Rates opened much higher this morning in response to international markets and to More FED Speeches. There are no major economic items today. There are the usual Treasury Auctions. In early morning trading the yield on the 10-year Treasury was as high as 5.160% which was +.042% above Friday’s close.

Action Economics reported on a speech by Cleveland Federal Reserve President Sandra Pianalto. She said that economic fundamentals remain "solid" while inflation remains the major risk to the economy.  That was not good for rates.

News that Japan's gross domestic product was revised to a 3.3% annualized growth rate also fed concerns that upward pressure will remain on bond yields and interest rates in light of economic expansion around the world.

Late morning trading began to moderate some. The 10-year Treasury is +.019% with the yield at 5.135%.

There is as of yet, no commentary as to why the moderation on the ‘wires’. In all likelihood, this is simple correction as traders come in for bargain shopping.

SHORT-TERM OUTLOOK [06 June 2007]

We are reversing our view of Retail Sales for Wednesday. On 05 June we thought that there was some good news for the Retail Sales report on 13 June. Both UBS Store Sales and Redbook Survey have been trending downward in the last few weeks. This morning’s UBS Store Sales were -0.5% in week-to-week measurement, and +2.3% in year-to-year analysis. Redbook was up only 1.8%.

Neither number has any estimates, and both are largely ignored by the bond market. Still the can give an indication to next weeks sales numbers. When the estimates come out, they should be lower.

But, several of the private same stores sales reports have been coming in very strong. One of the analysts this blog follows is the Twin Cities radio show “Money Talk Live with Josh Arnold” AM 1280 Sunday evening at 17:00cdt {5:00pm, 22:00gmt}. On Sunday’s show Josh was reporting that several of the big chain, same stores sales were demonstrating very strong growth patterns.

That could contradict what UBS Store Sales and Redbook Survey are saying.

Economic items are light on Monday and Tuesday. This week will continue to respond to international economic events, on those two days. Bonds probably will continue the sell off. That will not help rates.

Economic events will get heavier and heavier as the week goes on. Friday will be the heaviest if with CPI & core-CPI, and Current Account at the opening. Also on Friday morning the NY Empire Index, Net Foreign Purchases, Industrial Production, Capacity and Michigan Consumer Sentiment-preliminary Index will all be out. These are at least moderately important to heavily important, and all can move rates.

Thursday’s PPI, and attached but more important core-PPI, and weekly Jobless numbers will be published.

Wednesday begins the heavy part of the week with Retail Sales, and the more important core-Retail Sales, and Import and Export Prices.

MID-TERM OUTLOOK [11 June 2007]

There may be a few problems for rates for this quarter.

1.) Investor sentiment leans towards higher rates.

A few months back this blogger wrote that the bond market seemed to be looking for any excuse to buy bonds and thus drive rates lower. It appears that that trend has reversed itself. It seems now that the bond market is looking for any reason to sell, and correspondingly raise rates.

31 May 2007 one such example. There were six items published that day. Even though most of the economic items came in as expected, three did not. Of the three, two were lower than expected and should have moved rates lower. Instead rates continued their upward trend. Clearly investor sentiment has turned bearish on buying bonds.

MarketWatch added to this view on 11 June 2007: "Basically, it's a continuing reassessment of the possibilities that the Fed will ease, and of whether it might actually tighten, and that there might be more inflation out there that was expected until recently," said Michael Gregory, fixed-income analyst at BMO Nesbitt Burns.

2) The housing bubble has ‘burst’. The question is, will housing continue to decline? Is it flattening? Or, is it on the verge of a rebound? The data over the last few months has been a resounding maybe to all three. IF homeowners start to see a rebound in housing their confidence will increase. As confidence increases, so will spending. Economic growth is moderate now with problematic inflation. Strong growth could renew strong inflation.

On 08 May 2007 the bond market responded to an unscheduled announcement by the National Association of Realtors (NAR). The NAR reduced its sales forecasts for 2007 and 2008, predicting that stricter lending standards would limit home buying. That only makes sense as stricter guidelines reduce the number of buyers able to get a mortgage. Given the already oversupply of houses, verses the very number of buyers we have a buyers market now. Reducing the number of buyers hits the real estate market with a double whammy.

Sales of existing homes will probably fall about 3% this year to 6.29 million from 6.48 million in 2006. Sales of new homes are projected to fall about 18% to 864,000, compared with a 14% drop predicted last month. Housing starts are expected to drop 19% to 1.46 million.

The results in May were mixed. New Home Sales were for April were up, while Existing Home Sales were down. At the same time, the Mortgage Bankers Association Application Index has been moving upward, indicating more people are looking.

When there are signs of housing market weakness it helps the price of bonds. Since it is a sing of a slowing economy it instills safe-haven interest.

3) IF investors continue to be concerned with the FED’s ability to fight inflation. The confusion of the FOMC meeting on 21 March, and the subsequent release of the Minutes on 11 April, caused the bond market to issue a collective HUH?!?! Economists and FED watchers echoed the HUH!?!, and added a wha...?.

There has been one more Fed meeting on 09 May, and it caused rates to move up a bit. The FED action that has impacted rates more dramatically has been comments by FED officials since the last FOMC meeting. FED officials, most often Jeffrey Lacker have spooked the Bond market and pushed rates up in the last few weeks.

4) In February we wrote:

We have one great inflation fear in the mid-term; corn prices. With all the talk of alternate fuel and ethanol, corn futures have nearly doubled. Corn is a staple of many food products that we eat. Increases in corn prices will not just impact corn flakes, but pop/soda, beef, and pig, chicken, candy bars, just about anything we eat.

None other than the Western Hemispheres worse dictators agrees with us. (For once He understands economics.)

An open letter signed by Cuban leader Fidel Castro, titled "More Than 3 Billion People in the World Condemned to Premature Death from Hunger and Thirst," circulated in the media Thursday, 05 April 2007. In his first major statement in months, Castro rejects the use of crops for biofuel production. …he is concerned that President Bush and the US Auto Makers enthusiasm for flexfuel vehicles will have disastrous environmental and food-price consequences for developing countries.

Castro and his ally, Venezuelan President Hugo Chavez, probably are concerned that the Brazilian-U.S. ethanol initiative, launched during Bush's recent Latin American tour, threatens Venezuela's influence in Central American and Caribbean countries through its subsidized oil Petrocaribe initiative.

Even the best estimates of corn based fuel say that it will never replace the need for fossil fuels. At best it can only reduce the demand some. It would be much better for us to reduce our demand on foreign oil and decrease the price at the pump by; 1.) Drilling where we know that there is oil, 2.) Build refineries, 3.) Eat food as food.

Steve Boxmeyer [612] 799 – 6858
Steve@LendWithIntegrity.com