Equity markets sold off about 300 points on Thursday in anticipation of disappointing jobs data on Friday morning. The Labor Department reported that the August unemployment rate rose to 6.1%, its highest level in nearly five years, well above the expected 5.7% reading. August non-farm payrolls decreased for the seventh month in a row, dropping by 84,000 jobs, slightly more than expected, while the prior two month's number was revised even lower (July revised to -60K from -51K and June revised to -100K from -51K). In addition, the Q2 mortgage delinquencies reading rose to 6.41%, the highest level since records began 29 years ago. Equities sold off on Friday morning after the data, but found a bid in the afternoon, as the DJIA and S&P500 managed to eke out a positive close on Friday afternoon.
Crude continued it march towards $100 a barrel, with prices dropping to five-month lows close to $105 as fears of spreading economic slowdown and fresh dollar strength compounded the non-event that was Hurricane Gustav. Oil traded within a $111.50-105 band as it trended down this week, closing out Friday around $106.50. Oil-related stocks have been wacked by the continuing declines, with the OSX down close to 10% on the week. This drop occurred despite the OPEC meeting in Vienna scheduled for Tuesday, during which it is speculated the cartel could cut production to defend the $100/bbl level. The three storms developing in the Atlantic also did not perturb the energy market, even though hurricane Ike appears to be tracking toward the Gulf of Mexico.
Other commodities also experienced dramatic declines, with copper down 7.6%, and gold down 3.5% on the week. Corn, aluminum, nickel, tin, lead and zinc also dropped. The 13.6% decline in the XAU indicates the pain among commodity-related names. The commodities deleveraging has badly hurt hedge funds as well, and rumors circulated all week focusing on fund failures. The WSJ noted that hedge funds such as Ospraie are reporting losses at a time when investors have been less willing to put new money into hedge funds. On Thursday, hedge fund Atticus had to deny rumors that it is liquidating due to crippling losses.
August same-store sales reports were mixed, offering even more evidence that the consumer remains challenged. The bright spot was among discounters like Wal-Mart, BJ's and Fred's which came in ahead of estimates. Indeed, Wal-Mart's sales growth was nearly twice the expected figure. However, WMT's CEO noted that customers were skipping certain ancillary purchases and spending a greater share on staples. Department stores BONT, DDS and JWN reported worse-than-expected sales declines for the month.
The Lehman Brothers drama continued as reports emerged regarding the firm's ongoing negotiations with potential investors. On Wednesday, South Korean media said that the Korea Development Bank would like to buy a 25% stake for around $4.4B, in addition to a guarantee that it could boost the position to 49% in the future. South Korean newspaper Chosun Ilbo reported that HSBC and an unidentified Chinese bank are also among potential investors, citing a financial industry source. Later in the week the London Times reported that Tokyo Mitsubishi (unit of Mitsubishi UFJ) may join the bidding, and may even try to take control of the firm. A Mitsubishi UFJ executive later denied the reports. Lehman got a boost on Friday as a report emerged that Blackstone and KKR are exploring options to buy Lehman's real estate unit in a deal that could be valued at around $5B.
Investors spent the week fleeing to safety in treasuries, sending yields to fresh multi-month lows. Friday's jobs data solidified the trend, although yields bounced off their worst levels as some players look to shrug off the jump in unemployment as more of a seasonal effect. The fed fund futures have fully priced out any chance of a rate hike this year, and the Dec and Jan contracts actually began pricing in a very small chance for a cut late this year. The benchmark curve was also a bit steeper as the two-year yield approached levels not seen since mid-March below 2.15%.
The dollar has maintained a firm note all week long as technicals prompted a fresh wave of selling in European currencies prompted by deepening concern about the Continent's growth outlook. UK Exchequer Darling noted the unprecedented economic challenges facing the UK, pointing to the fact that sterling has been declining for over a year while also cautioning that FX rates continuously fluctuate. Despite the slowing economic outlook both the BoE and ECB left their key interest rates unchanged, as expected. The greenback ended the week just off its best levels as the spike in US unemployment above 6.0% forced some profit taking against the European majors. The EUR/USD was seen consolidating between its 100-week moving average (last violated back in April 2006) and the prior 2008 low of 1.4365 set back in January. Both the EU's Juncker and the IMF noted that despite the recent dollar strength, the euro remains overvalued against USD.
Once again the ECB cited concerns about the secondary effects of inflation. As if to illustrate the point, Germany's IG Metall union said it would demand a pay raise of at least 7%. The ECB also noted that it would remain focused on battling inflation even after slashing its economic growth forecasts for this year and the next; the current rate will certainly aid the bank in this effort. ECB staff projections lowered the GDP outlook for 2008, narrowed the 2009 range and made a modest upward adjustment in its inflation forecast. In addition, the ECB noted that corporate demand for loans was slowing, but it expects a gradual recovery and resilient global growth. In a separate move, the ECB altered its collateral rules, downplaying the change as a “mini” interest rate hike and calling the measure “better risk management.” The "refined" rules, will take effect in February, 2009, include a 12% haircut on asset-backed securities and an add-on haircut of 5% for unsecured bank bonds.
The carry-related crosses became more active as the week progressed. The heavy tone in equity markets helped the EUR/JPY test below the 151 handle, while the yen price action ignored the resignation of Japanese PM at the beginning of the week. Emerging market currencies took steep losses as the South Korea Won and Russian Ruble weakened significantly. The South Korean Deputy Finance Minister reiterated that South Korea is not facing crisis, insisting that the situation is totally different than the 1997 crisis. The Russian Central Bank said it has no plans to widen the ruble's trading band over next few months and downplayed the currency's decline. It also said it has not sold a significant amount of currency to support the ruble and does not plan to take any special steps to support the currency.
In other FX highlights this week, Australia's RBA lowered its interest rates for the first time in seven years. Dealers are concerned that the RBA's ease was not aggressive as it could have been. The Bank of Canada left its interest rate unchanged at 3.00%. The German finance minister and ECB's Trichet met with PBOC's Zhou on Friday; currencies were discussed and the German official noted that the CNY does not reflect fundamentals.
Late Friday, the WSJ reported that the Treasury is close to finalizing a plan to backstop Fannie Mae and Freddie Mac, and it could be announced as soon as this weekend. This sets up a potential rally in the financials early next week as the news is digested. Fannie and Freddie stock dropped after hours on Friday, as shareholder equity may be wiped out under a backstop deal, while other troubled financials like Lehman and Merrill traded higher.
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