The yen, interest rates, stocks and liquidity

Liquidity is important for everything in life and the markets. If we don’t drink enough water each day we become dehydrated which in some cases can be life threatening. If the markets don’t have liquidity (the ability to buy or sell without big price movements) they tend to create high volatility which leads to a difficult environment for businesses to operate. Yesterday’s stock decline (300+ pts.) was clearly a liquidity event caused by the market that is controlling almost all of the worldwide markets: the yen. I wrote a couple of weeks ago that something felt different as the US stock market reached new highs and the yen failed to hit new lows. In the last week the yen rose from the 122 level to 118 (panic buying). It’s extremely important to remember that markets move quickly when the majority of leveraged participants are losing money and must rush to exit positions for fear of not having enough capital to fight another day. Initial positions can be entered using patience but when one is losing the exit door needs to found quickly and before everyone else breaks down the door. The “yen carry” trade has been the key driver in 2007 as hedge funds and anyone else seeking a “low risk” way to make profits has borrowed yen (under 1% borrowing rate) and then converted the yen to high yielding currencies (Australia, New Zealand) or strong stock markets (US) or anything else that is solidly moving in one direction. Unfortunately for those caught yesterday the only safe haven was US Treasuries as many investors find it to be the best resting place until we see the level that stabilizes the yen.

Mortgage market update

On March 23rd (see archives) I wrote: “Soon we will see the prime mortgages priced at higher spreads to treasuries and it would NOT surprise me to see Treasury rates much lower in six months but mortgage rates higher due to a cut back in demand from securitized buyers at current spreads.” If you are in the mortgage or real estate business you are acutely aware that mortgage rates have not dropped anywhere near as much as Treasuries in the last month as lenders do exactly as I predicted: they have widened their lending spreads in an effort to increase profits to offset losses from their sub-prime, alt-a and every other product they have sold to customers but not been able to sell to the street fast enough to avoid losing money.

There are few advantages of growing old but when you are as old as I am you do have something important and it’s called “perspective.” I have been watching markets on a daily basis for over 40 years and vividly remember the late 70’s/early 80’s when interest rates moved 50 basis points in a few hours and the Fed made changes to the funds rate in the middle of the day (decision made by telephone). The 1987 stock crash (caused by Greenspan’s insistence on holding up the value of the dollar) saw extreme volatility and more painful lessons for the rookies that had never seen this scene from a movie that many of us had viewed before. I have written many times that we only see life from our own experiences and the blood in the mortgage market is being spilled from those that refuse to believe that the world is anything but the way they have experienced. Whether it be margin calls to lenders with warehouse lines that were more than enough in the past few years or just a feeling that the lending tree could grow to the sky it is very difficult to break away from the pack and leave the party before the authorities arrive with the paddy wagon.

Over the past two years I have given many speeches to audiences that were anything but friendly with a typical comment that I would surely be wrong because: “This is how I make my living and I don’t know anything else that makes this much money.” The markets don’t know you and don’t really care about you or me and unfortunately one of my favorite Goldingerisms is so true today: People would rather lose in company than win alone. Very few people were smart (or lucky) enough to take their chips off the table and walk away early despite the fact that they could be ostracized by their friends, business partners, etc. Long term winners are never afraid of anything and Sam Zell looks like a genius for his sale earlier this year of his Equity Office Partners to Blackstone.

Bear markets are unusual and almost unheard of in residential real estate. For the past two years I have been writing over and over and over again that this would be the most unusual decline for real estate in history. Unlike the past 30 years we would not see every small decline in prices met with buyers that would drive prices to new highs. Those real estate agents that told me “I have seen everything, nothing could be as bad as the early 80’s” laughed when I said this would be very different: a long, slow, painful decline that would last a minimum of 5-7 years. Despite what everyone is hoping for we are still at the very beginning of this decline with a few months pause to be followed by more pain in 2008. I look for the stated income loans to soon be replaced in the mortgage marketplace by the old fashioned full doc loans back at the forefront of the mortgage products offered by the dwindling number of lenders. If stated income loans do survive it will be only for loans with very low (50%) LTV’s. Credit scores have proven not to be a good barometer of a borrower’s ability to pay and having studied the history of market meltdowns (and up) it is clear that we always have an over reaction in the other direction after the smoke clears. Regulators and the government move slowly and will want to make sure the housing market is never able to repeat the events of this year again (at least in their lifetime) so the change to tighter underwriting guidelines is also just at the beginning.

One of the reasons that the price of residential real estate must continue to fall comes from Virginia. Earlier this week an article pointed out that home prices continue to be priced at a level where the monthly mortgage payment is greater than the needed income of area buyers would need to qualify for a loan. “To buy a $600,000 home, a buyer would need at least $120,000 cash as the down payment.
To cover the roughly $3500 monthly mortgage payment, the buyer would need a pre-tax, household income of about $95,000, said Eric Compton, mortgage broker with Salem Financial. The median household income in the Roanoke Valley is about half that, limiting the pool of potential buyers.” Last year this could have been an easy stated income loan but now it needs full documentation and won’t qualify. Strap on your seat belt, big changes are on the way.

Interest rates

On June 1st I wrote (see archives): “Until the yen rises to the 118 level (yesterday) the US stock market should have clear tracks to travel faster and faster and faster speeds until its ultimate hard correction similar to its February 27th pit stop.” Obviously yesterday’s 311 point Dow drop qualifies as a hard correction. Nothing has changed the relationship between the yen and the US stock market, it doesn’t pay to try and guess the day the link breaks, just watch it daily and it’s actions will speak volumes to us about the future.

One June 8th I wrote (see archives): “Nothing has changed with my forecast of lower rates once we pass the July 4th holiday. Pessimism is building in the press with Pimco chief Bill Gross writing on his website yesterday that long rates will reach 6.50% in the next few years. Interest rate speculators are increasing their bets on higher rates and the best way to create higher prices is for shorts to be set at lower prices and yesterday’s heavy volume shows that many lenders threw in the towel and hedged their positions at what will soon be seen as too late.

It is said that the average person forgets over 90% of what we experience each day in just 3 weeks. With my declining memory it is imperative that I review and review the past 85 years of rates to stay ahead of the crowd. When everyone was panicking (especially in the press) I was able to go back into my extensive history of data and charts and calmly conclude that the stage was being set for an explosive rally in bond prices (rates declining) and warn my readers not to panic.

At 1:56pm on Thursday July 19th I sent an e-mail to the owner of the firm where I work: it looks like interest rates are getting ready to break hard below 5.00% on the 10-year…the market acts very short, the yen isn’t falling, more stocks made new lows yesterday than new highs…..it feels like the bond market wants to erupt like a dormant volcano…

I will add anyone who wishes to receive these periodic e-mails to a list for the remainder of the year for a $100 donation to Food on Foot.

At this point most of you are probably tired of my ranting and want to know where we are going from here….

The US 10-year Treasury is currently trading at 4.78% and is probably headed for the 4.50% level. This proved to be formidable resistance earlier this year (March 13th – 4.49%). The Fed clearly does NOT want to lower the Fed Funds rate (ease) as it would be a clear admission that the US economy is much weaker than forecast. Fed Chairman Bernanke has stated that the housing problem would not have a material impact on the economy and this morning’s 2nd quarter GDP number (+3.4%) has calmed the markets at least for a few hours. The strength in the economy is clearly coming from an increase in exports to countries not suffering from a home/mortgage problem. The stock market was hit hard yesterday and after a few days of higher prices (next week) should test yesterday’s level again in August. I find the recent action in oil to also be of interest. Oil acts well and clearly wants to make a run for the $80 level (especially at the sign of an August hurricane) and only sold off yesterday when the stock decline created forced selling of every other market as investors were raising cash to meet margin calls.

I wrote last week that the yellow flag would come down after we saw two weeks of trading under 4.98% on the 10-year and that is surely coming next week. My only hesitation with the bond market is the fact that the recent rally is being led by the short end (5 yrs and under). Long lasting rallies (lower rates) are almost always led by the long end (10 yrs. and over) and that is the part of the curve the Fed watches closely along with the inflation component. If the short end continues to lead then the Fed will be forced to ease and that will cause a rush into Treasuries which will push rates towards the 4.00% level. The long end is probably watching to see if the consumer cuts back on spending and then translating to a higher unemployment rate.

Pay close attention to the daily value of the yen and the relationship between the short and long end of the yield curve. If the long end begins to lead we will soon see a move to the 4.50% level on the 10-year. The recent increase in volatility will be with us for the next few months and agility will be important for those of you that need to lock loans or play in these risky markets. As always I remind everyone this is NOT an investment newsletter and everyone should consult your professional advisor before making any decisions that could affect your wealth or income.

Bottom Line: Interest rates are acting exactly as we said they would earlier this year and should extend their decline over the next few months. The fuel for the continuing decline will be the news of a slowdown in the US economy accompanied by an inflation rate of under 2%. The shorts (see above) that were set by mortgage lenders and others betting on higher rates have not been fully exited and that should allow us to see lower rates soon. The icing on the cake will be if the next phase of the bond rally is led by the long end.

Finally a reminder that the lock meter is updated daily around 2pm and has had an outstanding record this year for those that need short-term timing in the mortgage market.

Next week brings a lot of economic news headlined by Friday’s (8/03) jobs report but I am not sure the interest rate market is focusing on any news other than from other markets (yen, stocks, etc.). The monthly employment release from the BLS has lost much of its credibility due to a faulty seasonal adjustment (birth/death model) but the unemployment rate will carry weight with the Fed if it begins to move higher over the next few months. Personal income, spending and inflation indicators come Tuesday morning (5:30am) and might be helpful if they showed a marked slowing in spending or inflation. The big date for August will come on Tuesday the 7th as the world will anxiously await a Fed statement that should include some mention of this week’s meltdown in the mortgage lending market.

This newsletter remains free of charge to all readers but if you have enjoyed or profited from these most accurate predictions I ask you to consider a contribution to the non-profit that I started over 11 years ago and spend much of my time helping the homeless find housing and jobs: http://www.foodonfoot.org. Your generosity would be most appreciated.

Flight from cash into risk is now a flight to safety

The green flag is back up in front of the yellow flag as the US 10 year Treasury rate fell today below the key 4.98% level to close at 4.95%. The yellow flag will come down if we are able to hold under 4.98% for two weeks. Today’s rate dive was clearly a flight to quality as fears of a bigger mortgage meltdown are rising in an area where clearly understood information is at a premium. Yesterday Fed Chairman Bernanke told members of Senate Banking Committee (and the world watching on TV) that he expected losses of $50-100 billion (yes, billion) from the sub-prime mortgage meltdown. On Wednesday before the House Financial Services Committee he said that the mortgage problems will get worse before they get better. It’s important to remember that just two months ago he said the Fed did not expect any significant spillovers from the sub-prime market to the financial system. The Fed head has no choice but to follow the bouncing ball down the hill even though it makes the Fed look like it missed the boat and has tried to catch up to a speed boat with members of the Fed paddling a dingy. If he moves from behind the curve to the front he could really send shock waves thru the financial system and it’s a prediction that would have to be 100% correct or he would be hung out to dry by the press for causing an acceleration in the downtrend.Stocks fall, yen rises

Stocks were clobbered today (Dow down 149 pts.) in a session that seemed to be met with a yawn by most Wall St. experts. It seems that everyone wants to buy a dip and every decline is soon followed by another record high a few days later. For those who bought today you will want to know that in the last 25 years the Monday after the July option expiration (today) stocks rose only on 4 occasions. For the past few months Friday buyers have been met with weekend mergers or takeovers thus creating quick profits early in the next week. For the past few months I have noted the strong correlation between yen weakness and stock market strength. Last week I mentioned the lack of follow thru to a new low by the yen as the US stock market was climbing to new highs. Today the yen rose to 121.2 after again not confirming earlier week highs by stocks and spending the first four days of the week at 122.2. If the yen moves under 120 I would be very surprised if the US market was able to maintain its recent strength. Earlier this week it was reported that Iran has asked Japanese oil refiners to make all payments for crude in Japanese yen instead of the more common US dollars. Very difficult to believe that this event will have any effect on the price of the yen which until recently was dominated by “hedgies” who were borrowing yen, converting to another high interest currency (New Zealand, Australia, etc.) and profiting from interest rate differentials and a declining value of the yen. The yen continues to be an key part of the equation for markets this summer and every reader should at least review the price of the yen each day.

Jobs update

Two weeks ago the world markets were intently focused on the monthly jobs number which showed an increase of 132,000. This morning the BLS (Bureau of Labor Stats) announced the monthly SOS report (state of the state) BLS which actually breaks down the jobs data on a state by state basis. The part that caught my attention was that in the last 12 months the BLS tells us that 1.925 million jobs were added but when they collected the actual data from the states we found an increase of only 1.67 million or a decrease of 21,250 per month. One of the best ways to track the economy is not to look at the headline numbers but the actual revised stats which are quietly announced a few months later. When revisions are all to the downside we find the economy to be much weaker than priced by market participants. The SOS report also showed a marked slowdown in job growth from the three fastest growing states of 2006-07….California, Texas and Florida and most of the adjustments are in construction jobs. When not if the BLS catches up to its faulty seasonals for construction jobs the monthly jobs numbers will plummet when it is least expected.

Quotes of the week

There was a tie for best quote of the week: The first comes from Florida Palm Beach where Ara Hovnanian (CEO of the eponymous home builder) was asked how to halt the declining price of homes. “Raise prices,” he said. “Buyers aren’t buying because they think you’re going to lower prices again. Raise prices 3-4 percent and quit giving discounts.” If it was only that easy everyone would raise prices and why only limit it to 3-4 %, why not 10-20%. A free economy uses price discovery (supply and demand) and Mr. Hovnanian is probably just frustrated that he didn’t see this coming. How could he? We only see life from our own experiences and he and everyone else have never seen what we are going thru and it’s going to get alot worse before it gets better.

The second quote from Riverside Riverside and the owner of a real estate firm who is having trouble finding a price that will be satisfactory to both buyers and sellers. His description of the market in Moreno Valley might be something we soon see in other areas of the country. “The market is in a free fall. Every time we move the price down (seller) to get ahead of the pack, the competition comes back just as fierce, dropping their price further.” Mr. Hovnanian should visit Riverside and see what happens to sellers that “raise prices.”

Did you know?

From an article in a North Carolina paper we see that second homes represent 36% of all residential property sold in the US last year. North Carolina

From North Port, Florida (population 50,523) there are 500 vacant lots for sale with the three biggest area home builders not buying a new lot since 2006. Florida It is going to take some very creative marketing to find buyers anytime in the next few years.

Subprime….non-prime….and then prime?

This morning we heard a new word from a Fed President describing the mortgage problem: non-prime. Up until today we were told that the problems were only with sub-prime mortgages but now we learn that non-prime mortgages have payment problems. According to St Louis Fed President William Poole the mortgage mess has leaked into the Alt-A area which if true will surely make this more than a $100 billion dollar problem that will spread to other areas of the economy. St. Louis

The future is next week

2007 has been a year of big profits for those that have borrowed in low yielding currencies (Japan) and invested on big leverage in high yielding countries (New Zealand, Australia) and almost every worldwide stock market. Stocks have risen more because of a shrinking supply than booming fundamentals but when you get paid at the cashiers window do you really care how you won? (luck, skill, etc.) The momentum from today’s reversal in many markets should continue next week. If it does we could easily see long term rates fall quickly to the next key level of 4.50%. The Fed would be hard pressed to not follow with easier monetary policy for fear of impeding with the liquidity of the US economic system. If we bounce back above 4.98% in the 10 year with the yen falling back to the 123-125 and the US stock market bouncing back to new highs it will only delay the inevitable…..either way rates are headed much lower before the end of this year.

Oil $80? Sugar???

With oil in its strongest seasonal period of the year (thru August) and no hurricanes (yet) affecting the petroleum market we may be looking at $80 oil in the next 45 days. If oil continues its recent rise the price of sugar may finally be ready to advance (ethanol) and the recent spike above the 10cent level could be the spark for the eruption that is long overdue. Better late than never?

The US consumer is not spending anyone’s money……..

Last week I wrote about the fact that consumer credit is expanding due to an increase in credit card spending as the US consumer attempts to maintain a life style built on the back of a real estate bubble. This morning the Commerce Department reported that retail sales for June fell by 0.9% the largest amount in almost two years. With the home equity ATM machine now clearly run out of cash and credit cards the last resort for many tapped out homeowners it appears that there is only one cashiers window that remains open: the stock market. This week after an early decline on sub-prime worries, the stock market climbed the proverbial wall of worry (and big short positions) and continued to set new highs. The US stock market has defied gravity and seasonal analysis this year by rising in the face of a mortgage meltdown because of a huge shrinkage in the supply of shares (stock buybacks & mergers) and the ever popular yen carry trade. But there is another important point that I haven’t seen covered by the press concerning the runaway stock market and that is the belief that the stock market is an accurate barometer of the health of the US economy. If the stock market was not screaming to new highs would everyone believe that everything was ok with the economy? GDP growth isn’t really affected by stock market fluctuations (except psychologically) and the same figures that are being interpreted bullishly by analysts would be seen in a much different light if the stock market was not reaching new highs. The bouncing ball to follow over the next few weeks should be the stock market (not the Fed) and how the stock market will react to the changing value of the yen versus the dollar. On a very short-term basis I found it very interesting that the yen did NOT fall to new lows this week as the US stock market was reaching new highs. If yen strength (relative) continues it will create a major roadblock to more advances from stocks.The Fed speaks loudly

Next week’s big news comes Wednesday morning when I will be glued to my TV as I watch the semi-annual testimony from Fed Chair Ben Bernanke to the House Financial Services Committee. Slated for a 7am start his prepared remarks and then always colorful question and answer session will be analyzed by pundits around the globe. I always tape the entire proceedings and then play it back at night to see if anything was missed including facial expressions when answering a specific question. It is the same procedure as sports stars study their opponent before a big match. This is the big time for everyone in the interest rate arena and every edge must be used to uncover even the slightest change in upcoming Fed policy. The Fed head’s remarks will follow CPI and housing starts that will be released at 5:30am on Wednesday. The bond market’s reaction to the congressional hearing is usually met with high volatility and sharp movements as there are frequently different interpretations to what are often just simple pronouncements by the Fed chief. The good news is that Mr. Bernanke is well aware that the world is watching and he has often said the Fed watches the market’s reactions to their announcements. So we have come full circle, the market anticipates the Fed, the Fed acts, the market reacts and then the Fed reacts to the market’s reactions. It’s amazing that rates move at all as it reminds me of a dog repeatedly chasing its tail until it falls down from exhaustion.

Home builders struggle to find buyers

This week’s best quotes come from an interview of home builder Toll Bros. CEO Bob Toll by Fortune magazine. When asked about the incentives being offered by builders instead of price reductions, Mr. Toll said: “When you start selling homes for $400,000 that were $500,000, all the homeowners who paid $500,000 are going to be in your sales office complaining, “Why are you doing this to me? Why don’t you just put a sign on my lawn saying, “I’m a schmuck?”. Good answer as to why we are seeing incentives instead of price cuts and that the prices of houses aren’t fully reflecting the decline in demand and increase in supply. Side note, Builder Hovnanian was up 12% today as rumors swirled that Warren Buffett was about to purchase a stake in the firm. Mr. Buffett has an excellent reputation but remember that he is not always right, is a long-term investor and is frequently very early in his timing. I continue to believe that we are very early in a slow, painful bear market for home prices. Bear markets are deceptive and often give us the belief that the worst is over just as we fall off another cliff to lower levels.

What goes up, usually comes down

For many state governments the real estate bubble was like having the income from a state lottery with none of the costs. Sales and income tax revenue soared as people moved from other states, bought homes and spent money that came from the home equity ATM machine. Now it appears that many of these same states are finding that revenues are falling short of predictions and that this may be the beginning of a trend. Arizona was set for a $530 million surplus for this fiscal year and now may see that turn into a deficit as expected revenue disappears with the housing slump (May tax collections fell 27%). Many states will be forced to cut expenditures or create bigger and costlier lotteries to make up the shortfall as states (unlike the federal government) must balance their budget every year.

Are rates still going to decline this year?

The question I most often receive each week as many await my boldest prediction of the year. My answer continues to be: yes, long rates will go lower this year as market participants begin to see that inflation is not a problem and the housing problem is not going away. The key levels are now 4.98% and 5.32% in the US 10-year treasury note. It’s impossible to know what will spark the fire that will carry us outside this range but with strong seasonal trends, a weakening in credit demand (except from those that have no other lender) and a weakening of consumer demand, it is just a matter of time before we begin the next move to lower rates that will be followed, not led, by the Fed. The stock market continues to tell us that the sub-prime mortgage problem is transitory and a small part of the overall mortgage market but we must remember that much of the sub-prime debt owned by hedge funds, etc is held on 10:1 or more leverage so a small move down in price creates massive losses in equity and big margin calls are on the way as these securities are marked to “market” and not marked to “model”.

The biggest problem for those that spend their life studying markets is we tend to see the world far in advance of the majority which can be disastrous to one’s wealth. A lot of patience is often needed as one only needs to go back to my call for much higher corn prices a couple of years ago. Obviously sugar has not (yet) reached the levels predicted early this year but it will for those who have the stamina to wait and wait and wait…Interest rates are headed lower…

The US consumer is spending someone else’s money (part 2)

Friday I wrote about the monthly jobs report that clearly shows US employment growth coming from BLS seasonal adjustments more than actual real jobs. This afternoon we saw May’s Consumer credit rise by $12.9 billion with a huge jump in revolving credit of $7.2 billion. These figures were far above the experts’ predictions but clearly show a dramatic increase in borrowings by consumers using credit cards to make monthly mortgage payments, gasoline, food and other necessary purchases. When income isn’t increasing enough to maintain a certain standard of living the average consumer chooses the easiest alternative: borrow, borrow and borrow more until the lenders (credit card companies) won’t extend any more credit. We are at the very beginning of what will clearly be an ugly trend as the lender of last resort for many homeowners will be high interest credit cards.

The Fed is coming, the Fed is coming

This could be a busy week and for sure next week promises to bring plenty of fireworks. Tomorrow morning at 10am Fed Chairman Bernanke will address the National Bureau of Economic Research in Massachusetts on inflation and has agreed to a question and answer session after the speech. Although the press will have start to finish coverage it would be surprising if the Fed head made any big news as he probably wants to wait until his semi-annual Humphrey Hawkins testimony to Congress that begins at 7am on Wednesday July 18th. This is the usual spot for the Fed Chairman to announce any major policy changes and most importantly give an updated Fed forecast for interest rates and the economy for the remainder of the year. Friday (7/13) will bring the monthly retail sales numbers with a small positive number expected but as we learned today the US consumer won’t change spending patterns until every borrowing hole is dry.

Focus on the four parts to the puzzle

For the next six months it is important that readers focus on four distinct parts of the interest rate equation. The unemployment rate of 4.5% shows job growth at a steady pace and as long as the stock market continues to advance the “feeling” among consumers, corporations, investors, etc. will be that everything is ok in interest rate land. The new consensus is that the Fed remains on hold for the next 12-24 months and the economy grows with a 2% inflation rate and long-term rates go slightly higher. Although the consensus is not yet complacent a few more months of continued stock and bond market action will surely leave everyone with the feeling that “we finally got it right.” The remaining two important variables that must be watched are loan demand and the yield curve. Commercial and Industrial loans continue growing but real estate loan demand has slowed (especially residential) but much like a cruise ship changing directions it often takes more time than many would prefer while waiting for the new scenery to come into view. The momentum built over the past few years and created by historically low short-term interest rates is slowing but at a much slower rate of decent than our other trading partners. Finally we must watch the yield curve which is the comparison between short- and long-term rates. After spending the last year with short rates (Fed Funds) above long-term rates (10-yr.) the last month has seen the 10-year briefly reach the 5.32% mark (0.07% above the Funds rate). The biggest questions we face today are the direction of long term-rates for the remainder of the year and what conditions need to exist for a change in Fed policy.

Fed policy

Let’s tackle the easier of the two questions: Chairman Bernanke and his FOMC team members do NOT want to change level of the Fed Funds rate (5.25%). They have drawn a line in the sand (6/06) and have been able to hold the line even in the face of lower long-term rates (3/13 – 4.49%) and I believe that unless the 10-year rate rises above the key 5.25% level for two weeks we will not see any change in the Funds rate this year unless the housing problem accelerates to the point where it inhibits liquidity in the banking system. If that were to occur long rates would fall rapidly towards the 4.50% level seen earlier this year. The only way I see long rates going above the 5.25% level for two weeks or more is if inflation expectations begin to rise and so far there is no sign of inflation on the horizon. Since March 13th the 10-year has risen from 4.49% to today’s level of 5.14% for an increase 65 basis points. The key part of the increase is the fact that the inflation component of the 10-year has only risen 6 basis points with the other 59bp coming from an increase in the perceived real growth of the economy.

Market rates

Finally we attempt to hit one out of the park with an accurate call on the direction of long rates for the remainder of the year. The 2nd half of the year has a very strong seasonal tendency for a decline in rates. The June advance in market rates was driven by a “fear” that an increase in economic growth would translate into future inflation due to a lack of labor and operating capacity. Although the jobs number receives much press each month we must remember that the unemployment rate and job growth numbers are coincident indicators not “leading” and tell us what is happening and not what will happen in the future. With today’s consumer credit numbers we see the consumer spending money but mostly using borrowed dollars. It’s true that everyone who has predicted the demise of the US consumer has been laid to rest many times as the consumer has more lives than the energizer bunny. BUT I don’t see the housing decline ending soon and feel that we are at the beginning of a long bear market that will take approximately five years to recover in many areas. The key is income growth because the increase in wealth due to higher asset values is only helping a very small part of society.

Long-term interest rates will fall in the next few months as predicted, how far will depend upon how fast the four pieces to the puzzle are able to turn in direction.

Another piece of the puzzle drops in… (part 1)

I am on the road today so this week’s newsletter will be published in two parts with a much more in depth discussion about rates delivered in the early afternoon on Monday (7/09). This week we saw long rates climb from the 4.98% level to the 5.20% mark this morning after the jobs number. I have been writing for the past few weeks that I expected another push back up to test the June highs (5.32%) and it appears that is exactly what began on Monday of this week. I continue my belief that we will see much lower long rates in the 2nd half of this year.

Job growth?

The jobs growth of 132M was not surprising but the bond market focused on the last two months revisions (May +33M, April +42M) and decided everything else was unnecessary until revised at some later date. I find it very hard to believe that what appears to be an increase in employment is actually predicting a stronger economy in a few months. Temporary help jobs fell again last month (-8M) following an 11M drop in May. The key diffusion index (the % of industries showing job gains) fell to 53.2 from 59.7% showing that fewer industries are hiring but construction jobs did add 12M. The government uses an average of 51 workers per firm in its counting and I’m sure are missing many of the much smaller builders. Most importantly the BLS (Labor Bureau) used a seasonal adjustment of 156M for June from their now famous birth/death model where they attempt to guess as to how many firms opened new businesses in June. Without this very unreliable guess the US would have shown NO growth in jobs in June. Almost all of the increase in 2007 has come from this “seasonal adjustment” number and not from real paying jobs. I would love to have a “paying job” that was only an adjustment of the governments books and records.

The Fed speaks

Early this morning in Singapore San Francisco Fed President Janet Yellen gave a very insightful speech in which she addressed current Fed monetary policy. Rarely do we hear a Fed speaker discuss topics that will help us clarify current Fed speak and forecast future policy moves but this speech is a must read for everyone that has any interest in the movement of rates for the next few months. She spoke about investors underestimating risk in the carry trades, the yield curve and the recent rise in long-term rates. There is no question that Mr. Bernanke and the Fed are closely watching the inflationary expectations component of long-term Treasury securities and have come to the conclusion that the recent rate rise is global in nature and not from a perceived inflation scare in the US.

I will have much more on Part 2 on Monday.