Equities spent the first half of the week on an even keel, making solid gains as investors took heart from positive quarterly results out of home improvement retailers Lowe's and Home Depot and reports that several leading banks would be allowed to repay TARP funds soon. In another milestone on the road to healthier markets, the VIX volatility index dropped below 30 on Tuesday for the first time since Lehman's failure, while the DJIA had risen nearly 450 points to a weekly high around 8590 by Wednesday morning. However Q1 National Association of Realtors report that forecasted commercial real estate activity would remain weak for six to nine months and the release of the April 29th FOMC minutes helped slam on the breaks. The FOMC minutes forecasted a deeper recession in 2009 and a slower rebound in 2010, and revealed that the Fed is open to expanded quantitative easing, reminding market participants about the precarious state of the economy and ballooning US government debt. Then on Thursday afternoon S&P cut its outlook on the UK's AAA sovereign rating to negative from stable, a move that cast a shadow on the AAA ratings of the United States. This led to renewed weakness in the greenback against other major currencies, which in turn helped keep crude futures above $60/barrel. For the week, the S&P 500 rose 0.4%, while the DJIA and the Nasdaq Composite each gained 0.7%.
Another week has yielded little concrete progress on a final restructuring plan for GM. Negotiations continued with bondholders, the UAW and the Treasury, with the latter pledging another $30B in funding to support GM's restructuring process and promising to refloat GMAC as a publicly traded company. The UAW finally agreed to some further concessions, but bondholders rejected an offer of a 10% equity stake in the restructured company in exchange for billions in debt. In Europe, multiple bidders emerged for Opel, with Magna International seen as a leading candidate. By Thursday the Washington Post was reporting that the Obama Auto Taskforce was preparing to send GM into bankruptcy as early as next week, prompting a response from White House economic advisor Austin Goolsbee, who said the administration is "committed" to getting a workable restructuring plan by the June 1st deadline, although Goolsbee also admitted that negotiations would likely be "down to the wire."
The unofficial government policy of dribbling out information about its various bailout programs was on full display this week. Administration officials disclosed a few more details on the Public-Private Investment Program (PPIP): in Congressional testimony, Treasury Secretary Geithner said PPIP would commence within the next six weeks, in line with recent comments on timing out of the White House and the FDIC. For its part, the FDIC said it might go ahead with plans to float a "pilot sale" of toxic "legacy" assets without any government financing, implying that there could be a part of the program lacking a "public" component, although the Treasury has said nothing regarding the proposal. Over the weekend reports circulated that five or six more banks might be cleared to pay back their TARP funding. On Tuesday the Fed confirmed that the first official responses to banks looking to repay government funds would come on June 8th, with further disclosures on a monthly basis thereafter. Goldman, JP Morgan and American Express are reportedly first in line to repay, according to the FT, followed possibly by Morgan Stanley, State Street and US Bancorp. At the firm's shareholder meeting, JP Morgan CEO Jamie Dimon told investors that the TARP program has been a "painful experience" for the bank.
The banks are continuing the process of raising capital to pay back TARP funding or meet stress test requirements. Bank of America said it has sold 1.25B shares since May 8th, or just short of 20% of its market cap, worth $13.5B, in its quest to satisfy government capital requirements. The bank also said it is considering a conversion of preferred shares to common equity as the means to raise the rest. Regions Financial is selling $1B in common stock (about 34% of market cap) and Fifth Third Bank filed to sell $750M in common equity (17% of market cap) plus offer holders $1.1B in preferred shares; both regional banks are looking to fulfill the demands of the Fed stress tests.
The credit card reform bill and its contentious "Bill of Rights" passed Congress and was signed by the president. The legislation puts a variety of new restraints on interest rates charged for consumer credit, which are seen as good for consumers and bad for lenders. In a related story, JP Morgan shifted a portion of its debt card users to Visa from MasterCard, affecting more than half of MA's $59B portfolio of debit card users. A MasterCard spokesperson insisted the move would not have any material impact on revenue.
Thursday was a pivotal day for overall sentiment in US Treasury markets, as the safe haven status of US government paper appeared to be seriously questioned. After S&P downgraded the UK, treasuries and the USD sold off sharply in tandem with equities, in contrast to the inverse relationship that has been en vogue since the collapse of Lehman in September. With some obvious similarities between the two economies, including rapidly expanding national debt and deficits, speculation ensued amongst many players. Adding to the uneasiness, the NY Fed's 22nd round of outright coupon purchases was subsequently met with a wave of unparalleled selling, as dealers submitted a record $45.69B in offers, with the increase ominously attributed to central banks. Disappointment was palpable after the Fed only bought 16% of the bids submitted compared to the 25% they had been averaging, especially in light of Wednesday's FOMC minutes which indicated the Fed could become more aggressive in buying back assets. Subsequently the yield on the 10-yr note surged roughly 15 basis points though 3.30%.
By Friday the US 10-yr yield pushed above 3.4% for the first time since November, while the benchmark spread found traction above 250 basis points. The question remains whether the weakness in US Treasury markets is really signaling a pivotal change in investor demand or whether it is just technically driven trade in a thin holiday market ahead of the first new supply in weeks. Next week the US Treasury will be auctioning off $101B in 2-, 5- and 7-yr notes, offset by just two Fed coupon purchases. Investors will certainly be paying close attention to both sets of auctions to get a better sense of supply/demand dynamics.
In currency trading, risk appetite was in the air early in the week, prompted by growing speculation that three big American banks would repay a total of $45B in government funds and also helped by the seventh consecutive month of improving German ZEW data. The resounding victory of the ruling Congress Party in India'a elections powered a 17% surge in the Sensex 30 Index on Monday on the hope that India would consolidate and extend economic reforms. However, a sense of caution crept back in later in the week, as the minutes of the April FOMC meeting posited the US recession could be longer and steeper than expected, and the World Bank cautioned that optimism about China's recovery was premature (not to mention S&P's action on the UK's sovereign ratings outlook).
In cutting its outlook on the UK's AAA rating, S&P highlighted its concern that Britain's government debt could approach 100% of GDP and stay there in the medium term. The UK Treasury immediately countered S&P's warning by saying it was confident it could sustain its debt-to-GDP ratio projection of 60% in 2009-10 and 80% in 2013-14. The UK reiterated that S&P's outlook could return to stable if comprehensive measures were implemented to put public finances on a sustainable footing or if fiscal conditions turned out to be more benign than anticipated. The USD was softer in the wake of the move, with a big assist from Bill Gross who said the US is vulnerable to losing its AAA sovereign rating for similar reasons. Concerns over the US's fiscal health were highlighted by the Congressional Budget Office (CBO), which called its own March economic forecast "too optimistic" and warned any economic recovery could take several years. The CBO also said the US jobless rate might peak above 10% in 2010. Currency and fixed-income dealers expect higher budget deficits given this change in outlook, with obvious implications for US ratings. Concerns are also simmering at the state level, especially after California voters rejected special ballot measures aimed at curbing the state's widening budget deficit on Tuesday. And keep in mind that the dollar's status as a reserve currency can only decline if recent softness persists. Dealers were noting this week that the Kingdom of Oman recently purchased sterling and euros for its reserves.
Sterling was actually having a good week before Thursday's rating action, probing its best levels since early November against major pairs, including 1.58 in GBP/USD and below 0.8800 in EUR/GBP. Within 30 minutes of S&P's rebuke, GBP/USD slumped from around 1.5800 to test below 1.5550, while EUR/GBP rose from 0.8720 to 0.8870. The GBP/JPY cross-slumped over 300 pips from intra-day highs of 149.90. The pound only managed a little consolidation from these session lows.
The greenback has tobogganed downhill all week; EUR/USD bounced off its 200-day moving average of 1.3410 on Monday and never looked back. The Portuguese Finance Minister shook things up on Wednesday stating that the EU had no concerns about a stronger a euro, and also forecasted that the EU economy would hit bottom this quarter, helping to propel EUR/USD above the 1.3650 level to test just below 1.38 by mid week. The FOMC minutes that same day kept the pressure on the USD thanks to a revised growth forecast and more hints of quantitative easing. On Friday, the pair tested the 1.4000 handle. USD/JPY ended the week testing the 94.00 level.
The weaker dollar was complemented by higher commodity prices in both energy and metals. NYMEX July crude ended the week above the $60 handle, at its best level since early Nov 2008. Spot gold also had a good week, ending at a two month high around $957. With energy and metals in positive territory, the commodity currencies like AUD and CAD were firmer.
The week in Asia was highlighted by the upgrade in the outlook for economic conditions issued by the Bank of Japan and a recovery in Japanese equities. The Bank of Japan predictably left interest rates unchanged at 0.10% but surprised the markets by raising its economic assessment on the economy for the first time since July of 2006. Over the prior session, Governor Shirakawa refuted earlier press speculation that growth forecasts for the domestic economy would be raised. However, the BoJ did in fact drop its view of a severe ongoing economic contraction, noting that the economy would moderate gradually, leading to a more pronounced recovery taking place in the second half of the year. The jury on the timeliness of the revision may still be out however, particularly against the backdrop of Japan's Q1 GDP coming in at its worst contraction on record just this week. The Nikkei briefly tested on the downside of the 9,000 level for the first time since early May, but ended the week down only fractionally.
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