The rising price of energy continued to obsess markets this week, as crude futures spiked to record highs above $140/bbl after the Saudi's Jeddah oil meeting proved to be a dud. Rumors circulated early in the week that Israel had bombed a nuclear site inside Iran, drawing a quick denial from both sides. Equity indices crawled along sideways until OPEC President Khalil sparked this week's rise in crude by predicting on Thursday morning that prices could rise to as high as $170/bbl this summer. That same morning, Libya announced it would consider cutting output, citing oversupply in markets. Traders reacted by dumping stocks: the DJIA dropped 100 points before the open on Thursday and fell a further 250 points by the close, settling below levels not seen since September 2006.
For the week, the DJIA fell 4.2%, the S&P500 dropped 3%, and the Nasdaq Composite was down 3.7%.
The overall market weakness was accentuated by news in individual names: UPS cut its forecast on Monday, RIMM posted disappointing earnings and guidance on Wednesday and GM fell to its lowest level in over five decades on production cutbacks in trucks and SUVs. The auto sector as a whole suffered further thanks to rumors circulating that Chrysler would declare bankruptcy imminently; Chrysler denied the rumors but the damage was done and auto stocks continued to slide.
After showing some strength midweek as the Kuwait Sovereign Wealth Fund confirmed it had purchased $3B in securities from Citibank and rumors swirled that UBS or Wachovia might be acquired, the financials continued their long march into the red. A Lehman analyst revised FY08 EPS outlook for Merrill sharply downwards, noting that the bank would likely increase writedowns to $3B from $2B in the second quarter, and there was a lot of talk about what moves Merrill would make to raise capital. Then Friday afternoon, Moody's announced it was reviewing Morgan Stanley's Aa3 rating for a possible downgrade, sending the stock down 2% before recovering.
Gold pushed higher hand in hand with crude, with futures closing at their highest level in a month, at $930. Metals stocks were mixed, although the steel sector was notably strong after Reliance Steel (RS) raised guidance.
There was little for the bulls to cling to on the data front. The June Consumer Confidence reading fell to its fifth lowest reading ever at 50.4, well below the estimate of 56, while one-year inflation expectations matched last month's record high of 7.7%. Housing data gave more cause for disappointment, with the April House Price Index down 0.8% m/m, four-tenths worse than expected, and the May New Home Sales data showing median prices fell 5% m/m to $231,000 while inventory rose to a 10.9 month supply.
The FOMC held rates this week at 2.00% as expected, adding token language to their statement in order to reassure that they are watching inflation closely. Specifically, the FOMC said the upside risks to inflation expectations have risen, while downside risks to growth have diminished somewhat, which was taken as a signal that it would be on hold for some time. The committee also pushed back its forecast for the timeframe in which inflation is expected to moderate to "later this year and next year" from the prior forecast of "in the next few quarters."
Treasury prices pushed markedly higher on the week, spurred on by the deterioration in equity markets and continued reaction to Wednesday's FOMC statement. Yields remained under pressure across the board and by Friday the steepening seen in the curve following the FOMC decision had given way to stronger buying at the long end. The two-year yield has slid some 35 basis points from its reactionary high of 3%, while the 10-year is below 4.0% for the first time in nearly a month. The 30-year cash yield is heading back towards 4.55%. Fed fund futures have pushed back expectations for higher rates after the Fed failed to signal a rate hike was imminent, while continued gloomy economic data as well as heightened risk aversion among investors indicated the economic situation remains uncertain. Fed fund futures are pricing in roughly a 25% chance for rate hike at the next meeting while the November contract now sees less than 30% odds of an additional 25 basis points worth of tightening on top of any potential hike this summer.
The dollar began the week on an optimistic note as evidence of slower economic growth began showing up in Europe; both the French PMI reading and German IFO data came in below expectations. A defensive tone set in for the USD as commodities firmed up and weighed on sentiment. ECB hawks were circling over markets mid-week, insisting that expectations for a July rate hike were appropriate and implying that further action may be necessary if inflation prospects worsen after July. There were some half-hearted attempts at verbal intervention in the USD ahead of the FOMC rate decision, while Russian President Medvedev stated that a weak USD is an international problem and ECB's Wellink said he believed the EUR/USD pair above the 1.60 level was out of equilibrium. These commentators were making their call at the same level where Fed Chairman Bernanke noted the Fed's attentiveness to implications of the dollar's decline back on June 3. The dollar ended the week on the soft side following the FOMC's optimistic assessment of inflation expectations.
On Thursday the BoE's King attempted to clarify the reasoning in the bank's recent letter to the Exchequer on the state of inflation, noting that the missive was not intended to be "dovish" but rather a balanced assessment and adding that any prolonged price rises will force the BoE to act on rates. The GBP/USD pair climbed above its 1.9790 nine-month downtrend line, and was seen probing 1.99 by Friday.
The USD/JPY pair continued to lack the momentum to overcome its 200-day moving average in the 108.00 area. But the end-of-week equity sell-off finally brought some risk aversion into the carry-related currency pairs, with cautious comments on the US brokerage sector, rumors of potential auto bankruptcies and the OPEC rhetoric helped the EUR/JPY pair hit all-time highs of 169.44 before retracement.
Elsewhere, the Indian Central Bank raised its Repo rate for the second time this month. The RBI raised rates by 50 bps to 8.50%, saying the increase was aimed at anchoring inflationary expectations. The Russian Central Bank noted it was considering whether to add more CHF to Russia's FX reserves.
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