Fixed Income Weekly

Short-term yields continued their march downward this week mostly driven by comments from St. Louis Fed President James Bullard. Headlines read “Fed will not increase rates until early 2012”, but were pretty misleading if read without the rest of the speech.

Below is a graph of the current on-the-run 2-year since it was issued late last month. Yesterday the 2-year tested the all time lows of .649% set in late 2008.


The majority of the Fed President’s speech focused on monetary policy going forward, namely the status of quantitative easing and near zero fed funds. Bullard prefaced the quote that ran across the newswires by sighting that the Fed has waited 2.5-3 years from the end of the past two recessions to begin raising interest rates, which would give us an early 2012 initial interest rate hike if the Fed decided to follow similar protocol. Problem is, this is no normal recession and the Fed has chosen to fight the deflationary threat to the economy in non-traditional ways (i.e. QE).

Instead of waiting for an initial hike from current levels 2.5 years from now, a scenario where the Fed moves to more of an accommodative policy within a year while beginning to test the securities market with reverse repos to unwind the QE is more likely.
Early year-end profit taking may have been another factor pushing the short end lower this week. According to Bloomberg, 3-month bills traded as low as .005% on Thursday and stayed that low all day Friday, likely due to managers moving to the sidelines through the holiday season and year end. Stocks are down a little for the week so this seems like a logical thought at least.

The last time bills yielded below .05% was in the aftermath of the Lehman Brothers bankruptcy which forced The Reserve Fund (a major money market fund who held a concentrated position in commercial paper issued by Lehman) to break the buck. This forced an exodus of cash from mmkt funds into bills, sometimes accepting negative yields in order to do so. We are in same place now for a different reason. Now more than ever, the Fed’s liquidity is urging investors to love risk again by punishing them for hoarding cash.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks lost ground on Thursday, following a slide in overseas bourses. A bout of concern that stocks have gotten ahead of economic growth prospects (we’ve heard that one before only to see stocks resume rally mode) and an analyst’s downgrade of the semiconductor space resulted in some profit taking.

A round of economic data didn’t help matters as initial jobless claims refuse to fall below the 500K level and mortgage delinquencies and foreclosure rates continue to rise – although high jobless claims and terribly elevated foreclosure rates haven’t had an adverse effect on stocks thus far during this meteoric rise from the March depths; maybe something has changed as we close in on year end – we shall see.

There was a pretty good flood into the short-end of the Treasury curve as the two-year note fell 4 basis points to yield 0.7%. The two-year yield hasn’t hit this level since we were in the middle of the storm in December 2008 – maybe fund managers have decided to begin booking equity-market gains and sit in Treasury securities to year end.

Still, the 1.34% decline in the broad market was hardly substantial considering the spike in prices over the past eight months; the rush into the Treasury market – the two-year yield has plunged 30 basis points since late October, the 10-year yield is down 20 bps over this four-week span – would normally put significant pressure on stocks, yet they are barely off recent highs. It’s a strange market environment for sure. The broad market was actually down 2% at the day’s nadir, but rallied in the final 90 minutes to erase a good deal of those losses.

Energy shares led the decline (down 2.07%) with financials and information technology not far behind. Traditional areas of safety, consumer staples and health-care, were the relative winners on the session – down 0.33% and 0.53%, respectively.

Market Activity for November 19, 2009
Initial Jobless Claims

The Labor Department reported that initial jobless claims held steady last week at 505,000 (in line with the expectations of 504K) from the upwardly revised reading of the prior week -- originally estimated at 502K, but revised up slightly to 505K. The four-week average of initial claims fell 6,500 to 514,000.

We’re still waiting for that move below the 500K level.

Continuing claims fell for a ninth-straight week, down 39,000 to 5.611 million in the week ended November 7 (there’s a one week lag between initial and continuing claims). However, as we’ve been talking about, jobless benefit extensions rose, more than offsetting the decline in standard continuing claims. As the unemployed see their traditional 26 weeks of benefits run out they are moved to Emergency Unemployment Compensation (EUC) and its several extensions. EUC rose 101,838 for the week and extended benefits (the various tiers to EUC) rose 17,170.

Extended benefits now run up to 99 weeks, as we discussed earlier in the week. This extremely wide social safety net (maybe more appropriate to term it a hammock) will, at the margin, keep the jobless rate high.

I’ve put this exhaustion rate chart up several times now. It is a monthly number so it hasn’t changed since last week, but I find it helpful to paint the picture. This is the exhaustion rate of standard (26 weeks) unemployment benefits. It continues to make new highs not only because the labor market is a wreck, but also because Congress continues to add extensions.


Philly Fed

The Philadelphia Federal Reserve Bank’s survey of manufacturing activity accelerated to 16.7 in November from 11.5 in the previous month – the estimate was for a move to 12.2. This is a big reading for Philly and is a bit contrary to that of Empire Manufacturing, which showed New York-area factory activity decelerated – these are the first looks at factory activity for November.

A couple of the sub-indices showed substantial improvement. New orders jumped to 14.8 from 6.2, great sign for next month’s activity; shipments soared to 15.7 from 3.3 – although this is a just a follow through of the prior month’s higher reading. The number of employees remained in contraction mode, but rose to -0.5 from -6.8; the average workweek moved to expansion for the first time since December 2007 – that’s when the NBER (official arbiter of business cycle expansions and contractions) stated the recession began.

However, while employees and average workweek improvements show the pace of firings declined, a couple of indicators on actual hirings moved deeper into contraction. Unfilled orders fell to -5.4 from -1.3. The delivery times readings fell to -12.7 from -9.3. These readings indicate that factories are not burdened with a degree of orders that current payroll counts cannot fill or deliver. It does not speak well for new hires because it shows they’re not needed.

Just as we’re watching for a meaningful move below 500K on initial jobless claims, we will keep a close on these two factory readings (unfilled orders and delivery times) for evidence that meaningful additions to payrolls are on the horizon.

The inventories index rose to -17.3 from -31.8 – a substantial improvement but shows firms are still destocking. A full-blown inventory dynamic is not yet upon us but GDP only needs for stockpiles to decline at a slower rate to boost the reading. The fact that this inventory reading is barely better than the average since the recession officially began (-17.3 vs. -20.4 average) illustrates that business confidence remains lackluster.

Mortgage Delinquencies

The chart above speaks for itself, but it does exclude the inventory of foreclosures. The number of mortgages either delinquent or in foreclosure is 14.11%.

Here is the delinquency breakdown:

Among fixed rate mortgages, the delinquency rates are as follows: 5.67% of prime loans; 24.57% of subprime; 13.90% of FHA

Among adjustable rate mortgages, the delinquency rates are as follows: 12.37% of prime loans; 28.23% of subprime; 14.36% of FHA

What we have seen over the past few months is that prime loans are beginning to drive foreclosures; at the beginning of this housing contraction, it was sub-prime leading foreclosure rates higher. This tells us it is not just about bad loans written and a lack of credit standards, but the highest jobless rate in 26 years is doing the damage.

This data screams of a significant increase in home supply. The number of loans 90 days late or in foreclosure is now over 4 million, according to the Mortgage Bankers Association. To put this number into perspective, there is currently 3.8 million new and previously occupied homes for sale.

Based on such a larger number of homes waiting to hit the market I fail to see how housing escapes another round of price decline, and the resultant increase in bank losses. Economists who expect a robust economic expansion to ensue appear to be living a fantasy.


Have a great weekend!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks stumbled, but just slightly, as the latest mortgage applications index and October housing starts showed that a new round of home-buying weakness is likely upon us. Concerns are also increasing over FHA-backed mortgage loans. The latest to express concern about the FHA is Robert Toll, CEO of home builder Toll Brothers, who referred to the situation as “a definite train wreck.”

The FHA’s required down payment is only 3.5% and these loans now make up 24% of the market, up from 3% in 2006, if memory serves -- we’re looking at a lot more mortgages going underwater. With 14.4% of FHA-backed loans at least 30 days late and 7.8% at least 90 days late (according to the Mortgage Bankers Assoc.), this will work as another incremental force keeping foreclosure rates heightened and another taxpayer bailout is coming. Book it, it’s a done deal.

However, this market is living in a keep-up-the-bad-work mindset. The broad market rallied late in the session to darn-near erase earlier-session losses. What’s bad is good in this bizarro environment because it signals an increase in ZIRP’s lifecycle – easy money continues to boost the appetite for risk.

Financials led the rally as billionaire John Paulson, president of the eponymous hedge fund, put a price target of $29.81 on Bank of America by 2011 – the stock currently trades at $16.35. Sounds like he either wants to juice his trade or believes the Fed will remain at or near zero for another two years.

Among the 10 major industry groups, health-care and telecoms were the only other sectors to close in positive territory. I found it interesting that basic material and energy stocks failed to close higher even as metals and energy prices gained ground. Also, the dollar nearly gave back all of its prior session gains, still these dollar-down trades couldn’t make it to the plus side.

Volume was weak again as barely more than one billion shares traded on the NYSE Composite – that’s roughly 18% below the six-month daily average.

Market Activity for November 18, 2009
Mortgage Applications

The Mortgage Bankers Association reported that its applications index fell 2.5% in the week ended November 13, even as the 30-year fixed-rate mortgage averaged 4.83% -- the lowest level since May.

The purchases index fell for a sixth-straight week as buyers were frozen, uncertain as to whether the tax credit would be extended or not. Now that that extension has been promulgated, it should unfreeze home sales in the coming weeks. Nevertheless, I wouldn’t expect quite the effect it had in the summer as we’re now past the traditional buying season and most of those who were able to take advantage of the credit probably have.

The purchases index is down to the lowest level since late 1997.

Refinancing activity slipped 1.4% after large bounces over the previous two weeks of 11.3% and 14.5%, respectively.


Consumer Price Index

The Labor Department reported the headline consumer price index (CPI) rose 0.3% in October (+0.2% was expected). The core rate, excludes food and energy, rose 0.2% (+0.1% was expected).

Year-over-year, headline CPI was down 0.2%, the slightest decline since y/o/y comparisons began posting negative readings in March. This will change to an increase when the November data is released. Even if CPI comes in unchanged for the month, the y/o/y figure will be up 1.5%. If the current monthly trend continues to December, the y/o/y figure will close in on 3%. The degree of increase in the headline y/o/y readings from there will depend upon the direction of the dollar and the rise in commodity prices.

The y/o/y reading on the core rate remained benign, 1.7% for October.

The main contributor to the October rise in headline CPI was the transportation segment (which consists of private and public vehicles and gasoline) – it accounted for 71% of the increase. The core rate was driven by new and used vehicle prices, accounting for 58% of CPI’s October increase when excluding food and energy.

Used vehicle prices, at least according to CPI, rose 3.4% last month and this component is up 31% at an annual rate over the last three months -- clearly a function of clunker cash. Thanks Congress!

Housing Starts

The Commerce Department reported that housing starts plunged 10.6% in October – which is pretty amazing considering starts remain on the mat, but this is necessary due to weak fundamentals. Builders broke ground on 529,000 units at an annual rate, the market was expecting a rise to 600,000 units. Overall housing starts are down 30.7% from the year ago period and 76% from the cycle peak hit in January 2006. (On the chart below, SAAR stands for seasonally adjusted at an annual rate.)

Construction starts on single family units fell 6.8% in October. The 476,000 in single family starts (at an annual rate) is 33% above the all-time low hit in February but even with this bounce the number remains 9% below the erstwhile record low, which was hit in 1981.

Multi-family starts slid 34.6% in October, which follows a 19% decline in September. The 53,000 in multi-family construction starts marks a new all-time low.

Housing construction permits, obviously an indication of future work, fell 4.0% last month -- down 24.3% from the year-ago period. It appears that boost third-quarter GDP receive from residential construction (the first in 15 months – sorry I think I stated 13 months in a letter earlier this week) was a one-and done event.

Bumpy Road – Not Just a Metaphor

We are in the process of $787 billion in deficit spending that is specifically slated as stimulus – traditional infrastructure projects, entitlements, health services, energy efficiency, etc. Something in the range of $45-$65 billion is earmarked to highway and transportation projects. So why exactly do I find myself dodging I-270 potholes on the way to and from work?

Recall our skepticism early this year regarding the claim that there are “shovel ready” projects. That is, the claim that money will be delivered directly to state and local governments which have projects ready and waiting, and thus immediately result in new work – a wonderfully conspicuous event for politicians as Americans would be able to see this activity as they go about their daily lives. Well, only the naïve believed this claim as there is an arduous, and well-known, appropriations process that stands in the way of immediate results. Still, one would think we’d get something to show for this, one of many budget busting, programs. Apparently, they can’t even resurface roads in a reasonable timeframe.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks refused to stay down yesterday, extending the latest winning streak to three days. After spending nearly the entire session below the flat line, the major indices rallied in the afternoon to eventually close the session slightly higher. The S&P 500 is within 1% of recouping half of its losses from the October 2007 record high of 1565 – 1120 on the S&P 500 marks that point from the closing low of 676 on March 9, 2009.

The market completely shook off a lackluster industrial production report and comments from Fed Chairman Bernanke the day before on the state of the economy, statements that had pre-market trading tracking lower. A rally in commodity-related basic material shares (up about 1%) led the broad market into positive territory.

Consumer discretionary shares were the biggest loser on the session (down 0.74%). Of the 10 major industry groups, six rose and four fell.

Volume was very weak as less than one billion shares traded on the NYSE Composite.

Market Activity for November 17, 2009
Producer Price Index (PPI)

The Labor Department reported that producer prices rose 0.3% in October (+0.5% was expected), after a 0.6% decline in September. Year-over-year the reading is down 1.9%. Excluding food and energy, what’s known as the core rate, PPI fell 0.6% for the month and is up just 0.7% year-over-year. So on the more headline numbers the data remains uneventful.

A look within the report gets a little more interesting. Over the past three months, PPI is up 7.4% at an annual rate. That’s up from +0.6% by the same meaure in September.

Total intermediate goods (those used in the middle stage of production) were up 0.3% in October and are higher by 9.7% annualized over the past three months (although mostly due to a large increase in August, which had clunker-cash auto assemblies written all over it). Core intermediate goods fell 0.5% in October, but are up 5.5% over the past three months at an annual rate. Crude materials (those used at the initial stage of production) were up 5.4% in October; the core rate was up just 0.5% after huge back to back gains in September and August of 3.6% and 6.0%, respectively. On a three month basis, total crude goods are up 31.5% and the core rate for crude goods is up 48.6% at an annual rate – albeit from pretty low levels.

So, there is evidence of underlying inflationary pressure. We’ll see how this materializes into higher headline PPI readings and later consumer price inflation. For sure much of these underlying pressures will be absorbed as the slashing of payrolls has worker productivity at elevated levels; nevertheless, we’ll certainly see PPI begin to post positive year-over-year numbers when the November reading is released. By December, it is likely y/o/y PPI will begin to run at 3.5%-4.0%. Not terribly concerning, but it is a significant turn from the trend of negative readings of the past year.

We’ll continue to watch credit. When it begins to expand again, that is when the unprecedented level of dollars the Fed has pumped into the system will result in much higher inflation readings.

Industrial Production and Capacity Utilization

The Federal Reserve released their monthly industrial production figure, which showed if not for the third-coldest October on record production would have ended a three-month streak – a bounce off of the most prolonged contraction in the post-WWII era.

Industrial production (IP) rose 0.1% last month (+0.4% was expected) after rising at a downwardly revised 0.6% in September – previously estimated to have risen 0.7%. There are three main components to this data: manufacturing, utility and mining production.

Manufacturing fell 0.1%, held back by a 1.7% decline in auto production after huge increases over the previous three months. There we had clunker-cash driven auto sales (and thus assemblies) driving the previous IP gains and now that that has run its course, we’re seeing the short-term effects of that program in this weak reading. Machinery orders did rise, up 0.2% for the month. Computer and electronics production fell 0.3%. Overall business-equipment production fell for an eighth month in 10 and is down 6.7% year-over-year – down 10.79% at an annual rate since peaking in March 2008. Production of construction supplied fell hard for a second-straight month, down 1.2% in October and down 17.0% over the past year.

Mining production fell 0.2%, a bit of a surprise at these commodity prices.

Utility production saved the month as the segment posted a 1.6% gain.

Capacity utilization (CU) inched up for the fourth-straight month, touching 70.7% -- the cycle low, also the all-time low (data goes back to 1967), of 68.3% was hit in June. The long-term average on this reading is 81.0%, so we’ve got a ways to go before a meaningful degree of hiring begins. Firms will increase current employees’ hours worked before adding to payrolls, as we’ve been talking about for some time now.

Manufacturing industry CU ran at 67.6% in October – the long-term average is 79.7%. Utility CU ran at 79.0% -- the long-term average is 87.6%. Mining CU ran at 83.5% -- the long-term average is 87.5%. It won’t take long for mining utilization to blow through the average if the dollar stays down and commodity prices high.

National Association of Home Builders (NAHB) Index

The NAHB showed confidence among homebuilders remained at depressed levels in November, unchanged from October at 17 – a reading below 50 illustrates most home builders view conditions as poor. High joblessness, lofty foreclosure rates (filings surpassed 300,000 for the eighth-straight month in October, according to RealtyTrac) and problems obtaining credit are all holding down sentiment.

The NAHB also gauges buyer traffic and sales expectations for the next six months. The buyer traffic gauge was unchanged at 13 – the recent high is 17 and the all-time high is 60. The gauge of future sales rose two points to 28 – the recent high is 30 and the all-time high is 83.

For Some Reason I’m not Feeling Stimulated

Bloomberg News reported yesterday afternoon that the House is working on a “job creation” plan this year that will include money for highway construction (sorry, that creates work not jobs), tax credits for small businesses to hire more workers (one assumes this is the vaunted concept that first made the rounds this past summer – a $4,000 tax credit to be paid over two years; if members of Congress took the time to inform themselves of what it costs to hire a worker they’d understand how silly this $ amount is), and finally, drum roll please…another extension of jobless benefits (that would bring us to triple digits as current extensions run out at 99 weeks).

Bienvenue a l’aupair etat.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks shook off an ugly consumer confidence reading to close higher on Friday. The gain pushed the broad S&P 500 up by 2.26%, which follows a 3.20% move in the week prior – completely erasing the pullback of late October. The Dow Industrial Average added 2.46% for the week and the NASDAQ Composite rose 2.62%.

Consumer discretionary shares led Friday’s gains, which was pretty strange considering the latest consumer confidence reading – we’ll touch on those results below. It appears the consumer discretionary trade got a boost from Disney’s earnings that beat expectations on Thursday night. But the results were able to beat only because of massive cost cutting and a jump in fees from cable operators. The television division drove the number. Advertising and them parks continue to struggle, which is to be expected.

Technology shares also performed well, as did traditional areas of safety such as utility and consumer staples.

Small cap stocks also rose for the week, but have underperformed the large caps over the past four weeks, which may be a sign this rally is getting tired.

There’s certainly no indication the equity sprint is running out of steam this morning though as stock-index futures are up big. A pledge from Asian countries to maintain stimulus measures – pretty much a redux of the statements we got out of the G-20 a week ago – has provided more juice for the risk trade. Commodities continue to roll as gold has hit $1130/oz., oil’s closing in on $80/barrel again (even though fuel demand is weak) and copper hit a new 14-month high -- and is not all that far from the super-spike level of 2008.

The dollar, of course, is getting hammered back to the 74 handle on the Dollar Index as the Chinese government said they will not re-value the yuan (which we talked about last week) and is having a field day ripping on Fed policy over the past several years.

Forget the problems that ZIRP causes in an economically endogenous sense – higher commodity prices, the improper assessment of risk as investors scramble for yield, dropkicking the dollar and exacerbating the credit contraction as banks simply borrow at nothing and invest in Treasury securities instead of making loans. This Fed policy has enormous potential in creating international tensions, problems to which we won’t know the extent until they occur.

Instead of acknowledging this issue, along with the massive deficit spending and protectionist policies that are also damaging relationships, our policymakers are in Asia talking about climate change. You want to talk about misplaced priorities, this is a striking example. When we get to the end game, when the markets no longer rise simply because countries say they are going to keep their stimulus measures floored and the consequences of all of this short-minded stimulus must be paid, I’m betting we’re not going to find anyone who takes life seriously concerned about climate change (it’s interesting how the climate Malthusians no longer call it global warming).

Market Activity for November 13, 2009
Trade Balance

The Commerce Department reported that the September trade balance registered a deficit of $36.472 billion for the month, a widening from the -$30.849 billion difference in August. The real (inflation-adjusted) deficit widened to $41.71 billion, or 10.1%, from 37.86 billion.

There are a couple of quick takes from this: One, the punishment the dollar has endured isn’t helping to narrow the deficit – which is what all the academics tell us must happen; some people are not surprised they’re wrong. Two, since this is the trade data for the last month of the third quarter, it means a lower revision to the GDP reading – a widening of the trade figure subtracts from GDP.

A significant reason for the wider difference between exports and imports is the higher price of oil, this is one reason the “lower dollar is good for narrowing the trade balance” conventional wisdom is flawed – a lower dollar means an increase in the price of oil.

Indeed, the imported crude-oil number jumped to $4.06 billion for the month, or a 26.2% increase. (The trade deficit hit its historically wide levels back in 2006-mid/2008. Those wides in the trade figures were driven by Greenspan/Bernanke & Co. keeping rate too low for too long, which encouraged the credit expansion and thus the big import flows. Of course, the seven-fold increase in the price of oil (from $20 in 2002 to $140 by the summer of 2008) had something to do with this too. The dollar, which plunged 40% in value against a basket of other currencies during this period, drove that oil price. Again, so much the conventional wisdom – according to their beliefs the U.S should be running a huge trade surplus as a result of such dollar decline.

But back to this latest data, exports rose a healthy 2.9% for the month, but imports rose more, up 5.8%. Ex-petro, imports still rose 4.4% and this was fueled by the clunker-cash scheme (and you thought you had heard the last of that term) as auto parts and supplies imports jumped 11.5% -- automotive goods accounted for 18% of all imports in September.

The exports reading was boosted by a 45.7% increase for commercial aircraft after a 40% decline in the previous month – this volatility is not unusual. Exports of industrial machines and telecom equipment were also good.

Import Prices

Import prices rose 0.7% in October, up for three-straight months and seven of the past eight. No one seems to be paying much attention to this data, probably because the year-over-year reading is down 5.7% -- the 12th month of decline. But over the past six months, import prices are up 13.3% at an annual rate. The actual year-over-year reading is going to post a dramatic shift by the time of the December figures -- even if the number is flat over the next two months that reading will shift from -5.7% as of this data to +7.0% by the December reading.

University of Michigan Confidence

The U of M.’s headline consumer confidence reading for November fell back to 66.0 from 70.6, which brings the index back to where it stood in July. The Economic Conditions reading slipped to 69.6 from 73.7 (which was the highest level since April 2008). The Economic Outlook reading fell to 63.7 from 68.6.

This survey does not involve a specific question on consumers’ take of the job market environment, such as the more widely watched Conference Board’s confidence reading does. Thus, one may expect another decline in that survey, which is already at a level that matches the worst readings of prior recessions, going back to 1967.

The Week Ahead

This week will be a big one on the data front as we get retail sales (October), Empire and Philly Manufacturing (November), Industrial Production (October) and Housing Starts (October).

Today we’ll kick it off with one of the most watched numbers, retail sales for October. The reading should post fairly strong results, a number that has a good shot of beating the 0.9% increase that’s expected (+0.4% ex-autos and +0.2% ex-auto and gas).

This market is likely to get excited if the reading is as good as I think it will be as there’s a lot of wishful thinking rolling out there with regard to intermediate-term consumer activity trends. But the weather will have provided a fake out. Last month was the third-coldest October on record and that means it pushed forward fall and winter apparel sales. We’ll see how it turns out in about 30 minutes.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks remained in rally mode on Monday after a good retail sales report and Asian countries’ pledge to maintain stimulus spending. As a result, energy and basic material (commodity-related shares) led the advance.

The largest daily gains over the past couple of weeks have followed policymakers’ statements that aggressive monetary and spending policies will continue. For instance, the broad market jumped 1.92% the day following the latest Fed meeting in which the FOMC stated conditions warrant “exceptionally low levels of the federal funds rate for an extended period.” Then the S&P 500 rallied 2.22% a week ago Monday after the G-20 members agreed to continue stimulus spending. Now we have this 1.45% move yesterday, which immediately followed the pledge from APEC (Asia Pacific Economic Cooperation). The impetus for these rallies appears to be pretty obvious.

To be sure, the retail sales data had something to do with the rally. Or rather what it didn’t do, it didn’t damage the higher sentiment that was evident by pre-market futures trading. A number of segments within that report showed decent-to-solid growth, but the ex-autos number did miss expectations and the downward revision to the previous month was substantial. The overall reading easily surpassed expectations, but only because auto sales bounced from a very weak September reading -- the autos sales chart below tells it all.

Advancers trounced decliners by an eight-to-one margin on the NYSE Composite. Volume was unimpressive as less than 1.1 billion shares changed hands.

Market Activity for November 16, 2009
Bernanke’s Dollar

Whoa! The Fed chairman not only mentioned but spent considerable time talking about the dollar, and the corresponding increase in commodity prices, in yesterday’s speech to the Economic Club of New York. Of course, he had to point out that he believes inflation will remain subdued for some time (and he may be right so long as credit continues to contract, but the moment it picks up so will the velocity of money and all of those dollars pumped into the system will cause prices to rise, and fast).

The Dollar Index spiked on the news, but quickly plunged back to where it was trading before the comments. The markets will require action, talk is not nearly sufficient to reverse the dollar down trade – but if this is a first step we’ll take it. Is this an early signal the Fed is thinking about a little ratcheting? Let’s think about that.

If mildly increasing fed funds shows the world that the Fed is somewhat serious about keeping the dollar from drowning in a sea of aggressive monetary easing, it will make their eventually unwinding of current policy much easier. Conversely, if they keep ZIRP in place and the dollar heads lower, commodity prices keep flying and traders continue to push stocks to valuations that do not appear to be commensurate with realities on the ground, then the Fed’s job in the months ahead will become all the more politically unsavory. The longer they wait, the more aggressive the tightening campaign will be and this will be very harsh on asset prices. I know I’m reaching here. It’s highly unlikely the Fed will move on rates before the unemployment rate peaks (and we’re at least six months from this occurring). But allow me to dream for a moment.

The market surely didn’t view his statements as anything but lip service as stocks kept chugging along and the Dollar Index moved down to the 74 handle and then to intraday lows. The dollar bounced off of that low mark but finished below the day’s average price – as you can see above.

Retail Sales

The Commerce Department reported that retail sales jumped 1.4% in October (+0.9% was expected) after a big downward revision to the previous month – down 2.3% vs. the -1.5% initially estimated.

The overall gain in retail sales for October was mostly due to a bounce in auto sales after a very weak September. (Of the $4.7 billion increase in sales, autos accounted for $4.0 billion.) But we did get good results from the apparel and general merchandise segments – there’s that colder weather event we talked about; last month marked the third-coldest October on record.

Excluding autos, retail sales rose 0.2% (following a downwardly revised 0.4% increase for September. The ex-auto reading was weighed down by a large 2.4% decline in building materials. Take out autos, building materials and gasoline (what’s known as core retail sales and the number that feeds directly into the personal consumption reading for GDP) and retail sales were up 0.5% for the month – that gets the fourth quarter off to a good start.

Quickly on that building materials decline, this is a pretty bad sign for residential home construction. Home building added to GDP last quarter for the first time in 13 quarters. The increase in this area will probably prove fleeting.

Autos (motor vehicles and parts) jumped 7.4% in October. Gas station receipts were flat after rising for two months in a row. The segment is down 15% year-over-year.

Clothing and general merchandise looked good as sales for those segments rose 0.4% and 0.8%, respectively. Eating, drinking (the segment that I often refer to as unfazed by high joblessness as a significant portion of this reading involves 20-somethings) jumped 1.2%.

Furniture, electronics, sporting goods, and again that building materials reading, were all down.

From a year-over-year perspective, overall retail sales are down 1.7% from the very weak October 2008.

Empire Manufacturing

New York-area manufacturing activity grew in November but at a reduced rate relative to October. The Empire Manufacturing index came in at 23.51 for the month (6.5 points below the expectation) after a 34.57 in October. A reading above zero marks expansion, so this is a good number even if it missed the forecast. (This differs from the ISM and Chicago manufacturing surveys in which a reading of 50 is dividing line between expansion and contraction.) That big reading for October (the best since 2004) seemed to be artificially boosted by auto assemblies following clunker cash.

In terms of the sub-indices, new orders fell to 16.66 from 30.82 in October. Delivery times fell to -2.63 from 3.90 in October – this shows firms are having no problems delivering orders even with the slashing of payrolls, not a particularly good sign for job gains. Employment fell to 1.32 from 10.39. However, these are the first back-to-back positive readings since the spring of 2008.

The two readings getting most attention right now – inventories and average workweek – were not helpful.

Inventories ticked up to -17.11 from -18.18, but remain well in contraction mode. We have yet to receive evidence that firms feel comfortable enough to boost stockpiles – and that means production remains lackluster.

The average workweek reading fell back to 5.26 after bouncing to 20.78 in October. We were waiting to see some extension to that previous reading, for sure current employees will have to see their hours worked increase dramatically before factories bring back those who have been laid off. It is good to see this reading in positive territory, but after the aggressive manner by which manufacturers have slashed payrolls, this measure needs to post a series of outsized gains in order to deliver an addition to factory employment anytime soon.


Business Inventories

The Commerce Department reported that business inventories fell 0.4% in September, the slowest rate in a year, showing what the latest GDP reading also illustrated – inventory slashing has ended. To be sure, stockpiles continue to be cut, firms have neither the confidence nor the demand to begin to rebuild, but this is an important first step. Auto inventories jumped in September, due to very weak sales for the month. Excluding auto, business inventories fell 0.6%.
The sales data attached to this report showed a decline of 0.3% after three-straight months of increase. The inventory-to-sales ratio held at 1.32 months worth of supply. This reading probably needs to fall back to 1.25 (near the record low) in order to get firms building stockpiles again in this environment.

Economists are watching for a build in ex-autos stockpiles as evidence the inventory dynamic has arrived – this is what will catalyze GDP for a couple of quarters. I’m guessing the first and second quarters of 2010. Many readers may notice I keep pushing this estimate forward. A couple of months back I had estimated the inventory dynamic would be in full swing by the fourth quarter. We’re still waiting for its arrival.



Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Weekly

The process of money creation is complex. Flooding the market with cash to keep Fed Funds low is a very traditional way to stimulate an economy, and the Fed is all in on that front with Fed Funds at zero. They took it a step further this year and moved into longer assets to bring down longer term interest rates on things like mortgages. All of this buying has left banks flush with cash and rates low, hoping to spur lending and economic growth. Fed funds has been at 0-.25% for 11 months, they have purchased $300 billion in Treasuries notes, over $1 trillion in Agency MBS and over $100 billion in Agency debt in addition to $43 billion in TALF and billions more in other confusingly named programs. So why isn’t there any real growth?

The graphs below show the decline in credit since late 2008. The first graph shows Commercial Loans, the second shows Consumer Loans.

Banks are required to hold a certain amount of cash at the Fed, called required reserves. Excess reserves, cash that banks chooses to hold at the Fed in excess of the required amount, have grown since the Fed began pumping the system with cash. The reason for this is lack of demand for funds by both households and businesses – basically banks have nothing to do with all the liquidity. The graph below shows the level of reserves, both required and excess, that banks currently hold at the Fed.

True money creation is more than just Fed induced liquidity. Money creation will only happen if there is adequate demand for money, and right now there isn’t. Excess liquidity has a track record of producing high levels of inflation, but the lack of demand for loans is keeping inflation in check right now.

The public can ridicule banks all they want for not lending, but that is not the problem. Businesses are not expanding and households are still trying to repair the damage done to their home values and/or from their lost income. Stimulus, whether it is monetary or fiscal, still relies on true demand to foster a recovery, and risky asset rally that has been labeled an “economic recovery” has some difficult times ahead unless we get some.

Cliff J. Reynolds Jr., Investment Analyst