The equity rally started last week reached a plateau in the latter half of this week as investors lost their taste for the big US banks and the Fed rolled out yet another gargantuan effort to spend our way out of recession. With the Fed Funds target rate pinned close to zero, the Fed launched an effort to buy up to $300B worth of Treasuries as well as increasing purchases of MBS and GSE debt, expanding its balance sheet to an unprecedented $3T (with more to come when the bank bailout plan is finalized). The dollar rapidly weakened on the Fed news, sending NYMEX crude back above the $50/barrel level and gold halfway back to $1,000/oz after it retested $900 earlier in the day Wednesday. Meanwhile, the noise surrounding executive bonuses at AIG and other crippled financial institutions rose from a background hum to an unavoidable roar that could actually damage the institutions and sap the political will to provide any further bailouts. Despite losing steam later in the week, equity markets posted their first back-to-back weekly advance in 11 months. For the week the DJIA rose 0.7%, the Nasdaq Composite was up 1.8%, and the S&P500 advanced 1.6%.
The week began with banking stocks continuing to fuel overall equity gains, helped along by Bernanke's comment on 60 Minutes that all the large US banks are solvent and none of them will fail. In addition, the FASB issued its formal proposal on mark to market, saying it would like to let companies exercise more judgment in applying mark-to-market accounting rules (the board will vote on the proposals on April 2, with the objective to finalize the rules for Q1 financial reports). Later in the week, a certain amount of caution crept into financial stocks, with analysts cutting selected ratings mid week and Meredith Whitney warning that the banks are as bad as ever, reiterating her estimate that banks will cut consumer credit lines by around $2.7T. Adding to the pressure on consumer credit, President Obama said in speech on Wednesday that he supports a credit-card bill of rights, insisting that banks have pushed credit cards in "damaging way." The financials peaked mid-week after the FOMC decision, with Citigroup up nearly 100% over last Friday's closing price at one point, but many were flat on the week, and Morgan Stanley was down considerably.
On Thursday Citigroup outlined its strategy for converting the Federal government's stake to common equity from preferred stock. The bank has registered 4.38B common shares for the conversion, which is about 80% of its 5.5B shares of outstanding common stock, and plans to ask its shareholders to authorize an expansion of its share authorization to as much as 60B shares, as it needs up to 16B shares to fulfill the entire preferred stock conversion. Some noted that Citi will also be doling out common shares to employees in lieu of cash bonus payments, given the continuing financial bonus scandal. In addition, Citi said it intends to undertake a reverse stock split at a ratio of somewhere between 1-2 to 1-30 at a date before June 2010, to eventually mop up the big pool of shares outstanding that will result from these actions.
The Wall Street bonus soap opera shifted into overdrive as AIG CEO Liddy testified before Congress on Wednesday after admitting over the weekend that AIG would still be doling out $165M in bonuses that the firm was contractually bound to pay. After suggesting that AIG executives should apologize to the nation or commit suicide ('Japanese style'), Senator Charles Grassley (R) and colleague Senator Max Baucus (D) introduced sweeping legislation that would impose a 70% tax on bonuses at any firm that took more than $5B in TARP funds. The House later passed a bill that would levy a 90% tax on bonuses, and began discussions to ban bonuses outright at firms taking TARP funding. By Friday, the anti-bonus drum beat has picked up in Europe too, with UK PM Brown, French President Sarkozy and German Chancellor Merkel all making noises about enacting similar measures as those being considered in the US.
GM and Chrysler continue slouching toward solvency, with some kind of major decision promised before the end of the month from the Obama Administration's Auto Task Force. Chief advisor to the task force, Steven Rattner, said late in the week that both automakers would need more aid, while the automakers kept wrangling with their various partners. A UAW source said on Thursday that the companies' bondholders are refusing the government's loan terms, holding up final deals. Fiat responded to comments out of Chrysler on Wednesday, flatly denying its claim that Fiat would assume around one third of its debt to the US government as part of their alliance deal. One positive development was the announcement of a $5B Treasury program designed to support the struggling auto parts suppliers. UBS weighed in on Friday, initiating Ford with a buy rating, noting that it should gain market share from its distressed competitors.
Fears that protectionism could become a problem have gradually emerged over the course of 2009 as the economic outlook has grown dimmer. This week a couple of developments showed that protectionism is emerging as a real threat. China's Ministry of Commerce rejected Coca-Cola's bid for domestic firm Huiyuan Juice, stating that the deal would “hurt competition.” In Europe, DuPont said its business may be effected by new EU duties on basic materials; the EU duties will also hit Chinese iron and steel pipe products. Back in the US, many commentators discussed the implications of protectionist strings attached to government aid packages, notably “buy American” provisions in the stimulus package and prohibitions against hiring foreign workers.
In fixed income, US Treasury yields were at or near their highest levels for the year before the FOMC statement jolted markets on Wednesday with a big dose of quantitative easing. Yields dropped dramatically and the curve flattened out following the announcement, which commentators say was foreshadowed by speculation stemming from recent gilt reverse auctions. After holding close to 3%, the benchmark yield made a beeline for 2.5% and the spread narrowed some 30 basis points. Note that the $300B in Treasuries the Fed wants to buy looks somewhat paltry when compared the roughly $6T in Treasuries outstanding, while much of the early enthusiasm is being watered down by longer-term concerns that the unusual and ultra expansionary measures will stoke inflation down the road. The 10-year yield has held 2.5% backing up towards 2.6% with the future consolidating below 125, while the long bond yield is just a little more than 15 basis points below pre-announcement levels.
On Thursday the Fed kicked off the much-anticipated TALF program, designed to revive consumer and business lending. In the initial round of funding, the New York Fed lent out close to $5B to TALF borrowers who in turn purchased bonds from Ford and Nissan backed by auto loans as well as Citigroup paper backed by credit card payments. Though not all investors took advantage of government financing, the issuers did manage to unload all the paper at or below rates where similar securities were trading in the open market. The initial take seems to be the effort is having some success in thawing frozen ABS credit markets, and hope remains that the expansion of collateral announced on Wednesday for the next TALF installment in early April will help the program gain more traction. However, with the TARP-associated financial bonus fracas only getting worse, many commentators wonder if potential players won't be hesitant to participate in the TALF because of the potential for retroactive government rule changes. Late in the week, a report circulated that so far only a paltry 19 smaller hedge funds have filed applications for participation in the TALF.
Corporations continue to aggressively issue high-grade debt in credit markets around the world. It appears that CFOs are taking advantage of the current demand for such high-quality paper ahead any turn in the global economy. On Friday Wal-Mart sold £1B in 25-year Sterling-denominated bonds at less than 200 basis points above gilts, while BHP raised over $3B and UPS came to market for $2B, with each company selling 5- and 10-year notes. Corporate consolidation remains an underlying driver in credit markets as well. Early in the week Pfizer issued some $13.5B in credit in a five-part deal to help finance their acquisition of Wyeth. Ahead of the pricing, the WSJ speculated that Pfizer was looking to raise as much as $20B in what would have been the largest US Dollar debt issue ever. The article suggested drug companies are scrambling to leverage the current environment to finance the acquisitions desperately needed to diversify pipelines ahead of major patent expirations.
In currencies, broadly higher equity markets held the attention of investors and dealers as the week began, helping them ignore the lack of concrete proposals emerging from last weekend's G20 finance ministers meeting. Fed Chairman Bernanke offered a glimmer of hope, saying recession might end in 2009 but also conceding that the unemployment outlook remained bad. The German ZEW data also hinted that the German recession might hit bottom by mid 2009, although its overall outlook remained was pretty ugly.
The greenback began the week in consolidation mode, lingering near the 1.30 level in the EUR/USD pair. By Friday the dollar was poised to record its worst one-week decline against the euro since the latter was launched back in 1999, with the USD off around 6% in all. Two words explain the move: quantitative easing. With US interest rates effectively at zero, the Fed has followed its colleagues across the pond into the land of QE, announcing its big treasury buying program with the FOMC interest rate decision on Thursday. Ahead of the FOMC decision, the EUR/USD easily plowed through rumored Far East offers around the 1.3070 area to test 1.3145 for fresh seven-week highs, adding to the upside momentum to the recent consolidation. But after the decision the dollar faced a broad-based sell-off as chatter about QE's implications for the United States' AAA rating made the rounds and the EUR/USD finally broke above the initial resistance at 1.3536, moving toward the 1.37 level for fresh seven-week highs. Some analysts are now calling for a EUR/USD target near the 1.40 handle.
In Europe, the ECB said it was still assessing the risks associated with potential zero interest rates, insisting that there appeared to be more risks than advantages to dropping rates to zero. Sterling began the week steady following comments from Barclays that business has performed well in the first months of 2009 (echoing the recent rally-sparking comments of Citi, BoA and JP Morgan). But by mid-week the GBP was hitting some turbulence after the IMF said it might revise its UK GDP forecast lower for both 2009 and 2010 and the UK February claimant count surging to its highest level since records began back in 1971. By Friday GBP/USD was approaching 1.3840. Swiss National Bank Governor Roth shed some light on the rationale behind the bank's intervention last week, noting that the move was an attempt to avoid deflationary pressure rather than an effort to gain comparative advantage for exports. The SNB's Jordan followed up by insisting the bank would not tolerate any further appreciation of the CHF. Interestingly, the SNB also commented that it would not sell any of its gold holdings. In Eastern Europe, Russia proposed that the IMF study the possibility of launching a supra-national reserve currency and foster stronger global regulatory institutions.
In Asia, the Japanese government reiterated its dismal economic forecast, noting that Japan's economy is facing severe problems, a position that was reiterated by the Bank of Japan in its monthly report. The BoJ left key rates unchanged at 0.10%, as expected, but boosted its purchases of Japanese government bonds (JGBs). However, BoJ Governor Shirakawa cautioned that there was limited room to purchase additional JGBs, noting that the purchases were not aimed at controlling long-term interest rates but sought to ensure the stability of financial markets. Dealers said the yen softened up toward week's end thanks to the Bank of International Settlements (BIS) aggressively buying dollars against Yen. USD/JPY ended the week holding above its historical pivot point of 95.00 after testing its 100-day moving average of 93.50 on Thursday. Some traders said key moving averages are about to cross over, which could add to the pair's upside momentum. EUR/JPY pairs moved back above the 130 handle. There has also been talk of lingering risk of yen repatriation ahead of the end of Japan's fiscal year on March 31. Also note that the World Bank lowered its 2009 Chinese GDP forecast to 6.5% from 7.5%. However, the China government continues to adhere to its 8.0% growth target for the year.
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