Thursday Market Conditions

12/13/2007

Three economic reports at 8:30 had a dampening impact on the interest rate markets this morning.
Nov retail sales, expected to be +0.6% were up 1.2%; excluding autos sales retail was up 1.8% against estimates of +0.6%. Weekly jobless claims were expected to have declined 3K, they were down 7K. On the inflation meter is where the market took a step back; Nov PPI, expected to be up 1.5% overall, was up 3.2%; the core (ex food and energy) expected to be +0.2%, was up 0.4%. The increase in the overall PPI was the largest increase since Nov 1973. Taken the three reports together, the rate markets are under pressure in the early going this morning.

The cost of borrowing euros stayed at a seven-year high (although the 3 mo LIBOR rate did fall below 5.00% today), signaling a plan by the Fed and four other central banks to inject funds into the financial system is failing to persuade commercial banks to increase lending to each other. All key global equity markets were weak overnight as the skepticism remains that lenders will continue to keep their hands in their pockets, further depressing the economic outlook. Economists now say policy makers will cut the target Fed funds rate by at least another half percentage point because banks are raising costs for loans amid mounting losses from securities tied to subprime mortgages. The difference between the interest banks and the government pay for three-month loans, called the TED spread, rose to 2.21% yesterday from 1.59% on Sept. 18 when the Fed began lowering rates.

There hasn't been enough time or details yet to measure whether the Fed's consortium of central bankers will be beneficial in easing the credit lock up. Those jumping to judgment now are reacting to the uncertainty of details. Markets are increasingly becoming emotionally distraught over the slow pace of reaction by the administration and the Fed to come to assistance of lenders in this unprecedented sub prime mess; that still defies our imagination as to how lenders and financial markets allowed it to happen by throwing risk parameters out the window.

At 10:00, a relatively minor report, Oct business inventories. Inventories were expected to be +0.3%; they

At 1:00 this afternoon Treasury will re-open the current 10 yr note and sell $8B in their monthly auction.

The 8:30 report that PPI inflation is stronger than markets expected and the huge unexpected jump in retail sales have shaken the outlook for an economic decline and the idea that inflation isn't a problem. Well, we stand by our view that inflation concerns are over-blown, and that consumers are likely to pull back spending. PPI jumped on an increase of 17% for energy prices in Nov. Retail sales are likely the last gasp of heavy consumer spending. All that said, for the moment we have to act on what we know in terms of trading, and what we know based on the data this morning is that the economy doesn't look as bad as many have been thinking---us included.

Fed official Geithner said this morning the Fed is standing by to continue to develop methods to loosen credit at banks. No info, just a promise.

The rest of the day will take its direction from the action in equities. Stocks are starting weaker so far and although rates are a little higher, the weaker stock market is helping to support rates.