5:00 PM EDT : The 10- and 30-year Treasury securities made gains today as the shorter end of the maturity spectrum took losses. Stock rallied. In late trading, the 10-Year Treasury Note was up by 6/32, lowering its yield to 4.62%; the Dow was up by 142.99 points to 13,378.87; and the Nasdaq was up by 34.99 points to 2,576.69.
Today's economic news was surprisingly bullish. The level of durable goods orders jumped in July by the largest percentage amount in ten months and the key subcategories indicated that the gains were broad-based. And the report on new home sales for last month revealed a modest bounce in July though analysts had been looking for another decline to a new seven-year low.
The news helped lift stocks. Market sentiment has improved this week on generally easing concerns regarding the credit / liquidity issue. The Federal Reserve made no further cash injections into the monetary system today and this was seen as a positive sign; that is, reserve levels apparently seemed adequate to the Fed. Today's stock gains came even though oil prices moved up for a second day. The price of a barrel of light, sweet crude rose by $1.26 on the New York Mercantile Exchange to settle at $71.09. This was the largest one-day jump since July 31.
But by the end of stock trading, the Dow was up by 1.08%, the S&P 500 by 1.15%, and the Nasdaq by 1.38%. All three made solid gains on the week as well with the Dow gaining 2.29%; the S&P 500, 2.31%; and the Nasdaq, 2.86%.
The action in the bond market was at least partly attributable to position-squaring following the recent run-up in the yield curve. In the first two days of the week, investors made a massive shift out of short-term corporate debt and into Treasuries, sending short maturity Treasury yield sharply lower. On Tuesday, the closing spread between the 2-Year and 10-Year Treasury Note was 57 basis points, the largest gap since May 5, 2005. With losses at the short end of the market since then, today's gap is just 33 basis points. Nevertheless, yields at the short end are still sharply lower than they were in the beginning of the month.
Longer termed Treasuries made progress on the week with the yield of the 10-Year Note falling by 6 basis points. This follows a 13 basis point decline last week (yield moves inversely to price). And with the exception of last Tuesday's closing yield of 4.59%, today's was the lowest since March 28.
Next week’s economic calendar is much heavier than this week’s. Moreover, supply is an issue as there will be two Treasury auctions bringing an estimated $31 billion in new notes to market. The week is also the last of the month and is the time when portfolio managers rebalance their holdings on the basis of such characteristics as risk, yield, and return horizon. The process often entails the purchase of Treasuries though recent heavy buying may dampen the need for more purchases. And the week precedes a three-day weekend (Labor Day). Historically, trading volumes are thin in the last week of August as it is traditionally seen as the tail end of vacation season.
The first economic news comes on Monday in the report on existing home sales for last month. In June’s report, the National Association of Realtors said the seasonally adjusted, annualized rate of existing home sales fell by 3.8% from 5.98 million to 5.75 million. This was a fourth consecutive monthly decline and the pace was the lowest pace since March of 2003.
The report said that inventories of homes on the market fell by 4.2% in June, the first decline since December. But due to the slowdown in sales pace, the inventory represented 8.8 months of sales, matching May’s turnover rate.
Despite the decline in sales, home prices rose. The average price jumped by 6.1% to $276,700 and the median price by 7.4% to $230,100. This was the fifth consecutive monthly increase in both categories and the largest in two years. The average was a record high and the median the highest in eleven months. On a year-over-year basis, both categories were up by 0.3%, the first Y/Y gains since July of 2006.
Forecasts for July’s report call for another decline in the sales pace to about 5.70 million. This would be the lowest reading since November of 2002. But as today’s report on new home sales illustrated, monthly housing data can be relatively volatile since it can be affected by such variables as regional weather, economic, and demographic changes.
On Tuesday, the Conference Board, an independent research firm, will release its Consumer Confidence Index for the month. July’s index was 112.6, up from June’s 105.3 and the strongest indicator of consumer optimism since August of 2001. The healthy job market, falling gasoline prices, and high stock prices are presumed to be factors contributing to the jump in confidence. The expectations index rose to a seven-month high of 94.8 from 88.8 and the index of current conditions rose to 139.2 from 129.9. The current conditions index, like the overall reading, was the highest since August 2001.
For August, the index is expected to have fallen back to between 105.0 and 105.5.
On Tuesday afternoon, the Federal Reserve will release the minutes of its August 7th meeting of the Federal Open Market Committee (FOMC), the Fed’s monetary policy arm. While the meeting ended with no rate or policy position change, the meeting statement did acknowledge tighter credit conditions and the volatile financial markets. In addition, recent comments by board chairman, Ben Bernanke, have underscored the Fed’s concern with the health of the housing market and its influence on the general economy along with the problems with subprime mortgage products and their effect on the financial markets.
While the minutes of the last meeting might provide some clarification of these issues, they will probably not have a deep impact on observers since the credit situation has subsequently deteriorated.
Two weeks ago, Parabis, the largest bank in France, froze three of its hedge funds because they could not be adequately valued due to their U.S. mortgage-backed components. The incident roused liquidity concerns that spurred the European Central Bank to inject huge amounts of cash into its monetary system. Other central banks, including the Federal Reserve, followed suit and continue to stand ready to make additional, short-term monetary infusions.
Last Friday, in another measure to address the situation, the FOMC cut the discount rate—the interest rate charged to banks for loans directly from the Fed. Now, most Fed watchers feel that the FOMC will lower the fed funds rate at the next policy meeting slated for September 18. Some even feel that a cut may be made before then. The fed funds rate is the rate banks charge each other for overnight loans necessitated by daily reserve requirements. While the rate is determined by the borrowing activity, the Federal Reserve sets a target level and adjusts reserves to keep the actual borrowing rate near the target rate. The adjustment is made by injecting funds into or withdrawing funds from the monetary system by selling or buying securities (usually Treasuries or agency debt).
There are no major economic releases scheduled for Wednesday but there are a couple of minor weekly releases that could have an effect on the markets. These are the Mortgage Bankers Association of America’s report on mortgage application activity for this week and the weekly report from the Energy Department on oil inventories.
The bond market may feel some pressure from new supply on Wednesday as the Treasury will be conducting its monthly auction of 2-Year Notes. The arrival of new supply usually keeps bond prices down until the market has a chance to begin digesting the inventory. Traders who will be making bids refrain from pushing prices up prior to an auction in order to keep yields up (bids are for yield—the higher, the better for the auction participants). Other traders also avoid purchasing the soon-to-be off-the-run issue since the new one will have greater liquidity. They also assume a wait-and-see posture until the results of the sale are known.
Last month’s 2-Year Note auction drew lukewarm participation. Bids exceeded the $18 billion offer amount by 2.59 to 1, down from the 2.80 bid-to-cover ratio in June’s auction and from the average of 2.72 for the twelve auctions preceding July’s. Non-competitive bids, a gauge of individual investor demand, totaled $698 million, the lowest amount for a 2-Year issue since November of 2003. This represented 3.9% of the issue, matching April’s, but the twelve-month average was 4.5%.
Foreign demand was unimpressive. Indirect competitive bids, which include those from foreign central banks, garnered 27.4% of the issue. This was the same award percentage as in June’s auction but it was below the twelve-month average of 33.2%.
Wednesday’s issue is expected to have a face value of $18 billion, the same as in the last six offerings. The deadline for competitive bids is 1:00 Eastern Time.
On Thursday, the initial jobless claims report will focus attention on the employment situation once again. Yesterday’s report did not provide much insight. It said the seasonally adjusted level of initial claims for state unemployment benefits fell by 2,000 last week to 322,000. But the previous week’s originally reported figure of 322,000 was revised up to 324,000. The four-week moving average, which smoothes out some of the short-term volatility, rose by 4,750 to 317,750. The weekly average for the year to date is 317,576.
The initial claims data continue to suggest that hiring is outpacing layoffs, resulting in growing payrolls. But the level of continuing claims is continuing to creep higher. The report said that the level of continuing claims for the week ending August 11 (continuing claims must be at least a week old) rose by 16,000 to 2.572 million, the highest reading in four months. The four-week average was up by 7,750 to 2.553 million, the second highest reading in five months. The weekly average for the year to date is 2.524 million.
Also out on Thursday is the preliminary report on gross domestic product (GDP) for the second quarter. GDP is the market value of all final goods and services produced by labor or property in the country in a year’s time. Quarterly data is adjusted and annualized and changes from quarter to quarter indicate the strength and direction of the economy.
The advance report, released on August 30, said that GDP grew in the second quarter by 3.4%, the largest increase since the first quarter of 2006. But revisions going back to the beginning of 2004 resulted in eleven of the thirteen quarters being revised down. The average quarterly revision to the growth figures over that time span was a reduction of 0.3%. The originally reported final reading for the first quarter of 2007 was trimmed from 0.7% to 0.6%, the smallest increase since the fourth quarter of 2002.
The inflation signals in the advance report were mixed but a key indicator was particularly encouraging. The overall price index rose by 2.7% following a 4.2% increase in the first quarter but the price index for personal consumption expenditures (consumer spending) was up by 4.3% following a 3.5% rise. However, the chief contributor to the PCE price index growth was a jump in energy prices. Excluding the volatile categories of food and energy, prices were up by just 1.4% following a 2.4% increase in the first quarter. This was the smallest increase since the second quarter of 2003.
Earlier this month, the Commerce Department reported a much smaller trade deficit in June than had been predicted. In addition, May’s originally reported deficit was also revised down. The lower deficit numbers constitute a positive contribution to GDP. The latest retail sales report also indicated revisions in previously reported data that brightens the second quarter growth picture. Projections for Thursday’s report now call for a growth reading of about 4.0%.
More supply comes to market on Thursday in the monthly 5-Year Note auction. Last month’s was less than successful. The bid-to-cover ratio for the $13 billion offer was 2.15, down from June’s 2.73 and the twelve-month average of 2.45. Non-competitive bids totaled $122 million, down from $187 million in June’s auction and below the twelve-month average of $157 million. And foreign demand was weak. Indirect competitive bids garnered 19.7% of the issue, down from June’s award portion of 32.3% and below the twelve-month average of 30.5%. Thursday’s offer size is expected to be $13 billion, matching the last eight issues.
On Friday, the first release is the report on personal income and spending for last month. In June’s report, the Commerce Department said that personal income, the fuel for consumer spending, rose by 0.4%, matching the increase in May. Personal consumption expenditures (PCE or consumer spending) rose by just 0.1%. This was the smallest increase since a 0.1% decline last September, though May’s originally reported rise of 0.5% was revised to a gain of 0.6%.
The retail sales report for July indicated an increase of 0.3% following a decline the month before of 0.7%. This suggests that the PCE figure in next week’s report will show a stronger gain. Forecasts are calling for a 0.4% increase. Personal income is expected to have risen by 0.3%.
The next major release on Friday is the report on factory orders for July. In the last report, the Commerce Department said the seasonally adjusted value of new orders rose by 0.6% in June following a 0.5% decline in May. The increase was the largest since March though observers were expecting a stronger gain. The report said that durable goods orders rose by 1.3% (revised in today’s report to 1.9%) and that nondurable goods orders fell by 0.1%. Excluding transportation, orders were down by 0.5%. Excluding those in the defense sector, orders were up by 0.9% but if commercial aircraft orders were further excluded, orders were down by 0.9%. Ex-defense orders for capital goods minus commercial aircraft, a proxy for core business demand, were flat (0.0%) in June after a 1.5% decline in May.
Recent forecasts were calling for a 0.9% increase in factory orders in July but the much stronger than expected durables report suggests that the gain will be significantly stronger. A better estimate would be between 3.0% and 3.5%.
Also on Friday, the Chicago branch of the National Association of Purchasing Management (now known nationally as the Institute for Supply Management) will release its index figures on the region's manufacturing activity for August. July's release said the organization's Purchasing Managers Index came in at 53.4, down from June's 60.2. Any reading over 50.0 reflects a general increase of activity relative to the preceding month but July’s index was much lower than the 59.0 forecasters had predicted. Little change is anticipated in August's index reading.
The final release of the week is the final read on consumer sentiment according to the survey data compiled by the University of Michigan. In the preliminary reading, released last Friday, the overall index was 83.3, down from July's final reading of 90.4 and the lowest reading since last August. Analysts are predicting a slight improvement in the final reading to about 84.0 but this would still be the lowest final reading in twelve months.
10:30 AM EDT :
Despite stronger than expected economic data released this morning, Treasuries are holding up relatively well with the long end of the market in positive territory. Bullish data often hurts bonds since it diminishes the case for a Fed rate cut. The stock market has also failed to get a significant boost from the news and the indices are currently narrowly mixed.
In the first release of the day, the Commerce Department said that the seasonally adjusted level of durable goods rose by 5.9% in July, a much stronger jump than the 1.0% that analysts had predicted. It was the largest gain since last September. Moreover, June's last reported increase of 1.5% was revised to a gain of 1.9%.
Durable goods are defined as items meant to last three years or more. They are usually labor-intensive to produce, expensive, and therefore often financed. Because of this, the trend in orders provides some insight regarding upcoming production activity and the effect interest rates may be having on the process.
A volatile category is transportation and it saw a gain of 10.8% in July. Within the category, motor vehicle orders were up by 9.8% and orders for commercial aircraft were up by 12.6%. But even excluding transportation, orders were up by 3.7%, the largest gain since August of 2005.
Another category that can skew the overall picture is defense since orders there are not governed by standard market forces. Defense orders were up by 30.3% but excluding the category, orders were still up by 4.9%. Further excluding commercial aircraft from the ex-defense figures showed a gain in orders of 4.1% last month, the biggest jump since March of 2004.
And another closely watched category is ex-defense capital goods minus commercial aircraft. This category is seen as a proxy for core business demand on the production process. It saw an increase of 2.2% in July, the first increase in three months and the largest increase in four.
Later, in a separate report, the Commerce Department said that the seasonally adjusted, annualized pace of new home sales rose last month by 2.8% to 870,000, up from an upwardly revised 846,000 pace in June (originally reported as 834,000. The increases came as a surprise to analysts, who were predicting a decline in July to 820,000.
The increase was not geographically broad-based as the pace fell in the Northeast by 24.3% and in the Midwest by 0.9%. But in the larger contributing regions, the rate increased. The South saw a rise of just 0.6% but the West saw a spike of 22.4%, its largest increase since March of last year.
The report said that the inventory of homes on the market fell by 0.9% to 533,000. This was the fourth consecutive monthly decrease and the lowest level since January of last year. Combined with the increased sales pace, this inventory represented 7.5 months worth of sales, down from 7.7 months worth of inventory at the end of June.
The report said the average new home price fell to $300,800 from June's $304,900 but the median price rose to $239,500 from $230,600. The average price was down by 3.4% on a year-over-year basis and the median price was up by 0.6%.
This morning's data may still provide some traction for stocks and bond traders may begin to exercise some caution ahead of next week's heavier news calendar and new supply headed to market.
