Investors back from the brink, but not far

Investors have basked for months in a powerful stock and corporate credit market rally, but the glow may fade as unprecedented measures to kick-start flagging economies mean near-zero inflation and benchmark interest rates won't last forever.

A surge in bond yields in the United States and elsewhere portends a sustained period of higher interest rates, boosting the cost of capital for corporate and consumer America.

Rising U.S. Treasury yields, with the yield on the 10-year note this week nearing 4.0 percent, have driven mortgage rates back up. That has threatened to kill a refinancing boom that has helped preserve the still-fragile health of recession-weary households and the banks that lend to them, at a time when credit losses show no sign of leveling off and the nation's unemployment rate races toward double-digits.

The rise in bond yields and mortgage rates may also act to check the huge recent rally in global stock markets of the past three months, with the Federal Reserve trying to end an 18-month recession and yet not spur inflation.

"What mistake can the U.S. economy afford to make? If you look at it that way, I suspect that we will see the Fed engage again in these markets," Mohamed El-Erian, chief executive of bond giant Pacific Investment Management Co., told Reuters Financial Television on Friday.

Between June 15 and June 18, fifteen leading analysts, economists and strategists including Goldman Sachs & Co's Abby Joseph Cohen, Citigroup's Tobias Levkovich, and Nouriel Roubini, a New York University professor who predicted much of the financial crisis, will discuss where the global economy goes from here at the annual Reuters Investment Outlook Summit in New York.

They are expected to discuss the surge in long-term Treasury yields that has commanded the attention of perhaps the most important U.S. economist of all, Fed Chairman Ben Bernanke. He has worried that the increase reflects "concerns about large federal deficits but also other causes."

BALANCE SHEET BLOAT

Debate is brewing within the Fed over whether to ramp up purchases of Treasuries, agency bonds and mortgage-backed securities, after the Fed began buying much of the debt in March.

Fed liquidity programs begun last year have doubled the size of its balance sheet to around $2 trillion, as the central bank flooded money into the economy to address the worst banking crisis since the Great Depression and the worst economic recession in more than a generation.

The Fed's efforts have succeeded in stabilizing a banking system that appeared set to collapse last September as credit markets seized up.

That month, the largest U.S. mortgage financiers, Fannie Mae (FNM.P: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.P: Quote, Profile, Research, Stock Buzz), became wards of the state, Lehman Brothers Holdings Inc (LEHMQ.PK: Quote, Profile, Research, Stock Buzz) went bankrupt, Washington Mutual Inc (WAMUQ.PK: Quote, Profile, Research, Stock Buzz) failed, Merrill Lynch & Co was bought by Bank of America Corp (BAC.N: Quote, Profile, Research, Stock Buzz), and the insurer American International Group Inc (AIG.N: Quote, Profile, Research, Stock Buzz) had to be rescued. Soon after, more than 600 banks took federal bailout funds.

Now, though, close to three dozen banks have gotten the green light to pay back some of their bailout funds. On Tuesday, regulators authorized 10 big banks to repay $68 billion, led by JPMorgan Chase & Co (JPM.N: Quote, Profile, Research, Stock Buzz) with $25 billion.

"That banks are repaying capital suggests more than mere stability, but actual balance sheet health and an ability to withstand another shock," said Timothy Ghriskey, chief investment officer of Solaris Asset Management in Bedford Hills, New York.

NOT DONE

Jamie Dimon, JPMorgan's chief executive, has praised the Fed for having "acted extremely well and thoughtfully," but said it must tread carefully to remove quantitative easing.

"If that is not done exactly right you will have higher inflation on the other side," he said on May 27.

Indeed, leaders of the world's fastest-growing major economy are wringing their hands over the Fed balance sheet.

China is threatening to reduce its buying of U.S. Treasury debt if the U.S. dollar slides further, and has suggested that Special Drawing Rights of the International Monetary Fund replace the greenback as the world's main reserve currency.

A United Nations panel has seconded China's motion, but just in case it doesn't happen, China is buying gold.

The Fed knows it has much to do.

"We are out of the end zone .... still marching down the field," Dallas Fed President Richard Fisher said on June 9, using an American football metaphor. "We have a ways to go."

Talk of bailout, bonuses barred from AIG trial

The government bailout of AIG and controversial bonuses paid by the insurer cannot be brought up during trial of the company's suit involving former CEO Maurice "Hank" Greenberg, a judge ruled on Monday.

As the trial opened before a jury in U.S. District Court in Manhattan, Judge Jed Rakoff set narrow parameters for what can be discussed.

Also precluded is any talk of an investigation by then-New York Attorney General Eliot Spitzer and a parallel probe by American International Group Inc (AIG.N: Quote, Profile, Research, Stock Buzz) that resulted in Greenberg's ouster as CEO in 2005.

AIG's suit against Greenberg-controlled Starr International centers on a large block of AIG shares held by Starr. The stock was once valued at $20 billion but is now worth far less since AIG shares have tumbled over the last year.

AIG, claiming breach of fiduciary duty, is seeking to wrest back shares held by Starr and the proceeds of any sales, at the same time as it tries to repay $85 billion in taxpayer bailout funds.

Rakoff said he would exclude any discussion of AIG's taxpayer bailout or bonuses because its relevance to the case was "dubious in the extreme and prejudice clear."

Bonuses paid to executives of an AIG financial products unit responsible for a significant portion of the company's $100 billion in losses over the past year caused nationwide outrage earlier this year.

The U.S. government stepped in to save AIG from collapse under bad mortgage bets last September, and has put up to $180 billion at the company's disposal since then.

AIG has promised to use any funds won at the trial to repay U.S. taxpayers. Before the government bailout, Starr was AIG's biggest shareholder.

Starr's ownership of AIG stock has been in contention since Greenberg left AIG. Starr held about 290 million shares at the time.

Starr had held a sizable stake in AIG since 1970, when Greenberg structured the firm as a vehicle to protect the insurer from hostile takeover.

After jury selection, Ted Wells of the law firm Paul, Weiss, Rifkind is expected to make opening statements for AIG, arguing that Starr, under Greenberg's direction, established a trust in 1970 for the purpose of holding the block of shares expressly to fund deferred compensation for AIG's top employees.

David Boies, of Boies, Schiller & Flexner, representing Starr, is expected to argue that Greenberg used the stock to fund deferred compensation for AIG employees on a voluntary basis, and never expressly committed to continue the program indefinitely.

Starr ceased to be a compensation vehicle for AIG executives in 2005. It is now run by Greenberg as a private investment vehicle and for charity.

Greenberg, 84, was in the courtroom on Monday morning but ducked out as proceedings got underway. He is expected to be called as a witness by AIG as early as Tuesday.

Boeing Executive Optimistic Amid Gloom at Paris Air Show

LE BOURGET, FRANCE — The head of Boeing’s commercial jet division sought Monday to dispel some of the palpable pessimism at this year’s Paris Air Show, arguing that the global economy was showing signs of a recovery and predicting a resumption of growth in airline traffic as early as 2010.

“At this point it appears to us that the economic conditions have bottomed,” said Scott Carson, chief executive of Boeing Commercial Airplanes. “If they have bottomed and a recovery comes next year, I think we have a shot at getting through.”

Boeing has eschewed any slowdown of its assembly lines this year, though it expects to cut production rates for its long-range, wide-body 777 jet by 28 percent in mid-2010. Planned ramp-ups of 767 and 747 production were shelved. Its European rival, Airbus, has reduced output of both its A320 single-aisle plane and its A380 “superjumbo” while abandoning earlier plans to increase production of its wide-body A330.

Mr. Carson said the company’s moves on wide-body production were a specific reaction to the decline in air freight traffic that began in the fall of 2008. World air cargo traffic fell about 6 percent in 2008 and is expected to plunge by a further 17 percent in 2009.

“There remains some risk to the freight side but also an opportunity,” Mr. Carson said. “The next six months are going to be incredibly important to us as we watch to see if inventory rebuilding begins — which I believe it will.”

“It feels to me like we can manage our way to a recovery,” he said.

Mr. Carson added that he believed the current credit squeeze affecting airlines would be “short-lived” and that a “more normal trend” in lending would emerge by the second half of 2010.

Mr. Carson’s optimism was not universally shared by other participants at the Paris air show, however, where a thick, grey mantel of clouds hung like an unwanted metaphor over the opening day’s proceedings.

“You’ve got to look at the post-recession environment,” said Sash Tusa, an independent aerospace industry consultant in London. “What will be the effect of a rising interest-rate environment?”

Referring to Mr. Carson, Mr. Tusa added, “Financing orders a year out from now is not going to be as rosy as he thinks.”

The global economic slowdown has hit the airline industry hard, with passenger traffic expected to fall by 8 percent this year and cargo volumes down 17 percent. Just this month, the International Air Transport Association nearly doubled its forecast for 2009 industry losses to $9 billion from an earlier prediction of $4.7 billion. The industry lost $10.4 billion in 2008.

“I think the winter is going to be horrible” for air travel, said Nick Cunningham, an aerospace and airline industry analyst with Evolution Securities in London. “Returning to growth again is still about another year out — in other words, you’re looking at another 12 months of traffic still declining.”

“This is not a recovery,” Mr. Cunningham said. “This is just the worst juncture for year-on-year decline.”

Airbus, for its part, remains decidedly more cautious than its competitor. Over the weekend, Louis Gallois, chief executive of EADS, the parent company of Airbus, said that it was still impossible to predict when an economic turnaround might come.

“We have no capacity now to see what will be the depth of the crisis,” Mr. Gallois said.

Boeing last week lowered its 20 year market forecast for the first time in ten years, albeit only slightly. The Chicago-based company said annual air traffic growth, which has averaged more than 5 percent over the past 30 years, would dip to 4.9 percent per year over the next two decades. Aircraft deliveries for the period would fall by just 400 planes to 29,000, Boeing predicted.

Randy Tinseth, Boeing’s vice president of marketing, acknowledged that the forecast was based on assumptions made earlier this year about air traffic trends, which at the time assumed only a 5 percent decline in passenger traffic. Boeing plans to publish a revised forecast after the summer, Mr. Tinseth said.

Mr. Carson said that he did not expect the credit crisis to have a significant impact on the company’s deliveries in the near term. Boeing has a total order book valued at around $265 billion, equivalent to around 7 years of production at current rates.

“We believe we have the most coveted backlog in this industry — perhaps in the history of this industry,” Mr. Carson said.

Included in that backlog are around 860 of the company’s newest flagship, the 787 “Dreamliner,” which is due to make its first flight later this month and see its first delivery to All Nippon Airways of Japan in the first quarter of 2010. Mr. Carson said he did not foresee any of the airline customers lined up to buy the first of these planes running into financing trouble.

“We are highly confident of the financing for those early deliveries,” Mr. Carson said, though he did not specify how many planes were already fully financed. The 787 backlog extends out into 2020, he added, “so that’s a very long time with lots of opportunity for economic recovery.”

Sun Life to Buy U.K. Business of Lincoln National

Sun Life Financial Inc. agreed to buy the U.K. insurance business of Lincoln National Corp. for about 195 million pounds ($319 million), increasing its U.K. assets under management by 60 percent.

The cash purchase will be completed in the third quarter, and will add 8 cents to 10 cents to earnings per share in 2010, according to a statement today from the Toronto-based company.

Sun Life Chief Executive Officer Donald Stewart said as recently as last month that Canada’s third-biggest insurer may buy books and lines of businesses, rather than entire companies. The insurer was in talks earlier this year to buy most of Hartford Financial Services Group Inc.’s life insurance unit, according to people with knowledge of the matter.

The transaction, which includes clients in life insurance, pensions and annuities, will double Sun Life’s U.K. policies to 1.1 million. The purchase increases its U.K. assets to 10.6 billion pounds.

Lincoln is rebuilding capital after posting losses on investment declines and costs to protect savers from dips in the equity markets. The insurer, which cut jobs and slashed the dividend, announced plans today to accept $950 million in U.S. rescue funds and sell debt and shares.

The acquisition “is not a game changer,” Michael Goldberg, an analyst at Desjardins Securities Inc., wrote in a note to clients. “It is instead a modest tuck-in that still leaves Sun with capacity if other opportunities arise.”

Sun Life fell 36 cents, or 1.2 percent, to C$31.04 in 9:50 a.m. trading on the Toronto Stock Exchange. Lincoln, based near Philadelphia, fell $1.40, or 7.9 percent, to $16.35 on the New York Stock Exchange.

Obama to present sweeping market overhaul

President Obama will release details this week of his proposed financial market regulatory overhaul, Treasury Secretary Timothy Geithner said Monday.

The regulatory system "was fundamentally too fragile and unstable and it did a bad job of protecting consumers and investors," said Geithner, who spoke at a Time Warner (TWX, Fortune 500) summit on the economy. Time Warner is the parent of CNNMoney.com.

Geithner addressed the main objectives of the new regulatory system, although he was not willing to discuss specific details of the proposal prior to the official unveiling by Obama on Wednesday.

The U.S. financial system is far less centralized than other mature economies, according to Geithner, pointing to the between 8,000 and 9,000 banks throughout the country. To hold a vast system accountable, he said that there has to be a more centralized regulation system.

"At the core of making the system stronger is to give one place clear accountability and responsibility," he said.

Focus on reform: In a commentary published in Monday's Washington Post, Geithner and the Director of the National Economic Council, Lawrence Summers, said the proposal would grant the Federal Reserve increased power in the oversight and management of the largest financial companies in the market.

It would also create an agency like the Federal Deposit Insurance Corp., to oversee consumer-oriented financial products.

The two men wrote that the plan would point to the need for deeper cash reserves at major financial institutions. Those firms -- whose operations affect other, smaller institutions -- will be moderated by a consortium of Federal Reserve leaders.

In addition, the proposal intends to impose stricter reporting standards for asset-backed securities in an attempt to prevent a housing boom and subsequent bust like the one that catalyzed the current downturn, the two men wrote.

The housing collapse, fueled by the popularization of subprime mortgages, was evidence of weak consumer protection, Geithner and Summers wrote, adding that the proposal Obama will unveil Wednesday works to continue to protect consumers.

Another component of the plan, which "will be available only in extraordinary circumstances," according to Geithner and Summers, creates an option to dissolve financial companies that are too big to fail.

"It will help ensure that the government is no longer forced to choose between bailouts and financial collapse," they wrote.

The proposal will also pledge to lead a global overhaul in regulation.

Proposal still has to face Congress: Obama's proposal would require congressional approval before any of the changes are adopted. Geithner is set to testify about the plan before Congress on Thursday.

The plan will meet with opposition from those opposed to giving the government a more heavy hand in the financial marketplace.

While Geithner acknowledged the importance of competition to create innovation in a market economy, he was also unwavering in the defense of increased regulation.

"We are not going to go back to where it was. We can't," he said Monday. "The damage of the crisis was just too acute."

Geithner said it is crucial to reform the regulatory system even before the economy is completely out of the current recession. "We are trying to move very, very quickly while the memory of the crisis is still in the forefront of people's memory," he said.

U.S. Stocks Extend Global Drop as Oil, Metal Prices Retreat

By Sarah Jones and Jeff Kearns

June 15 (Bloomberg) -- U.S. stocks extended a global slide, dragging the Standard & Poor’s 500 Index down from a seven-month high, as falling oil and metal prices weighed on commodity producers. Treasuries rose and the dollar strengthened.

Exxon Mobil Corp. lost 1.3 percent as oil dropped for a second day. Freeport-McMoRan Copper & Gold Inc. slid 3.3 percent after copper sank by the daily limit in Shanghai on speculation supply may outpace demand in China, the largest consumer of the metal. Regional benchmark indexes for Europe and Asia slid at least 1.4 percent, led by BP Plc and BHP Billiton Ltd.

The S&P 500, which had climbed 40 percent from a 12-year low on March 9, decreased 1.8 percent to 929.16 at 10:27 a.m. New York time as a worse-than-estimated report on New York manufacturing also dragged down stocks. The Dow Jones Industrial Average, which last week erased its 2009 loss, tumbled 155.23, or 1.8 percent, to 8,644.03. Eighteen stocks fell for each that rose on the New York Stock Exchange.

“There’s no clear trajectory for moving us out of a recessionary environment,” said Wayne Wicker, who oversees $33 billion as chief investment officer at Vantagepoint Funds in Washington. “Given the shellshock of the last year and a half, you have a lot of people who don’t think this market is sustainable.”

Europe’s Dow Jones Stoxx 600 Index lost 1.6 percent after Group of Eight finance ministers, who met in Italy over the weekend, began drawing up contingency plans for rolling back budget deficits and bank bailouts as the economy shows signs of recovery and investors start worrying about inflation.

Empire Manufacturing

The S&P 500 erased gains from a two-day winning streak as the Federal Reserve Bank of New York’s general economic index fell to minus 9.4 from in June from minus 4.6. Readings below zero signal manufacturing is shrinking. Economists in a survey predicted minus 4.6. Stocks fell even as the International Monetary Fund raised its outlook for the U.S. economy.

The S&P 500’s rally since March left the index valued at 14.9 times its companies’ earnings, near the highest level since October. Last week, the Dow average became the latest major U.S. stock gauge to give investors a profit for the year amid growing optimism the worst recession since World War II is ending after the government and Federal Reserve pledged $12.8 trillion to revive economic growth.

The MSCI World Index has rebounded from a 13-year low in March. The rally pushed the index’s value to 18.2 times the earnings of its 1,655 companies, the most expensive level since December 2004, weekly data compiled by Bloomberg show. The Stoxx 600 Index trades at 25.4 times the earnings of its companies, the most in five years.

‘Good Shape’

Russian Finance Minister Alexei Kudrin said the dollar is in “good shape,” further affirming that there’s no substitute for the world’s reserve currency. “It’s too early to speak of an alternative,” Kudrin said in an interview two days ago in Italy after meeting officials from the G-8 nations.

Kudrin’s comments helped U.S. Treasuries climb for a third day, the longest streak in a month, even after international holdings of long-term U.S. financial assets rose at a slower pace in April as China, Japan and Russia trimmed holdings of Treasuries. Purchases of long-term equities, notes and bonds rose a net $11.2 billion, compared with buying of $55.4 billion in March, the Treasury said today in Washington.

Exxon, the biggest U.S. oil company, lost 1.3 percent to $72.80, while rival ConocoPhillips retreated 3.1 percent to $42.98.

Oil Slides

Crude oil for July delivery dropped as much as 2.1 percent to $70.55 a barrel in New York Mercantile Exchange trading as the dollar rose the most in a week against the euro, limiting investors’ need to use commodities as a hedge against inflation.

Freeport-McMoRan, the world’s biggest publicly traded copper producer, slid 3.3 percent to $56.58 as gold declined to a three-week low.

Inventories of copper in Shanghai warehouses grew for a second week to 60,647 metric tons last week, the highest since the week of March 20, 2008, the exchange said after the market closed June 12. China’s imports of the metal and its products increased 6 percent in May from April to 422,666 tons.

Wal-Mart Stores Inc. lost 2.4 percent to $48.63 after Goldman Sachs Group Inc. cut the largest retailer to “neutral” from “buy,” saying it sees “little near-term positive catalysts to drive shares higher.”

The S&P 500 may struggle to reach a so-called golden cross as trading volume decreases, according to a technical analyst at RBC Capital Markets.

‘Increasingly Tempting’

A golden cross, considered a buy signal by analysts who make predictions based on patterns in price charts, occurs when the 50-day moving average, which is currently at 889.24 for the S&P 500, rises above the 200-day moving average, which is at 911.65, according to Bloomberg data. The U.S. benchmark index closed at 946.21 last week.

The major stock indexes “are back above their 200-day averages, and it’s increasingly tempting to conclude that a new bull market is underway,” Toronto-based Ray Hanson wrote in a report dated June 12. However, the S&P 500 “has not yet achieved a golden cross” and “the steadily declining volume since early May suggests caution,” he said. since early May suggests caution,” he said.

To contact the reporters on this story: Sarah Jones in London at sjones35@bloomberg.net; Jeff Kearns in New York at jkearns3@bloomberg.net.

Nokia 5530 XpressMusic smartphone

Nokia, the world's largest mobile phone maker, rolled out three new devices at its Nokia Connection event in Singapore. The new smartphones are designed with connectivity and cost-consciousness in mind. Nokia is looking to deliver connectivity to users without breaking the bank.

The mobile device maker rolled out the Nokia 5530 XpressMusic smartphone. The 5530 has a touchscreen interface that is designed to allow users to interact with social networks, watch homemade videos or content uploaded to YouTube and stay in touch with friends through a rotating picture carousel of contacts.

The Nokia XpressMusic smartphone has a 2.9-inch screen and a 4 GB memory card to store downloaded content. However, the Nokia 5530 XpressMusic device doesn't feature 3G connectivity. Instead, the mobile device functions on the GSM/EDGE network, meaning the device won't have the speed of some of the other smartphones on the market.

The Nokia 5530 XpressMusic will be available in the third quarter of this year and start at the unsubsidized price of about $275, Nokia said in a statement.

The new Nokia E72 is an upgrade to the E71. The new smartphone is aimed at integrating the work and personal life of users, with new features including a refreshed optical navigation ball and better integration of desktop e-mail. The camera on the mobile device also gets an upgrade to 5 megapixels.

In addition to adding new hardware to the smartphone, Nokia also included service upgrades that the company hopes will make the phone more appealing to customers.

The E72 is equipped with an A-GPS (assisted GPS) and integrated maps. Noise cancellation was improved on this iteration of the phone, making audio crisper. Finally, Nokia included Quickoffice for business users, which provides enables users to view, edit and create Microsoft Office 2007 documents, with free upgrades in the future.

The Nokia E72 is expected to be released later this fall and will start around $485 before subsidies.

Finally, the debut included a new flip phone from Nokia, the 3710 Fold. The flip phone is designed to be feature-rich but at affordable price. Images taken on the 3.2 megapixel camera can be stored on an optional micro SD card. Like the Nokia E72, the 3710 Fold has internal GPS capabilities that can be turned on or off by users.

The Nokia 3710 Fold will be available in the third quarter and start without subsidies at about $190.

100th Paris Air Show Opens

The Paris Air Show marks its 100th anniversary Monday amid rain, a gloomy economic forecast and lingering uncertainty over Airbus aircraft, following the still unexplained Air France crash over the Atlantic Ocean, two weeks ago.

The mood should have been celebratory, to fete the Paris Air Show's first century of existence, but the week-long industry event instead opened Monday with the doldrums. Airline, passenger and freight traffic has dropped in 2009 for the first time since 2001.

And, airline companies are cutting staff to weather the global economic and financial crisis. Overall, the International Air Transport Association has warned airlines will lose about nine billion dollars this year.

The crisis has also forced airlines to scrap or delay plans to buy new planes. Analyst Pierre Condom says tight credit is only making matters worse.

Condom told French radio there are few new orders for planes this year because airlines are having a hard time borrowing money from banks to finance new airplane purchases. And, airlines do not know when the economic crisis will be over, which also makes them reluctant to purchase.

The Air France crash over the Atlantic Ocean has also cast a shadow over the air show. The investigation into the crash is focusing on chances that faulty speed sensors may have helped cause the crash. The A330 aircraft in question is made by European aeronautics giant Airbus, which announced it would replace old speed sensors on all its A330 and A340 models.

Still, the news is not completely gloomy. There is sunny weather forecast for the Paris Air Show later this week and about 300,000 visitors are expected to attend this year's event. Boeing executive Scott Carson told reporters on Monday that he expected the aviation sector would start to recover next year.