Economy in U.S. Grew at 5.7% Pace, Inflation still moderate

The inflation news is benign.

It always is at this point in the cycle.

The question now is, when will banks start to lend again?

Paterson's analysis site will have more details on the statistical release.

* * * * * J B K * * * * *

San Francisco

Inflation held below the Fed's long-term forecast. The central bank's preferred price gauge, which is tied to consumer spending and strips out food and energy costs, rose at a 1.4 percent annual pace following a 1.2 percent increase in the prior quarter.

The GDP price gauge climbed at a 0.6 percent pace, less than the 1.3 percent median forecast of economists surveyed.

http://www.bloomberg.com/apps/news?pid=20601087&sid=acQASpga4OhM&pos=1

PIMCO - February 2010 Gross Ring of Fire

One of the most annoying buzz-phrases in recent memory.

Gross is a good bond trader, but this is gibberish.

Not since the Spanish found a mountain of silver in the mountains of Bolivia has the money supply doubled in six months.

Nothing will be normal again until the Fed finishes its job.

That's the story.

* * * * * J B K * * * * *

San Francisco

In this New Normal environment it is instructive to observe that the operative word is "new" and that the use of historical models and econometric forecasting based on the experience of the past several decades may not only be useless, but counterproductive. When leveraging and deregulating not only slow down, but move into reverse gear encompassing deleveraging and reregulating, then it pays to look at historical examples where those conditions have prevailed. Two excellent studies provide assistance in that regard – the first, a study of eight centuries of financial crisis by Carmen Reinhart and Kenneth Rogoff titled This Time is Different, and the second, a study by the McKinsey Global Institute speaking to "Debt and deleveraging: The global credit bubble and its economic consequences."

http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2010/February+2010+Gross+Ring+of+Fire.htm

Banks pull another $1 billion from small business lending - Jan. 18, 2010

The story below shows the crux of the problem: lack of bank lending.

Banks are piling up reserves in case of another regulatory disaster.

The coming correction in the stock market will do nothing to assuage these fears.

Not even good earnings reports will be believed, since the general mood is so pessimistic.

Money market arbitrage looks better and better every day.

* * * * * J B K * * * * *

San Francisco

But small business owners tell a different story. They say that tighter lending standards leave too many viable businesses unable to access the credit they need to grow or finance routine operations like buying materials to fulfill customer orders. Lending standards have been growing steadily more restrictive for nearly three years, according to the Federal Reserve's most recent Senior Loan Officer Study, released in October.

Edward Yingling, CEO of the American Bankers Association, says that finding the right balance between caution and investment is critical to spurring economic recovery.

http://money.cnn.com/2010/01/18/smallbusiness/small_business_lending_drop/index.htm

Floating-Rate Note Sales Tumble on Fed Outlook: Credit Markets - Bloomberg.com

This Bloomberg story shows us the expectations of floating-rate securities buyers.

They want nothing to do with securities yielding one-half of one percent.

Savers are searching for yield and I don't know where they're going to get it.

* * * * * J B K * * * * *

San Francisco

Sales of floating-rate corporate bonds are fizzling, falling 68 percent from the start of the year, on growing expectations that central banks will refrain from raising borrowing costs anytime soon.

After more than $42 billion in the first two weeks of the year, sales of so-called floaters have fallen to $13.5 billion since Jan. 15, according to data compiled by Bloomberg. The debt has returned 0.41 percent this year, including reinvested interest, less than half the 0.99 percent of Barclays Capital's Global Credit Index.

"The market finally got its head around the fact that rates are going to stay low for a while," said Burt White, the chief investment officer at Boston-based LPL Financial Corp., which oversees about $250 billion. "Some people were really fantasizing that the Fed might raise rates in January, which was just ridiculous. That kind of takes a lot of the luster off floating rates."

http://www.bloomberg.com/apps/news?pid=20601087&sid=axkVCdMgxZ4k&pos=4

Swaps Trading Surges as National Deficits Rise: Credit Markets - Bloomberg.com

CDSs are a powerful tool for managing credit risk, and are used by all major buyers of sovereign debt securities.

CD swaps reveal the preferences of debt buyers for risky debt and clearly show trouble in advance of downgrades.

This article details the surge in purchases, and the change in prices in sovereign debt.

As tax revenues plummet, more sovereign nations will find it harder to sell debt, and some nations will default, CDSs will cushion the blow.

* * * * * J B K * * * * *

San Francisco

Traders are buying protection against defaults on sovereign debt at more than five times the rate of company bonds as governments fund ballooning deficits.

The net amount of credit-default swaps outstanding on 54 governments from Japan to Italy jumped 14.2 percent since Oct. 9, compared with 2.6 percent for all other contracts, according to Depository Trust & Clearing Corp. data. European countries led the jump, with the amount of protection on Portugal climbing 23 percent, Spain 16 percent and Greece 5 percent.

http://www.bloomberg.com/apps/news?pid=20601087&sid=ahKdQ_0KjwaQ&pos=4

Chavez Currency ‘Burn’ Failing as $93 Billion Leaves Venezuela - Bloomberg.com

Old lags have seen this before, but newer traders should watch carefully as the Forex markets demonstrate how little power a government has to stop the fall in its currency.

The problem began when Venezuela payed its bills with newly printed high-powered money, fueling inflation. Banks made loans with that money, further fueling price increases.

The normal solutions - as we see in China - is to purchase real assets, like land. But Venezuelans won't buy real assets in 'Zuela because the government is on a expropriation program for both domestic and foreign owners. Their land will be confiscated.

So, as prices rise, no one wants to hold Bolivars, the nation's currency, and they sell it as fast as they can to buy other currencies.

The sale of the currency forces the value of the Bolivar to fall, increasing import prices.

In response, the government buys these Bolivars with currency held in reserve. The currency stabilizes briefly.

Speculators now join with panicked sellers in selling Bolivars and the decline accelerates.

When the government's money runs out - as it always does - sellers buy back their positions at a dime on the Bolivar, and make a tidy profit.

For reference, see Zimbabwe's recent debacle.

For the future, watch the US's struggle to avoid the same fate.

Remember the simple rule:
Inflation dominates the function explaining currency movements, hot money further fuels this change, and trade is irrelevant at this point.

* * * * * J B K * * * * *

San Francisco

Venezuelan President Hugo Chavez is selling dollars from central bank reserves for the first time in six years in what Goldman Sachs Group Inc. and Barclays Plc say is a futile bid to shore up the bolivar in unregulated trading.

The central bank, under orders from Chavez to "burn the hands" of speculators betting against the bolivar, said it sold $179 million since Jan. 13, the first dollar auctions since trading restrictions imposed in 2003 spawned the unofficial market. Chavez said on Jan. 15 he wanted to strengthen the bolivar more than 30 percent in unregulated trading, where it fetches 6.3 per dollar, to contain inflation after he devalued the official rate as much as 50 percent to 4.3.

The plan will fail because Chavez's nationalizations and land seizures are prompting Venezuelans to pull money from the country, said Alberto Ramos, a Goldman Sachs economist. More than $93 billion has left the South American nation since 2005, according to the central bank's capital account data.

"You have a problem that can't be resolved by throwing reserves at it," Ramos said in a phone interview from New York. Venezuelans "pay a huge premium to get their assets out of the country, out of the reach of the government, so that they can't confiscate them," he said. "Under that situation, $20 billion, $50 billion or $100 billion is not enough. The entire capital stock of the economy could leave."

http://www.bloomberg.com/apps/news?pid=20601086&sid=a.eiJxW7dsGY

Corporate Bond Sales Fall, as Spreads Widen - Bloomberg.com

Corporate bonds sales will continue to grow.

Companies will extend the maturity of their liabilities and lock in long term financing.

Companies are faced with Fed action to reduce the monetary base, and Treasury sales to fund the deficit.

Banks will begin to participate in longer-term financing for credit worthy companies who don't have access to the bond market.

Paterson calls these yield spreads, 'credit spreads' to differentiate them from the yield spread between Fed Funds and the 10 year note.

* * * * * J B K * * * * *

San Francisco

Corporate bond sales are falling and borrowing costs are increasing for the first time in eight weeks amid investor concern the pace of economic recovery is flagging.

Bond sales worldwide fell 52 percent last week to $48 billion, from $99.8 billion in the previous period, according to data compiled by Bloomberg. So-called yield spreads widened for the first time since the five days ended Nov. 27, based on Bank of America Merrill Lynch's Global Broad Market Corporate Index.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a54_V.qLJknY&pos=6

Home Sales Decline but Prices Rise - Bloomberg.com

There is a glut of houses out there, thanks to Fannie and Freddie lowering their standards.

It will take years for the housing market to sort itself out.

The good news is that prices in select locations are rising.

Time to buy residential real estate.

* * * * * J B K * * * * *
San Francisco

Purchases slumped 17 percent the month after a government tax credit was originally due to expire, the biggest decline since records began in 1968, to a 5.45 million annual rate, the National Association of Realtors said today in Washington. The median sales price increased for the first time in two years.

First-time buyers rushed to complete deals before the $8,000 government incentive was due to end, pushing sales up 28 percent in the three months to November. The subsequent extension and expansion of the credit to include closings through June signal demand will strengthen in the first half of 2010, while raising the risk the market will then slow anew should jobs remain scarce.

http://www.bloomberg.com/apps/news?pid=20601068&sid=arAUMdte7f1Y

Bernanke's in trouble and so's the stock market

The following 4 articles show just how vulnerable Bernanke's tenure is at the Fed.

I predicted he'd not be re-nominated for the Chairmanship and was thankfully wrong.

How can he survive this current onslaught?

When combined with the administration's attempt to control bank activities, this is a warning shot to the economy.

Bond will probably rally through this as the stock market sinks lower.

* * * * * J B K * * * * *

San Francisco

1. Senate Democrats Put
Bernanke in the Crosshairs
Wall Street Journal [Washington Wire], by Susan Davis
http://blogs.wsj.com/washwire/2010/01/22/senate-democrats-put-bernanke-in-the-crosshairs/

2. Obama still confident
Bernanke gets second term
Associated Press, by Jeannine Aversa & Jim Kuhnhenn
http://www.washingtonexaminer.com/nation/obama-still-confident-bernanke-gets-second-term-as-fed-chairman-82387577.html

3. 2 Democrats Oppose Another
Term for Bernanke
New York Times, by Sewell Chan
http://dealbook.blogs.nytimes.com/2010/01/22/2-democrats-oppose-another-term-for-bernanke/

4. Sen Boxer To Vote Against
Second Term For Bernanke
Dow Jones Newswires, by Staff
http://www.foxbusiness.com/story/markets/sen-boxer-vote-second-term-bernanke/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+foxbusiness%2Flatest+%28Text+-+Latest+News%29&utm_content=Yahoo+Search+Results

Bank Supervisors in U.S. Impose Tougher Rules Without Overhaul - Bloomberg.com

In the Bloomberg story below we see the beginning of new bank regulation.

Interest rate and credit risk analysis will move to the front of banker's concerns as the Fed begins to tighten credit in the months to follow.

For now, short funding remains the tactic of choice, but the first signal of increasing short rates will signal the time to start extending the maturity of liabilities.

* * * * * J B K * * * * *
       San Francisco

U.S. banking supervisors are using existing authority to raise standards for capital, liquidity and risk management without waiting for the Obama administration and Congress to hammer out a new regulatory structure.

Agencies led by the Federal Reserve and the Office of the Comptroller of the Currency this year are set to propose rule revisions that would increase the amount of capital large banks must set aside against the risk of trading losses, according to government officials. The revisions would follow recommendations of the Basel Committee, the global coordinator for banking regulations based in Switzerland.

U.S. regulators are also proposing stronger guidelines on liquidity risk and this month told banks to improve strategies to guard against the possibility of an abrupt increase in interest rates. The renewed scrutiny comes as firms that received taxpayer support, including Goldman Sachs Group Inc. and JPMorgan Chase & Co., report earnings swelled by gains from securities trading.

http://www.bloomberg.com/apps/news?pid=20601068&sid=aQ0cQwZ3g0xI

Fed Assets Fall to $2.26 Trillion as Bank Loans Drop (Update1) - Bloomberg.com

Looks like the beginning of the end of the Fed's stimulus programs.

Now, we wait and watch.

* * * * * J B K * * * * *

San Francisco

Jan. 21 (Bloomberg) -- The Federal Reserve's balance sheet fell 1.7 percent over the past week to $2.26 trillion, as lending to commercial banks declined.

The central bank's total assets dropped by $39.8 billion as of yesterday, the Fed said today in a weekly statement. Credit extended to banks through the Term Auction Facility credit program declined by $37.4 billion to $38.5 billion.

The Federal Open Market Committee, after a meeting on Dec. 15-16, announced plans to close several emergency liquidity programs by Feb. 1.

The Fed is allowing the emergency programs to wind down "in light of ongoing improvements in the functioning of financial markets," according to its Dec. 16 statement.

The central bank's holdings of mortgage-backed securities increased by $2.31 billion to $970.9 billion. Federal agency debt gained $1.37 billion to $162.2 billion.

The increase in the balance sheet resulting from purchases of mortgage-backed securities and federal agency debt was offset this week by the decline in liquidity programs.

http://www.bloomberg.com/apps/news?pid=20601068&sid=a7XQZN3W9B_g

Leading Economic Index™ (LEI) for the U.S. Increases 1.1%

Leading indicators show a strengthening economy.

Please click on the links below for a complete picture.

More important is the strength in coincident indicators, rising 1.0% in the past month. This is the signal we've been waiting for.

Employment, as we expect, is the only coincident indicator not showing a gain. All others point to strong economic activity.

Paterson expects both employment and bank lending to increase in 2010 Q II.

* * * * * J B K * * * * *

San Francisco

Says Ataman Ozyildirim, Economist at The Conference Board: "The Conference Board LEI for the U.S. increased sharply in December, and has risen steadily for nine consecutive months. The six-month growth rate has picked up slightly to 5.2 percent (about a 10.8 percent annual rate) in the period through December, substantially higher than earlier in the year. In addition, the strengths among the leading indicators have remained very widespread in recent months."

Adds Ken Goldstein, Economist at The Conference Board: "The indicators point to an economy in early recovery. The coincident economic index shows slow expansion of economic activity through December. The leading economic index suggests that the pace of improvement could pick up this spring."

http://www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1

The pdf has all the details.

http://www.conference-board.org/pdf_free/economics/bci/goldenh.pdf

China Reins In Bank Lending's Wild Expansion

The recent increase in reserve requirements by Chinese banks is the first step in controlling future inflation.

This is the sort of drastic measure that monetary authorities take when they realize inflationary pressures are out of control and bank lending will further increase price pressure.

China's attempt to manage its currency value against the dollar is based on printing the yuan used to purchase dollars from exporters.

All that high-powered money will fuel inflationary lending, as Chinese citizens realize what's happening.

The clearest indicator that inflation is out of control in China is the increase in prices of real estate.

Either revaluation or recession is coming, the only question is when.

* * * * * J B K * * * * *

San Francisco

Beijing is worried that bank lending might spin out of control.

Loan activity soared 30% last year, to $1.4 trillion, notes Josef Karasin, head of emerging markets at research firm IdeaGlobal.

Beijing had been pleased at the hot pace of lending because the economy in China, like in most places, froze as the subprime mortgage crisis spread around the world.

Indeed, the government, which owns at least controlling shares in China's biggest banks, mandated that stepped-up lending.

But now the economy is roaring back, even as most nations tend to fledgling recoveries. Many analysts see 2010 GDP up about 10%.

Beijing finally tapped on the brakes a bit when officials saw that banks had lent 1.1 trillion yuan in the first few weeks of this year.

http://www.investors.com/NewsAndAnalysis/Article.aspx?id=518639

Producer Prices in U.S. Rose 0.2%; Ex-Oil Unchanged (Update1) - Bloomberg.com

THE ROLLER COASTER RIDE HAS BEGUN

One of the classic blunders of monetary policy is detailed below in Bloomberg's story.

The monetary authorities always wait too long before tightening because they don't understand inflation is a monetary phenomenon, not an effect of economic growth.

The article below clearly links inflation to growth, implying that excess capacity in the economy will restrain price increases. This is wrong today, and always has been.

By the time inflationary pressures surface, it will be too late to control future price increases by Fed action, and attempts to do so by reducing the monetary base will only increase long-term interest rates.

Further, attempts to constrain bank lending with quarter point increases in Fed Funds will have no effect on bank lending till short rates exceed long rates and the economy drops into a recession.

Prices always increase faster than the Fed can raise rates.

Sometime later this year, prices will begin to rise, and they won't understand why.

Watch for declining long bond prices, declining value of the dollar, and increases in gold and the CRB.

* * * * * J B K * * * * *

Producer Prices in U.S. Rose 0.2%; Ex-Oil Unchanged (Update1)
Share Business ExchangeTwitterFacebook| Email | Print | A A A

By Courtney Schlisserman

Jan. 20 (Bloomberg) -- Wholesale prices in the U.S. rose at a slower pace in December, showing the economy is recovering without the immediate threat of inflation.

The 0.2 percent increase in prices paid to factories, farmers and other producers followed a 1.8 percent jump in November, according to Labor Department data released today in Washington. The gain was more than anticipated and reflected higher food costs. Excluding food and fuel, so-called core prices were unchanged.

An unemployment rate projected to average 10 percent this year and excess capacity are giving companies room to hold the line on prices. Few signs of inflation will allow the Federal Reserve to keep interest rates near zero in coming months to help fuel the economic recovery.

"We're not looking at any sort of major inflation pressures emanating from the manufacturing sector," said Jonathan Basile, an economist at Credit Suisse in New York. The Fed's view on inflation is that it's "contained, subdued and that's what the PPI is telling us," he said.

http://www.bloomberg.com/apps/news?pid=20601068&sid=apq2nmpaKA.o

Corporate-Government Spread Widens: Credit Markets (Update3) - Bloomberg.com

More evidence that rates are low enough to justify extending the maturity of liabilities.

As these spreads widen, banks will be encouraged to begin lending again.

Paterson forecasts an increase in bank lending in Q II of 2010.

* * * * * J B K * * * * *

San Francisco

Corporate-Government Spread Widens: Credit Markets (Update3)
Share Business ExchangeTwitterFacebook| Email | Print | A A A

By Bryan Keogh and Caroline Hyde

Jan. 18 (Bloomberg) -- The cost to borrow in the corporate bond market is rising for the first time since November as Barclays Plc, Lloyds Banking Group Plc and more than a dozen other European banks sell record amounts of fixed-income securities to refinance $2 trillion of debt due this year.

The extra yield investors demand to own corporate debt instead of government securities widened on Jan. 15, expanding 1 basis point to 161 basis points, based on the Bank of America Merrill Lynch Global Broad Market Corporate Index. The last time the so-called spread expanded was Nov. 27, when it grew to 193 basis points from 191, or 1.91 percentage points.

Banks have sold more than $100 billion of securities this month, and the increase in spreads may be a sign the supply is crowding other borrowers out of the market. Investors say banks will face increasing competition from industrial companies and governments that may push up yields from a four-year low. Fortis Bank Nederland NV, controlled by the Dutch government, and Zurich-based Credit Suisse AG are among banks preparing to offer notes in coming days, according to data compiled by Bloomberg.

"We're seeing a glut of senior bonds from European financial issuers," said Philip Gisdakis, the Munich-based head of credit strategy at UniCredit SpA, Italy's biggest bank.

The decline in yields on financial bonds slowed last week, narrowing 4 basis points to 205 basis points more than benchmark rates, after a drop of 24 basis points the week before, based on Bank of America Merrill Lynch's Global Broad Market Financial Index. The two weeks marked the best performance since Aug. 7.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aAPnoA7ijOok&pos=2

* * * * * J B K * * * * *

San Francisco

James B. Klein
Paterson Financial Services

WEBSITE: paterson.com
WEBLOG: paterson-financial-services.blogspot.com
NEWS WEBLOG: paterson-financial-services-news.blogspot.com

Trading Pit Documentary Film

A BIT OF NOSTALGIA

I remember fondly the days of the Bond Pit in Chicago.

Here's a story about a documentary film made about the pit.

============================================================

By Tony C. Dreibus

Jan. 15 (Bloomberg) -- Doug Pringle saw punches thrown, blood spilled and fortunes lost during his 17-year career at the Chicago Board of Trade. He misses it, every day.

"The biting of the nose and the fights, sure, when you're throwing around that kind of money, people tend to lose it sometimes," said Pringle, 42, who traded corn, soybeans, 10- year Treasury notes and 30-year bonds. "I miss the excitement."

Chicago's open-outcry nostalgists can now watch their slow- motion obituary on film. "Floored," a documentary that premieres in the city tonight, captures the fading swagger of its exchange pits as electronic trading takes over.

Traders and former traders in the film recount drug-fueled road trips with prostitutes, living in mansions, and a crash that included divorce and having to take a $400-a-week job.

The numbers in Chicago's pits peaked in 1997, with about 10,000 traders flailing their arms with buy and sell signals in a daily scrum of sweating and shouting, said Steve Prosniewski, a trader who's one of the film's producers. Less than 10 percent of those remain, he said.

http://www.bloomberg.com/apps/news?pid=20601109&sid=avhLUj0FlZAw&pos=15

* * * * * J B K * * * * *

San Francisco

James B. Klein
www.paterson.com
paterson-financial-services.blogspot.com

Paterson's News Site Begins

Paterson will provide timely analysis of current events in the financial world.

* * * * * J B K * * * * *

San Francisco

James B. Klein
www.paterson.com
paterson-financial-services.blogspot.com
paterson-financial-services-news.blogspot.com