Market Snapshot August 9th

Very early this morning the bond and mortgage markets were trading lower in price with US stock indexes pointing to a better open at 9:30 after the serious beating taken yesterday. Nothing of substance changed over night, just a bounce in equity indexes after 634 points on the DJIA yesterday and 512 last Thursday, 1146 points. Yesterday the 10 yr note rate fell 25 basis points as money stampeded into the safety of US treasuries. Mortgages did better yesterday but were dragged higher in price primarily on treasury moves, 30 yr prices ended up .53 bp, not nearly the move seen in treasuries as it was driven by safety.

A perfect storm that hit its apex yesterday. The final straw was the S&P downgrade but there have been a few earlier straws that were breaking the backs of investors leading to the recent global panic. For a month we reported and commented on the continuing weaker economic data that in our judgment were suggesting the economy would slow in Q3 and Q4; it took a few weeks for the optimistic outlook to be blunted by reality. In Europe the EU economic outlook is also being revised lower. Emerging markets that depend on growth by exporting goods to the US and Europe also being hit. Take everything together and add in the fumbling out of Washington that fell way short of any significant spending cuts and throw in the increasing concerns that Europe may not have enough capital to fend off sovereign debt defaults and we have the perfect storm that is taking all global equity markets down. The outlook in the present hysterical atmosphere is for another decline into recession.

How bad is it for the economic outlook? It isn't looking good but is unlikely to be as terrible as what markets are currently believing. The economy cannot grow much with high unemployment and a depressed housing sector. As we noted yesterday afternoon, this is a time to take a breath and try to relax some; the outlook is not good, not nearly as was thought just a month ago. However, the outlook isn't quite as serious as the current panic would imply. Give this a week or two to settle, in the meantime interest rate markets and stock markets will be exceptionally volatile.

This isn't 2008 re-visited; in 2008 banks were broke, the financial system almost collapsed. This time banks are flush with cash, businesses are hoarding huge cash reserves and consumers have reduced debt substantially over the past four years. This is a lack of confidence in leadership in Washington and Europe. The recent demonstration in Washington of political ineptness and the continual inability of the EU and ECB to deal with their sovereign debt issues have finally shaken investors and consumers. Measures that gauge the level of European banks’ reluctance to lend to one another are approaching levels unseen since the aftermath of Lehman Brothers Holdings Inc.’s collapse. The result is, and will continue to be, fear; fear and greed drive markets---this is a period of fear. The prudent way to work through the next few months is to avoid risk, let the world settle----and it will in time-----always darkest before.....A few more sessions of hedge funds deleveraging should eventually calm things down. In the meantime expect volatility to remain at extreme levels.

This afternoon the FOMC will issue its policy statement; there is some speculation the Fed will act immediately to stem the current panic. Fed Chairman Ben S. Bernanke and fellow policy makers may extend a pledge following their meeting today to maintain record stimulus, according to economists at JPMorgan Chase & Co., BNP Paribas SA and Goldman Sachs Group Inc. What can the Fed do? There are many saying the Fed will act, but so far there isn't any suggestions of what the Fed could or would do. This isn't 2008 when financial markets were teetering on insolvency; the present situation is a lack of confidence, no jobs on the horizon and nothing that suggests the US has the will to cut spending. The Fed has little power to correct any of the issues facing markets and the economy.

At 9:30 the DJIA opened +137, the 10 yr note -18/32 at 2.38% +5 bp and mortgage prices -5/32 (.15 bp). By 9:45 the DJIA was up just 13, the 10 yr -11/32 at 2.35% and mortgage prices -2/32 (.06 bp). The equity markets still subject to selling. (see below for 10:00 levels for bonds and stocks)

This morning Q2 productivity was reported down 0.3%, a little better than -0.7% expected. Q2 until labor costs increased 2.2%.

At 1:00 Treasury will auction $32B of 3 yr notes.