Economic & Market Update: December 8, 2008
“Rough Sledding Ahead”
Chip Norton, Managing Director of Fixed Income & Economic Analysis
Last Week:
Unemployment Rate: 6.7%
Nonfarm Payrolls: Down 533k
Dow: 8635
S&P 500: 876
VIX: 59
3-mo TBill: 0.01%,
AAA 10-yr Municipal: 4.23%, selective bid in place
Dollar/Euro: 1.28 – Finding stability at current range
Oil: $43.5
Economics This Week:
Date Item Est. Comment
12/12 PPI -1.8%/0.2% Core and overall continue to decline
12/12 Retail Sales -1.4% Slowing continues
After last Friday’s employment report showing 550,000 jobs lost in November, one would expect the equity market to have a case of acid reflux. To the contrary, the market somehow figures out this is a good thing and the Dow rallies 259 points to close at 8635. It’s a hard one to figure out. Possibly, it’s a case of “sell on the rumors and buy on the fact.” Now that the bad news is in maybe market traders think it couldn’t get much worse. I’m not sure I’m willing to take that bet just yet. The wave of job layoffs is in its first stage. During December, many companies have closed their doors or downsized considerably. And, we haven’t even seen the first big rounds of downsizing by the car companies. Add to that, the continued year-end tax selling and the mountain of hedge fund redemptions in the wings and a case could easily be made that the bad news wave has yet to crest.
On the positive side, the fact that global governments seem to be in stimulus mode has provided some optimism for the equity markets. Indeed, as we begin this week, there is fresh talk in Asia, Europe and here in the US for significant stimulus packages (including the auto loan rescue). In China, the government announced it would expand the $590 billion spending plan it announced a month ago. Some of the big shops on Wall Street are now even calling a bottom.
At Standard & Poor’s the analysts see the bottom by summer. “S&P expects this recession will bottom in mid-2009, after setting a post-war record for duration. S&P’s IPC projects the S&P 500 to close 2009 at 1025, for a 20% rise from the expected 2008 close of 850, on an expected recovery in economic growth from massive government stimulus and a gradual improvement in corporate earnings outlooks.
Treasury Bonds Hot off the Press
To keep pace with the ever increasing stimulus programs, the Treasury is selling huge amounts of bonds, yet yields keep moving lower. The yield on the 10-yr is now at 2.65% while the two-year stands at just 95 basis points and the 3-month T-Bill is only 1 basis point. It’s hard to believe that with yields at such historic low levels, there would still be available buyers.
As we all know, China has been a major buyer of Treasuries but they too are seeing growth compress and are having to stimulate their economy. It would seem only reasonable that at some point they would need to divert their money to homeland projects rather than Treasury investments. But many say the Treasury still has plenty of willing buyers in the wings, especially overseas. Federal Reserve data show that ownership of Treasuries on behalf of foreign central banks and other institutions rose 12 percent since September, compared with a 7.7 percent increase last quarter. According to Bloomberg, gross issuance of Treasury coupon securities will rise to about $1.15 trillion in fiscal 2009 that started Oct. 1 from $724 billion the year before. Morgan Stanley, says it may reach $1.5 trillion.
Funds Rate to Zero?
Next week, the FOMC meet on monetary policy. The market consensus is that they will cut rates once again. However, it will be increasingly difficult to move the fed funds rate much lower than its current 1.0% level. Based on the fed fund futures, the highest probability is for a 75 bps cut to just 0.25%. Amazingly, there is a 25% probability for a full 1% cut which would bring the funds rate to zero. To manage this situation, Fed chairman Bernanke announced last week the Fed would possibly buy Treasuries directly from the market. Indeed, they already do this every day via their open market operations. However, Bernanke and team are running out of monetary levers to pull, so stepping up the open market operations is an easy course of action. It’s also why many market players are willing to own Treasuries at such low yield – they expect solid buying from the Fed.
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