Last week the interest rate update indicated about the different parts of an economic cycle and emphasized that we were in the expectations part of the current cycle. Last friday morning at 5:30am the Fed and everyone else received an urgent 911 call from the Labor department as the jobs report was even worse than reported by the press and quickly moved us into a new reality phase. The headline of a drop in 4,000 jobs sent interest rates, stocks and the dollar falling with the US 10-year treasury closing at a year-to-date low of 4.38%. Looking under the hood of the economic car (US economy) we see that the monthly seasonal adjustment (birth/death model) actually ADDED 120,000 jobs to the August job survey so the unadjusted number was -124,000. 75% of the jobs created in the past year are coming from a very faulty seasonal adjustment figure and this is easy to see when one views the monthly after the fact adjustments that don't receive much press each month. This morning the other big announcement was that last months jobs number was reduced by 24,000 and June 57,000 which again shows the government is overestimating job growth and using a faulty seasonal adjustment model. Today's report was the 11th consecutive August report where the consensus predicted a number higher than the actual job count. With futures markets available on everything there should be a way for investors to make money by betting against the "experts."

The jobs report also showed that only 51.3% of industries showed any job growth down from 57.4% last month. Temporary jobs fell again last month by 13,000 and the last 12 months show a decline of 62,000. If the economy was really as strong as the Fed wants us to believe wouldn't businesses be hiring a few temporary workers? The unemployment rate held at 4.6% only because there were more individuals that left the work force (340M) than those who lost their jobs (316M). This will surely change next month and you can fully expect this rate to reach 5.0% in the next few months. Today's news even woke up the politicians in Washington as Rep. Barney Frank called for the Fed to lower the funds rate in a "meaningful way." (http://www.bloomberg.com/apps/news?pid=20601087&sid=aFUSmiwolO60&refer=home) The Fed has enough troubles now as they try to recover from being run over by the interest rate market that clearly saw the storm clouds and now has to find a way to calm those in Washington who have left the Fed alone for the past 25 years.

Mortgage lenders can't stop the bleeding

This afternoon Countrywide (http://www.thestreet.com/s/more-job-cuts-at-countrywide/newsanalysis/banking/10378592.html?puc=_googlen&?cm_ven=GOOGLEN&cm_cat=FREE&cm_ite=NA) announced a job cut of 20% of their work force (12,000) as they desperately attempt to stay afloat with a much smaller business model. For those mortgage professionals who believe that we will soon see a return to narrower lending spreads remember that the system that made so much $$ for so many has changed and lenders will now try and make money the old fashioned way...use the government to guarantee the risk. Countrywide realizes that the conforming (417M) market for loans is much smaller so they must shrink the company to have any hope of living to fight another day.

This morning Michael Perry, the CEO of Indy Mac, had a blunt assessment of the state of the mortgage market when he told shareholders (http://biz.yahoo.com/bw/070907/20070907005442.html?.v=1) that his firm has also converted their mortgage production to a government guaranteed loan model. The company is cutting its dividend (50%) and expects loan volume to shrink by 50% in the fourth quarter due to the fact that "private secondary mortgage markets have significantly worsened."

The economy has now entered the realization phase where consumers see and hear that times have changed and they must cut back on spending because the normal outlets for borrowing (home) are gone. The consensus all year has been that there was no contagion but unfortunately the Fed is about to learn a most painful lesson that those of you readers of this interest rate update have learned a long time ago: we only see life from our experiences and that because we have never witnessed an event does NOT mean it won't or can't occur. The experienced real estate agents and mortgage brokers told us all year that they had lived through the early 80's and 90's and this meltdown was no different but they too have learned that history does repeat but not the way in which we expect.

Gold and the dollar

We saw gold rally this week to the $700 level accompanied by a fall in the dollar versus the yen and Euro. There was much discussion of the fact that foreign holdings of US Treasuries have fallen considerably in the past four weeks. The immediate conclusion is that foreign central banks have "lost faith" in the US and our ability to service our debt. Again looking below the surface we actually find another answer....with a huge contraction in credit availability to many corporations and worldwide hedge funds, central banks are repatriating reserves just in case they are needed to assist those that are being shut out of the borrowing market. Gold does act well and should see $750 before $650 and the dollar will not be defended by the US Treasury as the government soon realizes the only way to soften the fall from a cut back in domestic demand lies with a cheaper dollar that might bring extra sales from foreign countries. The Euro seems to be on its way to 1.40 and the yen to 1.10 without much resistance.

Libor and its implications for the Fed

Libor (London Interbank offering rate) is used by many lenders in both the mortgage and corporate market as the Prime rate has taken a back seat in the lending world. The three month Libor rate has been trading all week at 5.72% which is 47 basis points above the current Fed Funds rate of 5.25% where a normal relationship is just 10 basis points. A 5.72% Libor rate is equivalent to a 5.62% Fed Funds rate and obviously that is not a rate the Fed would even consider in this environment. If the Fed doesn't act soon to lower the Funds rate by 50 basis points it will have endorsed a tightening at a time when the economy needs lower short term interest rates and just as importantly the markets need to hear from the Fed that the mortgage mess has spread to the general economy and their forecast was wrong. This actually would give the markets confidence that the US central bank was back on track and in control. Markets have suffered from uncertainty over the past four weeks as they are seeing a set of events that was clearly not confirmed by the Fed Chairman or his FOMC members. The Fed will move before September 18th if the Libor rate holds at its current level or the US stock market falls sharply from current levels.

Next week and beyond