Recession?

Wednesday, September 19, 2007

ECONOMIC DATA / NEWS

The FOMC committee tried to keep some of their statement’s focus on inflation, but based on their words and actions, they are clearly more worried about economic growth at this point.  While at their August 7 meeting they said, “…the Committee’s predominant policy concern remains the risk that inflation will fail to moderate…”, yesterday’s statement shifted their attention to “Developments…have increase the uncertainty surrounding the economic outlook.”  Even more specifically than that was an earlier line in the statement which explained, “…the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally.”

But it was the combination of the expressed concerns mixed with their rate decision that presented the full picture.  Many already considered it extreme that the Fed cut the overnight lending rate by .50% (we feel it was just what was needed), but then they went farther than that by cutting the discount rate by an additional .50% on top of their mid-meeting cut, bringing that rate down by a full percent in a matter of a month.  These aggressive and decisive actions showed the financial and credit markets that the Fed is willing to step in and alleviate as much pressure as possible, despite their assertions that it is not the Fed’s responsibility to save people from poor investment decisions.

The CPI reported that overall consumer prices fell by .1% last month, and the core CPI rose by .2% as forecast.  The core rate is now at an annualized 2.3%, compared to 2.6% a year ago.  So, inflation is receding, which makes it that much more of moot point that the Fed has turned away from that issue.  Consumer spending has been slowing, which is why businesses have been unable to raise their prices any quicker.  If the economy were to slow down to the point of recession, then we could even see a reversal in prices, bringing inflation way down over the next year.

Housing starts were lower again in August, dropping from 1.38 million to 1.33 million.  Since the number of homes for sale has been rising, builders will continue to scale back.  An improvement in home sales will have a greater impact on the overall economy than growth in housing starts, but construction activity will be revived once homes sales increase anyway.

The Dow is up another 100+ points this morning to add to the 250 point gain following yesterday’s Fed announcement.  That is sucking some money out of bonds for now, but we expect this to be a very short-term effect.

TECHNICAL ANALYSIS

The FNMA 30-year 6.0% was up 6bp, but it couldn’t hold those gains.  Treasury prices have dropped a lot over the last 24 hours, so investors are looking for better returns from selling MBS instead.  There has got to be some profit taking occurring as well after the huge rally late yesterday.  Prices are now down 9bp at 100.66, which is still much better than the 100.34 price we started at yesterday.

As we just mentioned, Treasuries have seen some big losses since the Fed announcement.  Although we believe the prospects of a recession, as emphasized by the Fed statement, will ultimately lead to increased bond investment, the stock market was energized by the idea that the Fed is doing what they can to help the financial markets.  The money to buy the stocks has to come from somewhere, so Treasuries get the raw end of that deal.  The 10-year yield has jumped nearly 10bp to 4.56%, a two week high.  There is not much resistance before the 50-day moving average at 4.71%, but we don’t believe the yield will get that high before coming back down.

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