Friday Market Conditions

09/07/2007

Any debate about the Fed cutting rates on the 18th (or before) is finished now.
The Fed will cut rates as we have been saying, and it isn't likely to be just one cut as we thought until this morning. The August employment report sent shock through the markets as non-farm payroll jobs actually declined for the first time since August 2003. Market consensus was for job growth to increase by 120K, with many looking for 100K; job s declined by 4K in August. Turning the other cheek, the market got slapped again with revisions lower in June and July. June NFP jobs were originally reported at +126K, now revised to +69K; July was revised from +92K to +68K. The overall unemployment rate did stay unchanged at 4.6%; average hourly earnings were up 0.3%, in line with forecasts.

Recession coming? That is the topic the markets will wrestle with for the next few months. That is also what the Fed will be pondering. Given the decline in the jobs market today; unless we see huge upward revisions to it next month, a recession is now looking more of a possibility. At the moment it is just a possibility, but when the job losses in the mortgage lending area and in other financial institutions such as banks hit the data, the jobs picture will look even weaker.

The report this morning takes a cut from the Fed away from the idea a cut would be done to assist the financial markets in the credit crisis to the view the Fed has to cut because the economy is slowing rapidly. Until this morning the argument that as long as job growth continued a recession was unlikely, is out the window. Although it is just one month, and some are already saying it is an anomaly, the economy is slowing and the Fed is now way behind the curve in terms of its assessment of the future. With the housing sector in depression and now jobs declining, the Fed will have to step up quickly. Home builders and construction are falling like rocks, home prices have, and will, decline, foreclosures and mortgage delinquencies will likely increase even with assistance given to refinancing and lower rates, and now goods producing sector showed a decline in jobs in the details this morning, payroll declines in manufacturing (-46K) and construction (-22K).

Benny B and other Fed officials have to be talking now about at least 50 basis points in cuts over the next two Fed meetings. The US economy is declining, as the Fed itself indicated; but the slide appears to be a more steep slope than thought. One rate cut isn't going to do it. The Fed is now in a catch-up mode; a Bernanke miss of huge proportions unless today's employment report was just a blip----which we do not think is likely. AND, it isn't just the US: if the US slides the rest of the world is going to go with us. This morning the IMF has already said the global economy will contract.

If there is any good news this morning it is in the realm of refinancing some of the coming re-sets on the sub primes and ARMs. Lower interst rates and possibly some assistance from FHA should help salvage some of the potential delinquencies and foreclosures. (We believe one way to help is for Congress to allow the FHA to extend amortization of re-fionanced sub primes that are deserving to 40 yrs; there is precedent for it going back to the late 60s; keep the term to 30 yrs but amortize over 40 yrs---those mortgages won't last more than 10 yrs anyway).

The 10 yr note will likely test its key resistance at 4.40%; the lowest yield seen since August of 2005. A break below that may give us a run to 4.00% if economic data continues to decline. The dollar is taking a real beating today as interest rates decline.