The Sub-prime Mess: maybe a turnaround

The biggest U.S. banks and financial institutions with sub-prime difficulties recently returned the last quarter's earnings results suggesting we may be moving past the sub-prime problem.

• Merrill Lynch lost $2 billion in their first quarter due to mortgage losses but only $1.3 billion in their 2nd quarter reported on July 17th.
  
• Wells Fargo reported a 21% decrease in 2nd quarter income on July 16th along with a set aside of $3 billion for loan losses. But overall the results were positive as the company said it would increase its dividend by 10%. Net charge-offs were 1.55% down from the first quarter's 1.6%
• Citigroup reported a $2.5 billion loss in the 2nd quarter on July 18th along with $7.2 billion in provisions for loan losses. But both the losses and write-downs fell by about one half from the first quarter.
• Bank of America reported a 41% decrease in 2nd quarter income of 72 cents a share but beat analysts expectations of an average of 53 cents a share. The company said it expected to earn money this year from its acquisition of Countrywide (Countrywide is notorious for it's contribution to the sub-prime mess).
  
• Wachovia said it lost $8.66 billion in the second quarter on July 22nd. The company slashed its already-reduced dividend and boosted its provision for loan losses to $5.57 billion from $2.83 billion in the first quarter.

In the group above, only Wachovia had negative results. It looks like the big financial institutions have already posted the majority of their sub-prime losses. If this is true, credit will start loosening up as the banks' increased assets are put to work.

2nd Highest Inflation in 26 years: Bernanke reiterates the Fed's aim for "price stability"

The Labor Department reported today a 1.1% rise last month in consumer prices. This was the second highest increase in 26 years (exceeded only by a 1.3% rise after Katrina caused by the tremendous boost in energy prices). Even after subtracting food and energy, the "core" inflation increased 0.3% in June. Prices increased 5% in the last 12 months and 2.4% for "core" over the same period. This "core" figure is well outside the Fed's "comfort" threshold (1.5% to 2%) for inflation.

All of this seemed to start turning the big gears:

• The U.S. Dollar Index reversed two previous days of losses to close equal to the low of May 22nd. The dollar moved strongly up from its historic low of 71.55 reached yesterday to 72.3 now. It will have to move up past July 8th's high of 73.39 in order to move back into a bullish trend.
• Fed chairman Bernanke said today that inflation "is too high" and said (again) that the Fed's aim is to achieve price stability. But he also stated that the increase in energy and commodity prices were due to "factors out of the control of the Federal Reserve." What utter nonsense! Crude oil is priced in dollars - much of the price increase is due to the decrease of the U.S. Dollar.

Let's hope that this time, Bernanke will live up to his words.

Dollar drops to historic low while crude oil reverses to new high

Today the U.S. Dollar sank to an historic low, edging below the former bottom of April 22nd. The dollar had been in a bullish recovery after April 22nd until the Federal Reserve refused to raise rates at their June 25th meeting. They had earlier said they would defend the dollar. Instead, the dollar plunged back to its overall bearish trend channel originating last October.

While the dollar was sinking following the Fed's last meeting, crude oil rose 9% exceeding its July 3rd high for a new historic high of 147.27. Not surprisingly, wholesale inflation rose 9.2% over the past 12 months for the fastest increase in 27 years, according to the Labor Department.

Needless to say, the current Fed policy (rhetoric for defending the dollar but no concrete action) is not sustainable. The high price of gasoline is squeezing the economy and threatening major industries (e.g., the airlines). The Fed could solve both its growth and price stability mandates by raising rates.

U.S. Dollar up big on Thursday after Europe's Central Bank increases interest rates

Yesterday, Europe's central bank raised interest rates by 1/4 of a point but made it clear that they are unlikely to continue doing so. This seemed to energize the U.S. Dollar and push it back up to the bottom of its bullish trend channel. After making an historic bottom on April 22nd the U.S. Dollar rallied into mid June when it started to retreat. The day after the Fed left interest rates unchanged on June 25th the Dollar crashed through the bottom of its bullish trend channel.

The news that came that followed showed economic weakness:

• ADP's National Employment Report along with the Labor Departments Payroll Survey both reported national job losses of 79,000 and 62,000 respectively. It was the sixth straight month of job losses for the Payroll Survey.
• The Labor Department's new unemployment claims for the week ending June 28th increased by 16,000 and the previous week was revised by adding an additional 4,000.
  
• While factory activity based on the Institute for Supply Management's manufacturing index increased in June to 50.2 from May's 49.6 (i.e., from contracting below 50 to growth), factory orders went up only 0.6% for their worst performance in 3 months. In addition, orders for durable goods were flat while order for staples such as food and gasoline increased.
• ISM's non-manufacturing index fell to 48.2 from 51.7 - from growth to contraction.
  

What's behind this economic weakness? A tremendous increase in costs:

• The ISM's manufacturing and non-manufacturing indexes' prices paid components increased to extremely high levels: the highest level since July 1979 for manufacturing and higher than the index's entire 10-year history for non-manufacturing. This was due to the tremendous increase in crude oil and other raw material costs.
• August crude oil closed Friday up 13% in June alone to 144.18.
• August blended gasoline closed Friday up 7% in June to 3.549.
• September corn up 24% in June alone to 757.75

A large portion of crude's price increase is due to U.S. Dollar weakness. When the Fed starts to defend the dollar in deeds as opposed to words - commodities will likely plunge.