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.