Interest Rate Roundup

Wednesday, January 31, 2007

Some more thoughts on the Fed's stance

Well, there you have it -- no bearish Fed "hand grenades" = big rally in bonds. Bonds finished the day up 20/32, while 10-year note yields dropped 4.5 basis points to 4.82%.

Here’s the biggest problem, as I see it: There has been a gigantic, easy money fueled rally in the asset markets lately. Risk appetites are very high. The spreads, or differences, between yields on higher-risk bonds and loans and yields on low-risk Treasuries are very small when compared to historical averages. Commercial real estate values are going through the roof. Stocks are on fire.

Fed officials have stated that they will basically ignore any inflation in the asset markets, and focus on the "real" economy instead. But with money supply surging and risk-taking running rampant, that approach doesn’t make sense. Other central bankers – most notably in Europe – pay close attention to money supply and asset prices. If the Fed continues to keep the monetary taps wide open, we could end up with even more "new" bubbles to replace the one that just burst in housing.

Another key risk: The dollar. The recent rise in interest rates helped take the pressure off the greenback. But the dollar is slipping in the wake of this Fed news. That, in turn, is causing some reflation in commodity prices – oil shot up more than a dollar today, while gold rallied strongly. The end result: Inflation pressures could build right back up again. Indeed, a market-based indicator of inflation known as the TIPS spread is at its highest level since September.

Fed stands pat, more bullish on economy, neutral-to-dovish on inflation

That's my quick and dirty analysis of the Federal Open Market Committee meeting, whose results we just learned via this statement. Policymakers kept the federal funds rate at 5.25%. They pointed out the economy was a bit stronger, saying "Recent indicators have suggested somewhat firmer economic growth." Meanwhile, the inflation commentary seemed neutral-to-dovish. The Fed said "Readings on core inflation have improved modestly." At the same time, they reiterated a comment that "the high level of resource utilization has the potential to sustain inflation pressures." That's jargon referring to the low unemployment rate.

Markets usually swing wildly in the immediate aftermath of any Fed meeting. Whether they follow through or not is another thing entirely. That said, Treasuries had already reversed earlier losses, and they're gaining even more ground in the wake of the report. Ten-year yields were recently down 4 basis points, while long bond futures were recently up 13/32.

NAPM reports, construction data, housing affordability news -- it's all here...

The Chicago Purchasing Managers Index was surprisingly weak in January. It came in at 48.8 vs. a December reading of 51.6 and a forecast of 52. Readings on new orders, employment, and inventories were down big, a reading on prices paid was down small, and a reading on production was up by a decent margin.

On the other hand, the Milwaukee NAPM measure (yes, the state of Wisconsin releases important economic reports ... don't mock! LOL) was strong. It came in at 63, up from 58 in December. Readings on new orders, production and prices rose, as did indicators of employment.

Construction spending? -0.4% on the month vs. a forecast for no change. The November reading was revised down to -0.2% vs. a previous reading of +0.1%. I'll give you a wild guess where the most weakness showed up. Yep -- residential spending, at -1.6%. That's the biggest monthly decline since August. Nonresidential spending growth also decelerated -- to +0.8% from +1.8% in November. Every category of nonresidential spending (lodging, office, health care, etc.) weakened, except for public safety, transportation, and manufacturing.

Meanwhile, the National Association of Realtors' monthly home affordability index (PDF link) slumped in December. It came in at 109.2 vs. 110.7 in November. Longer term, it's above the July trough of 99.6, but well below the 120-140 range we consistently saw between 1992 and 2004. This just goes to show that the meteoric rise in prices has forced American families to stretch more to afford homes.

What was Wamu thinking?

Most of my comments here are focused on macro issues -- the interest rate environment, the mortgage and housing outlook, etc. But I just have to share this anecdote because it illustrates all that's wrong with the mortgage lending world these days:

My wife and I have a 30-year fixed mortgage with Washington Mutual. We closed on the purchase-money loan in November 2004 when we bought our house. Since that time, long-term interest rates have risen about 60 basis points, per the Mortgage Bankers Association. In other words, there's no reason whatsoever we'd consider a rate-and-term refi.

But lo and behold, we got a solicitation call from Wamu last night asking if we were “happy with our payment” or something like that. It was clearly a sales pitch ... an attempt to get us to refinance to generate some business. Given the fact a R&T refi would make zero sense, the only possible conclusion is that Wamu was calling to get us to refi into some other kind of mortgage -- an interest only loan, an option ARM, or some other kind of higher-risk loan. I didn’t even let the guy go any further … and hung up.

I understand that lenders are in the business to make money. And I can fully understand why they’d bother me at dinner time IF rates were falling — you don’t want your borrower to refi out from under you with the guy down the street if he can save money by refi-ing with you. But to try to hit me up to refi … when the interest rate climate is actually moving AGAINST me … that’s just wrong. What was Wamu thinking?

Lots of data, little reaction

Tons of data has been hitting the tape. In the past half hour or so, we learned that ...

* The economy created 152,000 jobs in January, according to ADP Employer Services. This report pre-dates the "official" Bureau of Labor Statistics report, due out Friday. ADP has a checkered history -- last month, it forecast a drop in jobs of 40,000 and the official figures showed a gain of 150,000. We'll see if ADP does better this time. It's January forecast is roughly in line with the consensus forecast of economists polled by Bloomberg -- 150,000.

* The employment cost index gained 0.8% in the fourth quarter, down from 1% in Q3 and below forecasts for a similar 1% gain this time around. Interestingly, total compensation was actually the strongest in construction (up 1.1%), retail trade (up 1.1%), education (up 1.4%) and leisure (1.4%). That last two make sense to me. The first two, not so much.

* Q4 Gross Domestic Product rose 3.4% year-over-year. Personal consumption was strong, up 3.7%, thanks to a big jump in durable goods consumption. Private investment was weak -- down 1% YOY -- thanks to a gigantic 12.6% plunge in residential fixed investment (think housing collapse here). Government spending was up fairly significantly as well, 2.8% YOY, thanks to a big pop in national defense spending and state and local spending. Could the state/local surge be due to the lagged effect of surging home prices ... which have resulted in a tax windfall for towns, counties, and states? That'd be my bet.

* So what about the price/inflation indices? Let's look at the annual rate figures there. The core personal consumption expenditures price index rose at a 2.1% rate. While that key measure watched by the Fed is down from 2.2% in Q3, it's still higher than the 1% to 2% range the Fed would like to see.

In early bond market action, traders aren't doing much. 10-year Treasury yields are up about 2.5 basis points, while long bond futures are down 6/32. Looking at the longer-term picture, however, the bond bulls are on the ropes. With yields still below the federal funds rate across the board ... the data continuing to bury the idea of a Fed rate cut ... and bond futures holding below key technical resistance, the door is open to further price declines and rate rises.

Tuesday, January 30, 2007

Yellow inflation warning from the TIPS market

If there's really no inflation, someone should let the guys in the TIPS market know ... because they're hoisting a big, bright yellow flag.

Some history first ... Several weeks back, I noted that the TIPS market was getting frisky. Specifically, I pointed out that the 10-year TIPS spread was widening out. That's the difference in yield between 10-year nominal Treasuries and 10-year Treasury Inflation Protected Securities. The wider the spread, the more worried bond traders are getting about inflation. Read the original post for more details.

Fast-forward to today ... and you can see in this chart that the TIPS spread is now running at 242 basis points. That's the worst level since mid-September. What's driving this activity?

Maybe it's the fact crude oil prices surged 5.3% today, while heating oil posted its biggest gain in 16 months.

Maybe it's because the economy appears to have rebounded from its recent rough patch.

Maybe it's because it's obvious to everyone but the Fed that easy money is out of control (Case in point: Eurozone M3 skyrocketed 9.7% YOY in December, the biggest gain since 1990) ... and that the excess funds are inflating several asset classes.

Whatever the cause, the effect is that we have a real-time indicator of inflation worries breaking out to the upside. You have to wonder if the Federal Open Market Committee will acknowledge that in its post-meeting statement tomorrow.

S&P/Case-Shiller index shows home prices still falling

One of the newest indicators of home prices is the S&P/Case-Shiller home price index. The index uses data from sales of individual properties. It attempts to improve on some of the other price measures out there, including the median price figures reported by the National Association of Realtors.

Anyway, in November, prices fell from a month earlier in 17 of the 20 U.S. metropolitan areas tracked. The U.S. composite index showed a -0.41% drop. That's the fourth monthly decline in a row, following changes of -0.24% in October, -0.2% in September, and -0.18% in August. On a year-over-year basis, the index was still up 1.71%. However, the rate of appreciation has been slowing month-in and month-out and the gain is the smallest the group has on record (its index dates back to January 2001).

Monday, January 29, 2007

Empty homes everywhere

The Census Bureau just released Q4 data on homeownership and home vacancy rates. The nationwide homeownership rate ticked down to 68.9% from 69% in both Q3 2006 and Q4 2005. Not a big deal, frankly.

What IS a big deal, however, is the ongoing spike in the vacancy rate. A whopping 2.7% of all U.S. homes were vacant as of Q4. That's up from 2.5% in Q3 2006 and 2% in Q4 2005. Moreover, it's the highest vacancy rate in U.S. history (the data goes back to 1960).
The homeowner vacancy rate is the proportion of the homeowner inventory that is vacant for sale. The fact so many homes are sitting empty is a testament to the fact that we overbuilt like crazy during the boom.

Friday, January 26, 2007

And after all that ...

... bonds ended up down a few ticks. I guess you'd call that a reversal of the reversal. Ten-year yields closed the day about flat, while long bond futures were off 6/32.

Next week, things will get real interesting. We've got several major economic reports: The Q4 Employment Cost Index ... the January ISM index ... and most importantly, the January jobs report. Oh, and did I mention the Federal Open Market Committee meets on January 30 and 31?

These events are either going to "validate" the sell off we've seen in bonds, or cause one heck of a nasty reversal. So fasten your seatbelts.

reversal alert...

Those bond buyers are pouring it on now, helping reverse the early losses. I said these levels were a key technical battleground, and it looks like things are getting bloody. Is all the bad news "priced in" to the bonds here for the very near term? Is this just short-covering? Are traders squaring their books ahead of next week's Fed meeting? Can I possibly ask more questions in a shorter period of time?

The skinny on new home sales ...

New home sales just hit the tape. They show …

* A gain in the monthly sales rate of 4.8% between November and December. That’s well above the forecast of a 0.5% increase. However, sales are still down more than 11% year-over-year.

* The Seasonally Adjusted Annual Sales rate came in at 1.12 million units vs. an upwardly revised 1.069 million units in November

* There were 537,000 homes on the market in December, down 6.3% from the peak of 573,000 in July. That’s good for a 5.9 months’ supply at the current sales rate. However, inventories are much, much higher than at any time in U.S. history (up 5.5% from a year ago and up 74% in the past five years)

* Prices remain relatively weak – down 1.5% year-over-year to $235,000 in December. That’s the third time in the past four months prices have declined YOY.


I expected the official, new home sales to look decent, given the roughly three-quarters of a percentage point decline in 30-year fixed mortgage rates from July through early December. The aggressive use of incentives by new home builders helped as well. Builders have been showering buyers with everything from free pools to mortgage buydowns to price cuts of $100,000 or more.

But there are a couple of major problems with the new home sales figures:

First, they do NOT take into account the impact of cancellations. When a home buyer signs a contract to buy a new house, it’s recorded as a sale. The official tally of homes for sale also drops by one. But if that buyer walks away from the contract, his property is not added back to the inventory count. And in recent months, home builders have been reporting extraordinarily high cancellation rates. One condo and single-family home builder that’s active here in Florida – WCI – actually reported net NEGATIVE orders … gross orders of 261 were wiped out and then some by cancellations of 270.

That’s an extreme example. But based on the cancellation rates public home builders have been reporting (30%, 40% or more), REAL sales are clearly lower and REAL inventories are clearly higher than the government’s numbers show.

Second, there’s the weather. December was an extraordinarily warm month and that probably distorted the sales gains. Just look at the regional breakdown of sales – sales were down 4.4% MOM in the West and virtually unchanged (up 0.3%) in the South, the regions unaffected by the warm weather. On the other hand, sales were reported UP 26.6% in the Midwest and UP 27.3% in the Northeast.

The new home market IS doing better than it was this summer. But this will be a long road to recovery. 2007 should be another relatively weak year for sales and pricing. After all, homes are still relatively unaffordable, especially with the recent rise in mortgage rates. And real, new home supply remains higher than at almost any time in the past 40-plus years. Buyers – you’re in the driver’s seat!

The NY Times tackles the subprime fiasco

Perusing the morning headlines, I couldn't help but notice the New York Times' coverage of the fiasco in the subprime lending sector. A few choice bits ...

--"The once booming market for home loans to people with weak credit — known as subprime mortgages and made largely to minorities, the poor and first-time buyers stretching to afford a home — is coming under greater pressure. The evidence can be seen in rising default rates, increasingly strained finances at mortgage lenders and growing doubts among investors."

-- "Wall Street firms were attracted to such lenders because they helped feed a pipeline of securities backed by the mortgages, a market bigger than the one for United States Treasury bonds and notes. Merrill Lynch, for example, securitized $67.8 billion in residential mortgages in the first nine months of 2006, up 58.4 percent from the period a year earlier.

But an increasing number of borrowers are defaulting on subprime loans earlier now than they did a year ago, often within six months of having taken the loan out, shaking Wall Street’s confidence in its subprime partners."

-- "Across the industry, 2.6 percent of the subprime loans securitized in the second quarter of 2006 had been foreclosed on or repossessed within six months. That is up from 1 percent for loans securitized in the second quarter of 2005, according to Moody’s Investors Service, the ratings agency."

How severe will the subprime shakeout get? That's the key question. I think it'll be worse than people expect simply because of the amount of fraud, misrepresentation of income, shoddy appraisals, and other junk lending practices that went on during the boom. Credit "bulls" say you can't have real mortgage lending trouble with unemployment low, the economy performing well, etc. I would ask them, "If that's true, why are delinquencies and foreclosures skyrocketing? By your logic, this 'can't' happen."

We're already seeing foreclosures in some states, like Massachusetts and California, surge to multi-year highs. I think we'll see more of that over time. And it's something we should watch closely. Subprime is no longer some small corner of the mortgage market -- it accounts for about a fifth of overall loan volume, up from a tenth a few years back. Even Congress is getting involved -- Senate Banking Committee Chairman Christopher Dodd has announced plans to investigate recent lending practices.

December orders lead to more bond pain, no gains

The December durable goods orders just hit the tape. They showed:

* A 3.1% headline gain, up from a revised 2.2% in November

* A gain of 2.3% after you strip out transportation orders. That's more than four times the 0.5% forecast.

* Non-defense capital goods ex-aircraft orders, a key measure of core business spending, jumped 2.4%, the biggest gain since September.

Bonds came into the number weak, with 10-year T-note prices taking out the last level of support I mentioned yesterday. They're getting even weaker as I write. Long bonds are down 11/32 right now, while 10-year yields are up a couple basis points to 4.9%.

There is simply no justification for a Federal Reserve Board rate cut in this environment ... and there may even be reason for a Fed HIKE. Just look at market expectations for inflation -- the 10-year TIPS spread has jumped to around 240 basis points ... a multi-month high. If you want to read more about this indicator, check out this post from mid-December.

Thursday, January 25, 2007

Closing bond update

Well, we did it ... closed above technical resistance on the 10-year Note yield, that is. At 4.87%, yields are at their highest level since mid-August. Of course, if you wanted to be really generous, you could argue that the PRICE of 10-year note futures held the 106-16 level. But that's about the only thing good you can say about the price action today.

Another BLAH Treasury auction

The bond market was already taking it on the chin earlier today, and the results of the 5-year Treasury Note auction that just came out aren't helping things. The details:

* Indirect bidders only bought 21.8% of the notes sold. That's the lowest since October. If you exclude the October reading of 21.7% (it's just one-tenth of a percentage point lower after all), you have to go back to June to find a lower reading (18.3%)

* The bid-to-cover ratio was just 2.21, also the worst since October -- or June, if you exclude October's 2.12 reading.

* The only good thing? The notes yielded 4.855% in the sale, slightly below pre-auction forecasts of 4.861%.

We are challenging the key yield resistance I highlighted in my earlier post as I write.

The REAL story on housing inventories

You've got to be kidding me! Some "experts" are pointing to the decline in existing home, for-sale inventory in December as proof the supply problem has been solved. These guys don't know the real estate market.

I went back and pulled the November-to-December change in for-sale, existing home inventory, for several years. Here are the percentage changes:

2006: -7.93%
2005: -2.67%
2004: -12.41%
2003: -9.56%
2002: -9.52%
2001: -13.2%
2000: -1.01%
1999: -10.17%

Before 1999, you have to use single-family only stats, rather than the combined single family/condo/coop figures. But the pattern is the same:

1998: -13.2%
1997: -11.05%
1996: -13.5%
1995: -9.2%
1994: -8.61%
1993: -12.14%
1992: -11.56%

In other words, supply ALWAYS drops this time of year. Happy talk about declining inventories should be ignored, with extreme prejudice. IF ... IF ... inventory does not pick up in the February and March reports, then that'll be worth noting. But I expect it will

10-year T-Note yields: This one's for all the marbles!

This is a chart of 10-year Treasury Note yields. We are right at significant technical resistance in the 4.80%-4.85% range. If we break through to the upside, Treasuries could be in real trouble. In other words, watch dem bonds!

My take on existing home sales

The existing home sales figures (full stats available here) for December were just released. They showed ...

* The Seasonally Adjusted Annual Rate of sales slumped 0.8% on the month to 6.22 million from 6.27 million in November. Single family sales dropped 1.3% while condo/coop sales rose 2.1%. From a year ago, home sales are down 7.9%.

* Inventories on a "months supply at current sales pace" basis were 6.8 vs. 7.3 a month earlier. The raw number of homes for sale also declined – 7.9% to 3.51 million units from 3.81 million in November. For-sale inventory was up 23.3% from the previous December, however.

* Median prices were up $5,000 from November, or 2.3%. They were flat YOY.

The housing market was like a trauma patient in the summer – suffering from multiple wounds and at death’s doorstep. Since then, a mild decline in interest rates and aggressive price-cutting/incentives from both new and existing home sellers have helped stabilize the patient. But he’s not getting off the gurney and walking out the door, either – not for some time.

Just look at the sales rate – at 6.22 million, it’s barely off the cycle low of 6.21 million in September. Look at median prices – they’ve gone nowhere in a year and a half. Or look at inventory. Yes, it dropped to 3.51 million units in December. But that is nothing unusual – it’s the customary, seasonal pattern we see year in and year out. Sellers who don’t sell during the main spring and summer seasons often pull their listings during the holidays, then re-list in the spring. Just to pick a few recent years, inventories dropped 2.7% between November and December in 2005 … 12.4% in 2004 … 9.6% in 2003 ... and 9.5% in 2002.

Lastly, there’s the interest rate picture. The yield on the 10-year Treasury Note has jumped about 40 basis points from its low in December. That is putting upward pressure on mortgage rates and helping stymie a rally in mortgage purchase activity.

Bottom line: The housing market is doing better than it was a few months ago, but it’s certainly not booming. I believe we’re in for a relatively weak spring selling season and a weak year. Expect subdued sales, flat to down home prices, and near-record inventories to keep buyers in the driver’s seat.

The hits just keep on coming in housing

It's one warning after another from the major public home builders. In the past couple of days:

* Beazer Homes reported earnings of 41 cents per share, ex-items, 10 cents below the Reuters Estimates consensus. Sales dropped 27% year-over-year. Its forecast for fiscal 2007, per-share earnings: $1.25 to $1.50 vs. a consensus forecast of $2.32. Orders (net of cancellations) plunged 54% to 1,779 in the first quarter from 3,872 a year earlier. As I've been pointing out, Florida continues to be one of the hardest-hit regions in this downturn. Florida orders collapsed 86% YOY.

* WCI Communities warned that Q4 earnings would fall below prior forecasts on weak demand, defaults of previously contracted condo units, and write-offs. Gross orders of 261 were wiped out by 270 cancellations, resulting in -9 net orders.

* Ryland Group reported a 46% drop in fourth-quarter profit and $54 million in costs to write down property and write off land options. The $1.98 per share in earnings missed forecasts for $2.07. Ryland announced a full-year target of $3.75 to $4.25 in per-share profit, missing the Bloomberg estimate of $4.72. New orders dropped 44%.

Other builders, including Centex and D.R. Horton reported more of the same -- weak orders ... lots of cancellations ... higher incentives ... falling profit. But the home building stocks have been strong lately on the assumption the worst is over. This spring selling season is therefore key -- will the optimists be rewarded with a strong season, or are pessimists like myself on the right track? We'll see...

Wednesday, January 24, 2007

Two-year note auction a mixed bag

Uncle Sam just moved $20 billion in 2-year Treasury Notes. How'd the auction go? Well ...

* The notes were sold at a yield of 4.93% vs. pre-auction expectations for 4.936%. I'd call that Neutral for bond prices.

* The bid-to-cover ratio measures the amount of bids submitted against the amount of notes sold. It was 3.03. That's well above average and the highest since November 2000. Bullish.

* Indirect bidders bought 26.6% of the sale. That's down from 34.7% last month and the lowest since August. Bearish.

So, I'd call this a wash. Bonds are ticking down in price, up in yield, ever-so-slightly in the wake of the results. The real fireworks start tomorrow, with existing home sales for December due out at 10 a.m. New home sales will follow on Friday, also at 10 a.m.

The housing inventory problem, writ small

I've posted a lot about my "big picture" take on housing, especially the inventory problem. Put simply, we have an Everest-sized mountain of homes for sale, both new and existing. That's going to take a long time to work through, even if demand remains stable.

I want to bring that down to the micro level today. I've been tracking how many homes are for sale in my zip code since June 2005. I use, asking every few days how many homes are for sale with at least 2 bedrooms and 2 bathrooms in a price range of $100,000 to $500,000. That's a good chunk of the low-to-mid-end of the market here in Northern Palm Beach County, FL.

Anyway, when I first started this exercise, I got 150 "hits." That climbed steadily before peaking at 634 on 11/13/2006 and dropping in December and early January. We've seen national inventory figures come down a bit as well, and I expect this week's existing home sales report for December to show the same thing -- an inventory decline. Many will no doubt cite these figures as "proof" that the housing inventory problem has been solved.

But I've said in several forums that something else entirely is at work: Seasonal influences. Many sellers who fail to sell during the peak spring and summer seasons pull their listings off the market late in the year. After all, they know buyers are few and far between during the holidays. Then these very same sellers re-list ahead of the spring season, starting in late January or February. You see the same pattern show up again and again, in both strong and weak years for real estate.

Lo and behold, I got around to checking inventory today and my search returned 643 hits. In other words, for-sale inventory just set a marginal new high. It's just one small corner of the national real estate market, of course. But I'd be willing to bet the same trend is showing up in other parts of the country. Look for the NATIONAL inventory stats to show an increase, beginning in either January or February. In fact, I wouldn't be surprised to see total existing home inventory rise to a new record by late spring.

Bounce in mortgage applications over?

Interesting data out of the Mortgage Bankers Association this morning: Applications for mortgages to buy homes dropped 8.4% after falling 7% the week before, as shown in this chart from Bloomberg. The purchase application index has been extremely volatile lately, with wild swings both up and down. That stems from seasonal adjustment problems related to the Christmas and New Year's holidays.

But after smoothing out that volatility, I think one thing is clear: The recent rise in interest rates, which bottomed out in early December, appears to be causing the late fall/early winter rally in housing market activity to stall out. Home sellers could be in for a shock if rates continue to climb into the start of the spring real estate season.

Tuesday, January 23, 2007

Oil surges ... bonds fall

Some breaking news: Energy Secretary Samuel Bodman is out on the tape, saying the U.S. will double the side of the country's Strategic Petroleum Reserve. Granted, this will occur over the next two decades, not the next two months or two years. But government buying is still expected to reduce supply by about 100,000 barrels per day, starting this spring. Crude oil has shot up more than $2 on the news.

Meanwhile, bonds are trading near the lows of the day. Whether or not it's related to the oil news (because higher oil prices could translate into renewed inflation pressure), you can never know for sure. But given the significance of the 4.80%-4.85% yield area in the 10s, I'm keeping a close eye on the market action. If we take that out, it wouldn't take much to get us to 5%.

TIPS auction pretty good, but ...

Unlike the most recent Treasury Inflation Protected Securities auction, today's sale of 20-year TIPS went over fairly well. The bonds were sold at a yield of 2.42% vs. pre-auction expectations of 2.435%. The bid-to-cover ratio was 2.05% -- down from the last auction's reading of 2.24% but still healthy from a historical standpoint. And indirect bidders (a proxy for foreign central banks) bought 58.9% of the bonds sold, down from 69% last time but not too bad vs. the longer-term average.

Yet bonds are extending earlier losses in the wake of the auction. The long bond was recently down a half-point, in fact. Ten-year yields are challenging strong resistance at 4.8%.

This begs the question: Is a strong TIPS auction really "good" news for bonds? I thought it would be, but apparently not. Maybe traders are saying that strong demand for TIPS shows that bond buyers are afraid of inflation and therefore, willing to pay up for inflation-protected debt.

Junk bond spreads collapse

Want to find examples of excessive risk taking and ample liquidity? No problem. It's like shooting fish in a barrel. The latest from a Bloomberg story -- the spread between yields on U.S. Treasuries and rates on high-yield corporate debt (translation: "junk bonds") has collapsed to its lowest level in years:

"The risk premium on high-yield, high- risk corporate bonds fell to the lowest in a decade as a drop in oil prices and surging consumer confidence boosts optimism the U.S. economy will grow fast enough to keep a lid on defaults.

"Investors demand an extra 2.69 percentage points in yield on average to own junk bonds instead of U.S. Treasuries, the smallest gap since 1997, according to data compiled by Merrill Lynch & Co. The spread has narrowed by a percentage point from a year ago and is below its five-year average of 5.17 percentage points, Merrill data show."

You could argue that some of the move is driven by fundamentals -- strong global growth, low default rates, and all that. But the MAIN force is ... you guessed it ... "money, money everywhere." Here's how David Darst, the chief investment strategist at Morgan Stanley Global Wealth Management described market conditions:

"There's capital out there searching for yield, and that's what has helped keep things low."

In other words, we have too much money chasing too few assets. Isn't that like "too much money, chasing too few goods?" -- the very definition of inflation? Yep. But oh yeah, asset inflation doesn't count!

More overseas rate hikes in store?

The British pound is flying this morning, and attempting to break out to a new high against the U.S. dollar. The catalyst: A Confederation of British Industry survey showed U.K. factories jacked up the prices they charge at the fastest pace in 12 years. The news comes just days after the Bank of England surprised the markets with a quarter-point rate increase ... and it's leading to speculation even more BOE hikes are in store.
If you're a U.S. resident, and you're traveling to London, your dollars aren't going to go too far. Each pound now buys almost TWO dollars -- or in other words, a 10-pound meal will cost you $20, up from around $18 a year ago.
One other thing to consider: In today's global marketplace, hot inflation news -- even overseas -- can pressure domestic bond prices. So it's no surprise U.S. long bonds were recently down about 7/32 and 10-year rates were up about 2 basis points.

Monday, January 22, 2007

Everybody's warning about risk ... but nobody's selling

I'm seeing, reading, and hearing a lot of warnings about complacency and risk-taking in the global financial markets. Just in the past few days, the Financial Times has chimed in with a story titled "The unease bubbling in today's brave new financial world." It recounts how hedge funds and global financial institutions are making risky bets in the leveraged debt markets ... and makes the claim that market players are privately worried sick about how this will all turn out.

Policymakers in Davos are also making noises about all the risk that the markets are underappreciating, according to Bloomberg. One quote from Willem Buiter, a professor at the London School of Economics who used to sit on the Bank of England's monetary policy committee ...

"Current risks are ludicrously underpriced ... At some point, someone is going to get an extremely nasty surprise."

Of course, the key words are "at some point." No one is willing to make the proverbial first move right now and aggressively unload his high-risk positions. Once someone does, things will get ugly fast. But it's anyone's guess as to what sparks the exodus, and when it starts.

OPEC selling Treasuries

I came across an interesting story this morning that I think is worth sharing -- Bloomberg is reporting that OPEC countries are dumping their holdings of Treasury securities. Countries like Saudi Arabia and Indonesia sold more than 9% -- or just over $10 billion -- worth of Treasuries in the three months through November 2006. The last time we saw three consecutive months of selling was mid-2003. For background, OPEC countries boosted their U.S. government bond holdings by 115% between 2002 and 2006.

My take: The money, money everywhere phenomenon I've described here before has been an important force holding long-term Treasury yields down. We're buying tons of goods and commodities supplied by overseas countries, including oil. The cash we're sending overseas for those purchases has been recycled back into our debt -- not just Treasuries, but mortgage bonds, "agency" bonds sold by Fannie Mae and Freddie Mac, corporate bonds, etc.

Now, oil prices are falling. That is helping reduce outflows of U.S. money to OPEC nations. So there is less money to be recycled back into our debt markets. Put another way, falling oil prices may actually help push UP bond yields -- an anomaly for sure, since conventional wisdom holds that declining oil prices are disinflationary, and therefore a positive for Treasuries.

Friday, January 19, 2007

"good" asset inflation vs. "bad"

I really enjoyed reading this New York Times story about how so much money is going into commodity index funds that it's driving up the price of key foodstuffs -- hogs, grains, wheat, corn, you name it. Here's an excerpt:

"A recent study by the Commodity Futures Trading Commission, which oversees the nation’s futures markets, has found that Wall Street commodities index funds — investments in futures that track the underlying commodities of a particular index — have a much heavier concentration in agriculture futures markets than many had expected.

"The commission found the Wall Street funds control a fifth to a half of the futures contracts for commodities like corn, wheat and live cattle on Chicago, Kansas City and New York exchanges. On the Chicago exchanges, for example, the funds make up 47 percent of long-term contracts for live hog futures, 40 percent in wheat, 36 percent in live cattle and 21 percent in corn."

To which, I say with a bad pun fully intended: "You reap what you sow!" Bear with me while I explain ...

The Federal Reserve slashed interest rates and let money and credit growth run amok after the Nasdaq crash. Its strategy was to head off a serious recession. It worked. But then the Fed failed to "mop up" all the excess liquidity it created. So ever since then, we've seen a series of rolling asset/price bubbles as excess money chases return.

Residential housing is one clear example. So much investment money plowed into residential real estate that it drove house prices far out of reach of traditional buyers using traditional financing. Ironically, those price gains were deemed "good" asset inflation -- or at least, asset inflation the Fed would be willing to ignore. It had an easy excuse: Actual home price increases and decreases don't show up in the Consumer Price Index. The CPI measure of "housing" inflation is based on imputed rents, NOT the prices people pay for homes.

That bubble has clearly burst. But instead of draining away, liquidity has continued to surge and create asset price bubbles elsewhere. Commercial real estate prices are surging and property yields are plunging. Junk bond prices are jumping and yield spreads are collapsing. Heck, even obscure markets, like the mezzanine financing world, are being distorted by the excess of liquidity chasing returns (You can read more about that at this piece I just penned).

Once again, that's apparently considered "good" asset inflation. You certainly don't hear the Fed complaining about it the way it does about oil prices, wages, etc. Unfortunately, as this Times story shows, you can't keep excess liquidity down forever. Eventually, it spills over and creates "bad" inflation. That's what happened with crude oil and gasoline (clearly, some of the price gains stemmed from investment money buying up futures) ... and now, that's what is happening in another commodity market sector -- foodstuffs.

If we're ever going to stop these rolling asset bubbles, we're going to have to drain some excess liquidity from the system. It's as simple as that. The question is, will the Fed (and other global central banks, for that matter) do so?

The longer-term supply/demand picture in housing

I had to prepare some statistics recently on the longer-term supply-demand situation in housing. One thing that really jumped out at me:

Between January 2001, when the Fed started cutting interest rates and got this whole bubble going, and July 2006 (the worst month of the bust so far), the supply of existing homes for sale shot up 117%. The numbers are 1.777 million units in 1/01 and 3.861 million units in 7/06.

During that same time, the Seasonally Adjusted Annual Rate of sales climbed from 5.1 million units to 6.33 million. That's a 24% increase. Even if you measure from 1/01 to the peak demand month (6/05), it's still an increase of just 43% in the sales rate.

In other words, the rate at which supply has increased has far exceeded the rate at which demand has increased. Since July, we have only whittled that supply mountain down by 1.1% (to 3.82 million units in November).

On the new home side of things, from 1/01 through 7/06, the seasonally adjusted annual rate of sales climbed just 4.6% (936,000 in 1/01 vs. 979,000 7/06). The gain as measured through the peak sales month (7/05 -- 1.367 million SAAR) was 46%.

From 1/01 to 7/06 (the high point to date), for sale supply shot up 94% (296,000 in 1/01 vs. 573,000 in 7/06). It has come down just 4.9% since then.

As I see it, the downturn will likely be a lengthy, drawn out affair, with relatively weak building activity, sales, and pricing lasting until at least 2008. There is simply too much inventory out there, and a lot of it is held by "weak" hands -- homeowners/speculators who bought as second homes or investment purchases. They were 40% of the purchase market in 2005, by the National Association of Realtors' own figures, the highest non-owner-occupied market share percentage in history. Unlike primary homeowners, these owners are more likely to try to sell when the going gets tough, as it has.

Consumer confidence pop

The University of Michigan's consumer sentiment index had quite a pop in January -- to 98 from 91.7 in December. Both the outlook and current conditions indices rose. The inflation expectations reading ticked up to 3% from 2.9% a month earlier. This is the highest the Michigan index has been since January 2004.

Confidence indicators tend to track stock prices, as near as I can tell, and they don't do a heck of a good job at forecasting the overall economy or spending levels. But taken together with all the other reports this week, this one kicks more sand in the face of those expecting some kind of imminent Fed rate cut.

Bonds are taking a bit of a hit on the number, but as I pointed out yesterday, prices are coming into an area of key technical support. Was this good economic news already "priced in?" We'll see how Treasuries close the day.

Thursday, January 18, 2007

The latest "Technical Take" on bonds.

From time to time, I've thrown in a post on the technical backdrop in bonds -- what the charts are showing. I want to do so again today.
This chart shows the price action in long bond futures. You'll see that I've added some lines -- they represent Fibonacci retracement levels. If you know what these are, more power to you! If you don't, suffice it to say they are key technical levels ... places where buyers who use technical analysis may choose to "make a stand" and step up.
In the past month and a half, we've retraced, or given back, about half the rally we got off the June low in long bonds. This 50% retracement level could act as short-term technical support. We're also coming into a price level that held on several tests back in September and October.
None of this changes the big picture -- that the latest economic and inflation data clearly eliminate the chance of an imminent Fed rate cut. But I think it's worth looking at the technicals AND the fundamentals in any given market.

More thoughts on housing starts and permits

Let's dig into the housing starts and permits report in a little more detail ...

First, the numbers:

* Housing starts rose by 4.5% between November and December. The December seasonally adjusted annual rate of starts, at 1.642 million units, was well above the 1.565 million expected by economists polled by Bloomberg.

* Building permit issuance (a leading indicator of future construction activity) also climbed – 5.5%. The 1.596 million reading for December topped expectations for a 1.505 million reading.

* Revisions to last month’s numbers were mild – starts were revised down slightly (16,000 units), while permits were revised up slightly (7,000 units)

Then, my analysis:

- Interest rates declined from late summer through December. Coupled with extremely generous incentives, this helped prop up home sales and likely encouraged builders to put more shovels in the ground late in the year.

- The weather helped, too – December 2006 was the warmest such month since 1957. Just look at the regional breakdown of starts ... they surged the most in the Northeast (+26%), where temperatures have been far above normal. Starts rose much less in the West (+12%) and the Midwest (+1.8%), and they actually dropped in the South (-2%).

- But there’s something else worth noting in the numbers – single-family home starts and permit issuance remain weak. Starts actually dropped by 52,000 units in the single-family market, a decline of 4.1%. Permits increased a tiny 1.4%. The strength in this report all stemmed from multifamily construction – townhouses, condos, apartment buildings and the like. Starts there vaulted ahead by 42%, while permits surged 19%.

- Why is multifamily leading the way? I see a couple reasons. First, the surge in nationwide home prices has made all housing less affordable. But single-family homes, which cost more on average than condos and townhouses, are even more so. That is likely shifting more buyers, especially first-timers, to purchase townhouses and condos if they’re going to buy anything. Builders are responding by building more of those units.

Construction of property for rent (apartment complexes, for instance) … which has been depressed for a long time … is also likely picking up as builders respond to the strong growth in rental rates over the past couple years. Quarterly construction of multifamily units for rent hit a low of 42,000 in Q1 2006 before rising to 46,000 in Q2 and 48,000 in Q3

Please note that the links in this post are to PDF documents.

Data flash: Hot CPI, Hot starts, Hot employment

Big data morning, and most of it is coming in "hot." Here's the quick and dirty recap ...

* The overall Consumer Price Index gained 0.5% against expectations for a 0.4% increase.

* The core CPI rose 0.2%, in line with expectations but also the biggest monthly gain since September. Price gains were widespread -- transportation, apparel, education/communication and other goods and services. Year-over-year core CPI is still far above the Fed's preferred range at 2.6%, though that is down from the peak of 2.9% in September

* Jobless claims dropped by 8,000 to 290,000 in the week of January 13 -- that's the lowest level in 11 months.

* Housing starts rose by 4.5% in December from November. Building permits climbed 5.5% on the month. Interestingly enough, single family home construction dropped 4.1% ... but construction of multifamily homes (townhomes, apartment buildings, etc.) vaulted 42%. The fall decline in interest rates helped stabilize sales at a low level, and that likely prompted builders to respond by picking up the pace of starts. Then there's the weather -- we haven't had a December as warm as last month since 1957.

BOJ takes a pass

Looks like the Bank of Japan couldn't stand up to all the political pressure after all. It stood pat on interest rates rather than raise them 25 basis points to 0.5%. The Japanese yen is plunging on the news to fresh four-year lows against the dollar. If there's any consolation for those looking for a hike, traders are now expecting an increase to come at the BOJ's February 21 meeting. One reason: The decision to stand pat was not unanimous. Of nine voters, three wanted a hike at this meeting.

Wednesday, January 17, 2007

Fed's Mishkin weighs in on house, asset prices

Lost amid all the other hubbub, Federal Reserve Governor Frederic Mishkin weighed in on the Fed and its view on how to respond to bubbles in asset and home prices.

First, he notes the extraordinary growth in home prices in recent years -- 8 3/4% annually over the past five years. He points out that we haven't just had huge increases in the U.S., but also all over the world, from Australia to Spain to the U.K. to Sweden (Hey wait a minute ... I thought the Fed believed there were just a few areas or localized "froth")

Second, he points out what I've been saying for a long time, notably ...

"Although increases in house price have recently moderated in some countries, they still are very high relative to rents. Furthermore, with the exception of Germany and Japan, the ratios of house prices to disposable income in many countries are greater than what would have been predicted on the basis of their trends"

Third, he went on to ask important questions that should have been asked a couple years ago ...

"Because central banks are in the business of managing total demand in the economy so as to produce desirable outcomes on inflation and employment, monetary policy should accordingly respond to home prices to the extent that these prices are influencing aggregate demand and resource utilization. The issue of how central banks should respond to house price movements is therefore not whether they should respond at all. Rather, the issue is whether they should respond over and above the response called for in terms of objectives to stabilize inflation and employment over the usual policy time horizon. The issue here is the same one that applies to how central banks should respond to potential bubbles in asset prices in general: Because subsequent collapses of these asset prices might be highly damaging to the economy, as they were in Japan in the 1990s, should the monetary authority try to prick, or at least slow the growth of, developing bubbles?"

As I read these first few paragraphs, I couldn't help but wonder: Are we making progress? Is an actual Fed official finally admitting on the record that 1) its own actions are the reason that house prices exploded beyond any measure of fundamental value and 2) that the Fed will do its best to avoid fueling asset bubbles in the future?

Yeah, right! In response to the questions he posed about whether the Fed should do something about ridiculous bouts of asset inflation, Mishkin said quite simply: "I view the answer as no."

He pointed out that while central bankers in England, Sweden, and Europe have either specifically mentioned home prices as a reason for hiking rates, or have indicated a willingness to lean against the asset bubble wind, he doesn't think that makes sense. He claims that:

1) The Fed can't identify a bubble in progress any better than the private market.

2) The Fed CAN effectively restore economic health in the wake of a bust by taking appropriate monetary actions, so there's no need to pre-emptively target an asset bubble. That's especially true in the case of a housing bust, according to Mishkin, because the consequences shouldn't be very painful for financial institutions. He says that's because house prices usually don't fall that much after a boom, because recoveries from foreclosures limit bank losses, and because default rates on residential mortgages typically are low.

3) Higher interest rates may not stem the inflating of an asset bubble ... instead, they could cause it to burst prematurely and more severely than it would if the Fed did nothing.

4) Lastly, he claims that if the Fed started going after asset prices, it would weaken public support for the Fed. That might "cause the public to worry that it is too powerful and has undue influence over all aspects of the economy."

But after claiming that the Fed cannot determine when there are asset bubbles ... and claiming that the Fed should not pre-emptively try to keep those bubbles from getting too big ... Mishkin says the Fed should absolutely step in when there's a bust. Specifically, he said:

"Instead of trying to pre-emptively deal with the bubble--which I have argued is almost impossible to do--a central bank can minimize financial instability by being ready to react quickly to an asset price collapse if it occurs. One way a central bank can prepare itself to react quickly is to explore different scenarios to assess how it should respond to an asset price collapse. This is something that we do at the Federal Reserve.

"Indeed, examinations of different scenarios can be thought of as stress tests similar to the ones that commercial financial institutions and banking supervisors conduct all the time. They see how financial institutions will be affected by particular scenarios and then propose plans to ensure that the banks can withstand the negative effects. By conducting similar exercises, in this case for monetary policy, a central bank can minimize the damage from a collapse of an asset price bubble without having to judge that a bubble is in progress or predict that it will burst in the near future."

As I see it, the problem with the Fed's "asset prices are not our problem" argument is the asymmetry of the whole thing. The Fed claims it can't identify an asset bubble as it builds ... and that it shouldn't be in the business of deciding whether the current level of asset prices is appropriate when those prices are rising.

But when an asset bubble bursts, and prices start falling, the Fed essentially believes it should swoop in and save the day. It should prevent financial institutions who took on too much risk ... and who helped speculators bid asset prices through the roof ... from failing. And it should work to stabilize asset prices -- in other words, it should substitute its judgment for the market's judgment that those asset values should decline even further.

You can call it the "Greenspan put" ... "Moral Hazard" ... or whatever you want. I just call it flawed monetary policy. It encourages speculators to go nuts and throw a gigantic party in asset market after asset market because A) They know the Fed won't intervene and take the booze away and B) Even if they get behind the wheel, drive drunk, crash into a tree, and go to jail, the Fed will be there to bail them out ... over and over again.

bonds slumping again ...

In the wake of the NAHB housing numbers, bonds are selling off. Long bond futures were recently down 8/32, after being up a few ticks before the PPI figures this morning. Ten-year Treasury yields were recently 4.77%. That's roughly even with the multi-month high seen a couple days ago.

Now, here's something to ponder: IF the recent improvement in mortgage activity and the NAHB figures stemmed from the late summer/early fall decline in interest rates ... then won't the rise in interest rates since December 4 hurt lending and sales? Put another way, is the housing market bounce sowing the seeds of its own unwinding by sidelining the Fed and/or prompting rates to rise?

Makes your head spin, doesn't it?

Housing Market Index rises

A bit of a surprise in the National Association of Home Builders' index this month. The January reading came in at 35, versus forecasts for a reading of 33 (which would have matched the December reading). The sub-index for buyer traffic was up 3 points, reversing the previous month's 3-point decline. The sub-index for present sales rose 3 points after being flat the previous month. The sub-index for future sales expectations was unchanged after gaining 4 points in December.

It's worth noting, however, that the index is well off its year-ago level of 57 and not far above its nadir -- 30 in September. It's also worth noting that interest rates have risen off their low, about 35 basis points on the 10-year Treasury Note. With the Fed likely sidelined by the latest economic and inflation news (meaning, no short-term rate cuts are imminent), I would expect mortgage and home purchase demand to ease back again soon.

Another bucket of bits this a.m...

Lots of things brewing this morning just like yesterday. Here are a few things I'm watching ...

* The December Producer Price Index rose 0.9% from November, versus expectations for a 0.5% gain. That's not a big deal for the market because everyone knows energy prices have tanked in January, and that should help lower the overall PPI.

* What IS potentially important is the gain in the "core" PPI -- finished goods prices, excluding food and energy, rose 0.2% in the month versus forecasts for a 0.1% gain. Core intermediate goods did slip 0.1% on the month, but core crude goods rose 1%. In other words, inflation pressure further up the goods "pipeline" is still there.

Bonds came into the number with small price gains. They gave those up after the 8:30 a.m. release, and are now trading roughly flat.

* Industrial production and capacity utilization figures for December also came in hot. Production popped 0.4% vs. forecasts for a 0.1% gain. Capacity utilization was at 81.8% vs. the 81.7% forecast (using Bloomberg estimates). Manufacturing activity had a big jump of 0.7%, the most since June.

* Purchase mortgage applications also gave back some of last week's gains -- dropping 7% on the week. Refinance activity remains elevated however, likely boosted in part by borrowers swapping from floating-rate loans to fixed-rate loans.

* One last little nugget: Several weeks ago, one of the brightest guys in the commercial real estate business, Sam Zell of Equity Office Properties, agreed to sell his company. The buyer was a private equity firm called Blackstone Group and the price was $36 billion. Rumors of competing bids have been rampant in the market as well.

But when you've got one of the smartest sellers selling, you have to wonder if he knows something the buyers are missing. My belief is that buyers are paying far too much for commercial property. Why? Because cash is pouring in from eager portfolio managers looking to diversify into a sector that has performed well for the past few years. In other words, it's too much money chasing performance. Fundamental measures of valuation (like capitalization rates, which measure the "yields" that properties throw off from rent at given purchase prices) are extremely stretched.

So I found it interesting yesterday when another company that's been in the real estate business for decades down here in Florida decided it was time to unload. St. Joe said it would sell its 17 office buildings, which consist of 2.3 million square feet of rentable space spread around seven Southeast markets. The company's Chief Executive Officer, Peter Rummell, had this to say:

"With capitalization rates in office markets across the nation at or near record lows, we believe this is the right time to be a seller ... That fact combined with the continued abundant flow of capital into real estate from a wide range of investors presents a unique time to potentially sell the portfolio."

I couldn't have said it better myself.

Tuesday, January 16, 2007

Straight talk on local home sales here in sunny South Florida

I live in South Florida, and I love it. But we're clearly at the epicenter of the housing bust. Our sales are down big-time ... our home prices are falling ... and our inventories remain extremely high.

Case in point: One of the real estate firms in my area posts Greater West Palm Beach, FL sales, inventory, and pricing data a few days before the official Florida Association of Realtors figures come out. The firm's web site was just updated with December figures. It looks like volume dropped 42% year-over-year, while median prices slumped 8%.

What about supply? Well, there were 21,699 properties on the market in December 2006 vs. 12,684 a year earlier. That's a 71% gain. Since December sales came in at 612 units, we're sitting on more than 35 months worth of inventory at the current sales pace. Yikes!

Some quick hits on a busy morning

When it rains, it pours! On the heels of a three-day weekend, lots of news is hitting the tape this a.m. in the markets I follow. So in no particular order, here's my recap of these quick hits ...

* In more concrete evidence of a housing market bottom (sarcasm on here), the fifth-largest builder in the U.S., KB Home, announced $255 million in charges to cut the value of its home inventory. It also wrote off $88 million in land options.

* Not to be outdone, the third-largest builder, Centex, said it would take a whopping $510 million in charges in the fiscal third quarter. The builder is walking away from options to buy 37,000 homesites, costing it $150 million. It's also writing down land to the tune of $300 million and taking a $60 million tax-related provision.

* Meanwhile, mortgage lender IndyMac just dropped its own earnings bomb. The company said it will earn 97 cents per share in the fourth quarter, down from a previous forecast of $1.30 per share to $1.40 per share. Once chief culprit: "an increase in credit costs." More and more loans are going bad throughout the industry, requiring lenders to increase their loan loss provisions and take write-downs on the value of souring mortgages.

* Last but not least, Japanese overnight lending rates are climbing to the highest level in more than 8 years. It looks like the Bank of Japan will hike rates another quarter-point at its policy meeting this week. Only a few weeks ago, no action was expected. Coupled with the surprise Bank of England rate hike several days ago, this could put more upward pressure on global interest rates.

Like I said, it's busy, busy, busy out there!

Friday, January 12, 2007

Bonds getting slapped around again

Looks like another down day in the bond market, with 10-year note futures off more than 6 ticks and the long bond down 12/32. Yields are up about 3-4 basis points across the board. Two catalysts today:

- Retail sales gained 0.9% in December, the most in five months. Excluding autos, sales were up 1% vs. 0.7% a month earlier

- Import prices were hotter than expected, up 1.1% on the month vs. a Bloomberg forecast of 0.6%. Some of that stemmed from rising oil prices, and obviously, they've dropped since the survey period. But import prices excluding petroleum also gained 0.4%, after rising 0.9% the month before. And import prices excluding ALL fuels rose 0.2%, the most in three months.

Bottom line: With the federal funds rate at 5.25% ... that "always right around the corner" Fed ease being pushed out even further ... and economic data revealing anything BUT economic Armageddon, Treasuries are in trouble.

Thursday, January 11, 2007

TIPS auction bombs

The Treasury Department just tried to move $9 billion worth of 10-year Treasury Inflation Protected Securities, or TIPS. The auction ... how can we say this politely? ... bombed.

The TIPS were sold at a yield of 2.449%, versus pre-sale expectations of 2.423%, according to Bloomberg. The bid-to-cover ratio, which measures the value of bids vs. the value of notes sold, was just 1.67, well off the 2.09 seen in the last auction in October and the worst in ANY auction since October 2002. Indirect bidder participation (seen as a proxy for participation by foreign central banks) was 41.8%, down from 54.4% at the last auction.

Treasuries are falling on the news, with the long bond recently down 19/32 in price. Yields, which move in the opposite direction of prices, are popping. Ten-year note yields recently hit 4.74%, the highest level since late October.

Fed's Bies sounds off on high-risk mortgage lending

There's not much "new" news here. But Federal Reserve Governor Susan Bies is warning today about several high-risk lending practices regulators are seeing in the mortgage market at a National Credit Union Administration conference. Low-or-no-documentation mortgages ... interest-only financing ... no-money-down lending. We've seen it all explode in recent years, and that's leading to some serious credit concerns. Here's just one excerpt from the Bies speech:

"Supervisors have also observed that lenders are increasingly combining nontraditional mortgage loans with "risk layering" practices -- such as by not evaluating the borrower's ability to meet increasing monthly payments when amortization begins or when interest rates on adjustable rate mortgages rise due to indexing or at the end of a "teaser" rate period. We are also seeing more frequent use of limited or no documentation in evaluating an applicant's income and assets.

Although some lenders may have used elements of nontraditional mortgage products successfully in the past, the recent easing of traditional underwriting controls and the sale of some types of nontraditional products to subprime borrowers may generate losses on these products greater than has been observed in the past. Additionally, information from other sources seems to indicate that more borrowers are purchasing real estate with no equity down payment by using simultaneous second liens. The greater prevalence of risk-layering practices and sales of nontraditional mortgage products to non-prime borrowers have occurred in the past few years as competition for borrowers and declining profit margins has prompted lenders to loosen their credit standards to maintain loan volume in a slowing environment."

Holy cancellation rate...

One other thing I just noticed while scanning the headlines this morning: M/I Homes reported a stunning 61% decline in net new home orders in the fourth quarter. The culprit: a gigantic 63% cancellation rate. That compared to 27% in 2005, according to a statement. Here in Florida, net new contracts were actually NEGATIVE 50, vs. 409 a year earlier.

While 63% is the worst cancel rate I've seen reported so far, rates are high throughout the industry. That, in turn, makes somewhat of a mockery of the Census Bureau's official new home inventory and sales stats, which do NOT take into account the impact of cancellations of previously signed contracts.

An interest rate surprise across the pond ... and some thoughts on housing affordability

At least one major, global central bank apparently thinks surging liquidity, soaring credit availability, still-high inflation rates, and exploding asset prices are a threat. I say that because the Bank of England just hiked interest rates by a quarter-point, or 25 basis points. This came as a complete shock to the experts, who expected the BOE to keep rates flat.

The European Central Bank, meanwhile, kept rates flat as predicted. But in the post-meeting press conference, ECB president Jean-Claude Trichet pointed out that "the rate of monetary and credit expansion remains rapid" and that "monetary developments continue to require very careful monitoring."

British short-term rates are now dead even with U.S. short-term rates at 5.25%. It looks like the BOE was spooked by the fact that U.K. retail prices gained the most in almost three years in November ... the fact that November overall inflation was 2.7%, the fastest rate in at least a decade ... and the fact that home values are rising fast again after taking a breather in 2005.

Speaking of home prices, the Financial Times had a great story about the problems brought about by the surge. A study from the Royal Institution of Chartered Surveyors concluded the average U.K. couple needed more than $63,000 to cover the costs of buying a property (the deposit, stamp duty, etc.). That's a whopping 82% of annual take home pay. Ten years ago, buyers needed to spend just 25% of their pay.

Am I the only one who thinks this is ridiculous? It shows the danger of a myopic focus on pure CPI-type inflation, and a complete disregard for ASSET inflation. U.S. Fed officials repeatedly commented during the housing boom that surging U.S. home prices were essentially not their problem. The result: Home prices exploded and got completely out of reach for average buyers using traditional loans. People were forced to turn to riskier products, like option ARMs, 40-year and 50-year mortgages, and interest only loans. And surprise, surprise, all that risky financing is now blowing up in our faces, with defaults and delinquencies surging.

All in all, I think home prices will need to stagnate or fall for much longer than the market realizes to sort this mess out. I mean, even now, many American workers still can't really afford median-priced homes, according to a just-released study. It points out that you need an annual income of nearly $85,000 to really afford a median priced home (assuming "old," prudent buying standards, like putting 10% down and spending no more than 28% of your income on the monthly principal, interest, taxes and insurance payment). Actual U.S. median household income was $46,326 in 2005, according to the Census Bureau.

Wednesday, January 10, 2007

Thinking outside the bond box

There's been this little theory bouncing around in my head about bonds for a while now. It could be total bunk. But why not throw it out on the table? There's nothing to lose after all!

First, understand that the behavior of long-term Treasury note and bond yields during this Fed hiking cycle was extremely unusual. Long-term interest rates usually follow the federal funds rate higher until the tail end of the hiking cycle. That's when bond buyers start positioning themselves for the end of the hikes ... and the start of the next round of cuts ... by stepping up to the plate, buying bonds, and driving long-term yields lower. Later on, the Fed cuts short-term rates.

That didn't happen this time around. In fact, yields on 10-year notes and 30-year bonds haven't moved much at all despite the 17 short-term interest rate hikes, which drove the federal funds rate up by 425 basis points.

Second, let's stipulate the CAUSE of this was the recycling of excess funds/dollars on the global markets. The exploding trade and current account deficits, and the explosion in money and credit creation we've seen in recent years, flooded the world economy with liquidity. Lots of those dollars accumulated in China, Japan, and other Asian goods-producing/exporting nations. Ditto for the Petrodollar economies in the Middle East.

They were simply overwhelmed with cash, and needed to invest it somewhere. Lots of it has flooded into commodities ... commercial real estate ... stocks ... and other assets. But tons of it also ended up getting dumped into bonds, despite rising inflation, rising short-term rates, and the falling dollar (all of which traditionally lower the value of bonds, especially for foreign bond holders)

The money has gone into different sub-sectors of the bond market at different times. Corporates seem to be the flavor of the moment, according to this recent Bloomberg story. But the impact seems clear to me -- surging liquidity has held long-term rates down by providing a steady source of funds for investing in yield-generating assets.

Third, IF that theory is correct, ask yourself what the impact of a slowing economy and lower liquidity would be on bonds? Traditionally, you'd see HIGHER bond prices. After all, slowing growth and slumping liquidity tends to lower inflation. But if surging liquidity and the strongest global growth in decades didn't cause bond prices to plummet (because of the liquidity/cash recycling effect), why would the opposite cause prices to rise? A liquidity drain may very well have a perverse impact this time: It could lead to a DECLINE in bond prices and a rise in interest rates.

It's just a theory, of course. But given how oddly bonds have behaved throughout the recent Fed rate hiking cycle, it's as good as any. It won't get tested until we see the aforementioned liquidity drain, though, and we haven't seen one yet as far as I can tell.

It's chart time again folks ...

Let's take a look at this longer-term chart of the 10-year T-Note futures. I think two things stand out:

1) The summer-to-fall rally in T-Notes failed right at long-term resistance in the 109-and-a-half range. Since then, we've pulled back about two points in price.
2) The current price level (roughly 107-and-a-half) looks important. It served as key resistance or support several times in the past six years.
So watch how Treasuries behave here. A break of this support level would be an important signal that rates are headed higher, in my opinion. A rally off of it could lead to another challenge of the long-term dowtrend.

Big bounce in MBA mortgage applications

Yowser ... I may be bearish on the outlook for the housing/mortgage industries. But that was one heck of a big bounce in mortgage applications in the most recent week. Apps for purchase loans jumped 16.2% in the week ended Jan. 5. That's the biggest one-week rise since May 2003.

Now, here's where it gets tricky -- the Mortgage Bankers Association's figures are notoriously volatile around the Christmas/New Year's holidays. Just three weeks ago, the purchase apps index plunged 10.6% after dropping 5.9% the week before. So you have to take the figures with a grain of salt. But it is clear that housing demand has bounced off the summer lows.

The question now is whether that bounce is sustainable and/or whether we've seen the worst of it in housing. I don't believe so, given the gigantic inventory overhang we have and the fact homes still remain largely unaffordable from a historical standpoint. I believe a weak spring selling season is in store, and that pricing, sales, and inventories come more into balance sometime in 2008.

Tuesday, January 09, 2007


That's what I'm seeing in various markets -- Emerging market shares. Subprime mortgage bonds. Certain commodities, especially oil. All of them have seen sharp corrections in recent days. That makes me wonder whether risk will finally get priced back into the asset markets.

For months now, we've been swimming in cash. I dubbed it the "Money, Money Everywhere" phenomenon back in November. Why? Central bankers have been doing the opposite of Theodore Roosevelt. Instead of "Speaking softly and carrying a big stick," they've been speaking loudly and carrying a twig. They've been talking tough about CPI-type inflation, but doing nothing about the credit/asset inflation that's jacking up the price of everything from high-risk corporate debt to commercial real estate.

A key question: Do these tremors foreshadow an asset pricing earthquake? Or should we continue to just go about our business. We'll see...

More bad news on home orders

The publicly traded home builders are starting to release preliminary earnings and orders news, and once again, the figures leave much to be desired ...

* Meritage Homes said net sales plunged to 1,201 homes in the fourth quarter from 2,072 a year earlier. That's a 42% drop in units. Order value dropped even more -- 51%. You can deduce from the figures that average prices slipped from $348,900 to $296,400 ... or 15%. The company said order cancellations surged to a record high of 48% of orders in 2006.

* D.R. Horton said net sales orders dropped 23% in terms of units, and 28% in value, in its fiscal first quarter. That means the value of each order slipped to $262,000 from $279,000, according to Bloomberg. That's good for a decline of 6%. Its cancellation rate was 33%, down a bit from 40% in the previous quarter, but still extremely high from a historical standpoint.

This also just serves to underscore my point from a few days ago -- that the official new home sales and inventory figures are flawed. That's because they don't capture the impact of cancellations. If you sign a contract to buy a new home, then walk away later, the sale doesn't get subtracted from the official tally. The home also comes off the inventory rolls with the initial contract, but doesn't get added back at the time of cancellation.

Monday, January 08, 2007

"Total Carnage"

Back in the early 1990s, there was a great shoot-'em-up arcade game I liked playing called "Total Carnage." You'd fight an army of mutants churned out by the villain General Akhboob, who would insult you as you fought your way through the various levels. Lots of fun.

I thought of that game today when I punched up the charts of some of the major subprime mortgage lenders. If you want "total carnage," that's where it's at. I've spelled out several reasons why in a number of venues, including this blog. But it all stems from one fundamental fact: We gave too much easy money to too many people who had no business borrowing during what was arguably the biggest housing bubble in U.S. history.

WSJ cuts through the B.S. on housing speculation in hot markets

Great story in the Wall Street Journal today about just how much of the housing boom was "real" demand vs. "B.S.-speculative frenzy" demand in Naples, Florida. I can't link to the subscription-only web site. But it's worth excerpting a few passages.

"The early run-up in real-estate prices in Naples was based on strong economic fundamentals. Low interest rates, the creation of new mortgage products and a strong economy triggered a wave of home buying by making ownership affordable for the masses. And Naples was especially desirable, with its chic restaurants, impeccably landscaped streets, stretches of pristine beaches and influx of baby boomers.

But it's increasingly evident that investors and speculators here and elsewhere played a greater role than previously thought in pumping up the real-estate bubble -- especially near the end of the run."

"Economists cite individual investors for pushing prices up excessively and lenders for lowering their credit standards. Borrowers were able to purchase homes with little or no money down and often without having to verify their income and financial assets. In many areas, builders made things worse by putting up too many houses for the market to absorb."

"Many economists and housing industry executives had previously estimated that as few as 10% of the buyers in hot markets were investors. A survey by the National Association of Realtors found that 28% of buyers in 2005 were investors. At the peak of the Naples market in 2004 and 2005, as many as 50% of buyers may have been investors, local real-estate agents say."

The article generally jibes with my own thinking -- the early part of the boom WAS driven by strong fundamentals. Then it turned into a classic bubble, and I suspect the fallout will last for a long time, especially in the bubbliest markets. And there are more than a few of those -- in Florida, California, D.C., Arizona, Idaho, Nevada, Utah, and many, many other places.

Friday, January 05, 2007

closing bond market action

Just to square the bond market circle, bonds rallied off their lows but still finished down for the day. Ten-year futures were off 6 ticks, while long bonds shed 8. Yield-wise, that's good for a 3 basis point gain in the 10s and a 2 bp gain in the bonds. Not much, but the resistance I highlighted held.

Economic data is fairly light next week -- with nothing major until Friday's retail sales and import/export price reports. So it'll be interesting to see how the bonds trade absent any fundamental catalysts. Do we get follow through selling? Or do buyers end up viewing this labor report as a one-off fluke and jump in?

I should mention that many interest rate-sensitive stocks got whacked pretty hard, including commercial REITs and banks. Anything that pushes out the fabled Fed rate cut (which we keep being told is "right around the corner" ... but which keeps getting pushed out into the indeterminate future!) seems to fluster the financial stock jocks.

Washington Post: Rent growth softening up

Just to follow up on my post about apartment REITs and rents, the Washington Post has a story talking about rent growth softening up in the D.C. area. I think this trend is only going to pick up in the coming months, and that it will catch those looking for some massive surge in rents off-guard. We simply built too many housing units of all shapes and sizes in the past few years. That will keep the for-sale and for-rent markets well supplied for some time to come.

where the job gains (and losses) were

Combing through the details of the report really tell the tale of where growth is ... and isn't ... in our economy.

* The mining and oil and gas industries added about 4,000 jobs. Construction lost 3,000 jobs, with big losses in residential-linked categories (residential specialty contractors were down more than 10,000, for instance). There were gains in commercial construction activity, however, helping to even things out.

* Manufacturing continues to do poorly, with another 12,000 jobs lost. Most categories were weak, with notable declines in the furniture and auto sectors (That's the impact from weak housing and car/truck sales)

* Wholesale trade employment bumped up 7,000, while retail employment slipped by around 9,000. The major categories of weakness: building/garden supply, sporting goods/hobbies, and clothing.

* Finance and insurance hiring was strong outside of residential real estate-linked categories. Professional and business services (accounting, architecture, consulting services) hiring stood out, at +50,000. So did education and health services (+43,000) and leisure/hospitality (+31,000)

jobs report stunner whacks the bonds

Yesterday, I said bond prices were at a key level -- testing the underside of a broken uptrend. And boy are they failing ... in a major, major way ... in early trading. The catalyst? The December jobs report. Some meat from the numbers:

* Nonfarm payrolls ROSE 167,000 on the month, vs. forecasts for a 100,000 gain. And "unofficially," I think a lot of people were looking for a nasty number because the ADP jobs report said the economy LOST 40,000 jobs.

* The unemployment rate remained at 4.5%.

* Here's the biggie for bonds: Average hourly earnings surged - up 0.5% vs. market forecasts for a 0.3% gain. The year over year gain in AHE was 4.2%, above the 4.0% forecast. This tied last month's cycle high, which was the highest since early 2001.

Bottom line: Bonds were UP about a half point going into the number. They're DOWN about a half point now. That's a gigantic reversal. I can't wait to see how things close.

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