Wednesday, November 28, 2007

FED to the Rescue!

Fed speak is featuring prominently this week with the chief and his foot soldiers out and about reassuring investors that they will not let them down. Yesterday Federal Reserve Bank of Philadelphia President and CEO Charles Plosser said that because weaker economic growth is already expected in early 2008 and was considered when the Fed cut interest rates in October, he is not inclined to seek another cut unless growth is much weaker than expected. He also predicted that residential investment will turn 'positive' in the last two quarters of 2008, and said the housing market should turn around by then as well. he said. Plosser strongly suggested that he is not in favor of an additional rate cut at the next policy meeting on Dec. 11"I expect that overall real GDP will grow faster in the second half of 2008 as it returns to its longer-run trend of about 2.75 pct,", "It is important to recognize that the Fed cannot resolve this price discovery problem. The markets will have to figure this out."

The odds of further interest rate cuts increased this morning
, after Federal Reserve Vice Chairman Donald Kohn said elevated turbulence in the financial markets could tighten financial conditions for households and businesses. December fed funds futures rose 0.005 points to 95.705, which implies a 64% chance that the Fed will lower its target on overnight rates by 50 basis points to 4% after its policy setting meeting on Dec. 11. Late Tuesday, the odds of a 50 basis point cut were 62%.

In Europe central bankers are admitting that they are in between a rock and a hard place when it comes to their monetary policy. Contrary to the FED they are focused on their primary mandate to keep inflation low by watching headline inflation and not diverting attention to the ridiculous core inflation. Inflation data published in Germany yesterday show that energy and food prices pushed prices this month to the highest level since at least 1995, leading economists to forecast the annual eurozone figure, released today, would reach 3 per cent or above for the first time in more than six years. That would pose a serious challenge to the ECB, which pledges to keep inflation “below but close” to 2 per cent. It remains to be seen if the European Central Bank can resist an easing cycle that has began on the other side of the Atlantic.

European Central Bank President Jean-Claude Trichet and other European authorities are in China this week for the Sino-European conference. They are trying to go where US treasury secretary Paulson failed so far. Trichet said China may allow the yuan to rise more against the euro even as Chinese officials signaled faster gains are unlikely. Premier Wen Jiabao reiterated China will pursue "gradualism'' in making the exchange rate more flexible and rejected Europe's argument that a quicker appreciation would help narrow the region's growing trade gap. The unprecedented visit to China of Trichet and Luxembourg Prime Minister Jean-Claude Juncker may have ended in disappointment as traders sold the yuan for the first time in four days on the bet that China will resist Europe's lobbying.

We can not forget about the financials even at a day like today when everybody seems to be upbeat and buying everything that has been sold for the last couple of weeks. After the closing bell yesterday, shares of Wells Fargo dropped more than 2 percent to $29.19 after the fifth-largest U.S. bank said it would take a $1.4 billion charge in the fourth-quarter due to mortgage losses. The charge shows how the housing downturn affects even lenders with relatively prudent underwriting standards, since the company never made many of the exotic mortgages that led to soaring defaults among borrowers.

The question comes to mind if Wells is taking such a big writeoff who else will be impacted. A source that has been swept under the rug are big investment pools like government pension funds. Florida local governments and school districts pulled $8 billion out of a state-run investment pool, or 30 percent of its assets, after learning that the money- market fund contained more than $700 million of defaulted debt. Almost 6 percent, or $2.4 billion, of the fund's short-term investments consist of asset-backed commercial paper that has defaulted. Those holdings include $425 million in Axon Financial, a structured investment vehicle, or SIV.

In the real world financial players are scrambling to stop the leaking of their portfolio assets, as Chicago's Santelli would say "the leaking of their SIVs." Shares of Freddie Mac fell in after-hours trading yesterday, after the No. 2 U.S. home financing provider said it would slash its dividend by 50 percent and would raise $6 billion through the sale of preferred stock. Yesterday Citigroup announced it is receiving a $7.5 billion capital infusion from the investment arm of the Abu Dhabi government. CIBC World Markets financial services analyst Meredith Whitney, whose vociferous comments on Citigroup prompted chairman and chief executive Chuck Prince to resign earlier this month, said the new investment was “not enough, and certainly too late”. “They’re desperate,” said Ms Whitney. “This $7.5bn is just not enough money by a long shot.” She believes that the odds that the bank, the world’s largest by assets, will still cut its dividend are “100pc”, while adding that the company may be forced to sell more than $100bn of higher quality assets at a discount in order to raise cash. Australian hedge fund Absolute Capital has been put into administration, the latest domestic victim of a credit squeeze that shows no signs of easing. Half the fund is made up of about 46 per cent complex sub-investment grade collateralised loan obligations, and 4 per cent collateralised debt obligations. In Europe the situation is not much better. State run bank KfW doubled it's loan loss provisions to 4.8 million euro after higher than projected losses in the failed lender IKB bank.

To make things worse Standard & Poor's said it may cut its credit ratings on six collateralized debt obligations in Europe because of losses on securities backed by U.S. subprime mortgages. S&P placed the ratings of 17 portions of CDOs on CreditWatch with negative implications, which applies to less than 1 percent of CDOs rated in Europe.

Another cloud that is gathering on the horizon is the commercial real estate market in the US. The cost of derivatives protecting investors from defaults on the highest-rated bonds backed by commercial properties more than doubled in the past month. Sales of debt secured by commercial mortgages tumbled 80 percent to $3.9 billion in October from a year earlier. The seven-year rally in offices and retail properties ended in September when prices fell an average of 1.2 percent. More losses are likely because banks are holding $54 billion of commercial mortgages they can't sell, although mortgage brokers say traders are overreacting. Defaults are running at 0.4 percent in the U.S., below the average of about 1 percent over the past 10 years.

Amongst all this trouble ironically the consumer is holding up. Online shopping reached a record this week. ComScore said sales on retailers' Web sites rose 21 percent to $733 million on Nov.26, the first Monday after Thanksgiving. The average customer purchase dropped 12 percent because new buyers tended to spend less online. Sales on so-called Cyber Monday a year earlier climbed 26 percent. Retail sales ex auto ex gas and Wal-Mart same store sales show a declining trend of consumer purchases.

Japan's retail sales rose at the fastest pace in more than a year as consumers bought new-model cars and record gas prices increased revenue at filling stations. Sales climbed 0.8 percent in October from a year earlier, a third monthly gain. Fuel sales advanced 2.3 percent from a year earlier, the most in 11 months. Motor vehicle sales surged 2.5 percent, the fastest pace since March 2006. This data comes on the tails of the Japanese Cabinet Office’s monthly economic report, which cut its assessment of the labor market for the first time in three years. With the bank of Japan unlikely to tighten rates anytime soon investors borrowed the yen to jump start the carry trade. The dollar rose as much as 0.7 percent to $1.4724 per euro, its biggest gain since Nov. 12, and traded at $1.4732 as of 7:35 a.m. in New York. European stocks advanced for the first time this week and brokerages recommended buying shares in UBS and British Airways. Japanese stocks fell, led by Sumitomo Mitsui Financial, after Wells Fargo announced a $1.4 billion pretax charge tied to increased losses on home equity loans. The Nikkei slid 69.07, or 0.5 percent, to 15,153.78 at the close of trading in Tokyo. The Topix index slipped 3.14, or 0.2 percent, to 1,475.64. In Hong Kong the Hang Seng advanced 161points or 0.6 percent. The Shanghai Composite was down 1.1 percent. U.S. stock futures also rose, buoyed by a hint of further rate cuts in December.

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