US Treasury Market “Bubble” – Given the extent of the recent US Treasury market rally on the heels of 2 Fed eases, precipitated by subprime loan problems, credit market seizures, and equity market contraction, the rally appears from most perspectives as being heavily overdone. The following 2 charts take a look at current market yields in an attempt to measure returns against a backdrop of rate expectations.
The bond market has several forecasting indicators that predict market yields. Some are the result of actively traded markets, while some are the median predictions of trained analysts and economists. At present, over roughly the next 2 years, current US Treasury market yields are all below market indicators that forecast where yields should be. Particularly in the short-end of the Treasury curve, Treasury yields are currently driven by an extraordinary flight-to-quality trade where investors facing losses in equities, mortgages, commercial paper, currencies, and other markets, have forsaken their risks and bought US Treasuries as a security measure. In bonds, excessive demand drives yields down. At present, US Treasury yields are very rich and potentially don’t even cover the cost of inflation rates, meaning the market’s “take-home” yield is actually negative.
Another method to measure if current market yields are attractive is to compare yields against inflation. The following chart details this comparison.
The chart above points to a distressing fact in today’s market, where investors are oblivious to the negative effects of inflation. Next week’s release of CPI is expected to show a current inflation rate of 3.5%. Deducting CPI’s cost against current market yields either totally eats up the return or leaves very little left over. The root cause of this is excess demand in Treasuries as a haven for risk in other areas. However, it appears investors are ignoring the most important risk to bonds – the risk of inflation.
Monday, November 12, 2007
Monday, September 24, 2007
Weekly Report 9/24/07
DE KONING & COMPANY, LLC
W E E K L Y E C O N O M I C & I N T E R E S T R A T E M O N I T O R
ECONOMIC CALENDAR PREVIEW (week of September 24, 2007)
Day Release Period Survey Actual Prior Revised
Monday No Releases
Tuesday S&P/CS Composite-20 YoY JUL -4.0% -- -3.5% --
S&P/CS Home Price Index JUL -- -- 199.2 --
Consumer Confidence SEP 104.0 -- 105.0 --
Richmond Fed Manufacturing Index SEP 5 -- 2.3% --
Existing Home Sales AUG 5.49M -- 5.75M --
Existing Home Sales MoM AUG -4.6% -- -0.2% --
ABC Consumer Confidence SEP 23 -- -- -- --
Wednesday MBA Mortgage Applications SEP 21 -- -- -- --
Durable Goods Orders AUG -3.5% -- 5.9% --
Durable Goods Ex Transportation AUG -0.8% -- 3.7% --
Initial Jobless Claims SEP 22 317K -- 311K --
Continuing Claims SEP 15 2555K -- 2544K --
GDP Annualized 2Q F 3.9% -- 4.0% --
Personal Consumption 2Q F 1.4% -- 1.4% --
GDP Price Index 2Q F 2.7% -- 2.7% --
Core PCE QoQ 2Q F 1.3% -- 1.3% --
Thursday New Home Sales AUG 828K -- 870K --
New Home Sales MoM AUG -4.9% -- 2.8% --
Friday Help Wanted Index AUG 24 -- 25 --
Personal Income AUG 0.4% -- 0.5% --
Personal Spending AUG 0.4% -- 0.4% --
PCE Deflator YoY AUG -- -- 2.1% --
PCE Core MoM AUG 0.1% -- 0.1% --
PCE Core YoY AUG 1.8% -- 1.9% --
Chicago Purchasing Manager SEP 53.0 -- 53.8 --
Construction Spending MoM AUG -0.2% -- -0.4% --
U. of Michigan Confidence SEP F 84.0 -- 83.8 --
Market Preview
Next week’s scheduled economic releases are expected to focus on many different fronts including housing, manufacturing, inflation and the consumer. Likely to be most closely watched will be those numbers related to the consumer’s health, given the market’s recent concerns over the economy and its roughly 70% control over the economy. As such, consumer-focused releases will come from Tuesday’s Consumer Confidence for September, expected to carry a 104.0 reading, the weekly ABC Consumer Confidence readings, Wednesday’s Personal Consumption figures for the 2nd Quarter and finally, from Friday’s triple reports of Personal Income, Personal Spending and September Final for the University of Michigan Consumer Confidence Index.
Housing-related data will carry near-equal weight where releases come from Tuesday’s S&P/CS Home Price Index and Existing Home Sales, expected to be down 4.6% from July. Thursday’s release of New Home Sales completes the housing picture for the week. Manufacturing data is reflected in reports from the Richmond Fed, Durable Goods Orders, and GDP for the 2Q07 and the Chicago Purchasing Manager’s Index. Lastly, any inflationary pricing pressures will be covered in the GDP’s Personal Consumption Index and the GDP Price Index, both expected to show contained prices.
In keeping with last week’s start of the quarterly earnings season, expect new and industry-leading companies’ releases to shape performance in the week’s equity markets. Expect bond markets to be primarily impacted by updated views about the likelihood of an economic recession.
ECONOMIC CALENDAR REVIEW (week of September 17, 2007)
Day Release Period Survey Actual Prior Revised
Monday Empire Manufacturing SEP 18.0 14.7 25.1 --
Tuesday Producer Price Index MoM AUG -0.3% -1.4% 0.6% --
PPI Ex Food & Energy MoM AUG 0.1% 0.2% 0.1% --
Producer Price Index YoY AUG 3.2% 2.2% 4.0% --
PPI Ex Food & Energy YoY AUG 2.2% 2.2% 2.3% --
Net Long-Term TIC Flows JUL $85.0B $19.2B $120.9B $97.3B
Total Net TIC Flows JUL $60.0B $103.8B $58.8B $34.4B
NAHB Housing Market Index SEP 20 20 22 --
FOMC Rate Decision Expected SEP 18 5.00% 4.75% 5.25% --
ABC Consumer Confidence SEP 16 -- -15 -17 --
Wednesday MBA Mortgage Applications SEP 14 -- 2.4% 5.5% --
Consumer Price Index MoM AUG 0.0% -0.1% 0.1% --
CPI Ex Food & Energy MoM AUG 0.2% 0.2% 0.2% --
Consumer Price Index YoY AUG 2.1% 2.0% 2.4% --
CPI Ex Food & Energy YoY AUG 2.2% 2.1% 2.2% --
CPI Core Index SA AUG -- 211.250 210.933 --
Consumer Price Index NSA AUG 208.000 207.917 208.299 --
Housing Starts AUG 1350K 1331K 1381K 1367K
Building Permits AUG 1348K 1307K 1373K 1389K
Thursday Initial Jobless Claims SEP 15 321K 311K 319K 320K
Continuing Claims SEP 8 2575K 2544K 2585K 2597K
Leading Indicators AUG -0.4% -0.6% 0.4% 0.7%
Philadelphia Fed. SEP 2.6 10.9 0.0 --
Friday No Releases
Last Week’s Market in Review
Markets last week were startled by news of the Fed’s larger-than-expected rate cuts, causing markets to square up to the new operating environment. As such, the following set of commentary is an attempt to report on changes in particular market segments while adding some perspective in the process.
Economic Statistics
Most economic numbers released last week were near or below their expectations, helping to solidify the Fed’s need to take more aggressive action, however some data clearly didn’t support the Fed’s moves, leading some market participants to question whether the Fed may have gone too far, bailing out risky investor behavior and violating the principle of moral hazard. In general, most inflationary numbers did give the all-clear sign for the Fed to lower rates, although with commodity prices hitting near-daily record highs, it’s a challenging debate to square up market activity with such benign inflationary readings, particularly the PPI numbers. Data not supporting the Fed’s moves were centered on manufacturing and employment. The Empire Manufacturing and Philly Fed reports showed manufacturing continuing to hum right along, perhaps benefiting from a lower US$ in world markets, while most troubling was the weekly Jobless Claims numbers, both Initial and Continuing. These numbers clearly threw a wrench into the market’s expectations of a recession, as both releases showed jobless claims contracting significantly. With last month’s weak Employment Report acting as the harbinger of swinging sentiment towards a declining economy and the need for a Fed rescue of sorts, this past week’s Jobless Claims figures bring into serious question last month’s Employment numbers, which may have an upward revision in its future. You may recall that August’s NonFarm Payroll numbers that showed a contraction of 4,000 jobs was mostly the result of a precipitous decline in government jobs. Some analysts suggested that a seasonal distortion in government jobs caused by teachers returning to classes may have been the primary reason for the decline, making the likelihood of later revisions possible.
Bond Markets
Commercial Paper – Asset-Backed Commercial Paper (ABCP) saw significant improvement last week, benefiting both from Fed action and lower perceived credit risks in the market, mostly the result of the ejection of defunct issuers in this market. Despite the market stabilization for the week, difficult markets prevailed as concerns over the market value of the assets collateralizing the ABCP continued to make it challenging environment to attract buyers. CP yields fell 44bp to end the week at 5.19% while outstanding CP balances continued to fall, ending the week at $1.87T, where an additional $48.1 billion in CP fell from the market. The CP market has now declined in each of the last 6 weeks, bringing it to the lowest outstanding CP market in the last 7 years. Declines in ABCP outstanding contributed $15.6 billion of the overall decline.
In improvements in the CP market in European markets, the Bank of England announced last week that they would copy the Fed’s move from a few weeks ago and will now accept 3-Month Commercial Paper as collateral for 3-Month borrowings from the central bank. This has significantly improved the standing of CP markets overseas.
Treasury Bills – Demand for 1, 3, & 6-month US Treasury bills increased again for the 4th straight week, causing yields to fall in response. Yields fell 53, 22 & 12 basis points to yields of 3.31%, 3.77% and 4.09%, respectively. Actions by the Fed and concerns over the potential rise of inflationary pressures from these actions steepened the short-end yield curve.
Treasury Notes - 2-10 year maturity US Treasury notes fell on the week, steepening the yield curve in the process. The closely-watched 2-10-year maturity spread rose 16bp over the week to a spread of 58bp. Yields for 2-Yr notes rose 1bp to end the week at 4.05% while the benchmark 10-Yr U.S. Treasury note also fell on the week, sending its yield up 17bp to a 4.63% level.
TIPS – Treasury Inflation-Protected Securities experienced a highly eventful week leading the benchmark 10-year security to see its yield rise 10bp to a 4.70% level. This yield increase was the result of a combination 20bp rise in the security’s real yield to 3.30% on investor’s revised views of higher future inflation and an updated CPI rate released last week that showed a lower year-over-year price rise. On the year, TIPS have generated the highest return of any investment-grade class of securities in the fixed income markets. Sporting a 6.54% return year-to-date, vs. a US Government Credit Index that has generated a return of 3.82% over the same period. In an era of higher expected inflation rates, TIPS would be expected to benefit more than nominal securities, due to this security’s unique capability of protecting investors from the negative effects of inflation.
Interest Rate Markets
Fed Funds – After last week’s surprise rate cut of 50bp by the FOMC to 4.75%, the options market is currently forecasting another rate cut by the October meeting to 4.50%. Options for the Fed Funds target rate forecast a 48% chance of a 25bp cut in the target Fed Funds rate, equivalent to the forecast of a 25bp rate cut held the prior week. The market holds a 37% chance of no change in the rate. [See FOMC Fed Funds Target Implied Probability Chart below]
LIBOR – Last week, actions by the Bank of England and the Fed served to reduce risks in most European markets, allowing LIBOR to fall. On the week, 3-Month LOBOR fell about 50bp, both on lower perceived risks to credit markets and the Fed’s rate cuts.
TED Spread – the “TED” spread, defined as the difference in Treasury vs. Euro-Dollar (or more precisely LIBOR) rates contracted by 23bp to end the week at a spread of 143bp. The TED spread has averaged a level of 50bp over the past 12 months 3-Month LIBOR rates fell to a 5.20% level, down about 44bp, while 3-Month Treasury bill yields fell a smaller amount of 22bp, ending the week at a yield of 3.77%. A significant improvement in the European financial markets and a reduction in short-term T-Bill rates on the view the Fed may be on the verge of a series of rate reductions designed to revive economic growth rates..
Discount Rate – The FOMC chose to reduce the discount rate at last week’s scheduled meeting by an equivalent amount as the targeted Fed funds rate, moving the lending rate to a 5.25% level.
Stock Markets
Stock market volatility fell significantly last week after the Fed’s move brought order to markets by reducing both the Fed Funds and Discount Rate. With a lower discount rate to apply to earnings models, stock markets rallied on the Fed’s news, ending up around 3% on the week from the previous week’s close. This was the largest one-week gain since March of this year. Year-to-date, the Dow Jones Industrial Average has risen 10.9%, while the S&P 500’s rise has been less robust at 7.6%. Large-cap stocks have led the markets this year primarily on their larger overseas exposures, which have benefited from a lower US$. The NASDAQ has risen 10.6% over the same time period as technology stocks have benefited from a strong level of business capital spending. While these returns are strong, they pale in comparison to the Chinese stock market’s impressive rise of 167.9%, also year-to-date.
The CBOE’s VIX index, which measures volatility in the S&P 500, fell significantly to a week-ending level of 19.00 from the previous week’s close of 24.92, and down from recent highs above 30, but still above its 1-year average of 14.60.
Currency Markets
US$ - On news of the Fed’s move with the Fed Funds and Discount Rates, the US$ lost even more ground last week, closing Friday at a 78.59 level against other major currencies, after hitting an intra-week low of 78.40. Only against the Japanese Yen did the dollar show any strength. Against the Canadian dollar, popularly referred to as the Loonie, value parity was reached, making both currencies’ value equal for the first time since 1976. Traders expect the dollar’s value to fall further, particularly if the Fed continues to reduce its targeted Fed Funds rate.
Commodity Markets
Commodities - as represented by the Continuous Commodity Index, or CCI, rose an additional 3.4% from the prior week as commodity prices reacted to supply constraints. This index has rallied over 10% higher over the last month. Crude oil continued to lead the index higher, closing the week at $81.620 per barrel, up $2.52, and after closing at an intra-week high of $83.90. Tensions with Iran resurfaced on the week, pushing traders to rally the commodity on views of possible supply disruptions. Other markets, such as corn and wheat continued to rally as well, with wheat continuing to hit another all-time high, closing the week at $874 per contract of 50,000 bushels, up $36 from the previous week’s close.
Fed and Global Central Banks
The U.S. Federal Reserve and the Bank of England garnered the spotlight last week, as the markets essentially forced both central banks’ hands to abandon the argument of moral hazard and move to restore market calm. The Bank of England’s moves were the most debated as their stronger views on moral hazard had caused them to avoid the prospects of bailing out its own markets, which saw the debate focus on the troubles of Northern Rock, Plc, a British building society (Britain’s equivalent of a U.S. thrift). Northern Rock had seen the value of its balance sheet deteriorate rapidly from recent market turmoil. At first, the BoE essentially ignored the troubles on the view of moral hazard, which implies that coming to its rescue would have effectively bailed out risky market behavior. When the BoE did act, they did so by copying the U.S. Fed’s recent allowance of accepting mortgage loans as collateral to any central bank borrowing. This news had the unintended effect of creating a run on the institution’s deposits. Arguing that their new plan would be focused on rescuing depositors, not shareholders, the BoE then took the drastic step of guaranteeing all or Northern Rock’s depositors regardless of their balances. On this news, the run was halted and European markets reacted favorably, sending LIBOR down to end the week at a 5.20% level.
The Fed’s spotlight was more timed as the scheduled FOMC meeting was widely expected to force the Fed’s hand through a 25bp cut in the targeted Fed Funds rate. When the Fed announced its move, it shocked most market participants by cutting both the Fed Funds and Discount Rate by 50bp, to 4.75% and 5.25%, respectively. In its closely-watched “statement” the Fed said it made its moves to prevent the downturn in the nation’s housing market from having further negative impact to the economy. Debates surfaced on the news, as several market participants began questioning the move based on arguments such as the potential of the move to raise inflationary expectations, to being non-supportive of the US$, to violating the Fed’s “moral hazard”. Most all analysts deemed this move as the establishment of the “Bernanke Put”. During Greenspan’s tenure as Fed Chairman, his accommodative moves to restore investor calm and promote growth were styled as the “Greenspan Put”, referring to a put as an investment security designed to provide gains in down markets.
Other market participants looked upon the Fed’s moves with even more questions. While most all welcomed the Fed’s moves on the views of it restoring calm and helping markets recover, there is a growing chorus of calls for the Fed to initiate some form of punishment to those viewed as having gotten the economy into this mess. Congress and other politicians have focused on the easy route, criticizing lenders’ actions as “predatory” and the result of “risky lending practices” over the past several years. The result has been a slew of bills and televised hearings. But other more thoughtful analysts have looked beyond that view to a deeper culprit, that of the ultimate buyer of subprime loans. In most cases these buyers are hedge funds. These analysts argue that subprime loans would not have been originated in the manner and depth in which they were, if it weren’t for the fact that willing buyers stood ready to assume the risks. The risk for prime loans is assumed by some market investors, but mostly by Fannie Mae, Freddie Mac and Ginnie Mae. No such governmental entity exists to buy subprime loans, with the exception of some small programs administered by the Federal Housing Authority, or FHA. Even deeper still, these analysts argue the extensive use of leverage by these subprime buyers (mostly hedge funds) has taken a loan type that represents only about 17% of the entire mortgage market and made it into a much larger problem through the extensive use of leverage. As all hedge funds are completely unregulated, these funds engage in behavior that most market investors would never consider, only to have the emergence of the Bernanke Put bail them out, by lowering their cost of funds. Just as leverage is limited in all markets, either by regulation or more conservative business practices, these analysts are using this as a wake-up call to the dangers that unregulated and highly aggressive investors can unleash on markets that are forced to obey the rules.
Economic / Interest Rate Survey
The following table details an August 9th survey of approximately 75 of the nation’s leading economists.
Indicator 3Q07 4Q07 1Q08 2Q08 3Q08 Avg. 2007
GDP 2.4% 2.2% 2.4% 2.5% 2.8% 2.0%
Prev. Survey 2.5% 2.6% 2.7% 2.8% 2.8% 2.0%
Cons. Spend. 2.2% 2.3% 2.5% 2.5% 2.5% 2.8%
Prev. Survey 2.3% 2.7% 2.6% 2.6% 2.6% 2.8%
Unemp. Rate 4.7% 4.7% 4.8% 4.9% 4.9% 4.6%
Prev. Survey 4.6% 4.7% 4.7% 4.7% 4.7% 4.6%
CPI 2.6% 3.3% 2.8% 2.2% 2.3% 2.7%
Prev. Survey 2.6% 3.4% 3.0% 2.3% 2.3% 2.8%
Indicator 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08
Fed Funds 5.00% 4.75% 4.75% 4.75% 4.75% 4.75%
Prev. Survey 5.25% 5.25% 5.25% 5.25% 5.25% 5.25%
10-Yr. Note 4.55% 4.63% 4.75% 4.90% 5.00% 5.00%
Prev. Survey 4.90% 5.00% 5.10% 5.15% 5.20% 5.25%
2-Yr. Note 4.20% 4.30% 4.40% 4.50% 4.60% 4.70%
Prev. Survey 4.80% 4.86% 4.90% 4.90% 5.00% 5.00%
Q07 4Q07 1Q08 2Q08 3Q08 Avg. 2007
Interest Rate Chart
Source: C15 Bloomberg
The chart above details the current US Treasury yield curve, along with the same yield curve 1 and 12 months ago.
FOMC Fed Funds Target Implied Probability Chart
The following chart details the market’s views of the probability of changes in the Fed Funds Target rates. Chart 1 shows the option market’s probabilities (of a change in the Fed Funds target level) over a timeframe covering each of the FOMC meetings held over the next several months.
CHART 1
Expected Future Outcomes and Most Likely Path(s)
W E E K L Y E C O N O M I C & I N T E R E S T R A T E M O N I T O R
ECONOMIC CALENDAR PREVIEW (week of September 24, 2007)
Day Release Period Survey Actual Prior Revised
Monday No Releases
Tuesday S&P/CS Composite-20 YoY JUL -4.0% -- -3.5% --
S&P/CS Home Price Index JUL -- -- 199.2 --
Consumer Confidence SEP 104.0 -- 105.0 --
Richmond Fed Manufacturing Index SEP 5 -- 2.3% --
Existing Home Sales AUG 5.49M -- 5.75M --
Existing Home Sales MoM AUG -4.6% -- -0.2% --
ABC Consumer Confidence SEP 23 -- -- -- --
Wednesday MBA Mortgage Applications SEP 21 -- -- -- --
Durable Goods Orders AUG -3.5% -- 5.9% --
Durable Goods Ex Transportation AUG -0.8% -- 3.7% --
Initial Jobless Claims SEP 22 317K -- 311K --
Continuing Claims SEP 15 2555K -- 2544K --
GDP Annualized 2Q F 3.9% -- 4.0% --
Personal Consumption 2Q F 1.4% -- 1.4% --
GDP Price Index 2Q F 2.7% -- 2.7% --
Core PCE QoQ 2Q F 1.3% -- 1.3% --
Thursday New Home Sales AUG 828K -- 870K --
New Home Sales MoM AUG -4.9% -- 2.8% --
Friday Help Wanted Index AUG 24 -- 25 --
Personal Income AUG 0.4% -- 0.5% --
Personal Spending AUG 0.4% -- 0.4% --
PCE Deflator YoY AUG -- -- 2.1% --
PCE Core MoM AUG 0.1% -- 0.1% --
PCE Core YoY AUG 1.8% -- 1.9% --
Chicago Purchasing Manager SEP 53.0 -- 53.8 --
Construction Spending MoM AUG -0.2% -- -0.4% --
U. of Michigan Confidence SEP F 84.0 -- 83.8 --
Market Preview
Next week’s scheduled economic releases are expected to focus on many different fronts including housing, manufacturing, inflation and the consumer. Likely to be most closely watched will be those numbers related to the consumer’s health, given the market’s recent concerns over the economy and its roughly 70% control over the economy. As such, consumer-focused releases will come from Tuesday’s Consumer Confidence for September, expected to carry a 104.0 reading, the weekly ABC Consumer Confidence readings, Wednesday’s Personal Consumption figures for the 2nd Quarter and finally, from Friday’s triple reports of Personal Income, Personal Spending and September Final for the University of Michigan Consumer Confidence Index.
Housing-related data will carry near-equal weight where releases come from Tuesday’s S&P/CS Home Price Index and Existing Home Sales, expected to be down 4.6% from July. Thursday’s release of New Home Sales completes the housing picture for the week. Manufacturing data is reflected in reports from the Richmond Fed, Durable Goods Orders, and GDP for the 2Q07 and the Chicago Purchasing Manager’s Index. Lastly, any inflationary pricing pressures will be covered in the GDP’s Personal Consumption Index and the GDP Price Index, both expected to show contained prices.
In keeping with last week’s start of the quarterly earnings season, expect new and industry-leading companies’ releases to shape performance in the week’s equity markets. Expect bond markets to be primarily impacted by updated views about the likelihood of an economic recession.
ECONOMIC CALENDAR REVIEW (week of September 17, 2007)
Day Release Period Survey Actual Prior Revised
Monday Empire Manufacturing SEP 18.0 14.7 25.1 --
Tuesday Producer Price Index MoM AUG -0.3% -1.4% 0.6% --
PPI Ex Food & Energy MoM AUG 0.1% 0.2% 0.1% --
Producer Price Index YoY AUG 3.2% 2.2% 4.0% --
PPI Ex Food & Energy YoY AUG 2.2% 2.2% 2.3% --
Net Long-Term TIC Flows JUL $85.0B $19.2B $120.9B $97.3B
Total Net TIC Flows JUL $60.0B $103.8B $58.8B $34.4B
NAHB Housing Market Index SEP 20 20 22 --
FOMC Rate Decision Expected SEP 18 5.00% 4.75% 5.25% --
ABC Consumer Confidence SEP 16 -- -15 -17 --
Wednesday MBA Mortgage Applications SEP 14 -- 2.4% 5.5% --
Consumer Price Index MoM AUG 0.0% -0.1% 0.1% --
CPI Ex Food & Energy MoM AUG 0.2% 0.2% 0.2% --
Consumer Price Index YoY AUG 2.1% 2.0% 2.4% --
CPI Ex Food & Energy YoY AUG 2.2% 2.1% 2.2% --
CPI Core Index SA AUG -- 211.250 210.933 --
Consumer Price Index NSA AUG 208.000 207.917 208.299 --
Housing Starts AUG 1350K 1331K 1381K 1367K
Building Permits AUG 1348K 1307K 1373K 1389K
Thursday Initial Jobless Claims SEP 15 321K 311K 319K 320K
Continuing Claims SEP 8 2575K 2544K 2585K 2597K
Leading Indicators AUG -0.4% -0.6% 0.4% 0.7%
Philadelphia Fed. SEP 2.6 10.9 0.0 --
Friday No Releases
Last Week’s Market in Review
Markets last week were startled by news of the Fed’s larger-than-expected rate cuts, causing markets to square up to the new operating environment. As such, the following set of commentary is an attempt to report on changes in particular market segments while adding some perspective in the process.
Economic Statistics
Most economic numbers released last week were near or below their expectations, helping to solidify the Fed’s need to take more aggressive action, however some data clearly didn’t support the Fed’s moves, leading some market participants to question whether the Fed may have gone too far, bailing out risky investor behavior and violating the principle of moral hazard. In general, most inflationary numbers did give the all-clear sign for the Fed to lower rates, although with commodity prices hitting near-daily record highs, it’s a challenging debate to square up market activity with such benign inflationary readings, particularly the PPI numbers. Data not supporting the Fed’s moves were centered on manufacturing and employment. The Empire Manufacturing and Philly Fed reports showed manufacturing continuing to hum right along, perhaps benefiting from a lower US$ in world markets, while most troubling was the weekly Jobless Claims numbers, both Initial and Continuing. These numbers clearly threw a wrench into the market’s expectations of a recession, as both releases showed jobless claims contracting significantly. With last month’s weak Employment Report acting as the harbinger of swinging sentiment towards a declining economy and the need for a Fed rescue of sorts, this past week’s Jobless Claims figures bring into serious question last month’s Employment numbers, which may have an upward revision in its future. You may recall that August’s NonFarm Payroll numbers that showed a contraction of 4,000 jobs was mostly the result of a precipitous decline in government jobs. Some analysts suggested that a seasonal distortion in government jobs caused by teachers returning to classes may have been the primary reason for the decline, making the likelihood of later revisions possible.
Bond Markets
Commercial Paper – Asset-Backed Commercial Paper (ABCP) saw significant improvement last week, benefiting both from Fed action and lower perceived credit risks in the market, mostly the result of the ejection of defunct issuers in this market. Despite the market stabilization for the week, difficult markets prevailed as concerns over the market value of the assets collateralizing the ABCP continued to make it challenging environment to attract buyers. CP yields fell 44bp to end the week at 5.19% while outstanding CP balances continued to fall, ending the week at $1.87T, where an additional $48.1 billion in CP fell from the market. The CP market has now declined in each of the last 6 weeks, bringing it to the lowest outstanding CP market in the last 7 years. Declines in ABCP outstanding contributed $15.6 billion of the overall decline.
In improvements in the CP market in European markets, the Bank of England announced last week that they would copy the Fed’s move from a few weeks ago and will now accept 3-Month Commercial Paper as collateral for 3-Month borrowings from the central bank. This has significantly improved the standing of CP markets overseas.
Treasury Bills – Demand for 1, 3, & 6-month US Treasury bills increased again for the 4th straight week, causing yields to fall in response. Yields fell 53, 22 & 12 basis points to yields of 3.31%, 3.77% and 4.09%, respectively. Actions by the Fed and concerns over the potential rise of inflationary pressures from these actions steepened the short-end yield curve.
Treasury Notes - 2-10 year maturity US Treasury notes fell on the week, steepening the yield curve in the process. The closely-watched 2-10-year maturity spread rose 16bp over the week to a spread of 58bp. Yields for 2-Yr notes rose 1bp to end the week at 4.05% while the benchmark 10-Yr U.S. Treasury note also fell on the week, sending its yield up 17bp to a 4.63% level.
TIPS – Treasury Inflation-Protected Securities experienced a highly eventful week leading the benchmark 10-year security to see its yield rise 10bp to a 4.70% level. This yield increase was the result of a combination 20bp rise in the security’s real yield to 3.30% on investor’s revised views of higher future inflation and an updated CPI rate released last week that showed a lower year-over-year price rise. On the year, TIPS have generated the highest return of any investment-grade class of securities in the fixed income markets. Sporting a 6.54% return year-to-date, vs. a US Government Credit Index that has generated a return of 3.82% over the same period. In an era of higher expected inflation rates, TIPS would be expected to benefit more than nominal securities, due to this security’s unique capability of protecting investors from the negative effects of inflation.
Interest Rate Markets
Fed Funds – After last week’s surprise rate cut of 50bp by the FOMC to 4.75%, the options market is currently forecasting another rate cut by the October meeting to 4.50%. Options for the Fed Funds target rate forecast a 48% chance of a 25bp cut in the target Fed Funds rate, equivalent to the forecast of a 25bp rate cut held the prior week. The market holds a 37% chance of no change in the rate. [See FOMC Fed Funds Target Implied Probability Chart below]
LIBOR – Last week, actions by the Bank of England and the Fed served to reduce risks in most European markets, allowing LIBOR to fall. On the week, 3-Month LOBOR fell about 50bp, both on lower perceived risks to credit markets and the Fed’s rate cuts.
TED Spread – the “TED” spread, defined as the difference in Treasury vs. Euro-Dollar (or more precisely LIBOR) rates contracted by 23bp to end the week at a spread of 143bp. The TED spread has averaged a level of 50bp over the past 12 months 3-Month LIBOR rates fell to a 5.20% level, down about 44bp, while 3-Month Treasury bill yields fell a smaller amount of 22bp, ending the week at a yield of 3.77%. A significant improvement in the European financial markets and a reduction in short-term T-Bill rates on the view the Fed may be on the verge of a series of rate reductions designed to revive economic growth rates..
Discount Rate – The FOMC chose to reduce the discount rate at last week’s scheduled meeting by an equivalent amount as the targeted Fed funds rate, moving the lending rate to a 5.25% level.
Stock Markets
Stock market volatility fell significantly last week after the Fed’s move brought order to markets by reducing both the Fed Funds and Discount Rate. With a lower discount rate to apply to earnings models, stock markets rallied on the Fed’s news, ending up around 3% on the week from the previous week’s close. This was the largest one-week gain since March of this year. Year-to-date, the Dow Jones Industrial Average has risen 10.9%, while the S&P 500’s rise has been less robust at 7.6%. Large-cap stocks have led the markets this year primarily on their larger overseas exposures, which have benefited from a lower US$. The NASDAQ has risen 10.6% over the same time period as technology stocks have benefited from a strong level of business capital spending. While these returns are strong, they pale in comparison to the Chinese stock market’s impressive rise of 167.9%, also year-to-date.
The CBOE’s VIX index, which measures volatility in the S&P 500, fell significantly to a week-ending level of 19.00 from the previous week’s close of 24.92, and down from recent highs above 30, but still above its 1-year average of 14.60.
Currency Markets
US$ - On news of the Fed’s move with the Fed Funds and Discount Rates, the US$ lost even more ground last week, closing Friday at a 78.59 level against other major currencies, after hitting an intra-week low of 78.40. Only against the Japanese Yen did the dollar show any strength. Against the Canadian dollar, popularly referred to as the Loonie, value parity was reached, making both currencies’ value equal for the first time since 1976. Traders expect the dollar’s value to fall further, particularly if the Fed continues to reduce its targeted Fed Funds rate.
Commodity Markets
Commodities - as represented by the Continuous Commodity Index, or CCI, rose an additional 3.4% from the prior week as commodity prices reacted to supply constraints. This index has rallied over 10% higher over the last month. Crude oil continued to lead the index higher, closing the week at $81.620 per barrel, up $2.52, and after closing at an intra-week high of $83.90. Tensions with Iran resurfaced on the week, pushing traders to rally the commodity on views of possible supply disruptions. Other markets, such as corn and wheat continued to rally as well, with wheat continuing to hit another all-time high, closing the week at $874 per contract of 50,000 bushels, up $36 from the previous week’s close.
Fed and Global Central Banks
The U.S. Federal Reserve and the Bank of England garnered the spotlight last week, as the markets essentially forced both central banks’ hands to abandon the argument of moral hazard and move to restore market calm. The Bank of England’s moves were the most debated as their stronger views on moral hazard had caused them to avoid the prospects of bailing out its own markets, which saw the debate focus on the troubles of Northern Rock, Plc, a British building society (Britain’s equivalent of a U.S. thrift). Northern Rock had seen the value of its balance sheet deteriorate rapidly from recent market turmoil. At first, the BoE essentially ignored the troubles on the view of moral hazard, which implies that coming to its rescue would have effectively bailed out risky market behavior. When the BoE did act, they did so by copying the U.S. Fed’s recent allowance of accepting mortgage loans as collateral to any central bank borrowing. This news had the unintended effect of creating a run on the institution’s deposits. Arguing that their new plan would be focused on rescuing depositors, not shareholders, the BoE then took the drastic step of guaranteeing all or Northern Rock’s depositors regardless of their balances. On this news, the run was halted and European markets reacted favorably, sending LIBOR down to end the week at a 5.20% level.
The Fed’s spotlight was more timed as the scheduled FOMC meeting was widely expected to force the Fed’s hand through a 25bp cut in the targeted Fed Funds rate. When the Fed announced its move, it shocked most market participants by cutting both the Fed Funds and Discount Rate by 50bp, to 4.75% and 5.25%, respectively. In its closely-watched “statement” the Fed said it made its moves to prevent the downturn in the nation’s housing market from having further negative impact to the economy. Debates surfaced on the news, as several market participants began questioning the move based on arguments such as the potential of the move to raise inflationary expectations, to being non-supportive of the US$, to violating the Fed’s “moral hazard”. Most all analysts deemed this move as the establishment of the “Bernanke Put”. During Greenspan’s tenure as Fed Chairman, his accommodative moves to restore investor calm and promote growth were styled as the “Greenspan Put”, referring to a put as an investment security designed to provide gains in down markets.
Other market participants looked upon the Fed’s moves with even more questions. While most all welcomed the Fed’s moves on the views of it restoring calm and helping markets recover, there is a growing chorus of calls for the Fed to initiate some form of punishment to those viewed as having gotten the economy into this mess. Congress and other politicians have focused on the easy route, criticizing lenders’ actions as “predatory” and the result of “risky lending practices” over the past several years. The result has been a slew of bills and televised hearings. But other more thoughtful analysts have looked beyond that view to a deeper culprit, that of the ultimate buyer of subprime loans. In most cases these buyers are hedge funds. These analysts argue that subprime loans would not have been originated in the manner and depth in which they were, if it weren’t for the fact that willing buyers stood ready to assume the risks. The risk for prime loans is assumed by some market investors, but mostly by Fannie Mae, Freddie Mac and Ginnie Mae. No such governmental entity exists to buy subprime loans, with the exception of some small programs administered by the Federal Housing Authority, or FHA. Even deeper still, these analysts argue the extensive use of leverage by these subprime buyers (mostly hedge funds) has taken a loan type that represents only about 17% of the entire mortgage market and made it into a much larger problem through the extensive use of leverage. As all hedge funds are completely unregulated, these funds engage in behavior that most market investors would never consider, only to have the emergence of the Bernanke Put bail them out, by lowering their cost of funds. Just as leverage is limited in all markets, either by regulation or more conservative business practices, these analysts are using this as a wake-up call to the dangers that unregulated and highly aggressive investors can unleash on markets that are forced to obey the rules.
Economic / Interest Rate Survey
The following table details an August 9th survey of approximately 75 of the nation’s leading economists.
Indicator 3Q07 4Q07 1Q08 2Q08 3Q08 Avg. 2007
GDP 2.4% 2.2% 2.4% 2.5% 2.8% 2.0%
Prev. Survey 2.5% 2.6% 2.7% 2.8% 2.8% 2.0%
Cons. Spend. 2.2% 2.3% 2.5% 2.5% 2.5% 2.8%
Prev. Survey 2.3% 2.7% 2.6% 2.6% 2.6% 2.8%
Unemp. Rate 4.7% 4.7% 4.8% 4.9% 4.9% 4.6%
Prev. Survey 4.6% 4.7% 4.7% 4.7% 4.7% 4.6%
CPI 2.6% 3.3% 2.8% 2.2% 2.3% 2.7%
Prev. Survey 2.6% 3.4% 3.0% 2.3% 2.3% 2.8%
Indicator 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08
Fed Funds 5.00% 4.75% 4.75% 4.75% 4.75% 4.75%
Prev. Survey 5.25% 5.25% 5.25% 5.25% 5.25% 5.25%
10-Yr. Note 4.55% 4.63% 4.75% 4.90% 5.00% 5.00%
Prev. Survey 4.90% 5.00% 5.10% 5.15% 5.20% 5.25%
2-Yr. Note 4.20% 4.30% 4.40% 4.50% 4.60% 4.70%
Prev. Survey 4.80% 4.86% 4.90% 4.90% 5.00% 5.00%
Q07 4Q07 1Q08 2Q08 3Q08 Avg. 2007
Interest Rate Chart
Source: C15 Bloomberg
The chart above details the current US Treasury yield curve, along with the same yield curve 1 and 12 months ago.
FOMC Fed Funds Target Implied Probability Chart
The following chart details the market’s views of the probability of changes in the Fed Funds Target rates. Chart 1 shows the option market’s probabilities (of a change in the Fed Funds target level) over a timeframe covering each of the FOMC meetings held over the next several months.
CHART 1
Expected Future Outcomes and Most Likely Path(s)
The Bernanke Put
The U.S. Federal Reserve and the Bank of England garnered the spotlight last week, as the markets essentially forced both central banks’ hands to abandon the argument of moral hazard and move to restore market calm. The Bank of England’s moves were the most debated as their stronger views on moral hazard had caused them to avoid the prospects of bailing out its own markets, which saw the debate focus on the troubles of Northern Rock, Plc, a British building society (Britain’s equivalent of a U.S. thrift). Northern Rock had seen the value of its balance sheet deteriorate rapidly from recent market turmoil. At first, the BoE essentially ignored the troubles on the view of moral hazard, which implies that coming to its rescue would have effectively bailed out risky market behavior. When the BoE did act, they did so by copying the U.S. Fed’s recent allowance of accepting mortgage loans as collateral to any central bank borrowing. This news had the unintended effect of creating a run on the institution’s deposits. Arguing that their new plan would be focused on rescuing depositors, not shareholders, the BoE then took the drastic step of guaranteeing all or Northern Rock’s depositors regardless of their balances. On this news, the run was halted and European markets reacted favorably, sending LIBOR down to end the week at a 5.20% level.
The Fed’s spotlight was more timed as the scheduled FOMC meeting was widely expected to force the Fed’s hand through a 25bp cut in the targeted Fed Funds rate. When the Fed announced its move, it shocked most market participants by cutting both the Fed Funds and Discount Rate by 50bp, to 4.75% and 5.25%, respectively. In its closely-watched “statement” the Fed said it made its moves to prevent the downturn in the nation’s housing market from having further negative impact to the economy. Debates surfaced on the news, as several market participants began questioning the move based on arguments such as the potential of the move to raise inflationary expectations, to being non-supportive of the US$, to violating the Fed’s “moral hazard”. Most all analysts deemed this move as the establishment of the “Bernanke Put”. During Greenspan’s tenure as Fed Chairman, his accommodative moves to restore investor calm and promote growth were styled as the “Greenspan Put”, referring to a put as an investment security designed to provide gains in down markets.
Other market participants looked upon the Fed’s moves with even more questions. While most all welcomed the Fed’s moves on the views of it restoring calm and helping markets recover, there is a growing chorus of calls for the Fed to initiate some form of punishment to those viewed as having gotten the economy into this mess. Congress and other politicians have focused on the easy route, criticizing lenders’ actions as “predatory” and the result of “risky lending practices” over the past several years. The result has been a slew of bills and televised hearings. But other more thoughtful analysts have looked beyond that view to a deeper culprit, that of the ultimate buyer of subprime loans. In most cases these buyers are hedge funds. These analysts argue that subprime loans would not have been originated in the manner and depth in which they were, if it weren’t for the fact that willing buyers stood ready to assume the risks. The risk for prime loans is assumed by some market investors, but mostly by Fannie Mae, Freddie Mac and Ginnie Mae. No such governmental entity exists to buy subprime loans, with the exception of some small programs administered by the Federal Housing Authority, or FHA. Even deeper still, these analysts argue the extensive use of leverage by these subprime buyers (mostly hedge funds) has taken a loan type that represents only about 17% of the entire mortgage market and made it into a much larger problem through the extensive use of leverage. As all hedge funds are completely unregulated, these funds engage in behavior that most market investors would never consider, only to have the emergence of the Bernanke Put bail them out, by lowering their cost of funds. Just as leverage is limited in all markets, either by regulation or more conservative business practices, these analysts are using this as a wake-up call to the dangers that unregulated and highly aggressive investors can unleash on markets that are forced to obey the rules.
The Fed’s spotlight was more timed as the scheduled FOMC meeting was widely expected to force the Fed’s hand through a 25bp cut in the targeted Fed Funds rate. When the Fed announced its move, it shocked most market participants by cutting both the Fed Funds and Discount Rate by 50bp, to 4.75% and 5.25%, respectively. In its closely-watched “statement” the Fed said it made its moves to prevent the downturn in the nation’s housing market from having further negative impact to the economy. Debates surfaced on the news, as several market participants began questioning the move based on arguments such as the potential of the move to raise inflationary expectations, to being non-supportive of the US$, to violating the Fed’s “moral hazard”. Most all analysts deemed this move as the establishment of the “Bernanke Put”. During Greenspan’s tenure as Fed Chairman, his accommodative moves to restore investor calm and promote growth were styled as the “Greenspan Put”, referring to a put as an investment security designed to provide gains in down markets.
Other market participants looked upon the Fed’s moves with even more questions. While most all welcomed the Fed’s moves on the views of it restoring calm and helping markets recover, there is a growing chorus of calls for the Fed to initiate some form of punishment to those viewed as having gotten the economy into this mess. Congress and other politicians have focused on the easy route, criticizing lenders’ actions as “predatory” and the result of “risky lending practices” over the past several years. The result has been a slew of bills and televised hearings. But other more thoughtful analysts have looked beyond that view to a deeper culprit, that of the ultimate buyer of subprime loans. In most cases these buyers are hedge funds. These analysts argue that subprime loans would not have been originated in the manner and depth in which they were, if it weren’t for the fact that willing buyers stood ready to assume the risks. The risk for prime loans is assumed by some market investors, but mostly by Fannie Mae, Freddie Mac and Ginnie Mae. No such governmental entity exists to buy subprime loans, with the exception of some small programs administered by the Federal Housing Authority, or FHA. Even deeper still, these analysts argue the extensive use of leverage by these subprime buyers (mostly hedge funds) has taken a loan type that represents only about 17% of the entire mortgage market and made it into a much larger problem through the extensive use of leverage. As all hedge funds are completely unregulated, these funds engage in behavior that most market investors would never consider, only to have the emergence of the Bernanke Put bail them out, by lowering their cost of funds. Just as leverage is limited in all markets, either by regulation or more conservative business practices, these analysts are using this as a wake-up call to the dangers that unregulated and highly aggressive investors can unleash on markets that are forced to obey the rules.
Thursday, September 13, 2007
Sell, Sell, Sell....
With the Federal Reserve's Open Market Committee (FOMC) scheduled to meet again next Tuesday, September 18th, US Treasury prices have risen recently to levels high enough to reasonably expect at least a 100bp reduction in the targeted Fed Funds Rate, even before the Fed meets and even before they begin what is expected to be, a change in policy to be more accomodative. Even though the markets are divided in their expectation of a 25 or 50bp cut in the rate, US Treasury yields have gone far beyond that. So, in a word.....SELL!
Take your profits, buy the rumor / sell the fact, take your money and run, sell and reload, however you think about it or want to justify it, just sell! And do so now before these prices go away and you've lost your opportunity.
In what I describe as the biggest bubble of them all, inflated Treasury prices, the benchmark 10-year US Treasury reached a yield of 4.32%, just a couple days ago. That's down in yield from a recent high yield of 5.30% on June 12, 2007. Has the world gone so awry in 3 months? I doubt it. And the statistics don't support it either. Sure, the chances of a recession have increased in recent days, but the consumer is still chugging along, and inflation is certainly not dead, as evidenced by yesterday's topping of $80 oil.
So, get busy and sell, sell, sell.
Take your profits, buy the rumor / sell the fact, take your money and run, sell and reload, however you think about it or want to justify it, just sell! And do so now before these prices go away and you've lost your opportunity.
In what I describe as the biggest bubble of them all, inflated Treasury prices, the benchmark 10-year US Treasury reached a yield of 4.32%, just a couple days ago. That's down in yield from a recent high yield of 5.30% on June 12, 2007. Has the world gone so awry in 3 months? I doubt it. And the statistics don't support it either. Sure, the chances of a recession have increased in recent days, but the consumer is still chugging along, and inflation is certainly not dead, as evidenced by yesterday's topping of $80 oil.
So, get busy and sell, sell, sell.
Monday, September 10, 2007
Weekly Report - 9/10/07
DE KONING & COMPANY, LLC
W E E K L Y E C O N O M I C & I N T E R E S T R A T E M O N I T O R
ECONOMIC CALENDAR PREVIEW (week of September 10, 2007)
Day Release Period Survey Actual Prior Revised
Monday Consumer Credit JUL $8.0B -- $13.2B --
Tuesday Trade Balance JUL -$59.0B -- -$58.1B --
IBD/TIPP Economic Optimism SEP -- -- 49.5 --
Wednesday ABC Consumer Confidence SEP 9 -- -- -17 --
MBA Mortgage Applications SEP 7 -- -- 1.3% --
Thursday Initial Jobless Claims SEP 8 325K -- 318K --
Continuing Claims SEP 1 2570K -- 2598K --
Monthly Budget Statement AUG -$81.3B -- -$64.7B --
Current Account Balance 2Q -$190.0B -- -$192.6B --
Friday Import Price Index (MoM) AUG 0.2% -- 1.5% --
Import Price Index (YoY) AUG -- -- 2.8% --
Advance Retail Sales AUG 0.5% -- 0.3% --
Retail Sales Less Autos AUG 0.2% -- 0.4% --
Industrial Production AUG 0.3% -- 0.3% --
Capacity Utilization AUG 82.0% -- 81.9% --
U. of Michigan Confidence SEP P 83.5 -- 83.4 --
Business Inventories JUL 0.3% -- 0.4% --
Market Preview
Next week’s scheduled economic releases will offer investors a closer look at consumer’s health and the manufacturing sector. Consumer data starts with Monday’s release of Consumer Credit, expected to rise $9.1B, down from June’s surprisingly high $13.2B reading. This will then be followed by the IBD/TIPP Economic Optimism report, the weekly ABC Consumer Confidence numbers and the weekly MBA Mortgage Applications reading, which has been up the last 2 weeks in a row, in spite of higher mortgage rates, falling house prices and talk of a credit crunch. Jobless Claims, both initial and continuing, will be closely monitored for any confirmation of last week’s surprisingly weak NonFarm Payrolls number. Consumer data will then conclude with Friday’s release of Retail Sales, expected to be up 0.5%, and finish with the preliminary September report on Univ. of Michigan Confidence reading, expected at an 84.0 reading. Tuesday’s release of the nation’s Trade Balance is expected at a $59.0 billion deficit. The Trade Balance deficit has stabilized over the past 1-2 years, as the effect of a lower US $ has made US goods more competitive overseas. The US still imports more than it exports, however that trend seems to be stalling somewhat. The nation’s Current Account Balance, expected at a $190.0B deficit, will be announced Thursday. Finally, Friday brings the Import Price Index, Industrial Production, Capacity Utilization and Business Inventories. All are expected to show a manufacturing sector exhibiting steady growth, contrary to the conventional wisdom of a looming recession.
Look for investors to regain some focus on economic numbers as they primarily watch the Fed for signs of an intra-meeting cut in the Fed Funds rate. Particularly, look for markets to focus on Thursday’s Retail Sales numbers. If they’re weaker than expected, markets will use this data to increase calls for a Fed rate cut on the view that an economy primarily based on the consumer will be witnessing a consumer retrenchment, requiring Fed action to stave off potential further declines.
ECONOMIC CALENDAR REVIEW (week of September 3, 2007)
Day Release Period Survey Actual Prior Revised
Monday Labor Day Holiday – No Releases
Tuesday ISM Manufacturing AUG 53.0 52.9 53.8 --
ISM Prices Paid AUG 63.0 63.0 65.0 --
Construction Spending MoM JUL 0.0% -0.4% -0.3% 0.1%
Total Vehicle Sales AUG 15.6M 16.3M 15.5M --
Domestic Vehicle Sales AUG 11.9M 12.7M 11.7M --
Wednesday ABC Consumer Confidence SEP 2 -20 -17 -19 --
MBA Mortgage Applications AUG 31 -- 1.3% -4.0% --
Challenger Job Cuts YoY AUG -- 21.7% 15.4% --
ADP Employment Change AUG 80K 38K 48K --
Pending Home Sales MoM JUL -2.2% -12.2% 5.0%
Fed’s Beige Book
Thursday NonFarm Productivity 2Q F 2.4% 2.6% 1.8%
Unit Labor Costs 2Q F 1.5% 1.4% 2.1%
Initial Jobless Claims SEP 1 328K 318K 334K 337K
Continuing Claims AUG 25 2575K 2598K 2579K 2573K
ISM Non-Manufacturing AUG 54.5 55.8 55.8 --
ICSC Chair Store Sales YoY AUG 2.5% 2.9% 2.6% --
Friday Change in NonFarm Payrolls AUG 108K -4K 92K 68K
Unemployment Rate AUG 4.6% 4.6% 4.6% --
Change in Manufacturing Payrolls AUG -12K -46K -2K -1K
Average Hourly Earnings MoM AUG 0.3% 0.3% 0.3% --
Average Hourly Earnings YoY AUG 3.9% 3.9% 3.9% --
Average Weekly Hours AUG 33.8 33.8 33.8 --
Wholesale Inventories AUG 0.4% -- 0.5% --
Last Week’s Market in Review
Markets last week returned to shaky ground, particularly after Friday’s release of the August Employment Report. As such, the following set of commentary is an attempt to report on changes in particular market segments while adding some perspective in the process.
Economic Statistics
Several upbeat economic numbers were released last week, but any progress was quickly smothered by Friday’s release of the August Employment Report. This report showed that August net job creation actually contracted by 4,000 jobs, the first contraction since August 2003. The Unemployment Rate stayed even at 4.6%. Adding to the injury, July’s figure was reduced from 92,000 jobs to 68,000 jobs. Economists had expected 100,000 jobs to have been created in August. On top of even that, Manufacturing jobs fell by 46,000 from the projection of a contraction of 10,000 jobs. This was viewed with alarm as previous reports had suggested the Manufacturing sector had been benefiting from a lower US dollar. Notably, the decline was led by a sharp drop in Government jobs, which some suggest is a seasonal anomaly associated with teachers and the new school year, while other analysts pointed out that the service industry, which drives approximately 70% of the total economy, actually boosted payrolls by 60,000 jobs in August, after adding 78,000 jobs in July. This suggested that the consumer may not be as affected by the market’s recent turmoil as the headline numbers might suggest.
It is believed that both job and wage growth is needed to help sustain consumer spending. This report kicks the legs out of the job growth side of the equation, but a 3.9% year-over-year gain in wages continues to support the wage side. Month-over-month, wages rose 0.3%, which typically wouldn’t occur in a time when jobs are actually contracting, bringing the question over the so-called seasonal effect from teachers on the headline numbers into a higher level of debate.
On the Employment Report’s release, markets sang with a chorus of calls for the Fed to lower the targeted Fed Funds rate, with many calling for an immediate intra-meeting decrease and others calling for a larger 50 basis point drop to occur. Even others said the Fed is emphatically behind the curve and isn’t in step with the impact of the markets recent problems.
Bond Markets
Commercial Paper – Asset-Backed Commercial Paper (ABCP) saw another week of difficult markets as concerns over the market value of the assets collateralizing the ABCP continued to make it difficult to attract buyers. As a result, CP market yields rose to another 6-year high of 6.30%. Outstanding CP levels fell an additional $54 billion on the week to a $1.93T level. Outstanding CP levels have dropped 13% over the past month, or roughly $300 billion, of which $216.2 billion are direct obligations of ABCP issuers. CP investors are being even more selective in recent days, focusing on avoiding issues from Structured Investment Vehicles, also known as SIV’s. SIV issuers are even more exposed to their ability to roll maturing paper than so-called conduits, due to their lower reliance on bank liquidity agreements to ensure investors will be paid at maturity. SIV’s are also required to hold assets and credit facilities equal to as much as 3 weeks of net outflows of maturing paper. These rollover issues have prompted SIV’s to be forced to liquidate assets to repay CP investors, furthering the downward market spiral. Increasing the ABCP market uncertainty, Moody’s last week downgraded or placed on review $14 billion of CP sold by SIV’s.
Market participants are beginning to realize that while increased foreclosures on subprime loans ignited the market’s flame, the extensive use of leverage by investors in these markets has built the flame into a firestorm. In past markets, this would have likely been a much more manageable problem, but in today’s markets where investors are leveraged through the issuance of CP many times over, any so-called run on the markets can have a devastating impact, even enveloping the financial health of non-leveraged investors.
Money-center and investment banks alike continue to have significant exposures to CP markets, namely from letters of credit they have issued to provide liquidity to these issuers in the event they cannot refund maturing paper. The reason these liabilities aren’t broadly reported is due to their structure as conduits where the 1st-loss exposure has been previously sold to equity driven investors. Because the 1st-loss exposure is held by others, accounting rules allow banks to treat their stop-gap exposures as off-balance sheet liabilities. Market participants are pressing these banks for more transparency regarding these exposures. The last time the shaky use off balance sheet accounting was a market issue, the collapse of Enron and other energy companies occurred.
The Federal Reserve has recognized the problems in this market and 3 weeks ago allowed banks to borrow from the Fed discount window and use ABCP securities as collateral for those borrowings – a significant expansion of the Fed’s willingness to contain the market’s recent problems. Other analysts see the exposures as too great for even the largest money-center and investment banks and have issued profit and sell warnings. Also, analysts insist that the requirements to lend money to CP issuers, per their letter of credit guarantees, is so great that it has created its own virtual credit crunch, where these bank’s lending capacity has been captured by their CP obligations, effectively shutting other legitimate borrowers out of the market. [See related discussion under Fed below]
Treasury Bills – Demand for 1, 3, & 6-month US Treasury bills increased somewhat for the 2nd straight week, causing yields to fall in response. Yields fell 13, 5 & 2 basis points to yields of 4.04%, 4.07% and 4.19%, respectively. Yields had risen throughout the week until Friday’s release of the August Employment Report increased calls for Fed rate cuts to combat what some are calling a likely recession.
Treasury Notes - 2-10 year maturity US Treasury notes rallied as well on the week where both maturities fell in yield. The closely-watched 2-10-year maturity spread widened for the 2nd week in a row by 9bp to a spread of 48bp. Yields for 2-Yr notes fell 23bp to end the week at 3.91%, in line with the rally in shorter bills. The benchmark 10-Yr U.S. Treasury note also rallied on the week, pushing its yield down 14bp to a 4.39% level.
Treasury Bonds – the 30-year long bond also rallied, moving down 12bp on the week to a yield of 4.70%. Treasury market activity on the week continued to flatten the yield curve, even though it’s still positive. Friday’s Employment Report significantly increased the market’s view of a looming recession, causing longer-dated yields to rally.
TIPS – Treasury Inflation-Protected Securities couldn’t stay out of the fray last week, falling in yield to 2.19% for the benchmark 10-year security. This is the lowest real yield since early 2007 and is down from the last 12 month high of 2.82%, recorded on 6/12/07. Many investors view falling real yields as tacit approval for the Fed to lower the targeted Fed Funds rate without igniting the threat of inflation, currently standing at 2.4%.
Interest Rate Markets
Fed Funds – The options market suggests a 42% chance of a cut in the target Fed Funds rate to a level of 4.75%. However, there’s a slightly lower 37% chance of a rate cut to only 5.00%. The previous week’s predictions forecast a 21% probability of a decrease to 4.75% and a 46% chance of a drop to 5.00%. [See FOMC Fed Funds Target Implied Probability Chart below]
TED Spread – the “TED” spread, defined as the difference in Treasury vs. Euro-Dollar (or more precisely LIBOR) rates widened further on the week to a spread of 166bp. This was after ending the prior week at 155bp. A rallying 3 Mo T-Bill and a rising 3 Mo LIBOR rate accounted for the changes.
Discount Rate – There was no significant news to report on Discount Rate activity over the past week.
Stock Markets
Stock market volatility picked back up last week, as equity prices fell around 2% from the previous Friday. The weak Employment Report pushed talk of an economic recession, sending prices lower, particularly those of consumer luxury items. Banks and financial companies continued to lag behind the broader market, now showing a year-to-date decline of 12.1% vs. a gain of 2.5% for the S&P 500. The CBOE’s VIX index, which measures volatility in the S&P 500, rose to a week-ending level of 26.23, though still down from recent highs above 30. Its 1-year average stands at 14.16.
Currency Markets
US$ - The US$ lost ground last week, closing Friday at its lowest level over the past year against other leading currencies. The greenback ended the week at a 79.96 level, suggesting that investment opportunities are contracting in the US markets.
Commodity Markets
Commodities - as represented by the Continuous Commodity Index, or CCI, rose another 1.2% from the prior week as commodities returned to reacting to their normal indicators. Overall, price advances in crude oil led the move higher, where crude ended the week at $76.70 per barrel, up $2.66 on the week.
Fed and Global Central Banks
The Federal Reserve stayed out of the spotlight last week although a significant amount of investor energy was focused debating what they should do. Clearly with last week’s weaker Employment Report, sentiment has shifted to calls in favor of the Fed lowering the targeted Fed Funds rate, possibly by 50bp, and also before the next scheduled FOMC meeting on September 18th.
Interest Rate Chart
Source: C15 Bloomberg
The chart above details the current US Treasury yield curve, along with the same yield curve 1 and 12 months ago.
FOMC Fed Funds Target Implied Probability Chart
The following chart details the market’s views of the probability of changes in the Fed Funds Target rates. Chart 1 shows the option market’s probabilities (of a change in the Fed Funds target level) over a timeframe covering each of the FOMC meetings held over the next several months.
CHART 1
Expected Future Outcomes and Most Likely Path(s)
W E E K L Y E C O N O M I C & I N T E R E S T R A T E M O N I T O R
ECONOMIC CALENDAR PREVIEW (week of September 10, 2007)
Day Release Period Survey Actual Prior Revised
Monday Consumer Credit JUL $8.0B -- $13.2B --
Tuesday Trade Balance JUL -$59.0B -- -$58.1B --
IBD/TIPP Economic Optimism SEP -- -- 49.5 --
Wednesday ABC Consumer Confidence SEP 9 -- -- -17 --
MBA Mortgage Applications SEP 7 -- -- 1.3% --
Thursday Initial Jobless Claims SEP 8 325K -- 318K --
Continuing Claims SEP 1 2570K -- 2598K --
Monthly Budget Statement AUG -$81.3B -- -$64.7B --
Current Account Balance 2Q -$190.0B -- -$192.6B --
Friday Import Price Index (MoM) AUG 0.2% -- 1.5% --
Import Price Index (YoY) AUG -- -- 2.8% --
Advance Retail Sales AUG 0.5% -- 0.3% --
Retail Sales Less Autos AUG 0.2% -- 0.4% --
Industrial Production AUG 0.3% -- 0.3% --
Capacity Utilization AUG 82.0% -- 81.9% --
U. of Michigan Confidence SEP P 83.5 -- 83.4 --
Business Inventories JUL 0.3% -- 0.4% --
Market Preview
Next week’s scheduled economic releases will offer investors a closer look at consumer’s health and the manufacturing sector. Consumer data starts with Monday’s release of Consumer Credit, expected to rise $9.1B, down from June’s surprisingly high $13.2B reading. This will then be followed by the IBD/TIPP Economic Optimism report, the weekly ABC Consumer Confidence numbers and the weekly MBA Mortgage Applications reading, which has been up the last 2 weeks in a row, in spite of higher mortgage rates, falling house prices and talk of a credit crunch. Jobless Claims, both initial and continuing, will be closely monitored for any confirmation of last week’s surprisingly weak NonFarm Payrolls number. Consumer data will then conclude with Friday’s release of Retail Sales, expected to be up 0.5%, and finish with the preliminary September report on Univ. of Michigan Confidence reading, expected at an 84.0 reading. Tuesday’s release of the nation’s Trade Balance is expected at a $59.0 billion deficit. The Trade Balance deficit has stabilized over the past 1-2 years, as the effect of a lower US $ has made US goods more competitive overseas. The US still imports more than it exports, however that trend seems to be stalling somewhat. The nation’s Current Account Balance, expected at a $190.0B deficit, will be announced Thursday. Finally, Friday brings the Import Price Index, Industrial Production, Capacity Utilization and Business Inventories. All are expected to show a manufacturing sector exhibiting steady growth, contrary to the conventional wisdom of a looming recession.
Look for investors to regain some focus on economic numbers as they primarily watch the Fed for signs of an intra-meeting cut in the Fed Funds rate. Particularly, look for markets to focus on Thursday’s Retail Sales numbers. If they’re weaker than expected, markets will use this data to increase calls for a Fed rate cut on the view that an economy primarily based on the consumer will be witnessing a consumer retrenchment, requiring Fed action to stave off potential further declines.
ECONOMIC CALENDAR REVIEW (week of September 3, 2007)
Day Release Period Survey Actual Prior Revised
Monday Labor Day Holiday – No Releases
Tuesday ISM Manufacturing AUG 53.0 52.9 53.8 --
ISM Prices Paid AUG 63.0 63.0 65.0 --
Construction Spending MoM JUL 0.0% -0.4% -0.3% 0.1%
Total Vehicle Sales AUG 15.6M 16.3M 15.5M --
Domestic Vehicle Sales AUG 11.9M 12.7M 11.7M --
Wednesday ABC Consumer Confidence SEP 2 -20 -17 -19 --
MBA Mortgage Applications AUG 31 -- 1.3% -4.0% --
Challenger Job Cuts YoY AUG -- 21.7% 15.4% --
ADP Employment Change AUG 80K 38K 48K --
Pending Home Sales MoM JUL -2.2% -12.2% 5.0%
Fed’s Beige Book
Thursday NonFarm Productivity 2Q F 2.4% 2.6% 1.8%
Unit Labor Costs 2Q F 1.5% 1.4% 2.1%
Initial Jobless Claims SEP 1 328K 318K 334K 337K
Continuing Claims AUG 25 2575K 2598K 2579K 2573K
ISM Non-Manufacturing AUG 54.5 55.8 55.8 --
ICSC Chair Store Sales YoY AUG 2.5% 2.9% 2.6% --
Friday Change in NonFarm Payrolls AUG 108K -4K 92K 68K
Unemployment Rate AUG 4.6% 4.6% 4.6% --
Change in Manufacturing Payrolls AUG -12K -46K -2K -1K
Average Hourly Earnings MoM AUG 0.3% 0.3% 0.3% --
Average Hourly Earnings YoY AUG 3.9% 3.9% 3.9% --
Average Weekly Hours AUG 33.8 33.8 33.8 --
Wholesale Inventories AUG 0.4% -- 0.5% --
Last Week’s Market in Review
Markets last week returned to shaky ground, particularly after Friday’s release of the August Employment Report. As such, the following set of commentary is an attempt to report on changes in particular market segments while adding some perspective in the process.
Economic Statistics
Several upbeat economic numbers were released last week, but any progress was quickly smothered by Friday’s release of the August Employment Report. This report showed that August net job creation actually contracted by 4,000 jobs, the first contraction since August 2003. The Unemployment Rate stayed even at 4.6%. Adding to the injury, July’s figure was reduced from 92,000 jobs to 68,000 jobs. Economists had expected 100,000 jobs to have been created in August. On top of even that, Manufacturing jobs fell by 46,000 from the projection of a contraction of 10,000 jobs. This was viewed with alarm as previous reports had suggested the Manufacturing sector had been benefiting from a lower US dollar. Notably, the decline was led by a sharp drop in Government jobs, which some suggest is a seasonal anomaly associated with teachers and the new school year, while other analysts pointed out that the service industry, which drives approximately 70% of the total economy, actually boosted payrolls by 60,000 jobs in August, after adding 78,000 jobs in July. This suggested that the consumer may not be as affected by the market’s recent turmoil as the headline numbers might suggest.
It is believed that both job and wage growth is needed to help sustain consumer spending. This report kicks the legs out of the job growth side of the equation, but a 3.9% year-over-year gain in wages continues to support the wage side. Month-over-month, wages rose 0.3%, which typically wouldn’t occur in a time when jobs are actually contracting, bringing the question over the so-called seasonal effect from teachers on the headline numbers into a higher level of debate.
On the Employment Report’s release, markets sang with a chorus of calls for the Fed to lower the targeted Fed Funds rate, with many calling for an immediate intra-meeting decrease and others calling for a larger 50 basis point drop to occur. Even others said the Fed is emphatically behind the curve and isn’t in step with the impact of the markets recent problems.
Bond Markets
Commercial Paper – Asset-Backed Commercial Paper (ABCP) saw another week of difficult markets as concerns over the market value of the assets collateralizing the ABCP continued to make it difficult to attract buyers. As a result, CP market yields rose to another 6-year high of 6.30%. Outstanding CP levels fell an additional $54 billion on the week to a $1.93T level. Outstanding CP levels have dropped 13% over the past month, or roughly $300 billion, of which $216.2 billion are direct obligations of ABCP issuers. CP investors are being even more selective in recent days, focusing on avoiding issues from Structured Investment Vehicles, also known as SIV’s. SIV issuers are even more exposed to their ability to roll maturing paper than so-called conduits, due to their lower reliance on bank liquidity agreements to ensure investors will be paid at maturity. SIV’s are also required to hold assets and credit facilities equal to as much as 3 weeks of net outflows of maturing paper. These rollover issues have prompted SIV’s to be forced to liquidate assets to repay CP investors, furthering the downward market spiral. Increasing the ABCP market uncertainty, Moody’s last week downgraded or placed on review $14 billion of CP sold by SIV’s.
Market participants are beginning to realize that while increased foreclosures on subprime loans ignited the market’s flame, the extensive use of leverage by investors in these markets has built the flame into a firestorm. In past markets, this would have likely been a much more manageable problem, but in today’s markets where investors are leveraged through the issuance of CP many times over, any so-called run on the markets can have a devastating impact, even enveloping the financial health of non-leveraged investors.
Money-center and investment banks alike continue to have significant exposures to CP markets, namely from letters of credit they have issued to provide liquidity to these issuers in the event they cannot refund maturing paper. The reason these liabilities aren’t broadly reported is due to their structure as conduits where the 1st-loss exposure has been previously sold to equity driven investors. Because the 1st-loss exposure is held by others, accounting rules allow banks to treat their stop-gap exposures as off-balance sheet liabilities. Market participants are pressing these banks for more transparency regarding these exposures. The last time the shaky use off balance sheet accounting was a market issue, the collapse of Enron and other energy companies occurred.
The Federal Reserve has recognized the problems in this market and 3 weeks ago allowed banks to borrow from the Fed discount window and use ABCP securities as collateral for those borrowings – a significant expansion of the Fed’s willingness to contain the market’s recent problems. Other analysts see the exposures as too great for even the largest money-center and investment banks and have issued profit and sell warnings. Also, analysts insist that the requirements to lend money to CP issuers, per their letter of credit guarantees, is so great that it has created its own virtual credit crunch, where these bank’s lending capacity has been captured by their CP obligations, effectively shutting other legitimate borrowers out of the market. [See related discussion under Fed below]
Treasury Bills – Demand for 1, 3, & 6-month US Treasury bills increased somewhat for the 2nd straight week, causing yields to fall in response. Yields fell 13, 5 & 2 basis points to yields of 4.04%, 4.07% and 4.19%, respectively. Yields had risen throughout the week until Friday’s release of the August Employment Report increased calls for Fed rate cuts to combat what some are calling a likely recession.
Treasury Notes - 2-10 year maturity US Treasury notes rallied as well on the week where both maturities fell in yield. The closely-watched 2-10-year maturity spread widened for the 2nd week in a row by 9bp to a spread of 48bp. Yields for 2-Yr notes fell 23bp to end the week at 3.91%, in line with the rally in shorter bills. The benchmark 10-Yr U.S. Treasury note also rallied on the week, pushing its yield down 14bp to a 4.39% level.
Treasury Bonds – the 30-year long bond also rallied, moving down 12bp on the week to a yield of 4.70%. Treasury market activity on the week continued to flatten the yield curve, even though it’s still positive. Friday’s Employment Report significantly increased the market’s view of a looming recession, causing longer-dated yields to rally.
TIPS – Treasury Inflation-Protected Securities couldn’t stay out of the fray last week, falling in yield to 2.19% for the benchmark 10-year security. This is the lowest real yield since early 2007 and is down from the last 12 month high of 2.82%, recorded on 6/12/07. Many investors view falling real yields as tacit approval for the Fed to lower the targeted Fed Funds rate without igniting the threat of inflation, currently standing at 2.4%.
Interest Rate Markets
Fed Funds – The options market suggests a 42% chance of a cut in the target Fed Funds rate to a level of 4.75%. However, there’s a slightly lower 37% chance of a rate cut to only 5.00%. The previous week’s predictions forecast a 21% probability of a decrease to 4.75% and a 46% chance of a drop to 5.00%. [See FOMC Fed Funds Target Implied Probability Chart below]
TED Spread – the “TED” spread, defined as the difference in Treasury vs. Euro-Dollar (or more precisely LIBOR) rates widened further on the week to a spread of 166bp. This was after ending the prior week at 155bp. A rallying 3 Mo T-Bill and a rising 3 Mo LIBOR rate accounted for the changes.
Discount Rate – There was no significant news to report on Discount Rate activity over the past week.
Stock Markets
Stock market volatility picked back up last week, as equity prices fell around 2% from the previous Friday. The weak Employment Report pushed talk of an economic recession, sending prices lower, particularly those of consumer luxury items. Banks and financial companies continued to lag behind the broader market, now showing a year-to-date decline of 12.1% vs. a gain of 2.5% for the S&P 500. The CBOE’s VIX index, which measures volatility in the S&P 500, rose to a week-ending level of 26.23, though still down from recent highs above 30. Its 1-year average stands at 14.16.
Currency Markets
US$ - The US$ lost ground last week, closing Friday at its lowest level over the past year against other leading currencies. The greenback ended the week at a 79.96 level, suggesting that investment opportunities are contracting in the US markets.
Commodity Markets
Commodities - as represented by the Continuous Commodity Index, or CCI, rose another 1.2% from the prior week as commodities returned to reacting to their normal indicators. Overall, price advances in crude oil led the move higher, where crude ended the week at $76.70 per barrel, up $2.66 on the week.
Fed and Global Central Banks
The Federal Reserve stayed out of the spotlight last week although a significant amount of investor energy was focused debating what they should do. Clearly with last week’s weaker Employment Report, sentiment has shifted to calls in favor of the Fed lowering the targeted Fed Funds rate, possibly by 50bp, and also before the next scheduled FOMC meeting on September 18th.
Interest Rate Chart
Source: C15 Bloomberg
The chart above details the current US Treasury yield curve, along with the same yield curve 1 and 12 months ago.
FOMC Fed Funds Target Implied Probability Chart
The following chart details the market’s views of the probability of changes in the Fed Funds Target rates. Chart 1 shows the option market’s probabilities (of a change in the Fed Funds target level) over a timeframe covering each of the FOMC meetings held over the next several months.
CHART 1
Expected Future Outcomes and Most Likely Path(s)
Friday, September 7, 2007
Weekly Report - 9/3/07
DE KONING & COMPANY, LLC
W E E K L Y E C O N O M I C & I N T E R E S T R A T E M O N I T O R
ECONOMIC CALENDAR PREVIEW (week of September 3, 2007)
Day Release Period Survey Actual Prior Revised
Monday Labor Day Holiday – No Releases
Tuesday ISM Manufacturing AUG 53.0 52.9 53.8 --
ISM Prices Paid AUG 63.0 63.0 65.0 --
Construction Spending MoM JUL 0.0% -0.4% -0.3% 0.1%
Total Vehicle Sales AUG 15.6M 16.3M 15.5M --
Domestic Vehicle Sales AUG 11.9M 12.7M 11.7M --
Wednesday ABC Consumer Confidence SEP 2 -20 -17 -19 --
MBA Mortgage Applications AUG 31 -- 1.3% -4.0% --
Challenger Job Cuts YoY AUG -- 21.7% 15.4% --
ADP Employment Change AUG 80K 38K 48K --
Pending Home Sales MoM JUL -2.2% -12.2% 5.0%
Fed’s Beige Book
Thursday NonFarm Productivity 2Q F 2.4% 2.6% 1.8%
Unit Labor Costs 2Q F 1.5% 1.4% 2.1%
Initial Jobless Claims SEP 1 328K 318K 334K 337K
Continuing Claims AUG 25 2575K 2598K 2579K 2573K
ISM Non-Manufacturing AUG 54.5 55.8 55.8 --
ICSC Chair Store Sales YoY AUG 2.5% 2.9% 2.6% --
Friday Change in NonFarm Payrolls AUG 108K -4K 92K 68K
Unemployment Rate AUG 4.6% 4.6% 4.6% --
Change in Manufacturing Payrolls AUG -12K -46K -2K -1K
Average Hourly Earnings MoM AUG 0.3% 0.3% 0.3% --
Average Hourly Earnings YoY AUG 3.9% 3.9% 3.9% --
Average Weekly Hours AUG 33.8 33.8 33.8 --
Wholesale Inventories AUG 0.4% -- 0.5% --
Market Preview
Next week’s scheduled economic releases offer a steady stream of much-anticipated news for investors. None, however, will be as closely watched as Friday’s Employment Report for August. After Monday’s market holiday, manufacturing data will take center stage with Tuesday’s releases of the ISM Report, Construction Spending, and Vehicle Sales. Vehicle Sales are expected to slightly rise overall to a 15.6 million unit annual rate, but investors will be watching closely for any negative impact to consumers from the market’s recent credit shock. Wednesday brings the ADP Employment Change report, which many investors watch as a barometer to the monthly Employment Report. The Fed’s Beige Book, which reports on economic activity for each of the Fed’s districts, will also be released on Wednesday, however investors aren’t likely to focus on its report as much due to its reporting period prior to recent market turmoil. Thursday’s releases will be watched closely for any uptick in Jobless Claims and also for recent consumer spending trends from the ICSC Chain Store Sales report. The Employment Report on Friday is expected to show an August gain of 105,000 jobs, above the 92,000 gain posted for July, with the Unemployment Rate staying steady at 4.6%. If job creation meets expectations, 1,789,000 net new jobs will have been created over the past 12 months. Not bad for an economy well into its 5th year of expansion. Overall, most releases are expected to be fairly upbeat while investors are likely to focus on releases covering August time periods to gain more information about possible signs of fallout from the market’s recent turbulence.
In the News…
Last Friday saw two speeches confronting the housing market’s problems from President Bush and Fed Chairman Ben Bernanke. President Bush outlined a plan to assist delinquent homeowners who have fallen behind in their mortgages by authorizing the Federal Housing Administration (FHA) to guarantee loans for delinquent borrowers, allowing them to avoid foreclosure and refinance at more favorable rates. The new program will be called FHA Secure. At the end of 2006, the Center for Responsible Lending, a market research organization, counted 7 ½ million subprime mortgage borrowers with $1.4T in loans, totaling 13% of the total mortgage market.
Chairman Bernanke, in his first public policy speech in 6 weeks, acknowledged that “further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing would be deeper or more prolonged than previously expected.” He further said, “The Federal Reserve stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets.” Some investors took this as a tip that the Fed is prepared to cut the discount rate further or additional tools (namely the Fed Funds rate) to ease market strains.
Both speeches were met with enthusiastic market response, propelling the stock market higher and driving yields of short-term U.S. Treasury bills higher on relief of the flight-to-quality trade.
ECONOMIC CALENDAR REVIEW (week of August 27, 2007)
Day Release Period Survey Actual Prior Revised
Monday Existing Home Sales JUL 5.70M 5.75M 5.75M 5.76M
Existing Home Sales MoM JUL -0.9% -0.2% -3.8% -3.7%
S&P/PCS Composite-20 YoY JUN -3.3% -3.5% -2.8% -2.9%
S&P/CaseShiller Home Price Index JUN -- 199.2 200.0 200.0
S&P/CaseShiller US HPI 2Q -- 183.9 186.0 185.6
S&P/CaseShiller US HPI YoY% 2Q -- -3.2% -1.4% -1.6%
Consumer Confidence AUG 104.0 105.0 112.6 111.9
Richmond Fed Manufacturing Index AUG 2 7 4 --
Minutes of August 7 FOMC Meeting
Tuesday ABC Consumer Confidence AUG 26 -- -19 -20 --
Wednesday MBA Mortgage Applications AUG 24 -- -4.0% -5.5% --
Thursday Initial Jobless Claims AUG 25 320K 334K 322K 325K
Continuing Claims AUG 18 2575K 2579K 2572K 2566K
GDP Annualized 2Q P 4.1% 4.0% 3.4% --
Personal Consumption 2Q P 1.5% 1.4% 1.3% --
GDP Price Index 2Q P 2.7% 2.7% 2.7% --
Core PCE QoQ 2Q P 1.4% 1.3% 1.4% --
Help Wanted Index JUL 25 25 26 --
House Price Index QoQ 2Q 0.3% 0.1% 0.5% 0.6%
Friday Personal Income JUL 0.3% 0.5% 0.4% --
Personal Spending JUL 0.3% 0.4% 0.1% --
PCE Deflator YoY JUL 2.1% 2.1% 2.3% --
PCE Core MoM JUL 0.2% 0.1% 0.1% 0.2%
PCE Core YoY JUL 2.0% 1.9% 1.9% --
Chicago Purchasing Managers AUG 53.0 53.8 53.4 --
Factory Orders JUL 3.3% 3.7% 0.6% 1.0%
U. of Michigan Confidence AUG F 82.5 83.4 83.3 --
NAPM – Milwaukee AUG -- 63.0 57.0 --
Last Week’s Market in Review
Markets over the past week calmed even more as volatility decreased and high-quality market issuance resumed. Market participants also continued to sort through the melee for projected winners and losers, while refining strategies to accommodate. As a result, subprime originators and leveraged investors still count for the hardest hit. As such, the following set of commentary is an attempt to report on changes in particular market segments while adding some perspective in the process.
Economic Statistics
Many upbeat economic numbers were released last week, while some just seemed to confirm current sentiment. All of which were totally ignored as investors chose instead to focus on the markets themselves, the Fed and market headline news. Upbeat numbers included Existing Home Sales, Consumer Confidence, Richmond Fed Manufacturing Index, 2Q GDP, Personal Income & Spending, Factory Orders, U. of Michigan Confidence and NAPM-Milwaukee. In addition, inflation reporting numbers also showed that pricing is in check.
As one might expect, the S&P/CaseShiller House Price Index did show that home prices fell 3.2% over the past year. This news was in addition to a report on Existing Home Sales that showed a higher-than-expected sales rate of 5.75M, but also showed that sales fell 0.2% from June’s level.
Recent market turmoil measurably converted into higher Initial Jobless Claims, which increased 9,000 to 334,000, and above the expectations of 322,000. Continuing Claims rose as well to 2,579K. On balance, investors chose once again to largely ignore the fundamental economic data and react instead to other market signs such as the Fed and market volatility.
Bond Markets
Commercial Paper – Asset-Backed Commercial Paper (ABCP) continued with difficult times last week as concerns over the market value of the assets collateralizing the ABCP continued to make it difficult to attract buyers. As a result, CP market yields rose to a 6-year high of 6.18%. Outstanding CP levels fell an additional $63 billion on the week to a $1.979T level. Outstanding CP levels have dropped 11% since August 8th. Several ABCP conduits experienced trouble during the week, most all of which act as funding sources for highly leveraged hedge funds that have invested considerable amounts in U.S. subprime mortgages. British fund manager, Cheyne Finance, as well as U.S.-based Thornburg Mortgage Co. (among others) failed to sell new CP to investors, causing assets to be liquidated to pay off CP investors.
Money-center and investment banks alike have significant exposures to CP markets, namely from letters of credit they have issued to provide liquidity to these issuers in the event they cannot refund maturing paper. The reason these liabilities aren’t broadly reported is due to their structure as conduits where the loss exposure has been previously sold to equity driven investors. As such, these banks treat their stop-gap exposures as off-balance sheet liabilities. The Federal Reserve has recognized the problems in this market and 2 weeks ago allowed banks to borrow from the Fed discount window and use ABCP securities as collateral for those borrowings – a significant expansion of the Fed’s willingness to contain the market’s recent problems. Market participants are pressing these banks for more transparency regarding these exposures. [See related discussion under Fed below]
Treasury Bills – Demand for 1, 3, & 6-month US Treasury bills increased somewhat over the week, causing yields to fall in response. Yields fell 6, 11 & 10 basis points to yields of 4.16%, 4.12% and 4.21%, respectively. With the fall in short-term yields, there is a significant difference in short-term US bills and other money market rates, such as the Fed Funds target rate of 5.25%, which is caused by both a significant flight-to-quality trade and high expectations of the Fed easing rates near-term.
Treasury Notes - 2-10 year maturity US Treasury notes also rallied on the week where both maturities fell in yield. The closely-watched 2-10-year maturity spread widened on the week by 7bp to a spread of 39bp. Yields for 2-Yr notes fell 16bp to end the week at 4.14%, in line with the rally in shorter bills. The benchmark 10-Yr U.S. Treasury note also rallied on the week, pushing its yield down 9bp to a 4.53% level.
Treasury Bonds – the 30-year long bond also rallied, moving down 7bp on the week to a yield of 4.82%. Treasury market activity on the week continued to flatten the yield curve, even though it’s still positive. Despite continued strong economic releases on the week, the markets continued to view a potential economic slowdown as more likely, causing longer-dated yields to rally.
Interest Rate Markets
Fed Funds – The options market suggests less than a 34% chance of a cut in the target Fed Funds rate to a level of 4.50%. However, there’s a slightly lower 31% chance of a rate cut to only 5.00%. Both probabilities are significantly higher than the market predicted both 1 week ago and 1 month ago. [See FOMC Fed Funds Target Implied Probability Chart below]
TED Spread – the “TED” spread, defined as the difference in Treasury vs. Euro-Dollar (or more precisely LIBOR) rates widened on the week to a spread of 151bp. This was after ending the prior week at 128bp and seeing an intra-week wide of 178bp and an intra-week narrow level of 100bp. Fluctuations on the 3Mo US Treasury bill account for most of the movement on the week.
Discount Rate – News of the surprise reduction of the Discount Rate 2 weeks ago continued to work its way through the financial system. Borrowings fell from the previous week’s borrowings of $2 billion in funds – led by 4 large US banks in a show of support to the Fed’s rate move. Currently viewed as perhaps even more significant is the recent news that the Fed further loosened its list of acceptable collateral to any discount window borrowings to allow “investment quality” Asset-Backed Commercial Paper. This came as the Fed has attempted to inject liquidity into that market and prevent the downward spiral of issuers being forced to sell assets to cover ABCP investor’s continued draw downs of funds from that market.
Stock Markets
Stock market volatility continued to wane over the last week as global markets continued their recovery, ending up on the week and perhaps more surprisingly, up for the entire month of August. Banks and financial companies continue to lag behind the broad market, where technology shares have taken most of the market lead on very strong business spending. Consumer related stocks have also lagged behind on the view of lower consumer spending. Despite the gain on the week, the CBOE’s VIX index, which measures volatility in the S&P 500, rose to a week-ending level of 23.38, though still down from recent highs. Its 1-year average stands at 13.97.
Currency Markets
US$ - The US$ continued to regain ground recently lost to the market’s volatility, ending the week at a level of 80.79, versus the index of major world currencies.
Commodity Markets
Commodities - as represented by the Continuous Commodity Index, or CCI, rose 1.2% from the prior week as commodities returned to reacting to its normal indicators. Overall, price advances in wheat and crude oil led the move higher, where crude oil ended the week at $74.04 per barrel, up $2.95 on the week.
Fed and Global Central Banks
The Federal Reserve’s policy makers spent their annual meeting in Jackson Hole, Wyoming where Chairman Bernanke stated that the Fed stood ready to accommodate the market with ample liquidity, if called upon to do so. Britain’s Bank of England was finally forced into the fray by lending money to Barclays Bank and other large banks to shore up its own ABCP markets as several leveraged hedge funds experienced an inability to roll maturing paper, forcing asset liquidations and draws on available liquidity sources.
In the U.S., market participants continue to view the Fed’s moves as adequate to date in addressing the market’s recent volatility, but significant pressure is building for the Fed to follow-through with the market’s perception of a cut in the Fed Funds rate.
Economic / Interest Rate Survey
The following table details an August 8th survey of approximately 75 of the nation’s leading economists.
Indicator 3Q07 4Q07 1Q08 2Q08 3Q08 Avg. 2007
GDP 2.5% 2.6% 2.7% 2.8% 2.8% 2.0%
Prev. Survey 2.6% 2.9% 2.9% 2.8% n/a 2.1%
Cons. Spend. 2.3% 2.7% 2.6% 2.6% 2.6% 2.8%
Prev. Survey 2.5% 2.7% 2.7% 2.6% n/a 3.1%
Unemp. Rate 4.6% 4.7% 4.7% 4.7% 4.7% 4.6%
Prev. Survey 4.6% 4.7% 4.7% 4.7% n/a 4.6%
CPI 2.6% 3.4% 3.0% 2.3% 2.3% 2.8%
Prev. Survey 2.6% 3.1% 2.8% 2.3% n/a 2.7%
Indicator 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08
Fed Funds 5.25% 5.25% 5.25% 5.25% 5.25% 5.25%
Prev. Survey 5.25% 5.25% 5.25% 5.25% 5.25% 5.25%
10-Yr. Note 4.90% 5.00% 5.10% 5.15% 5.20% 5.25%
Prev. Survey 5.10% 5.13% 5.20% 5.26% 5.30% 5.31%
2-Yr. Note 4.80% 4.86% 4.90% 4.90% 5.00% 5.00%
Prev. Survey 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
FOMC Fed Funds Target Implied Probability Chart
The following chart details the market’s views of the probability of changes in the Fed Funds Target rates. Chart 1 shows the option market’s probabilities (of a change in the Fed Funds target level) over a timeframe covering each of the FOMC meetings held over the next several months.
W E E K L Y E C O N O M I C & I N T E R E S T R A T E M O N I T O R
ECONOMIC CALENDAR PREVIEW (week of September 3, 2007)
Day Release Period Survey Actual Prior Revised
Monday Labor Day Holiday – No Releases
Tuesday ISM Manufacturing AUG 53.0 52.9 53.8 --
ISM Prices Paid AUG 63.0 63.0 65.0 --
Construction Spending MoM JUL 0.0% -0.4% -0.3% 0.1%
Total Vehicle Sales AUG 15.6M 16.3M 15.5M --
Domestic Vehicle Sales AUG 11.9M 12.7M 11.7M --
Wednesday ABC Consumer Confidence SEP 2 -20 -17 -19 --
MBA Mortgage Applications AUG 31 -- 1.3% -4.0% --
Challenger Job Cuts YoY AUG -- 21.7% 15.4% --
ADP Employment Change AUG 80K 38K 48K --
Pending Home Sales MoM JUL -2.2% -12.2% 5.0%
Fed’s Beige Book
Thursday NonFarm Productivity 2Q F 2.4% 2.6% 1.8%
Unit Labor Costs 2Q F 1.5% 1.4% 2.1%
Initial Jobless Claims SEP 1 328K 318K 334K 337K
Continuing Claims AUG 25 2575K 2598K 2579K 2573K
ISM Non-Manufacturing AUG 54.5 55.8 55.8 --
ICSC Chair Store Sales YoY AUG 2.5% 2.9% 2.6% --
Friday Change in NonFarm Payrolls AUG 108K -4K 92K 68K
Unemployment Rate AUG 4.6% 4.6% 4.6% --
Change in Manufacturing Payrolls AUG -12K -46K -2K -1K
Average Hourly Earnings MoM AUG 0.3% 0.3% 0.3% --
Average Hourly Earnings YoY AUG 3.9% 3.9% 3.9% --
Average Weekly Hours AUG 33.8 33.8 33.8 --
Wholesale Inventories AUG 0.4% -- 0.5% --
Market Preview
Next week’s scheduled economic releases offer a steady stream of much-anticipated news for investors. None, however, will be as closely watched as Friday’s Employment Report for August. After Monday’s market holiday, manufacturing data will take center stage with Tuesday’s releases of the ISM Report, Construction Spending, and Vehicle Sales. Vehicle Sales are expected to slightly rise overall to a 15.6 million unit annual rate, but investors will be watching closely for any negative impact to consumers from the market’s recent credit shock. Wednesday brings the ADP Employment Change report, which many investors watch as a barometer to the monthly Employment Report. The Fed’s Beige Book, which reports on economic activity for each of the Fed’s districts, will also be released on Wednesday, however investors aren’t likely to focus on its report as much due to its reporting period prior to recent market turmoil. Thursday’s releases will be watched closely for any uptick in Jobless Claims and also for recent consumer spending trends from the ICSC Chain Store Sales report. The Employment Report on Friday is expected to show an August gain of 105,000 jobs, above the 92,000 gain posted for July, with the Unemployment Rate staying steady at 4.6%. If job creation meets expectations, 1,789,000 net new jobs will have been created over the past 12 months. Not bad for an economy well into its 5th year of expansion. Overall, most releases are expected to be fairly upbeat while investors are likely to focus on releases covering August time periods to gain more information about possible signs of fallout from the market’s recent turbulence.
In the News…
Last Friday saw two speeches confronting the housing market’s problems from President Bush and Fed Chairman Ben Bernanke. President Bush outlined a plan to assist delinquent homeowners who have fallen behind in their mortgages by authorizing the Federal Housing Administration (FHA) to guarantee loans for delinquent borrowers, allowing them to avoid foreclosure and refinance at more favorable rates. The new program will be called FHA Secure. At the end of 2006, the Center for Responsible Lending, a market research organization, counted 7 ½ million subprime mortgage borrowers with $1.4T in loans, totaling 13% of the total mortgage market.
Chairman Bernanke, in his first public policy speech in 6 weeks, acknowledged that “further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing would be deeper or more prolonged than previously expected.” He further said, “The Federal Reserve stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets.” Some investors took this as a tip that the Fed is prepared to cut the discount rate further or additional tools (namely the Fed Funds rate) to ease market strains.
Both speeches were met with enthusiastic market response, propelling the stock market higher and driving yields of short-term U.S. Treasury bills higher on relief of the flight-to-quality trade.
ECONOMIC CALENDAR REVIEW (week of August 27, 2007)
Day Release Period Survey Actual Prior Revised
Monday Existing Home Sales JUL 5.70M 5.75M 5.75M 5.76M
Existing Home Sales MoM JUL -0.9% -0.2% -3.8% -3.7%
S&P/PCS Composite-20 YoY JUN -3.3% -3.5% -2.8% -2.9%
S&P/CaseShiller Home Price Index JUN -- 199.2 200.0 200.0
S&P/CaseShiller US HPI 2Q -- 183.9 186.0 185.6
S&P/CaseShiller US HPI YoY% 2Q -- -3.2% -1.4% -1.6%
Consumer Confidence AUG 104.0 105.0 112.6 111.9
Richmond Fed Manufacturing Index AUG 2 7 4 --
Minutes of August 7 FOMC Meeting
Tuesday ABC Consumer Confidence AUG 26 -- -19 -20 --
Wednesday MBA Mortgage Applications AUG 24 -- -4.0% -5.5% --
Thursday Initial Jobless Claims AUG 25 320K 334K 322K 325K
Continuing Claims AUG 18 2575K 2579K 2572K 2566K
GDP Annualized 2Q P 4.1% 4.0% 3.4% --
Personal Consumption 2Q P 1.5% 1.4% 1.3% --
GDP Price Index 2Q P 2.7% 2.7% 2.7% --
Core PCE QoQ 2Q P 1.4% 1.3% 1.4% --
Help Wanted Index JUL 25 25 26 --
House Price Index QoQ 2Q 0.3% 0.1% 0.5% 0.6%
Friday Personal Income JUL 0.3% 0.5% 0.4% --
Personal Spending JUL 0.3% 0.4% 0.1% --
PCE Deflator YoY JUL 2.1% 2.1% 2.3% --
PCE Core MoM JUL 0.2% 0.1% 0.1% 0.2%
PCE Core YoY JUL 2.0% 1.9% 1.9% --
Chicago Purchasing Managers AUG 53.0 53.8 53.4 --
Factory Orders JUL 3.3% 3.7% 0.6% 1.0%
U. of Michigan Confidence AUG F 82.5 83.4 83.3 --
NAPM – Milwaukee AUG -- 63.0 57.0 --
Last Week’s Market in Review
Markets over the past week calmed even more as volatility decreased and high-quality market issuance resumed. Market participants also continued to sort through the melee for projected winners and losers, while refining strategies to accommodate. As a result, subprime originators and leveraged investors still count for the hardest hit. As such, the following set of commentary is an attempt to report on changes in particular market segments while adding some perspective in the process.
Economic Statistics
Many upbeat economic numbers were released last week, while some just seemed to confirm current sentiment. All of which were totally ignored as investors chose instead to focus on the markets themselves, the Fed and market headline news. Upbeat numbers included Existing Home Sales, Consumer Confidence, Richmond Fed Manufacturing Index, 2Q GDP, Personal Income & Spending, Factory Orders, U. of Michigan Confidence and NAPM-Milwaukee. In addition, inflation reporting numbers also showed that pricing is in check.
As one might expect, the S&P/CaseShiller House Price Index did show that home prices fell 3.2% over the past year. This news was in addition to a report on Existing Home Sales that showed a higher-than-expected sales rate of 5.75M, but also showed that sales fell 0.2% from June’s level.
Recent market turmoil measurably converted into higher Initial Jobless Claims, which increased 9,000 to 334,000, and above the expectations of 322,000. Continuing Claims rose as well to 2,579K. On balance, investors chose once again to largely ignore the fundamental economic data and react instead to other market signs such as the Fed and market volatility.
Bond Markets
Commercial Paper – Asset-Backed Commercial Paper (ABCP) continued with difficult times last week as concerns over the market value of the assets collateralizing the ABCP continued to make it difficult to attract buyers. As a result, CP market yields rose to a 6-year high of 6.18%. Outstanding CP levels fell an additional $63 billion on the week to a $1.979T level. Outstanding CP levels have dropped 11% since August 8th. Several ABCP conduits experienced trouble during the week, most all of which act as funding sources for highly leveraged hedge funds that have invested considerable amounts in U.S. subprime mortgages. British fund manager, Cheyne Finance, as well as U.S.-based Thornburg Mortgage Co. (among others) failed to sell new CP to investors, causing assets to be liquidated to pay off CP investors.
Money-center and investment banks alike have significant exposures to CP markets, namely from letters of credit they have issued to provide liquidity to these issuers in the event they cannot refund maturing paper. The reason these liabilities aren’t broadly reported is due to their structure as conduits where the loss exposure has been previously sold to equity driven investors. As such, these banks treat their stop-gap exposures as off-balance sheet liabilities. The Federal Reserve has recognized the problems in this market and 2 weeks ago allowed banks to borrow from the Fed discount window and use ABCP securities as collateral for those borrowings – a significant expansion of the Fed’s willingness to contain the market’s recent problems. Market participants are pressing these banks for more transparency regarding these exposures. [See related discussion under Fed below]
Treasury Bills – Demand for 1, 3, & 6-month US Treasury bills increased somewhat over the week, causing yields to fall in response. Yields fell 6, 11 & 10 basis points to yields of 4.16%, 4.12% and 4.21%, respectively. With the fall in short-term yields, there is a significant difference in short-term US bills and other money market rates, such as the Fed Funds target rate of 5.25%, which is caused by both a significant flight-to-quality trade and high expectations of the Fed easing rates near-term.
Treasury Notes - 2-10 year maturity US Treasury notes also rallied on the week where both maturities fell in yield. The closely-watched 2-10-year maturity spread widened on the week by 7bp to a spread of 39bp. Yields for 2-Yr notes fell 16bp to end the week at 4.14%, in line with the rally in shorter bills. The benchmark 10-Yr U.S. Treasury note also rallied on the week, pushing its yield down 9bp to a 4.53% level.
Treasury Bonds – the 30-year long bond also rallied, moving down 7bp on the week to a yield of 4.82%. Treasury market activity on the week continued to flatten the yield curve, even though it’s still positive. Despite continued strong economic releases on the week, the markets continued to view a potential economic slowdown as more likely, causing longer-dated yields to rally.
Interest Rate Markets
Fed Funds – The options market suggests less than a 34% chance of a cut in the target Fed Funds rate to a level of 4.50%. However, there’s a slightly lower 31% chance of a rate cut to only 5.00%. Both probabilities are significantly higher than the market predicted both 1 week ago and 1 month ago. [See FOMC Fed Funds Target Implied Probability Chart below]
TED Spread – the “TED” spread, defined as the difference in Treasury vs. Euro-Dollar (or more precisely LIBOR) rates widened on the week to a spread of 151bp. This was after ending the prior week at 128bp and seeing an intra-week wide of 178bp and an intra-week narrow level of 100bp. Fluctuations on the 3Mo US Treasury bill account for most of the movement on the week.
Discount Rate – News of the surprise reduction of the Discount Rate 2 weeks ago continued to work its way through the financial system. Borrowings fell from the previous week’s borrowings of $2 billion in funds – led by 4 large US banks in a show of support to the Fed’s rate move. Currently viewed as perhaps even more significant is the recent news that the Fed further loosened its list of acceptable collateral to any discount window borrowings to allow “investment quality” Asset-Backed Commercial Paper. This came as the Fed has attempted to inject liquidity into that market and prevent the downward spiral of issuers being forced to sell assets to cover ABCP investor’s continued draw downs of funds from that market.
Stock Markets
Stock market volatility continued to wane over the last week as global markets continued their recovery, ending up on the week and perhaps more surprisingly, up for the entire month of August. Banks and financial companies continue to lag behind the broad market, where technology shares have taken most of the market lead on very strong business spending. Consumer related stocks have also lagged behind on the view of lower consumer spending. Despite the gain on the week, the CBOE’s VIX index, which measures volatility in the S&P 500, rose to a week-ending level of 23.38, though still down from recent highs. Its 1-year average stands at 13.97.
Currency Markets
US$ - The US$ continued to regain ground recently lost to the market’s volatility, ending the week at a level of 80.79, versus the index of major world currencies.
Commodity Markets
Commodities - as represented by the Continuous Commodity Index, or CCI, rose 1.2% from the prior week as commodities returned to reacting to its normal indicators. Overall, price advances in wheat and crude oil led the move higher, where crude oil ended the week at $74.04 per barrel, up $2.95 on the week.
Fed and Global Central Banks
The Federal Reserve’s policy makers spent their annual meeting in Jackson Hole, Wyoming where Chairman Bernanke stated that the Fed stood ready to accommodate the market with ample liquidity, if called upon to do so. Britain’s Bank of England was finally forced into the fray by lending money to Barclays Bank and other large banks to shore up its own ABCP markets as several leveraged hedge funds experienced an inability to roll maturing paper, forcing asset liquidations and draws on available liquidity sources.
In the U.S., market participants continue to view the Fed’s moves as adequate to date in addressing the market’s recent volatility, but significant pressure is building for the Fed to follow-through with the market’s perception of a cut in the Fed Funds rate.
Economic / Interest Rate Survey
The following table details an August 8th survey of approximately 75 of the nation’s leading economists.
Indicator 3Q07 4Q07 1Q08 2Q08 3Q08 Avg. 2007
GDP 2.5% 2.6% 2.7% 2.8% 2.8% 2.0%
Prev. Survey 2.6% 2.9% 2.9% 2.8% n/a 2.1%
Cons. Spend. 2.3% 2.7% 2.6% 2.6% 2.6% 2.8%
Prev. Survey 2.5% 2.7% 2.7% 2.6% n/a 3.1%
Unemp. Rate 4.6% 4.7% 4.7% 4.7% 4.7% 4.6%
Prev. Survey 4.6% 4.7% 4.7% 4.7% n/a 4.6%
CPI 2.6% 3.4% 3.0% 2.3% 2.3% 2.8%
Prev. Survey 2.6% 3.1% 2.8% 2.3% n/a 2.7%
Indicator 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08
Fed Funds 5.25% 5.25% 5.25% 5.25% 5.25% 5.25%
Prev. Survey 5.25% 5.25% 5.25% 5.25% 5.25% 5.25%
10-Yr. Note 4.90% 5.00% 5.10% 5.15% 5.20% 5.25%
Prev. Survey 5.10% 5.13% 5.20% 5.26% 5.30% 5.31%
2-Yr. Note 4.80% 4.86% 4.90% 4.90% 5.00% 5.00%
Prev. Survey 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
FOMC Fed Funds Target Implied Probability Chart
The following chart details the market’s views of the probability of changes in the Fed Funds Target rates. Chart 1 shows the option market’s probabilities (of a change in the Fed Funds target level) over a timeframe covering each of the FOMC meetings held over the next several months.
Wednesday, August 15, 2007
And Then There Were 3…
Last week, fitting with the fallout in the market for subprime mortgages, triple-A rated corporate bonds saw its ranks thinned even more as the ratings of Nestle were cut to AA+. Nestle, the last European company with triple-A ratings, had their ratings cut after announcing its biggest-ever equity share buyback. Credit-default swaps on Nestle are currently priced at 10.5 basis points, triple the 3 basis points reported in June. With this news, Exxon-Mobil, Johnson & Johnson and Toyota Motor Corp. are the only remaining members of the group of triple-A rated corporates.
Friday, August 10, 2007
America’s Banker Threatens its “Nuclear Option”
What a week in the world’s markets. Volatility has definitely returned, and with a vengeance. U.S. subprime mortgage losses have rippled through global markets causing everything from bankruptcies, equity losses, European Central Bank (ECB) and Federal Reserve intervention through injecting reserves into the markets, credit spreads to widen, calls for the Fed to reduce interest rates, fears of a possible recession, private-equity deals to be repriced, delayed or abandoned, up to a significant rally in yields of U.S. Treasuries as investors seek their safety.
In what was perhaps one of the more potentially fearful stories to hit during the week, and one which may have been drowned out in all the week’s mayhem, China (America’s Banker) has threatened the U.S. with its self-described “Nuclear Option” of selling its holdings in U.S. Treasuries.
To understand the potential impact of this, let’s look at the landscape. China (still a Communist nation at last look) is America’s largest holder of an estimated $407B of U.S. Treasuries – qualifying it as America’s Lead Banker. China owns an estimated $900B of all U.S. bond types, including U.S. Agency bonds, corporates, MBS, etc. 44% of the U.S. national debt is held by foreign investors. Recently, China announced it will establish a government agency to boost returns on its investments and that it may invest in other securities, both to diversify its holdings and to boost returns.
China has the funds to make a significant impact in global markets. Armed with $1.33T of foreign-exchange reserves, Chinese officials said this week that China had the power to set off a dollar collapse if it chose to do so. That’s not a good thing to hear from your Banker. This response came after a number of recent political reprisals from Washington, namely from a July 26 approval of legislation by the U.S. Senate Finance Committee to place higher duties on Chinese imports to compensate for what lawmakers say is an undervalued currency, the Chinese Yuan. Since July 2005, when the Chinese Yuan was allowed to switch to a “managed float” position, the Yuan has risen 9.4% vs the U.S. Dollar. U.S. legislators deem this to be too little, saying the Yuan is undervalued and calling for it to float freely with market forces. Certainly this managed float mechanism hasn’t failed to halt the rise of China’s trade surplus with the U.S., which reached $26.9B in June, so in a sense, Washington has a valid point. Further, certain Washington Senators this week threatened trade sanctions against China unless the Yuan rises faster. China responded by saying that using it reserves “as a bargaining chip isn’t something that can’t be considered in response to some silly U.S. senators”.
While this exchange is currently in the posturing and rhetoric stage, it’s never a good thing to argue with your banker, particularly given how much we owe them and the potential negative consequences if China were to sell its U.S. Treasury holdings which would include a significant backup in bond yields and a fall (dare we say a possible collapse) in the value of the U.S. dollar. It’s doubtful this sort of exchange will lead to China’s use of its “nuclear option” but this should serve America with further evidence of the vulnerability of its Economic Security and should push us to ways of defusing these types of threats by reducing our budget and trade deficits, among other things that would promote our economic security.
In what was perhaps one of the more potentially fearful stories to hit during the week, and one which may have been drowned out in all the week’s mayhem, China (America’s Banker) has threatened the U.S. with its self-described “Nuclear Option” of selling its holdings in U.S. Treasuries.
To understand the potential impact of this, let’s look at the landscape. China (still a Communist nation at last look) is America’s largest holder of an estimated $407B of U.S. Treasuries – qualifying it as America’s Lead Banker. China owns an estimated $900B of all U.S. bond types, including U.S. Agency bonds, corporates, MBS, etc. 44% of the U.S. national debt is held by foreign investors. Recently, China announced it will establish a government agency to boost returns on its investments and that it may invest in other securities, both to diversify its holdings and to boost returns.
China has the funds to make a significant impact in global markets. Armed with $1.33T of foreign-exchange reserves, Chinese officials said this week that China had the power to set off a dollar collapse if it chose to do so. That’s not a good thing to hear from your Banker. This response came after a number of recent political reprisals from Washington, namely from a July 26 approval of legislation by the U.S. Senate Finance Committee to place higher duties on Chinese imports to compensate for what lawmakers say is an undervalued currency, the Chinese Yuan. Since July 2005, when the Chinese Yuan was allowed to switch to a “managed float” position, the Yuan has risen 9.4% vs the U.S. Dollar. U.S. legislators deem this to be too little, saying the Yuan is undervalued and calling for it to float freely with market forces. Certainly this managed float mechanism hasn’t failed to halt the rise of China’s trade surplus with the U.S., which reached $26.9B in June, so in a sense, Washington has a valid point. Further, certain Washington Senators this week threatened trade sanctions against China unless the Yuan rises faster. China responded by saying that using it reserves “as a bargaining chip isn’t something that can’t be considered in response to some silly U.S. senators”.
While this exchange is currently in the posturing and rhetoric stage, it’s never a good thing to argue with your banker, particularly given how much we owe them and the potential negative consequences if China were to sell its U.S. Treasury holdings which would include a significant backup in bond yields and a fall (dare we say a possible collapse) in the value of the U.S. dollar. It’s doubtful this sort of exchange will lead to China’s use of its “nuclear option” but this should serve America with further evidence of the vulnerability of its Economic Security and should push us to ways of defusing these types of threats by reducing our budget and trade deficits, among other things that would promote our economic security.
Wednesday, July 18, 2007
UPDATE to The Municipal Market Goes to Court:
In the May 28, 2007 edition of this publication, we informed investors that the U.S. Supreme Court had agreed to hear the case of Davis vs. Kentucky. An investor (Davis) sued the state of Kentucky for taxing his out-of-state municipal bonds while simultaneously offering a tax exemption to Kentucky-issued municipal bonds. Davis claimed this violated the Interstate Commerce Clause. Initially Davis lost the case, only to win on appeal, setting the stage for a U.S. Supreme Court decision.
This past week, two legal scholars released a paper1 touting their opinion of what the Court’s outcome may be. Ethan Hale from Georgetown University and Brian Galle from Florida State published in the periodical “Tax Notes” that they believed the outcome of the Court will rule in favor of Davis, meaning the taxes over 42 state governments impose on out-of-state municipal bonds would be deemed unconstitutional. These authors claim that the U.S. Supreme Court has consistently found that state tax rules discriminating in favor of in-state activities are unconstitutional. If that indeed is the outcome, these states would have to decide whether to not tax out-of-state bonds or start taxing their own in-state bonds - decisions that would likely have a profound impact on the $2.3 trillion municipal bond market. Given that there are almost 500 single-state municipal bond funds with assets of more than $155 billion, an outcome as predicted by these professors would leave little reason for investors to choose these bond funds. Another, more significant issue arises when one considers that this outcome may force states to choose to tax all municipal bonds, pushing their borrowing costs of issuing additional municipal bonds to rise significantly, as investors would not have a tax-advantaged reason for buying these bonds. Speculation has also ensued about the potential for bond investors to sue states for reimbursement of taxes they have paid on out-of-state bonds in past years.
The reality is that this case may have profound and significant impact to the municipal bond market; an important investment vehicle to the nation’s banking system. Stay tuned for further updates.
This past week, two legal scholars released a paper1 touting their opinion of what the Court’s outcome may be. Ethan Hale from Georgetown University and Brian Galle from Florida State published in the periodical “Tax Notes” that they believed the outcome of the Court will rule in favor of Davis, meaning the taxes over 42 state governments impose on out-of-state municipal bonds would be deemed unconstitutional. These authors claim that the U.S. Supreme Court has consistently found that state tax rules discriminating in favor of in-state activities are unconstitutional. If that indeed is the outcome, these states would have to decide whether to not tax out-of-state bonds or start taxing their own in-state bonds - decisions that would likely have a profound impact on the $2.3 trillion municipal bond market. Given that there are almost 500 single-state municipal bond funds with assets of more than $155 billion, an outcome as predicted by these professors would leave little reason for investors to choose these bond funds. Another, more significant issue arises when one considers that this outcome may force states to choose to tax all municipal bonds, pushing their borrowing costs of issuing additional municipal bonds to rise significantly, as investors would not have a tax-advantaged reason for buying these bonds. Speculation has also ensued about the potential for bond investors to sue states for reimbursement of taxes they have paid on out-of-state bonds in past years.
The reality is that this case may have profound and significant impact to the municipal bond market; an important investment vehicle to the nation’s banking system. Stay tuned for further updates.
The Municipal Market Goes to Court
Last week, the US Supreme Court agreed to hear a case involving the nation’s municipal bond market, which could lead to profound changes in the $2.3 trillion muni market. The announcement stemmed from a case involving a Kentucky investor who sued the state of Kentucky, claiming that Kentucky’s taxing of out-of-state muni bonds the investor held unconstitutionally discriminated against interstate commerce by taxing income from out-of-state bonds while exempting earnings on local bonds. The local judge on the case initially ruled against the investor, only to have the outcome reversed by the Kentucky Court of Appeals in a 3-0 vote. When the Kentucky Supreme Court refused to hear the case, the stage was set for a possible US Supreme Court review, which will come about in their next 9-month term beginning in October. Possible effects on the muni market if the court rules against Kentucky, is that it may force the 42 states who give their own bonds special tax treatment to either eliminate their local tax breaks or extend them to out-of-state bonds.
According to experts of the US Supreme Court, the Court has on a number of occasions has said states may not use their tax codes to provide commercial advantages to local companies. However the Court rules this time, look for this case to gain stature and importance over the next several months, as the muni market awaits the outcome.
According to experts of the US Supreme Court, the Court has on a number of occasions has said states may not use their tax codes to provide commercial advantages to local companies. However the Court rules this time, look for this case to gain stature and importance over the next several months, as the muni market awaits the outcome.
Government at Work for the People
In what is sure to be viewed as a regulatory effort far overdue, the Securities & Exchange Commission (SEC) announced today that they were (finally) launching an investigation into insider trading abuses in the burgeoning (and totally unregulated) Credit Default Swap (CDS) market. CDS are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay its debt. The contracts pay if a borrower fails to meet its debt obligations on time. Hedge funds and other investors have increasingly turned to the CDS market to make bets (investments) because they’re cheaper and easier to trade, plus the market is completely unregulated. Both the SEC and the Commodity Futures Trading Commission (CFTC) have argued over which regulator has authority over the market. Absent a clear regulator, little to no regulatory action has been initiated to date.
Hardly a buyout over the past year or so, either by private equity or public companies has not been reported as experiencing surging trading in the takeover target’s CDS contracts. This has led to what appears to be significant, unrestrained and illegal use of insider information to profit from these swings. While government regulation is never a good thing, allowing some “investors” an unfair advantage over others and compromising the nation’s financial markets is even worse.
Hardly a buyout over the past year or so, either by private equity or public companies has not been reported as experiencing surging trading in the takeover target’s CDS contracts. This has led to what appears to be significant, unrestrained and illegal use of insider information to profit from these swings. While government regulation is never a good thing, allowing some “investors” an unfair advantage over others and compromising the nation’s financial markets is even worse.
Global Competition in Bond Yields
It’s a well-known economic story where the financial press has in recent years increased its coverage of the global economy and the U.S.’s place in it. Still the largest global economy by far as measured by GDP, the U.S. is critically dependent on other economies to buy our debt. Without foreign purchases of U.S. securities, the GDP growth we have would not be possible and certainly, U.S. interest rates would be significantly higher than they are now. Within this context and the U.S.’s need to finance its debt, it’s a reasonable proposition to keep an eye on the competition, particularly the competition for bond yields. With other global economies achieving higher GDP levels than the U.S., their own bond yields and inflation rates have increased, giving our debt markets some serious competition. When you consider that the potential downside of any foreign investment in U.S. securities includes currency risk and when you see that the value of the U.S. dollar has been down over the past year, hurting foreign investor’s returns, it’s a wonder these foreigners continue to invest in the U.S. Granted, significant benefits accrue to these investors, such as greater security and liquidity, but this advantage to U.S. markets is eroding as well. The answers come in the form of the need of the U.S. to reduce its debt burden significantly and soon, tackling the federal budget deficit as well as consumer indebtedness. Simultaneously, domestic savings rates need to rise to provide needed investment funds, while the Fed should remain diligent in its quest for price stability. Absent these efforts and others, in order to remain competitive and finance our debt, domestic interest rates would likely be forced to rise – to what level is another debate, but rise they would, just to finance the debt we have outstanding. To back this discussion up with statistics, view the following:
Country Current Yield Yield 1 Year Ago Difference CPI GDP GDP Rank
U.S. 5.03% 5.14% -0.11% 2.7% 1.9% 1
Japan 1.87% 1.83% +0.04% 0.0% 2.6% 2
Germany 4.56% 4.30% +0.26% 1.9% 3.6% 3
China 4.43% 3.13% +1.30% 3.4% 11.1% 4
U.K. 5.46% 4.60% +0.86% 2.5% 6.2% 5
France 4.62% 4.08% +0.54% 1.2% 4.0% 6
Italy 4.77% 4.24% +0.53% 1.9% 5.2% 7
Canada 4.55% 4.61% -0.06% 2.2% 2.3% 8
Spain 4.62% 4.06% +0.56% 2.3% 7.6% 9
Russia 6.05% 6.78% -0.73% 7.8% 7.9% 10
India 8.15% 8.19% -0.04% 7.7% 9.1% 12
Brazil 6.10% 7.11% -0.99% 3.2% 4.3% 11
Australia6.26% 5.78% +0.48% 2.4% 3.8% 15
While market yields in some countries have turned down over the past year, in general, most yields are up, particularly in those countries where economic growth has been the strongest, providing increasing competition between the U.S. and other countries for their investment funds.
Country Current Yield Yield 1 Year Ago Difference CPI GDP GDP Rank
U.S. 5.03% 5.14% -0.11% 2.7% 1.9% 1
Japan 1.87% 1.83% +0.04% 0.0% 2.6% 2
Germany 4.56% 4.30% +0.26% 1.9% 3.6% 3
China 4.43% 3.13% +1.30% 3.4% 11.1% 4
U.K. 5.46% 4.60% +0.86% 2.5% 6.2% 5
France 4.62% 4.08% +0.54% 1.2% 4.0% 6
Italy 4.77% 4.24% +0.53% 1.9% 5.2% 7
Canada 4.55% 4.61% -0.06% 2.2% 2.3% 8
Spain 4.62% 4.06% +0.56% 2.3% 7.6% 9
Russia 6.05% 6.78% -0.73% 7.8% 7.9% 10
India 8.15% 8.19% -0.04% 7.7% 9.1% 12
Brazil 6.10% 7.11% -0.99% 3.2% 4.3% 11
Australia6.26% 5.78% +0.48% 2.4% 3.8% 15
While market yields in some countries have turned down over the past year, in general, most yields are up, particularly in those countries where economic growth has been the strongest, providing increasing competition between the U.S. and other countries for their investment funds.
Tuesday, July 17, 2007
The Fed’s Inflation Measurement is Questioned
The Federal Reserve Bank’s PRIMARY mission is conducting monetary policy, which is focused on employment, price stability and long-term interest rates. That may catch some as a surprise, given the popular belief that the Fed is primarily focused on steering the economy towards growth, but that is an ancillary outcome of carrying out their primary mission. Directly from the Fed, their mission is described as:
• conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates;
• supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers;
• maintaining the stability of the financial system and containing systemic risk that may arise in financial markets; and
• providing financial services to depository institutions, the U.S. government, and foreign official institutions including playing a major role in operating the nation’s payments system
In carrying out their mission, the Fed uses a multitude of economic statistics to gauge their success and survey for potential problem areas before they can negatively impact their mission. Towards price stability, the Fed under Chairman Greenspan focused on the Personal Consumption Expenditures (PCE) Index, away from the CPI, because the PCE was believed to more accurately reflect current-day consumer buying patterns. Things have changed under new Chairman Bernanke who has focused on the traditional CPI reading while injecting his long-standing views that the Fed should identify a targeted inflation rate, discussed as being between 1-2% annually. This is a dramatic departure from Greenspan’s views and the Fed’s primary mission of stable prices, because it accepts a 1-2% inflation rate as being allowable and acceptable. More disturbing is that it redefines the meaning of the word stable. Under Greenspan stable prices meant 0% inflation. Despite this significant shift in views, the bond market still hasn’t caught on to this. If they ever do, one should expect a 1-2% increase in long-term rates to compensate investors for this so-called price stability.
A causal view to this lack of market response is that debt issuers are currently getting an even better deal than they may realize, through a cheap interest rate.
Last week, market controversy did surface, not on the issue of targeted inflation, but on the issue of the Fed’s use of “core” inflation versus the total inflation picture. Core inflation is defined as price changes stemming from every area of consumption except for food and energy categories. In the past, these areas were deemed too volatile on a short-term basis and were heavily impacted by their respective supply chains, such as short-term fluctuations in food prices caused by summer droughts or a winter freeze, or short-term fluctuations in energy prices caused by hurricanes or maintenance shutdowns at gasoline refineries. At issue with the market is that the volatility in these 2 categories is no longer looked upon as being short-term and predominantly caused by supply, but rather by demand issues. The difference in core and total CPI is significant, averaging 0.3% over the past 10 years and currently showing a spread of 0.5%. Investors have recently questioned does the Fed use the lower Core CPI to measure against its targeted inflation rate, or the total CPI rate? The market is currently moving towards using the total CPI figure, given the shift from short to long-term volatility and the shift from supply-generated to demand-generated pricing pressures. In fact the demand-generated move is expected to continue as rising world economies increase the global demand for energy, such as that demand coming from China. Food prices are expected to continue rising due to changing dietary habits of traditionally western foods, as these rising economies become more affluent. Demand for food as an energy source (ethanol) is also viewed as a long-term move.
If the market wins out and the Fed changes its focus from Core to Total CPI, how the market views Fed policy should change as well as the actual CPI would be further out from their targeted level, possibly requiring even higher short-term rates to bring the total CPI inflation into the realm of a “stable” prices.
• conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates;
• supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers;
• maintaining the stability of the financial system and containing systemic risk that may arise in financial markets; and
• providing financial services to depository institutions, the U.S. government, and foreign official institutions including playing a major role in operating the nation’s payments system
In carrying out their mission, the Fed uses a multitude of economic statistics to gauge their success and survey for potential problem areas before they can negatively impact their mission. Towards price stability, the Fed under Chairman Greenspan focused on the Personal Consumption Expenditures (PCE) Index, away from the CPI, because the PCE was believed to more accurately reflect current-day consumer buying patterns. Things have changed under new Chairman Bernanke who has focused on the traditional CPI reading while injecting his long-standing views that the Fed should identify a targeted inflation rate, discussed as being between 1-2% annually. This is a dramatic departure from Greenspan’s views and the Fed’s primary mission of stable prices, because it accepts a 1-2% inflation rate as being allowable and acceptable. More disturbing is that it redefines the meaning of the word stable. Under Greenspan stable prices meant 0% inflation. Despite this significant shift in views, the bond market still hasn’t caught on to this. If they ever do, one should expect a 1-2% increase in long-term rates to compensate investors for this so-called price stability.
A causal view to this lack of market response is that debt issuers are currently getting an even better deal than they may realize, through a cheap interest rate.
Last week, market controversy did surface, not on the issue of targeted inflation, but on the issue of the Fed’s use of “core” inflation versus the total inflation picture. Core inflation is defined as price changes stemming from every area of consumption except for food and energy categories. In the past, these areas were deemed too volatile on a short-term basis and were heavily impacted by their respective supply chains, such as short-term fluctuations in food prices caused by summer droughts or a winter freeze, or short-term fluctuations in energy prices caused by hurricanes or maintenance shutdowns at gasoline refineries. At issue with the market is that the volatility in these 2 categories is no longer looked upon as being short-term and predominantly caused by supply, but rather by demand issues. The difference in core and total CPI is significant, averaging 0.3% over the past 10 years and currently showing a spread of 0.5%. Investors have recently questioned does the Fed use the lower Core CPI to measure against its targeted inflation rate, or the total CPI rate? The market is currently moving towards using the total CPI figure, given the shift from short to long-term volatility and the shift from supply-generated to demand-generated pricing pressures. In fact the demand-generated move is expected to continue as rising world economies increase the global demand for energy, such as that demand coming from China. Food prices are expected to continue rising due to changing dietary habits of traditionally western foods, as these rising economies become more affluent. Demand for food as an energy source (ethanol) is also viewed as a long-term move.
If the market wins out and the Fed changes its focus from Core to Total CPI, how the market views Fed policy should change as well as the actual CPI would be further out from their targeted level, possibly requiring even higher short-term rates to bring the total CPI inflation into the realm of a “stable” prices.
Tuesday, April 24, 2007
WildmindZ: Solving Economic Problems in our Sleep!
Whew! I'll miss that one. Hardly ever is it a good thing to be considered old, but today's report favors us aging baby boomers. If you want to collect your Social Security check Uncle Sam has promised you, you were given a 1-year repreive, but you better do it sooner than later.
Today, the Trustees of the Social Security Administration released their annual report about the condition of the "so-called" Trust Fund and Medicare. The report said that the Social Security fund will begin to pay out more money than it takes in by the year 2017. That's 10 years folks. And, it will become completely broke by the year 2041. This is one year later than the group predicted in last year's report.
The Medicare fund will be completely broke by the year 2019. That's 12 years from now. That was also 1 year later than the group predicted in last year's report.
I plan to not help the situation by getting sick before Medicare goes broke, recovering around 2018, then drawing my social security benefits when I turn 70, 3 years after I'm eligible. That means the government will be paying me even more money every month as I live to 125!
Seriously, these are major problems that aren't going away. So, how can EconomindZers help. By solving the issues. Give us your WILD solutions!
Social Security is currently funded by 6.2% of your salary being taken as taxes. Your employer adds another 6.2% on top of that to get the 12.4%.
So, let's look at some of the solutions:
1) Extend the benefits-receiving age. Currently it's 67 for those born after 1960. Raise that by just a little bit every year, a sort-of indexing, if you will. Life expectancies are longer now than they were when SS was established. It's only common sense that this should be reflective of society. This is a solution that's already been implemented. For example, if you were born in 1937 or earlier, you can collect benefits at age 65.
2) Raise the 12.4% tax. Not likely as everyone hates higher taxes. Plus, this would be primarly borne by lower-income wage earners.
3) Raise the maximum wage amount. Probably the best solution. Currently, 12.4% of your wages are taxed up to $90,000. This means that all of low-wage earner's wages are taxed at the 12.4% rate, while the so-called "wealthy Americans" don't have to pay anything on wages above the $90K threshold. This would be the most politically-supportive solution (especially for the Democrats who fervently believe wealthy Americans don't pay any taxes, or at least their fair share). If my calculator serves me correctly, the maximum wage amount would have to rise to around $92,000. I got that be saying that $90k of wages delivers $11,160 of taxes at 12.4%. If the taxes needed were 1.89% higher {see next paragraph} to solve the problem, that would require $11,371 of taxes from every average American. Dividing the $11,371 by 12.4%, gives a higer wage amount of $91,701 taxed at 12.4% to solve the issue.
Outside of other solutions, this is the one I'd support of those listed here, as the Trustees project that it would only take an extra increase of 1.89%, to a full level of 14.29% for the Social Security fund to be fully in the black, given that 78 million aging Baby Boomers are soon on their way to receiving benefits. I believe this is one solution that if explained to the American public, they'd support fully as a fix to the SS problem.
4) Tax income above $90K. A variant of the last solution. This wouldn't have to be at the full 12.4% rate. It could be for say, 2-3% of all wages between $90K and $150K, for example.
5) Cut benefits. Not gonna happen as it'll hurt 2 of the 3 most sacred issues in American politics (women, children and farmers).
So, here are some possible solutions to this mega-problem.
Give us your own....before it's too late!
Today, the Trustees of the Social Security Administration released their annual report about the condition of the "so-called" Trust Fund and Medicare. The report said that the Social Security fund will begin to pay out more money than it takes in by the year 2017. That's 10 years folks. And, it will become completely broke by the year 2041. This is one year later than the group predicted in last year's report.
The Medicare fund will be completely broke by the year 2019. That's 12 years from now. That was also 1 year later than the group predicted in last year's report.
I plan to not help the situation by getting sick before Medicare goes broke, recovering around 2018, then drawing my social security benefits when I turn 70, 3 years after I'm eligible. That means the government will be paying me even more money every month as I live to 125!
Seriously, these are major problems that aren't going away. So, how can EconomindZers help. By solving the issues. Give us your WILD solutions!
Social Security is currently funded by 6.2% of your salary being taken as taxes. Your employer adds another 6.2% on top of that to get the 12.4%.
So, let's look at some of the solutions:
1) Extend the benefits-receiving age. Currently it's 67 for those born after 1960. Raise that by just a little bit every year, a sort-of indexing, if you will. Life expectancies are longer now than they were when SS was established. It's only common sense that this should be reflective of society. This is a solution that's already been implemented. For example, if you were born in 1937 or earlier, you can collect benefits at age 65.
2) Raise the 12.4% tax. Not likely as everyone hates higher taxes. Plus, this would be primarly borne by lower-income wage earners.
3) Raise the maximum wage amount. Probably the best solution. Currently, 12.4% of your wages are taxed up to $90,000. This means that all of low-wage earner's wages are taxed at the 12.4% rate, while the so-called "wealthy Americans" don't have to pay anything on wages above the $90K threshold. This would be the most politically-supportive solution (especially for the Democrats who fervently believe wealthy Americans don't pay any taxes, or at least their fair share). If my calculator serves me correctly, the maximum wage amount would have to rise to around $92,000. I got that be saying that $90k of wages delivers $11,160 of taxes at 12.4%. If the taxes needed were 1.89% higher {see next paragraph} to solve the problem, that would require $11,371 of taxes from every average American. Dividing the $11,371 by 12.4%, gives a higer wage amount of $91,701 taxed at 12.4% to solve the issue.
Outside of other solutions, this is the one I'd support of those listed here, as the Trustees project that it would only take an extra increase of 1.89%, to a full level of 14.29% for the Social Security fund to be fully in the black, given that 78 million aging Baby Boomers are soon on their way to receiving benefits. I believe this is one solution that if explained to the American public, they'd support fully as a fix to the SS problem.
4) Tax income above $90K. A variant of the last solution. This wouldn't have to be at the full 12.4% rate. It could be for say, 2-3% of all wages between $90K and $150K, for example.
5) Cut benefits. Not gonna happen as it'll hurt 2 of the 3 most sacred issues in American politics (women, children and farmers).
So, here are some possible solutions to this mega-problem.
Give us your own....before it's too late!
Wednesday, April 18, 2007
Is a Declining US $ a Protectionist Policy?
This week, the US $ fell to a level of just over $2 per British Pound. In fact the US $ has been falling against a number of world currencies over the past few years. Under a falling $, US exports become more competitive in world markets. As Secretary of Treasury Paulson hasn't done much to stop its fall, many investors are starting to believe that a declining $ is now policy.
Is it a reaction to other world economies having greater GDP growth than the US? Is it a policy being implemented to decrease the size of imports coming into the US?
No matter your view on those questions, the simple fact is that a lower US $ is not a good thing when you consider the nation's sizeable trade and budget deficits, that are being largely financed with other nation's investments. As the US $ continues to fall, if these deficits aren't reduced, interest rates will be forced to rise in order to continue to attract those foreign countries that have now become America's banker.
Is it a reaction to other world economies having greater GDP growth than the US? Is it a policy being implemented to decrease the size of imports coming into the US?
No matter your view on those questions, the simple fact is that a lower US $ is not a good thing when you consider the nation's sizeable trade and budget deficits, that are being largely financed with other nation's investments. As the US $ continues to fall, if these deficits aren't reduced, interest rates will be forced to rise in order to continue to attract those foreign countries that have now become America's banker.
Tuesday, April 17, 2007
EconomindZ Question of the Day: Should Sallie Mae be allowed to go private?
I agree with Ted Kennedy!
To my many friends and acquantances that know me too well, that's a shocking statement. We card-carrying conservatives are supposed to revile, sneer and generally ignore anything that Ted Kennedy says. But, I gotta give credit where it's due, I believe ol' Ted's right this time. Ted said recently regarding Sallie Mae's proposed buyout, "The key question is not what this deal means for investors on Wall Street, but what it means for the millions of students and families on Main Street who rely on student loans to get through college."
About 10 years ago, Sallie Mae went public, denying its implied government guarantee and causing its credit ratings to fall from Triple-A to Single-A. Gone were the protections afforded bond investors, who until that time, relied on Sallie's access to the US Treasury if things went awry. At the same time, Sallie Mae decided to reduce its exposure to the government-guaranteed student loan market. So, their asset mix went from 100% government-guaranteed student loans to the current mix of 40% gov-gtd loans and 23% private student loans, with the remainder filled out by college-savings (529) plans, debt management services and other business and technical products to colleges, universities and loan guarantors.
Sallie Mae was started by the US government to develop a secondary market for student loans. Even as a die-hard capitalist, that was a good use of our tax dollars. As Sallie Mae went public, the student loan market saw a resource of funding wither (as Sallie's exposure to government-guaranteed loans fell). Gone also was the federal government's ability to do anything about it. So, the investment of our tax dollars was now benefitting private investors. Now with a $60/share buyout proposal on the table, this source of funding to the student loan market will likely get even smaller and even more expensive. The reason is that yesterday, all major credit rating agencies placed Sallie Mae's debt on watch for a downgrade. With a current Single-A rating, Sallie Mae's credit rating is expected to be slashed up to 5 notches, to below-investment-grade. That's junk folks! At 12/31/06, Sallie Mae had over $108 billion of bonds outstanding, providing funding to over $142 billion of student loans. With its debt possibly going to junk, to pay the increased funding costs, student loan rates will likely have to increase, possibly causing more harm to the student loan market than good. And, according to the College Board, students at US colleges borrow an estimated $85 billion a year to finance school costs. As a parent of a high school junior going to college in 2008, Sallie Mae's buyout offer is a potential increased cost that myself as a parent and a taxpayer would rather avoid.
So, while Wall Street looks to line its pockets with fat fees and increased access to students to sell them other services, such as credit cards and mortgages, ol' Ted's got it right this time, trying to measure this buyout proposal against what matters most - access to a college education.
To my many friends and acquantances that know me too well, that's a shocking statement. We card-carrying conservatives are supposed to revile, sneer and generally ignore anything that Ted Kennedy says. But, I gotta give credit where it's due, I believe ol' Ted's right this time. Ted said recently regarding Sallie Mae's proposed buyout, "The key question is not what this deal means for investors on Wall Street, but what it means for the millions of students and families on Main Street who rely on student loans to get through college."
About 10 years ago, Sallie Mae went public, denying its implied government guarantee and causing its credit ratings to fall from Triple-A to Single-A. Gone were the protections afforded bond investors, who until that time, relied on Sallie's access to the US Treasury if things went awry. At the same time, Sallie Mae decided to reduce its exposure to the government-guaranteed student loan market. So, their asset mix went from 100% government-guaranteed student loans to the current mix of 40% gov-gtd loans and 23% private student loans, with the remainder filled out by college-savings (529) plans, debt management services and other business and technical products to colleges, universities and loan guarantors.
Sallie Mae was started by the US government to develop a secondary market for student loans. Even as a die-hard capitalist, that was a good use of our tax dollars. As Sallie Mae went public, the student loan market saw a resource of funding wither (as Sallie's exposure to government-guaranteed loans fell). Gone also was the federal government's ability to do anything about it. So, the investment of our tax dollars was now benefitting private investors. Now with a $60/share buyout proposal on the table, this source of funding to the student loan market will likely get even smaller and even more expensive. The reason is that yesterday, all major credit rating agencies placed Sallie Mae's debt on watch for a downgrade. With a current Single-A rating, Sallie Mae's credit rating is expected to be slashed up to 5 notches, to below-investment-grade. That's junk folks! At 12/31/06, Sallie Mae had over $108 billion of bonds outstanding, providing funding to over $142 billion of student loans. With its debt possibly going to junk, to pay the increased funding costs, student loan rates will likely have to increase, possibly causing more harm to the student loan market than good. And, according to the College Board, students at US colleges borrow an estimated $85 billion a year to finance school costs. As a parent of a high school junior going to college in 2008, Sallie Mae's buyout offer is a potential increased cost that myself as a parent and a taxpayer would rather avoid.
So, while Wall Street looks to line its pockets with fat fees and increased access to students to sell them other services, such as credit cards and mortgages, ol' Ted's got it right this time, trying to measure this buyout proposal against what matters most - access to a college education.
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