US Economy Health Pulse

Jobless Claims Surging Higher

2008-11-13T08:26:00.000-08:00

Initial jobless claims leaped up by 32k, to reach the highest level since September 2001, climbing from a revised higher 484k to 516k. The less volatile 4-week moving average has risen to 491k, the highest sine 1991. Thirty -six states saw new claims rise last week.

Continuing claims jumped to the highest level since 1983, rising to 3.897 million from 3.832 million the prior week. It is important to point out that the labor fource is much larger now than it was 25 years ago, so the unemployment rate is lower than it was then. The unemployment rate among people eligible for benefits held steady at 2.9% versus the prior week.

Initial Jobless Claims

Continued Claims

Today's TIDBITS

2008-11-13T08:24:00.000-08:00

Home Price Declines

From JPMorgan: “Peak-to-current home price decline reached -25.49% in September. We maintain our projection of -35% peak-to-trough decline and expect to see a bottom in early 2010. Given the October-November meltdown in markets, risks to price declines of -40% or greater have increased substantially…California experienced the biggest price decline of -28.91% annualized in August. The 12-month decline was -29.85% and the drop from the peak is now at -39.87%. There is little evidence of a slowdown in California home price depreciation; the 1-month decline is more severe than the 12-month for a number of metro areas, including San Francisco and San Diego. Unprecedented levels of REO inventories and liquidations in the housing market are, at this point, only a question of when they will happen, not if. Applying our analysis of default timing, we project a rough total of 7 million defaults flooding the housing market,

with the volume peaking in 2010. We expect this large liquidation volume will cause the housing market to hover around the bottom for a number of months or even years, rather than take a strong bounce off the bottom.”

From Reuters: “…U.S. existing home sales indicate there are about 1 million extra homes that can’t be sold. Defaults and delinquencies for home loans continue to climb, adding to the 6.9 million foreclosures over the past three years.”

New Pension Rules Hitting Companies at a Bad Time

From Financial Week: “By the time Mr. Obama assumes office in January, scores of corporations will likely be burdened with significantly underfunded pension plans. And, just as major losses in the equity markets sucked assets out of pension plans over the past 10 months, relatively new pension rules have the potential to drain billions from corporations' coffers next year… employers could be on the hook for up to $150 billion in pension contributions in 2009—triple the $50 billion in contributions companies will make this year. “Companies have already been forced to tap into their cash this year for basic business purposes, like making payroll,” … “With eroding cash positions, and very little access to credit, companies will be forced to fund their pensions by cutting their operations and work forces—and that clearly was not the intention of these new funding requirements.” The new funding rules, which were included in the Pension Protection Act of 2006 and went into effect this year, require companies with underfunded plans to make larger, more aggressive contributions to quickly get their pensions 100% funded (the previous target was only 90%). There was also a provision to force companies to freeze their pension plans if funding levels fall below 60%. “That's the double whammy,” … “At the same time people could be losing their jobs because their companies are forced to make cutbacks, workers' retirements could be compromised too…contributions appear as if they could be significantly more than many companies were figuring earlier this year. Consulting firm Watson Wyatt gathered data from 28 corporate clients, who estimate that their aggregate required pension contributions will be $2.1 billion—181% higher than those companies had previously budgeted. “You can make a reasonable argument that these kinds of unexpected increases couldn't come at a worse time for corporations,””

Foreclosure and REO Update

From LEHC: “RealtyTrac today released its October 2008 U.S. Foreclosure Market Report today, which showed that foreclosure filings — default notices, auction sale notices and bank repossessions — were reported on 279,561 U.S. properties last month, a 5% increase from September and a 25% increase from October 2007. October’s monthly increase came despite an 18% drop in California related to recent legislative actions. REO properties acquired by lenders were up by 4.4% from September – despite a 24.6% decline in California – and up by 58.3% from a year ago. REO properties acquired ex California in October were up 26.6% from September, with the biggest absolute gains coming in Arizona, Florida, and Georgia. RealtyTrac reported that the top ten states in terms of foreclosure filings per household were Nevada, Arizona, Florida, California, Colorado, Georgia, Michigan, New Jersey, Illinois, and Ohio. The metro areas with the highest foreclosure filings per household were Las Vegas, Cape Coral-Fort Myers, Miami, Stockton, Merced, and Riverside-San Bernardino.

MISC

From JPMorgan: “Treasury purchases of mtges were $21.5bb in October … The $21.5bb number is more or less what we anticipated, so the mtge mkt has not really reacted to the news. I do think it's noteworthy that $21.5bb represents ~75% of net issuance for the month”

From CITI: “The amount of Treasury issuance necessary to fund the various governmental programs already announced, the 2009 budget deficit, and the additional fiscal stimulus is mind-boggling. The tremendous size of the anticipated increase in Treasury issuance begs the question: Can the existing Treasury investor base handle the huge uptick in Treasury supply without significant disruption? If not, then the market needs to consider and prepare for the consequences of this Treasury tsunami well in advance of its appearance.”

From Merrill Lynch: “Intraday today, the dividend yield on the S&P 500 was higher than the 10-year T-Note yield (3.74% vs. 3.71%). By our reckoning, this is the first time the S&P 500's dividend yield has been higher than the 10-year T-Note yield since 1958.”

From Deutsche Bank: “The rise in this series [continuing claims] tells us that once workers are laid off, they are having tremendous difficulty obtaining employment. This does not bode well for future income prospects and is one reason why we are projecting an unprecedented slowdown in consumer spending in this cycle compared to the post-WWII period.”

From The Financial Times: “Writedowns by Fannie Mae, the US mortgage financier that was nationalised this year and AIG, the insurer that has twice been bailed out by the US government, have lifted total losses reported by financial institutions since the beginning of 2007 to $918bn, according to data compiled by Bloomberg.”

From CITI: “The next shoe to drop are the insurance companies- look for them to clamor for conservatorship. Why? They are the biggest holders of bad assets and cannot become bank holding companies to get government protection.”

From Reuters: “Credit losses from the financial crisis may exceed even dire estimates of $1.4 trillion, or more than 10% of U.S. economic output, according to the chief strategist of research firm CreditSights.”

From Bank of America: “A commodity-led fall in inflation ought to be good news for rich economies. It boosts consumers' real incomes and fattens firms' profit margins. Yet there is something pernicious about inflation falling too far, too fast. Because falling prices make debt more expensive, indebted households would be more anxious to pay off loans, even as other consumers were benefiting from a boost to their purchasing power. If deflation took hold, the gap in demand left by those fleeing debt would not be filled by cash-rich consumers, who tend to be less free-spending.”

From Bloomberg: “JPMorgan Chase & Co., Bank of America Corp. and Goldman Sachs Group Inc. are among banks that told the government its program to back their bonds is flawed because it doesn't have a strong enough guarantee. The Federal Deposit Insurance Corp. guarantee for repayments in default needs to be clearer, fees are too high and banks need more freedom on whether to opt in, according to a letter from law firm Sullivan & Cromwell LLP posted on the agency's Web site on behalf of nine banks. The comment period on the interim rules for the FDIC's Temporary Liquidity Guarantee Program ends today. The comments shed light on why almost a month after the government placed its guarantee behind new bank bonds, no U.S. company has yet tested the market.”

From CNN: “The head of the Senate Banking Committee Thursday said banks receiving money as part of the $700 billion federal bailout must step up their lending to consumers and businesses. Banks are failing to use public funds to make credit more available and to help troubled homeowners, said Sen. Christopher Dodd, D-Conn. Congress did not pass the bailout plan so banks could hoard the money or use it to scoop up faltering rivals, he said. "We want to see more progress from our friends in the financial sector -- more progress in foreclosure mitigation, in affordable lending, and in curbing excessive compensation," Dodd said. "And if that progress is not forthcoming, we are prepared to legislate." Lawmakers on both sides of the aisle have been critical of the Treasury Department's implementation of the bailout of the financial sector.”

From Bloomberg: “President George W. Bush today urged leaders of the world's biggest economies not to abandon free- market capitalism as they seek an escape from the financial crisis, calling it the ``best system'' for delivering growth…Bush said policy makers should resist the urge to meddle too much in markets as they seek to reverse the financial and economic turmoil now engulfing the world. ``History has shown that the greater threat to economic prosperity is not too little government involvement in the market, but too much,'' Bush said. ``Our aim should not be more government, it should be smarter government.''”

From Barclays: “Commercial paper outstanding rose just $2.9bn in the week ending

November 12 after surging $150bn over the prior two weeks, suggesting that the demand for funding through the Fed's commercial paper funding facility (CPFF) waned in the near term. Financial CP actually fell $15.7bn and was more than offset by a $9.2bn increase in asset-backed paper and a $9.4bn rise in non-financial CP. Yields moved lower across most types and terms of CP over the week, as did spreads over effective fed funds. The week's results may suggest that some of the pent-up demand for term funding through the CPFF has eased and outstanding CP will increase more incrementally.”

End of Day

From Bloomberg: “U.S. stocks staged a late-day rally to climb the most in two weeks as investors snapped up the cheapest energy shares on record and real-estate companies

gained after CB Richard Ellis Inc. raised cash in a share sale. Exxon Mobil Corp. and Chevron Corp. led gains in all 40 energy producers in the Standard & Poor's 500 Index and helped the Dow Jones Industrial Average rebound from a 317-point drop. CB Richard Ellis, the world's largest provider of commercial real-estate services, surged 43 percent for its steepest advance since going public in 2004. Declines in midday trading today pushed the S&P 500 to 35 percent below its average for the past 200 days, only the second time that's happened since the Great Depression. The last time was a day before the index rose 12 percent on Oct. 13, the biggest rally since 1939. ``Bottom line, stocks are incredibly cheap,'' … ``Volatility accelerates when markets reach bottoms…The S&P 500 added 6.9 percent to 911.29, reversing a slide of 3.9 percent. The Dow increased 552.59 points, or 6.7 percent, to 8,835.25. The Nasdaq Composite Index jumped 6.5 percent to 1,596.7. More than 14 stocks rose for each that fell on the New York Stock Exchange, where almost 2 billion shares changed hands in the busiest trading session since Oct. 16. The S&P 500 swung between gains and losses at least 38 times, including a drop that sent the benchmark index to its lowest level since the Iraq War broke out 5 ½ years ago. Europe's benchmark index fell 0.6 percent, led by banks and commodity producers, as Germany sank into recession and the OECD forecast a global economic slump. Asia's regional benchmark slid 4.8 percent after Commonwealth Bank of Australia said bad debts may double and China's industrial output missed estimates. The MSCI Emerging Markets Index lost 1.3 percent, extending its three-day slide to almost 10 percent.”

From RBSGC: “Treasuries ended the day lower with a decidedly steeper curve. The 30-year sector was appropriately weighed on by the 9.5 bp tail for the 30-year Reopening auction -- this also dragged the rest of the long-end lower. The front-end and belly carried a solid bid throughout much of the session -- owing primarily to the attempts of the stock market to crack lower. In the end however, stocks caught a bid -- firming off the lows and the strength reversed the flight-to-quality support for 2s and 5s.”

From UBS: “Full Moon Doesn't Disappoint…UST 2-year notes traded at a cycle low today of 1.136%, a mere 8 bps off the generational lows of 1.056% seen on June 13, 2003. Yields rose over the course of the afternoon as the equity market got its footing and rallied after it, too, set new lows for the move. The high and low point of the day occurred coincident with the 1:00 hour. Conspiracy theorists might draw some conclusions from the fact that stocks started their last swoon down around 12:45 and then touched bottom just as the bids were due for the $10B UST 30- year auction. The auction was sloppy for the Treasury, but a Dutch treat for the bidders. The issue tailed 9 bps from the 1:00 yield (1 18/32nds), with a cover of 2.07x, a stop of 4.31% (83.20%), and 18.2% indirect bidders. The long dated supply combined with the nice bounce in equities facilitated a steepening of the US2Y10Y curve by 11 bps to 260 bps. The CRB was +2.19 to 27.63. Oil rallied $2.91 and settled at $59.94/bbl. Stocks had an interesting trade with a new low and a solid price move higher, closing near the day's highs +553 to 8.835. Treasury volume was at the 30 day moving average, the first time this has occurred since September 19th…. The Trade Deficit was less than the number used by Commerce in its Advance Q3 GDP report, so our running revision of GDP is now -0.7% from the original -0.3% … Spreads a Sideshow to Equities and the Auction: Spreads were unsettled today as the market continued to digest the fact that Paulson was no longer planning to use the TARP to bid for distressed assets. The reality is that the idea was too complicated to structure and implement with only about two months of holiday abbreviated time until the Obama team takes over. Why saddle the new administration with a complicated and untested concept… Intraday the 10- year spreads hit a cycle low of 26.75 bps. Vol traded higher in line with the rate and spread moves to cycle lows. The correlation with the steepening curve remains intact. The VIX did not set a new high as the stock market plumbed new lows. Another divergence which we have noted (along with the RSI).”

Prices as of 4:45PM (Based on Bloomberg)

Three month T-Bill yield rose 5 bp to 0.19%

Two year T-Note rose 8 bp to 1.24%

Ten year T-Note yield rose 14 bp to 3.87%

30-year FNMA current coupon rose 13 bp to 5.59%

Dow rose 553 points to 8835

S&P rose 59 points to 911

Dollar index fell 0.53 points to 86.94

Yen at 97.7

Euro at 1.28

Gold rose $24 to $736

Oil rose $3.25 to $59.4

S&P Trading Today

Today's TIDBITS

2008-11-12T08:21:00.000-08:00

Comments on Mortgage Bail-Out Plans

From Bloomberg: “U.S. Treasury Secretary Henry Paulson plans to use the second half of the $700 billion financial rescue program to help relieve pressures on consumer credit, scrapping an effort to buy devalued mortgage assets. ``Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards,'' … ``This is creating a heavy burden on the American people and reducing the number of jobs in our economy.'' Paulson's remarks are an acknowledgement that the pitch he

made to Congress for the bailout hasn't delivered what was promised. Paulson sold the rescue plan as a way to rid bank balance sheets of illiquid mortgage assets, and he may encounter resistance from Congress for the remaining $350 billion in TARP funds after using most of the first half to buy bank stakes.”

From RBSGC: “Paulson has abandoned buying troubled mortgage assets under TARP. Exactly who gave him the right to change the plan? We don't doubt there are compelling reasons Treasury has changed course -- injecting capital rather than simply buying assets -- but if you were in Congress you might feel a bit duped that the approved half of the $700 bn bailout wasn't used for what you voted for. And you might be a bit more cautious in approving the second half. We're probably missing a point and obviously(?) Paulson had absolute authority to do with the money as he pleased. Indeed in this environment the extreme and untested becomes the norm, so this may be why the market took his decision in stride ("headline fatigue" according to one friend). Still, something doesn't sit well…”

From FTN: “The White House has a new plan to modify mortgages using Fannie and Freddie. Some mortgages will be modified so that payments are no bigger than 38% of income. Participation by mortgage holders in the plan will be voluntary, as Treasury is unwilling to violate the contracts under which mortgages were bundled and sold. Loan servicers would be paid $800 for every modified loan to cover administrative costs. The program will be open only to borrowers who owe more than 90% of the value of their house, who are not in bankruptcy and who are 90 days behind. These are similar to the HOPE for Homeowners plan, which to date has helped only a handful of people…the positive market reaction to the announcement may be misplaced, not only because it is near-impossible to construct an effective bailout for homeowners without encouraging new foreclosures and undermining mortgage contracts, but also because house prices are not going to rebound even when foreclosures stop. Much of the house price appreciation during the boom was speculative and will not return. The announcement was met with immediate criticism from FDIC head Sheila Bair, who said the plan does not go far enough. Bair is said to be on Obama’s shortlist for Treasury Secretary, in part because she has pushed the Bush White House to be more generous with loan modifications. Bair wants to use $40 billion of TARP money to refinance homeowners into cheaper loans. The Treasury is opposed to the idea, because it would encourage more foreclosures. Barney Frank wants to rewrite loan contracts to make modifications easier. Others think bankruptcy judges should be allowed to forgive a portion of mortgage principal and modify mortgage rates. Treasury warns that these changes would boost mortgage rates on all new loans, because they undermine the collateralization of loans. A semi-collateralized mortgage loan would presumably be financed at a rate closer to the rates for uncollateralized debt, like credit cards.”

From Deutsche Bank: “The FHFA Loan Modification program aims to change the payment through 3 ways - reducing the interest rate, extending the life of the loan or deferring principal payments. While previous agency loss mitigation methods were focused on not having to buy loans out of MBS, under conservatorship capital issues are minimal. While details are not completely clear, the loan mods may require loans being bought out of MBS, and could increase prepayments. The expected implementation date of Dec 15th implies that changes could be imminent. Note that Freddie Mac estimates a 60% workout possibility for troubled borrowers, so the impact is likely to be large. We estimate that Fannie Mae's existing Homesaver program (which involved loss mitigation without having to buy out loans) was responsible for about $12 bn workouts for Q308. Prepayments totaled $40.6 bn for fixed rate mortgages; troubled loans are thus significant in size. Moreover the total increase in non performing loans was about $18 bn, so the workouts appear to be a significant portion of this figure.”

Expect More Discussion than Resolution of Financial Woes at G20 Meeting

From AP: “World leaders are heading for a clash of expectations at this weekend's summit on the global economic crisis. Europeans are looking urgently for broad changes and tighter universal banking regulations…President-elect Obama, the leader who soon will assume the job of trying to keep the U.S. economy from capsizing, won't even be at the table. Saturday's 20-nation gathering will include leaders of the Group of Eight big industrial democracies - the U.S., Japan, Germany, France, Britain, Russia, Canada and Italy - as well as other major economies, including China, India, Brazil, Saudi Arabia and Australia….Bush convened the emergency session after receiving heavy pressure from Sarkozy …It is to be the first of a series of such gatherings to map out a coordinated response to the world's worst financial crisis in decades, one that began with losses in U.S. housing markets and quickly spread overseas…The summit offers Bush what may be a last chance on the world stage to move beyond a legacy of war emergencies and bank bailouts by helping to launch what he called a possible new framework for "democratic capitalism." But he warned that it should not come at the expense of "free markets, free enterprise and free trade."…"I'm not sure that even an Obama team wants to see the United States' style and method of capitalism and financial markets converted. We value our flexibility here, and I don't think we're willing to capitulate to as much regulation as the Europeans are suggesting, particularly the French." Stakes are high for the summit, even if chances for real progress are tenuous. With international investors already spooked, any perceived failure at the summit could send world markets tumbling anew… Obama is interested in the meeting and thinks it is a good idea. But…"there's only one president at a time, and we will stay up to date and briefed on what's going on but will not be a participant." That also keeps Obama from being tarnished by a less-than-successful summit or from having a hand in proposed solutions that don't pan out.”

From Bloomberg: “President-elect Barack Obama named former Secretary of State Madeleine Albright and former Republican Representative Jim Leach as his emissaries at the international economic summit in Washington. Albright and Leach will be available for unofficial meetings with representatives of industrial and emerging countries who

will be at the summit …The meeting is being held to coordinate government responses

to the worst financial crisis in 80 years. European leaders including French President Nicolas Sarkozy and British Prime Minister Gordon Brown have called for restructuring the international regulatory system to deal with the credit crisis. They will consider steps ranging from raising bank-capital standards to regulating hedge funds…the Bush

administration views the Obama team's participation appropriate and welcome.”

From Nikkei: “Japan is willing to tap its foreign exchange reserves to provide … yen to the International Monetary Fund in order to help the organization boost emergency loans to emerging countriesime Minister Taro Aso is to make the proposal at the global financial summit that will take place between leaders of the Group of 20 industrialized and emerging nations starting Friday in Washington…Japan hopes to contribute to stabilizing the global economy by supporting aggressive lending by the IMF. Under the draft proposal, Japan will offer to lend part of its foreign exchange reserves of 980 billion dollars…so that the IMF can smoothly procure money should it experience a shortage of funds. Although the amount is still undecided, the maximum is expected to be about 10% of Japan's foreign exchange reserves. At the summit meeting, Japan plans to call on other countries with ample foreign exchange reserves, such as China and Middle Eastern oil-producing nations, to provide funds as well.”

CFTC Chairman Proposes New Regulatory System

From AP: “The head of the federal agency that oversees commodities trading wants to replace it and the Securities and Exchange Commission with three new regulators to better deal with an increasingly complex financial system. "I believe the United States should scrap the current outdated regulatory framework in favor of an objectives-based regulatory system consisting of three primary authorities: a new systemic risk regulator, a new market integrity regulator and a new investor protection regulator," said Walter Lukken, acting chairman of the Commodity Futures Trading Commission. The CFTC oversees futures and options trading in commodities, including oil, natural gas and agricultural products…The new systemic risk regulator "would have the responsibility of policing the entirety of the financial system for 'black swan' risks" and would take preventive action in those cases, he said…. the House and Senate may form a special joint committee to draft the most sweeping changes to the financial regulatory system since the 1930s….unregulated corners of the industry, such as hedge funds and derivatives, could be subject to federal regulation for the first time. So could insurance companies, which are now supervised only at the state level. Industry lobbyists are seeking to use the overhaul to streamline what they see as overlapping regulators that operate on outdated distinctions among commercial banks, thrifts and investment banks….Under that plan, the Federal Reserve would take on the unwieldy role of ultimate cop in charge of financial market stability. Other agencies, such as the market watchdog SEC and the CFTC, would see their influence diminished. Some experts have expressed concern about concentrating too much power at the Federal Reserve while also streamlining or consolidating the duties of other regulators, saying that a safety net of checks and balances could be lost. Lukken said that under his scheme the new market integrity regulator would oversee the safety and soundness of key financial institutions, including exchanges, investment firms and commercial banks, while the new investor protection regulator would oversee business conduct across all firms in the marketplace.

Such a setup would focus on financial risks at all levels and would be "a radical departure" from the current regulatory structure, he said.”

China Focusing on Domestic Economy

From AP: “Preparing for a Washington summit to discuss a response to the global financial crisis, China indicated Tuesday its focus will be its own economy - not paying to bail out others…Beijing made the outlines of its strategy clear with the announcement of a multibillion-dollar package to stimulate its economy with more spending on construction, tax cuts and social programs, with no mention of efforts abroad… a Chinese Foreign Ministry spokesman said Beijing's priority is to "put our own house in order" and ensure domestic stability. "I believe this is the most effective contribution China can make to tackling this financial crisis. It will help to maintain the sound and steady development of the world economy," …Beijing was ready to make "concerted efforts" with other governments but gave no indication what that would include…the government says its resources are limited and it has to focus on domestic economic challenges.

Chinese leaders are alarmed at a sharp drop in economic growth, which fell to 9 percent in the most recent quarter. That is the highest for any major economy, but below last year's 11.9 percent and dangerously slow for a government that needs robust growth to satisfy a public that has come to expect steadily rising incomes. On Tuesday, the government's challenges were highlighted by the release of trade data that showed growth in foreign sales fell in October, adding to damage for struggling exporters that already are suffering from weak foreign demand. China's global trade surplus rose to a new monthly high of $35.2 billion but that masked a slowdown in export growth. Exports rose 19.1 percent - down sharply from July's 26.9 percent before the slowdown hit in earnest. Import growth also fell sharply, reflecting weakening domestic demand. The politically sensitive trade gap with the United States widened by 13.6 percent to $17.5 billion, according to the national customs agency. But its figures showed the global surplus for the first 10 months of the year is only about 1 percent bigger than for the same period last year. A downturn in export orders already has led to layoffs and factory closures….The government has tried to reduce China's reliance on exports by encouraging its own consumers to spend more. Retail sales are growing at annual rates of more than 20 percent but are still small as a share of the economy. Exporters and the companies that supply them employ tens of millions of people. Weaker demand for Chinese goods is expected to cause economic ripples to spread worldwide as China's manufacturers buy less imported factory machinery, industrial components and raw materials such as steel made with foreign iron ore. In a positive sign, the government reported Tuesday that October's inflation rate eased to 4 percent, down from September's 4.3 percent. That will ease the risk of new price rises as Beijing tries to boost growth by pouring money into the economy. The 4 trillion yuan ($586 billion) stimulus plan includes higher government spending on airports, highways and other projects, tax cuts for exporters and more aid to farmers and the poor. … The government has promised more bank lending for small businesses and consumers.”

From CITI: “At least the Chinese consumer doesn't appear to be slowing faster than expected. On the assumption that the data is accurate, the latest retail sales data show a 'slowing' in the annual pace of sales to 22% YoY in October from 23.2% in September. Note that this data was recorded before the recent announcement of the latest fiscal package.”

From MNI: “Actual foreign direct investment (FDI) in China in the first 10 months totaled 81.096 bln usd, up 35.06 pct year-on-year, the commerce ministry said.”

From Barclays: “…China is predominantly an importer of grains (and was a net importer of all agricultural commodities in September’s trade data)..”

From Euro Pacific Capital: “Asian markets were initially energized by China's announcement of a near $600 billion economic stimulus package for its own economy. Although I have never been a fan of government-fueled stimuli, the relative wisdom of the plan hinges on the source of funds the Chinese government decides to utilize. Their best choice would be the country's nearly $2 trillion in foreign reserves, the largest portion of which is held in U.S. Treasury and agency debt. This pile of dollars, which really amounts to no more than a subsidy for U.S. consumers, does nothing to benefit Chinese citizens. If it does decide to employ this ocean of cash, China will become a net seller of U.S Treasuries just as the U.S. Government itself will be pushing up its issuance of new Treasury bonds into record territory. With two huge sellers and few major buyers (just about every major creditor nation having problems of their own), the Federal Reserve will become the only reliable customer. As a result, not only will the Fed monetize our own economic stimulus packages, but will be forced to provide the same service to the Chinese. Most economists feel that China will maintain the status quo by borrowing or printing the funds for their own stimulus while continuing to hoard its trillions of existing U.S. dollars. Most also believe that the Chinese will substantially increase their dollar holdings in order to finance America's never-ending string of bailouts and its ballooning Federal deficit, which is soon to pass $1 trillion annually. These optimists are in for a rude awakening. The Chinese cannot follow such a course without unleashing intolerable inflation at home. Selling down their vast reserves of U.S. debt and using the proceeds for domestic infrastructure projects (or anything else for that matter) is a vastly superior stimulus mechanism than "lending" to Americans so we keep "buying" their products. When Chinese authorities finally figure this out the United States will suffer the consequences.”

Politics and Stocks

From Merrill Lynch: “…the stock market tends to perform slightly better under Democratic administrations than under Republican administrations. They examined the record back to 1932, and found that the stock market appreciates roughly 47% during the four years of a Democratic President (or about 10.1% per year) versus about 29% during a Republican President’s four-year tenure (about 6.6% annually). The calculations include President Bush’s current term to date… The time period used in a study can affect the absolute returns cited above, but all findings seem to support the notion that the stock market performs better under Democratic Presidents than under Republican ones. For example, Brian Belski (Chief US Sector Strategist) looked at performance back to 1921 and found that the S&P 500 rose 8.9% under a Democratic President versus only

3.8% under Republican leadership. Brian points out that the performance spread in the year after an inauguration is particularly dramatic. The S&P 500 historically rose about 21% during the 12 months after the inauguration of a Democratic President versus -6.4% during the first year of a Republican Presidency.”

MISC

From Bloomberg: “Harvard’s Feldstein…says “we’re just at the beginning” of U.S. recession…sees U.S. unemployment rate going to 8% or higher…”

From S&P: “Standard & Poor's Ratings Services is evaluating whether the guarantees of qualifying debt of U.S. banks, thrifts, and their holding companies under the Federal Deposit Insurance Corp. (FDIC) Temporary Liquidity Guarantee Program (TLGP) should be seen as equivalent to a rating substitution, which would permit us to rate the debt at the 'AAA' rating of the U.S. government… it is uncertain whether the FDIC's payment of interest and principal under its guarantee would have to be made on a timely basis… although the FDIC guarantees the ultimate repayment of guaranteed debt, there appears to be a potential for a significant delay in payment beyond the terms specified in the debt, even though ultimate repayment is expected. Accordingly, in our view, the program would result in, at most, limited rating elevation for guaranteed obligations. Unless the current proposal is amended to provide a guarantee of timely payment of interest and principal, we would be unable to rate the debt of financial institutions qualifying for the FDIC guarantees at the 'AAA' rating of the U.S. government.”

From FTN: “American Express, which was granted Bank holding Company status over the weekend, has requested $3.5bn in capital from TARP. But TARP itself may need some help. CNBC this morning was talking about “a rescue plan for the rescue plan.” Paulson says he wants to use $250bn for bank capital infusions and the rest for buying mortgages. But Treasury is burning through that first $250bn faster than expected, and some economists expect as much as $450bn in further capital losses. $250 billion may not be enough. Treasury may be addressing that reality in its latest TARP-related announcement that new applicants for capital may have to bring private-sector matching funds to the table. This would stretch the TARP capital further. Also, Neel Kashkari, who oversees the TARP program, apparently used his entire 30 minute time slot at SIFMA’s TARP conference to talk about the bank capital plan. When asked about using TARP to buy mortgages, he said it was up to Secretary Paulson if and when TARP would be used to buy securities.”

From Bloomberg: “General Electric Co. said the U.S. government agreed to insure as much as $139 billion in debt for lending arm GE Capital Corp., the second time in a month it has turned to a federal program designed to help companies during a global credit crunch. Granting GE Capital, which isn’t a bank, access to a new Federal Deposit Insurance Corp. program may reassure investors and help the unit compete with banks that already have government protection behind their debt…”

From Barclays: “It was just a month ago that global stock markets ended one of the worst weeks in history. On 10 October, the S&P500 ended the week at 899, while yesterday it closed at 898, unchanged over the month but with wild swings of ±10% in the interim. The initial stages of financial market stabilisation appear to be materialising. However investors remain extremely risk averse. Our equity risk indicator suggests that sentiment remains exceptionally weak with the probability of an equity market sell-off standing at 82%, little changed from the previous month's 81… investors remain sceptical after the raft of financial support packages, it seems that the next phase will require clarity over global fiscal packages before sentiment can improve enough to provide a floor for equities.“

From BMO: “With nearly 90% of S&P 500 companies reporting Q3 earnings, results are on pace for a 17% y/y drop, marking the fifth consecutive quarter of declining year-over-year earnings—that matches the length of the 2001 earnings recession.”

From The Financial Times: “The global economy is entering a slowdown of epic proportions comparable with the period after the 1929 crash, John Thain, chairman and chief executive of Merrill Lynch, warned on Tuesday…Mr Thain also said the economic problems afflicting the US, where housing prices and other asset values were falling, would wreak havoc across the world. “There is no such thing as decoupling,” he said, referring to the popular theory that emerging markets could sustain reasonable growth even while the world’s leading economies suffered recessions. “All equity markets are linked. Each individual economy will be more or less affected, depending on reliance on global trade and commerce.””

From CITI: “More recession signs in the data this morning, even if it was broadly as expected. Euro area industrial production fell -1.6%mom in Sept (cons -1.8%) while UK unemployment rose again in October (+36.5k) at a similar pace to September (+36.3k) but marginally less than the consensus expectations of 40k. Separately, Spanish inflation fell as expected to 3.6% YoY in October from 4.5%, reinforcing our view that euro area inflation in on course to return to target relatively quickly.”

From Merrill Lynch: “Not only are holiday shoppers telling pollsters they will be spending less this season, but they also intend to be spending their hard-earned cash on more practical items such as clothing rather than pricey discretionary items such as

iPods and Xbox, according to a report in this week's BusinessWeek. Some parents are going one step further to the practical side and giving savings bonds.”

From Merrill Lynch: “Container traffic at US ports is on track to shrink 7.1% in 2008, to the lowest since 2004, according to Port Tracker. This is a scaled back estimate from last month and is driven by a vastly more pessimistic retail sales outlook into year end.”

From Merrill Lynch: “In a strange turn of events, National Wholesale Liquidators, a company that specialized in purchasing odd-lots of brand name manufacturers, filed for

bankruptcy protection -- a company that should be benefiting from the US consumers’ trend towards getting small. If a company that specializes moving in severely discounted merchandise cannot make it in this tight retail market, it bodes very ill for full-price retailers, in our opinion.”

From FTN: “Pressure is mounting for an auto bailout…Pelosi wants to use TARP money, but a second, stand-alone bailout plan may be drawn up instead. Critics say the Big Three should be allowed to go into bankruptcy, which would free them from pension and healthcare liabilities. But Obama and Pelosi, both friends of the UAW, are opposed to any solution that would hurt auto workers. If the Big Three were to close their doors outright, it would cost as many as 1 million auto workers and auto parts workers their jobs, taking the unemployment rate to 9.5% or so. But freeing the companies from their pension and healthcare obligations would immediately level the playing field with other car makers.”

From The Financial Times: “Harvard, the world's wealthiest university, is considering spending cuts in the face of possible "unprecedented" losses to its endowment earnings…."We must recognise that Harvard is not invulnerable to the seismic financial shocks in the larger world," Ms Faust wrote. "Our own economic landscape has been significantly altered."…Harvard's endowment before the economic crisis was nearly $37bn....Ms Faust did not say exactly how much the endowment had lost recently, but she cited a Moody's projection of a 30 per cent drop in the value of college and university endowments this fiscal year. For Harvard, that would translate to an $11bn loss.”

From Merrill Lynch: “The need for substantial fiscal stimulus on top of monetary and financial stimulus has some investors worried about inflation. They have suggested that the US is “printing money” and, as a result, inflation is on the horizon. A basic economic rule of thumb is that money growth alone is unlikely to fuel inflation. The fuel for inflation is the combination of monetary growth and credit growth. Right now, credit growth is dormant even though the monetary aggregates are expanding. That suggests to us that, despite the notion that the US is “printing money,” portfolios should be structured for deflation rather than inflation.”

From SunTrust: “Emerging market currencies like the Indian rupee, Turkish lira, and South Korean won all closed lower today. The 2.4% drop in the rupee was the largest single day drop since 1996. The South Korean won fell over 2% as job growth data was worse than expected. Reports also showed that Asia’s fourth largest economy will grow only 3.1% next year, down from 4.2% this year.”

End-of-Day Market Update

From SunTrust: “Markets are suffering from bailout fatigue. American Express received approval to become a bank holding company and is asking for $3.5 bln from TARP. The auto-makers are walking through Congress passing around a tin cup. Equities are wallowing in a sea of uncertainty. The Dow has lost 1,200 points since election day (-13%). Markets are looking for some clarity on who will fill key positions in the new administration. Meanwhile, the Treasury market, instead of backing up due to increased issuance, continues to press higher in price, lower in yield. The t-bill market is at nosebleed levels, worse than anytime in the crisis so far. Inside 90 days, all issues are in single digits. The 2 yr note yields 1.17. The newly auctioned 3-yr note is trading at an 18 bp profit vs Monday's auction. The new 10-yr was not outstanding, but a decent auction, considering its size. The note came at 3.783 with good indirect bidder participation of 36%. Financial shares are hurting again today. Citi is trading below $10. Goldman is off another 10% today, 30% since election day.”

From CITI: “NO TRADITIONAL PLAYERS (PENSION FUND, REAL MONEY) SEEM ALL THAT EXCITED TO BUY A 4-4.25% BOND. REGARDING PAULSON COMMENTS, THE IMMEDIATE REACTION WAS THAT THIS IS BAD FOR BANK EARNINGS- LITTLE DID WE KNOW IT WOULD MEAN A 10% DOWNMOVE IN MOST FINANCIALS TODAY OR -35% FOR THE MONTH OF NOV FOR MOST PLAYERS (EX-JPM). CDS IS STABLE AS THE GENERAL FEEL IS THAT BANKS WILL GET THE CAPITAL NECESSARY TO STAY ALIVE BUT IT WILL TAKE A LONG TIME TO BECOME PROFITABLE AGAIN. IN OTHER WORDS, "ELIMINATION OF SYSTEMIC TAIL RISK". OVERALL, IN THE BIGGER PICTURE, IT SEEMS LIKE THE TREASURY'S ACTIONS ARE A TRAIL OF UNINTENDED CONSEQUENCES; (1) THE TARP. PAULSON STATEMENT TODAY SAYING THAT THEY WILL NOT BUY THE REAL BAD ASSETS ON BANKS BALANCE SHEETS THROUGH THE TARP MEANS THAT EQUITY STAKES IN FINANCIALS ARE GETTING CREAMED, WHILE THEIR CDS IS HOLDING AS IT IS NOW A CAPITAL-INJECTION PROGRAM AND NOT AN ASSET-PURCHASE ONE (EXPLAINED ABOVE). (2) INSURING BANKS. 3YR FDIC GUARANTEE ON BANK DEBT CRUSHED AGENCY DEBT VALUES WHICH HAVE ONLY BEEN SAVED BY THE THOUGHTS OF MORE EXPLICIT GUARANTEES OF THE GOVERNMENT (3) TAF AND TSLF TRULY MADE THE FED THE LENDER OF LAST RESORT. THIS HAS CAUSED FINANCIAL INSTITUTIONS TO GO TO THE GOVT AND NOT TRADE WITH EACH OTHER. WHY IS LIBOR LOWER? FED FUNDS ARE EFFECTIVELY ZERO AND YOU CAN MAKE THE ARGUMENT THAT WHAT DROVE IT HIGHER IS THE EXACT THING THAT DROVE IT LOWER. NO VOLUME AND A SUSPECT SURVEY SYSTEM.”

From Bloomberg: “U.S. stocks fell for a third day as Best Buy Co.'s warning of a ``seismic'' slowdown in spending and the Treasury's plan to use bailout funds to bolster consumer credit stoked concern the economic slump is deepening… The Standard & Poor's 500 Financials Index slid to a 12-year low as the Treasury scrapped plans to buy mortgage assets and shifted focus to consumer credit….Best Buy's forecast cut is ``a further sign of the retrenchment of the consumer and spending that's slowing very, very rapidly across the board.'' The S&P 500 fell 5.2 percent to 852.32 and lost 8.5 percent

over the past three days. The Dow Jones Industrial Average retreated 410.67 points, or 4.7 percent, to 8,283.29. The Nasdaq Composite Index lost 5.2 percent to 1,499.21, a five-year low. Almost 23 stocks fell for each that rose on the New York Stock Exchange. The S&P 500 is less than 0.5 percent above its lowest close in five years. The measure reached that level, 848.92, on Oct. 27 and rallied 18 percent in the following six days. Most of those gains have now been erased as companies from Blackstone Group Inc. to News Corp. reported weaker earnings and commodity prices tumbled. The stock benchmark is down 45 percent from its October 2007 record. The index is ``almost certain'' to revisit its October low, according to JPMorgan Chase & Co. strategist Thomas

J. Lee, who said such ``retests'' occurred in 86 percent of the bear markets since 1900… Energy companies in the S&P 500 lost 7.2 percent as a group, while raw-material producers declined 6.3 percent collectively. Oil sank 5.3 percent to $56.16 a barrel … amid decreased energy demand.”

Prices as of 4:30PM (Based on Bloomberg)

Three month T-Bill yield fell 27 bp to 0.15%

Two year T-Note yield fell 9 bp to 1.15%

Ten year T-Note yield fell 9 bp to 3.65%

30-year FNMA current coupon fell 16 bp to 5.44%

Dow fell 411 points to 8283

S&P fell 47 points to 852

Dollar index rose 0.40 points to 87.47

Yen at 94.9

Euro at 1.25

Gold fell $19 to $713

Oil fell $3.60 to $55.75

Consumer Credit Grew +3.2% annualized in September after falling at -2.9% annualized pace in August

2008-11-07T22:56:00.000-08:00

After a record drop in August (revised to $-6.3B from -$7.9B originally reported), consumer borrowing rebounded in September, rising by +$6.9B (consensus was for no increase). For the third quarter as a whole, consumer credit rose +1.25% annualized, with revolving credit growing at a 2.5% annualized pace, and non-revolving credit rising at a more restrained +0.5% annualized rate for the quarter.

Non-Revolving credit rose $5.9B in September, after falling -$6.6B the prior month. This is in spite of the decline in auto sales (-27% YoY in September), and a rise in car loan interest rates of over 100bp from the prior month, increasing from 5.11% to 6.24%. Revolving debt, also known as credit card borrowing, rose by $1B in September, after rising +$0.3B in August. Consumer credit data does not include mortgage debt.

The latest survey on bank lending by the Fed showed considerable tightening in credit approvals for new consumer debt. The increase in new consumer debt, as the economy slows, is a concern, and confirms that many are unable to tap savings to fund spending, but are having to borrow to fund everyday necessities.

Pending Home Sales Fell In September

2008-11-07T15:52:00.000-08:00

Pending home sales, which are new contracts to purchase existing homes, fell -4.6% MoM in September (consensus -3.4%, prior +7.5%). Pending home sales, along with new home sales, are considered to be the most timely indicators for the the housing market. Typically about 80% of pending home sales turn into existing home sales within the next two months, but with the tightening credit markets, more sales may fall out of the pipeline over the next few months. Over the past year, pending home sales rose +7.7% YoY in September versus a year earlier, the second monthly positive annual change.

Regionally, the West was the only region to see an increase in September (+4.1% MoM), after all four regions showed improvement in August. The largest monthly decline in September was the Northeast at -13% MoM, followed by the South at -7.6% MoM and then the Midwest at -0.6% MoM. Over the past year, the West was again the only region to see an improvement in sales, rising +4.8% YoY. The South saw the largest deterioration at -21% YoY, followed by the Midwest at -15% YoY and the Northeast at -10% YoY.

The worsening economy and tightening lending standards, including today's announcement of lower limits for conforming loan limits next year in some high priced regions of the country, will probably keep sales subdued, even where foreclosures are helping reduce prices substantially. It is estimated that foreclosure sales represent up to 35-40% of existing home sales, and are an especially important contributor to sales in the West this year.

**************

From AP - People looking to buy more expensive homes next year will have fewer options to find financing because Fannie Mae and Freddie Mac will have lower limits on the size of loans they can buy.
The changes, effective Jan. 1, will lower the limit in high-priced real estate markets to $625,500 down from $729,950. Consumers who need to take out home loans above that amount typically pay higher interest rates, and that can price some would-be buyers out of the market.
The Federal Housing Finance Agency, which regulates Fannie and Freddie, kept the limit for lower-cost metro areas at $417,000. Some counties, including parts of Virginia, Utah and Maryland, have limits that range between $625,000 and $417,000.
Lawmakers temporarily raised the loan limits for Fannie and Freddie in a housing bill passed over the summer.
There are fears, however, that the reduced limits will hurt the housing market next year. Fannie and Freddie have become the dominant source of mortgage funding since last year's collapse of the subprime lending market.
The National Association of Realtors is pressing lawmakers to keep the limit at $729,950 to help the U.S. housing market recover from its worst slump in decades.

September Wholesale Inventories Fall -0.1% MoM while Sales fall -1.5% MoM

2008-11-07T15:51:00.000-08:00

September wholesale inventories unexpectedly fell -0.1% MoM (consensus +0.3%), while sales fell an even larger -1.5% MoM, in line with the decline in August. Over the past year, sales have risen +9.1% YoY, while inventories have risen +9.7% YoY. Excluding petroleum inventories, which have gone down in value along with the price of oil, inventories rose +0.1% MoM in September (+9% YoY).

Durable goods inventories rose +0.8% MoM (+10.2% YoY), while lower oil prices helped non-durable good inventories to fall by -1.4% MoM (+8.8% YoY). Durable goods sales fell -1% MoM (+3.5% YoY) and non-durable goods sales fell -1.9% MoM (+14% YoY). Auto inventories eased by -0.3% MoM while sales rose +0.4% MoM in September. Sales of petroleum fell -3.6% MoM (+35% YoY) while grocery sales rose +0.7% MoM and drug sales rose +0.4% MoM. Sales of Machinery fell -1.6% MoM.

The inventory-to-sales ratio continues to inch higher, rising to 1.12 from 1.10 the prior month, and 1.06 in June. The ratio rose for all categories except for non-durable goods (petroleum).

Today's Tidbits

2008-11-06T15:53:00.000-08:00

Fannie Mae Financials May Show Record Losses

From Bloomberg: “Fannie Mae may post a record net loss in its first quarterly report since being seized by the U.S. government as Chief Executive Officer Herb Allison writes off bad debts and increases default estimates. The mortgage-finance company may say its third-quarter loss was at least $20 billion, including a previously announced plan to write down most of its tax credits… Washington-based Fannie may post results as early as tomorrow. Allison, installed when the government seized Fannie and the smaller Freddie Mac on Sept. 6, may use the report to slash the value of assets, as well as boost loss provisions and default estimates, said Paul Miller, an analyst at Friedman Billings Ramsey in Arlington, Virginia. Fannie has already posted losses of $9.4 billion in the past year as the worst housing market since the Great Depression increased defaults.

``Right now the market's numb about how bad the housing market is,'' Miller said. ``So why not clean the books out and clean it up.'' Fannie's new management will likely increase reserves for future credit losses from $3.7 billion last quarter and will take a higher-than-expected charge against its $5.2 billion in ``temporary'' losses, Miller said. Fannie also may increase its 2008 credit-loss ratio projection and post losses on its derivatives portfolio. ‘`It's going to be an ugly quarter,'' Shapiro said. Fannie has ``a new management team, it's got a new mission and they really have no stake in running it for profit right now.'' Fannie's writedown of its deferred tax assets, valued at $20.6 billion as of June 30, will potentially cut its book value in half and increases the likelihood the U.S. Treasury may need to pump cash into the mortgage-finance company. If McLean, Virginia-based Freddie follows suit as analysts expect, it would need to write down more than $18 billion, leaving it with a book value of negative $6 billion and triggering the Treasury aid. The Federal Housing Finance Agency placed Fannie and Freddie under federal control and forced out management after examiners found their capital to be too low and of poor quality. Treasury Secretary Henry Paulson pledged to invest as much as $100 billion in each company as needed to keep their net worth positive. The companies will need that money ``sooner rather than later,'' according to Miller. Allison, 65, will likely implement more conservative accounting policies and will need to write down higher-than-expected credit costs, Miller said. …Examiners from the Federal Reserve, who helped FHFA review the companies' books, found that in addition to thin capital, the Fannie and Freddie may have been understating their losses, Dallas Federal Reserve President Richard Fisher said last month. ``When you look at temporary impairments and so on, we found that many of them might not be so temporary,'' Fisher said in response to an audience question after a Sept. 8 speech in Austin, Texas. With Fannie under government conservatorship, Allison isn't as beholden to shareholders as his predecessor Daniel Mudd. Because Fannie and Freddie's market value was nearly wiped out with the federal takeover, Miller said, ``the new management team has no incentive to sugar coat their earnings.'' …Fannie reported a loss of $2.3 billion last quarter, and $1.4 billion in the three months ended Sept. 30, 2007. Fannie has booked $9.4 billion in cumulative losses over the previous four quarters.”

From Reuters: “Foreign central banks' holdings of U.S. agency securities at the Federal Reserve declined again as they continued to favor the safe haven status of Treasury debt, Fed data released on Thursday showed. Their holdings of agency securities fell by $7.24 billion in the week ended Nov 5 to $901.87 billion, following a $8.78 billion fall in the previous week. This brought the cumulative drop in agency holdings among overseas central banks to about $67.4 billion or 7 percent since the beginning of October. A federal measure to guarantee short-term bonds issued by banks has put them on a perceived higher credit standing than securities issued by mortgage agencies Fannie Mae, Freddie Mac and the Federal Home Loan Bank System….Meanwhile, overseas central banks' holdings of U.S. Treasuries at the Fed surged $19.13 billion in the latest week $1.594 trillion, following a $7.91 billion rise in the prior week. The Fed's combined custody of Treasury and agency holdings for overseas central banks increased $11.89 billion to $2.496 trillion in the latest week.”

Some Economic Priorities For President-Elect Obama

From The New York Times: “The credit markets have stabilized in the last few weeks and even improved a bit. But the rest of the economy is deteriorating fairly rapidly. It’s now in danger of falling into a vicious spiral, in which spending cuts by consumers and businesses lead to further layoffs and then more spending cuts. To prevent that from happening, the Obama administration will need to move quickly — before it takes office — to put together some emergency plans for the financial markets and the broader economy. Mr. Obama and his advisers acknowledge that their focus has to shift, but the change is still likely to be challenging, and a bit disappointing. “Unfortunately, the next president’s No. 1 priority is going to be preventing the biggest financial crisis in possibly the last century from turning into the next Great Depression,” says Austan Goolsbee, an Obama adviser. “That has to be No. 1. Nobody ever wanted that to be the priority. But that’s clearly where we are.” Throughout the campaign, whenever Mr. Obama was asked about the financial crisis, he liked to turn the conversation back to his long-term plans, by saying that they were meant to solve the very problems that had caused the crisis in the first place. Back in January, he predicted to me that the financial troubles would probably get significantly worse in 2008. They had their roots in middle-class income stagnation, which helped cause an explosion in debt, and the mortgage meltdown was likely to be just the beginning, he said then.

His prognosis was right — and the pundits now demanding that he give up major parts of his economic agenda in response to the financial crisis are, for the most part, wrong. When you discover that a patient is in even worse shape than you thought, you don’t become less aggressive about treatment. But you do have to deal with the most acute problems first.”

From Steve Roach at Morgan Stanley: “For President-elect Barack Obama, the campaign mantra of “change and hope” will meet a very quick reality test. Courtesy of a wrenching economic and financial crisis, his leadership skills could, in fact, be tested even before he assumes office. Not only would it be appropriate for him to weigh in on the mid-November G-20 summit in Washington, but his views could well be decisive in shaping the post-election efforts of the US Congress to craft another economic stimulus package. In these troubled times, the new leader of the free world can hardly afford to remain silent….core strategy should be to foster a long overdue rebalancing of the US economy. A dysfunctional growth model must be guided away from the asset- and debt-dependent consumption binge of the past dozen years toward a significant increase in long depressed domestic saving. Only then can the US achieve a sustained reduction of its massive current account deficit, necessary to fund sorely needed investments in infrastructure and human capital. Second, Barack Obama needs to move quickly in restoring America’s commitment to globalization. That means repudiating the politically inspired scape-goating of China and other saber rattling on the trade front. To do that, the president-elect needs to tackle a daunting middle-class real wage stagnation problem – the source of economic anxiety that has been the political foil for Washington’s increasingly worrisome protectionist tilt… Third, the newly elected president must provide leadership to the regulatory reform of America’s bruised and battered financial system. There is a very real risk in today’s highly charged political climate that a regulatory backlash goes too far and ends up impeding the efficiency of America’s market-based system of capital allocation. Reregulation must be even-handed, aimed not only at Wall Street but also at the rating agencies, a bubble-prone Federal Reserve, and other regulatory authorities. If President-elect Obama can push early for a principled and judicious approach to financial sector reforms, there is good reason to hope that the new system will be a major improvement from the old one – ushering in an era of transparency, improved disclosure, better underwriting standards, and enhanced oversight. America’s financial markets and institutions would then be grounded in a new sense of discipline, accountability, and stability – capable of providing just the anchor that an all too unstable and reckless world sorely needs.”

“Perfect Storm” for Retailers as Credit Tightens With Savings Low

From Reuters: “Retail chains posted the worst monthly sales data in more than three decades as consumers cut spending sharply in October, stunned by a financial crisis that has derailed the U.S. economy….The ICSC said it pared its forecast for what were already expected to be dismal holiday season sales. It now expect sales in November and December to rise 1 percent…"The great unknown is just how much lower can consumer spending go?" said Piper Jaffray analyst Jeff Klinefelter. "With savings rates at historic lows and constraints on the availability of consumer credit, I just think there's concern that the perfect storm is brewing." Wal-Mart Stores Inc stood out as one of the few bright spots. It posted a better-than-expected 2.4 percent rise in sales at U.S. stores open at least a year…Wal-Mart's results were a sharp contrast to other discounters like Target Corp and Costco Wholesale Corp, which reported larger-than-expected same-store sales drops. Across the sector, department store chains like Nordstrom Inc and specialty clothing retailers like Abercrombie & Fitch were among those hit hardest. Shoppers have pared purchases of discretionary items like clothes or computers and in some cases are carefully planning when they buy the most basic necessities, like baby formula… The crisis crimped spending even among the wealthy. Same-store sales fell 16.6 percent at upscale department store chain Saks Inc and dropped 15.7 percent at Nordstrom”

MISC

From BBC: “The Bank of England has made a shock one-and-a-half percentage point cut in UK interest rates to 3%, the lowest level since 1955. The size of the cut - the most dramatic since 1981 - signals the Bank's concern the UK is heading for a long recession…The cut was followed by the European Central Bank lowering its eurozone interest rates from 3.75% to 3.25%. The interest rate cuts come as the IMF predicts that developed economies will contract for the whole of the coming year for the first time since World War Two. “

From The Wall Street Journal: “Banks and other finance companies making loans for autos, credit cards and college tuition are having virtually no success in selling those loans to other investors, a potent sign of just how tight credit markets remain. The market for selling such loans -- by packaging, or securitizing, them into bonds -- had just one $500 million deal for all of October, according to Barclays Capital. That compares with $50.7 billion worth of deals made one year earlier…”

From Barclays: “Companies have been borrowing very aggressively to buy equities …the credit crunch has removed this buying, one of the reasons why equities have de- rated to lower PE ratios”

From Barclays: “Oil prices have continued to swing wildly across the $60 to $70 range at the front of the curve, while back end prices have stayed above $90 per barrel.”

From The Financial Times: “Over the next 22 years, consuming countries will devote 5 per cent to 7 per cent of their gross domestic products to pay for their oil, up from 4 per cent in 2007. This will have “serious adverse implications for the economies of consuming countries”. “The only time the world has ever spent so much of its income on oil was in the early 1980s, when it exceeded 6 per cent,” the report says. In 1998, when oil traded just above $10 a barrel, the world spent just 1 per cent of its GDP on oil.”

From Barclays: “Comparisons with the Great Depression are an exaggeration…The average annualised GDP contraction in the Great Depression was 14.1% The largest annual GDP contraction in the Great Depression was 23% in 1932.”

From Bloomberg: “U.K. house prices fell at the fastest pace in at least 25 years…The average cost of a home dropped 14.9 percent from a year earlier in October, the most since the index began in 1983… From September, prices fell 2.2 percent, the ninth straight monthly decline.”

End-of-Day Market Update

From UBS: “Central Banks Slash Rates, Stocks Slash Net Worth: There was a downshift in market activity as participants squared up and headed for cover in front of tomorrow's Non-Farm Payrolls (UBSe -250k, consensus -200k) and Unemployment Data (UBSe +0.3%/6.4%, consensus +0.2%e/6.3%e). Markets, rather than taking solace from the dramatic move by the BoE and rate cuts from the ECB, DNB, and SNB, seemed to interpret these actions as confirming that the situation is dire and that lower rates would provide little relief. The UST 2- year gapped to 1.244% on the BoE news, matching the cycle lows of 3/17/08 at 1.236%. The issue traded off for most of the day, but caught a late afternoon bid as stocks swooned. The curve steepened with long rates rising, as US2Y10Y steepened +7 bps to 241 bps. Next week's supply and tomorrow's data provided the rationale for lightening up on positions. There was little outright buying going on in spread markets, which had helped push rates lower in recent days. CRB was 257.10, -10.87. Crude was -$6.48 to $61.46/bbl. Stocks closed -443 at 8,696. Treasury volume was light at -26% of the 30 day mva…. Commercial Paper outstandings rose $50.5B in the week, after a $100.5B gain last week. Presumably this reflects activity at the Fed's CPFF facility. Recapping the day's central bank actions, the BoE cut by 1.50% to 3.0% (more than the 50 bps - 75 bps expected), the ECB dropped by 0.50% to 3.25%, the SNB reduced by 0.50% to 2.0%, and Denmark lowered 0.50% to 5.0%. It is worth repeating part of the BoE statement: "...the risks to inflation have shifted to the downside...the global banking system has experienced its most serious disruption in almost a century" and they observed a "very marked deterioration in the outlook for economic growth." Strong words from a sober group…Spread markets were much quieter today after the recent frenzy of buying. Tomorrow's data, supply, and ugly price action in equities dimmed investor ardour for basis risk. MBS spreads were broadly unchanged, with the current coupon at +167 over the 50/50 weighted 5- and 10- year swaps. The swap desk reported light position squaring with spreads slightly wider across the curve: 2- years were +2.0 bps to 107.25 and 10- years +1.75 bps to 42.25 bps. The agency desk relayed a similar tale, with better buyers in the short to intermediate part of the curve, but 10- year benchmarks were "an island unto themselves." FNMA 2- year benchmarks were 0.0 at 127 bps, 5- years were +0.1 at 121 bps, and 10- years were +8.0 to 125 bps (Bloomberg). It is interesting how "flat" the spreads are across the 2- year - 10- year curve. Volatility traded higher. Central banks left the door open to lower rates and stocks fell through a trap door to lower prices. With short rates probing a break to new lows, volatility hedgers remain on edge.”

From Bloomberg: “U.S. stocks slid, sending the market to its biggest two-day slump since 1987, after jobless claims jumped and the shrinking economy crushed earnings at companies from Blackstone Group LP to News Corp…. The Standard & Poor's 500 Index fell 5 percent to 904.9, extending its two-day loss to 10 percent. The Dow Jones Industrial Average retreated 443.48 points, or 4.9 percent, to 8,695.79. The Russell 2000 Index of small U.S. companies declined 3.6 percent to 495.92. The MSCI World Index of 23 developed markets lost 6.2 percent to 921.87. The two-day tumble wiped out more than half of the S&P 500's rebound from a five-year low on Oct. 27. An industry report showing an unexpected decline in sales at U.S. chain stores in October also weighed on stocks as 25 of 27 companies in the S&P 500 Retailing Index slumped… The S&P 500 is down 38 percent this year, the steepest annual retreat since 1937. The benchmark for U.S. equities has plunged 42 percent since its record in October 2007 as the U.S. economy shrunk in two of the last four quarters… The VIX, as the Chicago Board Opions Exchange Volatility Index is known, climbed 17 percent to 63.88. The measure tracks the cost of using options as insurance against declines in the S&P 500.”

Prices as of 4:45PM (Based on Bloomberg)

Three month T-Bill yield fell 8 bp to 0.30%

Two year T-Note fell 6 bp to 1.28%

Ten year T-Note yield fell 1 bp to 3.69%

30-year FNMA current coupon fell 1 bp to 5.44%

Dow fell 444 points to 8696

S&P fell 48 points to 905

Dollar index rose 1.29 points to 85.89

Yen at 97.7

Euro at 1.272

Gold fell $6 to $734

Oil fell $4.25 to $61

Economy lost 240k jobs in October and unemployment jumped to 6.5%

2008-11-06T15:49:00.000-08:00

But the bigger news is the huge revisions to prior data. They added -125 k job losses to September (most of the revision for September was focused on additional job losses in the previously strong government, education, and healthcare categories), - 54 k to August. Just in September and October of this year, the US economy lost over half a million jobs. This makes the cumulative job loss this year at over 1.3 million, much higher than originally thought. The September loss at -284k is the largest monthly decline since the -325k loss in October 2001, following the terrorist attacks.

The unemployment rate leaped from 6.1% in September to 6.5% in October, the highest levels since 1994. Aggregate hours worked continued to slide for at least the sixth straight month, falling -0.3% MoM, and at a -2.6% three month annualized pace, as demand for labor dissipates. This figure is a combination of total employment and average hours worked, so it is an important indicator of true labor demand. The declines suggest continued further derosion in GDP growth.

As has been the case consistently this year (except for September), private sector jobs fell more than the total, declining by -263k in October, while the government grew jobs by 23k. Manufacturing payrolls fell the most in 5 years, shedding -90 jobs in October, as the economy slowed, and the stronger dollar also reduced export demand. Goods producing job losses accelerated to -132k in October from -83k in September. Service sector jobs are no longer supporting the economy, as employment in this sector fell -108k in October, down for -201k in September, but only -13k in July. Financial services shed -24k position in October, while temporary help fell -38k. Construction job losses rose to -49k. The only sector to show growth, other than the government, was education and health, which rose +21k in October after falling by -16k in September. The closing of auto dealers caused -20k of the -38k in retail job losses last month. Trade and transportation related jobs fell -67k.

Surprisingly, hours worked held steady in October for all categories, after falling sharply in September. The average workweek is holding at the post-war low of 33.6 hours for the general workforce, with overtime steady at 3.6 hours. Despite the large drop in manufacturing jobs, manufacturing hours worked were unchanged at 40.6 hours per week. Average weekly earnings, managed to rise +0.2% MoM, and are up +2.9% YoY, a modest increase from the recent low of +2.8% YoY in September.

Today's employment data supports the view that the US has indeed entered into a recession. There was no good news in the report, which was much worse than expected when the revisions are included. Just after the employment release this morning, Goldman Sachs reduced their third quarter real GDP forecast to -3.5% and the first quarter 2009 to -2%. They are also looking for unemployment to rise to 8.5% by the end of 2009.

Productivity Slumped and Labor Costs Rose in 3rd Quarter after Real GDP Growth Disappeared

2008-11-06T15:47:00.000-08:00

As expected, the dramatic drop in real GDP growth in the 3rd quarter lead to a sharp deterioration in productivity and unit labor costs. This is normal early in a recession, as businesses are slow to shed talented employees until they are sure their services are not needed. Companies must balance the cost of hiring and training new employees versus the expected duration of a slowdown in demand for their products to optimize profitability.

The preliminary look at productivity shows 3rd quarter growth slowing to +1.1% QoQ annualized (consensus +0.7%) which was better than expected. But the relative improvement is tempored by the fact that the second quarter reading was revised down to +3.6% from +4.3% earlier. Output fell by -1.7% QoQ annualized in the 3rd quarter of 2008, while hours worked were cut an even larger -2.7%. This lead to a small net increase in output per hour.

Unit labor costs, rose more than expected, growing by +3.6% QoQ annualized in the preliminary 3rd quarter reading. Consensus had looked for an increase of 3%. In addition, ULC fell less than originally thought in the second quarter, falling only -0.1% QoQ annualized instead of the earlier reported drop of -0.5%. Compensation jumped a large +4.7% QoQ annualized, but is unlikely to continue heading higher as the recession evolves. The 5% jump in the inflation deflator, caused real compensation to fall -1.9% QoQ annualized, the largest decline since the 2nd quarter of 2007. The recession will reduce labor's bargaining power, and hours worked, which should help to reverse this trend toward higher labor costs in future quarters.

Number of people on unemployment rises to highest since 1983!

2008-11-06T15:46:00.000-08:00

Initial jobless claims rose to 481k last week (consensus 477k), following a revision higher the prior week to 485k from 479k originally reported. Continuing claims rose to 3.843 million, a 25 year high! The number of people claiming unemployment benefits is now at the highest level since 1983.

Today's Tidbits

2008-11-05T15:59:00.000-08:00

Updating Impact of Mortgage Equity Withdrawals on Consumption
From John Mauldin: “…net MEWs have fallen precipitously in 2008, down 95% from three years ago. On this data alone, GDP should be off by 3% this year. No wonder we are in negative economic territory. In 2005 there was almost $595 billion in mortgage extractions that went into some kind of consumer spending. Remember…that translated into a 3% rise in GDP. In 2007, MEWs were down to $470 billion, for a boost of 2% to GDP. The second quarter of 2008 saw an anemic $9.5 billion. At that run rate, we could see a drop-off of well over 90% from 2005! Now, think what the second quarter would have been without the federal stimulus program of $150 billion. It might have looked and felt like this quarter!”
Time to Pay for Past Excesses?
From Newsweek by Robert Samuelson: “Unfortunately, slower growth seems probable. What the new president, and everyone else, needs to understand is that the present crisis marks the end of an economic era. For roughly a quarter century, the U.S. economy benefited from the expansionary side effects of falling inflation—lower interest rates, greater debt, higher personal wealth—to the point now that we have now overdosed on its pleasures and are suffering the hangover. In our zeal to identify the villains of the present economic debacle, we ought to recognize that the larger causes lie in this prolonged prosperity and the permissive attitudes and practices it inspired. Largely unrecognized, the dominant economic event of the past half century was the rise and fall of double-digit inflation. On the way up, starting at about 1 percent in 1960, inflation destabilized the economy. There were four recessions between 1969 and 1981. Unemployment peaked at 10.8 percent in late 1982. That last devastating recession, imposed by the then Fed chairman Paul Volcker with Reagan's backing, purged the worst inflationary psychology. By 1984, inflation had dropped from double digits to less than 4 percent; by 2001, it was 1 percent. This declining inflation—disinflation—bolstered the economy. Consider what happened. The stock market recovered spectacularly: lower inflation led to lower interest rates, which caused investors to switch from bonds to stocks. The Dow Jones industrial average, which traded under 1,000 for much of 1982, averaged about 2,500 in 1989 and almost 10,500 in 1999. There was a consumption boom. Feeling wealthier, Americans borrowed and spent. The personal savings rate dropped from 11 percent in 1982 to almost zero by 2005. There were only two mild recessions (1990–91 and 2001). But what's clear now is that this prosperity bred bad habits. The present crisis, though usually attributed to dubious "subprime" mortgages, really traces its origins in the widespread optimism unleashed by disinflation. By now, the perverse consequences are clear. As stocks and real estate rose sharply in value, many Americans became convinced that prices could only go up. Once that mind-set took hold, lax investment standards (in the case of high-tech companies) and lending practices (in the case of homes) mushroomed. "Bubbles" followed. People overinvested in tech stocks and overborrowed to buy homes at inflated prices or to raise cash from bloated real-estate values. But the borrowing surge could not last indefinitely, because debts increasingly outpaced the rise of incomes. By 2006, household debt was 134 percent of personal income. Sooner or later, consumers had to retrench. They are now; car sales and retail spending are down. The recession will end, but recovery won't ensure a return to previous rates of economic growth. Just beyond the horizon looms a larger threat: an aging society. Arithmetically, economic growth reflects the increases in workers' hours and their productivity—a.k.a. efficiency. From 1960 to 2005, annual U.S. economic growth averaged 3.4 percent, split almost evenly between labor-force growth (1.5 percent) and productivity gains (1.9 percent). As baby boomers retire, labor-force growth will shrink. By the mid-2020s, the Social Security Administration expects economic growth of about 2.1 percent, with scant labor-force increases (0.4 percent) and higher productivity gains (1.7 percent). Because productivity reflects many influences—technology, management, workers' skills—even that projection could be optimistic. If productivity falters, as in the 1970s, the U.S. economy would virtually stagnate in the face of growing claims on people's incomes…. people will fight over pieces of a fairly fixed economic pie rather than sharing ever-larger pieces of an expanding pie…. Already, Americans face far more claims on their incomes than can be easily met. Start with government. It's overcommitted in the sense that it's made more promises than can be sensibly afforded. The largest of these involve retirement costs. As is well known, three programs for the elderly dominate the federal budget: Social Security, Medicare (health insurance) and Medicaid (nursing-home care for the elderly poor). These programs now represent more than two fifths of the $3 trillion budget, and as baby boomers retire, they could nearly double—measured as a share of the economy, gross domestic product (GDP)—in 2030. The tough questions are obvious. How much will we permit spending on retirees to raise taxes or crowd out the rest of government? Health care compounds the difficulty. About three quarters of the projected increase in federal spending for the elderly involves Medicare and Medicaid. As a society, we haven't learned how to control health spending. Most Americans think that people should get all the medical care they need. Spending controls—for government and private insurance—haven't worked, because Americans don't want them to work. Health spending has gone from 5 percent of GDP in 1960 to 16 percent now and may hit 20 percent by 2015. For workers with employer-paid insurance, that's depressed take-home pay by diverting dollars from wages into premiums. For everyone, health spending puts upward pressure on taxes and downward pressure on other government programs…. the great forces that propelled the economy forward for the past quarter century, fed by disinflation and the accompanying rise in personal wealth and borrowing, have clearly spent themselves. If the economy is to retrieve faster growth in the future, it will need to nurture new sources of advance.
Given the scope and scariness of the financial crisis, it has already stimulated massive government intervention—and there will be more. But there is a parallel danger that too much intervention, or the wrong kind of intervention, will suppress the impulse for expansion, investment and risk-taking.”
Government Entitlement Problems Lurk Like Sub-Prime Issues – Off Balance Sheet
From Fortune (By David Walker, former U.S. Comptroller General): “The U.S. Government Accountability Office (GAO), noting that the federal balance sheet does not reflect the government's huge unfunded promises in our nation's social-insurance programs, estimated last year that the unfunded obligations for Medicare and Social Security alone totaled almost $41 trillion. That sum, equivalent to $352,000 per U.S. household, is the present-value shortfall between the growing cost of entitlements and the dedicated revenues intended to pay for them over the next 75 years. Why call it a super-subprime crisis? Besides its gigantic scale, there are very disturbing similarities between the current mortgage-related crisis and our next potential disaster. First, like the securitized investment vehicles that blew up, federal programs were launched without adequately thinking through who would bear the ultimate cost and related risk. Just as originators of mortgages let themselves off the hook by unloading packages of dubious loans onto others, lawmakers have increased spending, expanded entitlement programs, and cut taxes while expecting future generations to pay the bill. Second, just as a lack of transparency associated with mortgage-backed securities resulted in big surprises and large losses for investors, our nation's huge off-balance-sheet obligations for Social Security and Medicare present a threat wrapped in camouflage. After all, the government's "trust funds" don't really provide much security since they don't hold anything but more government debt. Third, in the same way that private sector "risk management" executives failed to prevent the subprime mortgage crisis, overseers in Congress and the executive branch have turned a blind eye to costs associated with entitlement programs and tax cuts. While lax regulation of banks fed the current subprime crisis, a lack of statutory budget controls has led to a widening gap between the government's revenues and costs. At the heart of these problems is our leaders' collective failure to act in the face of known challenges. Our country has veered from its founding principles, which held to individual responsibility and accountability today in order to create more opportunity tomorrow. When our constitution was written, the concepts of thrift and prudence were no less at the During past financial crises and wars, the government went into debt because our nation's survival was at stake. What has changed is that piling up debt has become business as usual, even during times of prosperity.
Today we are headed toward debt levels that far exceed the all-time record as a percentage of our economy. In fact, by 2040 we are projected to see debt as a percentage of our economy that is double the record set at the end of World War II. Based on GAO data, balancing the budget in 2040 could require us to cut federal spending by 60% or raise overall federal tax burdens to twice today's levels. Medicare, Medicaid, and Social Security already account for more than 40% of the total federal budget. And their portion of the budget is expected to grow so fast that their cost, and the cost of servicing our debt, will soon crowd out vital programs, including research and development, critical infrastructure, education, and even national defense. The crisis we face is one of numbers and demographics but also of attitudes. Promises were made in an earlier time, when they seemed more affordable. Like homeowners borrowing against the value of their homes in the expectation that the values would go up forever, the American government borrowed against the future and assumed that the economy would grow fast enough to make that debt affordable. But our national debt is not limitless, and our foreign lenders are not fools. If we persist on our current "do nothing" path, our future will be jeopardized. Americans need to reconcile the government we want with the taxes we're willing to pay for it.”

Credit Markets Showing Signs of Imporving
From Bloomberg: “Credit markets are still creaking even after the biggest decline on record in the rate banks say they charge each other to borrow dollars. The London interbank offered rate, or Libor, for three- month loans fell to 2.51 percent today, from 4.82 percent on Oct. 10. The rate is still 151 basis points more than the Federal Reserve's target interest rate for overnight bank loans, compared with an average of 22 basis points in the five years before the global credit crisis began in August 2007. ``Banks are cutting back, the economy is in a deepening recession and in that environment, I don't think banks are going to become a lot more willing to extend credit soon,'' said Jan Hatzius, chief U.S. economist in New York at Goldman Sachs Group Inc., the world's biggest securities firm. Government bailouts totaling about $3 trillion, interest- rate cuts around the world and unprecedented cash injections by central banks drove Libor, the benchmark for $360 trillion of securities worldwide, lower in the past month without convincing financial institutions to lend. About 85 percent of U.S. banks tightened lending standards on loans to large and mid-size companies in the past three months, the Fed said on Nov. 3, the highest since the survey began in its current format in 1991…The credit-market seizure that began after BNP Paribas SA halted withdrawals on three hedge funds last year worsened when Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15,
driving dollar Libor up 200 basis points, or 2 percentage points, in the next 25 days to the highest level in 2008. The difference between Libor and the overnight indexed swap
rate, a measure former Fed Chairman Alan Greenspan uses to gauge the state of money markets, was at 201 basis points today. That compares with 87 basis points on the last day before Lehman's collapse and an average 11 basis points in the five years before
the crisis started…``Libor fixings are improving but it's too early to say that this
pattern is being replicated in the actual money markets.''…Central banks have driven money-market rates lower by offering financial institutions as much dollar funding as they need and acting in concert to slash interest rates. The Reserve Bank of Australia cut its benchmark rate 75 basis points yesterday, joining policy makers in China, Hong Kong, India, Japan and the U.S. in reducing borrowing costs in the past week. The European Central Bank and Bank of England will cut their key rates by 50 basis points tomorrow, according to Bloomberg surveys of economists. While cutting the U.S. target rate during the past 13 months to 1 percent from 5.25 percent, Fed Chairman Ben S. Bernanke has created six loan programs channeling at least $700 billion in cash and collateral into money markets as of Oct. 22….``It's all about buying time.'' Central bank operations helped the MSCI World Index of stocks rise almost 20 percent since falling to a five-year low on Oct. 27. Company borrowing costs have declined, with yields on the highest-ranked 30-day commercial paper, or CP, falling today to the lowest level since June 2004. The market, used by companies to cover daily expenses, grew last week for the first time since Lehman's collapse. Cash injections have had a limited impact because instead of lending the extra money received in auctions, some financial institutions are holding it on deposit with central banks. Banks lodged a record 296 billion euros ($381 billion) overnight with the ECB yesterday. The daily average in the first eight months of the year was 427 million euros. ``The money-market players remain cautious but we're at least seeing an improvement … ``Transactions remain limited and we still have a dislocated market, but we're seeing a significant pullback'' in rates, he said. In its quarterly Senior Loan Officer Survey, the Fed said about 95 percent of U.S. banks raised the costs on credit lines to large firms, and ``nearly all banks'' increased the spread on
borrowing rates over the cost of funds on loans to firms from July. About 70 percent of U.S. banks indicated they tightened standards on prime mortgage loans. Banks may not pass all of the benefits of lower interest rates on to consumers and businesses. Banks around the world are re-evaluating the price they put on risk, raising the cost of loans when compared with levels of pervious years, said David Hodgkinson, chief operating officer of HSBC Holdings Plc, Europe's biggest bank. ``Credit has to be priced appropriately to reflect the risk,'' Hodgkinson said in a Nov. 3 interview in Abu Dhabi. ``If interest rates are brought down significantly, then rates for borrowers will come down. But I'm not going to say it's absolutely linear because it depends on the particular transaction and the risk.'' In another sign that lending remains restricted, corporate bond sales in Europe dropped in October to the lowest level this year… U.S. investment-grade offerings fell to $21.6 billion, the least since July 2002. ``No one wants to lend because they are still wary of values of bank balance sheets, and no one wants to borrow from the money market because they can borrow directly from the central banks,'' …In effect, the measures taken by central banks are not providing incentives to go into the interbank market.''”

Russian Economy Remains Too Dependant on Commodity Exports
From The FT: “Russia … Its annual economic growth in real terms averaged 7 per cent in the years during which Vladimir Putin was president (2000-08), annual real wages rose by almost 15 per cent, the federal budget was continually in surplus… The Russian stock market has lost 70 per cent of its value this year. The commodity prices that spearheaded its boom are now falling. The easy credit money from the west that fuelled it has now fled. Russia has failed to diversify its economy and its politics have long made investors nervous. A confrontation with reality is long overdue. Metals, energy, and food account for 80 per cent of Russian exports. The growth of the economy in the Putin years was largely driven by the devaluation of the rouble in 1998-99 and the increase in the prices of these products: between 2000 and 2007 real prices of metals went up by 275 per cent, of energy by 210 per cent, and of food by 160 per cent… Since July, the commodity price index has dropped by more than 20 per cent…The downturn in the commodity economy will thus have a multiplied effect on the consumer economy and the Russian standard of living. Second, the government's spending plans are based on a $70 a barrel oil price. Every one-dollar decrease in the barrel price implies $3bn less in export revenues a year… Russia's banking system has been a poor channeller of commodity wealth into non-energy businesses. There are too many banks; most are undercapitalised. Growth in the non-energy sectors has been fuelled by collateralised loans from western banks. Russian banks and companies have about $450bn (€362bn, £292bn) of foreign debt, $50bn of which must be repaid or refinanced by the year end. So Russian businesses are exposed to the troubled European banking system when the value of the shares they put up as collateral may have fallen below the cost of the loans…Russia needs to scale down its geopolitical ambition to its real weight - that of an emerging economy with only 3 per cent of the world's gross domestic product and a quarter of America's living standard. Also, it desperately needs to develop its human capital.”

MISC
From Merrill Lynch: “The vast majority of questions we receive are about inflation, and whether the US is "printing money" to solve the crisis. Investors need to keep in mind that inflation is a lagging variable and that credit is a leading variable. Any devout monetarist will say that it is impossible to get inflation without credit creation. There is no credit creation. Investors should probably start worrying about inflation only after the credit cycle turns.”
From Deutsche Bank: “Massive long-end supply is coming The Treasury announced major changes to its auction schedule, reflecting what is likely to be a record high $1 trillion-plus budget deficit this year. Next week, the Treasury will begin auctioning monthly 3-year notes at $25 billion in size; the Treasury will then auction $20B in 10-year notes and these notes will be reopened in each of the ensuing two months (i.e., a double reopening). The Treasury did not specify the size of the 10-year reopenings but our initial guess is that it will be somewhere in the $10 to $15B range. The Treasury also decided that beginning next February it will begin auctioning quarterly 30-year bonds. Next week, though, the Treasury will…”
From Bloomberg: “Voters in states led by California embraced municipal debt as they approved about $39.7 billion of new borrowing, representing about 83 percent of measures for which results were available. Californians approved at least $27 billion, including money for schools and loans to veterans. Voters in 41 states from Rhode Island to Alaska considered $66.4 billion of bond proposals yesterday, the second-biggest slate after November 2006's $78.6 billion…”

End-of-Day Market Update
From Bloomberg: “The stock market posted its biggest plunge following a presidential election as reports on jobs and service industries stoked concern the economy will worsen even as President-elect Barack Obama tries to stimulate growth. Citigroup Inc. tumbled 14 percent and Bank of America Corp. lost 11 percent as the Standard & Poor's 500 Index and Dow Jones Industrial Average sank more than 5 percent. Nucor Corp., the largest U.S.-based steel producer, slid 10 percent after bigger rival ArcelorMittal doubled production cuts amid slowing demand. Boeing Co., the world's second-largest commercial planemaker, lost 6.9 percent after UBS AG forecast a 3 percent drop in global air traffic next year. `We had an election yesterday; that doesn't mean the problems go away,…``We still have an economic slowdown.'' The S&P 500 tumbled 52.96 points, or 5.3 percent, to 952.79, erasing yesterday's 4.1 percent rally. The Dow retreated 486.01, or 5.1 percent, to 9,139.27 and the Nasdaq Composite Index dropped 98.48, or 5.5 percent, to 1,681.64. Twelve stocks fell for each that rose on the New York Stock Exchange. The retreat halted an 18 percent rebound from the S&P 500's five-year low on Oct. 27. The benchmark for U.S. equities has lost more than 35 percent this year, the steepest annual plunge since 1937, and Obama will have to contend with an economy pummeled by the fastest contraction in manufacturing in 26 years and the lowest consumer confidence. The market's decline came a day after the biggest presidential Election Day gain since the NYSE first opened for trading on a voting day in 1984.”
From UBS: “ Prices as of 4:45PM (Based on Bloomberg)
Three month T-Bill yield fell 9 bp to 0.39%
Two year T-Note fell 4 bp to 1.33%
Ten year T-Note yield fell 4 bp to 3.68%
30-year FNMA current coupon fell 14 bp to 5.47%
Dow fell 486 points to 9139
S&P fell 53 points to 953
Dollar index fell 0.18 points to 84.61
Yen at 98.2
Euro at 1.297
Gold fell $21 to $742
Oil fell $5 to $65.50

Massive Service Sector Economy Falls Into Worst Contraction in Over 10 Years

2008-11-05T15:45:00.000-08:00

The October non-manufacturing ISM, which covers the majority service sector (88%) of the US economy, fell more than expected to 44.4 (Consensus 47, prior 50.2). This was the lowest reading ever recorded for the index, which goes back to 1997. Any reading below 50 indicates contraction.

Among the sub-sectors, business activity declined even faster than the headline reading, falling from 52.1 to 44.2. New orders fell from 50.8 to 44, and the order backlog eased down to 44 from 46.5. As with the ISM manufacturing index, inventory sentiment rose, indicating that inventories are probably growing larger than desired. One bright spot was that new export orders held steady at 50 vs 50.5 in September. In addition, the decline in commodity prices helped prices paid fall to 53.4 from 70 the prior month. Obviously lower oil prices feed through into reduced transportation costs for everything. The demand for labor remains subdued. Employment eased down to 41.5 from 44.2.

The composite index of the manufacturing and non-manufacturing indexes fell to 43.8 in October, from 49.4 in September. The ISM manufacturing data released earlier this week showed the manufacturing sector shrinking the most in 26 years in September, as the economy faltered, and credit evaporated for producers and consumers.

Job and housing data

2008-11-05T15:44:00.000-08:00

Challenger job cuts rose to a 5 year high, up 79% YoY, with losses in financial and auto jobs leading the way. 75% of job categories are now seeing lay-offs, as the labor market weakness spreads. Year-to-date, layoffs have totaled 875k.

****************

The ADP private sector employment job report showed a higher than expected loss of 157k jobs in October. Consensus looked for a 100k drop. This index has been under-estimating job losses by 71k on average each month this year. Consensus for Friday's payroll loss is currently 200k, which includes government jobs as well as private sector employment. Government jobs have continued to grow modestly as the private sector has been shedding positions this year. The economy has lost net jobs each month this year.

*************

MBA Mortgage applications fell 20% WoW, bringing them back to an 8-year low (12/2000), as thirty year mortgage rates rose 21bp to 6.47%. Purchase applications fell -14% WoW and refinance applications fell -28% WoW, as the housing slump continues.

Today's Tidbits

2008-11-04T16:09:00.000-08:00

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

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

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

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

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

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

September Factory Orders Plunge, with Ex-Transportation Orders Falling Most Ever

2008-11-04T15:43:00.000-08:00

New factory orders slid -2.5% MoM in September, much more than the -0.8% MoM drop that had been expected. In addition, August's figure was revised lower to -4.3% MoM from -4% originally, for the largest monthly decline in over 15 years. Excluding the weak transportation sector, new orders fell an even larger -3.7% MoM, just slightly larger than the -3.6% MoM decline in August, and a new record monthly loss. Surprisingly, unfilled orders continued to rise by +0.4% MoM (+12% YoY), while the inventory-to-shipments ratio popped up to 1.29, from 1.26 in August and a recent low of 1.21 in July.

Consumer goods demand remains weak, with new orders falling -5% MoM and shipments declining by -5.2% MoM. Over the past year, both categories have seen growth of 10% YoY.

Capital goods orders rose +3.1% MoM after falling -6% MoM the prior month, and are down -1.1% YoY. Most of this increase was in defense orders, which rose +19.5% MoM (+64% YoY), while non-defense factory orders rose only +0.8% MoM (-7.3% YoY).

Durable goods orders rose +0.9% MoM after falling -5.5% MoM in August, and they are down -3.6% YoY. Transportation equipment rose +6.5% MoM, but is still down -11% YoY. Non-durable goods orders fell -5.5% MoM, the most in two years, due to falling commodity prices.

Factory shipments fell -2.8% MoM after declining by -3.7% MoM in August, but they are up +2.5% YoY.

Inventories fell -0.7% MoM, the first decline in over seven months, but have risen +7% YoY. Durable goods inventories continued to rise, while non-durable manufactured inventories fell due to the decline in oil and other commodity prices

The worldwide economic slowdown, and tighter credit, combined with rapidly falling commodity prices, are quickly sapping notional growth in new factory orders for goods. All signs point to further slowing ahead.

ISM Manufacturing Data Looking Worst Since 1982 Recession

2008-11-03T15:42:00.000-08:00

According to the October ISM Manufacturing survey, manufacturing in the US contracted at the fastest pace since 1982 last month, when the index slid to 38.9 from 43.5 in September. September also saw a large decline from 49.9 in August. This rapid retrenchment indicates that the recent turmoil's in the financial markets have had an immediate impact on the real economy. The deceleration apparent in inflation, due to the record drop in commodity prices since peaking in July, is apparent in the prices paid index which has tumbled to 37 from 77 only two months ago. Any reading below 50 indicates contraction, while a number above 50 indicates growth.

The only sub-indexes to show growth last month were inventories, which are not a good sign for future demand. Production fell to 34.1 from 40.8, new orders slid to 32.2 from 38.8, and backlogs tumbled all the way down to 29.5 from 35. Supplier deliveries, eased into contraction at 49.2 versus 52.5 in September. New export orders, which had been supporting GDP growth, fell to 41 from 52 in September. Employment fell again to 34.6 from 41.8, suggesting larger employment losses for the October non-farm payroll report.

Manufacturing is on the front line of the slowdown in consumer spending in the US, as well as the tightening credit conditions globally, which are making it harder to secure funding for international trade.

U of M Consumer Confidence Remains Depressed in October

2008-10-31T15:41:00.000-07:00

The final University of Michigan consumer confidence figure for October held steady at 57.6, versus the preliminary reading of 57.5. The initial October reading dropped by the most on record (since 1978), when it fell from 70.3 in September.

The current conditions reading deteriorated slightly during October from 58.9 to 58.4, while the future expectations improved modestly to 57 from 56.7.

There was notable improvement in inflation expectations over the next year, which fell to 3.9% from 4.5%. This is the lowest reading since 3.6% back in February. The five year inflation expectations though rose to 2.9% from 2.8%.

Collapsing consumer confidence has fed directly into lower consumer spending, which is pulling down real GDP growth. The economic data does not look promising for a speedy recovery, as the financial markets remain in turmoil, and employment continues to decline. The timing of this slowdown is especially problematic for retailers as we head into the holiday season, which typically accounts for the highest percentage of annual sales. Recent reports show consumer spending falling at the fastest level in decades.

Chicago PMI Indicates Recession

2008-10-31T15:40:00.000-07:00

The Chicago Purchasing Managers Index for October fell much more than expected, falling to 37.8 from 56.7 in September. The market had looked for a decline to 48. This brings the index back down to its lowest level since the 2001 recession. Any reading below 50 indicates contraction.

Production plunged from 71.4 in September to 30.9 in October. New orders fell from 53.9 to 32.5. Order backlogs fell to 39 from 54.9, while inventories rose to 56.5 from 37.7. Employment fell to 41.5 from 49.1. Nothing was positive in this report except for the inflation front, where prices paid fell to 53.7 from 80.7.

Incomes and Spending Slowing, as Savings Rate Rises and Inflation Eases

2008-10-31T15:39:00.000-07:00

Personal income and spending growth are both decelerating, as expected. Income growth in September slowed to +0.2% MoM (consensus +0.1%, prior revised down to +0.4% from +0.5%). Personal spending contracted, shrinking by -0.3% MoM (consensus -0.2%, prior unch), the largest monthly drop in four years. This data confirms that the third quarter of this year had the weakest quarter of consumer consumption in decades. Inflation indicators eased less than expected, while the savings rate rose to +1.3%. The increase in the savings rate this month showed real determination on the part of savers, as there were no extra rebate checks to easily fund this growth.

Compensation rose +0.1% MoM, the smallest monthly rise since April. Disposable income improved, growing +0.2% MoM, the first increase in four months.

Purchases of durable and non-durable goods both dropped in September. Only demand for services, which accounts for almost 60% of spending, rose slightly. When adjusted for inflation, spending dropped an even larger -0.4% MoM, pulled down by an inflation-adjusted drop in durable goods spending of -2.9% MoM. Yesterday it was reported that spending on non-durable goods such as food and clothing fell by the most since 1950 in the third quarter of this year, with demand for durable goods falling the most in over 20 years. The steady deceleration in spending is a concern for the economy, which is heavily dependent on consumer spending. Weakening job prospects, declining net worth due to falling asset values, and tighter credit, suggest that the trend is likely to persist as the economy continues to weaken. This is an important contributor toward economists lowering growth prospects for the fourth quarter of this year and the first quarter of next year.

The PCE (personal consumption expenditures) deflator fell to 4.2% from 4.5% the prior two months. This indicator is viewed as the Fed's preferred measure of inflation for US consumers. The market had looked for a slightly larger decline to 4.1%. Core inflation rose +0.2% MoM in September, the same pace as August. Improvement was seen in the annual change in core PCE, which excludes more volatile food and energy prices, which eased down to +2.4% from the originally reported growth rate of +2.6% YoY in August, which was subsequently revised down to +2.5% YoY.

**************
Third quarter employment costs rose +0.7%, as expected, and the same pace as the first and second quarters. The annual increase, at +2.9% YoY, was the smallest rise since the first quarter of 2006. The second quarter's annual pace was +3.1%. Wages and salaries grew fast (+3.1% YoY) than benefits (+2.6% YoY) over the past year.

Today's Tidbits

2008-10-30T16:17:00.000-07:00

MISC
From Bloomberg: “Corporate borrowing in the U.S. commercial paper market soared the most on record after the Federal Reserve began buying the debt directly from issuers as part of its effort to lure back money-market investors. U.S. commercial paper outstanding rose by $100.5 billion, or 6.9 percent, to a seasonally adjusted $1.55 trillion for the week ended Oct. 29, the Fed said today in Washington. It was the first gain in seven weeks, reversing a 20 percent decline during the previous six weeks…. ``Knowing the Fed will buy the longer term means companies will be able to refinance and take backtheir short-term paper if need be.'' American Express Co., the biggest U.S. credit-card company, and General Electric Co. are among the companies that sold commercial paper to the Fed since the central bank began the program on Oct. 27 to unlock the short-term debt market.”
End-of-Day Market Update
From Bloomberg: “U.S. stocks rose after the economy contracted less than forecast in the third quarter and investors speculated global interest-rate cuts will stem a further slump. Intel Corp., Disney Co. and JPMorgan Chase & Co. climbed more than 5.3 percent after the government said the economy shrunk 0.3 percent last quarter. Colgate-Palmolive Co. jumped 7 percent on better-than-estimated earnings. The advance added to a global rally after Hong Kong joined the U.S. in lowering borrowing costs and the Federal Reserve provided $120 billion to spur lending in emerging markets. The Standard & Poor's 500 Index gained 23.93, or 2.6 percent, to 954.02. The Dow Jones Industrial Average added 189.73, or 2.1 percent, to 9,180.69. The Nasdaq Composite Index increased 41.31, or 2.5 percent, to 1,698.52. Almost seven stocks rose for each that fell on the New York Stock Exchange. ``There weren't any nasty surprises,'' in the economic data, …``GDP was better than expected. The real economy didn't fall as
dramatically as the financial markets. The central bank cuts are bringing a little bit of confidence.'' All 10 industry groups in the S&P 500 advanced after the decrease in GDP was less than the 0.5 percent forecast by economists in a Bloomberg survey. The benchmark for U.S. equities extended its gain this week to 8.8 percent. Russia's benchmark index rallied 19 percent and South Korea's climbed 12 percent after the Fed provided $120 billion to spur lending in emerging markets. Hong Kong's Hang Seng Index surged 13 percent and Taiwan's Taiex jumped 6.3 percent after their central banks lowered rates. The gains in developing nations pushed the MSCI Emerging Markets Index out of a bear market following a three-day jump of more than 20 percent. The S&P 500 is still down 35 percent in 2008 and 18 percent in October, poised for its worst month since 1987. The Fed cut its benchmark rate by 0.5 percentage point to 1 percent
yesterday and has reduced it from 5.25 percent in the past 13 months, while also creating lending programs to channel more than $1 trillion into the financial system in an effort to stem a recession that threatens to worsen corporate profits. Earnings for the 309 companies in the S&P 500 that have reported third-quarter results have dropped an average of 12 percent from a year earlier, according to Bloomberg data. Still, 206 of the companies have beaten analyst estimates, compared with 97 that missed.”
From UBS: “Rates rose again today as the coupon curve steepened. Price action was negative in the face of disappointing, though consensus economic news. Clearly the sense that equity and emerging markets are finding a foothold, combined with the almost daily issuance of UST, is keeping prices on the defensive. UST 2 Year yields rose 2.4 bps to the 1.60%, while UST 10 Year rose 7.3 bps to 3.95%. UST 10 Years are flirting with the last line of support at 3.95% before heading towards the recent yield highs of 4.10%. The UST2Y10Y curve steepened 5 bps to 235 bps. UST 30 Years traded as though they were on a mission again today as UST10Y30Y sector flattened by 4 bps…The UST 5 Year auction was respectable, stopping at 2.825%, +1.1 bps v. the 1:00 bid side. The cover was 2.48x, indirect bidders were $6.73B (28.3%) and the direct bidders were $3.4B (14.3%). Dealers purchased $13.7B or 57.4%. Stocks closed +190 at 9,180. The CRB was -7.80 at 266.54. Oil fell $2.21/bbl to $65.29. Treasury volume picked up slightly and traded at -20% of the 30d mva, compared to yesterday's -27%.... Economy Remains Under Stress: Initial Claims were basically in line with expectations at 479k, while the 4- week mva fell 5k to 475.5k. Continuing claims were -12k to 3715k, better than the 3735k estimate. Q3 GDP was -0.3% (UBSe -1.0%, -0.5%e) with PCE cratering -3.1% (-2.4%e). UBS Economics downgraded GDP forecasts today in recognition of recent deterioration in the economy. 08Q4 is now forecast to fall -3.5% (-1.5%p), 09Q1 is estimated at -1.5% (-0.5%p) and 09Q2 should be 0.0% (1.5%p). San Francisco Fed President Yellen (alternate), breaking with the traditional post-FOMC "blackout" period after the meeting, stated that recent data on the economy is "deeply worrisome" and it will be a "long way" before "significant healing." She also noted that the credit crunch has outpaced easing and implied that the Fed could move rates below 1.0% (Bloomberg)…Swap spreads were mixed across the curve with the desk seeing decent two way flow from limited players. Short dated and long dated swaps widened, while the intermediate spreads narrowed. There were some mortgage related flows and also some deal related hedging. Agency spreads were similarly mixed with FNMA 2 Years widening 9 bps to 150 bps, FNMA 5 Years +2 bps to 143 bps, while FNMA 10 Years narrowed 3 bps to 12 7 bps. Volatility was down again today, led by gamma. Vol remains at very high levels, and if the market doesn't move then it becomes expensive to pay away the time value. The VIX remains at an extremely high level of 63.”
Prices as of 5PM (Based on Bloomberg)
Three month T-Bill yield fell 20 bp to 0.38%
Two year T-Note rose 3 bp to 1.56%
Ten year T-Note yield rose 11 bp to 3.97%
30-year FNMA current coupon fell 2bp to 6.04%
Dow rose 190 points to 9181
S&P rose 24 points to 954
Dollar index fell 0.38 points to 84.69
Yen at 98.6
Euro at 1.292
Gold fell $17 to $738
Oil fell $1.70 to $65.80

GDP

2008-10-30T15:38:00.000-07:00

As expected, growth in the US contracted for the the first time since the third quarter of 2007, when it fell -0.2%, and the most since the 2001 recession. Real GDP fell -0.3% QoQ annualized (consensus -0.5%) in the 3rd quarter of 2008. This compares to growth of +2.8% in the 2nd quarter. This preliminary data will be revised again in November and December as more data becomes available. Over the past year, real GDP growth has slowed to +0.8% YoY, down from +2.1% YoY in the 2nd quarter.

The weakness was broad-based. Exports (+5.9% QoQ annualized) and inventories were supports to growth. If they are excluded, real GDP would have fallen an even larger -1.8%. Gross private investment fell -1.9%, the smallest decline in a year. Fixed investment fell -5.6% with residential investment easing by -19% and non-residential declining a more modest -1% in the quarter. Government spending rose +5.8%, with defense spending surging to +18% from +7% the prior two quarters.

Personal consumption was a huge detractor from growth in the third quarter. Personal consumption fell even more than expected, declining by -3.1% (consensus -2.4%, prior +1.2%). This was the first quarterly decline in spending since 1991, and the largest quarterly decline since 1980 when Volcker was hiking rates at the Fed to squash inflation. Durable goods spending fell a huge -14% quarterly annualized. Spending on non-durable goods fell -6.4%, the largest decline since 1950! The report also showed that inflation adjusted disposable income fell -8.7%, the most since records began in 1947. The impact was due to the timing of the rebate checks from the stimulus program which boosted the prior quarter by +11.9%

Record imported oil prices helped push the quarterly annualized growth in the GDP inflation deflator to 4.2% from 1.1% in the second quarter (consensus had looked for an increase of 4%). This was the largest rise in 17 years. The core PCE grew at a higher than expected +2.9% QoQ annualized pace, the fastest pace in 2 years. Consensus had looked for an increase to 2.5% from the 2.2% level in the second quarter.

Today's Tidbits

2008-10-29T16:19:00.000-07:00

Supply Replacement Still Important Constraint for Oil
From The Financial Times: “Output from the world’s oilfields is declining faster than previously thought, the first authoritative public study of the biggest fields shows. Without extra investment to raise production, the natural annual rate of output decline is 9.1 per cent, the International Energy Agency says in its annual report, the World Energy Outlook, a draft of which has been obtained by the Financial Times. The findings suggest the world will struggle to produce enough oil to make up for steep declines in existing fields, such as those in the North Sea, Russia and Alaska, and meet long-term demand. The effort will become even more acute as prices fall and investment decisions are delayed. The IEA, the oil watchdog, forecasts that China, India and other developing countries’ demand will require investments of $360bn each year until 2030. The agency says even with investment, the annual rate of output decline is 6.4 per cent. The decline will not necessarily be felt in the next few years because demand is slowing down, but with the expected slowdown in investment the eventual effect will be magnified, oil executives say. “The future rate of decline in output from producing oilfields as they mature is the single most important determinant of the amount of new capacity that will need to be built globally to meet demand,” the IEA says. The watchdog warned that the world needed to make a “significant increase in future investments just to maintain the current level of production”. The battle to replace mature oilfields’ output could even offset the decline in demand growth, which has given the industry – already struggling to find enough supply to meet needs, especially from China – a reprieve in the past few months…All the increase in oil demand until 2030 comes from emerging countries, while consumption in developed countries declines. As a result, the share of rich countries in global demand will drop from last year’s 59 per cent to less than half of the total in 2030. This is the clearest indication yet that the focus of the industry on the demand – not just the supply – side is moving away from the US, Europe and Japan, towards emerging nations.”
Short Sellers Rebut Evil Reputation for Being Bearish
From Bloomberg: “``Short selling is an expression of doubt, not a criminal activity,'' …``The management at Lehman, Bear Stearns and Merrill kept saying everything was fine. Then, every few weeks, they'd write off billions.' … The power of short sellers has been greatly exaggerated, says Douglas Kass, founder of Palm Beach, Florida-based hedge fund firm Seabreeze LP Holdings, which manages $200 million. ``The dedicated short pool totals about $5.5 billion,'' … ``Dedicated'' short-selling firms run funds that do nothing else. ``That's too small to have an impact,'' …The ban on short selling has exacerbated the financial crisis by driving dozens of hedge funds to the edge of bankruptcy, says Richard Baker, president of the Managed Funds Association, a hedge-fund-industry lobbying group. Quantitative hedge funds were put in the most jeopardy by the ban, he says. They use sophisticated computer algorithms to choose a group of stocks to buy. They then hedge the bet by shorting a second set of stocks. Their response to the short-selling ban has been to cut back on all trading, Baker says. Convertible bond funds have been hurt the most by the ban. Investors who buy convertible bonds -- bonds that can be converted to stock at a certain price -- usually short the same company's stock as a hedge against a fall in the price. Financial companies sold more than $30 billion of convertible bonds in the first nine months of 2008. In September, convertible bond arbitrage was the worst-hit hedge fund strategy, plunging 16.6 percent, … against a 6.9 percent fall for the industry. Most academic observers agree with Kass that the power of short sellers is overblown. ``In the current crisis, shorts are like flies on a carcass on the side of a road,'' says James Angel, a finance professor at Georgetown University in Washington who studies short selling. ``We should focus on who or what killed the animal.''…The short sellers have marshaled statistics in an effort to prove they played little or no role in the 2008 market downturn. Kass, for instance, points out that Morgan Stanley offers no data supporting CEO Mack's contention that short sellers were responsible when his company's stock price retreated 44.5 percent to an almost 10-year low of $22.55 in the three weeks ended on Sept. 18, the day short selling was banned. Morgan Stanley shares closed at $15.20 on Oct. 28, down 71 percent for the year. Data from custodians and brokerages compiled by London-based Data Explorers Ltd. show that as of Sept. 16, about 2.9 percent of Morgan Stanley's outstanding shares had been loaned to short sellers, down from more than 7 percent in July. According to Short Alert Research, a Charlotte, North Carolina-based firm that produces research for short sellers, from early July to late September short interest in 33 investment banks and brokers plunged by 33.3 percent. Yet, share prices still declined. ``It was the longs getting out,'' says Fleckenstein. ``Probably the insiders.''…the
SEC's short-selling ban and the federal government's $700 billion bailout package just postponed the day of reckoning. ``Capitalism is all about boom and bust,'' he says as he scans e-mails and monitors stock prices. ``To ban short selling is to say that the government is going to determine what stock prices should be.''
Fed Pushing Exchanges to Create Clearinghouse for OTC Credit Default Swaps
From Bloomberg: “The Federal Reserve has given U.S. futures exchanges until Oct. 31 to present written plans on how they'll make the $55 trillion credit swaps market less risky, according to four people familiar with the discussions. CME Group Inc. and Intercontinental Exchange Inc., the two biggest U.S. futures markets, are among companies vying for a share of the market for guaranteeing credit-default swaps, the volatile contracts blamed for the current financial crisis. …The Fed is pressing the industry to set up a central counterparty that would absorb losses should a market maker fail, a step that might have avoided last month's bankruptcy of Lehman Brothers Holdings Inc. The process may be heading toward a conclusion, said Brian Yelvington, a strategist at fixed- income research firm CreditSights Inc. in New York…. ``You're going to see one of these solutions come to fruition in the next four weeks.'' The Federal Reserve Bank of New York is seeking details on how credit-default swaps would be settled by a clearinghouse, how trades would be processed, what safeguards are in place in the event of a trader bankruptcy and how the system will insure against a meltdown similar to Lehman Brothers… Federal Reserve officials are not aiming to pick a winner to operate a clearinghouse, the people said. Rather, the central bank is hoping to set up a framework for the eventual winner…. Regulatory approvals to enact a framework may be in place as early as mid-November, the people said. Credit-default swaps pay buyers face value for the nderlying securities, or a cash equivalent, should the company fail to keep to its debt agreements. The swaps are blamed for hastening the bankruptcy of Lehman Brothers by driving down the investment bank's equity value. Because CDS contracts are traded bilaterally by banks, hedge funds, insurance companies and other institutional investors, each party faces the risk of losses should their trading partners default. A clearinghouse, capitalized by its members, all but eliminates the risk of trading-partner default by being the buyer for every seller and the seller for every buyer. It employs daily mark-to-market pricing and liquidates positions of traders who can't pay their margin. The four groups vying to operate clearing operations include partnerships of Chicago-based CME Group and Citadel Investment Group LLC, and Intercontinental Exchange, dealer- owned Clearing Corp. and credit-swap index owner Markit Group Ltd. Eurex AG and NYSE Euronext also have submitted proposals.”
International Trade Growth Has Rapidly Contracted Due to Fewer letters of Credit
From Bloomberg: “The inability of buyers in China and Vietnam to get letters of credit has cost his company as much as $4 million this year, a third of projected revenue, forcing him to lay off 15 of 35 employees, he said. Suppliers of oil, coal, grains and consumer products from Chicago to Mumbai are losing sales as the credit crisis spreads beyond financial institutions, and banks refuse financing or increase the fees for buyers. Coupled with declining demand, the credit squeeze is threatening international trade, one of the lone bright spots in the global economy… Emerging markets such as Brazil, Vietnam and South Africa are particularly vulnerable because buyers have more trouble proving their financial strength. The slowdown is also damaging the U.S., the world's largest economy, where exports accounted for almost two-thirds of the 2.1 percent growth in gross domestic product in the 12 months through June, according to the U.S.
Trade Representative's office. Another sign of trouble: The Baltic Dry Index, a measure of commodity shipping costs that banks watch as an economic indicator, fell below 1,000 yesterday for the first time in six years, dropping it 89 percent for the year. Global trade volumes may sink next year, their first decrease since 1982, according to Andrew Burns, a lead economist at the World Bank. While there is still uncertainty over future prospects, trade may contract by as much as 2 percent, after annual increases of 5 percent to 10 percent over the past decade. `We only see this kind of shock when we have outbreaks of war, or maybe the oil shocks of the 1970s,'' …. ``This lack of credit was a shock to the entire economy. We were hit second after the banks.'' Of the $13.6 trillion of goods traded worldwide, 90 percent rely on letters of credit or related forms of financing and guarantees such as trade credit insurance, according to the Geneva-based World Trade Organization. Letters of credit are centuries-old instruments that allow far-flung partners to complete large transactions. An importing company gets its bank to issue the letter, guaranteeing payment for a delivery. That bank provides the letter to the exporter's bank, which then guarantees payment to the exporting company. The system breaks down when banks don't trust one another and are unwilling to accept a letter of credit as proof that payment is coming. From 2000 through last year, the use of letters of credit declined to about 10 percent of global trade transactions, the IFC's Stevenson said. Over the past six months, they began ``roaring back into fashion'' as sellers sought to guarantee
payments from buyers they no longer trusted, he said. At the same time, liquidity problems caused banks to increase charges. The cost of a letter of credit has tripled for buyers in China and Turkey and doubled for Pakistan, Argentina and Bangladesh, said Uwe Noll, director of country risk sales at Deutsche Bank AG. Banks are now charging 1.5 percent of the value of the transaction for credit guarantees for some Chinese transactions, bankers say. ``The whole global trade production line relies on letters of credit,'' Matt Robinson, an analyst at Moody's Economy.com wrote in an Oct. 23 report. ``No letters of credit, no transactions -- and no transactions mean no international trade.'' The evidence is piling up in the world's ports…. ``This is absolutely a crisis situation here,'' … the demise of his deals with Asian buyers also reflects the weakness of the U.S. economy, including a slowdown in construction that has reduced demand for the wood products companies such as Shanghai VIVA make. Liu Jian Jun, manager of Shanghai VIVA, said weak demand inthe U.S. and elsewhere killed the deal with Cross Creek, not access to credit…. ``We've become more cautious,'' Ng said, blaming the
retrenchment on a decline in the number of credit-worthy customers. Bank bailouts funded by the U.S. and other governments have begun to ease liquidity problems. ``But we still have credit issues,'' he said. ``And they are going to get worse, not better, because the economy is getting worse.''”
End-of-Day Market Update
From UBS: “Yields rose from the belly of the curve out to the long bond and the UST2Y10Y curve steepened to 230 bps post rate cut. The market is grappling with the prospects of deteriorating data, possible further monetary accommodation, and massive forward supply. It will be difficult, however, for the front end of the curve to escape the gravitational pull of a 1% Fed Funds rate, especially when faced with the potential further easing in the pipeline. The UST 2 Year is currently about 50 bps over the Fed Funds Rate, which may represent fair value at this point. …Libor was set 4.5 bps lower today at 3.42%. The Dow closed -74 at 8,990. The CRB was +15.3 at 274. Oil ws $68.05/bbl, +$8.48. Treasury volume was -27% below the 30 day mva. The day of the last scheduled rate decision, September 16th, it was 71% above the 30 day mva…: UBS Economics Forecasts More Cuts to Come: The Fed rate cut was the predictable highpoint of the day. While the -50 bps cut was widely forecast, the statement was analyzed for signs of future intent. UBS Economics now forecasts a terminal Fed Funds Rate of 0.50%, with a -25 bps cut in December and -25 bps in January. In other news, more entities are trying to obtain government reprieves, outright funding, or guarantees to address their special interests. The Committee on Investment of Employee benefits is petitioning Congress for relief from provisions of the Pension Protection Act of 2006. The rapid erosion of financial assets has left many defined benefit plans with a gaping asset-liability mismatch. The rules begin to be implemented as of 12/31/08 with effect in 2009. Penalties are onerous and in some cases obligations could fall into the Pension Benefit Guaranty Corporation (Bloomberg). Treasury and FDIC are in the process of finalizing details for a proposed government guarantee plan for troubled mortgages. Loan guarantees of up to $500B will be used as incentives to servicers in the hope that this will encourage them to modify loans (Bloomberg). ..Spreads narrowed against the backdrop of relatively low realized rate volatility, a -50 bps rate cut and a statement which left the door open to more accommodation, and a relatively anxiety free trade in the equity and f/x markets. Stability breeds confidence which enables risk taking. Swap spreads narrowed -5 bps to 112.5 in 2Y, -5.5 bps in 5Y to 106.5, -4.25 bps in 10Y to 49.0, and -0.5 bps in 30Y to 4.0 bps. GSE benchmarks also narrowed with 2Y -4.0 to 145, 5Y -90 to 148, and 10Y -9.5 to 121.5. We continue to believe that short GSE spreads represent good value. MBS do not appear to be trading well, as they closed at +200 bps against a 50/50 weighting of 5Y & 10Y swaps. Lack of buyers and forced sellers seems to be the order of business.“
Prices as of 5PM (Based on Bloomberg)
Three month T-Bill yield fell 17 bp to 0.58%
Two year T-Note fell 11 bp to 1.53%
Ten year T-Note yield rose 2bp to 3.85%
30-year FNMA current coupon steady at 6.06%
Dow fell 74 points to 8991
S&P fell 10 points to 930
Dollar index fell 2.39 points to 84.64
Yen at 97.5
Euro at 1.29
Gold rose $10 to $756
Oil rose $5.50 to $68.25

Fed Cuts Rates 50bp, As Expected

2008-10-29T15:36:00.000-07:00

U.S. Federal Open Market Committee's Oct. 29 Statement: Text
2008-10-29 18:18:05.160 GMT

Oct. 29 (Bloomberg) -- The following is the full text of the
statement released today by the Federal Reserve in Washington:
The Federal Open Market Committee decided today to lower its
target for the federal funds rate 50 basis points to 1 percent.
The pace of economic activity appears to have slowed markedly,
owing importantly to a decline in consumer expenditures. Business
equipment spending and industrial production have weakened in
recent months, and slowing economic activity in many foreign
economies is damping the prospects for U.S. exports. Moreover,
the intensification of market turmoil is likely to exert
additional restraint on spending, partly by further reducing the
ability of households and businesses to obtain credit.
In light of the declines in the prices of energy and other
commodities and the weaker prospects for economic activity, the
Committee expects inflation to moderate in coming quarters to
levels consistent with price stability.
Recent policy actions, including today's rate reduction,
coordinated interest-rate cuts by central banks, extraordinary
liquidity measures, and official steps to strengthen financial
systems, should help over time to improve credit conditions and
promote a return to moderate economic growth. Nevertheless,
downside risks to growth remain. The Committee will monitor
economic and financial developments carefully and will act as
needed to promote sustainable economic growth and price
stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke,
Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke;
Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra
Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.
In a related action, the Board of Governors unanimously approved
a 50-basis-point decrease in the discount rate to 1-1/4 percent.
In taking this action, the Board approved the request submitted
by the Board of Directors of the Federal Reserve Bank of Boston,
New York, Cleveland and San Francisco.
--Washington newsroom +1-202-624-1820. Editor: Chris Anstey

Retail Sales Sink Without Tax Rebates To Support Spending

2008-09-12T13:34:00.000-07:00

Retail sales fell more than expected in August, dropping -0.3% MoM (consensus +0.2%, prior revised down to -0.5% from -0.1%). As retail sales account for about 30% of total consumer spending, which in turn accounts for about 70% of GDP, a slowdown here is bad for the economy. If auto sales are excluded, retail sales fell -0.7% MoM (consensus -0.2%, prior +0.3%), for the largest decline this year. Clearly, the impact of the tax rebate checks has faded fast as wages struggle to keep up with inflation and unemployment rises. Tightening credit is not helping the situation either. The sales declines were broad-based in August. Declines were seen in electronics, building materials, clothing, and even gas station sales (-2.5% MoM). The drop in gasoline prices was apparent. Excluding gasoline, retail sales were unchanged last month after falling -0.6% MoM in July. New incentives helped auto sales rise for the first time since January, growing +1.9% MoM after hitting a 15-year low in July. Department store sales experienced their largest drop in over a year at -1.5% MoM. Sales at non-store retailers (internet) fell an even larger -2.3%, for the largest drop since March 2007. Sales of goods excluding autos, gasoline, and building materials fell -0.2% MoM, the most this year. Back-to-school sales have been relatively weak this year hurting clothing retailers such as Gap and Target. Over the past year, retail sales have fallen -0.4% YoY, with sales excluding gasoline falling -2.8% YoY. Areas seeing the most weakness over the past year include motor vehicles (-17% YoY), furniture and building materials have both fallen -8.3% YoY, and department store sales have slid by -4.4% YoY. Strength has been seen in gasoline stations (+21% YoY), due to higher oil prices, and food (+6.4% YoY), again due to higher prices. General merchandise (+4.6% YoY) and sporting goods (+3.2% YoY) have also improved.

Lower Energy Prices Reduce Headline PPI, But Core Rises to 17-Year High

2008-09-12T13:33:00.001-07:00

Lower energy prices (-4.6% MoM, and biggest monthly drop in almost two years) let producer price inflation fall even more than expected in August, and for the first time in 2008. The headline PPI fell -0.9% MoM (consensus -0.5%, prior +1.2%) and eased back to 9.6% YoY from +9.8% in July. The market had looked for a further surge higher to +10.2% YoY. Core PPI, which excludes food and energy costs, came in closer to expectations, helped by falling vehicle prices. Over the past year, core PPI has continued to rise, growing by +3.6% YoY in August versus +3.5% YoY in July. This puts core PPI at the highest level since 1991. On a monthly basis, core PPI rose +.2% MoM, as expected, down from the +0.7% MoM pace of the prior month when oil prices spiked to a new record high. Excluding just energy, prices rose +.2% MoM and +5% YoY. Excluding only food, prices fell -1.2% MoM and rose +9.8% YoY. Consumer goods fell -1.2% MoM in August, but are up 12% YoY. The declines this month were led by natural gas falling -5% MoM and gasoline declining by -3.5%. The largest increase for a major category was in women’s apparel, which rose +.9% MoM. Passenger car prices eased back down, falling -0.3% MoM after rising +1.4% MoM in July. Capital goods prices rose +0.1% MoM (+3.2% YoY). This category includes computers (-1.2% MoM) and light trucks (-1.9% MoM), as well as civilian aircraft (+0.7% MoM). Intermediate goods prices fell for the first time in over six months, easing down by -1% MoM, but are still -17% higher YoY. Excluding food and energy, intermediate prices rose a relatively robust +1.7% MoM, which will remain a concern. Crude goods prices fell an even stronger -12% MoM, but are still up +38% YoY. The large drop in crude goods prices was for energy, which fell -20% MoM, but is still +59% higher YoY. The Fed will appreciate these inflation numbers, which supports their assertion that inflation will moderate as the economy slows. Slowing growth, both in the US and around the world, are helping ease the demand pressures for goods and commodities.