Daily Insight

Stocks stormed back from the depths of the intraday low – jumping 2.7% from that nadir – when Reuters reported Fed Chief Bernanke told the mortgage GSEs (Fannie and Freddie) they would have access to the discount window. This way, specifically with regard to Fannie, they could use its $1.5 trillion in unpledged assets as collateral to provide necessary funding, if needed. But minutes later Bernanke denied comment on the news. Stocks summarily lost momentum, but held onto half of the gains from the session’s low.

Benchmark indices began Friday trading lower and were down 2.3% at the lowest point, reached just after noon, as hypothetical situations had taken over and overwhelmed the current state of capital and liquidity positions at Fan and Fred. As three different financial analyst firms stated on Friday morning, home prices would have to decline 40% nationally and delinquency rates would need to rise ten-fold for the two to reach critical capital levels. One assumes it wouldn’t take this level of housing-market deterioration for the two to runs into capital constraints, but the overall point is salient – to this point there isn’t an issue.

The main concern was that hysteria would take over and a state of panic could set in. In light of this, the administration and Federal Reserve decided it important to get a plan out in order to quell this hysteria and to stop short-sellers in their tracks. The Treasury stated they would increase their credit lines to Fan and Fred, and would take an equity stake, if necessary, to inject a level of capital that would get them through a period of trouble. The Federal Reserve also stated they would open the discount window to the two GSEs, again if necessary. So it appears that Reuters’ story was correct.

These statements have calmed the market immensely, for now, as stock futures are up big and common shares of Fan and Fred are up 20% and 30%, respectively in pre-market trading.

Market Activity for July 11, 2008
In other news, the board of Anheuser-Busch agreed to the $50 billion ($70 per share) takeover from InBev last night, so the situation will go to shareholders for approval, which will undoubtedly get the green light.

I seem to be the only one talking about anti-trust issues, and maybe I’m in left field on this one, but I wouldn’t be surprised to see the political landscape attempt to block the deal. I don’t think there are realistic anti-trust problems, but we’ve seen the Justice Department block deals that were less compelling than this one. Antitrust blockage would simply be a pretense for politicians’ desire to keep their constituents happy. Bottom line, if Bud had run their business more efficiently, they’re stock price would have made a deal prohibitive – and of course some of this falls on the Fed for driving the dollar into the dirt, which also made the deal financially appealing to InBev.

Getting to Friday’s economic releases:

First, the Treasury Department reported the monthly budget surplus for June came in at a larger-than-expected level thanks to a 16% decline in spending. On the revenue side, things continue to deteriorate as financial-sector woes have hurt overall profit growth. Yes, several industries continue to post higher year-over-year earnings but the drag from the financial sector is too much for corporate tax receipts to remain positive from year-ago levels.

In addition, we have endured 438,000 payroll job losses since January, and while this is not a large number in a market with 137.6 million payroll positions, it does have an effect on individual tax receipts as the year-ago comparison enjoyed healthy job growth and an expanding tax base.

In a separate report, the Commerce Department stated the trade deficit narrowed in May and illustrated that strong export growth will continue to provide a boost to GDP. Exports rose 0.9% in May and have jumped 25% at an annual rate for the quarter. (This is for the second quarter which has passed, but we must frame it in a sense that it is still ongoing because the data has a large lag to it. We’ll get the June figure next month.)

Finally, the Labor Department reported that import prices for June jumped 20% from the year-ago level – up 2.6% from May alone. Both of these figures were higher-than-expected and the May data was revised higher as well.

Unfortunately, this received zero attention as everyone focused on the Fan/Fred story, but one has to worry that this level of price increases will funnel to the consumer level – as energy is already a major issue for consumers. The Fed continues to clinch, precariously, to their Phillips Curve models. These are Keynesian-economic teachings that state; so long as wage pressures do not present themselves, one doesn’t have to worry about inflation. Problem is, as is the case with most other Keynesian type beliefs, they are often removed from reality.

To my dismay, it doesn’t appear the Fed will raise rates any time over the next several months with all that is occurring related to the housing market, but they better get to some mild tightening regardless of this situation. They can begin by gently raising the fed funds rate 25 basis points at a time, until they get to 3.00% -- I don’t see how this will hurt things regarding the overall economy. In terms of mortgage resets, keeping the rate at 2.00% won’t do any good anyway for all of those that failed to put money down as their home value is currently less than what they own on the mortgage. Benflation Bernanke can push fed funds to zero and these people will still just walk away from their obligation.

The thing that worries me is the longer they ignore inflation and energy price realities, we’ll move to a situation where the Fed will have to jack rates to a level that will be economically harmful in order to get inflation back in its box. They still have time to avert such a scenario in my view, but must get to it.

Have a great day!


Brent Vondera, Senior Analyst