BondSquawk

August 3, 2010

The Federal Reserve purchased tremendous amounts of fixed income securities such as Treasuries, Agencies, and Mortgage Backed Securities during the height of the financial crisis and recession in order to pump money back into the system and to promote growth.  Now with the Fed’s balance sheet at nearly three times its original size from before the onset of the crisis, the question becomes what to do with it.  As economic data releases reveal that the recovery may be stalling, the Federal Reserve may consider further action to stimulate growth by maintaining or adding more to their balance sheet when they meet next week, according to the Wall Street Journal article, “Fed Mulls Sumbolic Shift.”

Federal Reserve officials will consider a modest but symbolically important change in the management of their massive securities portfolio when they meet next week to ponder an economy that seems to be losing momentum.

The issue: Whether to use cash the Fed receives when its mortgage-bond holdings mature to buy new mortgage or Treasury bonds, instead of allowing its portfolio to shrink gradually, as it is expected to do in the months ahead. Any change—only four months after the Fed ended its massive bond-buying program—would signal deepening concern about the economic outlook. If the Fed’s forecast deteriorates significantly, it could also be a precursor to bigger efforts to pump money into the economy.

Moving to stop the Fed’s portfolio from shrinking would prevent monetary policy from slightly tightening in the face of a weakening recovery.

The central bank’s $2.3 trillion portfolio has nearly tripled in size since 2007.

Buying new bonds with this stream of cash from maturing bonds—projected at about $200 billion by 2011—would show the public and markets that the Fed is seeking ways to support economic growth. It could also be a compromise that rival factions at the Fed support, as officials differ about whether and how to address a subpar recovery.

Whether the Fed makes any move next week depends in large part on economic data, particularly the government snapshot of the jobs market due Friday. Since Fed officials last met in June, data on consumer confidence and spending have softened and job data haven’t improved. But overall financial conditions have improved somewhat, with a rebounding stock market.

Officials in the Fed’s anti-inflation camp aren’t convinced the economy is slowing significantly and are wary of taking new actions. Others are eager to consider new steps to address recent signs of a slowdown and persistent high unemployment.

Fed officials aren’t yet prepared to take the larger step of resuming large-scale purchases of mortgage-backed securities or U.S. Treasurys. But they are holding open that option if the economy deteriorates. Private forecasters generally expect real GDP to grow by an annual rate of about 2¾% in the second half of 2010. If the picture deteriorates and they forecast growth falling below 2%, the Fed would be more likely to act.

Read the Full Article

By Rom Badilla, CFA – Bondsquawk.com

July 30, 2010

The U.S. Department of Commerce released data suggesting that economic growth slowed in the second quarter of this year.  Gross Domestic Product increased by a 2.4 percent annualized rate which disappointed surveys.  Economists were expecting GDP growth to come in at 2.6 percent.  Despite the slowing trend, economic activity in the first quarter was revised upward from 2.7 to 3.7 percent which can be attributed to a pickup in inventories.

In addition, it is apparent that people are spending less these days which is a drag to top-line growth as consumer activity represents about two-thirds of the economy.  Personal Consumption increased by only 1.6 percent in the second quarter, missing forecasts of 2.4 percent.  To add salt to the wound, consumer activity was revised downward in the preceding quarter from 3.0 percent to 1.9 percent.

Looking beyond just the headlines, the numbers look even worse for future prospects of the economy since inventories and government spending account for most of the activity.  Of the 2.4 percent in GDP growth, inventory accumulation represents 1.05 percent and government spending added 0.88 percent.  Once inventories are replenished and add in the fact that government spending is unsustainable, the economy will have one less leg to stand on and growth should slow down in the months ahead.

Price pressures remain subdued for the most part.  The GDP Price Index, which is a comprehensive indicator of inflation, increased 1.8 percent versus surveys of 1.1 percent and after a revised prior period of 1.0 percent.  Stripping out food and energy, prices increased by 1.1 percent which were above the median survey as economists expected a 1.0 percent increase.  The prior period was revised upward by 0.5 to 1.0 percent.

Business conditions in the Mid-West appear to be improving as surveys in both manufacturing and non-manufacturing activity increased.  The Chicago Purchasing Manger Index came in at 62.3 from 59.1 in the prior period.  Also, NAPM Milwaukee increased to 66.0 from 59.0.  Economists were expecting a reading of 56.0 and 57.0, respectively.

According to the University of Michigan, consumer confidence in July increased slightly.  The widely followed sentiment index increased to 67.8 from 66.5.  The increase surprised economists since consensus surveys were at 67.0.  With this in mind, consumer confidence is still at depressed levels.  Consumer confidence in the last 10 years reached a high of 112.0 at the beginning of this decade with an average of 86.0, in the 2 years before the official onset of the recession.  While today’s increase is a step in the right direction, the fact remains that this measure has a long way to go before waving the all clear signal.  As always, job growth will be the key in the coming months.

Given the deluge of generally gloomy economic data, Treasury yields are down, approaching recent lows again.  Stocks on the other hand, appear to be in denial as the S&P is close to unchanged.  Check back later today for Bondsquawk’s market recap across ALL bond sectors.

July 28, 2010

The U.S. Commerce Department released a report that new orders for manufacturing durable goods continues to decline which provides further evidence that the economy is slowing.  The Durable Good Orders dropped for the second consecutive month as the Index declined 1.0 percent in June after a revised 0.8 percent fall in the previous month.   The drop disappointed as economists were expecting a 1.0 percent increase.  This is the first consecutive monthly drop since January 2009 when new orders posted straight negative readings for the preceding seven months.

Durable Goods ex Transportations declined 0.6 percent in June versus surveys of a monthly increase of 0.4 percent.  The index was revised upward in May from an initial increase of 0.9 percent to a final increase of 1.2 percent.

BNP Paribas’ economics team offered the following color on today’s data releases in an e-mail sent to clients.

Durable goods orders fell by 1.0% m/m well below market and our expectations. Boeing orders jumped to 49 in June from just 5 planes in May, however, many of these orders were booked at the end of June and they were not reflected in the June’s report. As such, non-defense aircraft orders was down by 25.6% m/m. Defense orders dropped 6.8% m/m, following two months of declines in April and May. Ex-defense was down by 0.7% m/m. Computers & electronics fell by 1.9% m/m, machinery was down 0.7%. On a positive side, vehicles and parts orders increased by 2.5% in June, while electrical equipment was up by 3.7%. There has been some moderation in core capital goods (non-defense, ex aircraft). The index increased by 0.6% m/m following a 4.6% increase in May. On a 3-months annualized basis core capital goods were up 25.1% following a 32.5% increase in the previous month. Core capital goods shipments, which strips out spending on both defense and aircraft, increased by 15.8% on a 3-month annualized basis in June, following a 17.8% increase in May. This category most closely aligns with business investment in equipment and software in GDP, and it is still suggestive of a very strong gain in equipment and software investment in Q2 (we expect an 18% q/q AR increase in Q2) but points to a more moderate gain in Q3.  Overall, today’s report is consistent with the recent fall back in the ISM manufacturing index and slower export growth, and we expect further moderation in durable goods orders as the inventory cycle fades over the second half of the year.

The Mortgage Bankers Association released its weekly applications index which suggests further declining demand for housing.  The MBA Mortgage Applications Index for the week ending July 23 fell 4.6 percent to 720.6.  This decline falls after the index increased 7.6 percent in the previous week.  Comparatively and despite the low interest rate environment, the Index is far off from the highs of 1856.70, set in May of 2003.

The Federal Reserve released its so-called Beige Book regional survey which discusses economic conditions as reported by the central bank’s 12 district banks.  Today’s report comes after last week’s statement by Fed Chairman Ben S. Bernanke that the “the economic outlook remains unusually uncertain.” Last month’s Beige Book reflected that the U.S. economy strengthened in all 12 regions in April and May, while also noting that growth in many was subdued. 

Here’s some highlights of today’s report by the Federal Reserve, followed by the full text.

• Labor Markets “improved modestly” across regions
• Wage pressures remained “largely contained” across most districts with Dallas reporting pressure “mostly nonexistent”
• Credit conditions were “tight” in most districts
• Most districts reported “sluggish” residential real estate
• Some districts reported “modest increases” in the economy
• Economic activity “continued to increase”
• Economic recovery slowed in some areas
• Commercial real estate markets “continued to struggle”
• Increases in retail sales were modest in most regions
• Manufacturing expanded while some districts noted slowing

Beige Book Full Text

Economic activity has continued to increase, on balance, since the previous survey, although the Cleveland and Kansas City Districts reported that the level of economic activity generally held steady. Among those Districts reporting improvements in economic activity, a number of them noted that the increases were modest, and two Districts, Atlanta and Chicago, said that the pace of economic activity had slowed recently.

Manufacturing activity continued to expand in most Districts, although several Districts reported that activity had slowed or leveled off during the reporting period. Districts also noted improved conditions in the services sector. The five Districts reporting on transportation noted increased activity. Tourism activity also increased across the Districts, although the Atlanta District noted concerns about decreased leisure travel to the Gulf Coast. Retail sales reports generally indicated a continued rise in spending, and several Districts noted that necessities continued to be strong sellers, while big-ticket items moved more slowly. However, most Districts that reported on auto sales noted declines in recent weeks. Activity in residential real estate markets was sluggish in most Districts after the expiration of the April 30 deadline for the homebuyer tax credit. Commercial real estate markets, especially construction, remained weak. Banking conditions varied across the Districts, with some Districts noting soft or decreased overall loan demand; credit standards remained tight in most reporting Districts. Recent rains had mixed effects on crop conditions, while activity in the natural resources sector increased. Overall labor market conditions improved modestly across the Districts, with several reports of temporary hiring. Consumer prices of goods and services held steady in most reporting Districts. Input prices also held largely steady, with only a few reports of cost increases. Wage pressures continued to be contained on the whole.

Manufacturing and Other Business Activity
Manufacturing activity in most Districts continued to move up since the last report, although the pace of activity slowed or activity leveled off in the New York, Cleveland, Kansas City, Chicago, Atlanta, and Richmond Districts. Automobile manufacturing was a bright spot for the Cleveland, Chicago, and St. Louis Districts. Automobile parts suppliers also experienced increased demand in both the Richmond and Chicago Districts. Fuel demand at refineries in the San Francisco District improved, while gasoline demand was steady in the Dallas District. Firms in the semiconductor manufacturing industry reported relatively strong sales or demand growth in both the Boston and San Francisco Districts. Firms in aircraft and parts manufacturing saw sales pick up in both the San Francisco and Dallas Districts. Manufacturing firms in the Boston, Philadelphia, Kansas City, and Dallas Districts were optimistic that demand would continue to improve in the following months. However, Cleveland’s contacts expect demand growth to taper off, Philadelphia noted that the balance of positive over negative views had narrowed, and Atlanta reported fewer firms planning expansions in production. Richmond, Chicago, and Dallas reported that firms in construction-related manufacturing experienced weak demand; construction supplies sales were flat in Kansas City, and Minneapolis reported that a firm in the sector was increasing production. Steel production declined in both the Chicago and Cleveland Districts. Some manufacturers in the Atlanta and San Francisco Districts reported high excess production capacity. Capacity utilization was below pre-recession levels in Cleveland and edged lower among steel producers in Chicago.

Activity in the services sector improved across most Districts since the previous report. The freight transportation industry experienced gains in the Cleveland, Atlanta, Kansas City, Dallas, and Philadelphia Districts. Boston, Minneapolis, and Dallas reported a pickup in demand for some consulting firms. Tourism activity increased in the San Francisco, New York, Minneapolis, Richmond, Kansas City, and Atlanta Districts. Atlanta reported that leisure travel decreased in the Gulf Coast, but some of the lost tourist traffic was offset by the presence of cleanup crews, oil company workers, and the National Guard. Information technology firms saw increased business in the Philadelphia, Chicago, and St. Louis Districts, while activity was flat in the Minneapolis District. Demand for healthcare services was flat in both the San Francisco and Richmond Districts, while activity increased in the Boston District.

Consumer Spending
Reports on retail sales during the early summer months were generally positive, although in most Districts the increases were modest. Retail sales in the New York, Philadelphia, Minneapolis, and Kansas City Districts were higher than year-earlier sales, and Dallas reported solid gains. But sales in the Boston District were mixed compared with the previous year. Recent sales increased slightly in the Cleveland, Atlanta, Chicago, and San Francisco Districts; sales in the Richmond District weakened; and sales in the Kansas City District were flat compared with the previous report. Several Districts cited apparel, food, and other necessities as recent strong sellers, while big-ticket items were weak sellers. Contacts reported satisfactory inventory levels in the New York District, mixed inventory levels in the Boston District, and low or declining inventory levels in the Richmond, Atlanta, and Chicago Districts. The outlook for sales was mixed: Retailers in the Philadelphia, Cleveland, Kansas City, and Dallas Districts reported that they expect modest positive sales growth in the upcoming months; contacts in the Cleveland, Atlanta, and Chicago Districts reported a less optimistic outlook going forward than in the previous report; and retailers in the Boston District reported a cautious outlook.

The Districts that reported on auto sales during the early summer months generally noted a decrease in recent sales. Since the previous report, auto sales in the New York, Philadelphia, Cleveland, Richmond, Chicago, and San Francisco Districts declined, while auto sales in the Kansas City District increased and were unchanged in the Dallas District. Compared with last year, auto sales in the Atlanta and St. Louis Districts were higher. New York, Philadelphia, Cleveland, Chicago, Kansas City, and Dallas all reported that inventory levels were low or declining. Auto dealers anticipate little change in sales for the rest of 2010 in the Philadelphia District and expect sales to increase slowly in the Dallas District. Contacts in the Kansas City District expect continued strong demand, while those in the Cleveland District do not anticipate strong growth in the coming months.

Real Estate and Construction
Nearly all Districts reported sluggish housing markets in the months since the homebuyer tax credit expired on April 30. While some Districts, such as Boston and St. Louis, reported an increase in May and June home sales on a year-over-year basis, some contacts noted that these sales may reflect closings of homes under contract by the April tax credit deadline. The Boston, Philadelphia, Atlanta, and Kansas City Districts reported that home sales are expected to weaken going forward. Residential construction remained limited in several Districts. In the Atlanta District, residential construction activity softened from already weak levels. Homebuilders in the Cleveland District do not expect a turnaround in new home construction any time this year. Builders in the Chicago District are not introducing new inventory without a signed contract on a home. Housing starts were expected to decline for the second half of the year in the Dallas District and to increase slightly over the next three months in the Kansas City District.

Commercial and industrial real estate markets continued to struggle in all twelve Districts. Overall, vacancy rates were flat to slightly increased and continued to exert downward pressure on rents. Construction activity remained weak in most Districts. The New York District noted that commercial development remained generally sluggish despite some pickup in office and retail leasing in New York City. Atlanta, Minneapolis, and Dallas reported that construction activity continued to be weak or to decline, and Cleveland reported that the increase in construction from previous reports has begun to diminish. Philadelphia reported that projects funded with federal stimulus support were near completion with no prospects for additional major construction, while Chicago reported that public infrastructure construction picked up. Developers reported difficult credit conditions in the Cleveland, Richmond, St. Louis, and Kansas City Districts, while the Dallas District reported a few developers going out of business. The outlook for commercial and industrial real estate across the Districts ranged from further declines in activity to slow growth.

Banking and Finance
Reports on banking conditions were largely mixed across the Districts. Banking activity in Richmond and loan demand in Kansas City increased modestly. Overall loan demand was reported as soft or weak in Cleveland, Atlanta, and Dallas, while total outstanding loan volume decreased in recent months in St. Louis but was steady in Philadelphia and San Francisco. Demand for commercial loans was flat to increasing in the Philadelphia, Cleveland, Richmond, Chicago, and Kansas City Districts; in contrast, St. Louis reported a decrease in commercial loans outstanding, while New York, Atlanta, and San Francisco reported restrained or decreasing demand in this lending category. Demand for consumer loans was weak in Cleveland and eased in Philadelphia; Atlanta and St. Louis indicated a decline in consumer lending; but demand for consumer loans increased in New York and Kansas City. Demand for residential mortgage loans eased in the Philadelphia District but increased in the New York District; Cleveland reported residential mortgage activity below expectations at given rates; and real estate lending decreased in St. Louis. Credit was limited for commercial real estate loans in Chicago, and demand fell for these loans in New York and Kansas City.

Most Districts reporting on credit standards continued to note that lending standards remain restrictive. New York reported tighter credit standards for all categories except consumer loans, while Kansas City reported tighter commercial lending standards. Reports on credit quality were mixed in Cleveland and Kansas City, while quality was stable in San Francisco. Credit quality improved slightly in Philadelphia, Richmond, and Chicago. In the Dallas District, nonperforming loans have stabilized and are not expected to worsen. Meanwhile, Philadelphia, Cleveland, and Richmond continued to report delinquencies above historic norms. Delinquency rates in the New York District decreased for consumer loans but experienced little or no change in other categories.

Agriculture and Natural Resources
Recent rains improved the dry conditions in the Minneapolis and Dallas Districts and reduced irrigation needs in the Kansas City District. In contrast, excess precipitation caused some crop damage in the Chicago District and some delays in the winter wheat harvest in the Kansas City District. Parts of the Atlanta District experienced some crop stress due to dryness and heat. Contacts reported that crops were in good condition overall in the Atlanta, Minneapolis, Kansas City, and Dallas Districts, but crop conditions worsened slightly in recent weeks in the Chicago District and were mixed in the St. Louis District compared with last year. Producers in the Chicago District continued to expect good yields for their corn and soybean crops, and the outlook for cotton yields in the Dallas District has improved.

Overall, activity in the energy sector increased since the previous report. Oil production in the Atlanta District and oil and natural gas production in the Cleveland District were relatively unchanged, but other activity picked up throughout the Districts during the reporting period. The number of drilling rigs increased in the Dallas District, and production continued to expand in the Kansas City District. Additionally, oil exploration in the Minneapolis District and oil extraction in the San Francisco District increased. Activity in the Minneapolis District’s mining sector increased in recent weeks, as did production and demand for coal in the Cleveland District. Kansas City reported that contacts expect to see continued growth in energy production.

Labor Markets, Wages, and Prices
Labor market conditions improved gradually in several Districts. New York, Chicago, Minneapolis, Richmond, and Atlanta all reported that labor markets improved, albeit modestly in some cases, while Boston and Dallas reported that employment was steady. Philadelphia, Atlanta, Richmond, Chicago, and Minneapolis reported that temporary employment experienced increased demand. Contacts in the Philadelphia, Atlanta, Dallas, and San Francisco Districts said that they continued to rely on temporary staff over permanent hires. Cleveland, Richmond, and Chicago saw hiring in the manufacturing sector. Cleveland also reported some new job openings in the healthcare industry. Boston and Cleveland noted that firms in some services industries were hiring mostly for replacement. Dallas reported that firms in the energy industry experienced significant regional layoffs as a result of the deepwater drilling moratorium. San Francisco noted continued high levels of unemployment and limited hiring.

Wage pressures remained largely contained across most Districts. Boston, Philadelphia, Richmond, Minneapolis, and San Francisco reported little or no change in wages, while Cleveland, Chicago, and Kansas City reported that wage pressures were small or remained subdued. Dallas reported that wage pressures were mostly nonexistent, with the exception of the airline industry.

Prices of final goods and services were relatively stable in most Districts. Several Districts indicated that prices of raw materials also held steady, and only a few Districts reported input price increases. Steel prices moved slightly higher in the San Francisco District, but Cleveland and Chicago reported that steel prices were down. Chicago and San Francisco noted an increase in energy prices, but Atlanta reported that energy prices were mostly stable since the onset of the Gulf oil spill. Increased prices were noted for some metals by the Philadelphia, Minneapolis, and San Francisco Districts. Transportation costs increased in the Atlanta, Dallas, and San Francisco Districts, and the Richmond District noted that shipping lines were attempting to raise rates.