5:00 PM EDT :Stocks took a beating today as credit concerns intensified. Treasuries were the beneficiary of the retreat from risk and prices were up sharply across the maturity spectrum. In late trading, the 10-Year Treasury Note was up by 26/32, lowering its yield to 4.39%; the Dow was down by 366.94 points to 13,522.02; and the Nasdaq was down by 74.15 points to 2,725.16.
Though stocks had taken losses earlier in the week, they seemed to be holding up relatively well against technical pressures from recent gains (the Dow posted its record closing high of 14,164.53 on October 9), against soft economic data (bearish reports on industrial production, housing starts, initial jobless claims), and against signs that the housing / subprime mortgage / credit market problems were still threatening the economy.
On Monday night, Fed Chairman Ben Bernanke addressed the situation, saying, "Since the September meeting, the incoming data have borne out the Committee's expectations of further weakening in the housing market, as sales have fallen further and new residential construction has continued to decline rapidly. The further contraction in housing is likely to be a significant drag on growth in the current quarter and through early next year." With regard to the markets he said, "Conditions in financial markets have shown some improvement since the worst of the storm in mid-August, but a full recovery of market functioning is likely to take time, and we may well see some setbacks."
On Wednesday, the Fed's Beige Book also noted that many of the central bank's industry contacts were uncertain about the outlook for the economy and that the housing sector is likely to remain weak. On top of these negative signals, several large banking companies' earnings numbers for last quarter were lower than analyst projections. More bad news today concerning the credit situation was a downgrade by Standard and Poors on a broad array of mortgage-backed securities.
And though oil futures ultimately fell today, yesterday's close was a record high and a break above the $90 per barrel level in overnight trading has some market watchers pondering the possibility of a $100 per barrel price before too long. But today, profit-taking finally pulled futures lower. The price of a barrel of light, sweet crude oil for November delivery fell by $0.87 on the New York Mercantile Exchange, settling at $88.60. The November contract expires on Monday.
The accumulated pressure was finally too much for stocks and all three major indices nosedived today. By the end of stock trading, the Dow had fallen by 2.64%, the S&P 500 by 2.56%, and the Nasdaq by 2.65%. The declines were the steepest for the Dow and S&P 500 since August 9 and the steepest for the Nasdaq since February 27. For the week, the Dow was the biggest loser with a decline of 4.05%. The S&P 500 lost 3.92% on the week and the Nasdaq lost 2.87%.
In contrast, the yield of the benchmark 10-Year Treasury Note fell by an incredible 29 basis points this week (yield moves inversely to price).
Next week, the economic release calendar is light but it includes the reports on home sales (existing and new) for last month. Bonds will also be pressured by a heavy influx of new supply to compete for investor
dollars.
There are no major economic releases slated for Monday or Tuesday. But the first of three Treasury note offerings will be conducted on Tuesday. The Treasury will be auctioning an additional portion of last April's issue of 5-Year Treasury Inflation Protected Securities (TIPS) so the maturity will actually be 4-1/2 years. TIPS have a fixed coupon (interest) rate, but their face value is regularly adjusted according to the Consumer Price Index, so the interest payout amounts fluctuate according to the changes in inflation. At maturity, the greater of the inflation-adjusted or original redemption value is paid out.
The face value of the offering in April's auction was $8 billion, the lowest for an initial issue in the current issue schedule begun in 2004. Consequently, the face value of next week's offering is expected to be $6 billion, down from the $7 billion in each of the last two reopening sales.
In the last reopening in October of last year, the offering met with strong demand. Bids exceeded the offer amount by 2.89 to 1, the highest bid-to-cover ratio in all of the auctions (initial or reopening) in the current issue cycle including last April's. Individual investor demand was a little disappointing, however. Noncompetitive bids totaled just $67 million, down slightly from $68 million in the previous October's auction and well below the $111 million in the initial offering.
But foreign demand for was strong. Indirect competitive bids, which include those from foreign central banks, received 51.4% of all accepted competitive bids and 50.9% of the entire issue. The total award portion in the previous reopening (October 2005) was 23.2% and it was 26.1% in the initial sale of the issue (April 2006).
On Wednesday, the only major economic release is the report on existing home sales for September. In August's report, the National Association of Realtors said that the seasonally adjusted, annualized pace of sales fell by 4.3% to 5.50 million from July's 5.57 million. Though the decline was in line with predictions, it was the sixth in as many months and the pace was the lowest in five years. The report said that inventories of homes on the market rose to 4.581 million, a ten-month's supply at August's sales pace. Average prices fell by $6,700 and median prices by $4,200.
Current projections for September call for another decline in the sales rate of about 3.6% to 5.30 million. If the prediction is accurate, it would be the lowest sales pace since December of 2001.
More supply hits the market on Wednesday as the Treasury conducts 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 auction was generally successful. The bid-to-cover ratio was 3.29, down slightly from August's 3.97 but well above the 2.91 average for the twelve, 2-year offerings prior to September's. Noncompetitive bids were soft, however. They totaled $663 million, down from $856 million in August and down from the twelve-month average of $821 million. In fact, noncompetitive bids represented 3.7% of the issue amount, the lowest portion of a 2-year offering since April of 2005. But foreign demand was solid. Indirect competitive bids garnered 34.2% of the entire issue, the highest award portion since last April and slightly higher than the twelve-month average of 33.6%.
The last eight, 2-Year issues had a face value of $18 billion and that is the projected size of next week's. The deadline for competitive bids is 1:00 PM Eastern Time.
On Thursday, the jobless claims report once again highlights the employment situation. Yesterday's report said that the seasonally adjusted level of initial claims for state unemployment benefits jumped last week by 28,000 to 337,000 from the previous week's 309,000 (originally 308,000). The spike was the largest in eight months and the level was the highest in seven weeks.
The data series has been more volatile than expected in the last few weeks, moving back and forth in larger than expected swings. Analysts note that the latest spike could have been exaggerated by an additional adjustment made to offset the closure of labor offices on Columbus Day. The four-week moving average, which smoothes out some of this short-term volatility rose by 6,000 to 316,500. The average weekly initial claims level for the year-to-date is 317,878. For this week's claims figure, a decline of between 10,000 and 15,000 is anticipated.
The other early release on Thursday is the report on durable goods orders for September. 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.
In August's report, the Commerce Department said the seasonally adjusted level of durable goods orders fell by 4.9% and this was later confirmed in the factory orders report for the month. The information to follow uses whatever revisions the factory report may have made to August's report on orders for durables.
The decline was the largest in seven months but it followed a 5.9% jump the month before which was the largest increase in ten months. A large contributor to August's decline was the transportation category, which saw a contraction of 11.1%, and within the category, commercial aircraft orders were down by 39.9%. But even excluding transportation, orders were down by 1.8% -- also the biggest drop in seven months.
Orders outside the defense sector are often isolated by analysts since defense orders are not governed by standard market forces. The level of ex-defense orders declined by 5.9% in August following a 4.6% rise the month before. If commercial aircraft orders are further excluded from the ex-defense figures, orders were down by 2.0% in August following a 3.7% increase in July.
And ex-defense orders for capital goods minus aircraft -- seen as a proxy for core business demand on the production process -- fell by 0.5% in August and July's originally reported increase of 1.7% was revised down to a gain of just 0.9%.
For September, forecasters are looking for a bounce in durable goods orders of about 1.5%. The final economic release on Thursday is the report on new home sales. In August's report, the Commerce Department said that the seasonally adjusted, annualized sales pace fell by 8.3% month from 867,000 to 795,000. The decline was the largest since January and the sales rate was the lowest since June of 2000. Another decline in the sales pace of about 1.9% is predicted for September, bringing it down to 780,000. This would be the lowest pace since May of 1997.
Observers will also be watching for inventory levels and price changes. August's report said the number of homes on the market declined for a fifth straight month, falling by 1.5% to 529,000. The drop was the largest since last November and the inventory level was the lowest since January of last year. Yet, given the weak sales pace, the inventory represented 8.2 months worth of sales, up from July's turnover pace of 7.5 months.
The average new home price fell in August by $14,200 to $292,000 and the median price fell by $20,500 to $225,700. The average price was the lowest since last November and the median price was the lowest since November of 2004. On a year-over-year basis, the average price was down by 8.0% and the median price by 7.5%.
The last Treasury auction of the week comes on Thursday with the monthly issuance of 5-Year Notes. September's offering was met with strong demand. The bid-to-cover ratio was 2.86, the highest since August of 2006. But individual investor demand was soft. Noncompetitive bids totaled $119 million, the lowest amount for a 5-year offering since last April. But foreign demand was strong. Indirect competitive bids received 44.8% of the issue, the highest award portion since last December. The last ten issues of the 5-Year Note had a face value of $13 billion and that is the anticipated size of next week's.
On Friday, the only economic news is the final read on consumer sentiment from the twice monthly surveys conducted by the University of Michigan. The preliminary index, released last Friday, came in at 82.0, down from September's final reading of 83.4 and the weakest sentiment indicator since August of last year. Forecasters had predicted a more optimistic reading of about 84.0. Some improvement was seen in the index of current conditions. It came in at 98.2 for the early part of October, up from September's final reading of 97.9. But the expectations index slipped to 71.6 from 74.1.
Recent projections for October's final index number were for little change or a slight rise to 82.5. But recent economic data has been bearish and the sentiment indicator could be lower than expected. If the index has held steady or increased slightly, the news is likely to be discounted unless there are some bullish surprises in upcoming economic data.
10:30 AM EDT :
After solid gains this week, Treasuries are up once again this morning despite a lack of any new economic data. The stock indices are down sharply, spooked in part by further increases in oil futures in overnight and early U.S. trading. But, after the front-month contract price broke through the $90.00 per barrel level last night, it has retreated on a round of profit-taking and in recent trading was at $88.76, $0.71 below yesterday's NYMEX closing level of $89.47.
The fear that tight credit conditions still pose a threat to the economy were stoked by additional poor earnings news in the financial sector. Today's report came from Wachovia and it indicated earnings well below street projections. It joins other misses in the sector reported this week including those from SunTrust, First Horizon, Bank of America, and Wells Fargo.
With attention refocused on the situation, even the better than expected earnings report from Google, released after the bell yesterday, has failed to give the stock market any footing.
The drop in stocks is providing a flow into Treasuries but technical pressure may cap gains today. Although there are no major economic reports today and next week's calendar is light, a heavy load of new supply is heading to market next week as the Treasury will be auctioning a 5-Year Treasury Inflation Protected Securities issue (actually a reopening of last April's TIPS issue), a new 2-Year Note, and a new 5-Year Note. This competition for investor dollars will keep a lid on the bond market until the results of the auctions are known.
The existing and new home sales reports for last month will be released next week. Though they are expected to show further declines -- a plus for bonds in that this would further bolster the case for a Fed rate cut -- they could surprise on the high side so this gives traders another reason to be defensive. And, of course, traders may be inclined to cash in on some of their recent gains.
But for now, the bond market is being driven by the losses in stocks. Recent economic data has been bearish and the indices have been at historically high levels despite the swelling parade of quarterly earnings report releases. Yesterday's flat finish for the market may have been a last stand against the combination of negative influences as all three indices have given up a lot of ground in early trading today.
