U.S. stocks stumbled a bit Wednesday after Fed Chairman Bernanke touched on a number of challenges the economy will have to deal with and a large decline in consumer credit raised concerns about the pace of future consumption.  All in all though, especially since the Greece story remained in the headlines, stocks held in there pretty well.

All 10 major industry groups lost ground on the session, with telecom shares leading the decline by a large margin – the index that tracks these shares lost 2.34%, which was well-worse than the 0.59% broad-market decline.  Energy and utility shares rounded out the three worst-performing sectors. 

The relative winners were tech and health-care, down 0.21% and 0.42%, respectively.

The major indices were able to withstand the rather negative comments from Bernanke, his speech occurred around lunch and an hour later the broad market was hovering just below where we opened.  It was the consumer credit report that had the larger effect on sentiment, as the relative slide occurred directly after that release.

Market Activity for April 7, 2010

European Sovereign Debt Issues

The debt-financing issues in Greece are hitting a crescendo as that government’s bonds are trading at historic wides to German bonds, or bunds as they call them.  (Germany is the benchmark for the Eurozone.)  As the chart below illustrates, the bond vigilantes have begun to truly step in as Greek 10-yr debt trades at a yield 439 basis points (4.39 percentage points) higher than that of German bunds of the same maturity.  Hat tip to my colleague Cliff Reynolds for sending me this chart. 

This means that Germany and France are going to step up and officially announce a backstopping plan, not some mealy-mouthed commentary but an official and concrete plan, to help Greece keep these rates from widening further.  But Greece is just the tip of the iceberg, the canary in the mine, as social programs in Euroland are not sustainable.  There are serious foundational cracks in the quixotic dreams of democratic socialism, and they can no longer be hidden – too bad Washington doesn’t seem to be getting the message.

Making the Rounds

There were several Fed officials out making speeches yesterday.  Chairman Bernanke was out talking about economic challenges; New York Fed Bank President William Dudley addressed the Fed’s role in confronting asset bubbles (which should have been a speech on the Fed causing asset bubbles); and KC Fed Bank President Thomas Hoenig, now known as the lone dissenter – the only FOMC member to call for the removal of the “extended period” phrase, gave a speech on the potential perils of keeping fed funds at zero.

The market’s main focus was likely on Bernanke’s comments but William Dudley’s were interesting so I’ve got to comment on that speech first.  

The NY Fed Bank president made a point of mentioning that the bully pulpit and regulations were the best way to deal with asset bubbles, not monetary policy.  In Dudley’s terms, using the bully pulpit means that policymakers should “lean against the wind of conventional wisdom.”  That is, to point out that the assumptions embedded in the rapid rise of asset prices are wrong. 

Sometimes I wonder, does joining the Fed make one delusional?  Anyone who has watched these asset bubbles take off, which we’ve all seen at least three at various times over the past decade (stocks, housing and commodities) understands that the euphoria and performance chasing tendencies that arise during a bubble would easily drown out any talk from government officials that people are acting irrationally.  Use the bully pulpit?  I’ve got to get some of what he’s smoking. 

In terms of regulations, go ahead and try – and we surely will over the next couple of years, but the market always seems to be several steps ahead of regulators. 

On the Bernanke comments, the Fed Chairman explained “we are far from being out of the woods” as the U.S. faces hurdles including the lack of a sustained housing rebound, a “troubled” commercial real estate market and “very weak” hiring.  He also mentioned that “bank lending remains very weak, threatening the ability of small businesses to finance expansion and new hiring.” 

Right on Mr. Chairman!  In fact, I’d take it a step further.  The Fed’s ZIRP is actually contributing to the fact that bank credit continues to contract.  It’s not the whole story, as bank loan losses are also holding back the supply of loans and weak small-business sales continue to hamper the demand for loans.  But the ZIRP is definitely contributing as it sets up a scenario where banks don’t have to take the risk of making loans; they can make plenty of riskless income by borrowing from depositors at near nothing and buying Treasury securities that yield something substantially higher.  While this is helping the government fund its wild spending at a very low cost (for now at least) it is doing nothing for the private sector in the form of business loans. 

On KC Bank President Hoenig’s comments, the focus of the speech was the Fed’s need to get fed funds above zero – in fact the speech was titled, What About Zero? Hoenig argues that the FOMC should begin with changing the “extended period” phrase (with regard to the length of time they’ll keep fed funds floored) to
“sometime soon.”  This would then be quickly followed up by boosting the rate to 1.00%.  I couldn’t agree more.

Mortgage Applications

The Mortgage Bankers Association reported that their applications index fell 11% in the week ended April 2, following the previous week’s 1.3% increase.  Refinancing activity led the index lower as the segment slid 16.9% -- with the bump in the 30-year fixed rate mortgage, rising last week to 5.31% from 5.04%, this isn’t surprising.  Purchases managed a third-straight weekly increase, but just barely as they rose just 0.2% -- this follows increases in the prior two weeks of 6.8% and 2.7%, respectively. 

Purchases have seen a little life of late, after making a new 12 ½-year low in January, as buyers seek to get in before the tax credit expires.  However, we’ve got the Fed out of the game, for now at least, as they completed their goal of buying $1.25 trillion in mortgage-backed securities.  That buying held mortgage rates lower than they otherwise would have been. 

The housing market has become conditioned to ultra-low interest rates, which is evident in the fact that people now view a 30-year fixed rate of 5.50% as unappealing – historically anything below 7.5% had been seen as appealing.  I fear the housing market will take a very long time still to work through its problems, and the conditioning to super-low rates due to an unprecedented easing campaign by the Fed will only extend a housing market revival.

Consumer Credit

Consumer credit took another hit in February after rising for the first time in 11 months during January.  Credit fell $11.5 billion in February (expected to come in essentially unchanged) after an upwardly revised $10.6 billion in January. 

The revolving credit segment of the report (credit card debt) led the number lower as it slid $9.4 billion to $858.1 billion.  We’ve talked about this for well over a year now, when default rates rise credit-card lines get cut and the process likely has a ways to go.  The non-revolving segment (largely auto loans) fell $2.1 billion to $1.59 trillion, which was the first decline in three months.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900