Monday, June 30, 2008

Trichet Backs Inflation Hawks, Risking Weaker Growth (Update1)

By Simon Kennedy

June 30 (Bloomberg) -- For all his talk of consensus, European Central Bank President Jean-Claude Trichet is having to acknowledge he can't please all of the people all of the time.

A rare public division on his 21-member governing council is forcing Trichet to take sides, backing those who want to raise interest rates this week to curb inflation. Doing so may open an ever bigger rift by easing price pressures in Germany, Europe's biggest economy, at the expense of weaker neighbors.

``I don't remember such an explicit split at the ECB,'' says Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc in London. ``By lifting rates, the ECB will take unprecedented risks with growth.''

Expansion in the 15-nation euro area is already deteriorating as costlier fuel, food and credit undermine household and company spending, and a strong euro and slowing global demand sap exports. As rates rise, the pain will be spread unevenly. The economies of Germany and France are holding up, while Portugal's is contracting, and growth in Ireland and Spain may be the slowest in 15 years.

``Monetary policy could exacerbate this divergence if the ECB begins a sizable rate-hike cycle,'' says Laurent Bilke, an economist at Lehman Brothers Holdings Inc. in London who previously worked at the ECB.

Quarter-Point Increase

Trichet surprised investors and economists on June 5 when he said there was ``no unanimous'' agreement among members of his council on whether to raise rates and signaled a bias toward an increase with talk of ``heightened alertness'' on inflation. Before then, not one economist out of 32 surveyed by Bloomberg News had predicted higher rates this year.

``Frankly, we didn't quite believe our ears when we listened to Trichet,'' says Erik Nielsen, chief European economist at Goldman Sachs Group Inc. in London. All but two of 58 economists surveyed this month forecast the ECB on July 3 will boost its main rate a quarter point to 4.25 percent, the first increase in a year and the highest since 2001.

Forcing the ECB's hand is inflation that surged to 4 percent in June from a year earlier, the fastest in 16 years and in breach of the bank's target of just below 2 percent for a 10th month. A European Commission poll of 30,170 citizens last week showed rising prices overtaking unemployment as their main concern.

Crippling Blow

``The ECB is facing elevated inflation risks,'' says David Mackie, chief European economist at JPMorgan Chase & Co. in London. ``The idea that a 4 percent rate is enough doesn't seem convincing.''

The risk for Trichet is that a strike against inflation now delivers a crippling blow to the euro zone's more fragile economies. Reports last week showed manufacturing and services industries in the region unexpectedly shrank in June, confidence among consumers and businesses fell more than economists forecast and retail sales plunged. The outlook so concerns Marc Touati, chief economist at Global Equities in Paris, that he has launched an online petition against higher rates at

A widening continental divide is the price of a ``one-size- fits-all'' monetary policy, says Nick Kounis, an economist at Fortis Bank NV in Amsterdam. ``The ECB is not that interested as it sets policy for the region and for inflation -- not growth,'' he says.

`Painful Adjustments'

Eric Chaney, chief European economist at Morgan Stanley in London, says the region faces its biggest test since 1992, when a system of pegging currencies to the deutsche mark collapsed as stumbling economies forced some countries to devalue.

The Economic and Monetary Union that followed in 1999 is in no such danger, Chaney says. Still, ``painful adjustments are likely to take place'' in the form of slumping demand and plummeting real-estate values in economies such as Spain's that became overextended, he says.

Other vulnerable economies include Italy and Greece, as well as Portugal and Ireland. After bingeing on borrowing and real-estate booms as interest rates fell to a four-decade low of 2 percent, most of these nations would be hamstrung by increased borrowing costs and a higher euro.

Private debt totals 175 percent of gross domestic product in Ireland, compared with 97 percent in the euro area, according to Merrill Lynch & Co. Spain is more susceptible to shifts in short-term borrowing costs, with 90 percent of the country's mortgages carrying variable interest rates.


Competitiveness has also suffered as labor costs jumped and current-account deficits ballooned, with the deficit for Greece now close to 14 percent of GDP.

The hangover may now be hitting. Portugal's economy shrank in the first quarter. Ireland's Economic and Social Research Institute said last week the country will fall into a recession this year, the first since 1983. Economists surveyed by Bloomberg News see a 45 percent chance Spain will suffer the same fate before the end of 2009.

Meanwhile, Germany's economy is showing resilience after companies cut costs and its government reined in its budget deficit. Germany's growth was the fastest in 12 years during the first quarter, and its current account is in surplus. That leaves consumer prices as the chief worry after they rose 3.4 percent in June from a year ago. So far, the economies of France, Austria, Belgium and the Netherlands are also weathering the global slowdown and credit crisis better than their neighbors on Europe's periphery.

`Considerable' Risks

The differences in the euro area are reflected within Trichet's governing council. Axel Weber, a former academic and president of Germany's traditionally hawkish Bundesbank, led the charge for a rate increase and says inflation risks remain ``considerable.''

Spain's Miguel Angel Fernandez Ordonez has expressed concern about ``contractionary trends'' in his economy, and Lorenzo Bini Smaghi, a member of the ECB executive board, said June 17 that a single quarter-point rate increase ``should be enough.''

Trichet, who speaks today at the Bank for International Settlements meeting in Basel, Switzerland, has typically declared after ECB decisions that they were reached by consensus. Recent comments suggest ``it's going to be very hard for the ECB to come up with a consensus, even after this month,'' says Gilles Moec, London-based senior economist with Bank of America Corp.

Inflation Spreads

For now, Weber and the inflation hawks appear to hold sway as signs accumulate that inflation is spreading beyond commodities such as oil, which reached a record $142.99 a barrel last week.

Ludwigshafen, Germany-based chemical maker BASF SE is raising prices by as much as 20 percent, while employees at Cologne-based airline Deutsche Lufthansa AG want a 9.8 percent wage increase. Inflation expectations, measured by the breakeven on French inflation-indexed bonds, rose to 2.64 percent today from 2.12 percent in March.

``They will do their utmost to ensure inflation doesn't get out of hand,'' says Franz Wenzel, Paris-based deputy director for investment strategy at AXA Investment Managers, which oversees about $831 billion.

U.S. Stocks Decline on Record Oil Price; MBIA, GM Shares Drop

By Michael Patterson

June 30 (Bloomberg) -- U.S. stocks fell, dragging the Dow Jones Industrial Average down 20 percent from its October peak, as concern grew that banks and bond insurers are running short of cash and corporate profits will be hurt by record oil prices.

MBIA Inc., the world's biggest securities guarantor, tumbled to an all-time low on a report that the company is selling municipal bonds to raise cash. Wachovia Corp., the fourth-largest U.S. bank, slid to the lowest in 16 years after the New York Post said the company may have to buy back a stake in a joint venture. UAL Corp., operator of United Airlines, and General Motors Corp., the largest U.S. automaker, declined as crude rose to a record above $143 a barrel.

The Dow lost 25.56, or 0.2 percent, to 11,320.95, extending its worst June retreat since 1930. The Standard & Poor's 500 Index slipped 0.24 point to 1,278.41 at 10:17 a.m. in New York. The Nasdaq Composite Index decreased 5.95 to 2,309.68. About four stocks fell for every three that rose on the New York Stock Exchange.

``I really wouldn't fight the trend at this point,'' Malcolm Polley, who helps oversee about $1 billion as president and chief investment officer at Stewart Capital Advisors, said in Bloomberg Television interview from Pittsburgh. ``Earnings expectations are going to have to come back for the second half.''

The Dow has slumped more than 10 percent in June, extending its 2008 retreat to almost 13 percent, as record oil prices and $400 billion in global credit losses spur concern that earnings will slump for a fourth straight quarter. Citigroup Inc. strategist Tobias Levkovich said in a note to clients that analysts' profit estimates are still too high and projections for technology and industrial companies are ``excessive.''

-- Editors: Michael Regan, Chris Nagi

Friday, June 27, 2008

U.S. Stocks Slump, Pushing Dow Average to Brink of Bear Market

By Michael Patterson

June 27 (Bloomberg) -- U.S. stocks fell a second day, pushing the Dow Jones Industrial Average to the brink of a bear market, on concern subprime-related writedowns at banks will worsen and record oil and a slowing economy will prolong the worst profit decline since 2002.

The Dow extended its retreat from an all-time high in October to almost 20 percent, the threshold for a so-called bear market. American International Group Inc. and Merrill Lynch & Co. sent the Standard & Poor's 500 Financials Index to a five-year low on speculation of mounting losses. Hasbro Inc. and KB Home helped lead consumer stocks in the S&P 500 to the lowest level since 2003 as oil topped $142 a barrel.

The Dow average lost 106.91 points, or 0.9 percent, to 11,346.51, leaving it within 0.1 percent of a bear market. The 30-stock measure fell 10 percent this month for the worst June since 1930. The S&P 500 slid 4.77, or 0.4 percent, to 1,278.38 today. The Nasdaq Composite Index slipped 5.74, or 0.3 percent, to 2,315.63. Eight stocks declined for every five that rose on the New York Stock Exchange.

``The news on earnings is that the second quarter is probably going to be worse than we thought,'' said Ron Sweet, vice president of equity investments at USAA Investment Management Co., which oversees $100 billion in San Antonio. ``The old news keeps sticking around: it's energy prices, it's writeoffs at banks, it's the slow economy.''

The S&P 500 slumped 3 percent this week, the Dow slid 4.2 percent and the Nasdaq tumbled 3.8 percent. The S&P 500's 8.7 percent decline in June is the worst monthly performance since the 11 percent plunge in September 2002.

Earnings Slump

Analysts forecast earnings for companies in the S&P 500 will slump 11 percent on average, according to a Bloomberg survey today, compared with a projected decline of 8.9 percent a week ago. Goldman Sachs Group Inc. strategist David Kostin said in a report today that expectations for 2008 and 2009 profits are ``too optimistic'' and are likely to be reduced.

AIG decreased 34 cents to an 11-year low of $27.75. The world's biggest insurer plans to absorb losses for a dozen insurance units after their securities-lending accounts suffered $13 billion of writedowns tied to the subprime-mortgage collapse.

Merrill fell 35 cents to $32.70, the lowest price since March 2003. Lehman Brothers Holdings Inc. analyst Roger Freeman increased his second-quarter loss estimate on expectations subprime-related writedowns will be more than twice as big as previously projected.

`Tenuous Situation'

MBIA Inc. lost 22 cents to a 20-year low of $4.17. The world's largest bond insurer faces a ``tenuous situation'' as it seeks to cover payments and collateral calls on $7.4 billion of securities triggered by a credit-rating downgrade, Fitch Ratings analyst Thomas Abruzzo said.

MBIA may need to tap assets pledged to back other commitments as it comes up with the money, potentially opening the company up for further downgrades, said Abruzzo, who yesterday withdrew his rating on MBIA and Ambac Financial Group Inc. after the companies refused to give him information.

Ambac slid 19 cents to $1.61, a record low.

The S&P 500 Consumer Discretionary Index lost 0.7 percent, falling to the lowest since October 2003, after crude oil gained as much as 2.4 percent to $142.99 a barrel. Hasbro, the world's second-largest toymaker, lost $1.60 to $35.14.

KB Home, the homebuilder founded by Eli Broad, slumped 41 cents to $17.72. The company reported its fifth straight quarterly loss as rising mortgage rates and falling prices reduced demand for homes.

Worst Ahead?

Homebuilders in S&P indexes lost 1 percent as a group. Lennar Corp. fell 72 cents to $12.62, the lowest price since September 2000. The second-largest builder said yesterday that the housing market has yet to see the worst of the slump.

Micron Technology Inc. retreated the most since October 2006, falling 89 cents, or 13 percent, to $6.10. The largest U.S. producer of memory chips reported a wider third-quarter loss on weaker pricing for semiconductors used to store pictures and music in portable devices.

``June has been difficult,'' Matthieu Bordeaux-Groult, who helps oversee about $6.2 billion as fund manager at Richelieu Finance in Paris, said in a Bloomberg Television interview. ``There are a lot of negative elements in the market such as high raw materials prices, but valuations are low and offer buying opportunities.''

The S&P 500 gained as much as 0.5 percent earlier after U.S. consumer spending rose 0.8 percent in May, exceeding forecasts. Tax rebates drove the biggest gain in incomes in almost three years, enabling households to at least temporarily overcome soaring fuel bills.

Bristol-Myers Squibb Co. climbed the most since May 1, rising 63 cents, or 3.2 percent, to $20.30. The drugmaker selling a unit for $4.1 billion to finance acquisitions may itself be a takeover target, Sanford C. Bernstein & Co. analyst Timothy Anderson said.

Tuesday, June 24, 2008

U.S. Economy: Consumer Confidence, House Prices Slide (Update3)

By Shobhana Chandra and Timothy R. Homan

June 24 (Bloomberg) -- Confidence among Americans dropped to the lowest level in 16 years and house prices fell the most on record, raising the risk that consumers will cut back on purchases after spending their tax rebates.

The Conference Board's confidence index fell to 50.4 in June, lower than forecast, from 58.1 in May. Home prices in 20 cities dropped 15.3 percent in April from a year earlier, according to S&P/Case-Shiller, the most since the group began collecting data.

Consumers, whose spending accounts for more than two thirds of gross domestic product, are being hurt by the housing slump, rising unemployment and higher food and fuel bills.

``We've seen this dive in confidence in the last two months at the same time these stimulus checks'' have been mailed, Chris Low, chief economist at FTN Financial in New York, said in a Bloomberg Television interview. ``It tells me if we see this pop in spending, it's not going to last.''

The confidence measure reached the lowest level since February 1992, when the economy was in the midst of the so-called ``jobless recovery'' following the 1990-1991 contraction.

Concern over jobs contributed to the erosion in confidence. The share of consumers who said jobs are plentiful fell to 14.1 percent from 16.1 percent last month. Those saying jobs are hard to get increased to 30.5 percent from 28.3 percent. Buying plans over the next six months for automobiles, houses, appliances and vacations all declined.

Greenspan Pessimism

Recent economic data ``suggests we are on the brink'' of a recession in the U.S., former Federal Reserve Chairman Alan Greenspan said today via satellite to a conference in Johannesburg. The next year will be ``a very sluggish period,'' with a ``highly volatile oil market,'' he said.

Treasuries rose, dropping the yield on the benchmark 10-year note to 4.08 percent at 4:45 p.m. in New York, from 4.17 percent late yesterday. The Standard & Poor's 500 stock index fell 0.3 percent to close at 1,314.29.

Mortgage defaults and foreclosures are adding to the glut of properties on the market, while stricter loan rules are making it more difficult for prospective buyers to get financing. A separate report from the Office of Federal Housing Enterprise Oversight today showed prices fell 4.6 percent in April from a year earlier.

While the Fed has pledged to combat any increase in inflation expectations, economists predict the central bank will keep its benchmark interest rate at 2 percent tomorrow. They will also be reluctant to signal an imminent increase in borrowing costs.

Car Sales

Ford Motor Co., the second-biggest U.S. automaker, last week said domestic sales of large pickup trucks will decline because of $4-a-gallon gasoline. Best Buy Co., the largest U.S. electronics retailer, last week said first-quarter profit fell 6.8 percent as consumers bought less profitable items such as video games and laptop computers.

United Parcel Service Inc., the world's largest package- delivery company, yesterday lowered its second-quarter profit forecast because of rising fuel costs and a slowing U.S. economy.

``People are really, really ill at ease right now,'' New Jersey Governor Jon Corzine said in an interview today with Bloomberg News in New York in response to the consumer confidence report. Corzine, a Democrat, is the former chairman of the investment bank Goldman, Sachs & Co.

The public feels that way about elected officials and are concerned about the security of their own jobs, health care coverage and pensions, Corzine said. He advocates spending more on infrastructure, both in New Jersey and nationally, as a way to boost the economy.

April Drop

Home prices in the S&P/Case-Shiller index decreased 1.4 percent in April from a month earlier after a 2.2 percent decline in March, the report showed. The figures aren't adjusted for seasonal effects, so economists prefer to focus on year-over-year changes.

The index was forecast to fall 16 percent from a year earlier, after a previously reported 14.4 percent drop in the 12 months ended in March, according to the median forecast of 23 economists surveyed by Bloomberg News. The confidence index was projected to retreat to 56.

All of the 20 cities in the index showed a year-over-year decrease in prices for April, led by a 27 percent drop in both Las Vegas and Miami. Charlotte, North Carolina, showed a decline for the first time.

One bright spot in the report was that more cities showed a gain in prices in April compared with the previous month. Houses in eight areas rose in value, compared with just two in March. Month-over-month gains were led by Cleveland and Dallas.

`Some Surprises'

There may be ``some surprises in the next few months that would indicate we are at or near a bottom in probably one third to one half of the country,'' Karl Case, an economics professor at Wellesley College, said in an interview on Bloomberg Television.

Case created the home-price index with Yale University's Robert Shiller based on research from the 1980s.

Reports this week may reinforce the dim outlook for housing. Combined sales of new and existing homes in May probably were the third-lowest on record, according to the Bloomberg survey median.

New-home sales probably fell, approaching March's 17-year low, a report from the Commerce Department tomorrow may show. The National Association of Realtors may report the following day that purchases of existing houses, which account for 85 percent of the market, rose last month from a record low.

Rates Rise

Rising borrowing costs aren't helping. Fannie Mae, the largest mortgage buyer, last week cut its forecast for new and existing home sales this year as 30-year fixed mortgage rates jumped to an eight-month high.

Banks repossessed twice as many homes in May as they did a year ago and foreclosure filings rose 48 percent, according to RealtyTrac Inc., a real estate database in Irvine, California.

Homebuilders are reeling. Standard Pacific Corp., an Irvine, California-based homebuilder, last week said new home orders for April and May fell 12 percent from a year earlier, citing ``difficult housing conditions'' in most of its markets.

Ofheo's price measure has a broader geographical database than the S&P/Case-Shiller index, though it doesn't include so- called jumbo mortgages. Those loans are above the federal limits, which were raised on a temporary basis in February to as much as $729,750 in some areas.

Bernanke Plays `Dangerous Game' Weighing Talk, Action (Update2)

By Scott Lanman

June 24 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke, by voicing concern about inflation and the slumping dollar, has fanned investor expectations for an interest-rate increase as soon as August. He may regret it.

Raising rates may exacerbate the economic slowdown and roil banks whose losses sent their stocks down the most in a decade this month. Forgoing a rate boost next quarter risks damaging the Fed's credibility and deepening its divisions. Already this year, three officials have dissented on rate decisions.

While Bernanke's warning that the Fed will ``strongly resist'' a jump in inflation expectations led traders to bet on a rate increase, economists are more skeptical. All 101 in a Bloomberg News survey said the Federal Open Market Committee will keep the benchmark rate unchanged tomorrow and most analysts this month predicted officials will stand pat until 2009.

``That's the dangerous game,'' said Scott Anderson, senior economist in Minneapolis at Wells Fargo & Co., the fourth-largest U.S. bank by market value. ``Instead of putting the shot across the bow on inflation,'' Bernanke might have ``held off a few more months to let the credit crisis heal a little bit more.''

The Fed chief shifted stance after soaring costs of energy and imported goods threatened to stoke consumer price expectations. Gasoline climbed 37 percent in the past year, according to AAA. Import prices excluding petroleum rose the most since 1988 in the 12 months to May, government figures show.

Bernanke's Message

Bernanke said at a Boston Fed conference June 9 the risk of a ``substantial downturn'' in the economy had diminished and accelerating inflation ``would be destabilizing for growth.'' The previous week, he said the falling dollar caused an ``unwelcome'' increase in domestic prices and the Fed was ``attentive'' to the problem.

There are widespread expectations among traders for a rate rise in the next three months: There are 36 percent odds of a boost in August and 93 percent in September, according to futures contracts on the Chicago Board of Trade. Economists in a monthly Bloomberg survey through June 11 projected the Fed will keep the rate at 2 percent this year, according to the median estimate.

The FOMC began gathering today in Washington at 2 p.m. and will release its statement tomorrow at around 2:15 p.m.

``Unless the inflation expectations and the numbers come down, they're going to have to raise rates,'' William Ford, a former Atlanta Fed chief who's now at Middle Tennessee State University in Murfreesboro, said in a Bloomberg Radio interview. ``If he's saying we're going to fight inflation but he's all bark and no bite, division is what's going to happen.''

Rate Decisions

Dallas Fed President Richard Fisher, Philadelphia Fed chief Charles Plosser and William Poole, who retired from the St. Louis Fed in March, dissented on rate decisions this year.

The FOMC usually has seven Fed board members and five district-bank heads. Two board positions are now vacant, and a third opens in August with Governor Frederic Mishkin's departure.

That means the presidents, who tend to dissent more than governors, may get a majority. The Senate has yet to confirm the Bush administration's board nominees, though Democratic Senator Christopher Dodd of Connecticut, who chairs the Senate Banking Committee, has said he may hold a vote on at least one of the picks.

Officials are increasingly sounding the alert that they're prepared to raise rates this year.

``If we don't take action and stay on top of the situation,'' inflation will probably accelerate, James Bullard, Poole's successor, said June 11. Bullard doesn't vote this year. The Fed must ``act preemptively,'' Plosser said June 12.

Price Expectations

Consumers anticipate annual inflation of 3.4 percent in the coming five years, a 13-year high, a Reuters/University of Michigan survey showed this month. A measure of price expectations based on 10-year Treasury inflation-protected securities has also risen this year, to 2.46 percent.

A measure of prices tied to consumer spending has averaged annual gains of 3.3 percent so far this year, up from 2.5 percent in 2007. Excluding food and energy costs, the Commerce Department's index has averaged 2 percent increases this year, compared with a 1.8 percent average pace since 1998.

Bernanke has said the slowdown should alleviate price pressures. The economy expanded 0.9 percent in the first quarter, capping the weakest six-month performance in five years.

The downturn is weakening U.S. banks already struggling with the credit crisis and the worst housing slump in a quarter century.

The Standard & Poor's 500 Banks Index is down 20 percent in June, on course for the worst month since August 1988. More than 100 lenders have been forced to close, halt operations or sell themselves since the beginning of last year.

Quarterly Profit

Fifth Third Bancorp, Ohio's second-biggest bank, said June 18 most of its quarterly profit will evaporate after already posting nine consecutive declines.

A private survey released today showed that home prices in 20 U.S. metropolitan areas fell in April by 15.3 percent from a year earlier, the most on record for the S&P/Case-Shiller home- price index. Separately, consumer confidence dropped more than forecast to the lowest in more than 16 years, according to the Conference Board.

``The issue here is whether the Fed is willing to risk an escalation of inflation and then a bigger recession later, or acts earlier, taking a risk of a smaller recession, but preventing inflation from getting out of hand,'' Poole said in a Bloomberg Television interview.

Monday, June 23, 2008

Bear Stearns Mortgage Traders Leave for Goldman, RBS (Update1)

By Jody Shenn

June 23 (Bloomberg) -- Bear Stearns Cos. mortgage-trading executives Scott Eichel and Jeffrey Verschleiser agreed to take jobs with Royal Bank of Scotland Group Plc and Goldman Sachs Group Inc., according to people with knowledge of their plans.

Eichel, 33, who was co-head of mortgage- and asset-backed bond trading at the time of New York-based Bear Stearns's near- collapse, will join Greenwich, Connecticut-based RBS Greenwich Capital Markets, said one person, who declined to be named because the announcement hasn't been released. Verschleiser, 39, will help manage New York-based Goldman's mortgage department, two other people said.

``Bear Stearns had a very good reputation in terms of their trading abilities,'' said Don Brownstein, chief executive officer of Stamford, Connecticut-based Structured Portfolio Management LLC, which runs fixed-income hedge funds with about $1.5 billion in assets. ``They certainly were a powerhouse in the mortgage business, so it doesn't surprise me at all'' that the firm's staff is being recruited by other companies, he said.

At least 21 other senior employees have joined other companies since New York-based JPMorgan Chase & Co. agreed to buy Bear Stearns in March, according to data compiled by Bloomberg. The second-largest underwriter of mortgage debt last year, Bear Stearns sold itself after an exodus of clients and lenders threatened to plunge the company into bankruptcy. The transaction was completed on June 2.

Retaining Employees

Andrea Rachman, a spokeswoman for Goldman, declined to comment. Brian Marchiony, a spokesman for JPMorgan, and RBS Greenwich's Peter Ward didn't return calls for comment. Verschleiser didn't respond to messages left on his mobile telephone seeking comment.

Verschleiser was co-head of Bear Stearns's mortgage-trading business with Mike Nierenberg until late last year. They were replaced with Eichel and Josh Weintraub, who departed in April for GMAC LLC's Residential Capital LLC home-loan unit.

Goldman is adding to its ranks after Dan Sparks, who had run the department, left after 19 years. Josh Birnbaum departed to form a hedge fund.

JPMorgan, the third-largest U.S. bank, has been seeking to retain select Bear Stearns employees. The bank planned to replace 2,000 JPMorgan workers with Bear Stearns staff, a person familiar with the matter said last month.

Jeff Mayer and Craig Overlander, the former co-heads of fixed income at Bear Stearns, left JPMorgan even after they were named vice chairmen of the investment bank.

Thursday, June 19, 2008

Treasuries Advance After Moody's Cuts MBIA, Ambac Debt Ratings

By Wes Goodman

June 20 (Bloomberg) -- Treasuries rose, heading for a weekly gain, after Moody's Investors Service stripped bond insurers MBIA Inc. and Ambac Financial Corp. of their Aaa ratings.

Two-year notes advanced for the third time in four days after traders scaled back forecasts for how soon the Federal Reserve will start raising interest rates.

``There's still an underlying demand due to fears of credit blowing up again,'' said Edward Lee, a fixed-income strategist in Singapore at Standard Chartered Plc, a U.K. lender focused on emerging markets. ``Rate hikes are not on the cards.''

The two-year note yield fell 2 basis points to 2.93 percent as of 9:45 a.m. in Tokyo, according to bond broker BGCantor Market Data. The price of the 2.625 percent security due in May 2010 rose 1/32, or 31 cents per $1,000 face amount, to 99 14/32.

The yield declined 11 basis points this week. A basis point is 0.01 percentage point.

Wednesday, June 18, 2008

SNB May Leave Benchmark Rate Unchanged at 6-Year High of 2.75%

By Joshua Gallu

June 18 (Bloomberg) -- The Swiss central bank will probably leave its main lending rate unchanged at a six-year high tomorrow as slowing growth limits policy makers' room to combat inflation, a survey of economists shows.

The Swiss National Bank's Governing Board led by Jean-Pierre Roth will probably keep the three-month Libor target at 2.75 percent when it meets in Geneva tomorrow, according to 16 of 25 forecasts in a Bloomberg News survey.

Switzerland's economy may lose momentum in the coming months as weakening global demand erodes exports and losses from the U.S. housing crisis eat into earnings at the country's largest banks including UBS AG and Credit Suisse. At the same time, record oil prices are fueling the fastest inflation in 15 years, leaving the SNB in an ``uncomfortable situation,'' Vice President Philipp Hildebrand said May 22.

``The Swiss economy has already cooled considerably and is going to keep slowing in the second and third quarters,'' said Jan Amrit Poser, chief economist at Bank Sarasin in Zurich. ``Inflation is high, but it's mostly due to high oil prices, and the SNB can't do much about that. The real threat is to growth.''

Swiss economic growth slowed to 0.3 percent in the first quarter, the weakest pace in more than three years. The country's leading economic indicators fell for a 10th month in May, a sign growth will continue to ease in the coming six months.

Still, inflation threats have increased and gains in the price of oil had surprised the central bank, Roth said May 27. The SNB will take the risks of inflation seriously at its policy meeting tomorrow, Roth said. Crude prices have risen 40 percent this year, helping push the Swiss inflation rate to 2.9 percent in May.

Soaring Prices

The SNB will announce its decision at 9:30 a.m. and Governing Board members Roth, Hildebrand and Thomas Jordan will hold a press conference 30 minutes later.

Soaring prices for oil and food are prompting central banks from India to North America to shift attention from fighting slowing economic growth to stamping out inflation. European Central Bank President Jean-Claude Trichet said June 5 the bank may raise rates as soon as next month to combat rising prices.

Consumer price increases in the 15-nation euro area accelerated to 3.7 percent in May, the fastest in 16 years. The Swiss inflation rate held above the SNB's price-stability threshold of 2 percent for a fifth month.

Since Trichet's remarks, the Swiss three-month Libor rate has risen 15 basis points to 2.92 percent, almost a quarter point higher than the target, as investors increased bets the SNB would increase rates.

Changed Forecasts

BNP Paribas, Credit Suisse Group, Barclay's Capital, Deutsche Bank and economic research group BAK Basel Economics all changed their forecasts last week to say the SNB would raise rates to 3 percent in June.

``Markets have already priced in higher rates,'' said Reto Huenerwadel senior economist at UBS in Zurich who forecasts rates to be unchanged. ``Looking at the economic fundamentals, an aggressive tightening isn't needed. It's a really close call.''

Still, the franc's 19 percent gain against the dollar in the past year is helping cushion the blow of soaring oil prices. At the same time, slowing growth may weaken demand, relieving some pressure on prices.

``The extent to which the economy is going to slow isn't yet certain,'' said Bernard Lambert, an economist at Pictet & Cie in Geneva. ``It's a good time for the SNB to wait and see.''

Some price increases will likely linger even if growth slows. High food costs ``are here to stay'' as governments divert resources to make biofuels, amass stockpiles and limit exports, Peter Brabeck-Letmathe, chairman of Nestle SA, the world's largest food company, said June 16. Food prices ``will establish themselves on a higher level but not at the peaks we have seen,'' he said.

Monday, June 16, 2008

Dollar May Extend Drop Versus Euro on Signs of Weakened Economy

By Ye Xie and Bo Nielsen

June 17 (Bloomberg) -- The dollar may extend its drop against the euro on speculation a weakened U.S. economy will discourage the Federal Reserve from increasing borrowing costs this year.

The U.S. currency fell yesterday as New York state manufacturing shrank in June and crude oil prices touched a record high of $139.89 a barrel. Reports today are forecast by economists to show U.S. housing starts declined last month to a level close to the lowest since 1991 and producer price inflation excluding energy and food items eased.

``I'm not a dollar bull just yet,'' said Marios Maratheftis, a currency analyst at Standard Chartered Plc in London, in an interview on Bloomberg Television. ``There is another wave of dollar weakness to come in the next few months.''

The dollar traded at $1.5475 per euro at 6:02 a.m. in Tokyo, after declining 0.6 percent yesterday, the biggest drop since June 6. The U.S. currency was little changed at 108.23 yen. The yen traded at 167.48 versus the euro, following a 0.7 percent decline yesterday, when it touched 167.68, the weakest level since Oct. 15.

The greenback dropped 0.9 percent to 5.1807 against the Norwegian krone and 0.6 percent to C$1.0236 versus the Canadian dollar yesterday as crude oil touched the record before falling to $133.65 a barrel. Commodities such as oil and gold make up half of Canada's exports, while Norway is the world's fifth- largest oil producer.

The correlation of the dollar against the euro and oil prices is minus 0.93 for the past year, according to Bloomberg calculations based on value changes, indicating they have moved in the opposite direction 93 percent of the time.

`Under pressure'

``As long as oil keeps rallying, the dollar will be under pressure,'' said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York.

The U.S. Dollar Index traded on ICE futures decreased yesterday for the first time in three days, falling 0.7 percent to 73.61. The index, which tracks the dollar against the currencies of six U.S. trading partners, touched 74.31 on June 13, the highest since Feb. 28.

The Federal Reserve Bank of New York's general economic index, a gauge of manufacturing, decreased to minus 8.7 in June from minus 3.2 the prior month. Readings less than zero signal contraction.

U.S. housing starts probably dropped to an annual rate of 980,000 in May, from 1.032 million the previous month, according to the median forecast of 71 economists surveyed by Bloomberg News. The Commerce Department reported that housing starts fell to a 17-year low of 954,000 in March.

Wholesale Prices

The Labor Department will probably report that prices paid to U.S. producers, excluding food and fuel, rose 0.2 percent last month, following a 0.4 percent increase in April, according to the median forecast in a separate Bloomberg survey. Both reports are scheduled to be released at 8:30 a.m. in Washington.

``The Fed would like to hike, but if we continue to get the numbers along these lines, it will be very difficult for them to do so,'' said Matthew Kassel, director of proprietary trading at ING Financial Markets LLC in New York. ``The dollar rally is going to take a rest here.''

Fed funds futures on the Chicago Board of Trade show a 68 percent chance the U.S. central bank will increase the 2 percent target lending rate by at least a quarter-percentage point at its August meeting. There are 26 percent odds policy makers will lift the rate to 3 percent by December.

Bernanke on Economy

The U.S. currency rose last week the most against the euro since 2005 as Fed Chairman Ben S. Bernanke said economic risks have faded. The yield on the two-year Treasury note posted its biggest weekly increase in 26 years last week, rising 66 basis points to above 3 percent.

``The perception that the Fed will hike rates is still strong,'' said Shaun Osborne, chief currency strategist at TD Securities Inc. in Toronto. ``Short-term rates have risen quite sharply the last couple of weeks. That will keep the dollar sustained.''

The dollar will strengthen 3 percent to $1.50 per euro by year-end, according to the mean forecast of 39 firms surveyed by Bloomberg News.

The yen fell to an eight-month low versus the euro yesterday as reduced currency volatility encouraged investors to buy higher-yielding assets funded by low-cost loans in Japan.

Japan's currency dropped 0.8 percent to 17.92 against the Swedish krona and 0.7 percent to 212.23 versus the pound as investors increased carry trades in which they get funds in a country with low borrowing costs and buy assets where returns are higher. Japan's target lending rate of 0.5 percent compares with 2 percent in the U.S., 4 percent in the euro zone, 5 percent in the U.K. and 4.25 percent in Sweden.

The risk that fluctuating exchange rates will erase carry- trade profits fell yesterday. Implied volatility on one-month euro-yen options dropped for a fourth day, declining to 10.07 percent, from 10.31 percent on June 13.

Sunday, June 15, 2008

Dollar May Beat Euro as Inflation Focus Trumps Subprime Rout

By Lukanyo Mnyanda and Ye Xie

June 16 (Bloomberg) -- Currency forecasters are betting that the dollar rally is just getting started as the Federal Reserve's shift to fighting inflation makes it likely to raise interest rates more aggressively than the European Central Bank.

The currency will strengthen 2.5 percent to $1.50 per euro by year-end, according to the mean estimate of 39 firms surveyed by Bloomberg. Economists anticipate that the ECB will raise rates a quarter-percentage point by September and then cut borrowing costs by yearend. Fed Chairman Ben S. Bernanke, who said he's ``attentive'' to the U.S. currency, will boost rates three-quarters of a percentage point by the end of the third quarter of 2009, according to data compiled by Bloomberg.

``We've seen a very significant shift in Fed emphasis; they're now clearly focused on inflation and the need to control inflation expectations,'' said Ian Stannard, senior foreign- exchange strategist in London at BNP Paribas SA, the most accurate currency forecaster in a 2007 Bloomberg survey. ``We're likely to see the currency recover some ground.''

U.S. consumer prices rose 0.6 percent in May, the most since November and faster than forecast, the Labor Department said June 13. The report reinforced expectations the Fed will raise rates to 2.75 percent in the next 15 months from the current 2 percent.

The dollar had its biggest weekly gain in three years against the European and Japanese currencies. It strengthened 3.1 percent versus the yen to 108.19 and 2.5 percent against the euro to $1.5380.

Dollar, Stocks, Bonds

Concern about inflation also sent U.S. two-year notes to their steepest weekly loss in more than six years. The Standard & Poor's 500 Index, the benchmark for U.S. equities, dropped for a second straight week. Not since the week ending Feb. 8 has the dollar gained while Treasuries and the S&P 500 fell.

Options traders reversed bets in favor of the euro. A week ago, demand for options granting the right to buy the euro exceeded those offering the right to sell for the first time this year.

The so-called risk-reversal rate changed as traders speculated Group of Eight officials would signal they favor a stronger dollar and French Finance Minister Christine Lagarde described the U.S. currency's gains as ``very satisfying.''

``Verbal intervention has become more powerful,'' said Daniel Janis, who helps manage the $2 billion John Hancock Strategic Income Fund in Boston. ``You are likely to see a more stable dollar.''

Bear Stearns Rescue

The dollar index, which measures the U.S. currency against six trading partners, tumbled almost 9 percent between Sept. 18 and April 22 as the Fed cut its target rate for overnight bank loans by a total 3 percentage points to stave off a recession caused by tumbling home prices and a seizure in credit markets sparked by losses in subprime-related securities.

It rebounded 4 percent since then after the Fed helped arrange the bailout of Bear Stearns Cos. by JPMorgan Chase & Co. and investors shifted their focus to inflation instead of the credit crunch.

G-8 finance ministers said the credit squeeze has been replaced by surging food and fuel prices as the biggest threat to the world economy.

``The predominant concern is the inflationary effect that oil in particular and also food prices are having,'' U.K. Chancellor of the Exchequer Alistair Darling said June 14 after the talks ended in Osaka, Japan. Deputy German Finance Minister Thomas Mirow said oil's rise to a record means ``an enormous withdrawal of purchasing power.''

Oil reached $139.12 a barrel on June 6 and corn futures for December delivery rose 0.5 cent to $7.40 a bushel on the Chicago Board of Trade.

Price Stability

The Fed's commitment to price stability and maximum employment ``will be key factors ensuring that the dollar remains a strong and stable currency,'' Bernanke said June 3.

The remarks were a ``change of rhetoric'' that showed the dollar ``has bottomed,'' said Stephen Jen, chief currency economist at Morgan Stanley in London, who used to work at the Fed.

``Central banks are trying to get ahead of the curve by tightening faster than the market has been imagining.'' said Tim Bond, head of global asset allocation at Barclays Capital in London. The Fed will lift its target rate for overnight bank loans a quarter point in September and October, Barclays said in a report June 13. Higher interest rates support a country's currency by making its fixed-income assets more attractive.

Bulls in Minority

Dollar bulls are still in the minority, in part because ECB President Jean-Claude Trichet has also said inflation is a concern and the ECB rate is double the Fed's.

UBS AG, the second-biggest currency trader, last week cut its one- and three-month dollar forecasts against the euro to $1.60 and $1.53, from estimates of $1.50 and $1.47, respectively. Citigroup Global Markets Inc. reversed its bet on dollar gains, expecting the currency to fall to $1.63 within two months.

The dollar will trade at $1.50 to the euro and 105 yen by the end of the year, according to analysts in a Bloomberg survey.

``Actions speak louder than words,'' said Adam Boyton, a senior currency strategist in New York at Deutsche Bank AG, the world's biggest currency trader, according to Euromoney Institutional Investor Plc. He forecast the euro will trade between $1.50 and $1.60 in the next three months. The Fed's still ``some way away from actually being ready to pull the trigger,'' he said.

Stretched Strength

Technical indictors show the dollar's strength may be stretched. So-called trading envelopes, which measure how far from the mean a price has strayed, showed the dollar gained more than two-standard deviations in the past three weeks. The last time the indicator reached that level on May 8, the dollar lost 3 percent in two weeks.

Institutional investors bought more dollars than they sold this year, according to State Street Corp. and Bank of New York Mellon Corp., the largest money managers for institutions.

The dollar gained in 71 percent of the quarters over the past decade when they were net buyers, according to Boston-based State Street. The biggest investors bought more than they sold in all of the quarters when, like now, benchmark interest rates were below inflation and the current account deficit, the broadest measure of trade, exceeded 3 percent of the economy.

``There's much more scope for interest rates in the U.S. to get a lot higher,'' said Andrew Wilkinson, a senior market analyst at Greenwich, Connecticut-based Interactive Brokers Group Inc., which handles a fifth of all options traded in the U.S. ``We've put a floor under the dollar. I'll bet my money on the dollar rally.''

Thursday, June 12, 2008

Treasury 10-Year Note Yields Rise to Year High on Retail Sales

By Daniel Kruger

June 12 (Bloomberg) -- Treasuries fell, pushing the yield on the benchmark 10-year note to the highest level this year, after a larger-than-expected gain in retail sales bolstered the case for the Federal Reserve to boost interest rates.

The yield on the 10-year note has climbed 94 basis points since March 17, when the Fed backed JPMorgan Chase & Co.'s bailout of Bear Stearns Cos., a sign to traders that the seizure in credit markets caused by the subprime mortgage collapse was ending. Losses in Treasuries accelerated after policy makers signaled they would stop cutting interest rates and Fed Chairman Ben S. Bernanke said June 3 that ``we are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations.''

``The story right now is purely an inflation story,'' said David Glocke, who manages $75 billion of Treasuries at Vanguard Group Inc. in Valley Forge, Pennsylvania. ``The key issue is the market's response to increased focus by the Fed on the inflation picture.''

Ten-year note yields increased 14 basis points to 4.22 percent at 4:04 p.m. in New York, according to bond broker BGCantor Market Data. That's the highest since Dec. 27. The 3.875 percent security due May 2018 declined 1 6/32, or $11.88 per $1,000 face amount, to 97 7/32. A basis point is 0.01 percentage point.

Yields on 10-year notes had dropped to an almost five-year low of 3.28 percent on March 17. The increase in yields in the steepest in four years. Rates on three-month bills plunged to 0.39 percent, the lowest since the 1950s, the same day as investors sought the safety of the shortest maturity government debt.

`Act Preemptively'

Bond yields have climbed since, with Treasuries posting their worst two-months since 2004 in April and May, as the dollar weakened to a record low, crude oil climbed to an all- time high and prices of other commodities such as rice and corn surged.

Federal Reserve Bank of Philadelphia President Charles Plosser told CNBC today that central bankers ``need to act preemptively'' to forestall a jump in the inflation rate anticipated by the public. Vice Chairman Donald Kohn said yesterday that the Fed needs to counter any sign the public is beginning to expect faster increases in consumer prices.

Futures on the Chicago Board of Trade show odds of 22 percent the Fed will raise the target rate for overnight lending between banks by at least a quarter-percentage point to 2.25 percent at its June 25 meeting. The probability of an increase by year-end is 99 percent. Two months ago, the odds of a quarter-percentage point cut in the target rate was 90 percent.

The central bank has cut its target rate to 2 percent from 5.25 percent since September to keep a U.S. housing recession and credit-market losses from pushing the economy into a recession.

`Heightened Alertness'

The Fed isn't alone suggesting higher rates. European Central Bank council member Axel Weber reiterated today the bank is ready to raise interest rates to contain inflation. Last week, ECB President Jean-Claude Trichet said a July increase in the bank's benchmark rate, now twice the fed funds target, is ``possible.''

The dollar has fallen 11 percent against a basket of six major currencies in the past year; inflation is rising at a 3.9 percent rate, almost double its pace in August.

Retail sales rose twice as much as forecast in May as Americans used their tax rebates to shop, and record gasoline prices swelled service-station receipts. Purchases climbed 1 percent, the most since November, the Commerce Department said. Purchases excluding gasoline increased 0.8 percent last month.

Curve Trades

Inflation expectations among traders have risen this year to the highest level since August 2006. The difference between yields on 10-year Treasury Inflation Protected Securities, or TIPS, and conventional notes has widened to 2.51 percentage points, from 2.28 percentage points at the end of April. The figure reflects the inflation rate that traders expect for the next decade.

Yields on two-year notes have more than doubled to 3.05 percent since reaching 1.24 percent on March 17, the lowest since July 2003. They've risen 68 basis points since June 6, the biggest weekly increase since August 1982. Ten-year note yields have increased 31 basis points this week, the most since 2004.

Short-term Treasuries have fallen more as traders unwind bets that the yield gap between two- and 10-year notes would widen. The difference has narrowed to 118 basis points from 208 basis points on March 6. The difference, known as the yield curve, was 97 basis points at the start of 2008.

Lehman Brothers

The Treasury Department sold $11 billion of 10-year notes today at a yield of 4.225 percent, the highest level on the monthly sales since November. Investors bid for 2.33 times the amount of debt on offer, compared with 2.21 in May.

In a sign that the exodus to government bonds as a haven has diminished, yields remained higher today even after Lehman Brothers Holdings Inc. replaced Chief Financial Officer Erin Callan and President Joseph Gregory. The changes come three days after the firm raised $6 billion to help survive the collapse of the mortgage market and reported the first quarterly loss since the company went public in 1994.

``We're stuck between a very hawkish Fed and stronger data, and weak financials with bank stocks making new lows,'' said Carl Lantz, an interest-rate strategist in New York at Credit Suisse Securities USA LLC, one of the 20 primary dealers that trade with the central bank. ``The constant jawboning by the Fed is outweighing any of these financial concerns.''

Credit-Market Losses

Banks and securities firms have posted $391 billion in writedowns and credit-market losses since the start of last year, according to data compiled by Bloomberg. The Fed has pumped $1.69 trillion through the financial system through lending programs and debt sales, along with giving Wall Street firms direct access to loans for the first time.

``The liquidity facilities are the better way to deal with the credit crisis and fed funds is somewhat decoupled from it,'' said Jamie Jackson, who oversees government debt trading at RiverSource Investments in Minneapolis, which manages $100 billion of bonds.

Banks are less reluctant to lend to each other, as seen in the gap between three-month Treasury bill yields and the three- month London interbank offered rate. The so-called TED spread is 79 basis points, down from a high of 240 basis points Aug. 20.

G-8 Seeks to Aid Growth as Oil Focuses Central Banks on Prices

By Simon Kennedy

June 13 (Bloomberg) -- The world's most powerful governments are looking for ways to boost economic growth to compensate for record oil prices, just as central bankers gird for an inflation fight.

French President Nicolas Sarkozy wants to cap value-added taxes on fuel, the U.K. is cutting taxes for energy producers and Japan is helping truckers. Italy is threatening a levy on oil companies, while in the U.S., Democratic presidential candidate Barack Obama is calling for a second economic stimulus package.

Finance ministers from Group of Eight countries gather in Osaka today and tomorrow after the price of crude oil doubled in the past year to reach a record $139.12 on June 6. While they try to stave off a global recession, central bankers are turning their attention to quashing price increases after 10 months of defending the expansion from a credit squeeze.

``Inflation means central banks aren't in a position to provide great relief to growth,'' said David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York. ``There's going to be mounting pressure on governments to respond decisively.''

The International Monetary Fund in April predicted advanced economies this year will suffer their fastest price gains since 1995 and their weakest expansion in seven years. The World Bank said June 10 that global growth will slow a percentage point to 2.7 percent in 2008.

Bernanke Signal

Federal Reserve Chairman Ben S. Bernanke on June 9 delivered his clearest message yet that the central bank is done lowering interest rates after 3.25 percentage points of cuts since September, saying officials will ``strongly resist'' any surge in inflation expectations. European Central Bank President Jean-Claude Trichet said June 5 he may raise rates in July.

``What was a threat about half a year ago now appears to have become a reality -- stagflation,'' said Joachim Fels, co- chief economist at Morgan Stanley in London.

That leaves it to politicians to defend growth, and their own political standing, as U.K. motorcyclists and French taxi drivers protest rising fuel bills and consumers bemoan falling purchasing power.

`Very Worried'

``Governments are very worried about the impact of inflation economically and politically,'' said Klaus Baader, chief European economist at Merrill Lynch & Co. in London. ``They're going to take more and more compensatory action.''

Ed Gillespie, President George W. Bush's counselor, said June 6 the U.S. is ``constantly looking at options and proposals'' even after it began mailing more than $100 billion in tax-rebate checks. Four days later, Keith Hennessey, director of the White House National Economic Council, said the Bush administration is opposed to another stimulus package.

U.K. Prime Minister Gordon Brown last month relaxed taxes on some North Sea oil production sites in an effort to lift output and is facing calls to delay an increase in fuel duties and reverse a doubling of taxes for some cars.

Sarkozy is renewing energy-tax rebates for farmers and has proposed cutting the VAT on fuel, ignoring opposition from neighbors in the European Union.

Italian Prime Minister Silvio Berlusconi plans ``targeted'' tax cuts on fuels while Finance Minister Giulio Tremonti last week suggested oil companies be forced to pay a ``Robin Hood'' tax with the revenues being passed to households.

Temporary Relief

Meantime, the Japanese government is spending 215 billion yen ($1.9 billion) through March on easing the burden of higher oil costs on small and midsized enterprises. For trucking businesses, the discount for overnight highway tolls was raised to 40 percent from 30 percent.

While such measures may provide temporary relief, they might also exacerbate the inflation threat by reinforcing energy demand. A windfall tax could also deter companies from investing in exploration.

``Tax policies are not an appropriate means to counter commodity-price increases,'' Trichet said June 5. ``This would send the wrong signals to producers and consumers alike.''

Some G-8 politicians agree. German Finance Minister Peer Steinbrueck, who is not traveling to Osaka, said June 2 that governments shouldn't ``react politically and try to intervene'' to tame oil prices.

Past Failures

That means that as a group, the G-8 may shy away from backing coordinated fiscal responses, instead resorting to repeating past demands that petroleum producers pump more oil and consuming countries become more efficient.

That approach has so far proved unsuccessful. When it was adopted at a May 2004 meeting in New York, oil cost about $40 a barrel. Saudi Arabian Oil Minister Ali al-Naimi on June 9 rejected demands for higher output.

Geoffrey Yu, a currency strategist at UBS AG in Zurich, said the G-8 may also express concern that the falling dollar is fanning inflation. The G-8 ministers have refrained from making a joint comment on exchange rates for two decades as central bankers aren't present at the talks. A Canadian official said June 9 that currencies would not be a major topic.

``It's hard to talk about commodity prices and not the dollar,'' Yu said. Paulson told Bloomberg Television on June 10 that he would tell his counterparts that ``strong'' economic fundamentals will be reflected in the dollar.

The G-8 is composed of the U.S., Japan, Germany, Russia, U.K., Italy, Canada and France.

Tuesday, June 10, 2008

Dollar Gains Most Since 2005 as Bernanke Says Growth Risk Fades

By Bo Nielsen and Ye Xie

June 11 (Bloomberg) -- The dollar may extend the biggest two-day gain versus the euro since 2005 after Federal Reserve Chairman Ben S. Bernanke said economic risks have faded, spurring traders to boost wagers interest rates will rise.

The U.S. currency rose to a three-month high against the yen after Bernanke said late on June 9 that the central bank will ``strongly resist'' any waning of public confidence in stable prices. Economic fundamentals ``compare favorably with those of other industrialized major economies,'' Treasury Secretary Henry Paulson said yesterday in a Bloomberg Television interview in Washington. A Fed report today on economic activity, the so-called beige book, may show an improvement.

Policy makers are trying to ``dispel this notion in the market that the U.S. has a policy of benign neglect to the dollar,'' said Sophia Drossos, a currency strategist in New York at Morgan Stanley, in an interview on Bloomberg Television. ``They are making it very clear that the benefits of a weak dollar are far outweighed by the costs.''

The dollar traded at $1.5453 per euro at 6:45 a.m. in Tokyo, after rising 1.2 percent yesterday. It has surged 2 percent the past two days, the most since Nov. 4, 2005. The dollar traded at 107.40 yen, the highest since Feb. 27. Japan's currency traded at 165.96 per euro from 166.17 yesterday.

Futures on the Chicago Board of Trade show a 52 percent chance yesterday that the Fed will raise its 2 percent target rate for overnight lending between banks by at least a quarter point at its Aug. 5 meeting, compared with 31 percent the previous day. The contracts showed a 96 percent chance the Fed will increase the rate by December, up from 67 percent odds a week ago.

Crude Oil Drops

The dollar has fallen 11.5 percent against the euro and 7.2 percent versus the yen since September, when the Fed began to lower borrowing costs from 5.25 percent. Crude oil climbed to $137.98 a barrel yesterday in New York before declining. The price more than doubled in the past year.

``The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so,'' Bernanke said in a speech at a Boston Fed conference. ``The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations.''

The Fed is ``aware'' that the weak dollar boosts inflation, Dallas Fed President Richard Fisher said yesterday in response to questions after a speech at the Council on Foreign Relations in New York. Paulson repeated comments made the prior day that currency intervention is a tool for policy makers. He also urged China to loosen government controls on energy prices and the value of the country's currency.

Chinese Yuan

The yuan traded near the highest level since a dollar peg was scrapped in 2005. The currency was little changed yesterday at 6.9255 per dollar in Shanghai, compared with 6.9230 on June 6, according to the China Foreign Exchange Trade System.

A report yesterday showed that the U.S. trade deficit widened in April as the surging cost of oil boosted imports to a record, overshadowing the biggest gain in exports in four years. The gap grew 7.8 percent to $60.9 billion the Commerce Department said.

The two-year U.S. Treasury yields rose 21 basis points to 2.91 percent. The yield advantage of a German two-year bund over a comparable Treasury has narrowed to 1.73 percent from 2.26 percent on June 6, increasing the allure of the dollar- denominated asset.

``You are going to see the dollar rally over the next 12 months,'' said Michael Aronstein, chief investment strategist at Oscar Gruss & Son Inc. in an interview with Bloomberg Television. ``Global investors are quite underweight the U.S. You could see the beginning of a real reversal of that''

Group of Eight

The U.S. dollar index traded on ICE futures in New York rose 1.16 percent to 73.696, the biggest one-day gain since Dec. 14. The index tracks the dollar against six major trading partners including the yen, euro and pound.

Finance ministers of the Group of Eight industrialized countries may consider joint action to deflate the price of oil and prop up the dollar at their meeting June 13-14 in Japan, said DBS Group Holdings Ltd. in a report to clients.

The last time the major industrialized countries intervened was on Sept. 22, 2000, when they bought the euro after it tumbled 27 percent from its 1999 debut. They last propped up the dollar in 1995, when it sank almost 20 percent in four months against the Japanese yen to a post-World War II low of 79.95 yen.

The greenback dropped 1.4 percent against the euro last week, the most since March, after European Central Bank President Jean-Claude Trichet said on June 5 that policy makers may raise borrowing costs in July to contain inflation and the U.S. Labor Department reported the next day that the jobless rate increased the most in May in more than two decades.

The European Central Bank needs to act in a ``forward- looking'' manner in order to ensure price stability, said council member Axel Weber at the University of York yesterday.

Monday, June 9, 2008

Treasuries Slump After Bernanke Fans Speculation Rates to Rise

By Wes Goodman

June 10 (Bloomberg) -- Treasuries slumped, driving two-year yields up half a percentage point in two days, after Federal Reserve Chairman Ben S. Bernanke pledged to ``strongly resist'' any waning of public confidence in stable prices.

Two-year note yields approached the highest this year after Bernanke said the risk of a ``substantial downturn'' in U.S. economic growth has diminished, prompting traders to increase bets that policy makers will raise interest rates. The trading room at ICAP Australia Ltd. in Sydney erupted in noise after the comments, said Matthew Johnson, the firm's senior economist. The yield hasn't risen so much in two days since 1985.

``Treasuries have been decimated,'' said Kenny Borowicz, bond-futures broker at MF Global Singapore Ltd., part of the world's largest broker of exchange-traded futures and options contracts. ``All was quiet for the first two hours of trade until Bernanke's comments hit the wires. Australian and Japanese debt is also getting crushed.''

The U.S. two-year note yield rose 23 basis points to 2.94 percent as of 6:35 a.m. in London, according to bond broker BGCantor Market Data. The price of the 2.625 percent security due in May 2010 fell 13/32, or $4.06 per $1,000 face amount, to 99 13/32. A basis point is 0.01 percentage point.

Two-year rates, among the most sensitive to changes in Fed borrowing costs, may advance to 3 percent this week, ICAP's Johnson said. The high so far this year was 3.10 percent on Jan. 2. Ten-year rates climbed 4 basis points to 4.06 percent.

``The Fed is going to keep reminding us that they are worried about inflation,'' Johnson said. ``Bids disappeared for a while. Treasuries are still a sell.''

Rate Bets

Asian stocks and bonds slumped on concern the Fed will raise rates. The MSCI Asia-Pacific Index of regional stocks fell 2.2 percent. Japan's five-year bond yield rose 12 basis points to 1.41 percent. Five-year Australian bond yields rose 17 basis points to 6.84 percent. The dollar rallied to a three-month high of 106.70 against the yen.

Futures on the Chicago Board of Trade show an 88 percent chance the Fed will raise its 2 percent target for overnight lending between banks at least a quarter point by December, rising from 62 percent the previous day. A month ago, most of the bets were for no change in rates this year.

``The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so,'' Bernanke said yesterday in a speech to a Boston Fed conference. ``The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations.''

Stronger Language

Bernanke used ``somewhat stronger language than usual,'' Goldman Sachs Group Inc., the biggest securities company in the U.S., said in a report to clients. Fed officials have cut their benchmark lending rate from 5.25 percent in September to keep a U.S. housing recession and losses from the credit markets from throwing the economy into a recession.

The extra yield that two-year notes offer over the Fed's target interest rate widened to 94 basis points, the most since April 2005.

The slump in Treasuries surprised economists, who predicted two-year yields would end this month at 2.35 percent, according to the median of 48 estimates in a Bloomberg News survey. The most recent predictions are given the heaviest weightings.

``Treasuries have entered `buy' territory,'' said Adam Donaldson, head of debt research at Commonwealth Bank of Australia in Sydney, the nation's second-largest lender. ``Pressure from inflation and the economic growth slowdown will bear down on equity markets and investors will still shift asset classes to safety.''

`Complicated Balance'

The Fed faces a ``complicated balance'' of lowering interest rates to spur growth ``without taking too much risk that underlying inflation is going to accelerate,'' New York Fed Bank President Timothy Geithner said yesterday after a speech in New York.

The difference between yields on 10-year Treasury Inflation Protected Securities, or TIPS, and conventional notes widened to 2.58 percentage points from 2.45 percentage points a week ago. The figure reflects the inflation rate that traders expect for the next decade.

U.S. consumer prices rose 3.9 percent in May from a year earlier, the same as in April, according to a Bloomberg News survey of economists before the Labor Department reports the figure on June 13. That means that 10-year notes yield just 16 basis points after inflation, and shorter maturities don't yield enough to keep up with quickening prices for goods and services.

Yields on two-year notes climbed to within 1.12 percentage points of 10-year rates as traders gave up forecasts for Fed rate cuts. The difference was as wide as 2.08 percentage points in March.

``Treasuries will keep falling,'' said Mitsuo Masuda, a manager in Tokyo at the foreign bond section of Sumitomo Life, who helps oversee the equivalent of $28.1 billion in non-yen debt. ``The Fed will raise rates once or twice this year.''

Sumitomo plans to shift some Treasury holdings to euro- denominated bonds later in 2008, he said.

Fed, Banks Agree on Credit-Swap Changes to Cut Risk of Collapse

By Shannon D. Harrington and Oliver Biggadike

June 10 (Bloomberg) -- Regulators and banks agreed to changes aimed at easing the risk of a collapse in the $62 trillion market for credit-default swaps.

Morgan Stanley, Deutsche Bank AG and Goldman Sachs Group Inc. are among the 17 banks creating a system to move trades through a clearinghouse that would absorb a failure by one of the market-makers, the Federal Reserve Bank of New York said yesterday in a statement following a meeting with the firms. A guarantee may encourage more trading of default swaps, said NanaOtsuki of UBS AG, one of the banks involved in the agreement.

``Increasing liquidity as a result of the settlement house would be the key,'' said Otsuki, head of debt and equity research for Japanese financial institutions at UBS in Tokyo. ``Larger trading volume means higher efficiency.''

The central counterparty, more automated trading and settlement and other fixes ``will help improve the system's ability to manage the consequence of failure by a major institution, and we expect to make meaningful progress over the next six months,'' New York Fed President Timothy Geithner said in a speech to the Economic Club of New York yesterday.

Systemic Losses

Concerns that the market could fail erupted in March when Bear Stearns Cos., then the fifth-biggest U.S. securities firm, faced a cash squeeze. The central bank agreed to back an emergency sale of Bear to JPMorgan Chase & Co. in part because of the systemic losses that would have resulted if the firm had filed for bankruptcy, Geithner said.

The Fed has conferred with banks since September 2005 to improve processing and settlement in the market. Ten of the 17 banks at the meeting yesterday were owners of Chicago-based Clearing Corp., which has said it will start guaranteeing credit-default swap trades by September.

Investment firms AllianceBernstein LP, Citadel Investment Group LLC and BlueMountain Capital Management LLC joined the meetings yesterday for the first time.

In addition to a central clearing mechanism, the group agreed to include in standard trading documents a mechanism for settling trades with cash instead of having to physically deliver the underlying securities.

The group will reduce the volume of outstanding contracts through multilateral trade terminations. They also agreed to extend the changes in credit-default swaps to other derivatives contracts backed by equities, interest rates, currencies and commodities.

The group will provide details on its next steps by July 31, the Fed said in its statement.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value should the company fail to adhere to its debt agreements.