A whiff of fear in the air?

I'm not at work today -- someone has to watch the two kiddos while my wife and her coworkers spend the day at a bonding function! But that doesn't mean I'm not keeping one spare eye on the market. And I have to tell you, it smells like there's some real fear permeating the market air late today.

The stock market has suffered a dramatic reversal intraday, with brokers leading the charge lower.

Yet another mortgage firm, this time American Home Mortgage, warned of large losses related to poorly performing mortgages.

The federal banking regulators are tightening the screws (belatedly, but that's besides the point) on subprime mortgage lenders.

And Bloomberg really came out, guns blazing, in this story about the ratings agencies being behind the curve when it comes to downgrading mortgage bonds and CDOs.

Is the cumulative weight of this stuff finally getting traders down? Is it completely unrelated -- and instead a symptom of today's news out of London about potential terrorist attacks? I just don't know. What I do know is that market measures of fear and volatility have been rising, and that it could (emphasis on "could") signal a real change in tone for the capital markets. Needless to say, if there is some kind of market panic, my call for lower bond prices and higher bond yields will likely prove wrong, at least in the short-term, as flight-to-quality purchases outweigh everything else.

Fed keeps rates steady, issues murky inflation comments

As expected, the Federal Open Market Committee kept interest rates unchanged at 5.25%. In the post-meeting statement (some of which is copied below), the Fed highlighted the fact core inflation has come down. But it said it wasn't yet convinced that inflation pressures have abated over the longer term.

Maybe that's a sop to the fact HEADLINE inflation has stayed stubbornly high. After all, a few news stories -- like this one from the Washington Post and this one from the FT -- have popped up recently. They point out (to anyone who's been living under a rock) that "volatile" food and energy prices have basically been volatile in only one direction for the past few years -- up. It seems ridiculous to continually pay attention only to core inflation in that case. Anyway, here's the key text from the Fed's statement:

"Economic growth appears to have been moderate during the first half of this year, despite the ongoing adjustment in the housing sector. The economy seems likely to continue to expand at a moderate pace over coming quarters.

"Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

"In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information."

The market reaction? A few swings here and there for stocks and bonds, but not much net progress so far. Two-year yields are up about 4 basis points, while 10-year yields are up about 1.3 basis points. Long bond futures were recently down about 4/32.

Thoughts on mortgage applications and interest rates

According to the Mortgage Bankers Association, mortgage purchase application activity fell for the second week in a row. In fact, the 4.9% decline in the purchase mortgage index (to 428.90 from 450.90) was the biggest one-week drop since mid-January. The refinance index also dropped for the fourth week out of the last five to 1,731.60. That's the lowest level since the end of December.

Clearly, rising mortgage rates are starting to take their toll on mortgage demand. That will likely cause the housing market to downshift in June. The key question now is, where are rates headed next?

This weekly chart shows the yield on the 10-year Treasury Note. The blue line is a long-term downtrend in yields that dates back to late 1994. We broke above it several weeks ago, kept on going, pulled back, and are now "testing" that breakout point. If I'm right, and interest rates are still ultimately headed higher, this is as good a place as any for rates to make a stand. We'll see...

The "well-contained" myth...

The old phrase "well contained" seems to have gained a lot of traction in Washington lately. Inflation? Well-contained. The housing downturn? Well-contained. The subprime meltdow ... er ... minor blip? Well-contained. But the problem is that reality keeps intervening.

The latest example? Bloomberg has a story that leads off this way:

"U.S. borrowers with good credit are increasingly falling behind on payments, a sign that lenders have been offering 'higher risk' loans to people other than subprime borrowers, according to two studies by Standard & Poor's Corp."

The article goes on to point out that delinquencies on prime jumbo mortgages, large loans that don't fall under the conforming loan limits set by Fannie Mae and Freddie Mac, are climbing fast. The delinquency rate on the 2006 crop of those loans is the highest since at least 2000 (for mortgages that are less than 12 months old, or "seasoned.")

Some 4.21% of the Alt A mortgages made in 2006 are either late by 90 days or in default after 14 months of seasoning. That's more than double the 1.59% rate on 2005 mortgages that were that old, and more than five times the rate on 2004 loans.

And the "well contained" delinquency situation in subprime? It's getting worse. Another Bloomberg story recounts how a whopping 14.51% of a key crop of subprime bonds issued in the second half of 2006 were already either being paid late, in foreclosure, or in a position where the underlying property has been seized as of May. That was up 2.15 percentage points from April. The April rate itself was up 1.86 points from March. Almost 18% of the loans made in the first half of 2006 were in a similar situation.

In other words, almost 1-in-5 of these subprime loans is failing within a year and a half of origination. Unbelievable. It's a travesty these junk mortgages ever got made.

New home sales for May

Data on the new home market in May just hit the tape. What did it show?

* Sales fell 1.6% to a seasonally adjusted annual rate of 915,000 from a revised 930,000 SAAR in April (previously reported as 981,000). That was "better" than economists' forecasts for a 5.9% drop.

But the "beat" stems from the fact last month's big number was revised down sharply. If the April number stayed the same at 981,000, the drop would have been 6.7%. The actual SAAR -- 915,000 -- was below the actual forecast number -- 924,000. In other words, sales were weak. On a year-over-year basis, May sales were down 15.8% from 1.087 million in May 2006.

* For-sale inventory came in at 536,000 new homes. That was down 1.1% from 542,000 in April and 5% from 564,000 in May 2006. On a months supply at current sales pace basis, inventory was 7.1 months, up from 7 in April and 6.2 a year earlier.

* Median prices rose 1.5% to $236,100 in May from $232,700 in April. Prices were down 0.9% from $238,200 in May 2006, however.

So how did the new home market perform in May? Better than the existing home market at first glance. Sales were down a bit, but still off their March cycle low. We also saw a slight improvement in the inventory picture, at least when you measure it in terms of raw units for sale. And to top it all off, median prices were down by a much smaller year-over-year margin this month (-0.9%) than last month (-9.5%).

Unfortunately, the nationwide supply glut in the new home market is still extremely large -- we have about 150,000 more new homes on the market now than at any time in the last two and a half decades. Other indicators, like the record-high vacancy rate for U.S. homes, also suggest we have quite a few excess homes to work through before prices and home construction pick up meaningfully. Lastly, there are troubling indicators the market may be deteriorating again in June thanks to rising mortgage rates and tightening mortgage standards. So a lasting rebound is likely still a long way off.

Case-Shiller home price index shows 2.1% YOY drop

We just got the latest data on U.S. home prices from S&P/Case-Shiller. The group's composite 20-city index showed home prices down 0.23% in April from March. The index was down 2.13% from a year earlier.

It's worth noting that the 0.23% monthly drop is the smallest since last October. That might be slightly encouraging if it weren't for the fact that other data (May existing home sales, June home builder confidence, this morning's dismal earnings report from Lennar, etc.) indicate the market has deteriorated since then.

By city, the biggest year-over-year price declines were in Detroit (-9.35%), San Diego (-6.7%), and Washington D.C. (-5.7%). The largest gains were in Seattle (+9.64%) and Charlotte (+6.97%). 14 of 20 cities showed YOY drops.

Regulators sniffing around fantasy bond/CDO valuations?

A few days ago, I asked whether this whole "Maybe if we pretend this stuff isn't toxic and we keep it from trading at market prices, nobody will notice and everything will be fine" approach made sense. Specifically, I wrote ...

"My question is simple: If everyone knows this stuff is dreck, shouldn't firms just go ahead and write the value of their holdings down already? Sooner or later, someone is probably going to blink and start dumping in order to be the first person out the door. Anyone who's at the back of that seller's line is going to regret it. Alternatively, regulators could start applying pressure on firms to revalue their holdings at something resembling reality. Either way, it seems to me that Wall Street is just postponing write-downs that are all but inevitable."

Turns out, the regulators may now be on the case. Here's an excerpt from an FT.com story this evening mentioning that the SEC could be looking into the mis-valuation of junky securities. Things get curiouser and curiouser:

"The SEC has sent informal letters to Bear asking for details on how its two hedge funds fared so badly, sparking heavy redemption demands from investors and demands for repayment from creditors. Bear last week agreed to extend $3.2bn in loans to one of the funds. The other larger and more levered fund is still negotiating with creditors. Bear shares closed at $139.10 on Monday, a nine-month low.

"The SEC inquiry is at a very preliminary, information gathering stage, people familiar with the matter said. It is also said to be part of a broader inquiry by regulators into the way banks and other publicly-traded companies are valuing their holdings of subprime loans at a time when losses appear to be rising quickly."

The real story on May Existing Home Sales: The Supply Surge Continues

We just got our latest peek at the U.S. housing market -- May existing home sales data. What did it show?

* Sales dropped 0.3% to a seasonally adjusted annual rate of 5.99 million from a revised 6.01 million SAAR in April (previously reported as 5.99 million). That was right in line with economists' forecasts. May sales were down 10.3% from 6.68 million a year earlier.

* Inventory came in at 4.431 million single-family homes, condos, and co-ops. That was up 5% from 4.22 million in April, up 23.5% from 3.589 million in May 2006, and a fresh record high. On a months supply at current sales pace basis, inventory was 8.9 months, up from 8.4 in April and 6.4 a year earlier. That was the worst reading since June 1992.

* Median prices rose 1.8% to $223,700 in May from $219,800 in April. April's figure was previously reported as $220,900. But prices were down 2.1% from $228,500 in May 2007. That was the tenth straight year-over-year decline in prices, the longest such losing streak on record.

Anyone hoping the housing market would flower in May will be disappointed by the latest numbers. Sales dipped slightly to the lowest level since June 2003. Home values slumped, extending a record-breaking streak of year-over-year median price declines to 10 months.

Most importantly, the supply of homes for sale ballooned. We now have a whopping 4.43 million homes, town houses, condos, and co-ops sitting out there looking for buyers. That's the highest level ever, and roughly twice what was customary in the late 1990s and early 2000s. The only way we're going to chip away at this Mount Everest-sized pile of inventory is by price cuts, and so far, sellers haven't been aggressive enough. In other words, don't look for a lasting bottom in the housing market anytime soon.

Liquidity draining? Volatility and fear returning? Inquiring minds want to know

One of the hallmarks of this market has been a flood of liquidity, aided and abetted by extreme risk-taking. But several measures of liquidity and risk appetite appear to be flashing yellow. To whit:

* The VIX -- a volatility indices that track options activity, and which can be used as a rough gauge of investor fear and/or greed surged during the February market swoon. Then it came back down ... but notably did NOT drop below its pre-February level. Today, in fact, the VIX is up more than 2 points to 16.31. A chart of the VIX also shows a nice rounded bottom, indicating that maybe, just maybe, more fear and risk is being priced into assets after a three-and-a-half year downtrend.

* The carnage in the subprime mortgage market has started to spill over into the commercial mortgage market and to some degree, the high-yield corporate bond market. Bloomberg had a good story today about how junk bond conditions are getting a bit tighter, with Thomson Learning, a textbook and testing unit of Thomson Corp., cutting the size of its bond offering and paying more interest on its proposed loan. If spreads on high-risk debt over Treasuries increase, it will put the squeeze on credit availability at the margins.

* Then there's the Blackstone Group IPO. Yes, it is set to close above its $31 IPO price. But from an early intraday high of $38, it has sold off and sold down to the $35 and change area. The overall market has rolled over too. And another IPO -- a health care real estate company owned by CIT Group, flopped, losing as much as 13%. The size of the deal had been cut and the shares were priced at the low end of the range spelled out in earlier filings.

* One of the most overvalued asset classes, commercial real estate, has been coming back to earth, as I have noted on this blog before.

* Then there's the yield curve. The spread between 2-year and 10-year Treasuries is widening out quickly, to about 21 basis points. That's a sign of flight-to-quality buying in the short end of the curve.

These are all just individual data points that may ultimately add up to nothing. But they are worth noting because they are out of character with the action we've seen in the markets for many, many months.

More turmoil percolating in subprime

Some quick updates on the ongoing subprime/Bear Stearns/CDO debacle ...

* Bank of America is out with a note saying losses in U.S. mortgages could be just the "tip of the iceberg." Rising mortgage rates will make life tough for homeowners with adjustable rate debt -- with about $515 billion in ARMs facing higher payments this year and another $680 billion poised to reset in 2008.

* Things get curiouser and curiouser at Bear. The Wall Street Journal is reporting that the Everquest Financial initial public offering is getting yanked amid chaos in the subprime mortgage debt market. Bear owns 75% of Everquest, which was set up only last year to invest in the market for collateralized debt obligations, a complicated form of debt security.

* Speaking of Bear, Bloomberg is reporting today that the investment banking firm will assume $3.2 billion in loans to prevent other lenders from seizing and selling assets out of its struggling High-Grade Structured Credit Strategies Fund. Firms like Merrill Lynch, JPMorgan Chase and Lehman Brothers have been either grabbing collateral from the fund and holding or reselling it, or sending out signals they would do so down the road.

Bloomberg is calling this the biggest hedge fund bailout since Long-Term Capital Management blew up in 1998, citing the fact LTCM received $3.625 billion in bailout money.

So far, this mini-meltdown hasn't spread to the broader market. But the question in these situations is always: "Is this just smoke? Or is there fire out there?" Many folks are speculating that the reason Bear is so eager to help this fund out is to avoid a fire sale of fund assets. Such a sale would provide new market prices for all these esoteric, exotic securities, which are currently being carried on peoples' sheets at values estimated by models (values which likely don't reflect the reality that mortgage credit quality stinks)

My question is simple: If everyone knows this stuff is dreck, shouldn't firms just go ahead and write the value of their holdings down already? Sooner or later, someone is probably going to blink and start dumping in order to be the first person out the door. Anyone who's at the back of that seller's line is going to regret it. Alternatively, regulators could start applying pressure on firms to revalue their holdings at something resembling reality. Either way, it seems to me that Wall Street is just postponing write-downs that are all but inevitable.

Here's an analogy I thought up that might help you get your arms around what I'm saying: Say you're the CEO of a biotechnology firm. You have a promising new compound to treat a certain type of cancer. But there are some nasty side effects. You go before an FDA review panel to plead for regulatory approval, and your stock is halted until the outcome is known. Then your compound gets rejected.

You know that when the stock reopens, it could drop by 30%, 40%, or more. So what are you going to do? Beg the stock exchange to keep the trading halt on indefinitely? That might temporarily put off the day of reckoning. But it won't change a simple fact: It doesn't matter WHEN trading resumes, the result is going to be the same: Your stock is going to tank because your company has lost value.

Commercial REITs rolling over

I have gone on record in numerous venues (here's a post from May 2 ... and here's a longer story from around that same time) claiming that commercial REITs could be in trouble. I pointed out that valuations were extremely stretched, that tighter credit conditions and rising interest rates could cause them problems, and that the apartment sector in particular faced significant headwinds due to the supply overhang of former-flips-turned-rentals.

Today, the Dow Jones U.S. Real Estate Index Fund is breaking down from critical support, continuing a sell-off that has stretched back several weeks. Yep -- looks like Sam Zell sold out at the top to the geniuses at the Blackstone Group, as I mused back in November.

Dispatches from the housing and mortgage front

Good Wednesday morning -- If you have some time for "light" reading, you're in for a treat. There's a lot of news on the housing and mortgage front this fine a.m.

First off, check out this big story from Bloomberg. It tackles the issue of whether the housing sector is done going down, what the impact from higher mortgage rates will be, and how much -- if at all -- the housing slowdown will hit the broader economy. Some key points and facts from the piece (many of which I've touched upon before in this blog, but are worth recapping since Bloomberg has done a good job of bringing them all together in one place):

- National median prices will likely decline this year for the first time since the Great Depression (on an annual basis, that is).

- New home sales will likely drop 33% from the 2005 high to the end of 2007, making this downturn worse than the drop in 1991 (25% over three years), per the National Association of Realtors.

- Adjustable rate loans captured 29% of the market, on average, over the past three years. That compared with 17% over the previous three years. Now, those borrowers are facing rate and payment resets that will stretch their budgets.

- Mortgage rates have risen more quickly in recent weeks than at any time since 2004. That means borrowers can afford 8% less house.

- A greater percentage of home mortgages (0.58%) entered foreclosure in Q1 2007 than at any other time in history.

Second, it looks like the days might be numbered for a pair of Bear Stearns mortgage hedge funds, according to the Wall Street Journal (subscription required). These funds made big bets with borrowed money on subprime mortgage bonds. Turns out (surprise, surprise) that wasn't exactly the best path to investment riches. Here's an excerpt ...

"Two big hedge funds at Bear Stearns Cos. were close to being shut down last night as a rescue plan developed over several days fell apart in a drama that could have wide-ranging consequences for Wall Street and investors.

"Merrill Lynch & Co., one of the hedge funds' lenders, said it would move to seize collateral -- much of it mortgage-backed debt -- from the two funds and sell it, according to documents reviewed by The Wall Street Journal. At the same time, the funds' managers worked with a handful of other key lenders, including Goldman Sachs Group Inc. and Bank of America Corp., to pay off the funds' $9 billion in loans, according to a person familiar with the matter.

"As of a few weeks ago, the two Bear Stearns hedge funds held more than $20 billion of investments, mostly in complex securities made up of bonds backed by subprime mortgages -- the relatively risky home loans made to borrowers with troubled credit histories.

"In recent weeks, however, the firm's High Grade Structured Credit Strategies Enhanced Leverage Fund and High Grade Structured Credit Strategies Fund have been besieged by investors and lenders trying to recover their money as the value of the funds' underlying bonds fell sharply."

Unlike the Long-Term Capital Management meltdown in 1998, which had a significant impact on the broader capital markets, this Bear Stearns implosion hasn't derailed things.

But here's the thing -- a lot of investors are carrying subprime mortgage bonds, so-called collateralized debt obligations (CDOs), and other instruments that are valued based on certain pricing assumptions. If these Bear Stearns funds have a fire sale, and the MARKET sets new prices for its investments, other firms may need to revalue their holdings based on those market prices. That could lead to some nasty write-downs. Here's how the WSJ explained it:

"On Wall Street, the Bear Stearns hedge funds' problems point to another sensitive issue: Markets for exotic investments like derivatives linked to subprime mortgages have exploded in size in the past few years, but it is often hard to attach an accurate value to those assets.

"Last month, Enhanced Leverage reported that its value fell 6.75% in April after the fund's bets on the mortgage market went wrong. Two weeks later, it put the loss at 18%, spooking already-nervous investors and creditors and sending many of them running for the exits.

"The huge revision at least in part reflected conversations Bear Stearns hedge-fund managers had with bond dealers, three of which told them in late April that some of the funds' assets were worth less than the values stated on the funds' books, according to a person familiar with the matter.

"So far the turmoil doesn't seem to be significantly hurting the broader bond markets. But as the Bear Stearns funds unwind positions, investors and traders could reassess the value of other debt securities. As a result, investors far beyond the reach of the funds could find their holdings of similar debt worth less than they thought."

Third, the Mortgage Bankers Association's purchase mortgage applications index pulled back in the most recent week - by almost 3% to 450.9. It's still up quite a bit from its early 2007 low, but some of the gains likely stem from borrowers trying to "beat the clock" on interest rates. In a nutshell, they see rates are surging, so they clamor to get their applications in to their lenders before rates climb even higher.

Can purchases maintain their momentum now that rates are a lot higher? Or is the dip in the most recent week a sign of things to come? I tend to think the second of those two scenarios will play out. But only time will tell.

Bond bounce to run out of steam?

We've rallied a few points off the low in long bond futures -- from an intraday low in the high 104s on June 13 to a close of around 107 today. Ten-year yields have eased back to around 5.09%. I don't think the worst is over, though. This rally smacks of short-covering and consolidation of the big run up in yields rather than a change in trend.

Over the longer term, I tend to agree with Bill Gross -- that we've switched into a rising-rate environment from a falling-rate one. My best educated guess: We'll move up to 5.70% or so on the 30-year yield sometime in the next several weeks. That's the horizontal blue line on this monthly chart, which also shows that we broke above a long-term downtrend several months ago.

Permits and starts top expectations on multifamily business

We just got our latest look at housing construction activity. The May figures showed ...

* Housing starts fell 2.1% to a seasonally adjusted annual rate of 1.474 million from 1.506 million in April. April's starts were previously reported as 1.528 million. Economists polled by Bloomberg were expecting a drop of 3.6%. On a year-over-year basis, starts were down just over 24% from 1.944 million in May 2006.

* Building permit issuance rose a greater-than-expected 3% to a SAAR of 1.501 million from 1.457 million in April. April's permit issuance was the lowest since December 1997. On a year-over-year basis, permits were down about 22% from a SAAR of 1.918 million in May 2006.

* By category of construction, single-family starts dropped 3.4%, while multifamily starts rose 3.1%. Permit issuance dropped 1.8% in the single-family market, but shot up 16.5% in the multi-family arena.

* Regionally, starts rose sharply in the Northeast (+15.7%) and the Midwest (+15.5%), but dropped slightly in the South (-1.6%) and severely in the West (-19.7%). Permits dropped 6.5% in the Northeast, but rose 5.4% in the Midwest, 5.3% in the South and 1.1% in the West.

The story this month? Multifamily construction saved the day. Multiple-unit starts offset weakness in single-family starts. The same pattern holds true for permits: Permit issuance for buildings with 5 or more units climbed to its highest level since last June while permit issuance for single-family homes slumped to a fresh cycle low (and the lowest level since July 1997).

Looking at the big picture, the problem remains the same: Inventories of both existing and new homes are extremely high. We had 438,000 new homes and 4.2 million existing homes for sale at last count -- far, far above historical levels (roughly 300,000 to 350,000 in the new home market throughout the 1990s and 1.7 million to 2.5 million in the existing home market in the late 1990s and early 2000s). Until we whittle down those for-sale inventories, builders will remain cautious and home construction will remain weak.

NAHB index falls ... again

I know I sound like a broken record sometimes, but I just have to say it again: There is NO evidence the housing market has bottomed. If anything, the latest numbers show that it's getting worse. Just look at the National Association of Home Builders' index figures for June:

* The overall index dropped to 28 from 30 in May. That was worse than the 30 reading forecast by economists ... down sharply from 42 a year ago ... a fresh cycle low ... and the worst reading since February 1991.

* All three components of the index fell. The index measuring current single-family home sales dropped to 29 from 31 ... the index measuring future single-family home sales dropped to 39 from 41 ... and the index measuring prospective buyers traffic slipped to 21 from 22.

* Regionally, buyer traffic was up in the Northeast, but down everywhere else (Midwest, South, West)

The housing industry faces multiple problems -- Tighter mortgage lending standards, excess for-sale inventories, the absence of speculative buyers, and relatively weak sales from "core" customers. To top it all off, mortgage rates are climbing again. Thirty-year fixed mortgages are going for 6.61% now, according to the latest data from the Mortgage Bankers Association. That's the highest since last July.

These latest numbers confirm that all the talk of a housing market bottom is just that -- talk. My view remains the same: A longer-lasting rebound won't come until at least 2008, likely in the back half of the year, because supply and demand are way out of balance. Finding equilibrium will take time.

Closing bond market action ...

Long bond futures finished the day up 12/32 to 106 13/32. That means we held support in the mid-105s but haven't made a ton of upside progress. Ten-year yields were recently at 5.15%, down from the peak on 6/12 of 5.3%. I still think the idea of a nice, neat, clean double-top in this area is just too cute, and that we have more upside ahead. But I've been wrong before.

Next week, we get a peek at the June NAHB Housing Market Index on 6/18, May housing starts and building permits on 6/19, and the June Philly Fed Index on 6/21. That's about it as far as economic data is concerned, besides the usual weekly stuff (jobless claims, mortgage apps, etc.)

Have a good weekend!

The last of today's data deluge: Disappointing confidence figures

The last economic report just hit the tape -- June consumer confidence out of the University of Michigan. The confidence index actually fell to 83.7 in June from 88.3 in May, with both the current conditions and outlook readings falling. More importantly, inflation expectations rose. Consumers expect inflation to rise 3.5% over the next year. That's up from 3.3% in May and the highest reading since last August.

TIC shows a big bump in foreign flows ... while production and capacity utilization comes in light

You gotta love these big data days. They sure keep you on your toes. The latest two reports show:

-- Total net fund flows surged to $111.8 billion in April from a revised $30.1 billion a month earlier. That was well above the $55 billion estimate. If you exclude short-term securities and certain other trades, holdings were up to $84.1 billion from $51.2 billion. Foreign buyers piled into stocks and agency bonds (i.e. bonds sold by Freddie Mac and Fannie Mae), but bought the fewest Treasury securities in a few years.

By country, Treasury purchases declined a sharp $5.8 billion in China and $12.4 billion in the U.K., but rose by $3.2 billion in Japan.

-- Industrial production was unchanged in May, down from a 0.4% gain in April. Manufacturing activity was up 0.1%, while utility output was down 1.3% and mining was up 0.5%. Capacity utilization dipped to 81.3% from 81.5% in April. Both figures fell below expectations.

Bond market impact? Almost nil vs. where bonds were trading before this latest batch of data. Today's close should be interesting, to say the least.

Incidentally, the New York Times has a good story today about the potential impact of higher interest rates on different parts of the economy, including corporate and consumer borrowers. You can read it here.

Consumer Price Index comes in a bit cool, but ...

The latest Consumer Price Index figures were just released. Here's what they showed ...

* The overall CPI rose 0.7% in May, slightly above the 0.6% increase that was forecast. That puts year-over-year inflation at 2.7%

* The "core" CPI, which excludes things like food and energy that none of us use, of course, gained 0.1%. That was below the 0.2% increase that was forecast. But get a load of this: The three decimal place increase was +0.149%. In other words, this number was 1/10th of a basis point away from being reported in the media as 0.2%. Talk about being "cute." YOY core inflation came in at 2.2%.

* Within the report, housing inflation was 0.2%, food and beverage inflation came in at 0.3%, apparel prices dropped 0.3%, and education and communication costs rose 0.6%.

Another more current report on the economy was also released -- the June Empire State Manufacturing Index. The overall index soared to 25.8 from 8.03 in May. That was the highest reading since last June, and much better than the 11.3 reading that economists were expecting. Shipments and new orders were strong. However, the prices paid index surged to 42.55 from 34.44 in May. That was the highest reading since last August.

Also, the current account deficit rose to $192.6 billion in the first quarter from 187.9 billion in the fourth quarter of 2006. That was down from $200.6 billion a year earlier.

Still on tap: May industrial production and capacity utilization, plus international capital flows for April and University of Michigan June consumer confidence.

By the way, bonds like the news -- futures were recently up 6/32. But it certainly isn't a runaway rally yet. Ten-year yields are down about two basis points to 5.20%.

Sneak peek: May housing trends don't look so hot here in South FL

If you're a long-time reader of my blog, you know that there's a local real estate brokerage -- Illustrated Properties -- that puts up preliminary home sales figures for my part of the world (South FL) each month. They never match up exactly with the "official" Florida Association of Realtors figures. But they come out a bit earlier, and they get the general trends right. So I've found them to provide a nice "sneak peek."

Anyway, the May figures that were just posted look pretty awful. Here's the run down:

* Sales collapsed by 70.2% from a year earlier -- to 720 from 2,417 in May 2006.

* For-sale inventory bounced back from a dip in April. In fact, supply was up 12.9% year-over-year to a fresh cycle high of 24,852 (from 22,008 in 5/06)

* Median home prices dropped 5.2% YOY -- to $289,000 from $305,000 in May 2006. Average days on market also increased 58% to 144 from 91 a year ago.

Definitely no reason to jump for joy unless, of course, you're a buyer looking for a bargain. After all, you have more than 34 months worth of inventory to pick and choose from.

More fun with charts

I've been throwing a lot of charts up on the blog lately, each designed to shed some insight into where bond prices and yields might go. It's all educated guesswork, of course ... If I KNEW where prices and yields were headed, I wouldn't be blogging. I'd be ensconced somewhere on my own personal, private island. But since we all have some time in advance of tomorrow's CPI report, what do we have to lose?

Anyway, this chart shows 10-year Treasury Note yields going back about five years. You don't have to be a top-of-the-line technical trader to see that yields have made a series of higher highs and higher lows. And each time we broke out to a new high, we kept on running for several percentage points thereafter.

The percentage figures on the chart measure the yield extension -- how much of a percentage change we got in the 10-year yield -- AFTER the breakout. The average change over the past three breakouts was just over 7%. If the pattern holds this time, and we do break out here, 10-year yields could head to 5.5% -- or slightly higher -- in a hurry. As always, time will tell ...

Mortgage Bankers Association figures show a major foreclosure problem

The Mortgage Bankers Association releases a quarterly report on delinquencies and foreclosures. It covers prime, subprime, and government-backed mortgages, including FHA and VA loans. So what did this report show for the first quarter?

* The share of loans on which lenders began foreclosure proceedings climbed to 0.58% in the first quarter. That was up from 0.54% in the fourth quarter, 0.42% a year earlier, and the highest level in history.

* The overall foreclosure rate (which includes loans in foreclosure already AND those entering the process) climbed to 1.28% from 1.19% in Q4 2006 and 0.98% in Q1 2006. That's the highest for this series since Q1 2004. The high, for perspective's sake, was 1.51% in Q1 2002.

* The overall delinquency rate actually dipped slightly quarter-over-quarter -- to 4.84% in Q1 2007 from 4.95% in Q4 2006, which was the highest since Q2 2003. On a year-over-year basis, the DQ rate was up from 4.41% in Q1 2006.

* By loan type, prime mortgage delinquencies increased to 2.58% from 2.57% in Q4 2006 and 2.25% a year earlier. That's the highest reading since Q2 2003 (2.60%). DQs on subprime loans jumped to 13.77% from 11.50% a year earlier. That's the worst DQ rate since Q3 2002 (14.39%). The improvement in overall DQ rates stemmed from improvement in the performance of FHA and VA loans.

What happens when you lend too many borrowers too much easy money? You get rising delinquencies (from a year earlier) and record foreclosure starts. We now have the highest subprime delinquency rate since late 2002 and the highest prime delinquency rate since mid-2003. The improved performance of FHA and VA loans, which drove the delinquency rate down from the fourth quarter, is slightly more encouraging. But those mortgage programs capture a much smaller part of the market than they used to.

As for foreclosures, they're either already high or climbing in two types of housing markets: Those with weak employment and economic growth, like Ohio, Michigan, and Indiana, and those with rampant speculation during the boom, including California, Florida, Nevada, and Arizona. Given the large overhang of unsold homes, slumping prices, and relatively weak sales, we likely haven't seen the worst of this foreclosure wave.

PPI comes in a bit hot...

We just got the Producer Price Index for May. Here are the details ...

* Headline PPI rose 0.9% last month, a bigger increase than the 0.6% gain expected by economists. The year-over-year PPI rate jumped to 4.1% from 3.2% a month earlier. That's the biggest YOY increase since June 2006.

* The "core" PPI, which excludes food and energy, rose 0.2%. That was the biggest increase since a 0.4% rise in February, but it was right in line with the average forecast of economists. The year-over-year rate of core inflation ticked up to 1.6% from 1.5%.

* Further up the "food chain," intermediate term goods were up 1.1% on the month and 3.7% on the year. Core intermediate goods inflation was up 0.4% on the month and 2.9% on the year. Crude goods rose 2% on the month and 11.5% on the year. Core crude goods rose 0.1% on the month and 9.2% on the year.

These inflation figures certainly weren't a blow out. But they seem to "validate" the move up in bond yields to some degree, because they show core producer prices ticking higher. Tomorrow's Consumer Price Index is much more important, though, in terms of potential bond market impact.

Speaking of which, long bond futures dropped as much as 18/32 after the number came out, but have since rebounded to -9/32. Ten-year yields are up about 2 basis points to 5.22%, but off their post-PPI highs.

By the way, I realized as I was going back over some of my recent posts that I sometimes didn't make clear whether I was talking about the cash part of the bond market or the futures. Typically, I'm referring to the futures when it comes to references to bond prices.

Is it all over?

That's the question bond traders are asking themselves today. After all, Treasury futures prices reversed off their lows and finished up nicely. The reversal also occurred right around the area of technical support I highlighted a little while back -- the low-105s.

But wasn't it just three sessions ago that we had our last supposed "key reversal?" And aren't we getting key inflation data tomorrow (Producer Price Index) and Friday (Consumer Price Index) -- data that could show inflation pressures have picked back up?

In other words, it's awfully tough to just declare "That's that." Instead, I believe the risk is for more downside in prices and more upside in yields, short-term corrections notwithstanding. Of course, you know what they say about opinions ...

Beige Book weighs in on housing ...

The Federal Reserve's "Beige Book" was just released. This report contains anecdotal reports on the economy, which serve to round out the statistical indicators the Fed follows. The gist is that the economy picked up in April and May, but housing is still sucking wind. Here's the key section on residential real estate (I'm inserting some breaks to make it a bit more readable):

"The real estate and construction industries were marked by continued weakness in the residential sector and increasing strength in the commercial sector. Most Districts characterized their housing markets as soft or weak.

San Francisco reported that sales volumes for both new and existing homes fell further in most areas, with modest price declines in some parts of the District. Minneapolis described the District's housing markets as mostly weak, and Dallas described the District's housing markets as soft, noting high cancellation rates for new home sales in Dallas and continued slowing in the Houston market.

Philadelphia reported no improvement in the housing market, and Cleveland reported that new home sales were stable but prices were down. Atlanta reported that sales stabilized at low levels in parts of Florida but continued to decline in Georgia. Reports from Richmond and St. Louis were mixed, with sales stabilizing or improving in some areas but declining in others.

The most positive report on housing markets came from the New York District where there were signs of strengthening in New York City, parts of Long Island, and some close-in New Jersey suburbs. However, housing markets in the rest of the New York District remain sluggish.

No District reported an increase in new home construction. Moreover, inventories and days on the market continue to rise in some Districts, although the Kansas City District has seen a reduction in inventories. Realtors in the Philadelphia, Cleveland, and Atlanta Districts anticipate that the weakness in the housing market will last several more months at least."

Blowout economic data ... wild swings in interest rates ... and what's going on with mortgage demand

What a morning! Let's try to recap all the amazing news that's hitting the tape ...

* First, May retail sales were a blowout. Sales gained 1.4% in May, more than twice the 0.6% increase that was expected and the biggest gain in any month since January 2006. Retail sales less autos? Up 1.3% vs. forecasts for a 0.7% gain. Even if you stripe out autos and gas (to account for higher gas prices), you get a gain of 1%.

* The import price index looked ugly from an inflation standpoint. Import prices jumped 0.9% on the headline, three times the 0.3% gain that was forecast. If you strip out petroleum, you get a gain of 0.5%. And if you strip out ALL fuels, you get a 0.4% rise.

* Meanwhile, mortgage demand jumped by 6.6% in the most recent week. The home purchase index came in at 464.70, the highest reading since the beginning of the year. Is the market coming back to life?

Well, my take is that applications likely jumped because borrowers are playing a game of "beat the clock" with interest rates. Last week, 30-year fixed mortgage rates shot up by 26 basis points. That was the biggest single-week increase in more than three years.

Borrowers see that rates are rising, so they're hurrying to get their paperwork in before rates climb even further. If we see purchase loan activity sustain these relatively higher levels -- despite higher mortgage rates -- I'd take it as a sign of potential improvement in the housing market. But I don't think we're there yet.

So what's the impact of all this news on the bond market? Absolute chaos! Bond prices initially tanked on the news, then rallied back to post a slight gain. Now, they're roughly unchanged. Tough to say how this all shakes out -- we're pretty "oversold" but we're also breaking above key yield levels and breaking below key price levels. Expect a real battle royale between the bulls and the bears here.

Bond market massacre, redux

At the end of the day, things got "Fugly" in the bond market (That's short for F...... ugly, in case you're wondering. Gotta' give credit for the term to a guy I've been friends with since elementary school) Long bond futures plunged another 1 5/32, using recent prices, while the 10-year note yield shot up above its 2006 peak. At 5.257%, it is now the highest in five years.

Here is a CNBC story with some comments on the topic.

Foreclosures soar to new high in May

RealtyTrac says foreclosure filings soared in May ...

* They were up a whopping 90% to 176,137 from 92,746 a year earlier.

* The May tally was also up sharply (19.3%) from April, when RealtyTrac tallied 147,708 foreclosures.

* The reading is the highest yet for this series, which goes back to early 2005.

* RealtyTrac said Nevada led the nation with 1 foreclosure for every 166 households. Colorado was in second place, with 1 filing per every 290 households. On a pure "number of foreclosures" basis, California led the U.S., with Florida next in line.

The ongoing credit problems in the mortgage industry show no sign of letting up. Monthly foreclosure filings are rising because more adjustable rate mortgages are hitting their adjustment dates and more interest only mortgages are starting to require payments on principal as well. At the same time, home prices are stagnant or falling, sharply in some markets. That's making foreclosure the only way out for many homeowners.

Long bond yield testing resistance ...

Quick market update: 30-year yields are up by around 8 basis points to 5.32%. We are now hovering around the double top we had in May-July 2006 ... the double top we had in May-June 2004 ... and the double top we had in August 2003. If we clear this level, we could get to 5.65% or so pretty quickly.

What it would take to "normalize" interest rate spreads?

I've spilled a lot of digital ink over the bond market sell-off recently -- and whether the worst is over. I recounted serious past market sell-offs carried, where some key areas of technical support lie, and more. Now, here's some more food for thought:

I analyzed the spread, or difference, between 2-year Treasury Note yields and 10-year Treasury Note yields going back to 1980. This "2-10 spread" is a key measure of the shape of the yield curve. When you have a positive spread, it means 10-year notes yield more than 2-year notes. It also means the yield curve is positively sloped (if you were to graph the yields on several Treasury bills, notes, and bonds of different maturities, starting with the shortest-term Treasuries at the far left of your screen, you'd get a line that slopes up and to the right.) When you have a negative spread, the yield curve is "inverted" -- 2-year notes yield more than 10-year notes.

Anyway, over the past 27 years, the average spread is +0.775%, or 78 basis points. A few minutes ago, the 2-year note was yielding 5.04% and the 10-year not was yielding 5.20%. That's a spread of +0.16%, or just 16 basis points. Now, this spread can increase in two ways:

1) All yields can fall, with short-term rates falling faster than long-term rates

OR

2) All yields can rise, with long-term rates rising faster than short-term rates.

The first method is generally "bullish" for the markets. The second method is generally "bearish." We're getting the second method -- in spades.

Now here's one last thing to consider -- to restore an "average" spread of 78 basis points ... even assuming yields on 2-year notes increased no more from here ... the yield on the 10-year note would have to rise from 5.20% to 5.82%. (5.82% new 10-year yield - 0.78% average spread = 5.04% current 2-year note yield)

Housing stories everywhere...

I guess this was the weekend when the greatest media minds got together and decided: "Let's really cover housing!" At least, that's what it looks like to me. Here are just a few of the stories to sink your teeth into ...

AP -- This story talks about how some buyers have been sitting out the downturn, waiting for sales and values to fall so they can buy at a better price.

US News and World Report -- This story talks about the "Spring of Home Sellers' Discontent," a phrase I actually used in an interview several weeks ago. The bottom line: Things still aren't looking good, with inventories running high and prices slumping.

Wall Street Journal -- This piece cuts to the chase, saying "Economists are giving up on the idea that the U.S. housing slump will be quick and relatively painless." For the life of me, I can't understand why anyone thought that in the first place. But that's just me.

Also, Harvard University's Joint Center for Housing Studies released its latest "State of the Nation's Housing" report. Here's a press release, and here is the report itself (large PDF link). The general conclusion: Low housing affordability, tighter mortgage standards, and a large inventory overhang will conspire to keep the market weak for some time, though ultimately, housing will recover.

Meanwhile, if you weren't up at the crack of dawn this morning, you can catch the quick CNBC segment on interest rates that I did here. The bottom line: I'm skeptical that we've seen the end of this bond market sell-off. I suppose only time will tell.

Bonds find inner peace ... for now

You gotta love the bond market volatility -- sure is a big change from what we've seen for the past several months. Anyway, Treasuries staged an intraday reversal and finished roughly unchanged in price. Yields dipped slightly. This begs the question: "Is the selling squall over with?"

One never knows. But technically speaking, there's still room for more downside. I also pointed out that these disturbances in the bond market force historically have resulted in larger price declines than we've seen to date. And over the longer-term, it definitely seems like we've shifted from a declining rate environment to a rising rate one, like I speculated on back in February.

As an aside, here's a quick story on today's market action from CNBC, with one of my comments. The gist: That if rates rise far enough, fast enough, it could threaten the excess liquidity/easy money boom that has fueled so much of the recent gains. Also, I'm scheduled to do Squawk Box Monday morning bright and early (6 a.m.) -- I'll be talking about interest rates, so if you're up with the roosters, feel free to tune in. Have a good weekend ...

The bond market meltdown continues ...

There's no rest for the weary in bond-land this morning. Treasuries continue to get whacked, with long bond futures off 22/32 at last count. 10-year T-Notes were recently yielding 5.18%, up about 5 basis points from yesterday. Obviously, what we're seeing is wave after wave of forced selling -- the kind of liquidation you don't see very often, but when you do, it can get ugly.

I looked back at the last several years of trading in long bond futures and found three similar selling squalls --the first began in November 2001, when a big run-up (sparked by the government's plan to abandon 30-year bond sales) was followed by an even more powerful sell-off. Then we had the big run-up in the spring of 2003, spurred by deflation fears, followed by an even more powerful sell-off. Finally, in early 2004, we had a sharp plunge on the belief the economy was finally regaining its footing.

The magnitude of those declines, price-wise, from high to low? Roughly 12%, 16.6%, and 12.7%. We also had a sharp rise in bond prices, followed by a plunge, in 1998 during the time of the Long-Term Capital Management scare. That decline, peak to trough, was about 7%.

How do things look this time around? Well, from the most recent peak in early May, we're only down about 6% in price. In other words, there could be more ugliness ahead -- though we are closing in on what I'd call pretty solid technical support in the low-to-mid 105s.

Long-Term Bond Bull Bill Gross Goes Bearish ...

Stop the presses: Pimco's Chief Investment Officer, Bill Gross, is reportedly going bearish on bonds, per Reuters. He has been a bond bull for 25 years and manages the world's largest bond fund. Wow. Gross now expects inflation will accelerate mildly and believes 10-year T-Note yields will range from 4% to 6.5% instead of 4% to 5.5% over the next 3-5 years.

For the day, long bonds finished the day down 1 11/32 in price. Percentage wise, that was a decline of about 1.24%, the biggest one-day drop in more than 26 months. The yield on the 10-year Treasury Note closed at 5.10%, the highest since July 18, 2006.

Here's some more coverage on the dramatic bond market action from Bloomberg and Marketwatch. As both articles make clear, some of today's decline stems from heavy mortgage-related selling. But the longer-term catalysts that got the bonds heading lower in the first place, in my view, are the ones I spelled out earlier.

WHY rates are soaring ...

About two weeks ago, I wrote a piece about why interest rates appeared to be on the verge of a big move higher. Obviously, we're starting to see the move now. Here is a link to the original piece from 5/25, and here is the relevant copy if you don't feel like clicking through:

Why the Snoozefest in Bonds May Be Coming to an End

When professional traders want to speculate on U.S. interest rates, they primarily use bond futures. And for several months, 30-year Treasury, or "long bond," futures prices have been fluctuating in a range — roughly between 109 16/32 and 115.

Remember, bond prices and yields (meaning, interest rates) move in opposite directions. But when bond prices go nowhere, interest rates remain stable. For example, the yield on 10-year Treasuries has vacillated between 4.43% and 4.90% for about nine months.

The primary reason for the lack of action in bonds? The economy has been trapped in what I call "Stagflation Lite."

See, inflation remains above the Federal Reserve Board's preferred range. Typically, that would drive bond prices lower and interest rates higher.

However, economic growth has been weakening — the economy expanded just 1.3% in the first quarter, the smallest gain in four years. Economic weakness typically drives bond prices higher and interest rates lower.

Bottom line: We've seen a big battle with a lot of bloodshed … but no real progress on either side. Thus, bond prices and interest rates have been stuck in neutral.

That may finally be changing, though:

1. China diversification fears — When it comes to currency reserves, China is the 800-pound gorilla. Its reserves topped $1.2 trillion in March, up 37% from a year ago. That accounts for 23% of the world's reserves, far ahead of the next largest player (Japan at 17%).

China's money pool is swelling because the country is running massive surpluses with its trading partners. In the past, it was content to just let the vast majority of that money sit in low-yielding U.S. Treasury bonds and other debt instruments. At last count, it had more than $420 billion of them.

Now, China is now looking to diversify its reserves into other investments. It's setting up a reserve-management business that will take those funds and invest them in all kinds of instruments — foreign stocks, Chinese firms, and more. We just learned, for example, that China is giving $3 billion to private equity firm Blackstone Group.

If China stops buying so many Treasuries, who's going to step up to the plate? That's a question bondholders can't answer, so they're turning into nervous sellers.

2. Inflation concerns are winning out — It was easy for bond traders to ignore high inflation readings a few months ago when the economy was falling apart, housing was crashing, stocks were tanking, and oil and gas prices were slumping.

But a few recent economic readings (initial jobless claims, industrial production, etc.) have leveled out. And while the news on housing isn't getting better, it isn't getting much worse, either (A note from today: That has changed since I wrote the piece with the news that for-sale inventories have soared to all-time highs). Plus, the global stock markets are rallying sharply.

As a result, fixed-income investors are finally focusing on the elephant in the room: Inflation. The fact of the matter is that import prices, producer prices, and overall consumer prices are all still rising at a decent clip. The so-called "core" Consumer Price Index isn't rising as quickly as it was a few months ago, true. But it remains well above the Fed's comfort zone.

3. Foreign interest rates keep on climbing — I've said it before and I'll say it again: While our central bank has wussed out in the anti-inflation fight, foreign central banks have not.

The European Central Bank is raising rates. The Reserve Bank of New Zealand is raising rates. Central banks in India and China are raising rates. And so is the Bank of England (BOE). In fact, policymakers at the BOE even considered raising rates by half a percentage point at their most recent meeting, rather than the customary one-quarter of a percentage point.

Until recently, those foreign rate hikes mostly impacted the U.S. dollar — driving its value down. Now, those rate hikes are starting to push up U.S. interest rates, too.

So if you're wondering WHY we're seeing carnage in bonds, that's my take.

Bond market massacre

Let's not mince words -- Treasuries are getting massacred here. Long bonds are off just over a point now, while 10-year note yields are soaring by almost 10 basis points. In fact, we are threatening a MONTHLY downtrend in 10-year rates that goes all the way back to 1994. This is a potentially major event in the bond market that shouldn't be ignored.

UPDATE: Long bond futures are now down a point and a half. That's a 1.36% decline -- the sharpest drop I can find in any day for continuous long bond futures going back all the way to March 22, 2005. Yeah, I'd call it a massacre.

More overseas central bank action: 1 hike, 1 cut, 1 pass

There's a lot of overseas central bank interest rate action to talk about this morning. Let's get right to it ...

* New Zealand's central bank went ahead and hiked rates, as I mentioned it might yesterday. That leaves that country's benchmark short-term rate at 8% -- its highest level ever. The New Zealand dollar climbed to a 22-year high as a result of the hike, the third since March.

* In Brazil, the central bank cut interest rates by 50 basis points to 12%, a record LOW. Rates have plummeted from a high of 19.75% in September 2005. Inflation there has been plunging due to a surge in the Brazilian currency, the real.

* Meanwhile, the Bank of England took a pass. It left short-term rates at 5.5%, a six-year high.

As for the U.S., Treasuries are getting plowed under yet again in early trading. The long bond is off 23/32 right now, while 10-year yields have shot up almost 7 basis points to 5.03%.

The NAR cuts its sales forecast ... again

It's like deja vu all over again -- the National Association of Realtors is cutting its 2007 and 2008 existing home sales forecasts. Here is a brief history of their calls over the past several months (forecasts are in millions of units). It shows that NAR's optimism about 2007 peaked in February, and has now dropped four months in a row. The actual Seasonally Adjusted Annual Rate of sales in the most recent month (April) was 5.99 million units.

Date of forecast ------ 2007 sales est. -------- 2008 sales est.
6/6/07 --------------------6.18-------------------- 6.41
5/9/07 --------------------6.29-------------------- 6.49
4/19/07 -------------------6.34-------------------- 6.52
3/13/07 -------------------6.42-------------------- 6.66
2/7/07 --------------------6.44-------------------- 6.64
1/10/07 -------------------6.42---(none referenced in release)
12/11/06 ------------------6.40---(none referenced in release)
11/10/06 ------------------6.43---(none referenced in release)

I have nothing against blown forecasts -- we all make 'em. What I can't stomach is how every single month, one after the other, there always seems to be some new sunny spin put on the numbers by certain interested parties. Remember, it was just this past fall that we were told it was "a great time to buy or sell a home."

The fact is, we have the biggest housing supply overhang (in raw numbers) in U.S. history and we have home prices that are still relatively unaffordable (and way out of whack with median incomes, rental costs, etc.) On top of all that, interest rates are starting to rise again. None of that bodes well for the housing market, in my view. That's reality -- not a bunch of happy talk.

Overseas central banks -- 1 hike, 1 pass, 2 on deck

Overnight and this morning, a couple of major central banks met to discuss interest rates. What'd they do?

* The Reserve Bank of Australia chose to leave its overnight cash rate at 6.25% for the sixth meeting in a row. That's still a six-month high for short-term Aussie rates.

* The European Central Bank, on the other hand, did raise short-term rates to 4% from 3.75%. That was the 8th increase since late 2005, and it leaves European rates at a six-year high.

Next up? The central banks in New Zealand and England. New Zealand may raise interest rates (currently at 7.75%) tomorrow, though that's a minority opinion, according to Bloomberg. The Bank of England also meets tomorrow, and is expected to stand pat at 5.5%.

The odd thing? The Australian dollar had a sharp RISE in the wake of the central bank's move to keep rates steady, while the euro lost a little ground after news of the ECB rate hike. Just goes to show you can't always "trade the news."

Bonds on the ropes again as ISM services index comes in hot

Bond traders are having another tough go of it this morning, thanks to a strong report on the service sector of the economy from the Institute for Supply Management ...

* The overall non-manufacturing index jumped to 59.7 in May from 56 in April. That's the highest since April 2006.

* The new orders sub-index rose to 57.4 from 55.5, while the employment sub-index climbed to 54.9 from 51.9.

* Inflationary pressures built. The prices paid index jumped to 66.4 from 63.5. That's the highest reading since August 2006.

Long bonds were recently down more than a half point (17/32) to 108 13/32. Ten-year yields hit a new high for the move of 4.97%.

Bernanke muses on the housing and subprime mortgage mess

Federal Reserve Board Chairman Ben Bernanke is speaking via satellite to the 2007 International Monetary Conference in Cape Town, South Africa conference this morning. Housing is a major focus of his address. Here are some pertinent comments, as well as his general comments on the economy:

* "The adjustment in the housing sector is still ongoing, and the slowdown in residential construction now appears likely to remain a drag on economic growth for somewhat longer than previously expected. Thus far, however, we have not seen major spillovers from housing onto other sectors of the economy."

* Bernanke notes that existing home sales are off by more than 10% from their mid-2005 peak, while sales of new homes have plunged 30%. And he confirmed the accuracy of my view, laid out several months ago (here's one and here's another), that the "bottom" was NOT yet in for housing. Specifically, he said that: "A leveling-off of sales late last year hinted at a possible stabilization of housing demand; however, once one smoothes through the monthly volatility of the data, more-recent readings indicate that demand weakened further, on net, over the first four months of this year."

* On construction, he had the following to say: "Homebuilders have responded to weak sales by curtailing construction. Single-family housing starts have declined by a third since early 2006, sufficient to subtract about 1 percentage point from real GDP growth over the past four quarters. Despite the drop in homebuilding, the inventory of unsold new homes has risen to more than seven months of sales, a level well above the average observed over the past decade. Accordingly, and as reflected in the continued downward trend in permits to build single-family homes, residential construction will likely remain subdued for a time, until further progress can be made in working down the backlog of unsold new homes."

* Bernanke also addressed the abandonmen ... er ... "loosening" of lending standards in the mortgage industry: "Some of the increased difficulties now being experienced by subprime borrowers are likely the result of an earlier loosening of underwriting standards, as evidenced by the pronounced rise in 2006 in 'early payment defaults'--defaults occurring within a few months of mortgage origination. All told, the rate of serious delinquencies for subprime mortgages with adjustable interest rates--corresponding to mortgages in the foreclosure process or with payments ninety or more days overdue--has risen to about 12 percent, roughly double the recent low seen in mid-2005."

* He said that subprime purchase originations peaked in late 2005 and have been falling sharply since then. He also notes that while subprime and Alt-A lending has dropped, it hasn't disappeared. But he added that "the tightening of terms and standards now in train may well lead to some further contraction in nonprime originations in the period ahead. We are also likely to see further increases in delinquencies and foreclosures this year and next as many subprime adjustable-rate loans face interest-rate resets."

* Bernanke also addressed inflation, saying that it remains "somewhat elevated" but that "we have also seen a gradual ebbing of core inflation." He claimed that shelter costs won't increase as quickly in the future, and that energy prices are still below last year's peak, despite recent increases. But he reiterated that "the risks to this forecast remain to the upside."

* Lastly, Bernanke addressed the ongoing efforts at the Fed and in Congress to better regulate and/or police the subprime lending industry. I have been studying this issue myself and hopefully will have some more details to share in the coming days and weeks.

Bonds getting taken out and shot

Remember that long bond chart I posted several days ago? Well, it looks like my "last ditch support" has given way. Bonds are getting taken out back and shot, with the long bond recently down more than a half point (18/32) and 10-year T-note rates breaking above 4.90% to 4.95%. This is a major technical event if you're the type that likes to keep an eye on the charts.

UPDATE: Long bond closed down 20/32 ... 10-year finished the day at 4.96%. This strong close could put the old yield highs around 5.25% into play over the coming several weeks.

A swing ... and a miss ... for pending home sales

April pending home sales data just hit the wires, and there isn't much positive to say about the numbers ...

* Pending home sales overall dropped 3.2% from March. Economists expected a 0.3% gain. March's 4.9% drop was revised slightly to a 4.5% fall.

* Sales fell sharply in the Northeast (-10.4%) and the West (-10.2%), rose slightly in the South (+0.7%) and climbed a bit more quickly in the Midwest (+2.3%)

* From a year ago, the seasonally adjusted pending home sales index is down 10.2%. The reading of 101.4 in April was the lowest since February 2003, and is off just over 20% from the April 2005 peak.

My take? The spring selling season just isn't going well. Sales volume is declining because homeowners are clinging to unrealistic asking prices. That's causing inventory to pile up -- and keeping the pressure on sellers. Unless and until existing home sellers start cutting prices aggressively ... like the new home builders clearly are ... the market will remain weak.

Meanwhile, keep an eye on interest rates. They're starting to rise again. That will only make mortgage financing more expensive for buyers here at the tail end of the key spring season.

The latest take on jobs and incomes

This morning, we got data on April income and spending and the job market in May. Here's a quick review of the highlights:

* Personal income dropped 0.1% from March, vs. expectations for a 0.3% gain. Personal spending rose 0.5%, above forecasts for a 0.4% rise. The savings rate, as measured by Uncle Sam, dropped to -1.3% from -0.7% a month earlier.

* The core inflation measure embedded in the income and spending report was tame -- it rose 0.1% on the month (forecasts called for a 0.2% rise). That brought the year-over-year core rate down to 2% from 2.1%. This is the lowest YOY rise since February 2006.

* But before you break out your bond market pom-poms, consider what the fresher data for May showed -- a 157,000 gain in non-farm payrolls (the Bloomberg forecast: +132,000) ... a 0.3% monthly rise in average hourly earnings ... and an uptick in the year-over-year rate of change in earnings, to 3.8% from 3.7% a month earlier. The unemployment remained at a relatively low 4.5%.

* Job creation was strong in the service industry (+176,000), led by gains in things like health care, education, and leisure. The manufacturing sector shed jobs yet again (-19,000), while construction employment was unchanged.

Net/Net, the report confirms other recent readings that show the economy picked up a bit more steam in May. Bonds are reacting by selling off 11/32. Ten-year yields have breached the 4.9% resistance I mentioned earlier, recently hovering around 4.92%. If we close here, it opens the door for a move to the old yield highs around 5.25%.