Need To Know News

U.S. markets reacted positively to the double barreled combination of Bernanke and Bush today with the Dow rallying behind Bernanke’s speech although there was little new contained therein. Bush’s proposals to help out subprime are likely to be significantly less than what’s needed to sort out imperiled homeowners especially given FHA will be charging homeowners market rates for mortgage insurance. That said, EQUITY INDICES rallied, albeit in thin trade. Mid-afternoon to late afternoon equities were very volatile with the market trading near the best levels of the day but falling back a bit on as business wound up for the week. Unsurprisingly, volume was at the lowest level of the week across indices.

Crude Oil rallied in response to the development of a tropical storm east of the Windward Islands but Unleaded sold off better than 1% today. Natural Gas remains under pressure due to massive supply in storage, closing down 3.35% on the day.

Gold looks to have gotten a good ‘flight to hard commodity bid’ ending the day up $7.80 and silver gained 27 cents on the day - likely on the same sentiment. Platinum and Copper rallied as well with the former gaining $11.50, the latter up 5.4 at 340.20.

The USD put in a mixed performance again today ending down slightly against the JPY at 115.80ish after trading to 116.60 during the session. EUR/USD ended flat on the day at 1.36ish and CABLE gained 50 pips to trade in the mid 2.01s.

All eyes will be on the data next week behind Bernanke’s comments re the smaller influence of past quarters and the emphasis the FED will put on coming figures.

Today’s equity market rally is on very thin volume; indeed volume has been falling off since the last sell-off down to the 12500 area in the Dow Jones as investor uncertainty appears to be keeping real money away OR the real money is gone. A slew of hedge funds have suffered profound and sometimes business-ending losses since July so they are no longer players. The massive widening out of credit spreads have likely turned off some real money accounts as well. Add to this the pervasive uncertainty in the market, the drying up of private equity deals and some well deserved risk aversion and it becomes clear why volume has fallen off. The VIX has retraced much of the week’s gains but does not look particularly like a buy at the moment. However it will be a buy if it manages to hold the 20 handle next week amid a slew of economic data including; Construction Spending and ISM Manufacturing on Tuesday, MBA Mortgage Applications, Challenger Job Cut Report, ICSC Chain Store Sales, ADP Employment, Redbook, ISM Manufacturing, Pending Home Sales and Beige Book on Wednesday; Thursday’s data includes Jobless claims and Productivity, DOE Inventories, Chain Store Sales and Friday is NON-FARM PAYROLLS, Wholesale Trade and the DOE’s Natural Gas Inventories Report.

As for the VIX, if it holds 20, it’s likely to shoot higher due to the stronger emphasis the FED is putting on data going forward and the likelihood that some of the releases may well point to a weakening economy including NFP which may include some of the recent job losses. The S&P 10 day Historic Volatility just jumped back over 20% yesterday after falling sharply from 30 in Mid August. Vol traders are likely to be put or straddle/strangle buyers ahead of data next week.

July Personal Income rose 0.5% vs. 0.3% consensus estimates. Core PCE M-o-M came in slightly below estimates at 0.1% unchanged from last month. This indicates that inflation may be easing as the FED’s primary concern. Factory Orders for July also came in above expectations at 3.7% vs. 0.6% in June. The August Chicago Purchasing Manager Index was slightly above estimates at 53.8 vs. 53.4 last month. UofM confidence for August came in at 83.4 vs. 83.3 prior reading. Overall the data for July was strong but still does not reflect the recent turmoil in the credit markets.

FED Chairman Ben Bernanke spoke this morning in Jackson Hole, Wyoming, saying that it is not the FED’s job to bail out investors and lenders that have engaged in speculative investments. Bernanke did acknowledge that subprime is the root of recent financial market volatility with consequences for performance of the broader economy. Bernanke gave little indication of whether or not the Fed is planning to cut rates in September, saying only that it was prepared to act as needed to provide liquidity to the markets. Bernanke did say economic data from previous months may not be as useful in forecasting for the coming months, so the FED will focus its attention on “the timeliest indicators”. In short, upcoming economic data will be emphasized rather than past performance.

President Bush delivered an address outlining steps the Administration is taking to help ease the subprime crisis. Bush laid out some modest steps for assisting troubled homeowners, including rewriting the tax code to make re-financing easier and working with the FHA to make mortgage insurance more readily available. Bush emphasized that there would be no bailout of lenders. He encouraged Congress to pass a bill regarding clearer and more transparent mortgage disclosures and blamed much of the problem on confusing and predatory lending practices.
The Fed added $5 billion to the banking system via 5-day Repos. Fed Funds are currently trading at 5.25%, right on the Fed’s target rate. Equities took a dip following Bernanke’s speech, but are back near session highs up 155 points. Treasuries started the day down significantly but have gained some strength on light volume.

The National Hurricane Center reports a wave about 250 miles east of the Windward Islands could form into a tropical depression later on Friday. The NHC said that this would be the sixth tropical depression of the 2007 Atlantic hurricane season.

Junk-bond mutual funds reported their first inflows in 12 weeks as investors regained their appetites for high-risk debt; this according to JPMorgan Chase who cited AMG Data services. T-bill yields and bond yields both increased as risk appetites grew.

USD/JPY traded in the red before reversing course after President Bush’s speech and is currently higher by 8 pips to 115.93. JPY was higher vs. most major currencies in earlier trade, however sold off as equities rallied. EUR/JPY is up 22 pips to 159.09; GBP/JPY is up 70 pips to 233.79. Cable is up 49 pips to 2.0167 as interest rate futures in the UK indicate a full rate hike before year’s end. EUR/USD is up 13 pips to 1.3638 helped by a higher than expected Business Climate Indicator for August. The USD Index is marginally lower after thin trading and an early close for the Labor Day holiday.

FED Chairman Bernanke went back to his academic roots, offering a history of the mortgage markets and a view on how they have evolved.  He notes that mortgages are rarely made from deposits and that the evolving nature of securitization, the process by which mortgages are packaged and sold, has raised risk.  Specifically, Bernanke noted the  widening of credit spreads on subprime paper, the falling off of issuance of subprime paper in July and the difficulty dealers have had placing AAA rated paper.   In addition, Bernanke noted that “global financial losses (due to subprime problems) have exceeded even the most pessimistic projections of credit losses on those loans.”  Given Bernanke’s comments, it not a leap to think the rapid contagion effect from subprime to virtually the entire credit market suggests  subprime lenders and securitizers likely knew subprime was on extremely shaky ground - especially in the 2005-2006 issuance period.

One of the most interesting notions raised in Bernanke’s speech was the weighting that updating economic data will be given.  Specifically, the FED Chairman noted that , “in light of recent financial developments, economic data bearing on past months and quarters may be less useful than usual for our forecasts of economic activity and inflation.”  He said the FED “will pay particularly close attention to the timeliest indicators.”   In short, the FED will give more weight to recent data and keep a wary eye on the subprime crisis and contagion effects on the broader economy.

Lastly, Bernanke re-iterated the Richmond Fed’s Lacker’s views that it is not the FED’s job to bail out institutions and investors that have partaken in risky investments.

Overall there is little in this speech the market did not know and the main effect of it may be to create more market volatility around upcoming releases as traders understand the FED will be focusing on these data with an especially sharp eye.

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Bernanke acknowledges subprime is root of recent financial market volatility with consequences for performance of the broader economy.  U.S. economic growth has been pared by about 3/4 of a point in the last 1.5 years due to the housing market decline and further market declines are expected. Bernanke says outlook for home sales and construction are dependent on developments in the mortgage marekt; specifically, the tightening of rates for subprime and jumbo borrowers, the 2 most affected groups thus far.   Adjustable rate mortgage deliquencies are running at 13.5% in June, double the June 2005 figure.  ARMs originated in 2005-2006 are performing the worst due in part to further loosening of lending standards, specifically high LTVs and no documentation; deliquencies are likely to increase in these loans.

Bernanke traces the problem from deliquencies to mortgage lenders to their lenders - those issueing asset backed commercial paper as bridge loans and ultimately to the seemingly unrelated corporate paper market.  Bernanke acknowledges financial markets believe that “credit risks might be larger and more pervasive” and that markets have become “increasingly impaired”.

Bernanke, after outlining what has been done to ease credit crunch - discount window and securities lending rate cuts - says the FED stands ready to “take additional actions to provide liquidity and promote the orderly functioning of the markets”.  However, in the next breath Bernanke brings hope for a rate hike to earth, noting “It is not the responsibilty of the Federal Reserve to protect lenders and investors from teh consequences of their financial decisions”.  He then swings in with “BUT, developments in financial markets can have broad economic effects felt by many outside the markets” and the FED takes those into account.

Bernanke says economic data from previous months may not be as useful in forecasting coming months so the FED will focus it’s attention on “the timeliest indicators”.  In short, upcoming economic data will be emphasized rather than past performance.  The Chairman also notes that sectors other than housing have been performing well.  He wonders about the effect of home equity and cash out refinancing and their effects on consumer spending, noting that consumer house related liquidity could “smooth consumption over time”, reducing consumer dependence on spending current income (recent savings data somewhat support this view) .

Prior: 57.0

Consensus: 82.5              Prior: 83.3

July orders for manufactured goods rose 3.7%, slightly better than analysts expected and stronger than the 1% increase in June. Ex-transportation equipment orders rose 2.4%. Durable goods orders were up 6%, virtually the same as last week’s advance orders numbers. Nondurable orders increased 1.3%. Nondefense capital goods ex-aircraft, one of the early indicators of business equipment investment, rose 1.7% slightly below the 2.2% increase in the advance report. New orders rose for most major categories except computers and electrical equipment. Motor vehicle orders increased 11% and nondefense aircraft orders were up 13%. Machinery orders increased 5.6%, driven by a 60% increase in construction equipment orders and a 10% increase in orders for industrial equipment; however, orders for material handling equipment and turbine and power equipment declined. Most of the nondurable goods categories showed modest gains with only a small decline in pharmaceuticals and a 3% decline in tobacco. Orders for defense capital goods rose 37% due to a doubling in defense communications equipment orders, a 16% increase in defense airline orders and strong gains in ship and navigation equipment. While today’s numbers show strong gains from June, the value of new orders for manufactured goods are unchanged from July of last year. Also reported in today’s numbers was a 0.2% increase in the value of manufacturers inventories and a 2.6% increase in manufacturers shipments between June and July.

Kathryn Kobe NTKN, Washington DC