Interest Rate Roundup

Wednesday, November 28, 2007

The latest from the Fed; Plus, how commercial real estate is starting to teeter

This morning's speech by Federal Reserve Vice Chairman Donald Kohn has the market all lathered up. Kohn basically opened the door to a rate cut at the FOMC's December 11 meeting by saying "we are going to have to take a look" at the credit market "turbulence."

Why is this such a big deal? Beats me. If you asked a room full of 100 Wall Street bond traders how many actually thought the Fed would stand up to the market and NOT cut rates, you'd probably see one, or maybe two, raise their hands. In other words, a cut was pretty much a given.

But stocks had gotten extremely oversold ... it's that time of year when we tend to get rallies ... and all it took was a spark. So there you go. The question is whether this rally is just like many of those '80s bands -- in other words, a "one hit wonder." After all, we sure saw a heck of a lot of this stuff (big sell-offs, followed by big short-term, short-covering rallies, followed by even bigger sell-offs) in the 2000-2002 bear market. I suppose time will tell.

Meanwhile, in the real world, the Fed just released its latest "Beige Book" report on the economy. It confirmed what I've been saying in a number of venues -- the credit markets are tightening, the housing market (still) stinks, and the overall economy is starting to soften.

Notably, this beige book also references the fact commercial real estate conditions are starting to deteriorate. I haven't talked as much lately about the bubble in commercial mortgage financing, or the ridiculous deals that were done in that part of the R.E. market over the past few years. But I was very vocal about it many months ago. Now, it looks like that part of the real estate market is heading south, too. This Bloomberg story has some interesting facts if you have the time to review.

If there's any good news in the Beige Book, it's that pass-through inflation, outside of food and energy, isn't all that big a deal. Now let's get to some excerpts (with key passages highlighted by me):


"District reports indicated relatively soft retail spending; most retailers said that they were expecting a slow holiday season, with only small gains in sales volumes compared with last year."


"Reports on retail spending were downbeat in general, with several significant exceptions. Most Districts characterized sales as weak or indicated that they had softened, with a few reporting that the volume of sales had fallen relative to the preceding survey period or a year earlier."


"Among product categories, several Districts noted continued solid growth in sales of consumer electronics, while a few also noted that demand for luxury goods continued to rise at a healthy pace. By contrast, sales of automobiles and light trucks were flat to down, with contacts from several Districts expecting declines going forward."


"Demand for residential real estate remained quite depressed, with only a few tentative and scattered signs of stabilization amidst the ongoing slowdown. Most Districts pointed to further increases in the inventory of available homes, with the earlier tightening of credit conditions for mortgage lending continuing to create barriers for some buyers. Consequently, prices on new and existing homes sold were reported to be down on a short-term or year-earlier basis in most Districts. The pace of homebuilding remained very low in general, and builders continued to shelve projects and lay off workers in many areas; contacts generally do not expect a significant pickup in homebuilding until well into next year at the earliest."


"A few Districts reported emerging signs of declining demand for commercial space: this included assorted indicators of weaker demand in the major metro areas in the Boston District, reduced leasing activity in Philadelphia, commercial construction activity that was described as "flat to down slightly compared with a year ago" in Atlanta, and reduced transactions and rising vacancy rates in some parts of the San Francisco District. Construction of commercial and public buildings and infrastructure projects remained high in most Districts, however, partly offsetting low residential building activity and helping to limit losses in overall construction employment."


"The glut of available homes continued, keeping downward pressure on prices and construction activity. The demand for commercial real estate remained strong in most areas but showed signs of leveling off in some. Reports from banks and other financial institutions suggested slower growth in overall loan demand, with some Districts noting a reduction in the volume of commercial and industrial lending. "

"Lending standards for construction projects and commercial real estate transactions tightened further in the New York and St. Louis Districts, and they remained tight more generally and reportedly held down the volume of lending for these categories in the Boston District. The reports indicated slight increases in delinquencies on commercial and industrial loans and slightly larger increases for commercial mortgages in many areas."

"Consumer lending was little changed on net, while residential mortgage lending continued its downward slide. More stringent credit conditions remained a constraint for residential mortgage lending in general, with additional tightening during the survey period reported by Chicago, Kansas City, and Dallas; scattered reports suggested slightly stricter standards on consumer loans as well. Mortgage delinquencies increased significantly in many areas, and some Districts pointed to slight deterioration in credit quality for consumer loans."


"Upward pressures on the prices of final goods and services remained modest overall but were significant for products and services that rely heavily on food and energy inputs. Increases in the costs of energy and selected raw materials pushed up production and transportation costs for firms in various manufacturing and services sectors, although this was offset in part by price declines for lumber and transportation equipment. Food prices remained on an upward trajectory. Outside of products and services that rely heavily on energy and food inputs, final prices were reported to be largely stable or down a bit. Wage increases were moderate in general; upward wage pressures eased in a few areas where labor markets loosened slightly, although they remained strong for assorted groups of skilled workers."


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