Fears of bank nationalizations and creeping socialism continued to grip the markets this week. On Monday the DJIA closed below its November lows, hitting levels not seen since late 1997, sending the VIX volatility index to a close over 50 for first time in a month. By Friday, the Dow had skidded to within 40 points or so of 7000 before retracing a bit. Testifying before the Senate on Tuesday, Fed Chairman Bernanke warned that recovery will only begin to take hold next year if the banks are stabilized, and it will take two or three years to return to normalcy. Toward that end, the Treasury sought yet again to solidify confidence in Citigroup by converting its preferred stake to common equity. The Obama administration launched its ambitious 2010 budget, with unsurprisingly huge deficits, and the promise of another big chunk of financial bailout money to boot. GE bowed to increasing economic pressure and cut its dividend, while JP Morgan cut its dividend by 87%. There was little to no positive economic data to speak of in the week, which had the advantage of numbing investor completely by the time the dreadful -6.2% Q4 preliminary GDP revision was announced on Friday. For the week, the DJIA lost 4%, and the Nasdaq Composite dropped 4.4%; the S&P500 fell 4.5%, ending the week below the November intraday low of 741, at a 12 year low.
The administration released its 2010 budget proposals late in the week, following a brief outline in President Obama's national address on Tuesday. Unsurprisingly, the budget foresees a significant shift in funding priorities and projects massive deficits. It includes health care reforms and a tax increase on top earners, as expected. There is also plan for cap and trade scheme for C02 emissions. The budget officially projects a $1.75T deficit, but other sources using different arithmetic have counted a 2010 deficit as high as $3.5T. The budget includes a $250B "placeholder" for bank bailouts and warns that the administration could seek up to $750B in funding for the financial industry. Interestingly the budget envisions a return on TARP purchases around $0.66/dollar, which is well below prior forecasts.
Line items in Obama's budget directly impacted share prices of selected pharmaceutical and managed care names, and took a big bite out of student loan servicer SLM Corp. Managed care names CVH, AET, UNH, CI and HUM are suffering from proposals that would make significant changes in the government's role in health care, including big cuts to private Medicare Advantage reimbursement plans. Both Eli Lilly and AstraZeneca stated that changes to Medicare included in the budget would cost them hundreds of millions of dollars. Another budget proposal includes a provision that would make the government the sole provider of federally backed loans to students, blindsiding SLM. The budget also looks to cut various agricultural subsidies, impacting selected potash names in the short term, although big agriculture names like ADM didn't budge. In addition, the budget removes several tax breaks for oil and gas companies, notably hiking the excise tax on Gulf of Mexico operations through 2019.
Investors were focused on Citigroup all week long, waiting for details of the Treasury's plan for converting its preferred shares into common equity. Earlier in the week various administration and Congressional figures went to great lengths to counter speculation that the government was planning to nationalize a "too big to fail" Citigroup. The plan finally arrived on Thursday evening, and whether Citi has been "nationalized" or not depends on who you ask. The final plan sees converting nearly $27.5B in preferred stock sold to private and public investors and up to $25B in government-held preferred stock into common shares, at a conversion rate of $3.25 a share, raising the government's stake to 36%. Citi CFO Crittenden stated that the intent of the aid package was to eliminate any need for more capital, but warned that it doesn't guarantee that this will be the case. Shares of Citi dropped another 40% on Friday, closing out the week at $1.50.
On Wednesday the Treasury finally shed some more light on how it would conduct stress tests of major banks, although it remains somewhat unclear how the process will work. What we do know is that US banks that need fresh infusions of funding will be strongly incentivized to raise private capital first, and banks that have already taken government capital will be encouraged to replace it with private funding. Stress tests are based on a baseline of adverse GDP and employment forecasts, including unemployment of 10.4% by 2010. Stress tests will consider loan, trading and securities losses. Notes that the Treasury has said that there will be no "explicit cap" upon funding it will provide to banks that go through stress tests, and said the capital assistance program will be open for a significant period of time. In any case, the results of stress test results will not be made public. Testing is set to begin on March 25. Bank of America's CEO Lewis said that BoA should be able to pass any stress test the government throws at it.
General Motors reported a giant $9.6B quarterly loss on Thursday. For the year, GM lost $30.9B, which admittedly is less than last year's $43.3B loss. The wounded automaker said that it anticipates receiving a "going concern" opinion from its auditors in its 2008 10-K. At the very end of its earnings press release, GM briefly noted that it requires funding from the US Treasury to continue operations. Various reports confirmed that Obama administration officials are continuing their talks with both GM and Chrysler to review viability plans and fashion another round of loans. GM sent a request to Germany for support of its Opel unit; reports indicate that the division needs more than €3B to avoid insolvency.- The final week of February saw sellers return to the US Treasury market. The benchmark 10-year yield reclaimed 3% nearing multi-month highs reached earlier in February, while the benchmark spread is approaching 2%. Spreads across the curve widened out in the final few sessions as much of the weakness was seen at the long end of the curve. Selling action appears to be related to concerns over an impending deluge of supply thanks to the administration's ambitious budget proposals. Expect to see continued focus on how the Treasury market digests the upcoming issues, starting with next week's auction announcements. Analysts are looking for the Treasury to announce some $60B in auctions of 3-, 10-, and 30-year paper which would be $2B more than was auctioned off in February for those maturities. Corporate bond markets remain strong, especially in the high-grade arena. February looks to be one of the strongest months on record in terms of high-grade debt issuances, with roughly $10B coming to the market on Thursday alone.
In currencies, the greenback ended the week on a firm note. Dealers indicated the dollar's safe-haven status is outweighing worries over the mountain of debt needed to finance a cumulative US deficit of $3.8T in the 2010 to 2014 period. Chatter about growing dissention within the ranks of the ECB ahead of next week's policy meeting weighed on the euro over the course of the week. In addition, German IFO business confidence hit a fresh 26-year low and warned that economic data was not signaling a cyclical turning point, although the IFO noted the situation was improving slightly.
Sterling was pushed lower by the -1.9% UK GDP data (the largest annual decline since 1980) and the announcement of the UK Treasury's Asset Protection Scheme. Dealers are noting that the potential liability of British taxpayers has reached £1.3T since the start of the credit crunch, which one perceptive trader noted is equivalent to almost the entire annual output of the British economy. Needless to say, this sort of arithmetic is causing concern among investors. BoE members summarized that quantitative easing was a step into unknown but insisted the UK economy would get a boost from low interest rates and softer sterling FX
The yen fell to a 12-week low against the dollar, blasting through a key technical break above the 95 level while EUR/JPY was above the 121.20 neighborhood. Note that 95.00 has been a historical pivot point in USD/JPY, as it was the former coordinated intervention point back in 1995. The general JPY weakness is being attributed to chatter circulated that Japanese firms have scaled back their fiscal year-end yen purchases as the slump in corporate earnings abroad leads to a drop in yen repatriation. Japan's January exports fell by almost 50% y/y with record slides in shipments to the United States, Europe and the rest of Asia pointing to a deepening recession across much of the world. Trading desks and analysts are now dreaming up lots of reasons for a weaker JPY, ranging from fundamentals and valuation, to technical factors. Elsewhere in Asia, officials said Hong Kong's GDP would contract by up to 2%, representing the enclave's first negative growth in six years.
In Eastern Europe, the looming threat of sovereign rating downgrades kept things dicey all week long. Rating agencies noted that any rate decisions would be based on the depth of the region's crisis which is "gathering momentum," as S&P put it. On Tuesday, S&P cut Latvia's sovereign credit rating and put the ratings of Lithuania and Estonia on watch negative. The Swedish Kroner was broadly weaker as it was hit by fallout from the Baltic states-Austrian and Swedish banks are said to have significant exposure to Eastern Europe. Then on Wednesday S&P downgraded Ukraine's sovereign credit ratings to CCC+ from B. In the CEE4 region, central banks all commented that the excessive depreciation of their currencies have not been in line with the economic reality on the ground. The Polish Central Bank reiterated that it could undertake actions to prevent negative impact of FX rate on the economy. S&P noted that the resilience of the region's economies seems to be crumbling under the weight of high foreign currency debt and the looming reprioritization of lending among foreign banks.
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