Mortgage rates are a hair lower, under 6.75 percent now, but spreads to Treasurys have widened despite overt Treasury backing of Fannie and Freddie.
There is a three-track story unfolding today: the U.S. economy, the ex-U.S. global economy, and The Crunch. To maintain clarity and composure, keep ’em separate!
The domestic economy is weakening. New claims for unemployment insurance spiked last week to 448,000, and all hands expected some pullback. Instead, 455,000 this week — the worst in six years. The collapse in auto sales to the annual range of 12 million (from the 15.5 million forecast) has been a recent, June-July event. However, modern "just-in-time" delivery of components means instantaneous negative feedback all the way back through the supply chain to labor and raw materials. Credit-default measures and bond prices indicate imminent bankruptcy by all of the used-to-be Big Three.
Housing shows no bottom, and without one soon and tentative recovery, credit losses will be unbearable. The best marker of U.S. condition: the Fed’s post-meeting statement abandoned its June observation that "downside risks have diminished," and despite its new recitation of inflation risks made clear there is no intention to raise its rate.
The global scene is changing very rapidly, all for the good here and bad elsewhere.
In this past year, a tribe of economic astrologers have claimed that a weak dollar was the cause of high oil and all other U.S. woes, and if only the Fed would tighten all would be well. This alternate universe collapsed in today’s trading.
The dollar was weak because our Fed properly eased into the crunch (interest rate differential is a prime driver, and European Central Bank rates have been double our Fed’s), and because of our immense trade deficit. This week marks the beginning of dollar reversal and reversal of a lot of other things.
The Euro-zone sag to recession means the ECB is done with rate hikes. It may take well into 2009 for 4.1 percent Euro inflation to break, and the ECB to ease, but that event is no longer a theory but visible on the horizon. German bond yields are in free-fall in anticipation. As the Euro-zone tanks along with us, so do markets for Asian exports, and weakness there is daily more plain and will further undercut commodities.
The consequences of these shifts are profound in today’s markets. Oil has dropped to $116, natural gas to $8.39, and gold all the way to $858. The dollar is rising fast (certainly not because of some imaginary Fed defense): the euro barely holding $1.50, ditto sterling at $1.90 and yen at 110 to the U.S. dollar. Europe is inheriting our currency problem: the anti-inflationary benefit from lower energy prices will be delayed by falling euro value.
Then there’s the crunch. Credit scarcity as measured by spreads to Treasurys now affects all borrowing. The notion that the crunch is confined to mortgages and structured securities stands exposed as urban legend: top-quality municipal and corporate borrowers are suffering. Consumers show signs of last-ditch credit-card defense: consumer credit outstanding jumped $14 billion in June, with borrowers unable to pay down month-end balances and having nowhere else to turn for a loan.
The best model for the crunch dates to January with Jan Hatzius (Goldman Sachs) and the Bank Credit Analyst with the same insight: capital shortage means insufficient credit. Here’s the equation: system write-offs in the last year total about $500 billion, and only $350 billion in new capital has been raised. That $150-billion shortage, by the miracle of 12-to-1 bank leverage (and 25-to-1 broker-dealer and hedge-fund leverage) leads to a credit shortfall of at least $2 trillion. This shortage shows up as price-rationing: if you want to borrow, you have to pay a hefty spread over Treasurys or do without.
Losses yet unrecognized are at least double the ones taken, and market capital is almost unobtainable. Despite the excellent news on the dollar, energy, commodity, and inflation front, "The Crunch" is the dominant force, and worsening. That’s why the Dow is still lurching around in the 11,000s instead of rocketing on that good news.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
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