The Federal Government Is Swimming in Red Ink

From the WSJ:

The Treasury market is abuzz with chatter about possible changes to the government's supply calendar as the bill for the credit crunch and the weak economy keeps rising.

The Treasury Department reports its next quarterly refunding schedule on July 31. Bond investors are speculating it could bring back either the three-year note, which was eliminated a year ago, or the seven-year note, which was last sold in 1993, to meet its increased funding needs. A third option is to expand the sale of 10-year notes, making it a monthly event. Currently, the department auctions a new 10-year note every quarter and reopens it one month later.

The need for change in the supply calendar has grown in the past year as the economy has slowed, resulting in lower tax receipts. This year's economic-stimulus package has added to the budget shortfall. Other items, such as support for mortgage lenders Fannie Mae and Freddie Mac, would further increase borrowing needs.

Let's take a look at the government's revenue and expenditure line from the St. Louis Federal Reserve:



Notice that space between the red and blue line? That has to be filled in by debt. And here is the debt we have issued over the last 7 years:

09/30/2007 $9,007,653,372,262.48
09/30/2006 $8,506,973,899,215.23
09/30/2005 $7,932,709,661,723.50
09/30/2004 $7,379,052,696,330.32
09/30/2003 $6,783,231,062,743.62
09/30/2002 $6,228,235,965,597.16
09/30/2001 $5,807,463,412,200.06
09/30/2000 $5,674,178,209,886.86

Given the top chart, it's no wonder that we need more debt. But note that the government has needed debt for some time. This isn't a new development.

The Problems At Freddie and Fannie Run Deep

From the WSJ:

Bank examiners from the Federal Reserve and the Office of the Comptroller of the Currency are looking at the books of mortgage investors Fannie Mae and Freddie Mac, a person familiar with the situation said.

The examiners are working with the two companies' main regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, this person said. This joint effort to assess the financial condition of the two government-sponsored companies was first reported by the New York Times Web site late Monday.

Fannie and Freddie face sizable losses as defaults increase and home prices fall. That has caused a plunge in their share prices over the past few weeks, though the shares have recovered somewhat in recent days. Ofheo has said that the companies' capital remains above their regulatory minimums.

And why are they being looked at? Here's why:

Fannie Mae and Freddie Mac may need to record more writedowns after they expanded their purchases of non-guaranteed subprime and Alt-A mortgage securities just as other investors fled to safer investments, their regulator said.

The value of $217 billion of the so-called non-agency securities is falling as other financial firms write down their holdings, the Office of Federal Housing Enterprise Oversight said in its annual mortgage market report. Privately issued securities backed by subprime mortgages made up 9.2 percent of the companies' combined portfolio, while Alt-A represented about 5.8 percent, Ofheo said.

By investing ``heavily'' in private-label securities in 2004 and 2005, the companies ``significantly increased their exposure to fair value losses from changes in market prices,'' Ofheo said. Structured investment vehicles and securities firms, battered by $452 billion in asset writedowns and credit losses, were invested in similar securities and have contributed to the price swings that may lead to more losses at Fannie Mae and Freddie Mac under generally accepted accounting principles.

``To the extent that those institutions recognize fair value losses on their private-label portfolios under GAAP, Fannie Mae and Freddie Mac may have to do so as well,'' the Washington-based regulator wrote in the report.

Subprime makes up 9.2% of the GSE's portfolio at a total of over $200 billion dollars. Imagine what happens when that portfolio has to be written down.

The following is pure conjecture; I have no inside knowledge of such things.

About a week and a half ago we started to hear very negative stories about the GSEs. Then we started to see news stories about how these entities needed cash and/or were in trouble. Here's what I think happened.

Sometime during the week of July 7 phone calls were made that involved Bernanke, Paulson and the heads of the GSEs. The main thrust of the calls was this: Fannie and Freddie were not doing well. Between rising delinquencies and falling home values the GSEs portfolios were in serious trouble and getting worse. Considering that subprime debt is 9.2% of GSE portfolios we now know that GSE's are getting hit really hard.

Then we started to see a whole lot of government support packages come out in the form of trial balloons. Basically, the federal government was trying to see what the best way to handle the situation would be.

Then we saw the Paulson GSE bail-out package come out:

First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn.

Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed.

Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer.

Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards.

Note the breadth of this package. The Treasury would determine the terms and amount of the line of credit; but there is no mention at all of the possible amount. Secondly, the Treasury will essentially provide a floor for GSE stock by allowing the Treasury to buy GSE stock in the open market. This plan would essentially allow the Treasury department to prevent a GSE bankruptcy.

There are two possible explanations for this plan.

1.) Paulson is striking while the iron is still hot. He doesn't really need all of this money and authority relative to the GSEs, but he might as well ask for it now because he might need it in the future and Congress is in a giving mood right now. This is always a possibility with a package that involves politics.

2.) Paulson has seen the books and determined the GSEs are in serious trouble and he is trying to prevent a bankruptcy or something close to it. Personally, I think this is the real answer. the GSEs have been given way too much attention lately for this to not be the explanation.

Treasury Tuesdays

Here's a question for you: "would it be a Bonddad post without charts?"



From Tuesday of last week through Friday we see the IEF -- the 7-10 year Treasury sector -- dropped continually. It continually moved through support and made new lows. The primary reason for this move was the stock market's rally. There are times in the market when stocks and bonds are inversely related; as stocks move higher they pull money away from the fixed income market. Last week was one of those times.



Looking at the 6 month daily chart, notice the IEF peaked in mid-March of this year and has been in a downward sloping trend/channel since. This also corresponds to a rally in the stock market. However, starting in mid-June the Treasury market caught a bid again largely as a result of safe haven buying. But last week prices dropped in reaction to the stock market.



On the three month chart, notice the following:

-- Prices are below the 200 day SMA

-- The 10 day SMA turned negative

-- The 50 day SMA is still heading lower, but at a smaller angle

-- The 20 and 200 day SMA are heading higher

-- Prices are below all the SMAs

-- Prices and SMAs are bunched up pretty tightly.

So -- the chart is giving some pretty mixed signals. The shorter SMAs are bearish but the longer SMAs are bullish.

Today's Markets

Let's step back a bit and take a look at the latest rally to see what it looks like and where we are in the rally cycle.

The rally started last Tuesday when the market gapped down at the open, but then rallied throughout the day. Although the market fell in the last 30 minutes, the table was set. The market rallied hard on Wednesday, especially after prices moved through the 200 day SMA and broke through upper resistance from a triangle consolidation near the same time. The market consolidated gains again early on Thursday and then broke through upper resistance again. However, from mid-day Thursday through Friday of last week the markets formed a broadening top formation. In addition, today the markets formed another consolidation pattern -- this time a triangle. Notice that after the strong run from Tuesday through Thursday of last week, the market has taken two days to consolidate gains. Also note prices are near the 200 day SMA, which will provide crucial support for a possible rally.



On the daily chart, notice prices are having a problem with the 20 day SMA providing upside technical resistance to the rally. Also note the declining volume over the last 5 days indicating declining buying interest.

What does all of this mean? The rally is stalling or consolidating. We'll know more over the next few days.

Media Appearance

I'll be on KTLK at 2:30 CST today

About Last Week's Rally ----

Food for thought ---

Everybody was excited because things weren't as bad as expected. It wasn't because things were better than expected or because companies beat with huge increases. Instead, companies showed smaller losses than those expected.

Are these reasons really a good reason to rally -- that is, do you want to buy something because losses aren't that bad? Or, do you want to buy something because it is earning a whole lot more than expected?

Now let's compound the problem. Over the last year, how many negative stories have we seen come out of the financial sector compared to positive news stories? Let's compound it even more. How many times has a financial CEO said "things are fine" only to have really bad news hit the wire within a week of the positive statement?

The Credit Crisis is Far From Over

From today's WSJ:

Banks also are pulling back on the amount of rainy-day money they have been giving out to corporate clients in the form of loans called revolving-credit facilities. Retailers such as Sears Holdings Corp. and Talbots Inc. have struggled to renew revolving-credit facilities with their bankers in recent months. Other companies, including Wal-Mart Stores Inc., AT&T Inc. and American International Group Inc., have had to agree to tougher terms on such credit.

Overall, the value of credit held by banks in the second quarter shrank 1.5% from the first quarter, according to Federal Reserve data. That was the largest three-month contraction since 1948.

These tight credit conditions are particularly worrisome because the Federal Reserve has responded aggressively since the credit crunch emerged last July. The central bank has cut interest rates seven times by a total of 3.25 percentage points.

Retailers having a harder time getting credit indicates there is concern about the strength and/or sustainability of retail spending. Also note that Wal-Maryt -- the largest retailer in the world -- had to agree to tighter lending controls. This is a company with 378 billion in revenue last year. They have to agree to stricter lending standards.

This is why last week's euphoria regarding the financial sector was so completely overblown. Everyone was thrilled because several banks reported losses that weren't as large as feared. That was the good news -- banks didn't lose as much money as projected. Yet they still lost lots of money and wrote down lots of debt. And all of those writedowns are starting to crimp lending.

Much of the decline in outstanding credit has been due to banks sharply reducing the amount of bonds and other debt securities held on their books, but the slowdown is apparent across all forms of lending. The heavy losses banks have taken on mortgage-related securities are forcing them raise cash levels, leading to tighter lending. Because they can't know what other problems might be lurking on their balance sheets, they are being especially cautious.

None of this should be surprising to anyone. We have seen over $400 billion dollars in writedowns. We have seen 266 mortgage lenders shut their doors. All of this is bound to have an impact -- which it has in the discount spread:



Also note that LIBOR is still higher than the discount rate.

Ladies and gentlemen -- anyone that is recommending you move into financial shares is an idiot. There are still major problems out there. Credit standards are tightening and loans are getting harder to come by even though the Fed has (again) lowered interest rates to 0% after adjusting for inflation. None of this is good news.

Market Monday's

I'm only going to use two charts today. But the purpose of these two charts is to demonstrate a key point: we're not out of the woods yet by any means.



On the P&F chart, simply note there is no turnaround caused by last week's price action. None. We're still printing a bearish pattern where prices have broken through support and are moving lower.



On the daily chart, notice the following:

-- The last two days the market printed two spinning tops -- candles with narrow bodies and long wicks. These are weak candles. They mean that there wasn't a great deal of intra-day action to move the markets higher; most of the gains came from the opening gap higher.

-- Prices are above the 10 day SMA but are running into resistance at the 20 day SMA

-- Prices have not broken though longer term resistance.

-- All the SMAs are still headed lower

-- The shorter SMAs are still below longer SMAs

-- Prices are below the 20 and 50 day SMA, but above the 10 day SMA

This is a chart that could continue to move higher. But the underlying technicals are not amazingly bullish right now.

Forex Fridays -- the Euro

This will be my last post before the weekend. I'm on a panel at the netroots nations convention on the subprime crisis. When the panel is over I'll be driving back to Houston so I'll be a bit preoccupied.



On the P&F chart, notice the euro has been in a very strong rally since 2002. Also note the especially strong run in 2008. However, note the possible double top forming as well. Bottom line: this chart says bull with a possible caution of a double top forming.



The euro's weekly chart has the euro in a strong rally from the end of 2006. The currency has continually moved through resistance and then consolidated those gains. However, note (again) the possible formation of a double top. But also note the bullish configuration of the SMAs -- the shorter SMAs are above the longer SMAs, all the SMAs are moving higher and prices are above all the SMAs.

I mention the possible double top because currency traders have continually referred to the 160 level as an area of key resistance for the euro.



The daily chart shows the clear issue the euro has with the 160 level. Prices hit this level in mid-April and then retreated. They meandered sideways a bit and are now making another run at the 160 level. On the bullish side, prices are above the SMAs, and the shorter SMAs are above the longer SMAs. The 10 day SMA is moving sideways, although that could change fairly quickly. The bottom line is this is a chart that is either getting ready to move above key upadie resistance or it will back down. Only time will tell which one it is.

Forex Fridays -- the Yen

Let's continue Friday's usual forex theme with a look at the yen.



First, let's look at the P&F chart. This will give us an idea of the "absolute moves" of the yen. Notice that from 2004 until the beginning of 2007 there was a general downward sloping trend to the chart as prices made a series of lower peaks and lower lows. This is indicative of a bearish slump in the overall value. Then note that at the beginning 2007 the trend reversed, although the last two columns of the chart indicate some selling activity.



On the weekly chart, notice that since mid 2007 prices have risen sharply, continually breaking through resistance and then consolidating gains in a downward sloping flag pattern. However, prices broke below this upward sloping trendline in June of this year and are now using this trendline (along with the 10 week moving average) as resistance.



On the daily chart of the yen notice the following:

-- Prices were in a downward sloping trading range from late March until early July.

-- The 10 and the 20 day SMA are both moving higher

-- The 10 day SMA has crossed over the 20 day SMA

-- The 10 and 20 day SMA are below the 50 day SMA

-- The 50 day SMA has leveled out

This chart is in transition. The March - July correction is over, but the price/SMA picture is still cloudy. The short term SMAs are heading higher, but they are still below the longer SMAs. In addition, prices have broken above the 50 day SMA but have retreated from those levels.

The Credit Crisis is Far From Over

Just this morning the following three items were on the front page of the WSJ

Citigroup Swings to Loss

Citigroup Inc. swung to a second-quarter loss as it reported around $7 billion more in write-downs as credit costs continues to rise, and the company said it cut 6,000 jobs during the period.

Merrill Reports Loss

The brokerage firm's second-quarter loss of $4.65 billion, or $4.95 a share, was one of the worst in Merrill's history and more than twice as steep as the loss for which analysts had been bracing. Already clobbered by subprime-related write-downs of more than $30 billion in the previous three quarters ended in March, Merrill took an additional $9.7 billion hit in the second quarter, which caused the bulk of the company's net loss.

The results underscore why Merrill is parting with valuable assets, such as its 20% stake in news and data provider Bloomberg LP, which is being sold back to the news and information provider's parent Bloomberg Inc. for $4.4 billion. Merrill also announced Thursday its plan to sell Financial Data Services Inc., valued at $3.5 billion.

.....

The moves haven't yet led to a rebound in Merrill's overall performance. Merrill has had to raise $15.5 billion in new capital since Mr. Thain arrived and hasn't come close to turning a quarterly profit. In another sign of tough times at the firm, Merrill recently halted talks to occupy a new tower on the World Trade Center site in lower Manhattan, opting instead to negotiate with its current landlord.

Freddie Mulls Stock Sale

Mortgage giant Freddie Mac -- emboldened by emergency regulatory actions that have triggered a two-day rebound in its battered stock -- is considering raising capital by selling as much as $10 billion in new shares to investors, according to people familiar with the matter.

The high-stakes maneuver would have the potential to avoid a full-blown government rescue for Freddie Mac and Fannie Mae, twin keystones of the U.S. housing market. The publicly traded, government-sponsored companies own or guarantee about $5.2 trillion of home mortgages, or nearly half the total outstanding, and are at the center of government efforts to prop up the sagging housing market.

Countrywide has a bunch of crap in their portfolio:

An amended complaint filed Thursday by the California attorney general related to a suit against Countrywide Financial Corp. sheds new light on the poor quality of loans the company was planning to sell to investors.

The new data provide a close look at 158,000 mortgages that had been slated for sale by Countrywide Homes Loans before last summer's credit crunch -- which was triggered by rising mortgage defaults -- turned investors away from mortgage-backed securities. Nearly 48% of nonprime loans and 21% of pay-option adjustable-rate mortgage in that portfolio were in some stage of delinquency or foreclosure as of April 30, according to the amended complaint, filed by California Attorney General Jerry Brown in state court in Los Angeles. Overall, more than 21% of all loans in that portfolio were in some stage of delinquency or foreclosure, it says.

These loans account for roughly 17% of mortgages held by Countrywide, says Dan Frahm, a spokesman for Bank of America Corp., which completed its acquisition of Countrywide earlier this month. Mr. Frahm added that 9.53% of all loans owned by Countrywide were 30 days or more past due as of the end of April.

Let's review:

We have two of the largest and most important financial institutions writing off an additional 16.7 billion in writedowns. As of a few days ago and according to an on-screen graphic from Bloomberg total worldwide writedowns are now over $400 billion dollars. Most of those are from the US and Europe -- which leads me to wonder why Asia hasn't reported a lot of losses yet. Either they were smarter than the average bear or we have a wave of bad news from another continent on the way.

We have a government sponsored entity saying it is thinking about selling $10 billion in equity. This is on top of the Paulson plan which calls for an unlimited line of credit for these two companies in addition to letting the Treasury purchase Freddie and Fannie stock in the open market. Yet we are continually told the GSEs are in good shape. For a company that is in good shape, it sure looks like they are in desperate need of money.

And then there is Countrywide -- a company under federal investigation. We now know they were selling, well, crap. And that's a huge problem because a lot of the crap that Countrywide sold is backing up bonds in portfolios across the globe.

But over the last few days we've seen the financials rally because they're a great place to put money?

Forex Fridays -- the Dollar

Let's take a look at the weekly and daily chart of the dollar to see how they look:



The dollar has been dropping for the last few years, continually moving through support and hitting new lows on a regular basis. All the SMAs are moving lower, All the shorter SMAs are below the longer SMAs and the prices are below the SMAs. Bottom line this is a bearish chart, plain and simple.



On the daily chart, notice prices rallied over the last three months but have now fallen through support. Also note the following:

-- Prices are below all the SMAs

-- All the SMAs are moving lower

-- The shorter SMAs are below the longer SMAs

In other words, prices and SMAs are now bearishly aligned.

Today's Markets

Actually, I'm going to pull the camera lens back a bit and look at the last 4 days of action:



The markets dropped on Monday and then gapped down on Tuesday. However, the markets formed a double bottom with the first bottom occurring early Tuesday and the second bottom occurring early Wednesday. Prices moved through the 200 minute SMA on mid-Wednesday. They have been hugging the upwardly sloping SMAs since, using the 10, 20 and 50 day SMA for technical support. Prices have moved up nearly 5% in the last three days.



On the daily chart for the SPYs, notice the following:

-- Prices have moved through the 10 day SMA.

BUT

-- All the SMAs are still headed lower

-- The shorter SMAs are below the longer SMAs

-- Prices are still below the 200 day SMA

-- Prices are below three SMAs

This is still a bearish chart.

There are several reasons the SPYs are rallying



The financials ETF have rallied almost 20%. that's a huge move. The reasons for this rally are several. Several banks reported better than expected earnings. In addition, the sector was horribly oversold. Also note the incredibly high volume over the last three days. This is the type of volume that occurs on a market reversal. I'm not saying we're there because we won't know for a bit. But the volume indicates there is a great deal of excitement about the sector right now.



Oil has dropped hard over the last three days and has quickly moved though important technical levels. It has dropped through the 10, 20 and 50 day SMA along with the upward sloping trend line that started in late March/early April. Traders are taking profits, using the opening of Federal lands as a reason to sell. In addition:

Crude oil fell more than $5 a barrel, dropping below $130 for the first time in six weeks, as natural gas futures tumbled and global economic growth slows.

Natural gas dropped more than 7 percent after a government report showed that U.S. supplies rose a greater-than-forecast 104 billion cubic feet last week. Some users can switch between oil- based fuels and gas depending on cost. Oil also fell because of reports showing that the U.S. and Chinese economies are slowing.

``The rout in natural gas is pulling oil lower,'' said Addison Armstrong, director of market research at TFS Energy LLS in Stamford, Connecticut. ``The sheer weight of the decline is bound to impact all the energy markets. A consensus was already forming that prices were too high.''

The question now becomes, can this continue? Tune it tomorrow.

Manufacturing Not Looking That Hot

One of the areas of the economy the NBER looks at when determining a recession is the manufacturing sector. This week we've gotten the Empire State and Philly Fed releases. Neither have been good.

Here's a chart from Econoday of both numbers:



From the NY Fed:

The Empire State Manufacturing Survey indicates that manufacturing activity in New York State worsened for a third consecutive month in July. The general business conditions index increased slightly from last month’s level but, at -4.9, remained below zero. The new orders and shipments indexes both rose into positive territory, while the unfilled orders index was negative and drifted downward. The inventories index fell to its lowest level in a year. The prices paid and prices received indexes both reached record highs, and the employment indexes dipped below zero. The future general business conditions index fell sharply, reaching a level not seen since September 2001.

There is a bit of good news in here with the increase in new orders and shipments. However, the record high level of prices paid and prices received indicates inflation is present in the system at uncomfortable levels. In addition, the employment indicator is negative -- another indicator the NBER looks at when dating a recession.

From the Philly Fed survey:

The region’s manufacturing sector continued to contract this month, according to firms polled for the July Business Outlook Survey. Indexes for general activity, new orders, shipments, and employment were all negative again this month and little changed from their readings in June. Despite the overall weakness in current activity, slightly more than three-fourths of respondents reported cost increases this month, and more than one-third reported higher prices for their own manufactured products. The region’s manufacturing executives remained generally optimistic that manufacturing conditions will improve over the next six months.

Activity is down and prices are up. Isn't that just wonderful news....

Seriously -- things aren't looking that hot right now and haven't for some time.

Bernanke the Whiner....Pt. II

In his opening remarks to Congress, Bernanke highlighted the current economic situation. This provides a really good overview of the economy at large. Let's see what he sees:

The economy has continued to expand, but at a subdued pace. In the labor market, private payroll employment has declined this year, falling at an average pace of 94,000 jobs per month through June. Employment in the construction and manufacturing sectors has been particularly hard hit, although employment declines in a number of other sectors are evident as well. The unemployment rate has risen and now stands at 5-1/2 percent.

Job growth is down and overall growth is weak. If it wasn't for the cheap dollar and the positive effect on exports we'd be in more trouble. Overall, this is not a very good picture of the economy.

In the housing sector, activity continues to weaken. Although sales of existing homes have been about unchanged this year, sales of new homes have continued to fall, and inventories of unsold new homes remain high. In response, homebuilders continue to scale back the pace of housing starts. Home prices are falling, particularly in regions that experienced the largest price increases earlier this decade. The declines in home prices have contributed to the rising tide of foreclosures; by adding to the stock of vacant homes for sale, these foreclosures have, in turn, intensified the downward pressure on home prices in some areas.

Basically, there is still a massive inventory overhand of homes for sale. Foreclosures are increasing which means inventory will continue to expand. At the same time consumer confidence and sentiment is still at record lows and total household debt is still at really high levels. House prices are still dropping hard as well. Bottom line: these really isn't much reason to think we're near the bottom in housing.

Personal consumption expenditures have advanced at a modest pace so far this year, generally holding up somewhat better than might have been expected given the array of forces weighing on household finances and attitudes. In particular, with the labor market softening and consumer price inflation elevated, real earnings have been stagnant so far this year; declining values of equities and houses have taken their toll on household balance sheets; credit conditions have tightened; and indicators of consumer sentiment have fallen sharply. More positively, the fiscal stimulus package is providing some timely support to household incomes. Overall, consumption spending seems likely to be restrained over coming quarters.

Bernanke makes an incredibly solid point here: the fact that consumers are spending at all is an amazing fact right now considering all of the headwinds they face at the macro level. Between a softening job market and high energy inflation the consumer is under tremendous pressure. Bernanke also notes the drop in household net worth caused by the drop in the stock market and home prices. Bottom line: the consumer is under assault from literally every front right now.

In the business sector, real outlays for equipment and software were about flat in the first quarter of the year, and construction of nonresidential structures slowed appreciably. In the second quarter, the available data suggest that business fixed investment appears to have expanded moderately. Nevertheless, surveys of capital spending plans indicate that firms remain concerned about the economic and financial environment, including sharply rising costs of inputs and indications of tightening credit, and they are likely to be cautious with spending in the second half of the year. However, strong export growth continues to be a significant boon to many U.S. companies.

Business is pulling in their spending as well because they are concerned about the overall economic environment. Imagine that.

Inflation has remained high, running at nearly a 3-1/2 percent annual rate over the first five months of this year as measured by the price index for personal consumption expenditures. And, with gasoline and other consumer energy prices rising in recent weeks, inflation seems likely to move temporarily higher in the near term.

The elevated level of overall consumer inflation largely reflects a continued sharp run-up in the prices of many commodities, especially oil but also certain crops and metals.2 The spot price of West Texas intermediate crude oil soared about 60 percent in 2007 and, thus far this year, has climbed an additional 50 percent or so. The price of oil currently stands at about five times its level toward the beginning of this decade. Our best judgment is that this surge in prices has been driven predominantly by strong growth in underlying demand and tight supply conditions in global oil markets. Over the past several years, the world economy has expanded at its fastest pace in decades, leading to substantial increases in the demand for oil. Moreover, growth has been concentrated in developing and emerging market economies, where energy consumption has been further stimulated by rapid industrialization and by government subsidies that hold down the price of energy faced by ultimate users.

Great news here, huh? Prices are spiking for necessary things like food and energy. And by the way -- if the US rate of consumption slows we can probably count on developing nations to keep up the pressure on oil and food.

In conjunction with the June FOMC meeting, Board members and Reserve Bank presidents prepared economic projections covering the years 2008 through 2010. On balance, most FOMC participants expected that, over the remainder of this year, output would expand at a pace appreciably below its trend rate, primarily because of continued weakness in housing markets, elevated energy prices, and tight credit conditions. Growth is projected to pick up gradually over the next two years as residential construction bottoms out and begins a slow recovery and as credit conditions gradually improve. However, FOMC participants indicated that considerable uncertainty surrounded their outlook for economic growth and viewed the risks to their forecasts as skewed to the downside.

The Fed doesn't see this getting better anytime soon. Great news, huh?

Thursday Oil Market Round-Up

FYI: I'll be on KTLK today at 11:30 CST to talk about the economy.

Lots of interesting action in the oil market over the last few days. The primary reason is the news contained in the weekly oil market report along with a sluggish economy:

Futures have dropped $10.58, or 7.3%, over the last two sessions on concerns that a prolonged economic downturn in the U.S. will leave a hole in oil demand too big for growing Asian economies to fill. Oil prices remain up about 80% from a year ago, however, and the market has recovered from proportionately larger downward corrections this year.

Stockpiles of crude oil and gasoline as reported by the U.S. Energy Information Administration rose unexpectedly in the week ended July 11. Distillates, a category of fuel that includes diesel and heating oil, increased by twice as much as expected.

Oftentimes rising inventories signal faltering demand.

"This is about as straightforward a set of bearish data as we're likely to see," said Tim Evans, an analyst with Citi Futures Perspectives.

Sluggish growth and record oil prices have translated into a 2% drop in U.S. gasoline demand this summer. Gasoline futures have tended to lag behind crude, while heating-oil futures, acting as a stand-in for world-wide diesel demand, have seen bigger gains. Refiners responded by turning a record 30% of their production over to distillates last week. Growing inventories are the result.

I should add: this is one week's report. While the news is bearish, it is still one week's report, in a series of trends. Another way to look at this situation is the market needed a reason to take profits and this week's news gave the market the reason to do so. If we see a few more weeks news like this, then we can say things may be changing. But right now we have a single data point which is counter to a whole series of data points.

Let's go to the charts to see what all of this means.



Yesterday prices broke the upward sloping trendline that started in early April. Now there are two important points to make:

-- The amount of the break is small. In his book on technical analysis, Pring uses a 2%-3% rule, meaning prices have to break a trend by a specific amount. This allows for daily fluctuations and in general is a good rule.

-- Will the trend break continue? If we continue to see prices move lower or sideways, then we can say we've got a definite change in psychology.

In addition, note the following:

-- The 10 day SMA has just turned downward

-- The 20 and 50 day SMAs are still moving higher

-- The shorter SMAs are still above the long term SMAs

-- Over the course of this rally, note that prices have corrected between the 20 and 50 day SMA.



On the weekly chart, notice that prices are also on the verge of breaking through support. However -- this is a weekly chart, and the week isn't over yet. That means the bar could change over the next few days.

Also note the following:

-- The shorter SMAs are above the longer SMAs

-- All the SMAs are moving higher

-- Prices are right at the 10 week SMA

In other words, there are still a lot of technically bullish signs on this chart



On the PF chart, notice the following:

-- The chart added two more o's yesterday, meaning prices are moving lower.

-- BUT -- note there is strong price support at 132.

To sum up, we have two days of a sell-off caused by a single report. We have a long way to go before we're in correction territory. But we mush also be aware that new information which runs counter to the prevailing sentiment and perception is out there as well.

Today's Markets

Today was a very strong rally. The market dropped a bit at the open as a result of the CPI news. But the Wells Fargo's news that it would increase its dividend helped to move the market a bit higher. Prices rallied into the 200 minute SMA a little after 10 AM. Prices fell back to the 50 minute SMA and then made a strong move through the 200 minute SMA. Prices continue to use the 10 minute SMA for support until 1PM, when prices retreated a touch. But they regained their momentum into the close, moving higher by a total of 2.74%.

Also helping out today were lower oil prices which I'll cover tomorrow. Also note the financial sector moved higher by 12% -- a huge rally for this area of the market. However, I'm guess this is a reaction rally, meaning prices moved higher not because things are great but because the index has dropped hard for so long; nothing goes down forever.



On the daily chart, note the following:

-- Prices rallied today to just short of the 10 day SMA.

BUT

-- Prices are still moving lower

-- All the SMAs are still moving lower

-- The shorter SMAs are still below the longer SMAs

-- Prices are still below the 200 day SMA, and

-- Prices are still below all the SMAs

In other words, one day does not a massive turnaround make.

Bernanke the Whiner....

Here is a link to the testimony.

Here is a great overview of how we got here.

The U.S. economy and financial system have confronted some significant challenges thus far in 2008. The contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable losses at financial institutions and a sharp tightening in overall credit conditions. The effects of the housing contraction and of the financial headwinds on spending and economic activity have been compounded by rapid increases in the prices of energy and other commodities, which have sapped household purchasing power even as they have boosted inflation. Against this backdrop, economic activity has advanced at a sluggish pace during the first half of this year, while inflation has remained elevated.

Let's take this one at a time.

The contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable losses at financial institutions and a sharp tightening in overall credit conditions.

Translation: as housing fell apart, so did anything associated with housing. This means mortgage debt is in serious trouble. According to a blurb I recently saw on Bloomberg, worldwide writedowns are now over $400 billion. Here's a scary point -- Asia has reported very little in writedowns. Either they were really smart, or we have some problems coming down the pike.

The credit markets are still not in good shape. Here is the Tedd Spread from the Fed:



Short version -- short-term debt is really expensive. This indicates people are hoarding cash and not lending.

The effects of the housing contraction and of the financial headwinds on spending and economic activity have been compounded by rapid increases in the prices of energy and other commodities...

...which have sapped household purchasing power even as they have boosted inflation

Retail sales are not adjusted for inflation.

These are not pretty pictures.

He forgot to mention poor job growth, or the the fact that real household income is down for this expansion. Bottom line -- we're got serious problems.

What Inflation?

From the WSJ:

The consumer price index jumped 1.1% in June, the Labor Department said Wednesday. Excluding food and energy, it advanced 0.3%. Wall Street economists had expected a 0.7% rise in the headline and 0.2% core increase, according to a Dow Jones Newswires survey.

Unrounded, the CPI rose 1.056% last month. The core CPI advanced 0.323% unrounded.

Consumer prices swelled 5% on a year-over-year basis, the highest rate since May 1991. The core CPI grew a more modest 2.4% compared to June 2007, though that's still well above the Fed's long-term goal of 1.5% to 2%. Over the past three months, core inflation rose at a 2.5% annual rate.

Here's a chart of CPI



As mentioned below, agricultural prices are coming down. We don't know if that is a permanent or temporary situation. The long-term chart can be read as both a consolidation and a retreat so we'll have to wait until prices give us a confirmation. I'll cover oil prices tomorrow, but they are still in a rally.

Paulson's Opening Remarks From Yesterday

Here is a link to the remarks

Fannie Mae and Freddie Mac, two of the government-sponsored enterprises (GSEs), are also working through this challenging period. Fannie and Freddie play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their role in the housing market is particularly important as we work through the current housing correction. The GSEs now touch 70 percent of new mortgages and represent the only functioning secondary mortgage market. The GSEs are central to the availability of housing finance, which will determine the pace at which we emerge from this housing correction.

Translation: If the GSEs fail, we're hosed. Therefore, we need to do everything possible to keep these institutions afloat

In addition, debt and other securities issued by the GSEs are held by financial institutions around the world. Continued confidence in the GSEs is important to maintaining financial system and market stability.

Translation: This is probably the primary fact that got and kept Paulson's attention. As a former big guy at Goldman Sachs, he was involved in one way or another with Freddie and Fannie debt issues on many occasions. His experience is telling him how important these institutions are.

Our proposal was not prompted by any sudden deterioration in conditions at Fannie Mae or Freddie Mac. OFHEO has reaffirmed that both GSEs remain adequately capitalized. At the same time, recent developments convinced policymakers and the GSEs that steps are needed to respond to market concerns and increase confidence by providing assurances of access to liquidity and capital on a temporary basis if necessary.

Translation: This is a statement from the same guy who keeps saying the US has a strong dollar policy.

Here's the three point plan:

First, as a liquidity backstop, the plan includes an 18-month temporary increase in Treasury's existing authority to make credit available for the GSEs. Given the difficulty in determining the appropriate size of the credit line we are not proposing a particular dollar amount. Flexibility is the best means of increasing market confidence in the GSEs, and also the best means of minimizing taxpayer risk.

Translation: In a previous paragraph, Paulson said, "OFHEO has reaffirmed that both GSEs remain adequately capitalized." Now he states he is "not proposing a particular dollar amount" regarding the total loan value. These two statements do not jibe. My guess is the GSEs are in far more trouble than we thought. Why else would be need an unlimited amount of discretion for the total amount of the dollar injection?

Second, to ensure the GSEs have access to sufficient capital to continue to fulfill their mission, the plan gives Treasury an 18-month temporary authority to purchase – only if necessary – equity in either of the two GSEs.

Translation: The Treasury will now become a GSE shareholder. I wonder how other members of the financial community will feel about this? I bet Citigroup would love to have this kind of support for its stock price. How long do you think it will be before the market forces the Treasury to act on this promise?

Let me stress that there are no immediate plans to access either the proposed liquidity or the proposed capital backstop. If either of these authorities is used, it would be done so only at Treasury's discretion, under terms and conditions that protect the U.S. taxpayer and are agreed to by both Treasury and the GSE. I have for some time urged a broad range of financial institutions to raise capital and at Treasury we have constantly encouraged the GSEs to do just that. In March, at my request, both the Chairman and Ranking Member of this Committee hosted a meeting with me and the CEOs of the two GSEs where they agreed to raise capital and you began the effort to move your GSE reform bill, which is now hopefully about to be enacted with the modifications we are recommending today.

Translation: hold on -- monkeys are flying out of my butt.....give me a minute.....

Third, to help protect the financial system from future systemic risk, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by providing the Federal Reserve authority to access information and perform a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards. Let me be clear, the Federal Reserve would not be the primary regulator. As I have said for some time, the Fed already plays the role of de-facto market stability regulator and we must give it the authorities to carry out that role. This role for the Federal Reserve with respect to the GSEs is consistent with the recommendation made in Treasury's Blueprint for a Modernized Financial Regulatory Structure. Clearly, given the scope of the GSEs' operations in world financial markets, a market stability regulator must have some line of sight into their operations.

Translation: Because we are lending the GSEs more and more money we will be looking over their shoulder more and more. That makes sense.

So -- here's what we have

1.) The Treasury can pump as much money as they want whenever they want into the GSEs. In the same breath we're told the GSEs are in good shape. Bullshit. The Treasury is asking for this loan ability because the GSEs are not in good shape and the Treasury is concerned that over the next 18 months we're gong to have additional problems.

2.) The Treasury is backstopping GSE stock. The treasury has the possibility of becoming the largest GDSE shareholder out there.

3.) The Treasury and Federal Reserve will perform more oversight.

Wednesday Commodities Round-Up

Let's start with gold. First, gold is a proxy for inflation expectations. If traders are concerned about inflation rising they will bid up the price of gold as a hedge against perceived or real inflation. The reverse is also true.



The three year weekly gold chart is in a clear bull market. It has continually moved higher, consolidated gains and then moved higher. This is a good example of what an extended rally should look like.



On the daily chart, notice the following:

-- Gold consolidated in a triangle from mid-April to late June of this year

-- Prices have broken through upside resistance from the triangle

-- The shorter SMAs are now above the longer SMAs

-- All the SMAs are moving higher

-- Prices are above all the SMAs

This chart is short-term very bullish.



On the weekly agricultural prices chart, notice that prices are forming a double top. This is to be expected for several reasons. First, nothing cures high prices like high prices. In other words, as prices increase they lead to a change in the nature of supply and demand -- either people will demand less (unlikely with food) or more supply will come on the market. Either way prices start to drop.



On the daily chart the double top is clearer. Also notice the following:

-- Prices have moved bellow the 10 and 20 day SMA.

-- The 10 and 20 day SMA have both turned lower

-- The 10 day SMA has crossed below the 20 day SMA

-- Prices are currently using the 50 day SMA as technical support

The recent run-up is a direct result of the Iowa floods. As the flood waters receded, the reason for bidding up prices disappeared. Also note that before the Iowa floods prices were already dropping, indicating a change in the market's psychology. This chart is shifting from a bullish to a bearish chart, but hasn't quite made the transition complete yet.



Overall, the CRB is still in the middle of a strong bull run that started in mid-2007. Prices have continually moved through upside resistance, consolidated gains, and then moved higher.



On the daily chart, notice the following:

-- Prices have been rising since late March, although the 420-430 area provided a great deal of upside resistance

-- Prices broke a mini-rally that started in June

-- Prices have now dropped a bit and are consolidating in a triangle pattern

-- Notice that prices and the 10 and 20 day SMA are bunched together. This is still bullish, but a bit less so then the other charts we have seen.

-- Also note the 10 day SMA is now headed lower, although it is still above the 20 day SMA

-- Prices have moved below the 10 and 20 day SMA

-- Note that in the past, prices have used the 50 day SMA area as support. They may be looking to do that again.

Overall, this is still a bullish chart, but less so then others we have seen. There are some incredibly strong bullish trends, but it looks as though we're going to see a bit of a consolidation or correction in the near future.

So, we have gold telling us inflation expectations are increasing. With oil in a rally that shouldn't be surprising. However, agricultural prices are dropping which is putting some downward pressure on the CRB.

Today's Markets

The markets gapped down at the open. There were several reasons for this. There was a hangover from yesterday's session. PPI was high (see post below), indicating inflation is still an issue. In addition:

A gauge of manufacturing in New York State contracted in July for the third consecutive month, though the rate of decline was less severe than in June, the New York Federal Reserve said in a report on Tuesday.

The New York Fed's "Empire State" general business conditions index came in at minus 4.92 in July from minus 8.68 in June, while its gauges of inflation also posted increases.

Industrial production is one of the areas of the economy the NBER analyzes when it is looking to date a recession. The Empire State survey has not been doing well over the last few months. In addition to that:

U.S. retail sales rose a disappointing 0.1% in June despite nearly $50 billion in stimulus checks for consumers, Commerce Department data released Tuesday revealed.

Sales were boosted by higher prices for gasoline, food and other consumer goods. The figures are seasonally adjusted but are not adjusted for inflation.

It was the weakest sales report since February's 0.2% decline.

Sales in June were held back by the biggest drop in auto sales in more than two years. By contrast, sales at the malls and shopping centers were relatively healthy, stimulated by the tax rebate checks,

Excluding the 3.3% drop in auto sales, sales rose 0.8%, the slowest in three months.

Excluding the 3.3% rise in gasoline station sales, sales fell 0.5%, the biggest drop since December. Excluding both autos and gas, sales rose 0.2%.

Despite Washington pumping money into the economy, retail sales are lackluster.

So, there was a lot of negativity at the open. Prices moved lower a bit more and then gapped down around 9AM CST. Then prices started to move higher. They crossed over the 10 and 20 minute SMA, then rose a bit before hitting resistance at the 50 day SMA. Prices fell back to the 20 minute SMA and then printed two strong bars right before 11 AM to get over the 50 minute SMA. Prices continued to rise until a little after 12 when they ran into upside resistance at the 200 minute SMA. Prices dropped a bit and then everything moved sideways before making another move higher. Right after 2 PM prices moved through the 200 minute SMA. But they couldn't hold momentum and they fell into the close.

Despite all of the positive technical developments in the day -- the continued moves through upside resistance and the important move through the 200 minute SMA near the close, prices just couldn't keep the momentum going. That indicates there is still a great deal of concern out there. Also note that prices fell into the close, indicating traders don't want to hold anything overnight which is another bearish sign.

What Inflation?

From Bloomberg:

Prices paid to U.S. producers rose for a sixth month in June, pushed up by surging fuel costs that underscore risks of inflation.

The 1.8 percent increase was the biggest gain since November and followed a 1.4 percent jump the prior month, the Labor Department said today in Washington. So-called core producer prices that exclude fuel and food increased 0.2 percent, less than economists forecast.

Higher prices for fuel and raw materials cut into corporate profits and pressure them to raise prices. Federal Reserve policy makers, who have paused in their steepest rate cuts in two decades, last month said ``upside risks'' to inflation had increased and they would act ``as needed'' to foster both stable prices and growth.

``It was primarily confined to the energy sector,'' said Lindsey Piegza, an analyst at FTN Financial in New York, which correctly forecast the rise in the core rate. ``There is risk that in the future they could seep through and cause an inflationary spiral, but right now inflation is going to take a back seat to the slowing economy'' on the list of Fed concerns.

See -- if only we the news reports dealt exclusively with core inflation then everything would be OK.

Also note the following:

The Labor Department said producer prices over the last 12 months were up 9.2 percent, the biggest increase since a 10.4 percent gain in June 1981 when the United States was last mired in a low-growth, high-inflation period known as stagflation.

Isn't that just wonderful?

The Credit Crisis is Far From Over

From today's WSJ, talking about the Freddie and Fannie bail-out:

But analysts warned that a bailout carries considerable risk for the government. The two lenders carry $5.2 trillion in mortgages on their books, dwarfing even the $2.9 trillion in spending budgeted for the entire federal government in fiscal 2008. Washington would essentially be betting that only a small portion of the agencies' mortgages will result in defaults in the months ahead, analysts said.

The bottom line is Freddie and Fannie have a combined portfolio value that is almost twice the size of the federal government's budget. Let's play this out a bit further and assume that only one of these companies needs help -- and more than a loan at the discount window. Where is the federal budget is the money coming from?

Also consider this:

Traders and analysts said the woes of IndyMac, once one of the nation's largest independent mortgage lenders, also underscored the possibility of meltdowns at regional firms that may be too small to merit a Bear Stearns-style intervention. Regulators are keeping tabs on the health of about 90 banks.

Shares of such companies were sharply lower Monday. Zions Bancorp dropped 23.2% and First Horizon National plunged 25.2%.

National City slid 14.7% despite issuing a statement that it "is experiencing no unusual depositor or creditor activity. As of the close of Friday's business, the bank maintained more than $12 billion of excess short-term liquidity." National City also said its capital position was strong after its recent capital raising.

.....

Other banks also saw big declines. Washington Mutual fell 34.8% and Wachovia dropped nearly 14.7%.

Investment banks also fell. Lehman Brothers Holdings, which has been battered in recent weeks, was down more than 12.2%. Merrill Lynch dropped nearly 6.3%. Morgan Stanley fell 5.1% and Goldman Sachs Group was down 2.3%.

Shares of M&T Bank slid 15.6% after the company reported a 25 % drop in second-quarter profit, missing analysts' expectations.

The firm's report was part of a series of earnings announcements due this week from financial institutions, with analysts expecting to see more write-downs and disclosures of bad credit bets. Reports are due Thursday from J.P. Morgan, Merrill Lynch, and Zions. On Friday, Citigroup will report. Overall, Wall Street expects the financial sector to lead a decline of over 13% in aggregate profits at S&P 500 companies for the second quarter, according to Thomson Reuters.

Expect more reports like this:

U.S. Bancorp posted a larger-than-expected 18 percent decline in quarterly profit due to mounting housing-related credit losses, and said that tough economic conditions will cause bad loans to increase further.

The results, from a bank that has avoided the massive credit losses afflicting many rivals, do not augur well for the rest of the nation's banks, many of which are expected to report dismal quarterly results this week and next.

U.S. Bancorp, whose shares fell nearly 7 percent in pre-market trading, is the sixth-largest U.S. bank and the first of the 10 biggest to report.

The entire financial sector is suspect right now -- not just IndyMac. Here are some charts to prove it:



Bank of America is tanking, as is



Citigroup



Lehman Brothers



Merrill Lynch



Wachovia and



Washington Mutual

For anybody that is saying:

-- Schumer caused the IndyMac failure, and/or

-- To keep buying those bank shares because they're cheap,

Please shut up. Schumer is an idiot of the highest order (isn't everybody in Washington?), but Indy Mac caused their own problems. And the financial sector is about to go through another round of writedowns caused by the mortgage mess. And this one won't be the last either. The Case Shiller index is still dropping hard. As prices of homes drop, the mortgages tied to those properties become less valuable. Hence, the owners of those mortgages must lower the estimated value of those mortgages leading to more and more writedowns.

Treasury Tuesdays

Let's go to (what else?) the charts to see what they're telling us this week.



Above is a 1 year chart of the 7-10 Treasury ETF. This part of the market rallied from the end of last summer to March of this year. The credit crisis started last summer, which was a natural stimulus for the Treasury market because of its safe haven status. In March of this year the Fed back-stopped the Bear Stearns deal which indicated the Fed was going to be far more open to the idea of intervention. This made Treasury bonds less attractive. However, over the last month or so we've seen a the Treasury market start to advance again.



Above is a three month chart of the 7-10 year Treasury market ETF. Notice the following.

-- Prices have moved above the 200 day SMA, indicating a move into bull market territory

-- The short term SMAs (the 10 and 20 SMA) are both moving higher

-- The 10 day SMA has just moved over the 200 day SMA

-- Prices are above all the SMAs

This is a chart in transition. Traders are obviously more confident about the future price prospects of the Treasury market -- or are more interested in the short-term safety of these bonds. Considering inflation is higher than we would like, the safety argument is probably the primary reason for the rally.



On the 6 day chart, notice the following:

-- Prices rallied from Monday until Thursday as the market fell.

-- The market formed a double top and then fell hard on Friday, largely as a reaction to the news of Freddie and Fannie. A federal bail-out means more government spending.

-- Prices rallied yesterday as traders realized the Fed plan might actually help.

Today's Markets

The markets gapped up at the open, but then fell just below the 20 minute SMA. Prices tried to rally, but ran into resistance at the 10 minute SMA. Prices then ping-ponged between the 50 and 20 minute SMAs until they fell below the 10 minute SMA a little after 10 AM. But then the 10 and the 20 minute SMA had crossed under the 50 minute SMA, indicating further moves downward. Prices continued to fall until 11 AM when prices stabilized. Then they moved sideways until 12:30. Prices moved above th 10 minute SMA and then advanced above the 50 minute SMA. But prices were again pulled down. They attempted one more run right before closing but could not maintain the momentum. We closed near lows for the day.

Financials were the main issue:

Washington Mutual Inc. posted its biggest drop ever and National City Corp. tumbled to a 24-year low after last week's collapse of IndyMac Bancorp Inc. spurred speculation that regional banks are short of capital. The companies said they've seen no unusual depositor activity. Fannie Mae and Freddie Mac erased an earlier rally fueled by Treasury Secretary Henry Paulson's plan to help rescue the largest U.S. mortgage lenders.

.....

Zions Bancorporation, the Salt Lake City-based lender with operations in 10 Western U.S. states, fell 23 percent to $19.73. First Horizon National Corp., Tennessee's biggest bank, slumped 25 percent to $5.04.

This shouldn't be surprising considering all the turmoil related to Fannie and Freddie over the last few days. And don't be surprised to see it continue.