February 28, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 150 basis points from 1.00% to its current 2.50%. The US Treasury 30 yr. interest rate is DOWN 88 basis points from 5.59% to its current 4.71%.

Let’s start the evening thousands of miles away in Australia where the Sydney Morning Herald has just reported that Australia has recorded it’s worst current account deficit on record…$29 billion. http://www.smh.com.au/articles/2005/03/01/1109546844746.html This might not seem like a big deal to you but the underlying reason is important as is the currency reaction to this news. The deficit was driven by a sharp fall in exports and “Australians’ insatiable desire for cheap consumer good imports”. Does this sound familiar??? Doesn’t it remind you of the US??? I have written for months about trade deficit’s being caused by strong economies where consumer’s have the $$$ to buy goods and services. The big difference is that the Aussie dollar is now trading at 79 cents up from 67 cents in 2004 and just 49 cents in 2001. Why is the Aussie dollar so strong??? Let’s start with a short term interest rate of 5.56% on the one year T-bill…..again we have a flat yield curve with 30 yr. Treasury bonds at 5.64%.. A strong economy and low inflation and high interest rates equals a very strong currency. As soon as Mr. Greenspan raises short term interest rates to the level of long term rates the US will have a flat yield curve where rates are ABOVE inflation and the dollar will soar…..yes, it’s really that simple….hot global money seeks the highest real (after inflation) rate of return……

Fed Chairman Greenspan will testify before the House Budget committee at 7am on Wednesday and again the world will be watching every word (CNN, Bloomberg, CNBC) to see if he gives any clues about future monetary policy.

Friday (3-04) we have the dreaded jobs number where the consensus is rising daily and is now expecting 250,000 new jobs. Long term interest rates have risen 30 basis points in the last two weeks due to a fear of rising inflation and a fear that the Fed may have to start to increase the Fed Funds by 50 basis points at its next FOMC meeting. Remember that the Fed does NOT have to wait for the regular FOMC meetings to change the Fed Funds rate, it can and has changed rates thru conference calls (maybe next time it will be thru e-mail).

Loan demand has slowed in the real estate area and although it is still too early to say the trend has changed it is worth watching on a close basis. Heloc loans have shown no growth in 2005 (they were the leader in 2004) and the overall real estate sector has risen a small 8 billion in the last month (406.6 total).

Staying with real estate it was announced today that the median price of a new US home is DOWN 4.8% from a year ago and that the number of new homes for sale in January rose to 440,000 which is the largest number on record. (since 1965).Didn’t the LA Times just report that Southern California homes ROSE 12% in the last year. There is a BIG disconnect between the California market and the remainder of the country and I sincerely doubt that gap will be filled by the other parts of the country catching up with California.

Mr. Greenspan’s favorite inflation indicator (PCE DEFLATOR) rose 0.3% in January and has now risen 1.6% in the last 12 months, not exactly soaring inflation…..

Finally tonight I will leave you with an interesting thought on how hard it is to find high yielding investments. Did you know that almost 16% of corporate bonds issued today are rated C by Moody’s?? The definition of a “C” rating is: very poor quality or imminent default is expected. The yield spread on these bonds compared to US treasuries has fallen to 6% from a high of 23% in 2002. What is most staggering is the fact that almost 80% of these bonds default before they mature.There is way too much $$$ chasing too few good investment opportunities and they are receiving a very LOW interest rate return for their very HIGH risk. There is usually only one way this ends and it is NOT pretty for those reaching for these high yields….There is a time and a place for everything and today is NOT the right time or place to be investing in high yield bonds.

February 22, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 150 basis points from 1.00% to its current 2.50%. The US treasury 30 yr. interest rate is DOWN 91 basis points from 5.59% to its current 4.68%.

The last few days have been anything but quiet for the financial markets. Today the Dow dropped 174 points, its worst loss since May 2003. Long term interest rates have risen 30 basis points in the last two weeks and twenty in the last two trading days. Oil has again jumped over $50 and is trading at $51.34 in overnight trading. Copper has jumped to a new 16 yr. high and is trading at $1.48. But the real kicker came last evening when the South Korean central bank announced that they are going to diversify their currency reserves OUT of dollars and into other currencies (yen, euro, aussie, kiwi, etc.). They hold the fourth largest FX reserves in the world at just over $220 billion. Again I ask why a central bank would make this announcement??? Have they already sold dollars??? Are they trying to push the dollar down further??? It sounds like a trader trying to get the market to follow in the same direction as his position…..Big players do NOT telegraph what they are doing in advance, it’s never done and as far as I am concerned it makes no sense so I will stand with my opinion that the dollar will be the surprise story of 2005 and rise…squeezing all the shorts (Gates, Buffett, Bank of South Korea, etc.)…there are just too many people on one side of this trade and it rarely works out that everyone makes money….who are the losers???? maybe just me if dollar continues to sink…..

We haven’t written about Fannie Mae and Freddie Mac lately but not much was said about Mr. Greensapn’s comments to Congress last week that the size of their mortgage porfolios should be limited to 200 billion down from the current one TRILLION, if that occurs the mortgage market will be rocked like a fighter that doesn’t see his opponents left hook coming…Mortgage lenders would be forced to hold more in their portfolios and sell less…increasing their risk of major losses….It’s almost impossible to see a major catastrophe coming BEFORE the fact but this has the makings of being the “mother” of all financial calamities……

The FDIC has just released a report entitled ” US Home Prices: Dies Bust always follow boom?” One of its conclusions is that history may NOT repeat (most housing bubbles are NOT followed by busts) and that we are in uncharted territory.It is worth your reading: http://www.fdic.gov/bank/analytical/fyi/2005/021005fyi.html

Wednesday morning brings two pieces of important economic information. At 5:30am we have the CPI (expected up 0.2%) which is normally not a major event BUT Friday’s PPI gain of 0.8% has everyone fearful that the big inflation monster is knocking at our door. That’s doubtful but the market is running scared and the few remaining longs seem to have thrown in the towel. The yield curve has widened the last two weeks mostly because of unwinding of profitable flattening trades. It’s important at times like this to remember that markets don’t travel in one direction for very long they do and can fluctuate due to a difference in investor and trader opinions. Long term rates have declined for the last 7 months but not in a straight line and although we are experiencing a small uptick I continue to believe that short rates will rise and long rates will fall so they will meet in the 3.5-4.5% range sometime later this year.

At 11am tomorrow morning the Fed releases the minutes of their FOMC meeting held earlier in February. This is a new event for the Fed and has become a MAJOR event for investors around the world. Every word, sentence, innuendo, etc. will be analyzed over and over by reporters, economists, traders, etc…..but sometimes we all spend too much time thinking and not enough time just sitting back and seeing what is really happening in the world……Mr. Greenpsan is retiring in January 2006 and does NOT want to leave any heavy lifting for the next Fed Chairman so he will raise short rates enough to cap future inflationary expectations. The big fear today is a lower dollar and higher long term interest rates and BIG money is NOT made through investments made by fear rather by going against the crowd and with the obvious economic trends that have been in motion for many years. If inflation is to really rise again from the ashes it will give us plenty of warning and the Fed will give us plenty of notice that the heavy artillery is going to be used (much higher short term rates 6-8%), until then sit back and enjoy because the ride is far from over…….

February 16, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 150 basis points from 1.00% to its current 2.50%. The US treasury 30 yr. interest rate is DOWN 107 basis points from 5.59% to its current 4.52%.

Mr. Greenspan spoke this morning before the Senate Banking Committee and basically said the same thing he has said for weeks; The Fed will keep raising the Fed Funds rate until it is time to stop…..Nothing new but he did add that the Fed is confused about the DROP in long term interest rates since 6-30-04 (see above). I have one question tonight for Mr. Greenspan: What would his reaction be if long term rates were quickly rising instead of falling??? I’m sure the answer would be that the Fed needs to increase short term rates even faster because the market is not happy with the current rate of advance for the Funds rate. I believe that the Fed actually sees the drop in long term rates as an approval sign from the bond market and believes as I do that short term and long term rates will soon meet somewhere in the 3.5-4.0% range. This will result in an inverted yield curve AND give the Fed a reason to STOP raising short term rates which is what everyone wants as soon as possible…..This all may sound confusing but Mr. Greenspan is being driven by the fact that he is retiring on 1-31-06 and wants to make sure that all Fed interest rate increases are done on his watch so the next Fed Chairman does NOT have any heavy lifting early in his term. As a result I expect all of the Fed moves to take place before Oct/Nov which gives the Fed enough time to switch the markets focus to the naming of a new Chairman. Does anyone remember how Mr. Greenspan was greeted in 1987 with the switch from former Chairman Paul Volker??? An increase in short rates and then a stock market crash…welcome to life at the Fed, it was a difficult beginning and one that Mr. Greenspan has never forgotten…..

The clock is about to strike midnight so it’s time for me to go home for a couple of hours as Mr. Greenspan will address the House Financial Services committee at 7am on Thursday and as usual everyone will be analyzing every word…Friday the bond market closes early at 11am and Monday it is closed for President’s Day (a day of rest for weary Fed watchers)

February 15, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 150 basis points from 1.00% to its current 2.50%. The US treasury 30 yr. interest rate is DOWN 110 basis points from 5.59% to its current 4.49%.

We are just a few hours away from Fed Chairman Greenspan’s testimony to the Senate at 7am on Wednesday. This is truly a world wide event and will be televised by business channels (CNBC, Bloomberg, etc) and every word will be analyzed many times to see if a change in US monetary policy is on the horizon. Wednesday (2/16) mornings edition of the Sydney (Australia) Morning Herald has a cover story entitled “Greenspan feels heat on deficit and savings” Obviously the Aussies see the US more in terms of our currency than our interest rate markets. http://www.smh.com.au/articles/2005/02/15/1108230002221.html

My view is unchanged, The Fed will continue to raise short term rates until they exceed long term rates and with the two now converging it shouldn’t be long before we have an inverted yield curve. (short rates higher than long rates)

This morning it was announced that inventories and retail sales (excluding autos) increased last month with much of the inventory gain being financed by the banks (see the growth in C&I) loans in 2005.

The Philadelphia Fed surveyed 36 of the top economists in the US and it was 100% unanimous that US rates will rise this year. They are half right, short rates are rising but long rates are falling and will continue to fall due to low inflation and excess capacity utilization in the US.

Final thought: Over the past 16 times Mr. Greenspan has given semi-annual testimony to Congress the bond market has moved an average of 9 basis points and the stock market 76 points so tomorrow should be an interesting day for Wall St. and the bond market.

February 14, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 150 basis points from 1.00% to its current 2.50%. The US treasury 30 yr. interest rate is DOWN 114 basis points from 5.59% to its current 4.45%.

The big news for the week occurs on Wednesday when Fed Chairman Greenspan speaks before the Senate Banking Committee at 7am. This is his semi-annual economic address and will be televised around the world as investors, traders and anyone else breathing will be looking for clues about future monetary policy. According to Robert Novak (NY Post) Mr. Greenspan is being urged to allow a quick and dramatic fall in the dollar due to the huge US trade deficit. I have my doubts that will occur and if he continues to raise short term interest rates the dollar will be continue its rally despite all of the experts who say the opposite, money flows to the countries that have the highest interest rates and the US is higher than Japan and Germany and slowly closing in on England and Canada. Fighting currency battles usually leaves the underlying economy flat on its back. Japan is considering raising taxes to close it’s deficit which will create another recession for an economy that doesn’t seem to get out of its own way. By the way why is no one screaming about the fact that debt in Japan exceeds its GDP by 50%!!!! Yes the yen is strong but what has that done for deflation???? growth???? etc…..If you want a trade surplus just trade with countries that have strong consumer demand (US) but again I am not sure what that brings to the overall economic health of the country.

Barrons ran an article over the weekend about the US issuing 30 yr. Bonds, something we wrote about last week…economically a great decision to lock in low rates for 30 yrs., politically a great decision to lower the deficit….what is Washington waiting for????

The LA Times had an article on Sunday titled “What’s the Bond Market Saying?”, rarely does the bond market make the LA Times headlines and the article talked about low US interest rates due to massive Asian buying….I am not sure that is really it…how about low US and WORLDWIDE inflation and a feeling that the Fed isn’t going to stop raising short term rates until they are HIGHER than long term rates. Remember Greenspan retires in a year and he wants to make sure the next Fed Chairman is not left with any heavy lifting of rates.

In Saturday’s London Financial Times the lead story was “Saudis to increase oil capacity” as they plan on operating new rigs to bring production back to levels last seen in the 1970’s. With high prices comes more supply and eventually lower prices BUT for now with oil in the $45-$50 range the Saudi’s are becoming more convinced that high oil prices are here to stay and if they follow thru (maybe) they will be creating the seeds of the next big oil price decline in 5-10 years.

An interesting piece in Saturday’s The Scotsman that was about slowing house price increases are making existing homeowners (UK) eager to cash in on their profits. A survey found that an increasing number of sellers were more willing to accept less for their houses in the FEAR that prices would start to plummet. This is not happening in the US but it is interesting to see how those across the big pond are reacting to the global economy as they were first on the ship “Higher home prices” which set sail in the mid 90’s in England.

Friday’s Fed loan numbers again showed an increase in C&I loans with a jump of $3.6 billion and we feel that that is due to increase M&A activity and raw material inventory building, not the categories that create new jobs. BUT the real estate sector continues to slow as the HELOC area showed an unchanged amount and almost no growth for 2005 so far…Has everyone tapped all of the equity out of their houses??? If the answer is yes….unless the average consumer hits the weekly lottery then retail sales are going to have a hard time increasing over the next few months.

Merrill Lynch polled their worldwide money managers and found that 0% were bullish on bonds in the US (rates down) with 75% bearish (rates up) and 25% neutral. When everyone is on one side of the boat the results are usually not what everyone expects….

Final thought for this Valentine’s Day evening at my office: I am often asked if Mr. Greenspan is watching the real estate market and if his decisions are influenced by the ever increasing US home prices….On Friday February 4th in London Mr Greenspan said: “The growth of home mortgage debt has been the MAJOR contributor to the decline in the personal savings rate in the US from almost 6 percent in 1993 to its current level of 1 percent.” There are only two ways for the consumer to increase their savings with one being to continue to cash out equity from their homes and the second being to cut spending and invest more at higher rates of interest. Is there any doubt which answer Mr. Greenspan prefers?????

February 10, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 150 basis points from 1.00% to its current 2.50%. The US treasury 30 yr. interest rate is DOWN 112 basis points from 5.59% to its current 4.47%.

Finally we saw a sell off in the long end of the US Treasury market as three (3yr, 5yr, 10 yr.) auctions were just too much for the bond market to absorb in one week. I find it interesting that in this time of very low long term interest rates around the world that the US Treasury is NOT considering issuance of 30 yr. or longer bonds. Wouldn’t it be a good idea to lock in these low rates and at the same time lower the interest cost part of the deficit for the next generation???? France is considering 50 yr. bonds and the UK is talking about 40 yr. bonds, it’s amazing how short sighted the politicians can be when they are not focused on such a simple solution that would NOT have any negative political implications…..

The National Association of Realtors reported that the average price of a condo for 2004 was $193,600 which now exceeds the average price of a house – $184,100. The house market is seven times bigger than the condo market but it does say volumes about the current state of the real estate market in the US. The WSJ ran an article today that showed that of the 10 most overpriced real estate markets 8 are in California which is no surprise….

Not much economic news on Friday with just 2 Fed speakers in the early afternoon. The BIG news next week occurs on Wednesday (2-16) when Mr. Greenspan gives his semi-annual testimony on the state of economic affairs before Congress and it will be televised around the world. To bond traders it will be equivalent to the Super Bowl with everyone hanging on every word from the Fed Chairman.

Commercial paper issuance was down slightly last week for the second week in a row. I will be interested in seeing the Fed loan numbers tomorrow at 1:15pm to see if the trends of higher C&I loans and flat RE loans continued this week.

February 8, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 150 basis points from 1.00% to its current 2.50%. The US treasury 30 yr. interest rate is DOWN 122 basis points from 5.59% to its current 4.37%.

Down and down and down some more as long term interest rates fell again today and the yield curve just gets flatter….with 2 yr. treasury notes yielding 3.31% and 10 yr. notes at 4.01%. It’s just a matter of months before the long term rates are LESS than the short term rates (see England) The world’s hedge funds have jumped on a runaway freight train by the name of “flattening yield curve”, Australia, England, Canada and the US are all seeing higher short term interest rates due to a fear of central bank tightening and this is accompanied by lower long term rates. As a result the “hot money” goes where there is the most pain and that comes from those who still believe that higher long term rates follow higher short term rates. The word is finally getting to the public as this morning’s LA Times ran an article that tried to explain why long term rates are falling while short term rates are increasing and the reason is NOT foreign money but lower inflationary expectations.

A couple of days ago I wrote that the amount of loans (ex-Real Estate) has increased in 2005 but I couldn’t figure out why….many of the answers may be found in today’s release by the Federal Reserve of its loan officer survey taken in January. http://www.federalreserve.gov/boarddocs/SnLoanSurvey/200501/default.htm . Commercial and Industrial loans are demand driven and although US banks seem to have lowered or eased their lending standards and lowered their margins over their cost of funds, the BIG reason still comes from increased demand for money. But with the economy not growing at any more than an average rate and inflation under control (1.6%) why would corporations need to borrow???? The answer is right there in this report for everyone to see: “Greater need for inventory financing was the most-often-cited reason for increased demand for C&I loans at domestic banks.The second most important reason for increased demand was an increase in merger and acquisition activity.” Inventory growth is due to stock piling for future demand which appears to be stalled and M&A activity is because it is cheaper to buy existing corporations that build new ones…The main point is that neither of these reasons for increased loan activity is INFLATIONARY and that is why long term rates continue to decline. $$$ used to keep inventories afloat does NOT create new jobs and $$$ for M&A activity may actually CUT existing jobs due to economies of scale. Sometimes the answers to the most perplexing economic questions are rather simple and right in front of us….we only had to wait a couple of days for the answer.

Other items of note from this Fed report: Large numbers of banks increased their tolerance for risk to create more loans, 30% of banks reported weaker demand for mortgages to purchase homes. 25% of banks said their mortgage holdings had increased because a larger share of their originations DID NOT conform to Fannie Mae and Freddie Mac standards. It appears that these lenders are reaching for riskier loans in an effort to keep market share.This was a powerful report from the Fed and I urge you to print it and then save it to read again because much of what is going to happen to interest rates in the next few months will emanate from this report.

Final note: I will often read a Greenspan speech over and over until I find the “golden nugget” and last night around midnight I believe I found that sentence that tells us everything we need to know about Fed policy for 2005. It is found in his speech in London last Friday: “The growth of home mortgage debt has been the major contributor, at least in an accounting sense, to the decline in the personal saving rate in the United States from almost 6 percent in 1993 to its current level of 1 percent.” Mr. Greenspan is terrified that the low savings rate combined with an economic slump and/or a decline in real estate prices could accelerate into a severe economic contraction due to the consumer being “tapped out”. The Fed will force the consumer to save by raising short term interest rates ABOVE long term interest rates and the inflation rate thus giving the economy a cushion in case of a fall….I’m not sure I agree with his reasoning but remember it never pays to fight the Fed…….

February 7, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 150 basis points from 1.00% to its current 2.50%. The US treasury 30 yr. interest rate is DOWN 117 basis points from 5.59% to its current 4.42%.

Long term interest rates fell again today as the world’s hedge funds piled on to the hottest trade of the year: long 30 yr. treasury bonds and short 2 yr. treasury notes. This trade is profitable when the yield curve flattens (short rates up and long rates down) and that is exactly what is happening every day in the US bond market. Have you notice that a conforming 30 yr. loan today is 5.125%???? Remember the average American homeowner/consumer believes interest rates are HIGHER than they were a year ago, the message that rates are actually lower has NOT been driven home and won’t be until much later in the year.

Last night we wrote about the slowdown in real estate loans that might lead to a flattening in home prices. From Scotland we read about foreigners that are buying real estate in the US due to a lower dollar. It will be interesting to see if this really has much of an effect on our home prices and if so it will probably be confined to the coastal areas of the US. For the entire article visit: http://business.scotsman.com/print.cfm?id=137612005&referringtemplate=http://business.scotsman.com/index.cfm&referringquerystring=id=137612005

There has been much written about the so called January effect in the stock market where the market follows the January action the remainder of the year. Merrill Lynch researched the January effect on long term interest rates and found that since 1982 that 5 out 0f 6 times rates fell in January they continued to fall for the remainder of the year. Too small a sample for me but interesting.

After diving deep into Friday’s jobs numbers I found the most interesting part was that November and December were revised DOWNWARD by 29,000. In an improving economy jobs numbers are usually revised upwards which brings me back to the point I made last night….every part of the puzzle comes together perfectly EXCEPT for the fact that corporations are borrowing from banks and thru commercial paper like it’s the 1980’s again…..why??? I’m afraid I don’t have the answer but I promise you I will soon……

February 6, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 150 basis points from 1.00% to its current 2.50%. The US treasury 30 yr. interest rate is DOWN 111 basis points from 5.59% to its current 4.48%.

I spent the weekend shopping for a new crystal ball as my forecast of 300,000 new jobs was not even close to the actual number of 146,000. The business of economic and interest rate forecasting is a humbling one and the only solace is that if you make small bets along the way you will still have enough to fight another day. Yes I am well aware that the average miss for all economists each month is 76,000 but it still stings to be soooo wrong…the good news is that the markets opened in Asia tonight just like they always do and I look forward to another week of interest rate gyrations with a new crystal ball that I purchased at a store down the street for $1.99.

Friday’s Fed loan stats continue to show what just might be a change in direction for both commercial and real estate loans. Commercial and industrial loans rose $2.9 billion last week and rose almost $20 billion for the month of January. Rising loan demand in the face of higher short term interest rates is quite unusual and if it continues would show that companies that are sitting on a record amount of savings are borrowing to create jobs??? But according to Friday’s employment numbers jobs are not increasing at a quick pace…something should give sooner than later…usually loan growth PRECEDES Fed tightening but in this case the Fed tightened BEFORE loan growth so we’ll have to wait for this answer.

The other loan category of interest to everyone is Real Estate and that just might be slowing down….a heavy emphasis must be put on maybe because predicting the end of the real estate boom could be dangerous to your wealth if you are wrong. BUT real estate loan growth slowed to an increase of just over $10 billion in January and that amounts to a growth rate of only 0.4%. It’s way too early to see anything but 2004 saw a 14.4% increase for the year so again we will just have to wait and see….Lastly the Heloc category which showed explosive growth in 2004 with a 42% gain was up only 1.7% in January…..

Last thought for this evening….The best news of the week came from the Federal Reserve and the long term interest rate market. If the Fed continues to raise the Fed Funds rate and the 30 yr. Treasury rate continues to decline they will soon meet somewhere in the 3.5-4.0% range which will create 4.5% 30 yr. fixed rate mortgages and more importantly put the Fed in a position where it usually STOPS raising short term rates. An inverted yield curve (short term rates above long term rates) is NOT a normal occurrence for this country and usually puts a quick halt to economic growth and inflation (current rate 1.6%). It has and does occur but usually for short periods of time and I will soon write about those periods and the changes in Fed policy that followed….As usual it’s never dull in interest rate land….