Monday October 26, 2009

Monday, October 26, 2009
Continuing concern over China's role in our country's growing demand for debt to fund our government's out of control spending addiction will create further instability for the dollar and its effects will be felt throughout our economy as we move forward.
Bank credit weakness still seems to have a way to go...how far and how deep remains the rather large elephant in the room...

prb

Subject: S&Y PSG Morning Market update for Monday October 26th

- There was a report out overnight (10/26) by the Peoples Bank of China, which suggested the Chinese government should scale back its reserve holdings of dollars and increase both Euro and Yen holdings. Although the report was described as simply a researcher’s personal opinion, it pushed the dollar down to a new 14-month low versus the Euro. It appears that China, with the Yuan under pressure because of its huge trade surplus, and large dollar-denominated holdings, is on the verge of making changes in the way it manages its currency/reserves. Because the Yuan is pegged to the dollar, the Yuan is depreciating versus other Asian currencies thereby making Chinese goods cheaper, earning the enmity of other Asian exporters. However, allowing the Yuan to “float” would immediately push up its value and effectively raise the prices of Chinese goods. At the same time, China could also reduce its dollar holdings. Regardless of what the Chinese decide to do, the dollar will suffer. Although a weaker dollar would be beneficial for US exporting industries, it will undoubtedly put upward pressure on Treasury rates. Should the Chinese opt to buy fewer Treasuries as the US deficit driven borrowing needs soar, yields may ratchet up.

- Third quarter bank earnings reports continue to come in, but the recent releases by some regional and sub-regional banks have been mixed at best.
On Friday Huntington Bank ($51 billion assets) reported 3rd quarter net income was -$195 million and loan quality deteriorated with nonperforming assets increasing +17%. Synovous Bank ($35 billion in assets) reported a loss of -$438 million for the quarter and nonperforming assets increased +2%. Obviously both of these banks remain under earnings and capital pressure as asset values deteriorate. This is also reflected in the fact that outstanding loans for both institutions declined in the 3rd quarter; -3% for Huntington and -4% for Synovous. As these banks wrestle with the conflicting demands of capital adequacy, profitability and falling asset values, loan production inevitably suffers.

- From a macro-economic perspective, this lack of bank loan growth is problematic for both the Fed and policymakers. Regardless of the reasons, as long as banks generally are not making loans, it is a sign that an economic recovery will be weak at best. The majority of any economic expansion of production, i.e. GDP growth, must be funded via new loans.