Equities calm but credit markets still jittery
By R. Mark Rogers, Senior Economist, Econoday
August 24, 2007
This past week had a lot more going for it than is typical in late summer. Short-term Treasuries swung sharply but equities calmed significantly as liquidity problems eased. Stocks even posted moderate net gains as the economic-indicator front ended the week on a strong note.
Crude oil prices eased over the first part of the week only to firm the last two days. Nonetheless, crude oil prices ended the week down somewhat. Prices fell $2.67 over the Monday-Wednesday period as it became apparent that Hurricane Dean would miss key oil platforms in the Gulf of Mexico. Tuesday’s close at $69.41 was the first below $70 close since June 28 of this year. Prices began to firm after Wednesday’s petroleum report indicated low inventories with upward pressure continuing Thursday and Friday. Friday’s strong durable goods report helped boost prices.
The spot price per barrel for West Texas Intermediate ended down this past week. Spot prices for West Texas Intermediate slipped $0.64 per barrel to close at $71.34 per barrel.
Equities took solace from the Fed’s actions the prior Friday to ease a credit crunch and ended the week on a positive note — especially in the tech sector. The Fed’s August 17 cut in the discount rate boosted bets by the markets that the Fed will be cutting the fed funds rate by 25 or possibly 50 basis points at its September 18 FOMC meeting and make additional cuts during the remainder of the year. Equity gains essentially have built in lower short-term rates during the rest of this year and next. Midweek saw stocks boosted sharply by merger talk. Recent declines in stocks had partly been fueled by concern that credit would not be available for mergers and acquisitions, and the ease in the credit crunch has restored some optimism that M&A activity will pick back up – especially if the Fed cuts rates. Stocks got a nice bump up on Friday from positive reports on durable goods and new home sales, but reduced expectations of a Fed rate cut damped the gains. Trading was thin at week end due to departures for vacation.
Last week, major indexes were up net. Major indexes were up as follows: the Dow, up 2.3 percent; the S&P 500, up 2.3 percent; the Nasdaq, up 2.9 percent; and the Russell 2000, up 1.6 percent.
Year-to-date last week, the Dow is up 7.4 percent; the S&P 500, up 4.3 percent; the Nasdaq, up 6.7 percent; and the Russell 2000 is up 1.4 percent.
Interest rates ended the week up net but the near end was whipsawed early in the week. Even though the Fed’s earlier discount rate cut calmed the equity markets this past week, the credit markets remained quite jittery from subprime problems. Flight to quality was strong with demand greater for shorter maturities. At one point during trading on Monday, the 3-month T-bill was down nearly 140 basis points and ended the day down 69 basis points at 3.07 percent. Increasing the volatility and drop in the 3-month T-bill was a lack of sellers. Also, money market managers were taking in as many short-term Treasuries as possible, partly to avoid risk and partly in anticipation of likely needing cash for redemptions. The Fed and other central banks continued to inject more liquidity in the credit markets. The fed funds rate traded just above 5 percent and well below the target of 5.25 percent – indicating plenty of available liquidity.
Tuesday’s credit markets were calmed by an unexpected source — Senate Banking Chairman Christopher Dodd. Dodd met with Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson to discuss credit market problems. After the meeting and during a long press conference, Sen. Dodd stated that the Fed would use “all tools available” to alleviate the credit squeeze. Many saw this as Congress pushing the Fed to cut the fed funds target rate. Dodd’s comments led to a reduction in fears that the credit crunch will impact the economy, and investors moved out of short-term Treasuries, pushing the 3-month T-bill rate back up to 3.64 at the end of the day on Tuesday. With the boost in durables orders on Friday, T-bill and T-note rates jumped significantly. Despite the 69 basis point drop on Monday, the 3-momth T-bill ended the week up very sharply. Long-term rates were down during the week, continuing to benefit from flight to quality.
The 3-month T-bill rate swung sharply early this past week – down 69 basis points at close on Monday and up 57 basis points on Tuesday.
The Treasury yield curve rose last week except on the far end, which declined. Much of the rate gains reflected more confidence by investors that credit crunch problems were easing, resulting in a partial unwinding of flight to quality in Treasuries – especially on the near end. Yields were up as follows: 3-month T-bill, up 46 basis points; 2-year T-note, up 12 basis points; 3-year, up 6 basis points; and the 5-year, up 7 basis points. The 10-year bond was down 5 basis points while the 30-year bond was down 9 basis points.
The 3-month T-bill fell sharply early this past week but ended the week up sharply on an unwinding of flight to quality and strong economic data.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
Last week was relatively quiet in terms of the usual monthly fare of economic indicators. The standard fare was reserved for Friday’s release of durable goods orders and new home sales which both turned out to be positive. But the biggest news was essentially a stealth release – one flying under the radar, the Fed’s H.4.1 statistical release on Thursday.
The biggest economic event this past week likely was one not noticed by most – the release of the Fed’s H.4.1 statistical release on reserve balances at depository institutions. It provided interesting insight into the need or not for banks to take advantage of the Fed’s cut in the discount rate on August 17 from 6-1/4 percent to 5-3/4 percent. The Fed also announced that it was willing to take home-mortgage and related collateral for as many as 30 days.
Much was made over a week ago about the need for the Fed to take action to relieve the credit crunch related to subprime lending and the holding of securities with subprime loans. But this past week, we may have seen that once the Fed cut the discount rate and was emphatic that financial institutions should pay their bills first without waiting to be paid themselves that the severity of the crisis was vastly overplayed. This past week, the Fed released some regularly reported but generally obscure data on reserve balances that indicated that the need for a discount rate cut was more symbolic than actually needed. We have a case in which “the dog didn’t bark.”
In the Sherlock Holmes story “Silver Blaze” by Sir Arthur Conan Doyle, the detective Holmes was able to deduce that the killer of the racehorse was the owner of the stable dog. As Dr. Watson, the fictional Holmes chronicler explained the only person at whom the stable dog would not bark was his owner. The dog's silence during the time of killing was proof that the killer was the dog's owner. Hence, the metaphor of the "dog that didn't bark" characterizes the importance of any conspicuous silence. This past week we had a huge silence on the need for emergency liquidity. And if you listened, the silence was deafening.
Borrowing at the discount window during the August 16 through August 22 week proved smaller than expected, at $2.262 billion on Wednesday August 22 vs. $264 million on the prior Wednesday which of course preceded Friday's Federal Reserve cut in the discount rate and accompanying statement that strongly encouraged banks to use the window for their funding needs. Of the $2.262 billion in outstanding loans, $2.001 billion was for primary credit and $261 million for seasonal credit. Four large banks have said they borrowed $500 million each at the window, indicating these few large banks (with one newswire reporting five) made up almost all of the borrowing at the discount window. Some other loans certainly were made by other banks and were repaid before the August 22 report date. The large banks announced their borrowing at the discount window – according to them – to take a leadership role in easing liquidity problems. In any case, smaller banks appear to have used the window very little, suggesting that conditions in the credit market may not be as severe as feared and more limited to a narrow portion of the financial sector.
The detail from the H.4.1 report provides interesting insight into how needy or not lending institutions were. The big numbers were $1.0 billion in loans outstanding at the New York Fed and $1.0 billion at the Richmond Fed which covers the banking center of Charlotte, North Carolina. These were four of the big banks that announced making large loans at the discount window. But two district banks had no loans outstanding on August 22 (Boston and Cleveland). Three district banks had declines in loans outstanding from August 15 through August 22 (St. Louis, Minneapolis, and Dallas). The biggest change in loans outstanding over this period was a moderate $9 million increase at the Kansas City Fed. By August 22, there appears to have been very little of a credit crunch within the banking community overall.
While the liquidity crunch indeed was complex, it may have been more psychological than real and more narrowly focused. The cut in the discount rate restored confidence along with the Fed taking some securities with subprime components as collateral at the discount window. If there really had been a continuing broad credit crunch, we would have seen a jump in borrowing at the discount window by more than the few large banks that supported the Fed’s urging to ease the crisis by getting cash (reserves) at the discount window. Problems with subprime lenders continue and uncertainty remains over the worth of securities that have subprime components. But based on the lack of a rush by lending institutions to get cash at the discount window, the liquidity problems of mid-August have faded to a large degree.
The biggest news on the economic indicator front was a surge in durable goods orders. Durable goods orders jumped 5.9 percent in July, following a 1.9 percent partial rebound in June. Even when excluding the volatile transportation component, new orders posted a large gain, up 3.7 percent in July following a 1.2 percent decline in June.
Strength in durables orders in July was broad-based. Industry categories posting gains in June were primary metals, up 7.9 percent; fabricated metal products, up 1.4 percent; machinery, up 5.5 percent; computers & electronics, up 7.4 percent; and transportation, up 10.8 percent. The only major industry category declining was electrical equipment which was down 1.2 percent.
Year-on-year, new orders for durable jumped to up 8.1 percent in July from down 0.2 percent in June. Unfilled durables orders stood at up 20.9 percent year-on-year in July, compared to up 19.8 percent in June.
While the July orders preceded the August credit crunch and decline in equities, the key point is that manufacturing sector had significant momentum heading into the financial turbulence of August. While output intended for the U.S. consumer may be moderating, strong economic growth overseas and a weak dollar are boosting overall manufacturing.
July brought modest relief from the downward spiral in housing – at least for new home sales. New home sales rose 2.8 percent in July to an annual rate of 870,000 and followed a 4.0 percent drop in June. Year-on-year sales were down 10.2 percent for the latest month, still weak but much better than June's 21.2 percent year-on-year decline. Regionally, strength was in the South and in the West. The Midwest was little changed but the Northeast showed a sharp decline. Importantly, supply on the market edged back slightly to 7.5 months from 7.7 months but is still high and will keep construction soft. The median sales price rose 3.9 percent in July to $239,500 but was likely skewed higher by fewer sales of lower priced homes, the result of tightened lending standards. Year-on-year, the median price is up 0.6 percent.
The Conference Board's index of leading economic indicators rose 0.4 percent in July vs. a decline of 0.3 percent in June. A rise in consumer confidence and a slowing in vendor performance were the top positives in July. Even stock prices were a positive. Building permits were July's biggest negative. But looking forward we can expect stocks to be down in August and there are signs that consumer confidence is dipping.
Credit and equity markets have calmed somewhat since the Fed’s discount rate cut. Now, focus should be on the health of the real economy. What does the economic scoreboard show for the economy bulls and bears since the August 17 cut in the discount rate' Economic news has been limited but does give an indication on the economy’s health. For the bulls are 1) leading indicators, 2) initial jobless claims (see Looking Ahead), 3) durable goods orders and 4) new home sales. For the bears, nada, zip, zero. Yes, leading indicators are old news and new home sales are still soft but both were still positives even if minor ones. But the totality of the data is that there was considerable forward momentum in the economy heading into the mid-August credit crunch. And the high frequency claims numbers are fresh and strong. There are still quite a few innings worth of economic data before the September 18 FOMC meeting but for now, the economic bulls are leading 4 to 0 in terms of economic data being positive or negative. From the Fed’s perspective, a cut in the fed funds rate in September is not a done deal. Sticking with the baseball analogy and quoting Yogi Berra (the famous Yankees baseball manager), “It ain’t over ‘til it’s over.” We really will not know what the Fed is going to do in September until the meeting announcement on the afternoon of September 18.
This coming week gives us more insight into housing with existing home sales and on how the consumer sector is holding up with the personal income report. Also, markets will be poring over the minutes of the August 7 FOMC meeting to gain insight into Fed thinking even though it must be viewed in terms of coming before the August credit crunch and is a little dated now.
Existing home sales fell 3.8 percent in June to a 5.75 million unit annualized pace. June was down 11.4 percent on a year-on-year basis. Sales were down in all regions with both single-family and condo categories showing declines. The 5.75 million headline rate is the lowest since November 2002. Analysts will be closely watching the supply figure for July—June’s supply stood at a swollen at 8.8 months, the same as May. The price data are not having a lot of meaning currently. Tightened lending standards have cut low end sales, boosting the median price somewhat artificially.
Existing home sales Consensus Forecast for July 07: 5.70 million-unit rate
Range: 5.60 to 5.85 million-unit rate
The Conference Board's consumer confidence index surprisingly jumped to 112.6 in July from 105.3 in June. Strength was centered in job readings. Another positive in the report was the 12-month inflation outlook, easing 3 tenths to 5.1 percent. Buying plans also improved with more saying they will buy a car over the next six months, 7.2 percent vs. 6.0 percent, and even more saying they will buy a house, 3.1 percent vs. 2.9 percent. However, since the last report, consumer will have seen much more on subprime problems and a lower stock market. On the other hand, labor conditions remain tight and the price of gasoline has come down somewhat.
Consumer confidence Consensus Forecast for August 07: 105.0
Range: 99.0 to 107.6
The Federal Reserve releases FOMC minutes of the August 7 meeting at 2:00 p.m. Eastern Time. While a little dated with the August 17 cut in the discount rate, the minutes will still give insight into Fed thinking on the status of the economy and whether a cut in the fed funds target rate is likely at the September FOMC meeting.
Second quarter real GDP strengthened to an annualized 3.4 percent from an anemic 0.6 percent pace in the first quarter. The stronger second quarter growth was primarily due to a jump in nonresidential structures investment, stronger exports, and a decline in imports. As expected, residential investment was quite negative. However, personal consumption growth slowed notably. On the inflation front, the GDP price index slowed to 2.7 percent pace, following a 4.2 percent increase in the first quarter. The core PCE price index also slowed to a 1.4 percent growth rate in the second quarter, after a 2.4 percent boost in the first quarter. Given that many are concerned about how subprime problems and stock market declines may be affecting consumer spending, second quarter revisions may seem unimportant. But the data will provide the starting point for evaluating whether coming moderation in consumer spending is coming off robust numbers and whether other sectors are taking up the slack sufficiently.
Real GDP Consensus Forecast for preliminary Q2 07: +4.0 percent annual rate
Range: +3.6 to +4.3 percent annual rate
GDP price index Consensus Forecast for preliminary Q2 07: +2.7 percent annual rate
Range: +2.6 to +2.8 percent annual rate
Initial jobless claims edged down 2,000 to a bit higher-than-expected level of 322,000 in the week ending August 18. There were no special factors in the week. The labor market has remained strong though layoffs in the mortgage industry have been piling up in recent weeks. We are likely to start seeing some of the lay-offs in the financial sector start showing up in jobless claims in the upcoming release.
Jobless Claims Consensus Forecast for 8/25/07: 320,000
Range: 310,000 to 330,000
Personal income increased 0.4 percent in June, following a 0.4 percent gain also in May. Within personal income, the wages and salaries component posted a 0.5 percent gain in June, following a 0.5 percent rise the month before. Personal consumption edged up only 0.1 percent, following a 0.6 percent boost in May. Spending weakness was in the volatile durables component which includes motor vehicle sales. On the inflation front, the core PCE price index rose 0.1 percent - the same as in the prior three months. The overall PCE price index eased, rising 0.1 percent in June, following a 0.5 percent jump in May. The latest employment report suggests a moderate rise in income while the latest CPI report indicates that the core PCE price index is likely to edge up.
Personal income Consensus Forecast for July 07: +0.3 percent
Range: +0.2 to +0.5 percent
Personal consumption expenditures Consensus Forecast for July 07: +0.4 percent
Range: +0.3 to +0.4 percent
Core PCE price index Consensus Forecast for July 07: +0.2 percent
Range: +0.1 to +0.2 percent
The NAPM-Chicago purchasing managers’ index fell to 53.4 in July from 60.2 in June, pointing to an abrupt slowing in the rate of growth in the area's manufacturing and non-manufacturing sectors. However, this index – with its small sample size – is notoriously volatile.
NAPM-Chicago Consensus Forecast for August 07: 53.0
Range: 51.0 to 56.0
Factory orders rose 0.6 percent in June, reversing a 0.5 percent decline in May. More recently, new durables orders in July rose a sharp 5.9 percent and should boost overall factory orders for the month.
Factory orders Consensus Forecast for July 07: +3.2 percent
Range: +0.5 to +4.2 percent
The Reuter’s/University of Michigan’s Consumer sentiment index fell more than 7 points to 83.3 in August. The index's two components, current conditions and expectations, both showed roughly equal weakness. Importantly -- inflation expectations -- the battle up at least to last week that the Federal Reserve was fighting, fell back: down 2 tenths for 1-year expectations to 3.2 percent and two tenths for 5-year expectations to 2.9 percent.
Consumer sentiment Consensus Forecast for final August 07: 82.5
Range: 81.0 to 86.5
|
