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Archive for September, 2008

“The real interesting question at the moment,” opined Alan Greenspan to CNBC yesterday, “why is the economy in the world still in positive territory?

“The United States is weakening, obviously, and it’s stagnant,” Greenspan said. “But we’re holding up, and the developing world, while coming down from its dramatically rapid rates of increase, has slowed, as well. And so, I think the real interesting question is why are we doing as well as we are?”


And the answer’s in my new edition of The Age of Turbulence!

Greenspan said — again — that the U.S. still has a “50% or more” chance of entering recession. He also forecast (gotta sell those new paperbacks) “when we get beyond this [financial crisis], I think we’ll see a re-emergence of inflation, which we have not seen for years.”

The U.S. housing market has taken another turn for the worse. Pending home sales fell 3.2% from June to July, reports the National Association of Realtors. Year over year, the NAR’s index for homes under contract to be built is down 6.7%.

“Buyer confidence remains low,” said the typically cheery Laurence Yun, chief economist for the NAR. “Even with the Treasury Dept.’s direct intervention in the secondary mortgage market, it is unclear if we will go back to sound normal underwriting criteria, or if it will remain overly stringent. The housing market outlook is very cloudy.”

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Monday: 09/08/08 5

Treasuries were all over the place today as the news of the Fannie and Freddie takeover scared off traders. But the changed dynamics in the mortgage backed securities market spurred a heavy round of hedging activity that involved the purchase of Treasuries. 

As a result, Treasuries recovered from their losses to finish with modest gains at the long end of the market. Stocks soared on the takeover news and, despite some choppy action, two of the three major indices retained strong gains while the third posted a mild increase.In late trading, the 10-Year Treasury Note was up by 6/32, lowering its yield by 3 basis points to 3.67%; the Dow was up by 290.43 points to 11,510.74; and the Nasdaq was up by 13.88 points to 2,269.76.

The government seizure of the two giant mortgage agencies heartened stock traders who see it as restoring some confidence in the credit market. Of course, a big beneficiary was the financial sector though shares of both Freddie and Fannie fell today. The sector shift diminished some of the luster of tech stocks and they lagged in performance.

Oil futures also gyrated today but the price of a barrel of crude for next month delivery eventually closed with a nominal gain of $0.11 to settle at $106.34. The price had fallen in each of the previous six sessions for a total of $11.92 and the drop was attributed to projections of lower future demand for the commodity as the world economy cools.

Today’s pause is being attributed to uncertainties about tomorrow’s policy meeting of the Organization of Petroleum Exporting Countries (OPEC). A couple of storms are also threatening to disrupt production facilities in the Gulf of Mexico this week.

By the end of stock trading, the Dow had gained 2.58% and the S&P 500 was up by 2.05% while the tech-heavy Nasdaq gained only 0.62%. The movements should be taken in context, however. While the Dow has gained 2.88% in the last two sessions, it fell by 2.99% last Thursday. The S&P 500 rose by 2.50% in the last two sessions but it also fell by 2.99% on Thursday. The Nasdaq has not performed as well; today’s increase was the first following six session losses totaling 6.46%.

In the bond market, today’s gain for the benchmark 10-Year Note was not enough to make up for Friday’s loss but the yield closed today at its second lowest level since April 15 (yield moves inversely to price).

Tomorrow brings the report on pending home sales and the report on wholesale inventories — both for July. After a general decline in the last two-and-a-half years, the sales index perked up in April and June as falling home prices have begun to attract buyers.

But progress in the housing sector is still being blocked by tighter credit conditions, higher mortgage rates, and an aversion to borrow money to buy an asset that is declining in value. For July’s pending sales index, a decline of between 1.0% and 1.5% is predicted.

The growth of wholesale inventories has been relatively strong this year (with the exception of just slight growth in March). Moreover, outflows have also been strong, keeping inventory levels exceptionally lean. In June, the seasonally adjusted level of inventories rose by 1.1% and the sales level rose by 2.8%. This left the inventory-to-sales (I/S) ratio at a record low 1.06. This meant that at June’s sales pace, without any additions to stocks on hand, inventories would be entirely depleted in a little over one month.

For July, inventories are expected to have increased by 0.7% and the I/S ratio will remain low.

Tuesday’s releases are not considered high-impact indicators and trade is expected to remain volatile in the markets as participants continue to sort out the implications of the mortgage agency changes.

10:30 AM EDT : Treasuries began the day deep in the red in response to Sunday’s news of the federal takeover of secondary mortgage giants Fannie Mae and Freddie Mac. The move undercuts the value of Treasuries by removing their safety advantage now that mortgage debt is also essentially government-backed. Treasuries are also hurt by the increase in supply that may be needed to finance the capital support for the mortgage agencies.

The news has also eased concerns about the health of the credit market in general and this has spurred a strong rally in stocks this morning. The rise in stocks makes bonds less attractive by comparison.

But Treasuries have pared much of their earlier losses though this may just be due to technical factors; for instance, a bounce may have triggered a round of short-covering that snowballed and/or traders who may have been sidelined during the Labor Day holiday period may be adjusting their positions.

In any case, the major influences appear to be aligned against bonds and price action may be volatile again today. The benchmark 10-Year Note had been down by as much as a point (32/32) but was recently trading down by just 10/32.

Freddie Mac, originally named the Federal Home Loan Mortgage Corporation, and Fannie Mae, originally the Federal National Mortgage Association, were hybrid companies, established by the government but run as private corporations known as government sponsored enterprises (GSEs).

The agencies purchase loans from approved lending institutions, create mortgage backed securities, and sell the securities in the financial market. Servicing of the loans is handled by the primary lending institutions or servicing companies. A portion of the securities are held by the agencies themselves. They also issue their own corporate bonds as well as issue stock to raise capital.

In the last couple of years, the collapse of the securities sector backed by high-risk mortgages has weakened the companies and clouded confidence in their ability to continue functioning effectively. The worries have persisted despite the agencies’ credit lines with the Treasury and other sources of capital including the Federal Reserve’s discount window. The situation ultimately led to yesterday’s announcement by Treasury Secretary Henry Paulson that the companies had been taken over and are now under the operational control of the Federal Housing Finance Agency (FHFA).

The takeover is the focus for the markets as there are no major economic releases scheduled. Tomorrow, a minor indicator on the housing sector and a second-tier inventory report will be released. The housing release is the report on pending home sales for July. In June’s report, the National Association of Realtors said that its seasonally adjusted index of pending sales rose by 5.3%. Though the jump surprised observers who were expecting a decline, the index (unadjusted) was down by 12.1% from June of last year.

The pending sales information is somewhat dated and its significance is diluted by the fact that the index is just an indicator of upcoming actual sales. The data was first published in 2005 with data going back to 2001. The index is a measure of the seasonally adjusted, annualized rate of contract activity in a month. The NAR asserts that 80% of contracts become sales within two months and a large portion of the rest become sales two months thereafter.

For July, the index is expected to have declined by 1.0%.

The other release of the day is the report on wholesale inventories for July. This data is also somewhat dated and it only provides one piece of the overall inventory picture. The more comprehensive, business inventories report will be released at the end of the week.

In the report for June, the Commerce Department said that the seasonally adjusted level of wholesale inventories rose by 1.1%, almost twice as large an increase as analysts had predicted. The level rose by 0.9% in May. Rising inventory levels are bullish if they are perceived as anticipating demand instead of reflecting a back-up due to falling demand. June’s increase reflected rising demand as the sales level increased by 2.8%, the largest jump in over four years.

The combination pushed the inventory-to-sales (I/S) ratio down to a record low 1.06 from May’s previous record low of 1.08. The I/S ratio is the value of stocks on hand at the end of a month divided by the value of sales for the month. It indicates how many months it would take to entirely deplete existing inventory at the prevailing sales pace. Low turnover times mean there is high pressure to replace supplies and it is, therefore, a positive economic indicator.

A smaller inventory increase of about 0.7% is predicted for July, which, if accurate, would be the smallest rise in four months. The I/S ratio may edge higher but it will still indicate extremely lean inventory levels.

There are no major releases scheduled for Wednesday so a couple of minor releases may get added attention. These are the weekly oil inventory report from the Energy Department and the report on mortgage application activity from the Mortgage Bankers Association of America.

On Thursday, the employment situation will be reviewed once again in the jobless claims report. In last Thursday’s report, the Labor Department said that the seasonally adjusted level of initial claims for state unemployment benefits rose the week before by 15,000 to 444,000. This followed three weeks of declines totaling 28,000 but this in turn followed four weeks of increases totaling 109,000. The latest reading was the third highest since early 2003.

The four-week moving average fell by 3,250 to 438,000 but this was still the fourth highest reading since early in 2003. For the first thirty-five weeks of the year, the average weekly, initial claims reading has been 377,514. For the same period last year, the average was 316,000.

The report said that continuing claims in the week of August 23 (continuing claims must be at least a week old) rose by 6,000 to 3.435 million. The four-week moving average rose by 33,250 to 3,400,250. Both levels were the highest since November of 2003. For the first thirty-three weeks of the year, the average weekly, continuing claims reading has been 3,020,647. For the same period last year, the average was 2,521,618.

Thursday also brings a couple of trade related releases. The first is the report on international trade for July. June’s report was more bullish than expected. The Commerce Department reported that the seasonally adjusted value of imports exceed that of exports that month by $56.8 billion. The deficit figure was 4.1% smaller than May’s revised $59.2 billion and was a much smaller gap than the $61.5 billion that forecasters had predicted.

Higher oil prices helped boost imports by 1.8% to a new record high, but exports rose by 4.0% — also to a new record high. The decline of the dollar over the last six years has made U.S. goods cheaper abroad, thus spurring increased foreign buying.

Net exports are a component of gross domestic product and the smaller subtraction to the GDP calculation contributed to an upward revision in last week’s preliminary report on the second quarter. The advance report had said that GDP grew at a 1.9% rate but this was revised to 3.3%. A final report will be released on the 26th of this month.

July’s trade figures will provide the first look at situation for the third quarter. Forecasters are looking for a wider gap of $58.0 billion, but the bearish aspect may be blunted somewhat by expectations of a smaller deficit in August due to a sharp decline in oil prices.

The other trade related news on Thursday will come in the report on import and export prices for last month. In July’s report, the Labor Department said its index of import prices rose by 1.7%. This was the smallest increase since February but it was still strong by historical standards and it topped analyst predictions. In addition, June’s originally reported increase of 2.6% was revised up to 2.9%.

Of course, a major contributor to the increase was a 4.0% rise in the price index for petroleum products (oil). Though this was also the smallest increase in five months, it was still strong, and excluding the category, prices were still up by 0.9%, matching the increase in June when the index for petroleum products rose by 8.9%.

On a year-over-year basis, the import price index was up by 21.6% in July. It was the highest Y/Y margin going back to at least 1989 (available data before that time is quarterly). The petroleum index was up by 79.2% on a year-over-year basis, down from June’s 82.6% margin but the second highest in the history of the available data series. Excluding the category, the price index was up by 8.0%, the highest Y/Y margin in the data series.

Export prices also saw large gains. The overall price index rose in July by 1.4%, the largest jump in four months and the twenty-first consecutive monthly increase. The volatile agricultural product category saw an increase of 6.7%, the largest monthly jump in the available history of the data series. Excluding the category, export prices were up by 0.8% in July following a 0.9% increase in June.

On a year-over year basis, export prices were up by 10.2%, agricultural prices were up by 39.9%, and ex-ag prices were up by 7.5%. All of these margins were the highest in the history of the available data.

The average spot price of crude oil fell last month by the largest amount in almost two years and this is expected to translate into a hefty decline in the overall import price index. This would be welcomed by both stock and bond traders.

On Thursday afternoon the Treasury will release its budget figures for last month. In August of last year, government outlays exceeded receipts by $117.0 billion. Next week’s report is expected to show a smaller deficit of about $105.0 billion. The reason for the prediction is partly due to the fact that July’s deficit figure of $102.8 billion was much larger than anticipated and may have been skewed by calendar issues.

But even if the prediction is accurate, the running total for the fiscal year to date (begun last October) would be a deficit of $476.4 billion, a far larger gap than the $274.2 billion posted for the same period in the 2007 fiscal year. Large deficits are bad for Treasuries because it means more securities will have to be issued to cover existing debt and government operating expenses.

Friday has a heavy slate of economic releases. A major release is the retail sales report for last month. In July’s report, the Commerce Department said the seasonally adjusted level of sales slipped by 0.1%, the first contraction since February. However, the report said that the level rose in June by 0.3% instead of the originally reported 0.1%.

A large but volatile sales category is automobiles and light trucks. Sales there fell by 2.4% in July — a sixth consecutive contraction. But even excluding the category, sales were up by 0.4%, a weaker increase than June’s 0.9%,

Another large and volatile category for obvious reasons is sales at gasoline stations. The level in this category rose by just 0.8% in July. Excluding both the auto and gas station categories, sale rose by 0.3%, the smallest increase since a flat reading (0.0%) in February.

According to recent reports from auto makers, sales remained weak last month and sales at gas stations are expected to be soft because of falling prices. Consequently, predictions call for only a slight gain in overall sales in August and excluding autos, sales are expected to be little changed.

Another major release on Friday is the Producer Price Index (PPI), a gauge of inflation at the wholesale level. It rose by 1.2% in July following a 1.8% rise in June. The volatile category of energy was a major contributor with an increase of 3.1%. Another volatile category, food, rose by just 0.3%. But even if these volatile categories are excluded, the so-called core index rose by 0.7% in July, the largest increase since November of 2006.

On a year-over-year basis, the PPI was up by 9.8%, the largest Y/Y increase since June of 1981. The energy index was up by 28.0% Y/Y, the largest margin since November of 1989. The core index was up by 3.5% from last July, the largest margin since June of 1991.

Price pressures were also high further down the production pipeline. At the intermediate stage of production the price index rose by 2.7% in July following a 2.1% rise in June and a 2.9% rise in May. Excluding food and energy, the index was up by 2.0% in July.

On a year-over-year basis, the intermediate index was up by 16.6%, the largest jump since April of 1980. The core index was up by 10.2%, the largest Y/Y margin since September of 1980.

At the initial or crude stage of production, prices were up by 4.2% in July. On a year-over-year basis, they were up by 52.1%, the largest increase since January of 2001.

August’s headline figure is expected to be welcomed by both stock and bond traders. Because of the decline in oil prices, the index is expected to have declined by 0.3%. If this is the case, it would be the first contraction since last December. The core index is expected to have risen by an in-trend 0.2%.

As noted above, the report on business inventories for July will be released on Friday. The report on factory orders has already revealed that manufacturers’ inventories rose by 0.5% and by Friday we will know the disposition of the wholesale sector. The only unknown will be the retail sector. If the wholesale level rose by the predicted 0.7% and the retail level rose just slightly, the overall inventories level would have risen by about 0.5%.

This would be a deceleration from June’s rise of 0.7% but it would be the sixteenth consecutive expansion. The I/S ratio came in at a record low 1.23 in June and July’s is likely to be as low or possibly lower.

The final release of the week is the preliminary report on consumer sentiment from the twice monthly surveys conducted by the University of Michigan. Due to shaky economic data and the rise in gasoline prices over the last year, consumer optimism has been trending down. The overall index hit its lowest reading in June since May of 1980.

But since gasoline prices have eased, the index rose in July and August after nine straight months of declines. Another rise to between 64.0 and 65.0 is predicted for Friday’s reading but this would still be sharply lower than the final reading of 83.4 posted in September of last year . . . .

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