Market Overview Wednesday Morning 07/18/07

10:30 AM EDT :

Treasuries are getting a boost from the opening remarks in today's testimony by Federal Reserve Board Chairman Ben Bernanke before the House Committee on Financial Services. The stock indices began the day in negative territory and they currently remain there.

As expected, Mr. Bernanke depicted an expanding economy that is being constrained somewhat by the weakness in the housing sector. The Fed's prediction for the economy is growth of between 2.25% and 2.50% this year and between 2.50% and 2.75% next year. He said the projections for the current year are 0.25% lower than they were in February due to weaker than expected residential construction activity.

With regard to inflation, he said that the index of personal consumption expenditures shows an elevated year-over-year gain throughout the first five months of the year but recent core indicators (ex-food and energy) have moderated in the last couple of months. He warned, however, that the core data could reflect transitory conditions and that increased resource utilization and a spill-over of high energy prices into other areas could lead to higher levels of inflation.

Aside from the lowered estimate of economic growth for the year, bond traders have noted an emphasis on the subprime mortgage situation. This further rouses fears concerning securities backed by such loans and, therefore, generates an investment flow into the greater safety of the government-backed debt (Treasuries).

This emphasis was evident in the last part of his prepared remarks which addressed the issue of the Fed's role in protecting consumers in financial services transactions, particularly with regard to subprime mortgage lending. He outlined a number of initiatives taken by the Fed individually or in cooperation with other agencies. They include encouraging lenders to work with borrowers, consumer counseling, review and modification of mortgage-related policies in Regulation Z, and compliance reviews of subprime mortgage lenders. (BERNANKE TESTIMONY)

The economic releases of the day generally conformed to Mr. Bernanke's testimony. The Labor Department reported that its Consumer Price Index, a gauge of inflation at the retail level, rose by 0.2% last month following a spike of 0.7% in May. June's gain was slightly higher than predictions of a 0.1% rise but it was still the smallest increase since January. Excluding the volatile categories of food and energy, the so-called core index also rose by 0.2% last month, as expected. The index for food prices rose by 0.5% while the index for energy fell by 0.5%.
The decline in energy prices was reflected in a 0.2% decline in the transportation category. But the largest change came in the price index for apparel. It fell by 0.6%, the fourth consecutive monthly decline.

In the other major economic release of the day, the Commerce Department said that the seasonally adjusted, annualized pace of housing starts rose by 2.3% in June to 1.467 million. Analysts had been looking for a weaker rate of about 1.450 million. But the news was offset somewhat by data revisions that reduced May's rate from 1.474 million to 1.434 million and April's pace from 1.506 million to 1.485 million. And, despite the increase in June, the starts pace was still the third lowest in seven years.

The increase came from the two largest regional contributors. The largest contributor, the South, saw an increase of 2.4% and in the West, the rate increased by 9.0%. In the Midwest, the pace fell by 3.7% and by 2.4% in the Northeast.

A weaker than expected item in the report was a plunge of 7.5% in the rate of building permit issuance to 1.406 million (seasonally adjusted, annualized). The decline was the largest since January of 1995 and the rate was the lowest in ten years. The issuance rate is seen as an indicator of near-term start activity.

In industry news, the Mortgage Bankers Association of America said that its application index edged up last week by 0.9%. The rise came on the back of a 4.9% increase in the refinance index, the first gain in that category in the last five weeks. The purchase index fell by 1.6%, the first decline in three weeks. Refinances accounted for 37.6% of application activity last week, up from 36.2% in the preceding week but still the second lowest portion in almost a year. The news release said average fixed 30- and 15-year mortgage rates declined last week
while rates for adjustable rate mortgages were unchanged.