industrial Average has fallen 30% and sometimes much, much more. The Dow decline of 2000 through 2003 involved a loss of 55%, the bear of '73-'74 caused a 50% loss and the 1929 market wiped out a full 85% of the Dow's value."
From Barron’s: “S&P500 investors are on the verge of experiencing something not seen for a very long time -- a losing decade. If markets continue their losing streak for a few more months, that is a realistic possibility. The S&P500 is now down 4.8% since June of 1999. To hit the decade mark, the SPX would need to be below the 1998 close of 1,229 -- less than 50 points below Friday's close of 1278.38 come December 31st. This has not occurred since the 1930s.”
From Barclays: “The aggressive sell-off in equities last week suggests the S&P500 is poised to retest its 2008 low, but oversold momentum implies the risk of a snap-back is growing. What is surprising is that the talk of a global slowdown and weaker equity markets is having no impact on commodities, which continue to surge higher. Most surprising of all, copper appears poised to retest its 2008 following the gains last week and the higher oil price. In some part, this could be explained by a weaker dollar but it suggests this is not going to be a straight forward week of trading. In FX markets, risk reduction is the theme with the carry trade under pressure…”
From UBS: “The BIS Annual Report came out earlier this morning and in that report the BIS warned that the unwind of the credit bubble could, after a period of temporary inflation, turn into a deflationary battle that would be hard for global central banks to fight.”
From Lehman: “We aren't going to see any refi driven prepayments for years.”
From PIMCO: “…gross private domestic investment (machines, houses, inventories) has declined by $200 billion since its peak in late 2006.”
From JPMorgan: “The growth/inflation trade-off is getting worse for developed economies. At the same time as inflation is reaching new highs in G3, the Euro area and Japanese economies are weakening into midyear, with the risks skewed to the downside to our already anaemic growth forecasts…How central banks will manage this mix of weakening growth and rising inflation remains unclear. Our calls anticipate a series of one-off moves by the ECB, the Fed and the BoE, but much will depend on exactly how the growth/inflation mix evolves over the next few months. The ECB is set to raise rates next week but it is far from certain what the Fed and the BoE will do. EM policy makers are facing a much more serious inflation problem, with signs of overheating and wage/price acceleration. Their reluctance to respond aggressively to the inflation threat now is eroding their credibility, raising the risk that they will have to move more abruptly next year, damaging their economies and local markets.”
From Lehman: “Stocks are as cheaply priced now as they were in 1974 or 1978, relative to 'risk-free' rates, which suggests that 'stagflation' is no longer viewed as a possibility, but a probability by equity investors.”
From Citi: “CDS spreads have been ticking up ominously in recent sessions as equities come under further pressure. The uptick has not been as dramatic as in previous bouts of 'risk aversion' but we are seeing movements in cross-JPY in FX space which is reminiscent of developments earlier in the year.”
From Merrill Lynch: “During the last week, NYMEX crude oil prices rose US$7.71 (+5.8%) to US$139.64/bbl. Natural gas prices rose US$0.24 (+1.9%) to US$13.11/mmbtu.”
From BMO: “The preliminary estimate for Eurozone CPI jumped 4.0% y/y in June, up 0.3 percentage points from May and the fastest increase since mid-1992.”
From JPMorgan: “…Russia which has become investors’ preferred country for commodity exposure. In contrast, Brazil continues to experience large outflows with $6bn withdrawn over the past month.”
From JPMorgan: “The bottom seems to have fallen out of the UK housing market this spring. UK mortgage purchase applications nosedived to 42,000 in May (consensus 51k), down almost 70% from the November 2006 peak. Recently, we downgraded our house price forecast to show a decline of 12%oya by the end of this year, but risks to this forecast are to the downside. Relatedly, UK consumer confidence declined in June to the lowest on record since the survey began in 1986.”
End-of-Day Market Update
From RBSGC: “Quarter-end, month-end, were the main constraints and motivations for lackluster trading Monday, which left yields little changed from Friday's robust closing levels, but the curve a tad flatter… Stocks managed a small bounce for an inside day. But if anything supported the interest rate market it was stocks -- selectively. Freddie and Fannie both lost about 6%, Lehman was off nearly 10%, but the headlines were merely about the price action itself vs. a new explanation for the price action. And weakness in these issues, the financials in general, are simply par for the course. We note that the S&P Banks and Brokerage indexes are now through their March lows… To underscore the subdued activity, volume amounted to 81% of average.”
From UBS: “Treasuries fell early from the overnight highs--dragged lower by the European debt markets--before grinding all the way back by the 3pm close… Swaps saw good interest in steepener trades, and swap spreads ended mixed on the day. Agencies saw large month-end extensions out of 1-year paper and into 2-3 year maturities. Agencies outperformed Libor by 2bps in the front end and stayed in line the rest of the way. Mortgages saw fast money short covering early in the morning, which pushed MBS 9 ticks tighter to Treasuries and 7 to swaps. Sellers then emerged at the tights and mortgages went back out to only 1 tighter against Treasuries and swaps. Despite the action, volume was fractions of the norm while liquidity was fleeting, at best. It seems summer has arrived.”
From Bloomberg: “Corn fell the maximum permitted by the Chicago Board of Trade and wheat dropped the most in 13 weeks after the government said U.S. farmers planted more of both crops than previously expected.”
From Bloomberg: “Most U.S. stocks fell for a third day, capping the market's worst month in six years, on concern that deepening mortgage losses will force more banks to cut dividends or sell shares at a discount. Wachovia Corp. tumbled to the lowest since 1992 after an analyst said the lender may cut its payout, while Merrill Lynch & Co. and Citigroup Inc. dropped as JPMorgan Chase & Co. said prices for some mortgage securities may sink further. Lehman Brothers Holdings Inc. plunged as traders speculated the fourth- largest U.S. securities firm may be sold for less than its market value. Devon Energy Corp. led gains in oil producers, which sent the Standard & Poor's 500 Index and Dow Jones Industrial Average higher, after analysts increased profit estimates through 2009. Three stocks dropped for every two that rose on the New York Stock Exchange. The S&P 500 increased 1.62 points, or 0.1 percent, to 1,280, paring its retreat this month to 8.6 percent. The Dow added 3.5 to 11,350.01. The Nasdaq Composite Index lost 22.65, or 1 percent, to 2,292.98… The Dow pared its monthly retreat to 10.2 percent, still the biggest June loss for the 30-stock gauge since 1930. The measure dropped 7.4 percent since the end of March for its third-straight quarterly slide, the longest stretch of declines since 1978. The S&P 500 slid 3.2 percent during the quarter, while the Nasdaq increased 0.6 percent… The Financial Select Sector SPDR Fund, a so-called exchange traded fund that tracks U.S. financial stocks, lost 1.5 percent to $20.26, the lowest since March 2003. The shares, known by their XLF ticker, were the second most-traded among stocks and ETFs in New York today… Newly delinquent homeowners outnumbered those who caught up on overdue payments for a 26th straight month in May, the Mortgage Insurance Companies of America, which tracks loans to people who put down less than 20 percent, said today. ``A lot of people are fearing with these financials, as we hear these second-quarter earnings, that there's going to be a lot more writedowns,''… More than $800 billion in announced buybacks last year helped the S&P 500 and Dow average climb to all-time highs in October. The pace has slowed as the U.S. housing slump spurred the longest steak of earnings declines for S&P 500 companies since 2002. U.S.
companies announced $197 billion in planned buybacks this year through June 26, 52 percent less than during the same period last year, according to Birinyi Associates Inc.”
Three month T-Bill yieldrose 7 bp to 1.73%.
Two year T-Note yield fell 1 bp to 2.62%
Ten year T-Note yield unchanged at 3.97%
Dow rose 3.5 points to 11,350
S&P 500 rose 1.5 to 1280
Dollar indexrose .16 to 72.52
Yen at 106.1 per dollar
Euro at 1.575
Gold fell $3 to $925
Oil fell $0.14 $140.1
*All prices as of 5:20 PM
Chicago PMI Unexpectedly Rises, But Mix Doesn't Look Sustainable
The Chicago Purchasing Manager's Index for June unexpectedly improved to 49.6 from 49.1 in May. The market had looked for a decline to 48. So, while the index remains in contractionary territory, it is near breakeven at 50. for comparison, the index averaged 54.4 in 2007. The weakening dollar is helping to keep export demand growing as the the domestic economy slows. The breakdown of the components doesn't look as strong as the headline. Declines were seen in production to 45.1 from 51.5, and new orders to 52 from 56.1, and order backlogs to 42.3 from 46.8. Improvement was seen in prices paid which eased down to 85.5 from 87.5. and employment which rose to 46.7 from 41.2. Inventories also rose to 50.5 from 42.2, suggesting slowing production in the future to work off excess supplies. The national ISM, due out tomorrow, is expected to remain weak.
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