Need To Know News

The advance report on third quarter GDP growth showed the output of goods and services expanded at a 3.9% annual rate during the July to September period. That was substantially above the 3.1% that analysts expected and slightly outpaced the second quarter growth rate of 3.8%. Final sales grew at a 3.5% annual pace, almost the same as in the second quarter.

The GDP price index increased at a 0.8% annual rate, its smallest rate of increase since the second quarter of 1998. The core price index rose 1.6%, that matched the rate of increase seen in the second quarter. The Fed’s favored PCE core price index rose at a 1.8% annual pace, slightly faster than in the second quarter but still within the Fed’s comfort zone.

Personal consumption expenditures rose at a 3% annual rate and contributed 2.1% to GDP growth. That was about twice the growth rate of PCE during the second quarter of the year. Durable goods sales increased at a 4.4% annual rate and services increased at a 2.9% pace. Business investment grew at only a 0.8% annual rate after a 4.6% increase in the second quarter. That reflected the continuing weakness in residential construction, down at a 20.1% annual rate, which took over a percentage point off of GDP growth. However, nonresidential construction added about 0.8% to the GDP gains with nonresidential structures showing a 12.3% annual rate of growth and equipment investment up 5.9%. Exports grew at a strong 16.2% annual rate. Imports grew at a 5.2% annual pace, after falling 2.7% in the second quarter. Overall trade contributed slightly less than a percentage point to the GDP gains as the increased imports partially offset the 1.8% contribution of exports alone.
Government expenditures increased at a 3.7% annual rate with Federal expenditures up 6.8% largely due to defense expenditures. Inventories expanded by $15.7 billion in real terms. Nonfarm inventories rose $12.4 billion, a larger increase than in the second quarter. Even though there were two auto strikes during the quarter, auto and truck output increased at a 12% annual rate during the quarter after growing only 1% in the second quarter. Despite two quarters of relatively strong growth in GDP, real output is only 2.6% above year earlier levels.

The surprising GDP data should yield some bond selling, while equities and the USD should pick up strength.

Kathryn Kobe NTKN, Washington DC

Q3 Employment Cost Index up 0.8%, marginally less than the expected 0.9% on a quarterly basis. Wages and Benefit costs were both up 0.8% in the June through September period. On an annual basis, Compensation rose 3.3%, unchanged from last quarter’s reading. Wages rose 3.3% on an annual basis, nearly unchanged from the Q2 reading of 3.4%. On a quarter-on-quarter basis, benefit costs fell from 1.3% to .8%. Service worker wages and salaries increased the most at 1.5% versus no increase in wages in the Production, Transportation and Material moving industry. State and Local Government wages increased on par with Management, Professional and related jobs at 0.7%. The smaller than expected increase suggests inflationary pressures, via compensation, are at bay.

September Housing Starts in Japan came in at -44% year-over-year, while
Construction Orders fell 16.3% year-over-year. The Bank of Japan voted 8-1
in favor of holding the Japanese benchmark at 0.5%. The Japanese central
bank has previously expressed desire to raise its extremely low benchmark at
a gradual pace. The BOJ voted against a rate hike today as the collateral
effects of the US subprime mortgage meltdown have yet to fully manifest. The
Nikkei gained 86 points finishing at 16737 and the Hang Seng fell 285 points
to 31352. The yield on the 10yr JGB fell 0.1 to 1.6% overnight while
Japanese Yen is lower vs. most major currencies, falling .37% vs. the USD at
115.06.

Deutsche Bank reported Q3 net income at $2.34 bln, which helps ease concerns
over the German banks exposure to US subprime. The Euro-Zone annualized
unemployment rate in September came in higher than expected at 7.3% as did
Euro-Zone CPI year-over-year at 2.6%. Oct. Consumer confidence also came in
lower than expected at -6, while economic confidence came in just below
estimates. The DJ EuroStoxx is up 12 points to 4475; the FTSE 100 is up 13
points to 6672 and the DAX is up 12 points to 7990.

Nationwide House prices in the UK came in higher than expected at 1.1%,
evidence the housing market in the UK has yet to slow down. Cable hit
another record high overnight at 2.0743 ahead of today�s FOMC rate
announcement.

MBA Mortgage Applications came in at 3.8% vs. a 0% reading last week. ADP
Employment change comes out at 8:15 and is expected to come in at 58k vs.
58k prior. Q3 GDP comes out at 8:30, expected to be at an annualized rate of
3.1%; the employment cost index also comes out at 8:30. At 10:00 we�ll bring
you Sept. Construction spending, expected to be at -0.5 vs. 0.2% prior. At
2:15 we�ll bring you the FOMC rate announcement, where the FED is expected
to cut 25 BPS.

Equity and Bond trading was somewhat subdued today with equity markets opening lower then selling off behind worse than expected Consumer Confidence data from the Conference Board. This is the 3rd month running that Consumer Confidence was lower; expectations on employment, business conditions and earnings were all lower as well. Equities sold off in the wake of the data and bonds went bid. Bonds have pared their gains and are near unchanged from the 2 to the 30yr. Equities are up off their day low levels but have not undergone a significant sell-off.
The Dollar took another shellacking today with CABLE trading up near 2.07 late in the afternoon. Clearly the FX markets are expecting a cut in rates as well as a recessionary flare up. EUR/USD is also trading near day highs, the third day in a row of EUR/USD record levels.

Oil sold off sharply behind the OPEC President’s pledge to supply needed oil, his notion that Oil would not reach $100 per barrel and the admission the OPEC has an excess of 3.5mln barrels per day; the implication was clear. PEMEX reopened the spigot today as well. Goldman Sachs jumped on board saying traders should take profits on new highs in crude oil. NYMEX front month ended the day down $3.59, nearly 4% on the day.

Some profit taking pushed metals lower with Dec. Gold losing $7.40, Silver off 15.5 cents and Platinum down $25.

Tomorrow’s data includes ADP Employment at 8:15am, Employment Cost Index at 8:30am, Q3 Advance GDP at 8:30am, Chicago PMI at 9:45am, Construction Spending at 10:00am, EIA Petroleum Statistics at 10:30am and the FOMC decision near 2:15pm.

Q3 advance GDP is likely to come in below the 3.8% achieved in Q2;, the question being how much lower?
The consumption input for Q3 GDP is not likely to impress; both durables and non-durables are expected to show a Q3 drop. And services, though expected to be positive, are not likely to cancel out the drop in durables and non-durables. Q3 GDP should leave no doubt of the credit crunch’s effect on consumption.
Continued housing weakness is likely to cause a drag on the investment portion of GDP. As well, investment in other sectors is likely to be restrained due to the credit crunch, which leads to further Q3 GDP deterioration.
Net exports will actually be a positive addition to Q3 GDP, thanks to a weak USD. The US still runs a trade deficit; however, this deficit will be less than in Q2. Government spending will also help Q3 GDP with a reduction in deficit spending. However, these positive developments are not significant enough to turn Q3 GDP positive.

Upside Surprise:
Even if Q3 GDP has surprises to the upside it is still likely to reduce the 3.8% annualized growth rate projected. A surprise to the upside is not likely to impress markets, however, may help prevent consecutive quarters of negative GDP, which of course means recession.
Downside surprise:
A downward surprise to Q3 GDP is less likely considering expectations for a poor reading. However, surprises are always on the table and a much worse than expected reading will open the door for 50bps speculation.

Wednesday should bring forth an interesting juxtaposition between rate expectations and economic expectations. Will bad news mean good news for markets? Or will bad news mean bad news for markets as it should?

The USD Index started the day higher, before falling off following today’s poor consumer confidence data. Also leading the dollar lower were comments from former FED Chief Alan Greenspan in which he mentioned “long-term USD erosion” thanks to the US trade gap. Oct. Interest rate futures show a 92% chance of a 25 BPS cut and an 8% chance of when the FOMC announces rates tomorrow. Cable hit a historical high at 2.0694; EUR/USD is flat at 1.4420; USD/JPY is flat at 114.72 and the USD Index is marginally lower at 76.805.

A 50 BPS cut tomorrow will likely result in a USD sell-off and a 25 BPS cut should also yield some USD selling as well; however, as a 25 BPS is widely expected and may have already been built into the USD. If the FED does not cut rates the USD is likely to rally.

The ECB Axel Weber said the ECB is more focused on price stability as opposed to stability in foreign exchange. Weber believes the ECB needs to raise rates to a “restrictive level” in order to combat upside risks to prices, which include energy and food costs. GBP/EUR is up .2% to 1.4324; EUR/JPY is up .25% to 165.79 and GBP/JPY is up .43% to 237.49.

Tomorrow’s Releases

ICSC/UBS Chain Store Sales up 0.1% (Oct. 27th week) vs. -1.5 prior
Y/Y—up 2.5% vs. 2.2% prior
Redbook Retails Sales: 1.9% y/y week; 2.2% y/y month; -0.3% m/m
S&P/CS Composite-20 y/y: -4% vs. -3.8% prior revised
Consumer Confidence: 95.6 vs. 99.5 prior revised
1:00e— 4-week bill auction

Merrill’s Stan O’Neil “steps down”

Stan O’Neil has stepped down as Merrill Lynch’s CEO following an abysmal Q3 that included $8.4 bln in write-downs. Alberto Cribiore will take over on an interim basis and help in the search for a new CEO.

US Treasury/ Fixed Income

The FED added $12 via 2-day REPOS and $5 bln via overnight REPOS

Oct. FED Fund Futures now factor in a 94% chance of a 25 BPS cut and a 6% chance of a 50 BPS cut when the FOMC meets on Halloween. FED Funds have averaged around 4.5% at day’s settle since the FOMC cut 50 BPS on Sept. 18th.

CBOT Oct. Binary Options show a 67% chance of a 25 BPS cut; a 15.5% chance of a 50 BPS cut and a 17.5% chance the
FED will leave rates unchanged.

Oct. FED Fund Options show a 74% chance the FED will cut 25 BPS; a 12% chance the FED will cut 50 BPS and a 12% chance the FED will leave rates unchanged.

The US Treasury will sell $20 bln in 4-week bills at 1:00e

Bonds are flat to lower as tomorrow’s rate announcement looms.

30-yr. yield: up .066 to 4.67%
10-yr. yield: flat at 4.38%
2-yr. yield: flat at 3.81%
6-month yield: flat at 4.07%
3-month yield: flat at 3.99%
4-week yield: flat at 4.07%

Equities

Equities started the day in the red and where sent lower following the poor consumer confidence data.
DOW Futures: down 64 to 13840
S&P Futures: down 9.5 to 1537
Nasdaq Futures: down 1.25 to 2214

Forex

The USD is mixed on the day, hitting a new record low vs. GBP

USD Index flat at 76.808
EUR/USD flat at 1.4429
USD/JPY flat at 114.67
Cable up .28% to 2.0681
USD/CHF down .35% to 1.1606
USD/CAD flat at .9538

Commodities

Energies and metals are lower across the board except natural gas.

Crude down 1.6% to 92.04
Unleaded down 1% to 230.43
Heating Oil down .46% to 245.32
Natural Gas up 1.63% to 8.106

Gold down .72% to 786.90
Silver down .66% to 14.335
Platinum down 1% to 1450.80
Copper down 1.92% to 345.35

October Consumer Confidence fell for the third month hitting 95.6, down 3.9 from the September reading nearing levels not seen since October 2005. The Present Situation Index fell to 118.8 from 121.2 in September and the Expectations Index fell to 80.1 versus 85.0 in September. The survey shows consumers overall are more pessimistic in their outlooks concerning jobs, business conditions and incomes. Consumers expecting business conditions to worsen in the next 6 months increased by about 2%. Those expecting fewer jobs going forward increased 1.4%. Consumers expecting higher incomes in the coming months fell .4%.