Interest Rate Roundup

Wednesday, February 28, 2007

New home sales stink up the joint

The new home sales figures for January were released today. Here’s my take …

* I hope your seat belts were fastened coming into this new home sales number, because sales came to a screeching halt! The seasonally adjusted annual rate of sales was a paltry 937,000 in January, down a whopping 16.6% from December’s 1.123 million SAAR. The January sales rate is the weakest going all the way back to February 2003, almost four years ago. The one-month decline was the single worst drop in 13 years.

* Inventories remain elevated – a seasonally adjusted 536,000 homes for sale in January. That’s roughly unchanged from December’s 537,000 and down from the 573,000 peak in July. But it’s up about 2.7% from a year ago. It’s also far above the roughly 280,000 – 370,000 range that persisted throughout most of the 1990s.

On a months’ supply at current sales pace basis, we had 6.8 months of homes on the market in January. That’s just shy of the cycle peaks – 7.2 months in October and July. Keep in mind that the new home inventories figures fail to account for order cancellations. Specifically, if you contract to buy a house, it’s recorded as a new home sale … but if you later back out of that contract, the home is not added back to the overall inventory count.

* Median prices remain roughly stagnant. They were roughly unchanged month-over-month ($239,800 in 1/07 vs. $239,400 in 12/06). But they are well off the high of $257,000 in April 2006 and they were down 2.1% from a year ago in January. That was the second biggest YOY decline reported for this cycle (behind September, when prices were down 5.7%)

Let’s cut to the chase – these numbers were ugly. While the month to month changes in new homes sales figures can be volatile, the magnitude of the decline is impressive – almost five times worse than the consensus forecast (-3.6%). This speaks volumes about the ongoing weakness in the housing sector. Inventories remain elevated. Housing affordability remains low, historically speaking. And now, mortgage lending standards are tightening. All of this bodes ill for the 2007 spring selling season. I don’t expect a true, lasting rebound in housing until at least 2008.

Yet another sign of potential problems in subprime?

Late yesterday, Fremont General Corp. said it's delaying the release of its Q4 and full-year 2006 earnings results. They were scheduled to be released today. It's not filing its annual report on time, either. No explanation for the delay was given. Fremont is one of the countries biggest subprime lenders. The stock was trading at its lowest level since early 2003 in the pre-market session.

The morning after ... the latest on housing ... and more

Phew! What a day yesterday. These global meltdowns don't happen very often, but when they do, they can take you for a real ride. So where are we this morning ...

Interest rates are modestly higher. A downward revision in Q4 Gross Domestic Product growth to 2.2% from 3.5% had little impact since everyone pretty much expected it. Next up is the Chicago PMI report (at 9:45 a.m.) and the January new home sales report (10 a.m.)

Stock futures are bouncing back a bit, the dollar is bouncing back a bit, and China's market bounced back a bit overnight.

Meanwhile, you can check out some of my comments on the latest housing stats here in Florida and around the country here and here. And Caroline Baum, one of my favorite writers at Bloomberg, had this great piece on how the credit carnage likely won't be confined to subprime ... and how tighter lending standards could harm home sales. Looks like she pretty much shares my thoughts, as expressed here.

Tuesday, February 27, 2007

Some amazing headlines ...

I can't believe the headlines coming across my Bloomberg ...

"Gauge of Investor Concern Surges by Most Ever as Stocks Tumble Worldwide"

"Corporate Bond Risk Increases Most in 18 Months, Credit-Default Swaps Show"

"Emerging-Market Bonds, Currencies Fall Following Decline in Chinese Stocks"

Need I go on? We've gone from "Money, Money Everywhere" to "liquidity wanted" virtually overnight.

Risk, repriced

Want to know what happens when a market completely ambivalent about risk suddenly wakes up and smells the coffee? Look at your trading screens. Bonds are screaming ... stocks are tanking ... the Japanese yen is flying ... volatility indices like the VIX and VXO are ramping. These are all indicators that a four letter word long forgotten is being remembered in a big way. Now, the question becomes: Is the worst over? Or is this Long-Term Capital Management all over again? If only the answer were clear...

My take on January Existing Home Sales

January existing home sales figures (PDF link) were just released. Here’s how they look to me:

* Sales rose: The seasonally adjusted annual rate of sales rose 3% to 6.46 million from 6.27 million units in December. The market was only expecting a 0.3% gain. So that’s good news? Well, not exactly. That’s because ...

* Home prices dropped sharply: The median price of an existing home tanked by $11,000, or almost 5%, between December and January. At $210,600, existing home prices haven’t been this low in 22 months. This makes one thing crystal clear: Home sellers HAVE to be aggressive on price if they want to sell. One key reason ...

* Inventories are climbing again because of the "March of the Re-Listers": The number of homes for sale rose to 3.549 million units from 3.45 million in December, a gain of almost 3%. Why is this important? Well, a lot of people crowed about the decline in inventory for sale in November and December. They said it was proof the market was stabilizing.

I argued differently. I pointed out that this was entirely seasonal – home inventories almost ALWAYS fall late in the year because of the holidays. Specifically, sellers who fail to sell during the peak spring and summer selling seasons pull those homes from the market around Thanksgiving, then start re-listing them early the following year.

This "March of the Re-Listers" is clearly underway in 2007. I expect the inventory numbers to continue rising in February, March, and April, and we may very well set a new high.

All in all, the housing market is still struggling. Mortgage purchase activity has trailed off. Inventories remain extremely high. And sellers are being forced to cut prices to bring in buyers. Expect conditions to remain weak throughout 2007, with many local markets doing poorly into 2008.

Crazy, crazy day unfolding

I'm swamped due to the wild markets we're seeing. But let me touch on some quick hits ...

* The Japanese yen is soaring -- up 1.49% recently against the dollar. Meanwhile, "carry trade" currencies like the New Zealand dollar are getting hit. Yen carry trade unwind action? Maybe.

* Bonds are rocking again (long bond up 12/32) on dismal durable goods orders figures for January. Orders for all goods plunged 7.8% from December, versus a forecast for a 3% decline. Durables, ex-transportation sank 3.1%. Forecasters were expecting a drop of just 0.2%.

* Stocks are getting shellacked, with one market (China) down by the most in around 10 years overnight.

* The subprime lending meltdown is showing signs of spreading to other sectors. More "mainstream" mortgage lenders and even diversified financials are getting hit.

* The S&P/Case-Shiller home price index dropped 0.7% month-over-month in December. That was the fifth decline in a row and worse than the 0.4% drop in November. Nine of the 20 metropolitan areas in the index reported year-over-year drops as well.

Monday, February 26, 2007

My latest local housing market update

I've been posting regularly about conditions in my real estate market (northern Palm Beach County, FL). Now, I have the latest stats on inventory, sales, and pricing for January, courtesy of a brokerage firm called Illustrated Properties. Some details:

* Sales continue to fall -- Based on the figures reported, sales were down 38.6% YOY in January.

* Inventory is rising again -- I've been saying for months that the "March of the Re-listers" would get underway soon. That's evident in the latest inventory stats. For-sale inventory is closing in on the 23,000 mark again, up more than 47% year-over-year and just shy of the high to date set in September, per this graph. If you divide the inventory count (22,888) by the January sales tally (519), you get a whopping 44 months worth of supply at the current sales pace.

(Side note: In my zip code alone, now turns up 678 listings that meet the selling criteria spelled out in my last post. That's up from 666 a week ago and a brand new cycle high.

* Pricing firmed, but -- The median price of sold homes climbed to $300,000 in January. That was the highest since August. It also ties the year-ago level. However, "days on market" jumped to a cycle high of 140 (vs. 99 a year ago). And given the current supply/demand imbalance, I'd expect any pricing gains to prove fleeting.

Some observations now that I'm back in the saddle...

Vacation is over, and it's time to get back to work. Here are some quick observations on the latest goings-on in the markets ...

* Bonds have been rallying for a couple weeks now ... despite stronger-than-expected inflation news. That raises an important question -- Why?

*I'd point to the subprime mortgage carnage. Things are NOT getting better there ... they're getting worse. Indices that measure the cost of credit protection on high-risk mortgage loans are blowing out (meaning, credit protection is getting much more expensive to buy) and more lenders are going under daily.

Moreover, the Wall Street Journal has a story today (subscription required) making the point I laid out for you several days ago: If home buyers with bad credit can no longer get the riskiest subprime mortgages, it will impact overall home sales at the margin, and prolong the housing slump. That, in turn, could weaken the economy and push the Fed toward easing rates at some point down the road.

* What else is noteworthy out there? My "loose money" indicators continue to go bonkers. Gold surged almost $22 an ounce in one day last week. The yellow metal has been steadily climbing since early January, and the only significant technical resistance left is at the old May 2006 high around $730.

At the same time, the biggest-ever leveraged buyout -- $45 billion -- was just announced. And "carry trade" currencies like the Australian dollar and New Zealand dollar are running. Both are closing in on fresh multi-year highs against the U.S. dollar.

Friday, February 23, 2007

Out on vacation (but hopefully, not out to lunch!)

Just FYI -- I'm catching a few days of vacation in the cold, snowy north. So I probably won't have any new posts up until Monday. Until then ...

Wednesday, February 21, 2007

FOMC minutes just out

The minutes of the January 31 Fed meeting were just released. Some noteworthy comments:

"Economic expansion had picked up in the fourth quarter of 2006. Considerable vigor in consumer spending late last year boosted economic growth in the fourth quarter, supported by further increases in employment and income."

"The decline in residential construction continued to weigh on overall activity, but some indications of stabilization in the demand for homes had emerged."

"Although a spike in energy prices lifted total consumer price inflation in December, readings on core inflation had edged lower in recent months."

"The prevailing level of inflation was uncomfortably high, and resource utilization was elevated. The upside risks to inflation remained the Committee's predominant concern."

"Many participants observed that labor markets remained relatively taut, with significant wage pressures being reported in some occupations."

Reading the whole document, you get the sense the Fed is a bit more hawkish. But Bernanke's latest testimony before Congress sounded outright dovish. In other words, there seems to be a lot of indecision in Washington, D.C.

Another subprime casualty

One last quick hit this morning: Subprime mortgage lender NovaStar Financial came out with atrocious earnings results after the bell yesterday. This story recaps all the bad news. Suffice it to say it lost money in the most recent quarter ... it doesn't expect to make much taxable income for several YEARS ... and it had to take several charges due to souring loans and declines in the value of mortgage securities.


The Bank of Japan decided to stick it to the politicians and hike interest rates by 25 basis points to 0.5%. The vote was 8-1 in favor of the move. So you'd expect the yen to surge and global interest rates to rise, right? Wrong. You see, the BOJ also indicated that further increases will be gradual. Traders took that as a green light to keep on keeping on with those carry trades. Notably, higher-yielding "carry currencies" like the Australian dollar and New Zealand dollar rallied on the BOJ move.

Meanwhile, here on the home front, the Consumer Price Index surprised to the upside. Overall prices rose 0.2% in January vs. the 0.1% expectation. "Core" CPI (excluding food and energy) jumped 0.3%, above the 0.2% forecast. The year-over-year rate of core CPI inflation rose to 2.7% from 2.6%, leaving it well above the Federal Reserve's 1% - 2% comfort zone.

Some highlights: Services inflation has gained 0.3% the past three months in a row. Food and beverage inflation jumped to 0.7% from -0.1% a month earlier. Lower gas and vehicle prices reduced transportation inflation, and education and communication prices dipped. But a big spike in tobacco prices (+3.1%) and medical care (+0.8%) helped drive overall inflation higher.

MBA data shows home purchases falling again

The Mortgage Bankers Association puts out a weekly index measuring home loan activity. It has two components -- refinance activity and purchase activity. I focus on the purchase numbers, because they provide the most up-to-date snapshot of home buying activity.
As you can see in this chart from Bloomberg, things aren't looking so hot. Purchase demand has fallen in five out of the past seven weeks. The index is now sitting at 381.4, its lowest level since the week of October 27. We set a cycle low that week of 375.6.
Could bad weather account for some of the most recent week's decline? Maybe. But the broader trend evident in these seasonally adjusted numbers is one of weakness -- demand just isn't what it used to be and will likely remain relatively weak for some time to come.

Tuesday, February 20, 2007

Inventory rising ... with a vengeance

Back in late January, I put up a post about for-sale housing inventory in my neck of the woods -- northern Palm Beach County, FL. I noted that the number of properties for sale that met my search criteria started declining late last year (November, to be exact). The same thing happened nationally -- existing home inventory for sale dipped 1.3% (month-over-month) in November and 7.9% in December.

A lot of chowderheads came out of the woodwork as a result, saying that was "proof" the inventory problem had been solved and that everything would be sunshine and roses again by this spring. But I told you it was nothing more than seasonality -- for-sale inventory almost ALWAYS declines late in the year due to the holidays. Many people who fail to sell in the spring and summer pull their homes around Thanksgiving-Christmas, then re-list 'em starting in late January.

As the above chart shows, 2007 is shaping up as I expected in my little corner of the world. For-sale inventory recently hit 666 units (hope you're not superstitious!), a fresh high and up from 150 when I started this whole tracking exercise in June 2005. If the same thing happens NATIONWIDE, and I suspect it will, look for a new high in for sale, existing home inventory sometime in the Feb-Mar-April timeframe.

Fed's Bies speaks out about mortgage risk ... again

Several headlines from a speech on high-risk lending by Federal Reserve Board Govenor Susan Bies are coming over the Bloomberg right now ...

"Bies says regulators concerned about mortgage underwriting."
"Fed's Bies calls subprime mortgage market 'very problematic'"
"Bies points to 'transaction-based mentality' among lenders"

Bies also spoke out in mid-January on this topic. I posted some comments about that address at the time.

The fact of the matter is, the Fed and other banking regulators are a day late and a dollar short. Rather than just introduce and debate weak-kneed "guidance" about high-risk lending -- starting back in December 2005 -- they should have done all they could to crack down on it. Because they didn't, we're experiencing the worst mortgage delinquency and foreclosure rates on high-risk loans in years.

BOJ the week's Big Kahuna

We're back in business after a three-day weekend for the U.S. markets (and boy am I ever swamped!) The big event of the week has to be the Bank of Japan's interest rate policy meeting. The two-day meeting, currently underway, is a toss-up -- some expect policymakers to implement a 25 basis point hike. That would bring Japanese short-term rates to 0.5%. Others think the BOJ will bow to political pressure and stay on the sidelines. The last meeting on January 18 resulted in a 6-3 vote to keep rates unchanged.

Why does this matter so much? It all goes back to the yen carry trade. If Japan gets serious about hiking interest rates, it could have vast implications for global asset prices. See this post for more background on the stakes.

Saturday, February 17, 2007

In case you didn't catch them ...

I hope everyone is enjoying their three-day weekend. Here are some stories on the latest housing news, with my comments, in case you didn't catch them already. Enjoy ...

The Wall Street Journal, 2/16/2007:
(subscription required)
Housing-Starts Plunge Prompts Question: Are We There Yet?

The Tampa Tribune, 2/17/2007:
Builders Start Work On Fewer Homes

Marketplace (Public Radio), 2/16/2007:
No good signs for housing market

Friday, February 16, 2007

Another small fry takes a big hit from real estate lending

Just something I came across late today -- American Mortgage Acceptance Co. announced a big financial whacking late today. The problem: $12 million in writedowns of principal and the reversal of $908,000 in accrued interest related to non-performing mezzanine loans. They were written in 2005 to finance two condo conversion projects in Tampa, FL and a real estate development transaction in New Jersey.

The stock closed down $3.92, 22.2%, due to the late afternoon announcement.

You may recall another lender active in FL, Coast Financial Holdings, has gotten into real trouble thanks to problems with construction lending. Specifically, according to this St. Petersburg Times story ...

"Coast Financial Holdings is finishing a turbulent three weeks in which it transformed from a fast-expanding community bank to a candidate for acquisition under scrutiny of state and federal regulators.

"The source of recent troubles was 482 loans for customers of St. Petersburg builder Construction Compliance Inc. CCI ran out of money last fall while building investment homes in the city of North Port in Sarasota County.

"CCI tapped about $70-million in construction loans from Coast but left customers with unpaid debts on vacant lots and unfinished houses. To the detriment of Coast, many customers vow to walk away from the deals, accusing Coast of failing to monitor and correct CCI's slide into insolvency."

These are just a few isolated incidents, of course. But they do show that loan losses related to the housing bubble/bust won't just be confined to losses on individual, subprime mortgages. Condo conversion loans ... lot purchase loans ... construction loans -- several of them could cause problems in the months and quarters ahead.

Housing starts disaster

Anyone who wants to sugar-coat the housing industry's state of affairs better look at this morning's housing starts report. Construction of new single-family and multifamily properties plunged 14.3% to an annualized rate of 1.408 million units from 1.643 million units in December. The year-over-year drop was even more dramatic -- 38%. Not only was January's starts figure well below the forecast for 1.6 million, it is the WORST TO DATE for the down cycle in housing. It leaves starts at the lowest level since August 1997. Both single family and multi-family starts dropped.

Building permit issuance also dropped -- 2.8% to 1.568 million units from a revised 1.613 million. Permits declined for single-family homes, but increased ever so slightly in the multifamily sector. Speaking of revisions to December data, they were mild on the starts front (+1,000 units), and a bit larger on the permits front (+17,000).

I've been saying it for a long, long time: The housing boom was the biggest in U.S. history in terms of construction activity ... sales ... price gains ... and speculative buying activity. That has left us sitting with near-record levels of homes for sale -- condos, town homes, single-family homes, you name it.

We had "see-through" office buildings in the commercial real estate boom that ultimately went bust in the early 1990s ... and we have "see-through" condo buildings and subdivisions now. It will take quite some time to work through that inventory overhang, and one component of that are sharper cutbacks in new housing construction like we saw this month.

Thursday, February 15, 2007

How about that screaming yen?

Just in passing, I can't help but point out how the Japanese yen is screaming higher here. It's up about 1.3% vs. the buck, the biggest gain in nine months. The fundamental catalyst was a stronger-than-expected Japanese Gross Domestic Product report for Q4. Growth surged at an annualized rate of 4.8% vs. forecasts for a 3.8% gain.

The question of the day is this: IF you assume the cheap yen and 0.25% Japanese interest rates have helped fuel the rallies in, well, basically every asset under the sun, then you have to wonder what a rising yen and/or rising Japanese interest rates might do. Could it cause an unwinding of the massive, global "carry trade?" Or is it meaningless in the grand scheme of things? There's no way to know for sure, of course. But it's worth pointing out that a big rally in the yen that began in April 2006 precipitated the May swoon in U.S. stocks.

Surprise pop in the NAHB index

Well, what do you know? The National Association of Home Builders February market index climbed -- to 40 from 35 a month earlier. That's an 8-month high and above the consensus forecast of 40. All three sub-indices (measuring present sales, future sales and buyer traffic) popped.

I should point out the NAHB index is still down 16 points from a year earlier, and well off its R.E. bull market high of 72 in June 2005. But at the very least, this confirms other indicators that housing demand has climbed ever so slightly off its low of last summer. As for the future, the key questions are whether inventories will keep falling ... whether the economy can remain strong enough to support demand ... and whether credit tightening in the mortgage sector will get worse. I believe inventories are going to surprise on the upside, and that the spillover impact of all the subprime lending shocks could be serious enough to dent demand.

Q4 home price data: U.S. down 2.7%

The National Association of Realtors just released their data (PDF link) on Q4 home prices by metropolitan area. They showed a 2.7% decline for the United States as a whole (single-family homes). That was worse than the 1% decline in Q3 2006 and a major swing from Q4 2005, when prices were UP 13.6%. The Midwest led the declines with a -4.2% change. The only 1 of 4 regions to show gains was the West, at +0.4%.

The picture was somewhat different for condos and co-ops. Across the U.S., prices for those properties were down 2.1%. The South and West showed big drops of -6.4% and -9.1%. But there were small gains reported for the Northeast (+1.2%) and Midwest (+2.7%).

Which metros showed the biggest gains, single-family wise? A few in New Jersey, like Atlantic City, and scattered locales in Utah, Oregon, North Carolina, and Louisiana.

The biggest declines? Sarasota-Bradenton-Venice, FL, at -18% ... Palm Bay-Melbourne, FL at -17%, and Cape Coral-Fort Myers, FL at -11.7%. Other drops were recorded in metros spread throughout Nevada, Ohio, Massachusetts, Illinois, Connecticut, and California. Condo prices fared much worse than single-family prices in some markets, with changes of -24% in Sarasota-Bradenton-Venice and 22% in the Palm Bay market.

The price drops are concentrated in two kinds of areas:

1) Those which experienced the most speculation during the boom and/or which have the most unaffordable homes relative to incomes. That includes large swaths of CA, FL, etc.


2) Those with the worst economic fundamentals. Midwest "Rust Belt" cities fall into that category, as do metros exposed to weakness in manufacturing, especially autos. Some examples include cities in Michigan, Indiana, and Ohio.

Lastly, per this AP story ...

"Median home prices fell in 49 percent of the 149 metropolitan areas surveyed in the fourth quarter, compared to the same period a year ago. That was the largest percent of metro areas reporting price declines since the Realtors began tracking price data in 1979."

industrial production stinks, too...

Wow, another stinker -- Industrial production FELL 0.5% in January, versus expectations for an unchanged reading. Capacity utilization dropped to 81.2% from 81.7% a month earlier. More dollar whackage ... more bond gains.

R-uh, R-oh: TIC data disappoints

That's me trying to sound like Scooby Doo, in case you're wondering about the "R-uh, R-oh" reference. I say "Uh Oh" (in dog language) because the December Treasury International Capital report looks ugly. The details ...

* Total foreign purchases of U.S. stocks, Treasury debt, and other bonds plunged to a net $15.6 billion in December from $84.9 billion in November. Forecasters were looking for $60 billion in net purchases.

* A broader measure of international money flows looked even worse -- it FELL by a net $11 billion, vs. expectations for a gain of $70 billion.

* Foreign private buyers were much, much less active buying our assets, while foreign official buyers (central bankers) picked up the pace from November.

* By country, Japanese holdings of U.S. Treasuries rose $6.9 billion, Chinese holdings rose $3.1 billion, and U.K. holdings jumped for a second straight month -- gaining $16.5 billion. There was big selling in the Caribbean region (that's a sign of hedge fund activity, since many operate via offshore banks located there). Other sellers included some smaller countries in Europe, like Switzerland, Ireland, and Italy.

As you might expect, the dollar is getting whacked on the news. Bonds are popping. The pattern lately has been for these two markets to trade inversely -- i.e. when bonds rally in price, the dollar falls in value.

Claims bad, Import prices mixed, Empire strong

Here we go -- lots of economic data just hitting the tape ...

* Jobless claims were much WORSE than expected - initial claims were up 44,000 to 357,000 versus expectations for 314,000. That was a 17-month high. Continuing claims also rose to 2,560,000, vs. a forecast for 2,500,000. Weather may be partly responsible for the spike

* Import prices dropped 1.2% between December and January, vs. a forecast for a 1.1% decline. Ex-petroleum costs were unchanged, vs. +0.5% in December. BUT if you exclude ALL fuels (oil and otherwise), import prices were up 0.3%, the biggest gain since September.

* An early reading on the economy in February, called the Empire Manufacturing Index, looked good. The index jumped to 24.4 from 9.1 in January. That was well above the 10.6 reading that was expected. Sub-indices measuring prices paid and prices received declined, while indices measuring new orders and employment popped.

The early market reaction? A small gain in bonds ... a small drop in the dollar ... and a small pop in stock futures. Next up -- international capital flow data at 9, industrial production/capacity utilization at 9:15, the Philly Fed at noon, and the February NAHB housing index at 1. Oh, and don't forget "Round Two" of Gentle Ben in front of the House at 10!

Wednesday, February 14, 2007

More on Bernanke's comments ...

A few things stand out to me in Bernanke's testimony.

First, he said ...

“Inflation pressures appear to have abated somewhat following a run-up during the first half of 2006. Overall inflation has fallen, in large part as a result of declines in the price of crude oil. Readings on core inflation -- that is, inflation excluding the prices of food and energy--have improved modestly in recent months.”

Any surprise there? No. These are all factual statements. The implication, though, is that the Fed is less concerned about inflation than it was in the past.

Second, he said ...

“If activity expands over the next year or so at the moderate pace anticipated by the FOMC, pressures in both labor and product markets should ease modestly” and “The projections of the members of the Board of Governors and the presidents of the Federal Reserve Banks are for inflation to continue to ebb over this year and next.”

That reinforces the message no more hikes are coming any time soon. It doesn't signal rate cuts are coming, however.

But let's step back for a minute and make a note of what Bernanke did NOT say. He did NOT express any reservation about the explosion in global and U.S. liquidity. He did NOT comment on the recent re-acceleration in money supply growth (The 5.3% YOY change in December M2 was the biggest gain in 22 months). He did NOT have much of anything to say about the near-record low in credit spreads ... the explosion in leveraged buyouts ... the mania in certain emerging markets ... and more. Not so much as a "We're seeing a bit too much irrational exuberance."

I think that's a big mistake. Indeed, I'll go back to what I've been saying for months -- the Fed ignored all the high risk lending, excessive risk-taking, enormous speculation, and more in the residential real estate market. That led to the biggest bubble in housing in U.S. history, the popping of which has led to real economic and financial pain (i.e. the foreclosure surge discussed earlier)

Is the LBO market next in line for a blowup? Commercial real estate? Derivatives? Emerging market debt? Who knows? What I do know is that the Fed has got to get a handle on this excess liquidity problem or we're going to just see a series of rolling bubbles. That's no way to run an economy.

Bernanke throws a big, juicy steak into the asset markets

I've updated this post to reflect Bernanke-related fireworks ...

This is an exciting day. We came into today's U.S. trading session with the dollar trading weak. The catalysts: Stronger-than-expected U.K. employment data and a European GDP report showing 0.9% growth in Q4, the fastest in six years. Dollar selling picked up after a report showing U.S. January retail sales were unchanged, and up just 0.3% excluding autos. Consensus estimates were for 0.3% and 0.4% gains, respectively.

Then Fed Chairman Ben Bernanke threw a big, juicy steak into the rink at 10 a.m. -- he failed to sound more hawkish on inflation, in either the "real" economy or the asset economy. This was taken as a green light signal to buy bonds, sell the dollar, and buy stocks. In other words, the same "Money, Money Everywhere" trade I've been talking about for months. Today's close in all the markets will be very, very important as a result: Is this just a near-term reaction or do the gains hold through the whole day.

Latest action:
US Long Bonds up 15/32
Dollar Index down 54 bps (euro up about a cent, pound up about 1.5 cents)
Dow up 48 points
GLD (gold ETF proxy) up 54 cents to new high for the recent move

another subprimer takes a beating

New Century and HSBC have already discussed major, negative trends in their subprime lending businesses. Now, Accredited Home Lenders has weighed in. The company is reporting a Q4 loss of $1.49/share. Looks like consensus estimates called for a loss of 36 cents.

There's a lot of what you'd expect in the release -- comments about the environment being "challenging" ... and comments about tightening requirements for credit score, loan-to-value, income documentation, etc. But it's the nitty-gritty in the report that really tells a sad tale ...

* Net gain on sale for whole loans dropped to just 1.4% from 1.86% in the prior quarter and 2.52% a year earlier. That a sign of profit margin pressure in the core lending business.

* The total provision for loan losses rose ... get this ... by 261% year-over-year.

* The delinquency rate (in the "old" LEND servicing portfolio, which excludes a company, Aames, that LEND just bought) jumped to 7.18% in the Dec. quarter from 5.44% in the September period and 2.49% in the Dec. quarter of 2005. In other words, the 30 day+ late payment rate has almost TRIPLED in just 12 months.

The news out of all these lenders just goes to show you that industry-wide, the whiz-bang default models aren't exactly hitting the ball out of the park.

The implications of tighter mortgage lending standards

It seems every day, another mortgage lender pulls one of its higher risk products. In the Wall Street Journal this morning, there's a story titled "Home Lenders Pare Risky Loans
More Defaults Prompt Cut In 'Piggyback' Mortgages;Housing Market May Suffer." You'll need a subscription to read the whole piece, available here. But here's an excerpt:

"Fremont General Corp., a major lender to people with weak credit records, has stopped providing these second mortgages, which are frequently used by financially stretched "subprime" borrowers who can't scrape together a down payment. A spokeswoman for Fremont, based in Santa Monica, Calif., confirmed the decision, which was first announced in emails to mortgage brokers earlier this week, but she declined to comment further.

"Fremont's move comes amid a rapid tightening of credit standards by subprime lenders as they find investors no longer are eager to buy types of loans deemed particularly prone to default. The pullback by subprime lenders could put a further dent in demand for housing by preventing some potential buyers from getting loans at a reasonable cost."

As I've been pointing out in earlier blog posts, including this one on the Fed's latest loan officer survey, the thing that had been missing in this housing market slump -- until recently -- was a tightening lending market. Lenders kept the pedal to the metal DESPITE obvious signs the housing market was deteriorating in 2005-2006. Their goal: Keep loan volume up, future defaults be damned.

Now, that's changing fast as secondary market conditions tighten up. Will this have a "second round" impact on the housing market? I believe so. More borrowers at the margin will not qualify for financing, and that will erode demand for both new and existing homes. My advice if you're gearing up for the spring real estate season:

* If you're a home buyer, you should recognize that tighter mortgage standards reduce your buying power. For example, you may have to come up with a larger down payment to qualify for a loan. That’s especially true if you have a lower credit score. Stated income financing and some higher-risk ARMs may also be tougher to find or more expensive.

*If you're a home seller, you should be more flexible on pricing. You're already competing with a near-record number of new and existing homes on the market. Now, you have to consider the possibility that prospective buyers will ultimately fail to obtain mortgage financing.

Monday, February 12, 2007

Foreclosures keep on climbing ...

RealtyTrac just released its latest foreclosure report for January 2007. FCs were up 19% month-on-month from December to 130,511. That’s the biggest MOM gain since August 2006, and it leaves the foreclosure count at a new high. This chart shows the history of the indicator, which I only have data for going back to 1/05.

If there was any sliver of a silver lining, it's that the year-over-year rate of increase was down to +25.1% from +34.9% a month earlier. The biggest YOY increase in any given month was November 2006 (+68.1%). But that's not saying a lot. The fact is, this mortgage delinquency/foreclosure problem is going to be with us for quite some time.

Technical Take on the 10s, circa 2/12/07

It's been a while since I threw a chart up on this here blog. So let's take a look at the 10-year T-Note futures. You can see that we recently broke above a short-term daily downtrend, but that we had a nasty pullback Friday ... and aren't doing so hot today. We're now testing that prior resistance, and it'll be interesting to see if it will prove to be support. Not shown on the chart is the 200-day moving average, which is also right around these levels.
Bottom line: If the bond bulls are going to pull it out, they better act soon.

Alan Greenspan responsible for all these "broken ARM?"

Yesterday evening, a debate erupted at another blog over former Fed Chairman Alan Greenspan's "bubble culpability." Did he, in fact, encourage borrowers and lenders to jump into ARMs and/or other forms of creative financing in early 2004 -- and thereby set people up for financial disaster? I'd say "Yes." Here's my post, and supporting evidence ...


Look — Alan Greenspan would never come out and say “Get an ARM loan.” But I am indeed one of those people who believe that speech was, essentially, a “call to ARMs.” It came at a time when the overall economy and job growth were relatively lackluster, and the housing market had gone about as far as it could go on fixed rate financing. So Greenspan gently nudged both lenders and borrowers in the direction of ARM financing … at absolutely the worst time in modern financial history (i.e. before a 17-hikes-in-a-row Fed tightening cycle).

Think back to the “irrational exuberance” speech — Greenspan never said: “Investors are demonstrating too much irrational exuberance.” Instead, in December 1996, he said:

“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?”

But he never would have written that comment into a speech unless he was trying to send a message. The fact of the matter is, the Fed has been just as bad, if not worse, at economic and interest rate turning points, with advice-giving. Never forget this gem of a speech from January 2000 about how great productivity growth, the tech boom, etc. virtually ensured the economy would remain on a strong growth trajectory…

"We are within weeks of establishing a record for the longest economic expansion in this nation’s history. The 106-month expansion of the 1960s, which was elongated by the Vietnam War, will be surpassed in February. Nonetheless, there remain few evident signs of geriatric strain that typically presage an imminent economic downturn.

"Four or five years into this expansion, in the middle of the 1990s, it was unclear whether, going forward, this cycle would differ significantly from the many others that have characterized post-World War II America. More recently, however, it has become increasingly difficult to deny that something profoundly different from the typical postwar business cycle has emerged. Not only is the expansion reaching record length, but it is doing so with far stronger-than-expected economic growth. Most remarkably, inflation has remained subdued in the face of labor markets tighter than any we have experienced in a generation. Analysts are struggling to create a credible conceptual framework to fit a pattern of interrelationships that has defied conventional wisdom based on our economy’s history of the past half century.”

I’m not saying I’m perfect, of course. I’ve miffed plenty of predictions. But I simply cannot excuse the inexcusable talking up of ARMs at precisely the wrong time.


I'm apparently not the only one who won't let Greenspan live that quote down. One of my favorite bond market columnists, Caroline Baum, took him to task in a piece today called "Banks That Took Greenspan's Advice Pay the Price" An excerpt ...

"It's too soon to know the extent of the problem from all the option ARMs (the interest is optional, but the principal is not!). Only three years ago, former Fed Chairman Alan Greenspan said homeowners could have saved a heck of a lot of money had they opted for adjustable-rate mortgages during the past decade.

Ex post, that was good advice. Ex ante, it's not looking good.

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed- rate mortgage,'' Greenspan said in a speech to the Credit Union National Association in Washington.

Lenders took his advice. Borrowers jumped at the opportunity. Everyone may suffer the consequences [emphasis mine]."

Sunday, February 11, 2007

G-7 G-ives G-o ahead for more G-onzo carry trades?

This weekend, top policy wonks from the Group of Seven nations (the U.S., U.K., Japan, France, Germany, Canada, and Italy) met to talk about the world economy. European delegates had one major beef going into the gathering -- the rapid, sizable decline in the value of the yen against the euro. They're mad because that is making Japanese exports more competitive vis-a-vis European ones on the global markets.

But when all was said and done, the G-7 failed to strongly support the yen in its post-meeting communique. One key reason: The U.S. isn't in a great position to support the yen ... and the Japanese themselves aren't eager to see the yen surge, either.

It's true that some groups here in the U.S. aren't happy about the Japanese currency's slide. Big U.S. manufacturers are at the top of the "angry" list. But U.S. Treasury Secretary Henry Paulson is in a tough spot -- the yen is NOT falling because Japanese policymakers are manipulating the market. It's falling because the Bank of Japan is dragging its feet on the interest rate front amid concern that higher rates will derail Japan's economic recovery. Paulson (and other Treasury secretaries before him) have repeatedly said that currency values should be set in open markets free of interference. A push to artificially inflate the value of the yen now -- when it's moving on its own accord -- would make U.S. policymakers appear completely hypocritical.

Why does this all matter so much for FINANCIAL markets? Because of the yen carry trade. Japanese interest rates are extraordinarily low (0.25% is the official BOJ target rate) when compared to rates in the U.S. (5.25%), the U.K. (also 5.25%), Europe (3.5%), and especially places like Australia (6.25%) and New Zealand (7.25%). That's encouraging global investors to borrow gigantic amounts of money at low Japanese rates and re-invest that money in assets in countries with higher interest rates. That buying, in turn, is inflating the value of foreign bonds ... foreign real estate ... stocks ... you name it.

How big of a factor is this? Here's an excerpt from a Bloomberg story that should make your skin crawl:

"Barclays estimates carry trades are at their most extreme since 1998, when Russia's economic crisis prompted traders to unwind their bets so rapidly that the yen soared 20 percent. Hedge-fund Long-Term Capital Management LP collapsed in the market turmoil."

At some point, this easy money-fueled madness will end. But the G-7's failure to specifically target the yen's value looks to me like a G-reen light for more G-onzo carry trades. We'll see.

Thursday, February 08, 2007

My thoughts on the subprime mess

I'm up in Orlando for the World Money Show, so I apologize for not blogging as much as usual given all the events out there in the markets I follow. But I had to drop in and comment today on the latest subprime mortgage sector news.

If you had the chance to catch CNBC today, then you saw my segment on the latest news out of New Century Financial and HSBC. I recounted some of the thoughts I've shared here -- namely, that when you give too much easy money to too many borrowers who probably had no business getting loans in the first place, this is what happens. Default rates surge. Losses pile up. Subprime lenders get killed. The last major down cycle in 1998 led to the closing or absorption of several major subprime shops (Anyone remember the Money Store?). It remains to be seen whether things get that bad this time around. But given the way lending standards were thrown out the window in the past couple of years, it's well within the realm of possibility.

Here's one last thing: How is it that so many people are shocked ... SHOCKED ... to see these kinds of blowups? All the ingredients for a colossal mess were there. In fact, I wrote back in January and much farther back -- in July 2006 -- that exactly this kind of scenario would likely unfold.

Am I happy about being right? Of course not. People are suffering real financial pain. It sucks. I hope next time housing starts booming, lenders won't push the envelope so much. I also hope regulators and monetary policy makers will act sooner to stop that boom from turning into a bubble. But given the experience of the past couple years, you can probably understand why I'm just a wee bit skeptical.

Wednesday, February 07, 2007

In other econ news ...

* Mortgage applications essentially treaded water in the week ended February 2. Purchases were down 0.8% from the week prior, while refinancings ticked up 0.2%. Home buying activity, as measured by these Mortgage Bankers Association figures, is off its July-October low but well below its 2005 high (and its recent high for that matter).

* Fourth-quarter productivity jumped 3%, versus expectations for a gain of 2%, and a big improvement from -0.1% in Q3. Unit labor costs rose 1.7%, down from 3.2% a quarter earlier and below forecasts for a gain of 2.1%. This will soothe labor-related inflation concerns and allow the Fed to continue to pursue a policy of: "Laissez les bon temps roulez!"

Fed talks, no one listens

Remember those old commercials for the brokerage firm E.F. Hutton? I sure do. They were all over the T.V. when I grew up. The tagline: "When E.F. Hutton talks, people listen."

Anyway, I was reminded of that today when headlines from Federal Reserve Bank of Philadelphia President Charles Plosser hit the the tape this morning. Among them: "Fed's Plosser says 'too soon to declare victory' on inflation" and "Plosser says inflation remains his 'primary concern' for 2007."

If you were following the early 2006 playbook, you'd expect panic. You'd expect bond traders to run around like chickens with their heads cut off. But you know what impact those headlines had on bond prices and interest rates? Zero. Zippo. Zilch. Comments from San Francisco Fed President Janet Yellen yesterday evening, which included one saying: "we've got an economy that is operating pretty close to what I call full employment" had a similar effect. Namely, nothing.

Why the lack of a reaction? Fed policymakers continue to focus narrowly on goods and services inflation, completely ignoring the ginormous surge in liquidity, risk-taking, money supply, and asset prices. Measured that way, inflation is elevated but coming down slowly. So, neither rate cuts nor rate hikes are imminent, and the markets can ignore speeches like Plosser's and Yellen's. In other words, when the Fed talks these days, no one listens!

Tuesday, February 06, 2007

Get me some 3-years ... stat!

That's what buyers appeared to say this afternoon. Indeed, the auction of $16 billion in 3-year Treasury Notes went over extremely well ...

* The bid-to-cover ratio was 2.97. That was up noticeably from 2.27 a month earlier and the strongest going all the way back to May 1998.

* The notes were sold at a yield of 4.80%, below pre-auction expectations of 4.82%.

* The only minor fly in the ointment: Indirect bidders bought 32.3% of the notes sold, up from 22.3% in August but below the average of 36% for the last 12 auctions.

Treasury prices were already up a few ticks on the day before the auction results were released and they're adding to those gains now. Long bond futures were up 13/32 at last count, while 10-year yields were down almost 3 basis points to 4.77%.

Derivatives distortions in the credit market

There's a great piece on Bloomberg today about the distorting impact that credit derivatives are having on the underlying bond market. It's complex stuff, so let's start with a bit of background:

* Low nominal interest rates have forced bond investors to chase higher yields anyplace they can get them.

* Many are buying up collateralized debt obligations, or CDOs. CDOs are securities comprised of credit default swaps (CDS) on underlying bonds. CDS are contracts that (in theory) protect bondholders against the risk of credit losses. If the company whose debt you own gets into financial trouble and defaults, the seller of the CDS contract you purchased is obligated to make you whole.

* Instead of buying cash bonds, many fixed income investors are buying CDOs because they pay higher yields. Hedge funds typically snap up the riskiest "tranches," or portions, of these CDO deals, while insurance companies and other conservative investors buy the highest-rated stuff.

So what's the problem?

Well, the market for credit derivatives is growing at an exponential rate -- so much so that it's dwarfing the size of the underlying bond market. As Bloomberg notes, CDS contracts provide protection on $26 trillion in debt ... five times the $5 trillion outstanding in global corporate bonds. In other words, credit derivatives are the tail wagging the bond market dog.

Because so much money is flooding into the CDO market, CDS sellers are being forced to accept less and less money for the protection they're providing. An example: European bondholders can now protect 10 million euros of bonds for five years at a record-low cost of 189,000 euros. That's down 58% from the 450,000 euros that protection cost in 2005.

This raises the whole issue of counterparty risk. A CDS contract isn't worth the paper it's printed on if the guy who sold you the protection gets vaporized in a credit crisis. You have to wonder: Are CDS sellers REALLY collecting enough money to put them in a position to make bondholders whole in the event of a default?

Then there's the distorting effect the CDO market is having on traditional market signals. Historically, when a corporate borrower starts getting into financial trouble, the spread between the yield on its bonds and the yield on risk-free Treasuries widens out. That's an important market signal to bond and stock investors -- a yellow warning flag, if you will. But because so much money is flooding into the CDO market ... and that money is artificially suppressing corporate spreads ... those market signals are being drowned out.

In the short-term, everything looks hunky dory. The corporate debt default rate is close to an all-time low, so the CDS system is not being stress-tested. But some serious imbalances are building up, and that raises the risk of a big blowup down the road.

Monday, February 05, 2007

Fed Survey: Mortgage lending standards tightening up

The missing ingredient in this housing bust cycle -- until very recently -- was tighter lending standards. Even after home sales topped out, price growth peaked, and inventories started building, mortgage lenders didn't start restricting credit. Indeed, they actually LOOSENED standards to keep loan volumes up.

Just look at the Federal Reserve Board's Senior Loan Officer Opinion Survey on Bank Lending Practices. The quarterly survey covers commercial and residential lending -- whether standards are loosening or tightening, whether demand for mortgage, commercial and industrial loans is rising, etc. It covers around 90 domestic banks and U.S.-based divisions of foreign banks.

The net percentage of institutions tightening standards for residential mortgages was NEGATIVE 9.4% in Q2 2006 and -9.3% in Q3 2006. In other words, once you netted out the banks that were tightening standards vs. those that were loosening them, you found that just over 9% were loosening. That was the most widespread easing of standards recorded since late 1993.

But boy have things changed. This Fed indicator has now swung to POSITIVE 16.4%, the highest reading since Q2 1991 (22.9%). Moreover, about half of domestic banks said they expect "a worsening of the quality of their nontraditional residential mortgage loans this year; a few institutions noted that they anticipate that the quality of such loans will deteriorate substantially in 2007."

Friday, February 02, 2007

FBR: Defaults worse now than during the 2001 recession

Friedman Billings Ramsey Group says that subprime mortgage default rates are now surpassing the dismal levels they hit in the midst of the 2001 recession. Specifically, as Bloomberg puts it, "the percentage of subprime mortgages packaged into bonds and delinquent by 90 days or more, in foreclosure or already turned into seized properties climbed to 10.09% [in November] from 9.08% in October." That tops the 10.05% default rate in November 2001, which was the end of the last recession.

I'm certainly not surprised by this. I've been saying for months and months that the subprime lending industry was in serious trouble. The industry tried to keep the boom going in 2004, 2005, and 2006 by progressively slashing lending standards more and more. Then you've got the problem of shoddy/fraudulent appraisals, overstated incomes, a slumping housing market, and more.

Moreover, this is happening DESPITE stronger-than expected economic growth (per the latest GDP stats) and the lowest unemployment rates we've seen in five years. According to the black box, "expert" models, that "can't" happen. But it is.

I'm not saying this is the end of the world or anything. But I am saying that you can't have the biggest housing bubble in the history of the U.S. ... and hand out mortgages on the easiest terms in history ... without expecting any fallout when the bubble bursts. Lots of people who should never have owned homes or gotten mortgages in the first place are going to have their financial lives ruined by foreclosure. And lots of investors in this junk mortgage paper are going to lose lots of money. Period. End of story.

The "Big Picture" on yields

Over on Barry Ritholtz' excellent blog, there's been a discussion about the longer-term outlook for interest rates. I couldn't help but weigh in. The short version: I suspect the great bull market for bonds ended in mid-2003, and that we're in a multi-year bear phase. I don't think we're going to see 10% 10-year anytime real soon. But 6% ... or even 7% in the next few years? Sure.
Technically speaking, this 10-year chart shows how we've tested the uptrend off the 2003 low twice ... and held. I also suspect we made an inverted head and shoulders bottom, with the left shoulder around the time of the Long-Term Capital Management crisis ... the head during the 2003 deflation panic ... and the right shoulder several weeks ago. If this uptrend line gives way, and/or we take out 4.4% or so on the 10-year, then my thesis is bunk.

Latest take on the jobs market

One of the biggest economic reports just hit the tape -- the January jobs report. Here's the skinny ...

* Nonfarm payrolls rose by 111,000 in January. That's below the 150,000 average estimate of economists polled by Bloomberg. However, there were sizable revisions to the past few months' figures. December job creation was revised up to 206,000 from 167,000 ... November jobs were revised up to 196,000 from 154,000 ... and October jobs were boosted to 109,000 from 86,000. Gotta love those gubmint bean counters!

* The unemployment rate nudged up to 4.6% from 4.5% in December. That was a tenth higher than the average forecast. The household employment indicator (which is based on a smaller survey than the one that determines nonfarm payrolls) was weaker. It showed a rise of only 31,000 jobs, a substantial drop from readings of 303,000, 286,000, 431,000, 288,000, etc. in recent months.

* What about the breakdown by industry? Manufacturing lost even more jobs -- 16,000. But that was it for losing industry groups. Construction ADDED 22,000, one of the biggest gains in a long while that was probably helped by the warm early January weather. We also continued to see decent growth in several services sectors, like education and healthcare (+31,000), leisure and hospitality (+23,000) and business services (+25,000)

* Average hourly earnings gained 0.2% on the month, below forecasts for 0.3% and the previous month's reading of 0.5%. The year-over-year change in average hourly earnings slowed to 4% from from 4.2% in December.

The market reaction? A rally in Treasuries. Long bonds were recently up 9/32, while 10-year T-Note yields were down about 3 basis points to 4.80%. Technically speaking, we're back in an area of congestion around the 110 and change level in the long bonds after failing to hold the breakdown from last week. In other words, quite a mixed picture. But "jobs day" is notoriously volatile so the close is extremely important.

In collateral markets, the Dollar Index is down about 13 bps, helping send gold and other commodities markets (like oil) up. Meanwhile, stock futures are in love with the "soft landing" nature of the numbers.

Thursday, February 01, 2007

Indecision clouds my vision

Sorry, I couldn't resist the lame reference to a Faith No More song that got heavy rotation back in my day! But it's true. The economic picture ... and hence, the bond market outlook ... is a lot cloudier these days. Prices shot up 20/32 yesterday thanks to Ben Bernanke's decision to pick up the "Easy Al" mantle and pronounce inflation dead buried. Then today, an early, moonshot, 20-tick rally has completely faded for the reasons I highlighted earlier. While the main GROWTH measure (ISM) was weak, the prices paid sub-index rose and the latest housing stats came in hot.

Personally, I think both "real" inflation -- and especially asset inflation -- is still a problem. I've talked about the recent rise in the TIPS spread so I won't hammer that point home again. But I will point something out -- not once during the September-to-January trough did this inflation indicator drop below 200 basis points. In other words, the market has NEVER prices bond as if the Fed would act tough enough to get long-term inflation back into its 1% to 2% professed comfort zone. Food for thought.

ISM worse, pending sales better

Pending home sales snapped back in December -- up 4.9% month-over-month. I'm not surprised that pending existing home sales rose like new home sales. After all, pending sales are based on contract signings (like new home sales), whereas the traditional existing home sales figures are based on closings of contracts signed 30-60 days previously, on average. Pending sales are still down 7.6% on a year-over-year, unadjusted basis.

Meanwhile, the Institute for Supply Management's manufacturing index slumped to 49.3 in January from 51.4 in December. That was below the 51.7 forecast. Among the sub-indices, new orders dipped a bit (to 50.3 from 51.9)... production dipped a bit more (to 49.6 from 52.4) ... employment was stable (49.5 vs. 49.4) ... and prices paid were up a fair amount (to 53 from 47.5).

Early reaction: Bonds are giving up early gains on the housing bounce and the elevated prices paid index. Stocks are still up, but not as much as they were earlier. And the dollar has bounced.

Japan's top currency official gives Paulson the brush off

Yesterday, U.S. Treasury Secretary Henry Paulson got dragged before the Senate Banking Committee to defend his record on the Chinese yuan. Despite verbally pressuring China to let its currency appreciate against the dollar, the U.S. administration hasn't gotten much for its efforts. The yuan is rising, but not by much -- and officials like Republican Senator Jim Bunning let Paulson have it.

What's interesting is that Paulson also said he's watching the yen "very, very carefully." He further implied the yen would be a topic of discussion at a G-7 meeting in Germany just over a week from now. Why so much focus on the yen? Because it's been tanking lately due to the Bank of Japan's wussiness over hiking interest rates. The weaker yen, experts argue, make Japanese exports more competitive versus those produced in other countries, giving the Japanese an "unfair" advantage.

Now here's where things REALLY get interesting. One of the forces driving the "money, money everywhere" phenomenon I keep harping on is the cheap yen. Investors the world over are borrowing cheap yen and using those funds to invest in countries and assets with higher yields. This is known as the "yen carry trade." Should the yen shoot up unexpectedly, it could cause that global trade to unwind, tanking asset prices.

There's no sign of that happening yet, of course. In fact, the Fed basically reinforced the"Party on!" attitude yesterday by playing down "real" inflation and making no mention of excessive asset inflation. And Japan's top currency official, Hiroshi Watanabe, just gave Paulson the brush off, playing down any possibility of a yen surge. But you definitely have to keep an eye on this as a carry trade unwind would result in the markets getting very ugly, very fast.

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