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Five Things You Need to Know: As Most Expected, GDP Unexpectedly Strong, FOMC: The Drama That Wasn't, Irrational Echo?, But What If?, Subprime Lending: The Rush to Disassociate


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. As Most Expected, GDP Unexpectedly Strong

Is anyone still looking for a rate cut sometime over the next six months? Because it turns out the economy grew at a robust 3.5% pace in the fourth quarter of last year and just about any way you slice the GDP report the Fed looks to be on hold.

  • This morning the Commerce Department reported that gross domestic product (GDP), the broadest measure of overall economic activity in the U.S., expanded at a 3.5% annual rate during the fourth quarter of 2006.
  • The headlines this morning suggest the GDP report was a big upside surprise, but the reality is that most expected the report to come in above... er, expectations.
  • Meanwhile, looking back at all of 2006, which was supposed to be the year of slowing growth in the face of the Fed "overshooting" on rate increases, we find that 2006's growth rate of 3.4% for the year actually exceeded 2005's growth of 3.2%.
  • So is inflation back in the mix? Not exactly. While growth is strong enough to keep the Fed in watch mode for inflation, the GDP price index came in at 1.5%, down from 1.9% in the third quarter.
  • OK, what about employment cost pressures? In a separate report from the Labor Department, the Employment Cost Index for Q4 came in at 0.8% versus 1%.

2. FOMC: The Drama That Wasn't

So much for talk about a rate cut. Also, so much for talk about a rate hike.

  • This FOMC meeting may be one of the most closely-watched non-events in quite some time.
  • Barely two months ago Fed Funds futures were pricing in nearly a 50-50 chance of a rate cut by the March meeting.
  • Now, that probability is virtually nil.
  • We know the Fed will make no move on interest rates. So what should we expect this afternoon?
  • About the only change one can expect today is how the FOMC deals with economic growth in the statement.
  • The December 12 statement said: "Although recent indicators have been mixed, the economy seems likely to expand at a moderate pace on balance over coming quarters."
  • Given the recent data, the Fed should be able to drop the word "mixed" from the statement today, but we see nothing to prompt the Fed to move away from the risk assessment that inflation remains the primary concern.
  • One final thing to watch: As you know, there are a number of new voters on the FOMC now. Among those no longer voting is "The Dissenter," the Richmond Fed's Jeffrey Lacker. Will someone on the FOMC grasp the vacant dissenter's role?

3. Irrational Echo?

A senior legislator in China told the Financial Times there may be a stock market bubble in China.

  • In a weird echo of former Federal Reserve Chairman Alan Greenspan's "irrational exuberance" remarks more than 10 years ago, Cheng Siwei, vice-chairman of the standing committee of the National People's Congress, told the Financial Times that the market there has developed a "bubble" and that people are running the risk of "making irrational investments."
  • This sounds intriguing, no?
  • But the reality is that, one, this is nothing new, and two, Cheng doesn't even have authority or even much influence over financial matters.
  • Chinese officials have been concerned about mal-investments and excessive speculation for months now.
  • Recently the government said it will take more official actions to rein in excessive speculation and investments, among them the enforcement of a land appreciation tax, and a banking ban on the investment of loan money in stocks.

4. But What If?

Ok, but what about this assertion that there really is a stock market bubble in China, any truth to that?

  • Speaking of Chinese bubbles, yesterday we noticed that the New York Times ran a front-page story on China's renewed love affair with stocks: "Chinese United by Common Goal: A Hot Stock Tip".
  • Among the irrationally exuberant datapoints:
    - In Shanghai, one of the most popular local television programs is "Stock Market Today."
    - Recently, a mutual fund raised $5 billion in a single day.
    - "When I go to the beauty salon, even the girls who give me a manicure are talking about stocks!" said Shirley Lei, a consultant in Shanghai who worries that inexperienced buyers could be cheated. "They ask me, 'What should I invest in?' They say they are doing research."
  • China-related stocks, ETFs and ADRs are down across the board this morning.
  • The iShares Xinhua 25 ETF (FXI) is off nearly 3%.
  • Of course, to put things in perspective, FXI was up more than 80% in 2006.

5. Subprime Lending: The Rush to Disassociate

While the housing market may indeed be stabilizing - at least in terms of its continuing downward spiral - it seems fewer and fewer firms are willing to hang in there for any rebound in the subprime lending market, with JP Morgan (JPM) becoming the latest firm to cut its exposure to subprime mortgages.

  • JP Morgan Chief Executive James Dimon said in an investor presentation Tuesday that the company has sold off most of the mortgage loans it made last year to people with weak credit histories, the Associated Press reported.
  • JP Morgan said in the presentation that "loss severities" in subprime mortgages have started increasing, and that delinquencies of subprime loans originated last year are higher than comparables in 2005 and 2004.
  • The cuts are not an abandonment of the subprime market, however, as the firm continues to hold $13.2 billion in subprime mortgages, the Associated Press story reported.
  • And, according to AP, Dimon said that if mortgage loans become cheap enough, the firm would consider buying multibillion-dollar portfolios from other lenders.
  • "We're an economic animal," he said. Seriously. He said that.
  • On a final note, what about the stability of the housing collapse?
  • This morning's GDP report showed that spending on new home building declined at a 19.2% rate during the fourth quarter, the biggest decline since a 21.7% haircut in the first quarter of 1991.
  • As well, Construction Spending declined 0.4%, compared to 0.0% expected.
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