There was a lot of stuff to cover on "The Call" today (see video) with financials selling off and dismal economic numbers to digest. The Producer Price Index was dramatically higher than expected, but the headline number of 1.2% and 9.8% annual gain has to be looked at in the light of a recent decline in oil prices. Inflation is a lagging indicator (as long as the right stuff lags!) and the recent decline in commodity prices will be reflected in future reports.

Today's rally in equities highlights the process by which investors are becoming/will become numb to weak economic news.

That's a function that will be very necessary between now and the end of the year, if equities are to continue rallying, given the high chance that economic data will worsen in the time ahead.

In particular, the collective turning of backs on today's jobless claims, which have moved increasingly higher in recent weeks, supports the idea that investors are coming to terms with the idea that the U.S. economy will be very weak in the time ahead.

Many forecasters have helped pave the way on the numbing process, forecasting that the economy's gross domestic product could decline as much as 2.5 percent at an annual rate in the fourth quarter (Merrill's recent forecast), with many firms looking for flat or down numbers.

Numbers to support such bad readings are yet to come, in particular big declines in the monthly payroll numbers.

The key to making money in riskier assets between now and the end of the year is this: to decide whether investors are in fact ready for the bad news to come, thanks in part to the jobless claims figures and other data, and when it appears the bad news is priced -- step in and buy.

This is what has worked in past recessions. A day like today indicates that the time to buy is either upon us or getting closer. Toeing into the idea is beginning to make sense, although given the likelihood of bad economic news ahead, it makes sense to also wait for additional tests of whether investors have truly become numb to weak economic news.

More: Click for Latest Economic coverage ...

__________

In response to weak employment news (for example, claims for jobless benefits increases their most in 16 years in July) and a downgrade by the Bank of England in its assessment of England's economic outlook, expectations for interest rate cuts from the Bank of England ramped up today.

The 90-day sterling futures contract, which is used as a proxy for the Bank of England's benchmark rate, has moved sharply, with the December contract down 19 basis points on the day, and the March 2009 contract down 27 basis points. The market is now priced for close to roughly 100% odds of a single 25 basis point cut occurring this year in the Bank of England's benchmark rate, which has been lowered three times since peaking at 5.75% last July. The BOE last cut rates in April and the rate now sits at 5.00%. A 25 basis point cut, which is now priced in for November, would bring the BOE's benchmark rate to its lowest since November 2006.

Looking further out, the market is priced for the BOE to cut rates to as low as 4.25% by the middle of 2009 and to leave rates there for the balance of the year. That would put the benchmark rate at its lowest since June 2004.

Expectations for decreases in short-term interest rates are playing an important role in the rebound in the value of the dollar and this looks likely to play a positive influence in the months to come. Interest rate parity is of course not the only influence on foreign exchange rates, but as I made clear in my note last week(Nine Reasons the Dollar is Rallying), there are many other factors boosting the value of the dollar and which could keep it going for a while.

More: Click for Latest Economic coverage ...

__________

In response to Tuesday's FOMC statement I said that the Fed's comment that it had "significant concern" about the upside risks to inflation was good news because it would help kick inflation while it's down (or moving down) and lower the chances at a revival of both the decline in the value of the dollar and the rally in commodity prices. The Fed's comment was a major blow to those who have been speculating that the Fed might consider another round of interest rate cuts in response to the weak U.S. economy. The Fed's removal of its previous comment that downside risks had diminished was far less important to the markets because it was widely expected.

The FOMC statement and the end to the Fed's recent rate cut cycle have played a major role in ending the dollar's decline. There are many other factors, and I have listed these factors, below. First let me repeat what I said at the end of May when I gave reasons, some of which are shown below, why I thought the dollar would rally by saying that I have for many years been in the camp expecting the U.S. dollar to decline in value.

My main thesis has been that the world's central banks would choose to diversify their reserve assets, which had been heavily concentrated in dollars despite the obvious changes that have occurred in the global economic scene. In 2002, for example, data from the Bank for International Settlements show that the U.S. dollar represented 70% of the world's reserve assets, while the euro represented 20% of reserve assets. Since that time, there has been a 7-point shift, to 63% for the dollar and 27% for the euro. It is quite plausible that the mix could move to 60%/30% (in the early 1990s, the dollar was about 55% of reserve assets).

The dollar rally is reversing a major negative for the U.S. economy, which will benefit more from the increased purchasing power than will result from any loss of U.S. exports.

1) The Fed toughened up: The Fed ended its rate cuts in April, paused in June, increased its inflation rhetoric, and in August said in the face of weakening economic activity and falling commodity prices that it had "significant concern" regarding the upside risks to inflation. The Fed, which until recently was behind the curve on inflation, has, by sounding tough in the face of falling asset prices globally, weakening global economic activity, and intensifying U.S. economic weakness, positioned itself opportunistically to appear to have a better handle on the inflation problem.

2) Economic growth is weakening globally: Data abound indicating weakening of global economic growth. England is moving toward recession, Germany on August 14th is expected to post a negative reading for Q2 GDP, Japan is moving toward recession, and even China is showing signs of slowing. Australia's currency has fallen nine straight days, its longest such streak since 1980 in response to weakening growth and expectations for interest rate cuts there. Relative growth patterns play a major role in determining foreign exchange rates.

3) Interest rate parity: Partly in response to signs of weaker growth abroad, the yield spread between foreign government bonds and U.S. Treasuries is narrowing. For example, the yield spread between Germany's 10-year note and the U.S. 10-year is today at 33 basis points, a 36 basis point drop from early July. Interest rate parity, which posits that interest rate spreads impact capital flows, has been an important influence on exchange rates over the past few years.

4) Purchasing power parity: The price of identical items sold in the U.S. and abroad has moved out of kilter. The Economist recently noted with its Big Mac Index that the price of a Big Mac indicated that the Euro was more than 50% overvalued. While the index almost certainly overstates the misalignment, it is difficult to challenge the notion that the dollar looks cheap on a purchasing power basis.

5) Massive unwind of commodity-linked trades: Many investors are on the same side of the market in a wide variety of commodity-linked trades and it has begun to unravel. For example, investors are long commodities, the currencies of countries that benefit from increases in commodity prices, their stocks and their bonds. In addition, many investors are invested in countries benefiting cross-border capital flows tied to increases in commodity prices (Eastern Europe, for example, which, according to the BIS, has been a major recipient of money from the Middle East). The U.S. dollar is a major safe-haven amid this major unwind.

6) Unwind of the de-coupling bet: Many investors have been betting on the idea that the global economy would be immune to the slowdown in the U.S. and many of the factors causing the slowing. Wrong.

7) Commodity drop is good for U.S. consumers: The U.S. economic outlook has improved as a result of the drop in commodity prices and anything that helps U.S. consumers has the potential to help the housing sector and hence, U.S. financial companies.

8) Change of U.S. leadership: There is much enthusiasm abroad for the prospect of a new U.S. president, particularly for the prospects of an Obama presidency. A recent Gallup poll showed that residents of the U.K., France, and Germany favored Obama by extremely wide margins, as high as almost 10:1 over rival McCain. Since most expect Obama to win, the prospect of him winning is working in favor of the dollar. An added boost is the notion that I have spoken about a number of times of Obama taking actions that put downward pressure on energy prices.

9) The Batman movie is a smash everywhere, causing a huge capital flight to the U.S.!

More: Click for Latest Economic coverage ...

__________

This was a very good sign for the US housing market and forthe credit crunch. June pending home sales (PHS)rose asurprising 5.3% vs expectations of a decline of1.0% .The National Association of Realtors saidthat the index was lead by a 9.3% jump in sales in the South.This increase wipes out last month's decline and should meanthat existing home sales (EHS) for July/August show gains.

PHS are essentially the leading indicator the housingmarket. These sales include homes, condos, and co-ops. Thebiggest complaint about EHS is that it counts only closings andthat these closings occur many months (2-4) after buyers decideto purchase. PHS tracks contracts that are signed and awaitingclosing.

We're all trying to figure out a bottoming process for thehousing market. This is how it works:

1. Foreclosures and inventories of unsold homes begin tobuild up as sales decline.

2. Prices begin to fall as no one is buying. Builders stopgetting permits and decrease starts.

3. Prices fall until we begin to find a level that buyerswill step in and buy.

4. Prices may continue to fall until the inventory of unsoldhomes is reduced to more normalized levels (Five months).

5. Home prices stabilize when inventories are reduced andthen prices of derivative products like mortgages and CMOsbecome attractive.

The increase in PHS is #3 in this process and this is whyguys like Roubini and Syron think we're only half way throughthe price decline process. It will all come down to the speedat which inventories decline. Let's see what July EHS on August25th looks like and how fast inventories decline with anincrease in sales. I think this will happen faster than mostexpect and we could be normalized (Five months) by November.Remember, the YOY numbers will improve dramatically starting inSeptember.

________________________

In early July I published a note discussing how expectations of an Obama win could knock $40 off the oil price. The note is below. One piece of the puzzle was put in place today with Obama mentioning that he might tap the Strategic Petroleum Reserve (SPR). He said as much in a speech he delivered on energy today in Michigan. Obama said "we should sell 70 million barrels of oil from our Strategic Petroleum Reserve for less expensive crude, which in the past has lowered gas prices within two weeks."Obama said many other things, such as investing in energy infrastructure, changes in the tax code to encourage energy conservation, and other ideas.

Additional impetus I believe for today's and the recent oil drop is coming from China's cutbacks on energy use amid efforts to cut pollution for the upcoming Olympic games. There were also likely bad longs betting on greater impact of the storm currently in the U.S. gulf than has thus far been the case.

Here is my the note I sent a number of weeks ago:

If Barrack Obama wins the presidency, the price of oil could fall $40 per barrel. The financial markets will discount the possibility before hand, at least partially. There are three ways in which this could happen:

Recently I wrote about how US Democratic Presidentialcandidate Barack Obama world tour hadn't lifted him above the50% threshold in the national polls. More importantly, state bystate electoral college voting was razor thin in favor ofObama. Well now comes a new Gallup poll showing that Obama'slead in national polling has shrunk down to 45-44 over McCain.This is happening despite a story on Reuters that has 3different economic models indicating a 5 point win forObama.

Why would this be occurring? Even though Obama looked andsounded great overseas, this doesn't resonate with voterslosing their jobs in the United States. Today's economicnumbers weren't great and may have been influenced by theextension of jobless benefits. The point is these are weak andvoters are focused intently on the economy.

The GDP number showed two things to me. Housing continues tobe a drag on the economy and subtracted 0.6%. Trade continuesto be a major boost to the economy. Without it, GDP would'vebeen -0.52% vs a +1.9%. McCain is a big proponent for trade andObama is for re-opening trade agreements. Again, Americanvoters are not as dumb as people think and the latest pollingdata could be showing they understand which policies are goingto work for creating jobs via trade.

LarryKudlow has repeatedly questioned whether thestock market has been selling off due to polling data showingan Obama victory. I believe he bases this on many policyproposals, but the big one is a rise in capital gains tax. Thishike could promote 2008 year end tax selling to garner thelower tax rate now in place and would be a major wet blanket inDecember. Could it be possible that a shift in the polls bringsa positive impact to the markets with McCain pulling even?

________________________

Energy prices continued to exhibit significant volatility this week. Gasoline and heating oil prices, as traded on the New York Mercantile Exchange swung ten cents or more per gallon, up and down and up, over the past several sessions.In a recent blog, I noted the critical price support level that $121 per barrel represented for crude oil. That level was tested on July 29th, but follow-through selling failed to materialize, and we are now back on the upswing.

Energy prices are being pushed and pulled due to conflicting economic data points and the situation surrounding Iran’s nuclear program.

The Iran situation dominated early trade on Friday, as Shaul Mofaz, a leading candidate to replace the departing Prime Minister of Israel, Ehud Olmert, and a name that is familiar to regular readers of this blog, has once again saber rattled, verbally. In a speech Friday morning in Washington, Mofaz made the claim that Iran is on the verge of making “major breakthrough” in its nuclear program, and a “second holocaust” would not be allowed to occur. It was Mofaz who last month stated that an attack on Iran was “unavoidable.”

The “breakthrough” assertion is consistent with reported Israeli intelligence that Iran is six months away from being nuclear weapon capable. Western intelligence, including that of the United States, does not share this view.

The rise to record price levels of $147 per barrel were due, in part, to a high level of anxiety over this situation, including a possible unilateral strike on Iran by Israel, at any moment.

The situation calmed, after some diplomatic outreach by the United States and even some tamping down of language by Iran. The unprecedented access given to Brian Williams of NBC Nightly News by Iran’s President was indicative of Iran attempts to manage the situation. In the interview, President Ahmadinejahd seemed to leave the door open a bit for some kind arrangement. However, it is also easy to view this rhetoric as further stalling, as their program advances. This is exactly the sentiment echoed by Minister Mofaz.

Iran is due to answer the United Nations negotiating team this weekend, and they will likely answer on Saturday. By waiting, they will have taken the full two weeks allotted to them to respond, which is not exactly evidence of enthusiasm on their part, either.

In terms of the economy, the US gross domestic product reading of 2.9%, China’s reading of 10.9%, and July job losses coming much less than expected, is supportive of energy prices. I note, as well, that drivers took the road in the past week in numbers not seen since December 2007. Evidently, sub-$4.00 per gallon gasoline has Americans somewhat reinvigorated about hitting the road again.

While the economy certainly seems challenged, these data do not suggest it to be challenged enough to break the back of high energy prices, as a result of reduced demand. I have taken to referring to the situation not as “demand destruction,” merely “demand dissuasion.”

_________________________________________

Today's employment report reinforces two major themes: the economy is contracting, but the depth of contraction is not yet deep. The data are better than feared, as yesterday's jobless claims figure caused many to downgrade their assessment of the labor market. There continue to be problems with adjusting for the amount of net business formation, but even with an adjustment for this glaring fact the figures are not yet as weak as in past recessions. It's more a slow bleed.

The economy lost jobs for a seventh straight month, shedding 51k jobs for a second month and bringing the average size of job losses for the seven months to 66k. These losses are consistent with economic recession but better than past recessions. For example, in the first seven months of the 2001 recession, job losses averaged 145k. In the first seven months of the 1990-1991 recession, job losses averaged 117k (keep in mind the fact that the workforce constantly increases, which should result in larger job losses as time goes on).

The increase in the jobless rate, to 5.7% from 5.6%, will not play well on Main Street and will impact consumer confidence as well as business confidence, as many will fixate on this most-understandable economic statistic. The increase follows a large half-point leap in May, which was the largest monthly increase since February 1986.

Minor solace will be had by observations about the wage figure, which increased an as-expected 0.3%. The gain is not large enough to illicit thoughts that wage demands are increasing much as a result of the recent acceleration of inflation.

Continuing to be odd is the government's assumption about the amount of net business formation occurring in the economy, which is represented by the statistics computed using the so-called birth/death model. In July, the Bureau of Labor Statistics added 4k jobs to the tally, 1k more than last July and 46k more than the 5-year average for the July data (January and July historically are two months when the amount of net business formation is negative). The fact that the government is adding in more jobs than in recent years seems odd given the downshifting in growth and in overall job creation. Most absurd is the assumption for net business formation in the construction sector, which resulted in a 1k boost in jobs to the sector compared to assumptions for slight losses on average over the past three years. It is obvious that the construction sector is contracting, yet the government has not yet made this assumption in its estimation of net business formation for the sector.

It wasn’t speculators; it wasn’t corporate greed; it wasn’t deregulation, nor Reaganomics. Fannie’s near-death experience came directly from her sponsor, the Federal government, which treated Fannie Mae like its own personal honey jar, to be raided at will.

Loading up the GSE (government-sponsored enterprise) with "pinstripe patronage" hires, dumping political loyalists and failed bureaucrats (like the former FBI chief whose tenure ended with the catastrophic intelligence failure known as 9/11), and practicing identity politics vote-buying using the GSE’s balance sheets, our representatives insured the bank’s eventual collapse.

Not surprisingly, those representatives are going to use our money to resuscitate their monster.

FNMA emerged out of the alphabet soup of New Deal regulatory agencies created during the 1930s under FDR. Desperate for cash, LBJ sold it to the public in 1968, creating what we now call Fannie Mae.

The Feds sold it but never really relinquished complete control of, or liabilities from, the entity. Fannie became a genetic splice of public and private -- merging the transparency of high finance with the efficiency of government -- a place to park political friends looking for work, and an instrument with which to engage in vote buying and social engineering.

Fannie, despite not being a direct mortgage lender, played her role well as midwife to the subprime mortgage bubble and the crisis that came from it. Regulators encouraged banks to discard traditional lending standards, which require a thorough credit history or a steady paycheck, and opt for standards which are not "discriminatory" or culturally biased. Don’t worry, they advised, Fannie and Freddie Mac will buy the paper.

Fannie did her part.

The internal investigation of allegations of accounting fraud -- which led to the departure of previous FNM CEO, Franklin Delano Raines, a former Clinton Administration official -- included a critique of the bank's "minority lending initiative," or MLI.

(See the full report here. )

Awhistle-blower in the company circulated an e-mail claiming that Fannie bought mortgages which were not financially sound, in order to bolster its minority-lending portfolio and resultantly, its political capital.

The report concluded that, indeed, Fannie had paid prices more consistent with prime mortgage values for loans that were closer to subprime in their credit characteristics. To add insult to injury, Fannie "capitalized" rather than expensed these premiums, and so doing exaggerated its earnings and the salaries of managers who received performance bonuses.

Nothing is more frustrating to me than to see this crisis laid at the door of "market failure" and thrown into the face of supply-siders like me. Fannie's not ours and she never was. From government she came; and whenever her plans fail, to government she returns.

What are other CNBC.com guest commentators saying?

________________________