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Five Things You Need to Know: Producer Price Index; Foreign Buyers Pick Up the Slack; Fannie Issues a Warning; Subprime Well Contained to All 15 ABX Indexes; Who Was Hayek and Why Should We Care?


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. The Producer Price Index

The Labor Department released the Producer Price Index this morning and we're not going to lie - the results were simply mind numbing. Why? Well, take a look at a couple of news headlines and summaries:

Wholesale Prices Drop in June - USA Today


Core Producer Prices Show Surprise Gain -


Ok, so what's the deal? First, let's get the basics down. The Producer Price Index tracks the prices producers receive for the stuff they make. It used to be called the "Wholesale Price Index" up until the late 1970s, but was changed to "Producer Price Index" after advertisers began to confuse government data collectors by offering stereos and eight track tapes at wholesale prices instead of retail prices. Think about it. If you are a guy at the government in charge of collecting producer and consumer price data, you can't have retailers selling Van Halen's debut eight track for wholesale - $6.99! They're ruining everything!

Anyway, the Bureau of Labor Services tracks Producer Price Index data through a sampling of producers in manufacturing, mining and service industries. There are a few categories to pay attention to if you want to look at the data yourself each month here.

First, there is the so-called "headline" number, which is typically the first sentence in the Labor Department's release:

"The Producer Price Index for Finished Goods decreased 0.2 percent in June, seasonally adjusted."

Because food and energy prices are volatile and show large fluctuations month-t0-month, most economists pay a bit more attention to the so-called "core" Producer Price Index, which excludes food and energy. The "core" reading today was an increase of 0.3%.

Most economists try and forecast each - the headline, and the core - separately. Today, for example, the consensus was for a headline PPI of +0.2%, instead it fell 0.2%. The "core" consensus forecast was for an increase of 0.2%, instead it rose 0.3%.

In addition to the headline and the core reading, the PPI breaks down price data based on the stage of processing: Finished Goods, Intermediate Goods and Crude Goods. Why? For one thing, this helps sort out where pricing pressure - or the lack of pricing power - are building in the so-called "pipeline," a fancy term for the many different stages of production - from obtaining the raw materials, to processing the raw materials, to products that are finally "finished" and ready for sale.

In today's PPI report, the "finished goods PPI" (which is the same as the "headline" PPI) was down 0.2%. The Intermediate Goods PPI was up 0.5%. The Crude Goods PPI was up 0.3%. What does this mean? Think about it for a moment.

If the prices you receive for finished goods are declining at 0.2% month-over-month, while the prices for intermediate and crude goods are rising, then there may exist the possibility that you are finding it difficult to pass through price increases to your customers. Of course, one month is not enough data to make any kind of serious judgment about pricing power... unless you are an economist But the BLS does collect this data longer-term, so by viewing this price series over a long period you may be able to see how prices at the producer level are playing out. As for forecasting the future? Well, that's a different story.

So what do we take away from today's release?
  • For all the talk about the "core" readings in the PPI and Consumer Price Inflation (which will be released tomorrow) - with many upset that price increases in food and energy aren't showing up - this is kind of the opposite reading core haters were hoping for.
  • Even so, apart from motor vehicles, the core PPI was just 0.1%.
  • Year-over-year core inflation declined to 3.3% in June from 4.1% in May.
  • Remember yesterday when we noted the overwhelming consensus that has developed around the Food Inflation meme? PPI food prices fell 0.8% in June, which follows May's 0.2% decline.
  • Year-over-year PPI food costs have now receded to a 2.6% annual rate.

2. Foreign Buyers Pick Up the Slack

Foreign buying of U.S. financial assets climbed to a record in May, led by corporate bond and equities purchases. Total holdings of equities, notes and bonds climbed a net $126.1 billion, from $80.3 billion the previous month, the Treasury Department reported. The Bloomberg consensus was for a net $72. billion in long-term securities.

Broken down by categories:

  • International purchases of U.S. stocks jumped a net $41.9 billion, compared with $27.4 billion in April.
  • And foreigners bought nearly double the amount of corporate bonds in May than were purchased the previous month; $72.6 billion of corporate bonds were purchased, compared with $33.5 billion in April.
  • Demand for Treasuries increased by $21.6 billion, compared with $376 million in April.
  • Purchases of agency debt slowed to $27.5 billion from April's net gain of $36.1 billion.
  • Finally, private investors purchased a net $152 billion in May, an all-time high according to Bloomberg.
So what do we make of this data, and why do we care? Two reasons:

1) Recall that the $3 billion China investment in Blackstone (BX) was announced in May, so a lot of eyes were watching the inflows today to see what kind of lemming effect China's investment might produce.

2) The sagging investment in agency debt is interesting and perhaps explains why Housing and Urban Development Secretary Alphonso Jackson was in China last week urging the central bank to buy agency debt.

Minyanville Presents:

The Conspiracy Theorist's Guide to Treasury Inflow Data


3. Fannie Issues a Warning

Speaking of agency debt, yesterday afternoon Fannie Mae (FNM) issued a stern mandate to mortgage lenders: Be more thorough in evaluating property appraisals in local markets experiencing declining home values. Fannie Mae, which buys mortgages from lenders, wants appraisers to pay close attention to local conditions and detail them in reports for loan files, according to Bloomberg. So what's the big deal?

  • It's a big deal because this is essentially opens another side door to tightening lending standards.
  • The order from Fannie Mae could make it more difficult for potential homebuyers since - in addition to already tightening mortgage qualification standards - lenders are being assessed to also evaluate the collateral (home) that is being used to secure the mortgage.
  • The USA Today this morning ran a piece, "First Rung on Property Ladder Gets Harder to Reach," detailing what new homebuyers are now facing: larger down payments, more cash reserves in the bank, higher credit scores, less debt...
  • The tighter standards are significant. Almost half of first-time homebuyers last year put down no money, according to the National Association of Realtors.
  • This is almost certainly why last week's item - "Can't Sell Your Home? It's Probably Because You Need the Money" - is true; sales at the top end of the housing market - that is, homes in the most expensive 5 % of the market - are still rising, while sales in the middle and bottom of the market have been falling. Not coincidentally, the bottom and middle ranges are where first time homebuyers are more likely to shop.

4. Subprime Well Contained to All 15 ABX Indexes

This morning, just as a Bloomberg headline scrolled by reporting that Merrill Lynch's (MER) CFO is assuring everyone that the Bear Stearns (BSC) subprime issues are "limited" and "well under control," we happened across another story noting that all 15 of the ABX Indexes - indexes made up of credit default swaps on subprime mortgage bonds with ratings from AAA to BBB- fell to record lows yesterday. All 15. Record lows.

Oh, but it's not just the ABX indexes under pressure. According to Bloomberg the CDX North America Investment-Grade Index of 125 companies was up big as well. An increase in the index suggests deterioration in the perception of credit quality. Corporate credit quality.

Eh, so what?

  • Maybe. But as Willem Sels, a credit analyst at Dresdner Kleinwort told Bloomberg, the question for investors -especially hedge funds - "is whether their prime brokers, the people who provide them with liquidity, get nervous and start demanding
    higher margins or more collateral."
  • Why does that matter?
  • Because it is simply a fancy way of describing more stringent credit conditions and a reduction in liquidity.

    Et tu, Triple AAA?

    Click to Enlarge

5. Who Was Hayek and Why Should We Care?

With Federal Reserve Chairman Ben Bernanke's Humphrey Hawkins testimony tomorrow wherein he will outline the latest Fed efforts to dismantle and bury the business cycle, we can't think of a more appropriate time to print and read some previously difficult-to-obtain economics books from Friedrich Hayek now available free online from the Mises Institute.

1) Monetary Theory and the Trade Cycle (pdf)
2) Prices and Production (pdf)
3) Monetary Nationalism and International Stability (pdf)

Who was Hayek?

  • Hayek was probably one of the most original and forward-thinking economists of the 20th century.
  • A winner of the 1974 Nobel Prize in Economics, Hayek was an important thinker both for his contributions to economic thought and also political thought.
  • In the texts above, both Monetary Theory and the Trade Cycle and Prices and Production further develop his theory of the origins of the business cycle - pay particularly close attention to his views on the role central bank credit expansion plays in the misallocation of capital spurred by artifically low interest rates designed to subvert the normal business cycle.
  • In the end, the business cycle will prevail; everything done to subvert it simply magnifies its effects.
  • For a perfect Hayek starting point, take a look at this Nobel Prize lecture - The Pretense of Knowledge.
  • Hayek in this speech rails against economists who pretend to use the tools of physical science to forecast and predict.

    "If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants."
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