Monday, March 30, 2009

Weekly Market Wrap Up

US equity indices sustained their upward march this week, sharpening speculation about whether the gains of the last three weeks are a bear market rally or the beginning of the end of the crisis. Monday saw the DJIA jump nearly 5% after Treasury Secretary Geithner finally got around to outlining a concrete framework for the public/private toxic asset plan on Sunday. Indices gyrated throughout the rest of the week, ending Friday near the closing level achieved on Monday. Financial and automotive sector news continued to dominate the headlines, highlighted by a conclave of bank CEO's powwowing the President Obama on Friday and the clock ticking down on the GM viability plan. Front-month crude spent the entire week above the $50 level, while dust ups in bonds (the failed UK Gilt auction) and currencies (the Geithner world currency gaff) kept things interesting. For the week the DJIA rose 6.8%, the Nasdaq Composite was up 6.1%, and the S&P500 advanced 6.2%.

Broadly speaking, the Treasury's toxic asset program is looking to generate more than $500B in purchasing power by leveraging $75-100B in funding from the TARP to finance the public-private partnership. Banks will decide which legacy loan assets they would like to sell off while the FDIC will analyze these pools and come up with a level of financing it is comfortable guaranteeing. Leverage will not exceed a 6:1 debt-to-equity ratio. The FDIC will subsequently auction off the loan pools in a complex process involving the FDIC issuing guaranteed debt. Executive pay limits will not apply to private investors. Complexity and pricing are still major hurdles for the program, but in general markets and participants greeted the refreshing level of clarity with enthusiasm, with US equity indices rallying around 5% on Monday on the news.

Various CEOs from the leading US banks discussed returning TARP funding this week, which seems to be a natural outcome of the AIG bonus battles in Congress and the media last week. Bank of America's Ken Lewis told the LA Times on Tuesday that his bank would begin repaying its TARP funds in April, further refining his timetable for returning government funding after pledging earlier this month that the bank would return the money this year or next. Goldman Sachs responded to press speculation that it would return its own TARP funds ASAP, with Goldman's President noting that no final decision has been made on when to return the money, noting that it would not be before results of the stress tests are released. JP Morgan's CEO Jamie Dimon, who is on the record as saying that his bank will return its TARP funds as soon as possible, qualified some of his early enthusiasm. Following the big banker' summit with President Obama on Friday, Dimon said JP Morgan won't necessarily pay back the funding immediately after the Treasury's stress testing is complete. His comment that March "was a little tougher" in terms of operating performance than January or February seemed to qualify this hesitancy. Following the same meeting, Morgan Stanley CEO Mack told the press "…Are we able to pay back TARP? Yes.” Following the upbeat meeting with Obama, the banking executives seemed to hold to the notion that we are “all in this together” as one CEO said, and that they would wait for guidance from regulators on how and when to pay back TARP funds in a way that is most beneficial to the country and the firms.

GM showed surprising strength late in the week, when the Finacial Times reported that GM would not ask for additional aid in its viability plan, which is due next week. This flatly contradicts statements by Presidential auto advisor Steve Rattner, who said last Friday that both GM and Chrysler will require need "considerably more" Federal aid." Labor negotiations between the Detroit three and the UAW are ongoing. There have been reports for a while that bondholders are holding up the process by refusing the government's terms on their share of losses, while the UAW has said its retirees should not make any more sacrifices. On Thursday night there were press reports that GM was unlikely to get concessions it needs from the UAW by the March 31st deadline, and then on Friday there was a report that GM was floating a plan to offer the union $10B in preferred stock at 9% over 20 years as an incentive to sign onto restructuring plans. The White House is expected to announce an auto industry viability plan on Monday.

Some positive news out of the tech sector offered more evidence that there are signs of hope out there in the real economy. On Wednesday the CEO of South Korean chip maker Hynix said that the chip industry bottomed in Q4, noting that he has seen a significant reduction in supply in 2009. The next day the chairman of Taiwan Semi said the semi industry is in better shape than it was a month ago, while a Samsung executive said the market will begin seeing spot shortages of memory chips given that inventory is inadequate already. In other tech news, Intel said it would formally unveil its new chip for server systems on Monday, noting that the chip would power forthcoming products from several big tech firms, including Dell's new server line and Cisco's push into the server space.

PBoC Advisor Fan Gang encouraged investors in Asia mid week by calling the bottom for the Chinese economy, citing improved car sales and rising levels of investment, as well as the slowing declines in steel and energy demand. Acknowledging that high inventories and overstretched capacity remain challenges, Fan Gang said that inflation could be more problematic than the current deflationary winds in the long term even as rate cuts continue to remain an option. Optimism of this sort was totally lacking in Japan this week: BoJ Deputy Governor Yamaguchi stated that Japanese economic conditions were more severe than in other countries and would likely stay that way. Tokyo saw a string of poor economic data throughout the week, including record drops in imports and exports, underperformance in manufacturing, and a miss in corporate service price index, confirming the growing sentiment among officials that domestic economic conditions were severe. Japan's National CPI fell 0.1% in February - the first decline since Sept of 2007 - a worrying sign of the disinflationary pressures haunting Japanese economy.

Weak government bond auction results sent shockwaves though debt and equity markets mid week. On Wednesday the UK Debt Management Office failed to sell £1.75B in 2049 Long Gilts. Total bids came in at £1.63B, producing a bid-to- cover ratio of just 0.93, with the auction drawing a massive yield tail of around 13bps. But keep in mind that a few unusual factors impacted the auction: the Long Gilt in question was ineligible for the BoE's Gilt purchase program, which was further compounded comments earlier in the week from the BoE Governor Mervyn King that the UK could not afford a further stimulus package, raising concerns over his commitment to the Gilt purchase program itself. King's comment was in direct contrast to the posturing of PM Gordon Brown, who is seeking an agreement on coordinated global spending at the G-20 meeting in April. Nonetheless this was the first failed UK auction since 1995. A 2022 linker auction on Thursday produced a better result, but the yield on the benchmark 10-year Gilt is about halfway back to its pre-quantitative easing levels at around 3.30%.

With a feeble 5-year BOBL auction also taking place in Germany, anxiety from Europe spilled over into Treasuries on Wednesday with a $34B 5-year note auction that could be best described as soft. The resulting sell off in Treasury and equity markets was somewhat offset by the first round of Fed Treasury purchases and Thursday's stronger 7-year auction yields. The 10-year note is yielding around the 2.75%, and bear steepening has pushed the 2-year/10-year yield spread back above 180bps. Like in the UK, the aforementioned benchmarks are about halfway back from lows made since the Fed's quantitative easing announcement.

Toward the end of the week traders and commentators saw focus shift to a developing divergence between fixed income and equity markets. Despite the explosive rally in stocks, signs continue to suggest credit markets remain highly dislocated and far from functioning optimally. The 1-month T-bill saw its yield fall into negative territory for the first time since December while the 3-month yield has slipped back to a paltry 0.12%. As during the height of last fall's crisis, investors appear content parking money in ultra safe and liquid short-term US paper, forgoing little if any return on their investments. Though higher investment-grade corporate paper has seen a noticeable uptick in activity around the world in the past few weeks, lower-quality companies continue to find it extremely difficult and expensive to raise money.

It remains clear that unfreezing the credit markets remains at the top of government officials' agendas in Europe and the US. Monday the US Treasury released some long-awaited details of the public/private partnership aimed at buying up toxic assets, and by Friday President Obama hosted a conciliatory meeting with Wall Street CEOs to drum up support. The UK has continued down the path of quantitative easing and also announced a small amount of corporate debt purchases. Speculation has increased that the ECB's will be forced to consider more creative and aggressive ways of implementing monetary stimulus, including some form quantitative easing. Late in the week the ECB's Papademos indicated one idea they are exploring is buying up private sector debt in the secondary market.

The week commenced with a return of risk appetite in currencies, spurred by optimism about the US Treasury's toxic asset plan and comments from the Chinese that the bottom in the crisis is nigh. Some dealers speculated that the Treasury's plan could revive the JPY carry trade. However, officials from around the globe took the opportunity to emphasize that economic storm clouds have not dispersed, reminding market participants that it remains an open question whether the worst of the global economic crisis is behind us or not. With the G20 set to meet next week, Russian and Chinese officials put forward proposals for a New World Order for currency, with the PBoC Governor Zhou pushing for the adoption (in the long term) of a non-sovereign global reserve currency, analogous to the IMF's special drawing rights (SDR) concept. Dealers noted that the US seems to be positioning itself so it is not forced into a corner at the G20, especially when it comes to restraints on its future borrowing power. This week's failed Gilt auction is seen as a warning shot across the bow for Washington in this respect.

Talk of super reserve currencies riled markets mid-week, when a misquoted comment attributed to Treasury Secretary Geithner caused a bit of a ruckus for the USD. On Wednesday, a wire service reported that Geithner said he was "open" to the idea of an SDR-based currency system, quickly sending the dollar into a tailspin. EUR/USD surged almost 200 pips to 1.3650 before a strongly worded clarification and media reviews of video of the actual statements from Geithner made it clear he said nothing of the sort. Damage control arrived within 20 minutes of the misquote, with Geithner strongly insisting that the USD would remain the dominant world reserve currency for "a long time" and that the US would act to preserve the dollar as such. The rebuttal helped the USD stabilize below the 1.36 area for the remainder of the week. So far as the SDR goes, Geithner actually said he had not seen the Chinese proposal but respectfully said the PBoC's ideas deserve due consideration.

By Friday, the USD had regained its footing against the European pairs. In an address to the German parliament, German Finance Minister Peer Steinbrueck said the euro was at risk if the EU's Stability and Growth Pact, which governs the continent's rules on budget deficits, was not taken seriously. Amplifying this sentiment, the Swedish finance minister commented that over 20 out of 27 EU states could break 3% limit under the pact in 2010. On the data front, European January Industrial Orders plunged 34% (y/y), for its largest decline on record. Negative German state inflation data triggered a huge batch of pre-placed euro sell orders as technical factors gave way below the 1.3480 and 1.3400 levels. Note that the 1.3000 one-month option out positions that were placed with size earlier in the week. The SNB made some cautious economic comments regarding the Swiss economy, the Euro Zone and the US, noting that the economic downturn in the Euro Zone was becoming increasingly pronounced while the US downturn would likely continue for the next few quarters. European services and manufacturing PMIs remain firmly below the 50 point no change mark, suggesting ongoing economic contraction.

GBP/USD surged above the 1.4750 level mid-week following the stronger than expected UK inflation data and comments from the BoE's King, who noted that the central bank's exit strategy might not involve a reverse injection of broad money but rather simply raising interest rates. Sterling sentiment ended the week weighed down by a corporate report that the volume of UK mortgage debt was running at an "unmanageable" 86% of GDP (or about £1.2T). The report recommended 60% as a sustainable upper level.

Dealers noted that the outlook for yen remained bearish, with Japanese fundamentals soft and improved risk appetite encouraging Japanese investor demand for overseas assets. Technical were also favoring a weaker JPY. By Friday, the JPY had firmed up a bit on fiscal year-end flows and chatter regarding Japanese pension funds allocating money to new managers for foreign equity allocation.

The Swiss Franc was mixed during the week, with the EUR/CHF being watched for renewed intervention by the SNB. Dealers were eyeing the 1.5180 level for signs of intervention; the level was not breached following the SNB currency intervention back on March 12th. Dealers are pondering whether the level is a "line in the sand" or simply a high water mark.

The economic crisis sweeping Central and Eastern Europe has claimed a third victim in a month after the Czech government lost a vote of no confidence on Tuesday night in a drama that risks setting off a fresh round of investor flight from the region. Euro-related CEE currency pairs continue to be hampered by the no confidence vote.

Trade The News Staff Trade The News, Inc.

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