Interest Rate Commentary: November 28, 2008

Late positioning for the month spurred buying in both stocks and Treasuries today but light volumes in abbreviated sessions may have exaggerated price moves. Some safety flows favored bonds as news of terrorist activity in India continues to come in. Events that may have an impact on the markets often motivate investors to seek areas of less risk before a weekend when they cannot react to the news. 

But the safety shift did not extinguish this week’s positive sentiment in the stock market as traders have been picking up what they perceive as bargains.In late trading, the 10-Year Treasury Note was up by 16/32, lowering its yield by 6 basis points to 2.92%; the Dow was up by 102.43 points to 8,829.04; and the Nasdaq was up by 3.47 points to 1,535.57.

Despite bleak economic news released this week and expectations of more to come, stocks have had a good week. Announcements this week of new government efforts to facilitate credit flows and the selection of economic officials for the next administration have kindled some optimism and traders began to perceive the stock market as being oversold. But analysts note that the bounce is a test of the recent downtrend and it could trigger new waves of selling as more bearish news is released.
Oil futures rose today with a barrel of light, sweet crude for January delivery up by $1.08 on the New York Mercantile Exchange to settle at $55.52. For the week, the price has risen by $5.59 and today’s close was the highest for the front-month contract in two weeks. However, the price was down for the month by $12.29.

By the end today’s stock trading, the Dow had gained 1.17%; the S&P 500, 0.96%; and the Nasdaq, 0.32%. All three made good gains for the week with the Dow rising by 9.73%; the S&P 500, 12.03%; and the Nasdaq, 10.92%. But they all declined for the month: the Dow lost 5.32%, the S&P 500 lost 7.48%, and the Nasdaq lost 10.70%.

The yield of the benchmark 10-Year Note fell by 28 basis points this week (yield moves inversely to price). For the month, the yield has fallen by 104 basis points and currently stands at an historically low level.

Next week brings the early-month heavyweight economic indicators: the national index on the manufacturing sector and the employment report. The manufacturing data from the Institute for Supply Management (ISM) comes out on Monday. In its report for October, the ISM said its purchasing managers index came in at 38.9. Any reading below 50.0 indicates a general contraction in activity relative to the preceding month and October’s reading was the lowest since September of 1982. Analysts had predicted an index of about 41.5 following September’s 43.5. In the last twelve month’s, the index has registered 50.0 or above only four times and the strongest of those readings was 50.7.

The news release included the following explanatory comment by Norbert J. Ore, chair of the ISM, “The PMI indicates a significantly faster rate of decline in manufacturing when comparing October to September. It appears that manufacturing is experiencing significant demand destruction as a result of recent events, with members indicating challenges associated with the financial crisis, interruptions from the Gulf hurricane, and the lagging impact from higher oil prices.”
A modest bright spot was a tame inflation indicator in latest data. The prices index came in at 37.0. This was the first contraction reading since December of 2006 and the lowest reading since December of 2001.

Also out on Monday is the report on construction spending for October. In September’s report, the Commerce Department said that the seasonally adjusted, annualized pace of spending fell by 0.3%. The decline was smaller than the 0.7% or 0.8% that analysts were predicting and August’s originally reported flat reading (0.0%) was revised to an increase of 0.3%. However, July’s previously reported decline of 1.4% (already revised from an originally reported drop of 0.6%) was once again revised to a decline of 2.4% — the largest in over two years.

The housing arena remained a weak spot. The last report said the pace declined in the residential sector by 1.3%. August’s originally reported increase of 0.3% was revised up to a gain of 1.9%, the largest jump since December of 2005. But July’s previously reported decline of 3.7% was revised to a steeper drop of 5.9%. Though July’s spending pace was lower, September’s was the second lowest since December of 2000.

On Wednesday, the revised report on productivity for the third quarter will be released. In the preliminary report released earlier this month, the Labor Department said that, according to preliminary data, the seasonally adjusted level of nonfarm business productivity (average output per worker per hour) grew at an annualized rate of 1.1% in the third quarter of the year relative to the second. This was the slowest pace of the year so far and the previously reported increase of 4.3% in the second quarter was revised to 3.6%.

A deceleration had been anticipated, however, because of the contraction reported in the advance report on gross domestic product. Also not unexpectedly, the lower productivity growth increased unit labor costs (ULC: average cost per unit of output). According to the initial calculations, they grew by 3.6% in the third quarter following a 0.1% decline in the second (revised from the previously reported decline of 0.5%).

Wednesday also brings the ISM index for the services sector of the economy. In October, the index came in at 44.4, down sharply from September’s reading of 50.2. As is the case with the manufacturing index, any reading of the services index under 50.0 reflects a general contraction in activity relative to the preceding month.

The current index, the NMI or Non-Manufacturing Index is new — first published last January. It is a composite of four seasonally adjusted indices: business activity, new orders, employment, and supplier deliveries. October’s reading is the lowest in the data series so far.
Before the NMI was instituted, the business activities index was the headline indicator on the services sector, but it is derived from a single question in the survey of business purchasing managers. The business activities index for October came in at 44.2, down from September’s 52.1. It was the lowest reading since last January’s 41.9 and the second lowest since October of 2001 when it came in at 40.5.

On Wednesday afternoon, the Federal Reserve will release its latest edition of the Beige Book, an anecdotal summary of economic conditions in the twelve Fed regions. The report is used as one of the background resources in the monetary policy committee’s deliberations. The next policy meeting is slated for the 15th and 16th of December.

The Beige Book rarely has much impact on the markets since previously released indicators have already sketched out the economic landscape. But any rhetorical variant, a particular focus or emphasis, could be perceived as a signal of Fed intentions and have some influence on traders. Currently, Fed watchers are anticipating another cut in the committee’s target for the fed funds rate (overnight borrowing rate between banks) and the discount rate (rate charged for loans directly from the Fed).

Thursday brings the weekly report on jobless claims and it will get added attention as it comes out a day before the employment report for November. The data collection periods for the two reports do not coincide but the trend in claims provides insight on the state of the labor market.
In Wednesday’s report, the Labor Department reported that the seasonally adjusted level of initial claims for state unemployment benefits fell last week by 14,000 to 529,000. The decline was not unexpected following two week’s of increases totaling 59,000.
In any case, readings over 400,000 are considered a sign that layoffs are outpacing hiring and the latest claims level was the second highest since July of 1992.

The four-week moving average, which smoothes out some short-term volatility, rose by 11,000 to 518,000 — the highest reading since January of 1983. For the forty-seven weeks of the year so far, the average initial claims reading has been 406,340. For the same period last year it was 319,085.
The report said that continuing claims fell by 54,000 to 3.962 million in the week ending November 15 (continuing claims must be at least a week old). This was the second highest reading since January of 1983. The four-week average rose by 60,250 to 3.929 million — the highest reading since January of 1983. For the first forty-six weeks of the year, the average continuing claims reading has been 3,203,413. For the same period last year, the average was 2,535,957.

Also on Thursday, the Commerce Department will release its report on factory orders for October. September’s report said that the seasonally adjusted level of new orders fell that month by 2.5%. The decline was stronger than the 1.0% that analysts had predicted. August’s originally reported decline of 4.0% was also revised to a drop of 4.3%, the largest decline since October of 2006.
All of the key sub-categories also saw sizeable declines. The order level outside the large but volatile category of transportation fell by 3.7% after a 3.6% decline in August. September’s drop was the largest in the history of the data series going back to 1992. Within the transportation sector, orders rose by 6.5%, the biggest increase in seven months.

Another closely watched category is that of orders outside the defense sector since those in the sector are not governed by standard market forces. Ex-defense orders fell by 3.3% following a 4.5% decline in August. Defense orders rose by 22.8%, the biggest increase since last December.
Orders for capital goods outside of the defense sector and excluding commercial aircraft are seen as a gauge of core business demand. The category saw a decline of 1.5% in September following a decline of 2.3% in August.

For October, recent predictions have called for a decline in the factory orders level of 2.7%. But Wednesday’s report on durable goods orders, which make up slightly more than half of all factory orders, indicated a drop 6.2%. This suggests that the overall order rate may be a larger decline than previously forecast.

On Friday, the often market-moving employment report comes out. In the report for October, the Labor Department said the seasonally adjusted level of nonfarm payrolls declined that month by 240,000. This was a larger decline than the 200,000 that forecasters had predicted. In addition, September’s originally reported decline of 159,000 was revised to a drop of 284,000, the biggest decline since November of 2001. August’s previously reported decline of 73,000 was revised to a drop of 127,000.

The report indicated that job losses were broad-based; losses were posted in both the goods producing and services sector. Besides the larger than expected loss in payrolls, the report said that the unemployment rate — the percentage of the active workforce without jobs — jumped from 6.1% in September to 6.5% in October. This was the highest reading since March of 1994.
For November, payrolls are expected to have fallen by between 250,000 and 300,000. The unemployment rate is expected to have risen to 6.8%. This would be the highest rate since October of 1993.

10:30 AM EST : There are no economic releases today and many traders are on the sidelines, extending the Thanksgiving Day holiday through the weekend. But this is the last trading day of the month, affording portfolio managers with their last opportunity to readjust their holdings before closing out their books for November.

The markets have been exceptionally volatile since August and they are especially vulnerable when trading volumes are low due to the loss of liquidity. With this in mind, many traders will attempt to take a conservative approach today, not wanting to rock the boat. That is evident in early action as both bonds and stocks are hovering in tight channels around unchanged levels . . . .

Source: LionMTS