Economic & Market Update: December 1, 2008

“The Final Stretch”

Chip Norton, Managing Director of Fixed Income & Economic Analysis

Last Week:

Q3 GDP:                                      -0.5%- weaker than expected

Consumer Confidence:           Lower again

Dow:                                               8829 – Nice rally off the lows

S&P 500:                                      896 – The support levels held

VIX:                                                55 – Volatility caves on equity rally, down 25 points

10-Yr Bond:                                  2.87%; Breaking the 3% barrier – lowest in 45 yrs

3-mo TBill:                                   0.04%; Still near zero interest

AAA 10-yr Municipal:             4.20%, selective bid in place

Dollar/Euro:                                1.26 – Finding stability at current range

Oil:                                                  $51.6 – Trends set for lower levels; Gas seen at $1.80

Economics This Week:

Date      Item                                                Est.                     Comment

12/5      Unemployment Rate                    6.8%                    Up from 6.5%

12/5      Nonfarm Payrolls                        -300k                   Another big hit

Like all of you, I turned the page in my calendar today to December. It’s been a long and stressful year to say the least, but we’re finally in the home stretch and things feel just a bit better on the home front. Even though today’s market appears to be set to be a weak one, last week’s multi-day rally and Black Friday’s shopping results suggest that there is some good news to be digested with the bad. 

The terrorist’s attacks in Mumbai over the weekend were appalling and have again raised geopolitical tension around the world. World markets are feeling this concern with weakness in nearly every sector. Indian officials still have not sorted out all the details, but a coordinated attack on multiple targets with such devastating results brings back to center stage the reality of the world we live in and the war we are fighting.

Holiday Shoppers Out for Bargains

On the home front, shopping results look stable with stores reporting on average about a 3%-5% increase in sales over 2008. Market research firm ShopperTrak reported that sales on “Black Friday” (the day after Thanksgiving – traditionally the launch of the “holiday” shopping season) increased 3% year-over-year, to about $10.6 billion. Last year, sales on that day increased 8.3% over the previous year. This is certainly remarkable given the state of the general economy and the decline in consumer confidence. Of course, we aren’t fully into the holiday retail season, and discounts are deeper than ever. We also know that this will be the last holiday for many stores, but hey, it costs about a third as much to fill up your car as it did in August!

Employment on Friday Won’t Be Fun

On Friday, we get the employment data for November and it looks like another tough month. Current estimates have the unemployment rate moving up to 6.8% and the job loss number at 300,000. This trend is one we all expected and will impact the ability of the economy to recover in 2009. The good news is that the most recent round of economic recovery plans appears to be favorable to Wall Street and could provide a path to a forward recovery.

Treasury 10-yr Bond Below 3%

Last week the 10-yr Treasury broke below 3% for the first time in over 45 years, to the lowest yield since the Federal Reserve started daily records in 1962. It also resulted in the largest one week gain in return since 1981. The drop to these new levels signals continued flight to quality focus by traders and investors and uncertainty in other financial assets, including bonds and stocks.

Source: Yahoo

TARP and Now TALF Takes a New Turn – For the Better

Last week, the Federal Reserve and the Treasury announced a new program to assist in the recovery of the economy and to provide new credit to a very tight market. The program announced on November 25th, called the Term Asset-Backed Securities Loan Facility (TALF), is designed to help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).

According to the Fed, “Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated asset-backed securities (ABS) backed by newly and recently originated consumer and small business loans. The FRBNY will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS. The U.S. Treasury Department--under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008 – will provide $20 billion of credit protection to the FRBNY in connection with the TALF. 

What prompted this new initiative was the near halt of ABS issuance in the last few months.  In 2007, almost $300 billion in ABS were issued. The ABS markets historically have funded a substantial portion of all consumer credit and SBA-guaranteed small business loans. The Fed and Treasury Departments indicated that continued disruption of these markets could significantly limit the availability of credit to households and small businesses and thereby contribute to further weakening of US economic activity. The TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads.

In the Fed statement last week, it stated that the Fed will purchase the direct obligations of housing-related government-sponsored enterprises (GSEs) – Fannie Mae, Freddie Mac, and the Federal Home Loan Banks – and mortgage-backed securities (MBS) backed by those same GSEs. “Purchases of up to $100 billion in GSE direct obligations under the program will be conducted with the Federal Reserve's primary dealers through a series of competitive auctions and will begin next week. Purchases of up to $500 billion in MBS will be conducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end.”

As with every other new credit program, this one is complex and far reaching but the bottom line is that the markets view this one very favorably. The equity markets were able to build a rally and bond managers we spoke to last week suggest this could finally be the path to setting good mark-to-market values in the mortgage market. Many sectors, including the plagued commercial mortgage backed securities (CMBS), have seen very solid rallies with spreads tightening. However, a look at the 3-month Treasury bill still tells the story of an intense flight to quality mentality existent in the market. The 3-month bill is yielding just 4 basis points (.04%) as we enter the week. In addition, the 10-year Treasury broke below 3% for the first time in 50 years. As we mentioned last week, when investors are willing to put money in something that provides only security and no return, you know you’re a long way from being out of the woods.

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