Wednesday Market Conditions

01/02/2008

Very early trade this morning had the rate markets open under a little pressure from Monday's early close. The holidays are over and its back to business, albeit with some minor football hangover. At 10:00 a huge rally.
The remainder of this week will be focusing on the Dec employment report on Friday; expectations are for the unemployment rate to increase to 4.8% from 4.7% with non-farm job growth at 70K. Tomorrow ADP will come with their estimate for jobs.

At 10:00 the ISM Dec manufacturing report; the overall index was expected at 50.5 from 52.86 (rev'd) in Nov---it hit at a weak 47.7; new orders at 45.7 from 52.6, employment at 48.0 from 47.8 and prices at 68.0 frm 67.5 The report is one of the weakest we have seen in over a year. The ISM index has now declined for six consecutive months and is certainly forcing the Fed's hand on more rate cuts in the future. Any read under 50 indicates contraction. The Initial; reaction has been as expected with this weak outlook for manufacturing, the 10 yr note has jumped 19/32 in five minutes and the 2 yr note yield has fallen to 2.92% from 3.05% on Monday. Mortgage prices are moving higher but it will take a few minutes for them to catch up.

Also at 10:00 Nov construction spending, expected to be down 0.4%, it was up just 0.1%----more evidence for those that are continuing to to talk bullish on the economic outlook.

Holiday Internet Sales Growth Slows as U.S. Consumers Hold Back Spending. Internet sales by U.S. retailers during the holiday season rose at the slowest pace on record as consumers grappled with $3-a-gallon gasoline and the worst housing slump in 16 years.

The U.S. dollar weakened against 13 of the 16 most-actively traded currencies as traders bet the Fed will reduce borrowing costs at least twice in 2008, extending last year's 10% decline of the buck. The dollar fell against the euro in 2007 as the Fed lowered its benchmark rate by 1.0% to 4.25% since September. The euro gained 10.6% last year as the European Central Bank raised its main refinancing rate twice to 4.0%, the highest in six years.

Most of the debate as the year gets rolling is on what the Fed will do as the US economy slows. The chance the Fed will cut its target rate for overnight lending between banks by a quarter-point to 4.0% at its Jan 30 meeting rose to 92% from 76% a week ago, according to futures contracts on the Chicago Board of Trade. The odds of a reduction to 3.75% at its March 18 meeting are 61%. As you know it is a moving target, and subject to huge sentiment changes on each key economic reading. That said, all recent data is pointing to an economic decline in 2008 with housing and foreclosures leading consumers to slow spending.

The first half of 2008 should see lower long term interest rates as the Fed is likely to continue lowering rates at each FOMC meeting through June. Inflation fears have increased recently as the Nov PCE (personal consumption expenditures) core rate (ex food and energy) jumped to +2.2% yr/yr---over the Fed's "comfort" level. The Fed however is likely to look more at economic weakness than the inflation increase as long as it doesn't continue to increase. That is however, a huge leap of faith at the moment with oil prices set to hit $100.00 before the end of this week. While the Fed is expected to cut rates; it isn't likely to be a smooth ride as there will be times when the outlook for more cuts gets wound up in contra economic data.

And we can't forget the sub prime mess; it hasn't gotten much ink the past few weeks but we expect a lot deeper losses as a result of the stupid attempt to paint low quality mortgages with a rose colored brush as was the case on The Street in 2005 and 2006. 2008 is also likely to ring in the next credit defaults in credit cards and auto loans. Credit card debt and auto loans were also bundled into packages and sold to investors not willing to be satisfied with low rates of returns on good debt.

Crude oil is on its way to try $100.00; this morning crude is up over $2.00 at about $98.00. Tomorrow the EIA will report last week's inventory levels and traders are expecting another drawdown.