Paterson Financial Services

Economy at crucial juncture

2010-04-30T06:35:00.001-07:00

The evidence is mounting that the economy is at a turning point.

First and most important, the Fed is about to start selling securities to reduce the monetary base.

Second, interest rates cannot go any lower.

Third, inflation is starting to grow.

Fourth, the US Treasury has a lot of borrowing to do.

All this means that bond prices are poised to fall, and long-rates rise a percent or so - to start with.

At the same time, the stock market will look carefully at earnings, and will punish any company with weak results. There will be opportunities for short sellers.

As inflation takes hold, the dollar will begin it's long slide.

Paterson's advice is to match up the book and extend liabilities further.

* * * * * J B K * * * * *

San Francisco

James B. Klein
Paterson Financial Services

WEBSITE: paterson.com
WEBLOG: paterson-financial-services.blogspot.com
NEWS WEBLOG: paterson-financial-services-news.blogspot.com

Treasury Auction Examined

2010-04-11T06:44:00.000-07:00

On Wednesday and Thursday of last week the Treasury successfully auctioned 10 year and 30 year securities.

Following a sharp sell off several weeks ago, the 10 year notes rallied after their auction and the 30 year bonds held steady.

For now, supply is not a problem.

Major breaks in bond prices are related to economic growth.

Money Numbers Examined

2010-04-11T06:34:00.000-07:00

The latest money numbers continue to show a massive increase in the monetary base.

In percentage terms, only M1 is growing.

M2 and MZM show little or no growth in the past year.

Until banks start making loans, the Federal Reserve will have little incentive to raise short-term interest rates.

10s today, 30s tomorrow, and we're at major support

2010-04-07T05:15:00.001-07:00

This is the week that helps predict the future for long-term interest rates.

The auction by the US Treasury of 10-year notes today, and 30-year bonds tomorrow provides the first data point in the new Fed-less bond market regime.

At the close of business yesterday, April 6, their respective yields were 3.98 and 4.84.

We will certainly revisit this data often in the months and years to come. Make a note.

The bond futures contract closed yesterday at 114.11. Make another note.

As the US Treasury sells more and more debt to refinance existing debt, and create new obligations to fund the expansion of government programs, rates are certain to rise.

Combined with the Treasury's added supply, the US Federal Reserve will be selling both mortgage-backed securities and treasuries to reduce the amount of inflationary fuel in the banking system before the banks can use it to make loans to credit-worthy borrowers.

As banks make loans, and the economic expansion takes hold, inflation grows. Further pressure on bond holders will come from the deteriorating value of the currency. Inflation kills bonds.

The combined pressure from these three sources will be too great for bond yields to hold, and they will certainly continue the rise that began more than a year ago, when 30-year bond yields bottomed at 2.58 in late December of 2008.

Our trader is shorting bonds at every resistance level, and will soon be aggressively selling when support breaks - like today and tomorrow.

Paterson's analysis suggests that the bond contract has a long way to fall, and will probably break par, with yields above 6%.

Get short and get rich.

* * * * * J B K * * * * *

San Francisco

James B. Klein
Paterson Financial Services

WEBSITE: paterson.com
WEBLOG: paterson-financial-services.blogspot.com
NEWS WEBLOG: paterson-financial-services-news.blogspot.com

Fed says extended period may last a long time | Reuters

2010-04-07T04:28:00.001-07:00

Bank lending is too weak to allow the Fed to push up the funds rate.

Until bank lending increases, the Fed seems happy to leave things as they are, and to focus on the long end of the curve.

Instead of bank lending, we see banks securitizing their loans and keeping their balance sheets flush with cash.

* * * * * J B K * * * * *

San Francisco

The Federal Reserve could keep interest rates ultra-low for even longer than investors expect if the economic outlook worsens or inflation drops, minutes from the central bank's last meeting suggested.

The minutes of the Fed's March 16 gathering, released on Tuesday showed lingering concern about the economy's prospects, with policymakers indicating they were in no hurry to raise interest rates.

"The duration of the extended period prior to policy firming might last for quite some time and could even increase if the economic outlook worsened appreciably or if trend inflation appeared to be declining further," the minutes said.

"Such forward guidance would not limit the committee's ability to commence monetary policy tightening promptly," they said.

http://www.reuters.com/article/idUSTRE6354CM20100406

‘Unloved’ Junk Debt May Be Best Bond Investment: Credit Markets - Bloomberg.com

2010-04-06T04:46:00.001-07:00

Reaching for yield and taking risk.

It's that time in the business cycle.

GS already has theirs, and they now want to sell it to you.

It's a good trade.

* * * * * J B K * * * * *

San Francisco

April 6 (Bloomberg) -- Speculative-grade bonds with the highest rankings may offer the best returns after trailing the riskiest debt in a record credit-market rally.

Goldman Sachs Group Inc. is recommending high-yield, high- risk bonds with rankings in the BB tier, the first below investment grade on the Standard & Poor's scale. Pioneer Investment Management Inc. favors BB and B bonds, the next lowest bracket, while saying the riskiest debt is overvalued. Debt ranked in the BB category gained 39.1 percent in the past 12 months, underperforming the CCC tier by 66 percentage points, according to Bank of America Merrill Lynch index data.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a7P22sf_Lf4Q&pos=3

How Texas Escaped the Housing Crisis - ABC News

2010-04-05T03:26:00.001-07:00

I'll be damned.

It's written in the state constitution: no cash-out refis.

I'd prefer to change Fannie and Freddie's underwriting guidelines.

* * * * * J B K * * * * *

San Francisco

But there is a broader secret to Texas's success, and Washington reformers ought to be paying very close attention. If there's one single thing that Congress can do now to help protect borrowers from the worst lending excesses that fueled the mortgage and financial crises, it's to follow the Lone Star State's lead and put the brakes on "cash-out" refinancing and home-equity lending.

http://abcnews.go.com/Business/TheBigMoney/texas-escaped-housing-crisis/story?id=10243782

Construction Spending in the U.S. Decreases to Seven-Year Low - Bloomberg.com

2010-04-02T11:57:00.000-07:00

It will be a long time before commercial real estate recovers.

The world has changed, and the use of commercial space is changing.

Stay away.

Residential will do just fine.

Everybody needs a home, whether they rent or buy.

Maybe it's time to buy an S&L - again.

* * * * * J B K * * * * *

San Francisco

April 1 (Bloomberg) -- Construction spending in the U.S. fell in February to the lowest level in more than seven years, signaling this part of the economy remains in a recession.

The 1.3 percent decrease to $846.2 billion, the lowest since November 2002, followed a revised 1.4 percent drop in January that was more than twice as large as previously estimated, Commerce Department figures showed today in Washington.

Housing will be slow to rebound as foreclosures climb and Americans are uncertain about job prospects. At the same time, commercial and government building are also slumping, restrained by a lack of credit and swelling budget deficits.

http://www.bloomberg.com/apps/news?pid=20601068&sid=aK4orcqqi590

Payrolls in U.S. Rose 162,000 in March; Unemployment at 9.7% - Bloomberg.com

2010-04-02T09:22:00.001-07:00

Wow.

It's not a big number, but it's earlier than even we thought.

Non-farm payrolls started increasing in QI 2010. Make a note.

The bonds are taking this hard, and are breaking minor support.

* * * * * J B K * * * * *

San Francisco

April 2 (Bloomberg) -- Employment in the U.S. increased in March by the most in three years and the unemployment rate held at 9.7 percent as companies gained confidence the economic recovery will be sustained.

Payrolls rose by 162,000 last month, less than anticipated, figures from the Labor Department in Washington showed today. The March increase included 48,000 temporary workers hired by the government to conduct the 2010 census, as well as job gains in manufacturing and health services.

The government revised January and February payroll figures up by a combined 62,000, putting the March gain at 224,000 after including the updated data. Caterpillar Inc. is among companies adding staff, indicating the recovery that began in the second half of 2009 is starting to foster the jobs needed to lift consumer spending and sustain the expansion.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aehAkiag49Hc

Fed Reveals Bear Stearns Assets It Swallowed in Firm’s Rescue - Bloomberg.com

2010-04-01T04:01:00.001-07:00

You'll want to read all of this article.

It shows the types of assets in the Fed's portfolio, and for which they paid hard cash.

Interestingly, they own some CDSs that made them some money.

* * * * * J B K * * * * *

San Francisco

April 1 (Bloomberg) -- After months of litigation and political scrutiny, the Federal Reserve yesterday ended a policy of secrecy over its Bear Stearns Cos. bailout.

In a 4:30 p.m. announcement in a week of congressional recess and religious holidays, the central bank released details of securities bought to aid Bear Stearns's takeover by JPMorgan Chase & Co. Bloomberg News sued the Fed for that information.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aZA_RWY3IJ2I&pos=3

Europe Inflation Jumps More Than Economists Forecast (Update2) - Bloomberg.com

2010-03-31T05:07:00.001-07:00

And this is from a currency that did not increase the monetary base.

How can the US avoid inflation?

* * * * * J B K * * * * *

San Francisco

European inflation accelerated more than economists forecast on higher oil prices, while the unemployment rate reached double-digits for the first time since 1998.

Consumer prices in the 16-nation euro region increased 1.5 percent in March from a year earlier, after a 0.9 percent gain in February, the European Union statistics office in Luxembourg said today. That is the fastest inflation since December 2008 and topped the median forecast of 1.1 percent in a Bloomberg survey of 36 economists. Unemployment rose to 10 percent in February, the highest rate since August 1998, a separate report showed.

http://www.bloomberg.com/apps/news?pid=20601068&sid=arrsXM4KpmGs

Reform in Congress Lacking Cash Clause to Stop Lehman-Like Runs - Bloomberg.com

2010-03-29T04:49:00.001-07:00

The problem is not liquidity, but rather government incompetence and corruption.

These problems would not exist if the Congress had not lowered Fannie and Freddie's standards.

There's where the reform must begin.

* * * * * J B K * * * * *

San Francisco

March 29 (Bloomberg) -- In 2,615 pages of financial reform legislation introduced in the U.S. Congress, there are no rules to ensure that banks keep enough cash-like assets when credit disappears.

Guidelines on liquidity risk management, which were published March 17 by the Federal Reserve, the Treasury Department and the Federal Deposit Insurance Corp., also avoided spelling out how much banks need to hold, and in what form, to make sure they don't collapse if short-term lending dries up. International efforts to do that for the global banking system could take years to implement.

Citigroup Inc., which came close to a funding shortfall in 2008 and received a $45 billion government infusion, is among U.S. lenders that have hoarded cash since credit markets seized up two years ago. Even so, the banks continue to rely on overnight borrowing for their funding needs. While down from its peak in 2007, the U.S. repo market, which provides banks with short-term lending backed by collateral, is still $2 trillion.

"The temptation always is to lower liquidity levels when times are good," said Baylor Lancaster, an analyst at CreditSights Inc. in Miami. "That's why we need rules. In three years' time, are people really going to care about liquidity as much as they do now?"

http://www.bloomberg.com/apps/news?pid=20601109&sid=aN8ApDdiCwcA&pos=12

Supply fears start to hit Treasuries

2010-03-27T03:28:00.001-07:00

I have two problems with this scenario.

1. When everybody knows about a problem, it doesn't happen.
2. When everybody understands a problem, it gets solved fast.

I'm betting on 2.

* * * * * J B K * * * * *

San Francisco

The bond vigilantes are finally flexing their muscles. A long period of stability for the US government bond market showed signs of cracking this week as a lack of investor appetite for new debt sent the benchmark 10-year yield to its highest level since last June.

For more than a year, analysts have been warning that record sized debt sales by the US Treasury were at odds with a 10-year yield sitting comfortably below 4 per cent. This week, the yield on 10-year notes jumped from 3.65 per cent to a peak of 3.92 per cent on Thursday. On Friday it was 3.87 per cent.

Chart: TreasuriesFalling inflation, rising unemployment, the housing market slump, the Federal Reserve's policies of a near zero overnight borrowing rate and its purchase of up to $1,700bn in bonds have all helped keep Treasury yields near historic lows.

But this week the mood shifted as yields for $118bn of new US debt were much higher than forecast, sparking overall selling of Treasuries. Sentiment also deteriorated in the UK bond market after the government's budget ahead of a general election expected in May failed to resolve doubts over future spending and debt reduction.

http://www.ft.com/cms/s/0/c51fbbce-3908-11df-8970-00144feabdc0.html

Yellen Says She’ll Be Ready to Raise Rates When ‘Time Has Come’ - Bloomberg.com

2010-03-24T08:47:00.001-07:00

Alan Greenspan in a skirt.

This is another San Francisco earthquake just waiting to happen.

Pray for the health and long life of Bernanke.

I am.

* * * * * J B K * * * * *

San Francisco

March 24 (Bloomberg) -- Janet Yellen, president of the Federal Reserve Bank of San Francisco, said that while it's too soon to raise interest rates, she'll be ready to do so "when the time has come."

Yellen said the Fed's pledge to keep rates low for "an extended period" was "appropriate" and that it made "no particular time commitment." In a speech yesterday in Los Angeles, she discounted concerns record budget deficits might fuel inflation.

"The Fed has to be ready to take away the punch bowl when it's necessary," Yellen told reporters after the speech. "When the time has come, am I going to support raising interest rates? You bet. I don't want to see inflation pick up."

http://www.bloomberg.com/apps/news?pid=20601068&sid=askizRCWdj2Q

Ackman’s Greatest Short - MBIA - Bloomberg.com

2010-03-24T07:51:00.001-07:00

The mortgage insurance companies were the canaries in this coal mine. MBIA, MGIC, and PMI.

To anyone who was watching, it was obvious that there were too many adjustable rate loans made to people with insufficient down payments, bad credit, and low income.

All that was necessary for the cave-in was a sustained increase in short-term interest rates. The idiot Greenspan provided the impetus when in 2004 he started raising Fed Funds from 1% to 5.25%.

By the time it was over, all the mortgage insurance companies were destroyed, as were Fannie and Freddie, the mortgage market was in ruins, CDS issuers were bankrupt, and the economy was collapsing.

* * * * * J B K * * * * *

San Francisco

"Our newest and largest [short] investment is on an extremely highly levered, yet AAA-rated financial institution, which we believe has inadequate reserves, undisclosed credit- quality problems, aggressive accounting and substantial unconsolidated indebtedness contained in off-balance-sheet special-purpose vehicles," he wrote. The position had the potential to generate a return of about five times the fund's total assets if it was successful.

Though little known outside of Wall Street circles in 2002, MBIA ranked as one of the five biggest financial institutions in the country in terms of outstanding credit exposure. It shared that distinction with Bank of America Corp., Citigroup Inc. and government-sponsored mortgage lenders Fannie Mae and Freddie Mac.

http://www.bloomberg.com/apps/news?pid=20601108&sid=aLmOb9zzVZ9A

JPMorgan Sells Debt: Credit Markets - Bloomberg.com

2010-03-19T04:27:00.001-07:00

Lengthen those liabilities.

* * * * * J B K * * * * *

San Francisco

March 19 (Bloomberg) -- Financial company bonds are beating industrial debt by the most this year after lagging behind in February, encouraging investors to snap up new issues from JPMorgan Chase & Co. and Credit Suisse Group AG.

Debt sold by banks, insurers and brokers returned 0.81 percent this month through yesterday, compared with 0.4 percent for the rest of the market, according to Bank of America Merrill Lynch index data. The cost to borrow for banks is the lowest since February 2008, with yields falling to within 1.93 percentage points of Treasuries on March 18.

http://www.bloomberg.com/apps/news?pid=20601087&sid=abb54OIrjRFc&pos=6

Bank Regulators Issue Guidelines on Liquidity Risk (Update1) - Bloomberg.com

2010-03-17T09:40:00.001-07:00

Our analysts are studying these reports and will have a comprehensive analysis for clients in a week or so.

There is nothing in either of these reports to immediately concern decision makers.

* * * * * J B K * * * * *

San Francisco

March 17 (Bloomberg) -- The Federal Reserve, the Office of the Comptroller of the Currency and four other bank supervisory agencies released guidelines for liquidity risk management to deter the funding practices that contributed to the financial crisis.

"Given the recent market turmoil, the agencies are reiterating the importance of effective liquidity risk management for the safety and soundness of financial institutions," the agencies said today in a release. The guidelines emphasize the need for diversified funding sources, stress testing and a contingency funding plan, they said.

The Fed and other banking supervisors are reasserting their existing authority without waiting for Congress to complete an overhaul of financial regulation. The agencies are raising standards for capital, liquidity and risk management, and increasing their control over compensation policies. In January, regulators issued guidance on managing interest rate risk.

http://www.bloomberg.com/apps/news?pid=20601087&sid=arGN45fk0JMQ&pos=4

The war on banks continues

2010-03-10T10:31:00.001-08:00

It's bad enough that big banks are getting hit with new regulations, fees, and taxes.

Now community banks are feeling the same squeeze.

The problem is the administration in Washington.

They want the banks and related institutions to pay for the mortgage market blunders committed by the Congress and the regulatory agencies.

Economic growth will be hampered by the unwillingness of small banks to make loans.

* * * * * J B K * * * * *

San Francisco

"We're hearing complaint after complaint," said Chris Cole, senior regulatory counsel for the Independent Community Bankers of America, speaking last week at the National Association of Attorneys General convention in Washington.

Bankers say a downgrade forces an institution to put more money in reserves, makes them reluctant to loan money and increases their FDIC premiums.

Those consequences are among the chief reasons many small businesses are finding it difficult to borrow money from their local, small banks, said Cole, whose group represents about 5,000 community banks with about $1 trillion in total assets.

http://legalnewsline.com/news/225958-community-bankers-decry-overregulation

Getting short the bond market

2010-03-09T13:57:00.001-08:00

In the months to come there will be many opportunities to short the bond contract.

One of the best opportunities is provided by US Treasury auctions.

We are now in the middle of a $13 billion long bond auction.

Pay close attention to the way bonds trade for the next week or so.

Paterson advised clients to sell bonds at the 117.16 level with a 16 tick stop.

Traders will close out the position on the next major sign of weakness.

* * * * * J B K * * * * *

San Francisco

Money Numbers

2010-03-09T13:52:00.000-08:00

The money supply is not going down.

MZM looks like its bottoming.
M1 is growing.
M2 is still weak.

Test

2010-03-09T13:43:00.001-08:00

There has been a problem posting to this weblog.

* * * * * J B K * * * * *

San Francisco

Market Roundup

2010-02-27T11:38:00.000-08:00

Summary

Correction in the stock market is over.
Money supply still not growing
Inflation begins
Interest rates not rising
Bank lending still falling
GDP soars
Business cycle growth continues
Stock market in orderly move higher
Government stimulus continues
Dollar mixed

Money Supply
The following three graphs tell the story. M2 and MZM are still slowing. Only M1 is growing, and that is probably due to increases in the Base. Banks are not lending.

Monetary base continues to grow.

Inflation

The first signs of inflation came with the PPI for December with an increase of 1.4% for the month.

The CRB trend has resumed its upward path.

GDP Soars

Economic growth continued this past quarter at increased at an annual rate of 5.9 percent in the fourth quarter of 2009 . In the third quarter, real GDP increased 2.2 percent.

Price deflators are still benign.

Leading Economic Indicators signaled continued growth last week.

Stock Market

The stock market punched through resistance and made new highs for the move, heading for a resumption of the uptrend.

European investors poured money into US equities again this week, abandoning their own stock markets in favor of American investments.

Tactics
Money market arbitrage gets harder and harder as spreads collapse and competition increases. To achieve even a 100 basis point spread between liabilities and assets requires taking on credit risk. The money market desk will earn its pay in the coming months.

Strategy
So far, the strategy of shortening asset maturities and lengthening liabilities has worked nicely. Keep doing it.

Tell the board it's time to find some credit worthy borrowers.

Make sure hedging operations are in place. Give the long bond desk a small position and encourage day trading: buying at support and selling at resistance. Get ready for the big short. It's coming.

Bank lending continues to fall

2010-02-23T04:37:00.000-08:00

* * * * * J B K * * * * *

San Francisco

Time to Sell Bonds

2010-02-20T08:04:00.000-08:00

The disaster in the bond market gained a new wreck this week with the release of the PPI.

An increase of 1.4% in one month is a warning to fixed-income investors that the inflation is back, and will build as the economy expands and banks resume lending.

Bonds are at the lows of a recent trading range and are poised to trade lower.

The following events will trigger a sell-off in bonds.

Money supply increases - M1, M2, MZM
Price increases - PPI, CPI, CRB
Quarterly refundings - 10 year notes and 30 year bonds

If your institution has the ability to lengthen liability maturities, do it now.

If your institution is selling bonds during one of these events, make sure you're hedged.

* * * * * J B K * * * * *

San Francisco

Correction time for stocks

2010-02-07T06:34:00.000-08:00

How big will this correction be?

Right now, we are at minor support: 1090 on the S&P 500.

If we drop below this level, the correction will continue for another 60-120 points.

At least.

At most, we could see a return to the lows of last March: somewhere in the 875 range.

This is not entirely implausible.

Recall the bottom back in 2002-3. There we saw a return to the same levels three times.

It could happen again, and for one simple reason.

The Federal Reserve will be selling bonds for the near future at a record clip, not buying them as they did during the last year.

Combined with US Treasury sales, the bond market will be under constant selling pressure for years to come.

Interest rates will rise.

As interest rates rise, the value of stocks must pause until rates settle down.

That is the situation facing us now.

SUMMARY
We are still in a bull market, and the bull market will continue.

But, be careful about adding new positions in the equities area.

Consider shorting this market if it drops below 1090.

Evaluate short positions every three days.

TACTICS

Money market arbitrage is still the best option for spread bankers.
Extend the maturity of liabilities
Find credit worthy borrowers.

STRATEGY

Tell the board that long rates will be rising
Short rates will not be rising
Credit spreads will be narrowing
Consider fee-based income alternatives

Factory orders rose 1.0 percent in December | Reuters

2010-02-04T09:38:00.001-08:00

WASHINGTON (Reuters) - New orders at factories jumped by an unexpectedly large 1 percent in December despite a drop in transportation equipment orders, while inventories shrank, a government report showed on Thursday.
Analysts polled by Reuters expected orders to increase by 0.5 percent. Factory orders for November were revised up to a 1 percent gain.
Transportation orders fell by 0.5 percent on a 34.1 percent drop in civilian aircraft orders. Excluding transportation, new orders rose 1.2 percent in the month.
Inventories fell for the first time in three months, dipping 0.1 percent.
The inventories-to-shipments ratio slipped to 1.29, the lowest since August 2008.
http://www.reuters.com/article/idUSTRE6133IB20100204

The business cycle rolls on.

* * * * * J B K * * * * *
San Francisco

Geithner: Banks must pay fully for bailout | Reuters

2010-02-04T06:33:00.001-08:00

WASHINGTON (Reuters) - The Obama administration is prepared to impose fees on financial firms for as long as necessary to ensure that every cent spent on bailing out banks is repaid, U.S. Treasury Secretary Timothy Geithner said on Tuesday.

Barack Obama

A proposed Financial Crisis Responsibility fee that is projected to raise $90 billion over 10 years could be extended if the cost of the bailout exceeds that amount, Geithner said in testimony before the Senate Finance Committee.

"The fee can and will be extended until every penny of taxpayer assistance to the financial system has been repaid and the cost of the rescue to taxpayers is zero," Geithner said.

http://www.reuters.com/article/idUSTRE6113IB20100202

* * * * * J B K * * * * *

San Francisco

James B. Klein
Paterson Financial Services

WEBSITE: paterson.com
WEBLOG: paterson-financial-services.blogspot.com
NEWS WEBLOG: paterson-financial-services-news.blogspot.com

Business Cycle Indicators

2010-01-23T03:18:00.000-08:00

Leading Economic Indicators jumped 1.0% in the past month, with strength coming from 8 of the ten measures.

Only the average workweek of production workers and manufacturers’ new orders for consumer goods and materials* held steady in December.

A further confirmation of the power behind the Fed's increase in the monetary base, the increase in LEI foreshadows changes in aggregate economic activity.

Coincident Economic Indicators also increased in December and it has gained in five of the last six months. Industrial production made a large positive contribution to the index, more than offsetting the decline in employment in December. Between June and December, the index has grown by 0.6 percent (1.2 percent annual rate).

Observers will note that employment continues to lag more than usual, in both LEI and CEI numbers.

The Lagging Economic Indicators (LAG) have started to bottom, but we are still a long way from a full recovery.

The only positive contributor to the index this month was change in labor cost per unit of output*. The negative contributors – beginning with the largest negative contributor – were commercial and industrial loans outstanding*, average duration of unemployment (inverted), and ratio of consumer installment credit to personal income*. The ratio of manufacturing and trade inventories to sales*, change in CPI for services and average prime rate charged by banks* held steady in December. Based on revised data, the lagging economic index decreased 0.5 percent in November and decreased 0.2 percent in October.

The most important measure here are
- C&I loans
- Consumer installment credit
- Prime rate.

TACTICS
Tactics remain the same. Focus on money market arbitrage, and look for quality lending opportunities.

Continue to shorten the maturity of assets.

Look for distressed assets and fund them with short liabilities until Fed tightening begins.

STRATEGY
The economy is in the early stages of the business cycle, and opportunities to purchase distressed assets will drive profits.

Inflation is beginning around the world, as the unprecedented monetary stimulus of the past year takes firmer hold.

As profitable companies emerge from the wreckage of the recent economic disaster, lending opportunities will increase. Take advantage of this opportunity to expand the roster of the institution's clients.

Asset-Backed Debt Revival in Europe Led by Ford, BMW (Update1) - Bloomberg.com

2010-01-14T03:37:00.001-08:00

Here is evidence that the market for asset-backed debt has finally revived.

--------------------------------------------------------------------------

Asset-Backed Debt Revival in Europe Led by Ford, BMW (Update1)

By Esteban Duarte and Jody Shenn

Jan. 14 (Bloomberg) -- Europe's asset-backed bond market, dormant for a year, is coming back to life as Bayerische Motoren Werke AG and Ford Motor Co. sell more than 1 billion euros ($1.45 billion) of debt backed by automobile loans and leases.

BMW, the world's biggest luxury car maker, is selling 742 million euros of bonds backed by German auto leases, said a banker with direct knowledge of the deal. Dearborn, Michigan- based Ford sold 300 million euros of debt tied to car loans on Jan. 8.

The revival in debt backed by consumer and business payments in the auto industry shows improving investor sentiment as Europe emerges from the recession. Yields on company bonds averaged 4.13 percent yesterday in New York, down from 4.37 percent at the start of the year, according to the Bank of America Merrill Lynch Global Broad Market Corporate Index.

"If BMW is successful, it would be a really good indicator for other issuers now monitoring the market," said Markus Ernst, a credit analyst at UniCredit SpA in Munich. Borrowers testing the waters is "definitely a good sign as it underlines that the market is not drying up," he said.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a2imcii4gez8&pos=4

* * * * * J B K * * * * *

San Francisco

James B. Klein
www.paterson.com
paterson-financial-services.blogspot.com

Money Supply Fails to Grow

2010-01-12T07:32:00.000-08:00

Here are the latest figures for M1, M2, and MZM.

In each case, the numbers suggest banks aren't making new loans. At this stage in the business cycle, this is predictable.

The question now is when will banks find borrowers with the credentials to justify lending. Paterson believes that process has already begun, and that loans will start to grow in the QII of 2010.

First, the M1 numbers.

This is the raw data, showing growth.

Next, the percentage change since last year. Growth is there, but not enough to keep the economy fueled.

Here are the M2 numbers.

First the total.

Next, percentage change from last year.

Finally the MZM numbers.

Here's the raw data. Again, there's growth, but not enough to fuel the economy.

Next, the percentage change since last year. Banks are not lending.

Summary

Without loans, businesses rely on earnings to fuel future growth. The economy is now at a point when earnings will be insufficient to finance future expansion.

Banks will now begin to find lending opportunities for those firms with credit worthy balance sheets and projects. Lending will begin to increase, and when the year is out, the money supply will be growing again.

2008 - Disaster in the bond market

2010-01-02T04:02:00.000-08:00

A long bond purchased one year ago for $1,000 would be worth $715 today, a decline in value of 28.5%.

Here are the figures from the Wall Street Journal.

On December 31, 2008 the value of the current long bond was 137:05, yielding 2.6677% (This is the 2038 May 15 4.500)

One year later, the same bond traded at 98:05 and yielded 4.6169%

Link: US Treasury Quotes

This is only the beginning of the disaster in bond prices unless the Fed can find a way to decrease the monetary base.

MONETARY BASE

In the same time period, the stock market increased 16% from 6000 to 7100 as Fed stimulus took hold.

NYSE COMPOSITE

During the same time period, commodity prices have soared in the past 18 months after collapsing in 2008.

Notice this is a three year chart.

CRB INDEX

Link: CRB Index

Producer prices have recently began to rise.

PPI

The value of the Euro has recently dropped after a prolonged increase.

EURO

SUMMARY
Increases in the monetary base dominated all other factors in explaining changes in economic activity including the stock market, bond prices, currencies, and commodities.

As banks find credit-worthy customers, consumption, income, production, savings and investment will increase for individuals, businesses and governments.

This time is still a long way off, at least 6 months and maybe as much as 18 months.

TACTICS
Money market arbitrage is still the best tactic for depository institutions. Spreads have narrowed as more market participants bid down yields on high-quality assets.

Let long term assets continue to roll off, and be very careful replacing them. No matter what the Fed does, there will be pressure on the long end of the curve.

Lending is still a difficult proposition with credit quality dominating decision making.

STRATEGY
The institution has weathered the most destructive and dangerous storm since the great Depression of 1929-33.

It is now time to re-asses risk taking. The businesses and borrowers that survived this period will thrive in the years to come.

Identify those businesses and activities in your market and begin to work with these borrowers.

Money Supply Explosion Continues

2009-12-15T08:29:00.000-08:00

When the story of this financial disaster is written, the lead item will be the massive expansion of the Monetary Base.

Here are the most recent numbers (in Billions)

2009-10-21 - - - 1949.799
2009-11-04 - - - 2024.393
2009-11-18 - - - 2012.162
2009-12-02 - - - 2093.677

Notice that the most recent number is $80 billion of new money in the system - in two weeks. It used to take a whole year to add that much in reserves.

These are huge numbers and ensure expansion and inflation unless something is done.

Here's the graph. (Click on the graph for a larger version)

This money is now sitting in bank vaults as excess reserves, waiting for bankers to decide who is credit worthy.

As loans pick up, the Fed will begin to withdraw this money from the system, but that time is a long way off.

Cyclical Indicators

2009-12-15T08:02:00.000-08:00

The Yield Spread continues to predict substantial growth in GDP in the years to come, provided the Fed manages the reduction in the monetary base smoothly.

The longer the yield spread remains above 300 basis points, the stronger will be the coming expansion.

Here is the recent chart.

History suggests the yield spread will stay low for another year or more.

In the chart below we see that the yield spread must remain above 300 basis points for long periods to ensure economic growth.

Other Leading Indicators

The Conference Board's Index of Leading Indicators has been positive since March of 2009.

Coincident Indicators are making a bottom and will be turning positive in the next few months as Fed stimulus takes hold.

See Conference Board

Bank Lending

2009-12-15T07:38:00.000-08:00

Bank lending continues to contract, as banks deny credit to all but the safest borrowers.

Commercial and Industrial Loans - still falling
Consumer Loans - - - - - - - - - still falling
Real Estate Loans - - - - - - - - still falling

At this stage in the business cycle, we expect to see real estate loans turn positive first.

Commercial and Industrial Loans will turn positive in the next 6 months, along with Consumer Loans.

Here is the data.

Click on each graph for a larger view.

First, Commercial and Industrial Loans

Commercial and Industrial Loans in percent.

Next, Real Estate Loans

Real Estate Loans - in percent

Consumer Loans

Consumer Loans - in percent

Bonds supported by the Fed

2009-10-09T05:58:00.001-07:00

The massive purchases of government and agency paper by the Federal Reserve have driven long bond yields below 4%.

Until the Fed stops buying, don't short the long bond.

Monetary Base Dominates Bond Prices

2009-07-18T07:13:00.000-07:00

Since the bottom in stock prices, and the top in bonds, the monetary base has dominated all other exogenous variables on the movements of stock and bond prices.

As the base increases, the stock market advances and the bond market declines. Markets follow Fed action precisely.

Thursday's announcement of a major increase in the base has caused a sell-off in bonds and an increase in stocks, gold, and commodities.

Leading Indicators Jump

2009-06-06T03:49:00.000-07:00

Leading economic indicators rose sharply in April, the first increase in seven months.

Strengths among its components exceeded the weaknesses for the first time in one and a half years.

Strengthening were the following.

Stock prices,
Interest rate spread,
Consumer expectations,
Initial unemployment claims,
Average workweek, and
Supplier deliveries.

Negative contributions came from these.

Real money supply and
Building permits.

When the real money supply starts to grow, this expansion will be unstoppable.

Look for continued weakness in long bond prices and the dollar.

Economists in Denial?

2009-06-04T04:52:00.001-07:00

Yesterday I went to lunch with a group of economists to discuss the recent disaster in the credit markets.

Here are the main concerns we discussed.

1. The effect of the Fed's purchase of more that $1 trillion of securities and the inevitable inflation arising from the injection of all that high-powered money.

2. The possible inflation coming unless the Fed can sell those securities promptly and reduce the monetary base.

3. The inability of the Fed to begin to sell the hundreds of billions of dollars while unemployment surges.

4. The effects on the falling value of the dollar for government borrowing. No one will want to own dollar denominated assets in this environment.

5. The effects on long maturity interest rates of Treasury borrowing, Fed selling, prudent risk managers not buying, and the dollar dropping.

In summary, most agreed that the situation is far from normal and will not return to normality until the economy recovers and the Fed can pull all this high-powered money out of the system.

That is a long way off.

Yet, three surprising opinions emerged.

1. The cause of inflation. Someone repeated the old confusion about inflation being caused by too much growth rather than too much money. It is astonishing to me that this debate has any credibility at the senior levels of macro analysis.

2. The effects of inflation on the bond and dollar markets. There was little concern over the disaster the US economy is facing and and underestimation of the time it will take to solve this problem.

3. The failure to place the blame for this disaster where it belongs: on Congress, Fannie and Freddie, the SEC, Greenspan's Tsunami in the Fed Funds market beginning in 2004, and unregulated Credit Default Swaps. This is most troubling for future disasters.

TACTICS FOR PORTFOLIO RISK MANAGERS
Brace yourself for higher long rates, a falling dollar, and continued high unemployment.

Extend the maturity of your liabilities as much as you can. The cost of borrowing farther out the curve - as much as 450 basis points - will deter many portfolio risk managers, but those who do will be favored when the yield curve flattens and rises.

It's time to tell senior management and the board that we're in for heavy weather.

The dollar is doomed

2009-05-16T04:56:00.000-07:00

There are three things that make the dollar fall.

1. US trade deficits increase
2. US interest rates fall relative to others
3. US inflation higher than others

Of these three, the last - inflation - is dominant, and the current Fed monetary policy ensures rising inflation in the months and years to come, causing the dollar to fall in value relative to countries with better inflation management.

The explosion of the monetary base, as the chart below shows is sure to cause inflation unless that money can be removed from the system quickly.

The dilemma facing the Fed is the effect of removing this new money on interest rates and economic activity. In order to take money out of the system, the Fed has to sell something, and that something is the securities they hold.

In particular, the Fed has to sell $1 trillion in securities, and that will raise interest rates as sure as the sun comes up.

Put this in perspective.

If the Fed sells $40 billion in securities each month, it will take two years to get all that money out of the system.

If the monetary authorities begin this program quickly, economic activity is certain to fall, and that is not in the Fed's plans.

So, until the Treasury stops selling bonds to fund the explosion in Federal expenditures, and the Fed can begin selling to reduce the monetary base, inflation is building and the dollar is doomed.

Here is the relevant currency chart.

The number of dollars it takes to buy the Euro.

Notice that the general trend is up, meaning the Euro central bank is better at controlling inflation than the US Federal Reserve.

Next, notice that the recent collapse in the US economy has reversed that trend.

Finally, notice that the trend is about to resume.

Unless the Federal Reserve can find a way to pull all that new money out of the system without crashing the US economy, the dollar is in for a long fall.

When combined with the flood of US securities coming, this is disaster for financial institutions unable to extend the maturity of their liabilities.

TACTICS
Extend the maturity of your liabilities. Get as far out the curve as senior management and the board will allow you. Make sure of credit quality as you add assets.

Money market arbitrage will power the institution for the years to come, as the spread between bank paper and everything else widens.

STRAGEGY
It's time to get back to work. We've survived the biggest scare since the Great Contraction of 29-33 and we now have profit opportunities not seen in decades.

Warn senior management and the Board that disaster is coming: inflation and rising long rates are certain.

Coming Bear Market in Bonds

2009-05-04T10:56:00.000-07:00

WHO'S NOT SELLING BONDS?
First, the US Treasury has hundreds of billions of dollars of bonds to sell to fund the trillion dollar deficits Congress is mandating.

Second, the Federal Reserve will be selling the trillions of dollars of securities they have purchased in the recent expansion of the monetary base.

Third, and finally, any investor who owns bonds will be selling to avoid the coming bear market.

Paterson is advising its clients to continue to extend the maturity of liabilities past the 5 year mark, and look at 10 year liabilities, or more.

TACTICS
Continue to shorten the maturity of assets and use money market arbitrage to improve earnings.

Consider borrowing long term deposits.

Use extreme caution on long term lending.

STRATEGY
Warn senior management and the board that a disaster is in the offing.

The flood of money recently added by the Fed will either cause inflation or increases in long term interest rates - or both.

Recession is Over

2009-03-27T12:31:00.000-07:00

March 2009 the NYSE hit bottom at 4,181.75, levels we will not see again for a long time - if ever.

In the decline from more that 10,000 at the end of 2007, more than half the value of the NYSE has been wiped out, leading to a massive decline in consumption, production, employment, savings, investment, and tax revenues.

The nation and the world will suffer from this debacle for years.

MONEY SUPPLY
Except for a short blunder in early 2009, the Federal reserve has performed magnificently, lending on troubled assets, neutralizing monetary injections when needed, and finally pouring high-powered money into the system when it was justified.

The latest program to add primary reserves to the system leads Paterson to conclude the recession is over. The temporary blunder of allowing the base to fall caused the final spike down in stock prices and convinced the Fed that money easing is the right policy.

CREDIT SPREADS
As Fed policy takes hold, and banks continue lending, credit spreads continue to tighten.

Paterson concludes the worst of the credit crunch is over, and lenders can resume longer-term lending.

TACTICS
Money market arbitrage should continue to take advantage of the wide spreads between bank issued paper and other assets.

Longer term lending can also continue, with careful attention to credit quality.

STRATEGY
The Portfolio Risk Management Team should plan some vacations to get away from the office and the grinding pressure of interest rate and credit risk.

Report success to senior management, and encourage a visit from Paterson to explain why it's time to take a breather.

FINAL NOTE
Thanks to those of you who have sent word of thanks and appreciation.

Paterson will be traveling to your town in the next few months, so please plan to spend some time reliving this debacle and our successful performance.

Credit Spreads at 800 Basis Points

2009-01-23T06:38:00.000-08:00

The spread between Baa credits and 10 year US Treasuries reached 800 basis points.

The cost of long-term corporate debt has declined more than 100 BPs, but is still at historic spreads to Treasuries.

MONEY CONTINUES TO GROW
The Fed's policy of adding reserves to the system continued in the past two weeks, and the monetary base is now twice it's value in September of 2008.

Here is the raw data.

2008-09-10 874.703
2008-09-24 939.395
2008-10-08 1014.655
2008-10-22 1174.106
2008-11-05 1265.015
2008-11-19 1506.539
2008-12-03 1502.872
2008-12-17 1689.661
2008-12-31 1728.184
2009-01-14 1773.924

Paterson is confident that the Fed's action to support the fixed income markets with massive purchases of securities will shorten the recession by many years.

REAL ESTATE LENDING RESUMES
Even as the economy continues to deteriorate from the collapse in wealth in the stock and property markets, the business of lending is stabilizing.

In California the number of homes sold last month increased nearly 200%.

As this trend continues, the housing market will stabilize.

However, do not expect the trend of the last 20 years to resume. Growth in the value of real estate was caused by the decline in interest rates due to the elimination of inflation. That game is over.

SUMMARY
The Fed's actions to stabilize money growth are succeeding, suggesting a resumption of economic growth in months, not years.

Residential real estate lending - at prudent underwriting standards - is safe again. It is unlikely we will see much more of a sell-off in residential real estate.

Commercial real estate is in much worse shape and should be avoided except for unique situations. The economy has much farther to go to see a bottom.

New lows in stocks. As the magnitude of the disaster grows, there is a significant probability we will see new lows in the stock markets. If this happens, it will probably present a buying opportunity. Look for record volume in shares traded as the signal we've seen the bottom.

However, do not expect a quick rebound. Paterson expects a double or triple bottom in stocks before all selling is done.

TACTICS
Continue money market arbitrage. Paterson is advising clients to take advantage of the double digit yields in high quality short term paper. These assets can be funded profitably with deposits and the book matched nearly to the day.

Do not run a mis-matched book.

Avoid commercial real estate.

Expand prudent residential real estate lending and sell all long-term assets in the secondary market.

Balance sheet lending is extremely risky.

STRATEGY
Make senior management and the Board aware of the successes of the risk management team. Suggest bonuses for continued excellent performance.

Cooperate with regulators to understand their concerns and allay their fears.

Money Explosion Continues

2009-01-06T06:31:00.000-08:00

Growth in the monetary base continues.

Since September, 2008 when the monetary base stood at $870 billion, the Fed has added more than $800 billion to the base.

With stimulus like this, the recession will be shortened by years, bringing the return to growth in the next year or two.

OTHER MONEY NUMBERS
MZM which had been stagnant, is now growing.

Here is the raw data.

Here is the rate of growth data.

M2 Growth Signals Economic Recovery

M2 is a leading indicator, signaling both financial and commercial expansion.

The rate of growth in M2 is soaring, approaching 10%

COMMERCIAL AND INDUSTRIAL LOANS

The problem now is to get banks to lend.

Though flush with cash, thanks to Fed actions, Banks are reluctant to lend to Commercial and Industrial companies for two reasons.

One, the uncertainty of every company's balance sheet in this world of Interest Rate and Credit Default swaps. Until this confusion is cleared away, very few financial institutions will take the risk of lending.

Two, economic uncertainty also brings a halt to lending. As economic activity collapses, even good companies might not be able to pay back their loans.

REAL ESTATE LOANS

The surprising fact is real estate loans are holding up well.

INTEREST RATES AND SPREADS

Credit spreads have stopped widening.

Of all the signs that the credit crisis is ending, this is the one most watched by forecasters.

The drop in BAA yields by 100 basis points is a sign that lower quality credits are finding buyers.

SUMMARY, TACTICS, AND STRATEGY

In summary, the Fed's aggressive expansion of the monetary base has shortened a 10 year depression into a 3 year recession.

Though it is not time to invest or lend yet, that time will soon be here.

Tactics
Continue money market arbitrage, extending deposit maturities to 2 years, and adding high-yield assets.

Spreads of 1,000 basis points on AAA quality credits are not uncommon.

Stragegy
Prepare senior management and the board for continued earnings enhancement thanks to the investment department. Focus attention on finding high-yield assets.

Base Growth Continues

2008-12-20T04:07:00.000-08:00

Monetary Base Doubles in 3 months.

The following table shows the growth in the monetary base since August.

2008-07-16 870.637
2008-07-30 870.659
2008-08-13 870.775
2008-08-27 869.886
2008-09-10 874.703
2008-09-24 939.395
2008-10-08 1014.662
2008-10-22 1174.141
2008-11-05 1265.079
2008-11-19 1506.630
2008-12-03 1502.996
2008-12-17 1689.771

Since October 2008 the monetary base has doubled, going from $800 to $1600.

Paterson will have more to say about this in future posts.

Monetary Base Explodes

2008-12-01T09:09:00.000-08:00

The explosion in the monetary base is historic.

As the money numbers shown below indicate, money growth is not signalling a continued recession.

However, credit spreads indicate profit opportunities for institutions with portfolio risk skills.

PROFIT OPPORTUNITIES
Recently a Paterson client locked in 22% on AAA rates securities for 9 months, bringing in a profit of nearly $2 million. If your institution is interested in Paterson's Money Market Arbitrage program, please contact us right away. Sellers are looking to clean out their portfolios by the end of the year.

10 Years of Growth in 10 Weeks.

Without this addition to reserves, money would not be growing as fast.

MZM

M2 Growing as Well

Loan Growth Slows

SUMMARY OF FED ACTION
Without the prompt and resolute action by the Board of Governors of the Federal Reserve System, the US and world economies would be collapsing.

With Fed action, the recession will likely last only a few years.

Money growth is a reassuring fact in this convoluted world.

Keep an eye on the monetary base in the months to come. If the Fed stops adding to the base, it's a sign that the markets are healthier.

INTEREST RATES
There is no sign of inflation in the bond market.

For the last 10 years there has been little change in long-term rates and none is expected in the future.

TACTICS
Money market arbitrage has become the most profitable thing for financial institutions.

Continue to fund at the short end of the curve, and match the book with high yeilding paper guaranteed by the Fed.

A billion dollar portfolio of deposits will purchase $100 million in profits in one year on AAA rated paper.

STRATEGY
Brief the board on the profit opportunities in short term paper and obtain authorization to expand the Money Market Arbitrage program.

Portfolio Risk Management

2008-11-16T03:54:00.000-08:00

There is no way to minimize the disaster that has befallen the US and world economies, and no way to repair the damage done by Credit Default Swaps.

In the coming months, it will become clear that the disaster of Greenspan's Tsunami has ruined the lives of three generations of US taxpayers. Current students will find no work when they graduate, their parents have lost half their wealth and can't access much of the remainder; their grandparents retirement will be cold and dark with pensions, health care, and real estate values tumbling.

Greenspan's Tsunami

Like an unexpected wave of disaster, the increase in Fed Funds from 1% to 5.25% caused the flood of defaults in the adjustable loan market, leading to the collapse in Fannie Mae, Freddie Mac, and AIG.

Bad Loans in the Mortgage Industry
Following the decision to relax loan standards in 1999 lenders flooded Fannie and Freddie with low quality paper: borrowers with insufficient downpayment, low income, and poor credit quality. As interest rates rose, these adjustable-rate loans fell into default, and foreclosure sales began.

As the assets behind these loans fell in value, investors in Fannie and Freddie paper looked to the agencies to make good on their promise to guarantee principal and interest. As the magnitude of the disaster became clearer, the markets knew the resources of Fannie and Freddie would not be adequate to make good the losses on mortgage-backed paper.

Credit Default Swaps
Standing behind Fannie and Freddie were sellers of Credit Default Swaps (unregistered insurance), but their capital proved insufficient too, and they failed. AIG and others are now wards of the US Treasury.

The lack of registration of CDSs meant that the risk of default, now spread throughout the system, was unknown and unknowable, leading prudent banks to shun all enterprises not protected by the Federal Reserve. Lending slammed to a halt.

For example, US exports now sit on the piers waiting for a letter of credit from a qualified lender so that the seller will release the goods.

Summary
In the months to come, the credit disaster will grow, and economic activity will collapse. Consumption, production, employment savings, investments, and tax revenues will all decline much more than the markets anticipate.

The stock market has anticipated most of the disaster, but not enough. There is still one more significant decline coming.

TACTICS
Continue money market arbitrage. Take advantage of low deposit costs and pick carefully through the wreckage of the market.

Lend only to solid companies or profitable residential real estate with good spreads.

STRATEGY
Tell the board we are in a long and deep depression and we will not recover soon.

Apology

2008-11-16T03:49:00.000-08:00

For the past three months Paterson has been busy working with existing and new clients to avoid the disaster in the credit markets.

My apologies to students, casual readers, and potential clients for the absence of this weblog.

Paterson is back, explaining the situation and suggesting tactical and strategic plans for dealing with the extended downturn.

Disaster in Gold, Currencies

2008-08-16T05:27:00.000-07:00

Gold Plummets to $791 at Friday's Close
After touching $1000 per ounce in July of 2008, gold prices have dropped more than 20% in little more than a month.

Friday's price action in the gold market confirmed our fears - and exceeded them!

This is a disaster of monumental proportions for analysts who are confident of gold's value as a hedge against inflation.

Inflation is done.

Currencies fall
The value of the British Pound and the Eurodollar also fell sharply.

Paterson has never been able to successfully predict currency movements except as they relate to inflation.

In this case, it looks like the rest of the world is inflating, while the US restricts its money supply.

Monetary Base Growth Below 5%

With the base growing at 2% per year, there is plenty of room to add high-powered money to the system.

MZM Growth Slows

Bonds Rally

In the past weeks the bond market has faced
* $27 billion in new 10 and 30 year securities
* CPI of 13.2% on an annual basis.

Credit Spreads Continue to Widen as Corporate Yields Increase

Put Options on Bear Stearns
A trader gambled $1.7 million on out of the money puts on Bear Stearns. The options had only a week till expiration, and were $30 out of the money.

The position made $270 million.

Read it all.

http://tinyurl.com/59mwwz

TACTICS
Continue money market arbitrage, extend the maturity of liabilities, add assets.

STRATEGY
Announce a major change in the economic future of the United States.

Inflation is finished for the future, until money growth resumes.

Be wary of hedging liabilities, and consider hedging assets when spreads widen and yields are attractive.

Asset quality is the topic of the year.

Markets at Major Turning Points

2008-08-09T05:28:00.000-07:00

Gold at Major Support

Most of the evidence suggests the bounce will be small, and prices will continue to drop. But, traders don't bet it that way.

Bond Refunding Successful
US Treasury sold $27 billion of notes and bonds following the largest increase in CPI since the Volcker years.

Treasury Note Futures

Treasury Bond Futures

Note that ond prices surged following a successful auction.

Corporate Bond Spreads Falling

Stocks finding Support

NYSE Composite

S&P 500

Russell 2000

SUMMARY
10 years from now this time will be seen as a major turning point in stocks. With inflation banished, and the bull market in bonds ended, only stocks will have the investment potential for the future.

Remember, stock prices rise when interest rates come down and stay down.

Fed and Treasury Up Again

2008-07-16T04:23:00.000-07:00

Recent moves by the US Treasury to purchase equity in Fannie and Freddie tell us two things.

1. They are in danger of going bankrupt.
2. The treasury will not allow them to go out of business.

Even though shareholders might lose all their money, the companies will still be reconstituted by injections of US government cash.

Along with this announcement came the news that the Fed will lend to the mortgage buying behemoths if necessary.

These two actions will support home lending by ensuring the ability to sell mortgages in the secondary market.

Stock Market at Support

2008-07-05T08:19:00.000-07:00

Investors will be watching the stock market closely for the next few weeks at prices approach support levels seen twice before in the last 6 months.

NYSE Composite

S&P 500

Russell 2000

Technical traders will be buying the Index here, and selling if the market trades below these levels.

SUMMARY
The usual rule is to buy the market when the situation looks bleakest.

That certainly is the case here.

Inflation and the Bond Market

2008-06-27T05:07:00.000-07:00

Bonds sank through support this month and are now back at May's support levels, now resistance for this instrument.

The question now is how low will prices go, and how high will long rates rise?

To answer this question we look at the money supply and the dollar. The first causes inflaton, and the second makes inflation worse.

MONEY SUPPLY
The monetary base is growing, but growth has been slowing for years.

This is a good sign for inflation, showing the Fed's commitment to control the supply of high-powered money.

In recent months, however, growth has accelerated slightly, but not enough to cause inflation.

Bank generated money has grown substantially in the past years, as businesses work their way through the recent Fed-caused disaster.

In recent months, growth in this leading indicator has slowed, leading to renewed confidence in the Fed's management of interest rates and the money supply.

In summary, inflationary pressures are not building, and there is no need to raise interest rates.

INFLATION AND THE DOLLAR
Price rises in the United States are connected to the falling dollar. Import prices are soaring as international demand for primary commodities pulls at suppliers.

The rise in commodity prices is directly related to the fall in the value of the dollar.

Notice the plunge in the dollar in 2006, and the simultaneous rise in PPI.

TACTICS
Prudent A/L managers will continue to lengthen liability maturities, shorten asset maturities, and work for higher spreads in lending.

Money market arbitrage is more profitable than ever, and those clients pursuing this activity have found their yields soaring dramatically.

The key to this business is a careful analysis of credit quality. High quality credits have been pushed off the curve hundreds of basis points, providing opportunities for lenders with excess cash.

STRATEGY
Now is the time to report to senior management and the Board on the A/L condition of the portfolio.

The institution is liquid, carrying good credits, good spreads, and profitable liabilities. In short, we are ready to lend to our existing customers, and prepared to take business from our weaker competitors.

The Asset/Liability department can take a bow.

Credit Crunch is Over

2008-05-31T06:03:00.000-07:00

Bonds broke support this week, signaling the end of the credit crunch and the return of investors to non-Treasury securities.

As the chart shows, bond prices have fallen through the 114 level on the CBOT and look likely to head lower as fears of inflation power sellers of long term securities.

At the same time, corporate securities have continued to climb in yield adding 500 basis points since the beginning of the year.

Inflation Tactics
The problem at this stage is inflationary expectations. The falling dollar combined with aggressive policies by the Fed concerns bond holders who are shedding long-term securities in fear of a long term commitments.

In our view, the Fed has not been particularly inflationary, as it has sold Treasuries to compensate for the extension of credit to banks and primary dealers. But, as long as inflationary pressures continue, and the business cycle expands, prudence requires reducing long-term assets and lengthening the maturity of liabilities.

Tactics
Continue money market arbitrage, shorten the maturity of assets and lengthen the maturity of liabilities.

Strategy
Senior management must aggressively prepare for new business as credit conditions improve. Prudent credit analysis can add high quality assets to the portfolio at bargain prices.

The risk is that lenders will not have the resources available to take advantage of these opportunities.

The board must understand the situation we are in, and must be appraised of the changes underway at this juncture. The economy has emerged from a potential catastrophe in better shape than any of us imagined.

It's time to take some risk, and prepare for the coming boom in lending opportunities.

End of a 25 Year Bull Market in Bonds

2008-05-07T05:51:00.000-07:00

The bull market in bonds is over. Never again will investors see a run like this.

Since Paul Volcker crushed inflation back in 1980 bond yields have made new lows with every cycle.

10 year US Treasury notes peaked at 15% in 1981, and have fallen consistently till the lows of 3.5% in 2003.

During this period real estate values boomed as capitalization rates fell and the cost of borrowing tumbled.

Refinances further fueled the mortgage banking business, bringing profits to finance companies.

Companies like GE, which based their growth on this trend will now see that portion of their earnings disappear, never to return again.

STRATEGY
For diversified companies, reduce expectations of future growth from financial activities. Explain to senior management and the board that lower interest rates will not happen again - ever.

For finance companies, explain to senior management and the board that the competition in the finance arena is about to get as tough as it gets, with more competitors chasing every deal, and lowering profits in order to compete.

TACTICS
Asset and Liability Management will dominate the discussion on adding assets and liabilities.

As the Fed moves to more market-based allocation of Fed Funds, expect to see more volatility at the short end of the curve.

Lengthen liability maturities and focus on solid spreads.

Recession is Over

2008-04-29T07:39:00.000-07:00

The danger from Greenspan's blundering is past, thanks to prompt action by the Board of Governors to reduce the Fed Funds rate and pull down the short end of the curve.

Without this action, a recession was inevitable. The yield curve was flat for nearly 18 months, from mid 2006 to the end of 2007, usually long enough to stall the economy.

That danger is now past.

Today, the spread between 3 month bills and 10 year notes is fully 250 basis points, a growth signal.

There is still a danger of a continued slowdown in the next few months, but the risk of a protracted recession is past.

This action, when combined with a massive injection of liquidity by the Fed's Open Market Committee to banks and primary dealers, suggests there is little danger of a prolonged recession.

YIELD SPREAD SIGNALS GROWTH
The spread between 3 month Bills and 10 year notes is the best predictor of recession.

Notice the last three recessions were preceded by a flat yield curve.

In Volcker's recession back in the early 80s, the yield curve was negative for an extended periond, signaling an unusually severe contraction.

CURRENT YIELD SPREAD
As the chart below shows, the spread between 3 month bills and10 year notes is about 250 basis points.

This is sufficient to allow for new bank lending and economic growth.

STOCK MARKET CONFIRMATION
The stock market confirms the forecast that the recession is over.

Notice the volume spike back in August of 07. As the effects of a flat yield curve spread throughout the banking and lending communities, the path to recession was clear and the stock market fell below the levels at the volume spike.

The market is now trading above those levels and finding support there.

INFLATION
The problem now is a continued rise in domestic prices both from additional liquidity in the system and from the falling dollar.

TACTICS
Continue to extend the maturity of liabilities to 5 years or longer. Borrowing now will lock in rates for the long term and fuel growth in assets. Be prepared to lock in profitable spreads on new assets.

Money market arbitrage is more profitable than ever. Aggressively raise deposit rates and expand the portfolio. Use the additional funds to acquire high-yield assets knocked down by credit concerns.

STRATEGY
Warn senior management of coming inflation.

Prepare hedging programs to take advantage of any spike in prices to hedge against the future sale of liabilities.

Evaluate credit risks and prepare to take advantage of distressed assets.
Insulate the portfolio from currency risk.

We're All Bankers Now

2008-04-15T05:12:00.000-07:00

There's a reason the Fed allowed Primary Dealers access to the Lending Window. With Interest Rate and Credit Default Swaps, Investment Banks do more banking than the Commercial banks.

If the swaps deals fail, as they have recently, it affects banks and then the money supply. The Fed has no choice but to allow these new bankers in the game. We're all bankers now, it seems.

Back in the early 80s the Interest Rate Swap was invented, allowing corporations to provide alternative lending services to each other. When the FHLB of Seattle did the first one with First Boston (now Credit Suisse) I was on the desk.

Since then, the market for swaps has exploded, and these unregulated securities threaten to destroy the world financial system. In the past these types of lending transactions were regulated, either by bank or securities regulators. No longer. The entire market is a mystery.

As the swaps industry progressed, interest rate and credit risk have been diffused across the economy, making every corporation a banker, and making the large investment banks a counterparty to each deal.

There is no doubt that the first task of the new regulators is to define these deals as securities and put the SEC on the case.

Give the Fed an A+

2008-03-27T06:44:00.000-07:00

Since 1987 when St. Paul the Tall left the Fed, there has been no one with less respect for the Fed than I.

That's changed.

BERNANKE
Bernanke has saved the US economy from a disaster of immense proportions. Had the credit system melted down, it would have taken commercial bank lending with it, and along with that, the money supply would have collapsed. If the money supply fell, the economy would also face depression, with employment, income, production and tax revenues falling precipitously.

The purchase of hundreds of billions of dollars worth of bad loans by the Fed has postponed that event. As long as the credit markets stabilize, as they are now doing, the US economy is safe.

COLLAPSE IN CREDIT
I never saw this coming. Not at these magnitudes.

As regular readers of this bulletin will remember, and can read in the archives, I advocated getting out of the adjustable rate business back in 04. That advice was prescient far more than I understood at the time.

It seems that everyone in the US had an adjustable rate mortgage, with little equity, and bad credit. But who knew? I didn't.

LESSONS LEARNED
The lesson is prudent asset and liability management. Match the book, and extend liabilities when the Fed starts raising rates.

None of Paterson's clients have been harmed - in the least.

In fact they are all in good shape with short term assets and liabilities in money market arbitrage, lengthened liability maturities, and solid spreads in new business.

This was a close one, believe me.

Subprime fallout continues

2008-03-09T10:40:00.000-07:00

Lengthen liability maturities!

As credit problems continue, and as inflationary pressures build, it's only a matter of time before the Fed's actions fail to hold government rates from rising.

When they do, long rates will increase 200 basis point and asset prices will fall again.

Prudent managers will lengthen liability maturities past the 5 year mark if they want to have the ability to make loans and take on assets.

Municipalities are suffering as their auction rate securities lose favor with investors. They will return to the fixed rate market to solve this problem.

FED'S BLUNDERING
There is always a shake out after a 25 year bull market as we've had in interest rates, but it's been exagerated by the Fed's insistence on managing the Fed Funds rate.

Recent actions to auction off $100 billion in short term credit move the Fed closer to a market based solution to short rates. Let's hope they finally stop meddling in the short end of the curve and leave those decisions to the market.

Except for crises like this, the Fed would be reduced to adding high-powered money on a regular basis and leaving the markets alone.

Credit spreads widen

2008-03-02T03:24:00.000-08:00

Credit spreads continue to widen as the Federal Reserve props up the Treasury market while it lowers short-term rates.

First, we review the Fed's recent policy of lowering short-term rates.

In a clear indication of the disaster of the policy of slow-and-steady short-term rate increases since 2004, the Fed has lowered short term-interest rates in a panic.

In the next chart below, we see the effects of the Federal Reserve's policy of pulling down long-term interest rates by purchases in the open market.

While this is occurring, credit spreads for other types of securities continues to widen. The latest casualty in this episode are auction-rate securities. In several recent episodes, auctioned securities have exceeded 15%.

This data carries a clear implication: Lengthen the maturity of liabilities. Had these institutions lengthened liability maturities, as Paterson has repeatedly recommended, they would not be in this situation.

LENGTHENING LIABILITY MATURITIES
When the Fed stops supporting US Treasuries, as it must, and interest rates rise in response to a weaker dollar and rising inflation, the yield curve will steepen and long-term interest rates will soar, adding two-five percent to liability costs: between $20,000 and $50,000 per million per year.

This is a potential increase of 40-100% of liability costs!

DOLLAR DETERIORATION CONTINUES

Paterson finds a continuation of the loss of purchasing power of the dollar, making exports more competitive, imports more expensive, and foreign earnings more valuable to US companies.

The chart below shows the trade-weighted value of the dollar.

Given Fed policy, Paterson sees no reason for this to change and for the dollar to continue to lose value.

TRADING RISK
After the multi-billion dollar loss by a French trader, one would think that trading rules and monitoring would have precluded unauthorized trades. It is not so.

In the recent debacle, a trader in wheat lost more than $100 million. In a bull marktet! Where was the supervision?

Though these problems are not specifically related to interest rates or monetary policy, they are an effect of fluctuating prices.

TACTICAL ASSET AND LIABILITY MANAGEMENT
Increase liability maturities, shorten asset maturities, and work money market spreads for income.

The debacle in the bond market is generating extraordinary returns on high-quality credits which can be funded with matching maturity liabilities. Some clients have experienced a 10% rate of return on select securities over a 6 month horizon.

Credit hedges must be evaluated daily during this time.

Currency hedges must be extended and widened to include currencies with low money growth.

STRATEGY
Though Paterson did not foresee the extent of the credit debacle, we can react to it with prudent actions.

First, the policy of money market arbitrage has proven to be a solid earnings gain.

Second, the policy of eliminating variable rate assets has insulated the portfolio from credit losses.

Finally, the policy of lengthening liability maturities has strenghted the balance sheet with fixed rates.

Senior management must keep the board informed about the deteriorating bond market and be prepared to hedge interest rates, credit risk, and currencies.

Money Supply Explodes

2008-02-16T05:23:00.000-08:00

At this stage of the business cycle, money growth is a confirmation of the growth in economic activity, and MZM is surging. There's no recession in sight.

MZM Surges to 15%

Behind this growth is an exploding loan portfolio at Commercial Banks.

Commercial and Industrial Loans

Real estate loans continue to fall.

Real Estate Loans

CONCLUSION
Economic activity will continue strong for the next 18 months.

Risk comes from a resurgence of inflation. Lengthen liability maturities.

Risk also comes from a deteriorating dollar. Hedge against this risk and emphasize foreign profit centers.

Credit will continue to improve as the Fed lowers short-term rates. Take advantage of Money Market arbitrage.

Another Fed-Caused Disaster

2008-01-30T05:49:00.001-08:00

In an astonishing repeat of the real estate debacle of the 1990s and the Internet bubble of the early part of this decade, the Fed has again blundered into another finance disaster.

This time, the Fed's policy of managing interest rates caused the disaster. After holding interest rates too low for too long, the Fed started raising rates in fear of inflation. Gold prices were climbing and until they stopped rising, the Fed continued to raise the Fed Funds target.

Once gold peaked - at $800 an ounce in mid-2007 - the Fed stopped raising rates. We are now feeling the effects of the Fed's actions.

Adjustable rate mortgages are getting killed.

Lenders should have been switching borrowers out of these types of instruments and into fixed rate loans. Instead, everyone hoped the problem would go away.

Once home values stopped rising, and began to fall, a payment problem turned into a collateral problem. Investors holding hundreds of billions of dollars of real-estate related paper are looking at billions of dollars of losses, and for some, bankruptcy.

SPREADS: US TREASURIES VS. BAA CORPORATES
In recent months, US 10 Year Treasuries have fallen a full percentage point while other debt instruments - Baa Corporates - have remained constant or increased in yield.

In a flight to quality, Treasuries lead the way.

Short rates also fell. Here is a chart of the CD-Treasury spread to illustrate similar changes in the short end of the yield curve.

And here an isolated look at the spread.

Notice that spreads between Treasuries and CDs have widened a full hundred basis points. For financial institutions, this can be a windfall, an opportunity to increase the return to money market operations.

Consider switching out of Treasury securities and into other instruments, increasing the yield on the Money Market portfolio.

When trading out of treasuries, select carefully the money market instruments replacing treasuries, with an eye on credit, exchange, and trading risk.

Yield curve steepens.

Markets are faced with a substantially steeper yield curve, allowing bank lending if they choose.

MONEY SUPPLY STOPS ACCELERATING
The news in the money supply story is the collapse in real estate loans at banks. Except for this activity, money growth signals a continued expansion.

Here is a graph of real estate loans.

After growing at a 15% rate for all of 2007, growth is barely above 5% today. Here is the real worry for financial institutions and the Fed.

If a bank wants to use these securities for collateral, there will be a significant hair-cut on the value.

Basic money supply - MZM - is still increasing in dollar terms.

Here is a chart of MZM's percentage change.

Notice the recent change in growth patterns.

The monetary base growth is around 2% and falling.

We conclude the Fed is doing all it can to restrain money growth.

C&I loans are growing at a robust 20% rate.

Banks are still lending to businesses.

M2 is growing at a 5% rate.

In summary, basic money growth is within the bounds of continued expansion.

For the past few months the Fed has lent money to banks on this troublesome collateral. Recent announcements indicate this policy will remain.

STOCK MARKETS
Here is the first indication that something's wrong with this economy. The NYSE Composite has lost 15% in the past two months.

Notice massive volume in early January. Traders will be buying this market for short term gains, and hoping for a retracement to the lows of this move to establish long term positions.

From the perspective of a business cycle investor, this is the time to add to positions.

The problem here is potential inflation. The market can't decide if recent Fed action will cause inflation in the months to come, and will be watching price indexes very carefully.

Treasury bond prices are rallying, and provide a sense of comfort that inflation is not coming back.

GOLD PRICES
Gold is telling a different story, shouting INFLATION as loud as it can.

Perhaps this is just a function of the collapsing dollar, but the collapsing dollar usually heralds inflation. This is cause for worry and vigilance.

SUMMARY
This is a delicate time. Be careful and pay close attention.

Money growth is not accelerating. Treasury prices are rising. Stocks have fallen dramatically and are stabilizing.

TACTICS
Continue money market arbitrage. This has been a successful plan for years.

Continue to lengthen liability maturities to be in position to make longer term loans.

Re-evaluate hedging and pricing policies to ensure good spreads and timely coverage. Notice the decoupling of Treasuries from other credits.

STRATEGY
Trumpet the success of the Asset/Liability department.

The portfolio must be carefully watched for interest rate and credit risks.

Spreads Widen in Flight to Quality

2007-12-07T05:08:00.000-08:00

In the past month, the debt and equity markets fluctuated widely in the face of economic and financial uncertainty.

Most surprising is the rally in US Treasuries following November's quarterly refunding.

As the chart shows, bond futures rallied from 114 to 119 before retracing to the 116 level today.

At the same time, spreads between Treasuries and BAA Corporates have widened more than 60 basis points.

EQUITY MARKET REACTION
The NYSE composite at first fell dramatically, signaling either a rise in long term interest rates of a decline in earnings.

As did the bond market, the equity market is retracing its steps.

MONEY SUPPLY
While all this is happening, the money supply growth accelerated exclusively from bank lending.

As the chart below shows, the Monetary Base has grown at a relatively mild 3% while MZM is growing faster every month.

INFLATION IS COMING
Money growth in excess of GDP growth causes inflation.

In its attempt to mitigate the damage from the Fed-caused rise in short term rates, the Fed has chosen to reflate the economy and allow banks to pour money into the system. This will cause inflation to rise in 6-18 months.

The Fed will then have to start raising rates again, and will probably push the economy into a recession in order to get money under control again.

SUMMARY
Until then, credit and equity markets will remain confused.

TACTICS
Money market arbitrage will continue to generate solid earnings.

Continue to reduce exposure to long term assets.

Re-evaluate asset pricing spreads to ensure an adequate return on risky lending.

Consider lengthening liability maturities further.

STRATEGY
Emphasize to senior management and the Board the dangers of money growth on inflation and interest rates.

Prepare them for action to lengthen liability maturities.

Discuss trading and hedging policies and procedures in preparation for future increases in long term interest rates.

Another Fed Blunder

2007-11-02T06:34:00.000-07:00

The latest reduction in the Fed Funds target is a disaster waiting to happen.

DON'T BUY LONG BONDS FOR THE NEXT TWO WEEKS.

Wait till this auction settles before taking on long term assets.

FED MOTIVATION
Why on earth would the encourage banks to create more money? MZM is growing fast enough to fuel inflation without this help.

Gold is making new highs. The last time gold was up here, the Fed was still increasing the Funds target.

The bond market is facing a quarterly refunding next week where investors will have to choose between long bonds at 4.75% or short-term instruments at the same rate. Any fear of inflation will make this auction a disaster.

TACTICS
Stay with money market arbitrage.

Extend the maturity of liablities today. Don't wait.

Bond futures are at resistance. This is the time to sell bond contracts.

Do not take on long term assets.

STRATEGY
Warn the board that inflation is coming.

Corporate/Treasury Spreads Widen

2007-10-12T07:06:00.000-07:00

In a further confirmation of the problems in US debt markets, corporate bonds are being pushed farther off US Treasuries.

As the chart below shows, BAA bonds are yielding more that 200 basis points more than similar maturity Treasuries.

As recently as July of 2007 spreads were 40 basis points lower.

Credit woes push CDs farther off Treasuries

2007-10-11T10:32:00.000-07:00

Markets are giving us a good estimate of the cost of borrowing for CD issuers.

As the chart below shows, CD rates are relatively constant over the past year or so, while yields US Treasuries have fallen substantially.

Spreads have widened to more than 150 basis points in the past few months as investors have bid up Treasuries.

The question investors will now be asking is "Will the spread continue to widen?"

Stock market surges following record volume

2007-10-04T03:50:00.000-07:00

The NYSE Composite Index is bumping against record highs following record volume back in August of 2007.

As the chart below shows, stocks are still in a bull market, begun back in early 2003, and will continue higher until the Fed signals the end of monetary expansion by raising short-term rates again.

INFLATION AND THE STOCK MARKET
If inflation is coming, as we forecast in a previous weblog entry, stocks will outperform bonds by a substantial margin - perhaps as much as 10% - until the Fed realizes how badly it's blundered and starts raising the Fed Funds target again.

As inflationary pressures push into the economy, businesses will use this opportunity to raise prices on all goods and services, fattening income, earnings, and dividends.

INFLATION AND THE VALUE OF THE DOLLAR
Inflation is also lowering the value of the dollar against most trading-partner currencies, making imports more expensive, and raising domestic US prices.

The lower-valued dollar will also make exports cheaper, boosting the sales and stock prices of major US exporters.

ASSET ALLOCATION
For all these reasons Paterson Financial has moved a portion of the portfolio out of two year notes and into the NYSE composite.

The fraction of assets held in fixed income securities should be reduced to no more than 30% of assets and aggressive managers might go as low as 10% in fixed income securities.

Very aggressive money managers will consider dividend-free equities as typified by the NASDAQ 100.

Notice the index has more than doubled since the lows of 2002 and will lead the way as stocks trade higher.

If the index doubles again in the next 4 years prices will approach the highs seen last in the year 2000.

CONCLUSION
Until the Fed sees the error of its ways, prudent money managers will reduce fixed income holdings past the two year note, and will continue money market arbitrage.

STRATEGY
Asset managers must re-introduce growing inflation into their models.

The board must be notified of the potential for increasing input and output prices, interest rates, and the stock market.

Senior managers must review lending policies and procedures to make sure to place a sufficient spread in all fixed income business, and ensure a match of asset and liability maturities.

Hedging programs must be examined for opportunities presented by occasional spikes in long term debt prices.

TACTICS
Extend the amount and maturity of liabilities.

Prepare bond offerings and use the CBOT in advance of bond sales if prices spike upwards.

Increase spreads on all loan transactions.

Be aware of Treasury refundings and take advantage of price changes.

Begin active hedging on a small scale, selling into overbought US Bond futures.

Fed Makes Another Mistake

2007-09-28T04:21:00.000-07:00

If there is any doubt the Fed is completely incompetent, their recent action to lower the Funds target to 4.75 will dispel the confusion.

The bond market fell, the gold market rose to new highs, and currencies rose. These markets quickly gave their opinion of the Fed's actions: this is an inflationary bungle of monumental proportions.

These markets are now stabilizing, and waiting for the next phase in their move to confirm the error of the Fed's actions.

With money (MZM) growing at better than 10% per year, mostly fueled by loan growth, this action will only encourage lending by banks, leading to further money supply growth, more inflation, and higher long term interest rates.

Prudent money managers are now extending the maturity of their liabilities, locking in long term financing at these levels.

BONDS
Let's look at the weekly chart for 30 Yr. US Bond Futures.

Notice the recent price action. After testing the old highs for the contract, the market began to fall in preparation for the Fed meeting.

Once the Fed made the decision to lower rates, the decline accelerated, and only this week has stabilized, four points lower.

It looks like there will be a steady decline back down to the 104 level, where we'll find temporary support.

GOLD
The gold market also moved well in advance of the Fed's actions.

Notice prices were at the $715 per ounce level before Fed action, and immediately punched through resistence, making new highs near $750 per ounce.

Record highs are not too far above us, now, and this market will certainly test those levels.

FED FUNDS
The last time gold prices were at these levels, the Fed was still raising short term interest rates, trying to slow money growth.

Note the date on which gold prices peaked and compare it to the date on which the Fed stopped raising rates.

Gold prices peaked in May of 2006 and the Fed stopped raising rates a few months later.

This action says to most participants that inflation - in the form of gold prices - is a primary concern of the Fed.

Will the recent spike in gold prices cause the Fed to reverse itself again and start raising short term rates again?

If so, what will this do to the US economy?

This is the nightmare scenario that's talked about in financial strategy sessions throughout the world.

TACTICS
Extend the maturity of liabilities to five years. Lock in rates at these levels, because inflation will raise long term interest rates.

Make no new long term loans for at least 6 months.

Retain all loan servicing.

Continue money market arbitrage.

STRATEGY
Senior managers must be warned of the potential for future inflation and increases in long term rates.

Senior managers must warn the Board of Directors of the potential dangers of continued money growth.

The Asset/Liability committee must review its plans for an extended period of instability in the long term credit markets.

Hedging programs must be prepared to allow the institution to take advantage of temporary spikes in bond prices and sell futures in anticipation of bond issuance.

Spreads must be widened on all loan transactions. Add fifty basis points today, and consider adding another fifty as bonds trade lower.

Correction

2007-07-21T05:06:00.000-07:00

What I meant to say was bond YIELDS declining.

In the previous post, I stated the opposite.

I'll Be Damned - Gold Loses its Luster

2007-06-15T08:10:00.000-07:00

Pondering the latest market news - described below - I finallly came to the conclusion that the gold market is out of synchronization with the rest of the financial markets.

The only explanation that makes sense is massive selling of gold.

In the decades since Paul Volcker destroyed and bankrupted the Hunt Brothers when they attempted to corner the silver market back in the 70s and 80s, the world has changed.

No one thinks inflation is coming back, and that's what the gold market is telling us.

Inflation is deader today than ever before in human history.

No longer will a flood of bullion lead to inflation as its done for thousands of years.

Now that money is a pure fiat with government control, and now that money growth is published weekly, the monetary authorities will never again fool the markets about inflation.

So, what we're observing is the sale of gold.

That's it.

As soon as the markets realize this, we're off to the races again, with bond prices declining, and stock prices rising.

The only question is whether the Fed will now lower short-term rates.

STRATEGY
Be very careful here, and be prepared for the Fed to lower rates.

Bond and Gold Prices Plummet

2007-06-09T10:30:00.000-07:00

This is a puzzle.

Money is growing more rapidly with each passing week as banks expand lending.

This should send bond prices lower - they are.

Stock prices should fall - they did.

But, gold prices should soar - they didn't.

What is going on?

Here are the relevant charts.

MONEY SUPPLY

BOND FUTURES

GOLD FUTURES

WHAT WILL THE FED DO?
The markets are confused, and not telling a consistent story.

Unless the Fed is about to raise short term rates. That's the only answer that makes sense.

Stay tuned.

TACTICS
Prudence is still the watchword. Reduce the size of the book, put all new money in the short end of the curve, and expand money market arbitrage.

Long term assets must have a profitable spread, or don't do it.

STRATEGY
Tell the Board and Senior Management we're in for a long, difficult period.

Reduce expectations, and build capital.

Bonds Break Support

2007-06-02T04:31:00.000-07:00

As the chart below shows, sellers are dominating the bond market right now.

Gold is still in a trading range.

Money is still growing.

Bonds have broken support and must be sold.

TACTICS
Continue to shrink the book, and put all new business into Money Market Arbitrage.

When making long term loans, make sure of both spread and credit quality.

Don't expect the Fed to lower short-term rates any time soon.

We expected the Fed to consider easing sometime this Summer, but with bond prices falling, there is little chance the Fed will lower the funds target.

STRATEGY
Warn the Board. Something is driving long rates up.

Stock markets making new highs

2007-05-23T06:09:00.000-07:00

In the month since the end of the correction, all major stock market indexes have surged to new highs.

The bull market is intact and will move higher in the months and years to come.

Get long and get rich.

STOCK PRICE INDEXES
First, the New York Stock Exchange Composite

Second, the S&P 500

Finally, the Nasdaq 100

GOLD
Gold prices are a puzzle. I would expect them to be surging with bonds falling.

BONDS
Bonds are at major support. The gold charts suggest this is the time to buy bonds.

Bank Lending Surges

2007-04-27T03:56:00.000-07:00

The basic money number, MZM, continues to surge, growing faster each month.

The Fed is not the problem, for a change. As this chart shows, the monetary base is not growing, so it must be bank lending.

At some point, the economy will slow, and so will lending, but for now, the Fed cannot lower rates or willl risk reigniting inflation.

GOLD PRICES

Gold prices are finding resistence at $700 an ounce - the highs of July 2007 - and should punch through with these latest money numbers. It's time for caution.

The old highs of $780 an ounce are easily within reach.

If gold surges to new highs, the Fed will be tempted to raise - not lower - short term rates. They will have no choice.

BOND PIRCES
Bond prices bounced these past weeks, but are in a longer term decline, signaling inflation worries.

This is just another indicator of the problems the Fed is facing. Raising short term rates must be in the mind of every inflation fighter on the Board of Governors.

Correction is Over

2007-04-13T09:58:00.000-07:00

As the chart of the NYSE Composite shows, the correction is over.

Prices make a double bottom
Trade up through resistance
Fed warns against inflation
Fed won't lower short rates any time soon
Stock prices retreat for one day
Prices make new highs for the move.

This correction is over.

Time to get back in the market and put that new money to work.

Money Growth Continues

2007-04-08T03:52:00.000-07:00

As the chart below shows, money growth continues, so don't expect any relief from high short term rates any time soon.

Gold prices are not falling and bond prices are. Be careful.

The stock market is sitting at resistance, waiting for this correction to resolve. Right now, it looks like the damage has been done, and the correction is over. We will know in a few weeks.

TACTICS
Stay away from long term assets unless they are perfectly matched. Continue money market arbitrage.

STRATECY
Steady as she goes.

Money Growth Puts the Fed in a Box

2007-03-31T07:55:00.000-07:00

As the chart below shows. MZM continues to grow, punching through the 6% level for year on year growth.

The Fed would like to address the looming slowdown by cutting Fed Funds, but can't.

Gold prices are rising, and bond prices falling, both potential signs of growing inflation.

STOCK MARKET WARNING
The danger here is for investors to shun the stock market.

First, new money will go into short-term debt instruments, not stocks.

Second, speculative long positions will be closed out.

Third, if prices drop below the big volume days around Feb 27th this will be a major sign of weakness and new short postitions will be established.

TACTICS
No new long term assets unless matched by liabilities with a good spread.

Expand money market arbitrage.

Lengthen liabilities on major weakness.

STRATEGY
Warn senior management and the Board of the potential for continued high short-term interest rates.

Consider buying puts or establishing short postitions in the futures market.

Stocks in Dangerous Ground

2007-03-17T04:57:00.000-07:00

As the weekly chart below shows, the current correction is stalled, waiting for new positions from investors.

First, notice the big volume day of February. Since then, prices have made new lows each week, but have closed strongly. This is a neutral sign.

Second, notice prices have retreated both of the last two weeks after reaching the same price level. This means sellers are waiting at that level.

Finally, the downward revisions to GDP are telling investors to beware, a slowdown might be coming. The Fed program to slow bank lending might be working.

In the face of a potential slowdown in the US economy, the Fed would like to cut short term rates.

GOLD

Gold prices are signaling potential inflation.

This is the market the Fed watches. Recall the peak in gold prices coincided with the end of the rise in Fed Funds. At the same time, the current rally in bond prices began.

Notice prices have not made new lows since the low of $560 in 2006.

With potential inflation looming, the Fed cannot cut short term rates.

MONEY
The Fed has been raising short term rates since the middle of 2002 and money growth slowed dramatically at first, from 20% to a low growth rate near zero in 2005.

Here's the problem: since the trough in growth rates in 2005, money began to grow again, and continues to grow at faster rates - 6% in the latest data.

This has to be troublesome for the Fed.

With money growth this strong, the Fed cannot cut short term rates.

TACTICS
Stay out of the stock and bond markets.

Stick with money market arbitrage. It's safe and profitable.

Lengthen liability maturities as rates allow.

Continue to shorten asset maturities. Place all new cash in Fed Funds and other short term instruments.

STRATEGY
Tell the board things are under control.

The spread continues to widen, making the bank more profitable.

The portfolio is nearly balanced, assets are over-weighted in the short end of the curve, and no hedging is required.

Stock Market Headed Lower?

2007-03-13T10:01:00.000-07:00

The rest of this week will tell investors what's happening, and it doesn't look good.

As the chart below shows, the danger now is a significant move down.

Prices have risen 4 out of the last five days, and could not get above the big volume day of February 27th.

Prices are now headed lower and technical traders will sell this market as prices drop below the lows of the 27th.

Storm Strengthens

2007-03-06T05:19:00.000-08:00

VOLUME yesterday was not enough to say this decline is over.

BEWARE the continuing fall in stock prices.

DO NOT add new money to the stock market.

STAND BY for continuing updates.

STOCK MARKET WARNING - HURRICANE

2007-03-05T15:21:00.000-08:00

Stocks made new lows, and closed at the low.

If volume was light, this could mean a prolonged correction.

The Fed has a habit of doing this.

KEEP YOUR POWDER DRY.
Fed funds will yield a riskless 5.25%. Take it

With today's price action, the technical traders will be licking their lips and fighting for a place in the pit to see this market and sell it if it goes south.

If we continue down for many more days, we will be below the large volume days of the last week in February, and that will become resistance.

The Techs will attack the NYA every time it pokes into resistance.

That will make it harder to bounce back.

Summary
We are still in a bull market, don't worry, but this could get ugly.

New Lows in Stocks

2007-03-05T06:59:00.000-08:00

The stock market is making new lows.

Get out of the way.

Gold Falls to $646

2007-03-02T12:06:00.000-08:00

Late Friday, March 2nd, gold broke support, closing at $646.

This is good news for everyone.

Be Careful Here

2007-03-02T07:27:00.001-08:00

VOLATILITY!

In the past two weeks we've seen volatility in gold, bonds, and stocks.

Something is going on be very careful.

This post was written before market close on Friday.

GOLD

NOTICE - Volatility started Wednesday the 21st of February and has continued, with prices falling a week later on the 28th, and then breaking support and making new lows on Friday the 2nd of March.

BONDS

NOTICE - Bonds began their recent climb at the end of January, and spiked on Tuesay the 27th of February.

STOCKS

NOTICE - Stocks broke on Tuesday the 27th while bonds were spiking.

Bonds back at support

2007-01-24T04:43:00.000-08:00

Since the last report, bond prices have steadily risen to 115 and then declined to 110, bringing prices back to the same levels of last October.

Time to buy again? Prices are at support. Time to sell if support breaks?

The answer to the first question is no more buying long term assets.

The answer to the second question is yes, sell if bonds break major support.

Money Market Arbitrage is the tactic of choice.

First, we look at the gold market.

GOLD FUTURES PRICES

Notice gold spiked back in June of 2006 and has stabilized at the $620 level and shows no sign of breaking out of this range.

Next, examine the money supply,

MONEY SUPPLY - MZM

Here we have troubling information. The money supply is still growing at an accelerating rate.

These numbers signal to both bonds and gold inflation is still a risk.

For this reason alone, it is prudent to keep an eye on the details of money growth.

What has the Fed been doing with the Monetary Base?

ST. LOUIS ADJUSTED MONETARY BASE

Base growth is declining, showing Fed restraint.

What have commercial banks been doing?

COMMERCIAL AND INDUSTRIAL LOANS

Here's the answer. Demand for credit is still running at 10% per year - even with Fed Funds at 5.25%!

This is a strong economy, with strond demands for credit, leading to strong growth in money.

If money growth is not met by equally strong growth in economic activity, inflation results.

How is the economy growing?

GDP - YEAR OVER YEAR CHANGES

The economy is growing nicely at the 6% level - year over year. No cause for alarm here. If money growth is 5% and economic growth is in the 6% range, there is no cause for alarm.

Is there reason for prudence? Or, should lenders and investors take this as another buying opportunity?

The alternatives are either long bonds or Fed Funds at 5.25%.

This chart looks at 30 year bonds for the recent past.

30 YEAR US TREASURY SECURITIES

Bond yields are still in the 5% range, but Fed Funds are higher.

Until the Fed decides to cut short-term rates, or until loan demand starts to slow, the prudent thing for an investor is to put extra cash to work in Money Market Arbitrage.

Buying Opportunity in Bonds

2006-10-16T04:26:00.000-07:00

Rarely does a market give a clear buy signal, but the US Treasury market is doing so today.

As the chart below shows, prices have broken out decisively through record volume, and returned to the breakout level to find support.

The weekly charts are clearer still. Here is a market that's made a double bottom, pushed up to resistance, found record volume, and pushed to new highs for the move.

It's time to add long-term fixed rate assets to the portfolio.

Gold prices are tamed, as the chart below shows. Inflation is no longer a worry.

TACTICS
Continue money market arbitrage. This will continue to be a money maker for at least another six months.

Begin adding long-term fixed rate assets with shorter-term liabilities.

Stop lengthening liability maturities.

STRATEGY
Inform senior management that the bear market in bonds is over.

The next Fed move will be to lower interest rates.

Be prepared for a long bull market in bonds: several years at least.

Reduce hedging programs, but continue to take advantage of yield spikes like the current one. They will come again, and are an excellent opportunity to add high-yielding assets.

Bear Market is Over!

2006-10-02T07:16:00.000-07:00

The bear market in bonds began in March of 2006 and ended in September of the same year.

This must be one of the shortest bear markets in history.

As the daily chart below shows, bond prices blasted through resistance and are consolidating at higher levels.

WEEKLY PRICE ACTION
The chart below is weekly price action and shows clearly that we've surged through the price levels we saw in March.

The bear market is over.

TACTICS
- Continue money market arbitrage.
- Cover long term liabilities with longer term assets
- Prepare options and futures programs for price volatility
- Warn the board and senior management

STRATEGY
In a climate of uncertainty, it's best to be prudent, and this is a time like that. Do not overplay the end of the bear market.

Reduce the warning level to neutral, and let the subject sit for a few months. The Fed is in no hurry to lower rates, and will probably do nothing till 2007, when signs of slower economic growth might arise.

The money numbers tell us the future of the economy is sound.

Gold prices tell us inflationary expectations are crushed.

Bank's are lending on commercial real estate, which contains no prepayment option, thus locking in long-term yields.

There will be powerful profit opportunities in futures and options. Educate senior management and the Board, and prepare them for some hedging. Contact outside consultants on this issue.

Time to Widen the Fed Funds Band!

2006-09-20T09:34:00.000-07:00

SUGGESTION:

Decrease Fed open market operations.

Allow overnight rates to fluctuate more than they do now.

Stop intervening in the markets except for permanent additions to the stock of money.

Increase the band sround the Fed Funds rate which causes the Fed to supply or drain funds.

REASONING
Look carefully at the changes in the basic money supply and you see volatility. Nothing but volatility.

Look carefully at the Fed Funds rate and you see stability. Nothing but stability.

To an economist, this is clear evidence of meddling by the Federal Reserve Bank's Open Market committee.

It's a misguided policy of interest rate stability; also called price controls. This is the last vestige of an obsolete activity.

Now that the economy has stabilized, it's time to let the market allocate overnight loans, rather than the OMC.

Let the Fed Funds rate fluctuate, as exchange rates do; as long-term interest rates do; as oil and gold prices do.

There will be no adverse effects if they widen the band around which the OMC performs open market operations and et short term interest rates fluctuate.

It's time for the Board of Governors to instruct the OMC to widen the bands on the Fed Funds target rate to at least one percentage point around the target rate each year until controls are ended.

CBOT Record!

2006-09-06T18:45:00.000-07:00

CBOT August Volume Reaches Second Highest Monthly Total in Exchange History

The CBOT announced today that average daily volume (ADV) reached 3,341,170 contracts in August, an increase of 23 percent compared with August 2005.

Total volume for the month reaches second highest monthly total in CBOT history.

Volume Spike in Bonds

2006-09-04T10:41:00.000-07:00

Both volume and open interest in the CBOT futures contract have spiked at this crucial juncture.

As the market moves away from this point, winners' hands get stronger, while losers' hands get weaker, reinforcing the movement in prices.

TACTICS

Sell bonds here.

Be ready to buy 'em back if they break out.

Be ready to go long if prices break out on the upside.

STRATEGY

Look out!

Warn the boss and the board.

This will mean a major inversion of the yield curve.

Next Fed move is down!

Bond Market at Major Resistance

2006-08-26T08:11:00.000-07:00

BONDS RALLY AFTER US TREASURY REFUNDING
In the weeks since the US Treasury sold 3, 10, and 30 year debt securities the bond market has rallied each week.

Here's the weekly data. Looks like a double bottom.

Bear markets don't behave like this. Something is going on.

Let's go to the charts.

GOLD - Daily prices till August 25th

Gold prices have broken. Unless money starts growing again, there is no upside for gold.

As we said back in July, when gold stops going up, so will Fed Funds.

Prudence will require the Fed to keep short rates at these levels for 6 months.

If the Fed knows it's business, it will widen the band for targeting Fed Funds and allow the market to allocate short term rates.

In addition, widening the band will also reduce the volatility of the Money supply.

MONEY SUPPLY - BASE, MZM, M1, M2
We present the data since the end of the last recession.

Monetary Base is growing nicely.

MZM has consistently declined and is still doing so, but still positive.

M1 Moves Into Negative Territory

After flirting with negative growth earlier in the year, M1 has moved into the red this past month.

As long as money doesn't grow, neither will inflation, or gold.

M2 Growing Nicely

M2 is growing at the 4% level

SUMMARY
Gold prices have broken decisively, bonds are making a base, money is under control.

TACTICS
Continue money market arbitrage and carefully add long-term assets as long as a profitable spread can be maintained.

STRATEGY
Hint - but only hint - that the bear market in bonds might be over.

Fed action to control bank lending has succeeded and money is not growing.

Short-term rates will stay high for another 6 months.

The bands on Fed Funds might widen and there will be more volatility in short term rates.

Strengthen the Treasury department and add a board member who's familiar with A/L management.

Day of Reckoning is Here

2006-08-14T13:12:00.000-07:00

As we suggested last week, traders are selling into the recent rally.

Prices are down a point and a half in the long-bond futures contract from the highs of last week.

In the days and weeks to come, the forces of inflation will battle those of higher short-term interest rates and in the end, Asset/Liability Mangers will have a clearer sense of direction for interest rates.

CURRENT MARKET SITUATION

As the chart above shows, bond prices have run up to the lows of last March, where this bear market began, and have fallen back.

TACTICS

Money Market arbitrage is the best policy for the next year or so.

Contact Paterson for more information.

STRATEGY

Continue to shrink the A/L portfolio, reducing long-term assets and liabilities, and adding to Fed Funds.

SHORTEST BEAR MARKET IN HISTORY?

2006-08-07T17:28:00.000-07:00

As the Treasury auctions 3, 10, and 30 year securities, the bond market has rallied sharply, returning to the levels of March 2006 when this bear market began.

Experienced traders will be selling into this rally, expecting prices to fall as new supply enters the market.

Gold prices have broken.

Money is under control.

TACTICS
Sell into this rally, but be prepared in the weeks to come to change your opinion of this market.

STRATEGY
Continue to put new money into shor-term instruments and expand the Money Market Arbitrage operation.

Treasury Refinancing in August

2006-07-30T08:56:00.000-07:00

On August 2, 2006 the US Treasury will announce the size of the auction for 3, 10, and 30 year securities.

This event will give the markets a good idea about the demand for long-term debt.

In the current situation, it's most likely prices will fall prior to the auctions, and rise afterward, as Wall Street sells these securities to the public. This is the standard scenario in a bear market.

The size of the fall in prices will tell us what kind of orders the Primary Dealers have for this issue. Small decline means many orders.

However, if after the auction prices fall, it will signal the next stage in the bear market, begun in March of 2006, and an unwillingness by pension funds, insurance companies, and mutual funds to take on these securities in this bearish environment.

WARNING!
Recent analysis of money data for the past four years reveals a puzzle.

Money is not growing at the rate one would expect in a bear market. Neither the monetary base, MZM, M1, nor M2 are growing fast enough to generate inflation.

Something else is going on here, and it pays to be prudent.

TACTICS
Do not extend liability maturities past two years.

STRATEGY
Keep the book matched, and keep adding to overnight funds for the near future.

Fed Funds will continue to stay high for the next year - at least - to control inflationary expectations.

Keep an eye on gold prices. They will tell A/L managers if the Fed will continue to raise rates.

GOLD IS STILL THE STORY

2006-07-17T05:10:00.000-07:00

As long as gold keeps going up, so will Fed Funds.

Long-term rates
Bond prices are not falling.

The bond market is a puzzle. Either gold is right, and inflation is coming, or the bonds are right, and inflation's under control.

Money Supply
Money usually tells the tale, but in this case, the data is confusing.

While most current money numbers are under control, past money growth has built a powerful backlog of fuel for price increases.

Money velocity increases as short rates rise, due to the increased benefit of leaving cash in an interest-bearing account, and this can temporarily increase demand.

Work the short end of the curve
Money market arbitrage is the tactic of choice at this time.

Call or email Paterson Financial for advice on making profits at the short end of the yield curve.

Fed's in a Box

2006-07-10T04:52:00.000-07:00

GOLD PRICES LEAD THE WAY AGAIN
In the past week gold prices have risen from $575 to $625 and look like they will head higher in the coming months.

If so, the Fed is now in a box and cannot escape raising rates again, and perhaps for several more times.

From the outset of Fed action, back in 2004 the gold market has led the way in forecasting future Fed action. As gold rises, so must the target rate for Fed Funds.

Once the gold market broke, back in May of 2006, it appeared the Fed had done its job and could stop raising rates. As the perception of this intent soaked into market thinking, the bond market stabilized, the stock market corrected, and a sigh of relief escaped from bullish traders.

That thinking is now in jeapordy, and the gold market is telling A/L managers to be very careful.

If the gold market is right, and inflation is still a powerful force, then the Fed is not done tightening, and short term rates are certainly headed higher.

TACTICS
At times like this the A/L department, and its senior managers play an important role in the profitability of the institution.

1. Be aware of all market action. Start with money numbers, then keep an eye on gold, bonds, stocks and other commodities. Watch inflation and output numbers. Don't leave your desk even to get a glass of water.

2. Communicate to senior management. Give the CEO the information necessary to implement the A/L management plan.

3. Review new business to see that sufficient spreads are being built into every deal. Highlight any new business that is not profitable right away.

4. As old loans roll off, make sure the assets are invested in Fed Funds or a equally short-term instruments. Both safety and yield are enhanced by shortening asset maturities. Remember, Fed Funds is the highest spot on the yield curve. Take advantage of that fact and take credit for making profits. Consider using a Funds broker like Tullet Prebon. Ask for Mark Edelsberg.

5. Review hedging programs and obtain conditional authority from senior management for quick action.

6. Encourage Board participation where needed. Sometimes, the board wants to know what the A/L department is doing, and if they do, make sure to tell them. The A/L department makes decisions that affect the entire institution, and the Board must know about them, and approve. People lose their jobs over these kinds of mistakes.

STRATEGY
Be foresighted. Look out several quarters and see what kinds of business is rolling off, what kinds of business is being done, and where the institution is heading.

Consider alternative revenue streams. As spread lending comes under fire from rising Fed Funds, consider fee based activities. Recommend this course of action to senior management.

Most important, ring the warning bell. Even if this is the bottom in bond prices, the top in gold, and the beginning of a massive bull market in stocks; even if your institution is heading for spectacular profits; and even if your A/L book is in great shape, there is still great uncertainty out there. Be careful. Be prudent. Be clear to senior management. The trouble is not over, yet.

Disaster in the Making?

2006-06-26T07:47:00.000-07:00

BREAKING NEWS
US Treasury Notes and Bonds broke recent support last week and are hovering below new resistance levels, waiting for bad news to propel them toward new lows.

It would be very surprising if bonds can rally from here.

If bonds start to go lower, it will be a major sell-off, confirming the trend begun back in Janury of 2006 and confirmed in early March when notes broke major support.

Paterson's analysis suggests the 10 Year US Treasury note could lose 5 full points in the coming months, increasing yields 70 basis points or more to US note yields in excess of 6%.

Changes of this magnitude will provide an opportunity to add high yielding assets only if the liabilty structure is in place to support it.

The job of the Asset/Liability department is to forsee this kind of action at this stage in the interest rate cycle and prepare the institution for the event.

ANALYSIS
Asset/Liability managers must warn senior management of potentially rising long term rates, and prepare them for an extensive program of lengthening liability maturities, shortening asset maturities, and pricing new assets conservatively, There also must be plenty of juice in every deal. Do not underprice deals!

Also, those institutions with the ability to trade futures, options, and swaps should prepare emergency hedging operations.

As we said last week, the money numbers look good, as do gold prices, so it seems this is a real demand for long term liabilities pushing up long rates, not just an inflation play.

Institutions will see increased demand for long-term loans as borrowers switch out of adjustable loans.

PATERSON's HEDGING AND TRADING SEMINARS
- Hands-on personal training for A/L managers and their teams
- Training for senior management
- Board of Directors presentations

PATERSON'S 2Q 2006 CHARTBOOK
Paterson's latest Chartbook will take a detailed look at the fundamentals of this quarter and analyze the situation in the debt markets.

Look for the Chartbook in the second week of July.

See www.paterson.com for details.

Jim Klein
Monday morning, waiting for the show to begin.

Is this this bottom?

2006-06-17T06:49:00.000-07:00

Is this the bottom, or just the first leg down?

FIRST, the money numbers are favorable. None of the Ms - M1, M2, of MZM - show any signs of growth above 10% per year. Money is behaving itself after a disatrous decade under Greenspan.

SECOND gold prices have collapsed in the past five weeks from a high above $700 to today's prices below $600.

THIRD Interest rates have started making a bottom in the past five weeks.

FOURTH the stock market has taken a slamming, similar to the one Greenspan caused back in 1987, and it might not be over in stocks.

SUMMARY, managers must be cautious here, cleaning up their books and preparing for the next move.

LOOKING AHEAD

* Short term rates will continue to stay high for the next 6 months

* Long rates will stay below short rates

* Spreads between Treasuries and other instruments will widen

* Keep an eye on gold and money supply

TACTICS

* Lock in profitable long-term fixed spreads

* Hold back on lengthening long-term liabilities

* Let the portfolio contract

STRATEGY

* If gold takes off again, be prepared to lock in long term liabilities.

* If the Fed eases, pay close attention to gold

Time to sell bonds

2006-05-21T22:25:00.000-07:00

The bond market has retreated steadily since major support was broken on March 3rd.

Prices have risen and rates have fallen slightly for the past few days as this CBOT chart shows.

This is not the end of the bear market. It is only a pause before rates start rising again.

All financial institutions should begin lengthening the maturity of their liabilities.

Encourage long-term deposits, borrow from Reserve institutions, and sell bonds.

As rates continue to fall, institutions should get aggressive in the cash market and prepare a futures, options, and swaps program. Educate the Board of Directors and obtain authority for the required actions.

Assets should be re-invested in Fed Funds or at worst, 90 day instruments. Short term assets will continue to rise in yield as the Fed continues to slow the growth of money

Asset pricing must continue to be aggressive, and spreads maintained, even in the face of declining new business, as liability costs will not be falling in the near future. Locking in a low-yielding asset right now is a mistake.

SENIOR MANAGEMENT
Senior management must address the asset/liability situation of the institution and provide the Board of Directors with a comprehensive plan for an extended bear market in bonds.

If the bear market continues, many institutions will fail, as they are unaccustomed to dealing with rising interest rates.

Recall, interest rates have been declining since 1986, and most managers are unfamiliar with the tools, techniques, and emotional requirements for dealing with inflation and rising rates.

See www.paterson.com for help managing your A/L situation.

Classic Bear Market Signals

2006-05-03T07:15:00.000-07:00

The bond market fell sharply today after the US Treasury announced a $34 billion refunding package of debt securities.

This is a classic signal of a bear market.

In a bull market - or at least a stable one - markets sell off in anticipation of refundings, and bounce back as Primary Dealers stabilze their books.

Fed Blunders Again

2006-05-02T06:19:00.000-07:00

In the tradition of incompetence established by his predecessor, Fed Chairman Bernanke mistakenly suggested the Board of Governors might be done raising short term rates.

When the news got to the markets, gold and stocks jumped, and bonds fell.

Now Bernanke says he was misunderstood.

Here's part of the quote:

WASHINGTON (MarketWatch) -- Federal Reserve Chairman Ben Bernanke says that the media and the markets had misinterpreted his words last week as a signal that the Fed would stop after one more rate hike, according to CNBC anchor Maria Bartiromo on Monday.

Bartiromo said she asked Bernanke in a conversation during a formal dinner on Saturday night whether "the markets got it right last week in speculating the Fed is done raising interest rates" after his testimony to Congress.

She reported that Bernanke replied no, and that he went on to say that he and his colleagues at the Federal Open Market Committee were trying to "create some flexibility for the Federal Reserve, saying the Fed may pause but the data will really dictate whether more rate hikes will occur at future meetings.