US equity indices have sustained modest gains in the four-day trading week (markets were closed for Memorial Day on Monday) on modest volume as investor attention has focused on big moves in bond and currency markets. With the fallout of the massive US budget taking its toll, yields on US Treasuries and currency trading in USD pairs took out key levels all week long. Bond guru Bill Gross summed up the situation in fixed income, noting that the "new normal" for Treasuries has arrived, warning that markets are wondering who will buy USTs moving forward. The EUR/USD closed out the week back above 1.41 for the first time in five months, helping to propel crude futures above $66/barrel. Crude had its biggest one-month percentage gain in nearly a decade in the month of May, rising over 30%. For its part OPEC met in Vienna and left its output levels unchanged, but said it would focus on continuing to improve compliance. Consumer confidence data surprised investors this week, with the Commerce Department reporting its May confidence reading well above expectations, hitting a seven month high. Markets also shrugged off a much worse than expected Chicago Purchasing Managers Index on Friday. That helped propel stocks to another weekly gain: for the week, the S&P 500 rose 3.6%, the DJIA gained 2.7% and the Nasdaq Composite climbed 4.9%.
Three separate data reports this week offered mixed signals on the US housing market, presenting no clear bottom yet. On Tuesday the March S&P/CS Home Price index was in line with expectations, but it's worth noting that the index has fallen more than 19% in Q1, the biggest y/y decline on a quarterly basis in its 21-year history. Home prices in the 20 cities tracked by the composite index fell by 18.7% y/y in March, which is a slight improvement over the February data. On Wednesday the National Association of Realtors' April existing home sales reading was +2.9% m/m, although the backlog of unsold homes rose 9% from March levels, with 10.9 months of supply in the pipeline. NAR's Chief Economist said most sales are in lower price ranges, with activity just beginning to pick up in the mid-price range while high-end sales are still sluggish. On Thursday the April new home sales data was a bit below expectations, with the backlog of homes in line with the NAR's data, at more than 10 months supply. Mortgage delinquencies surged in Q1 to 9.12%, marking the fifth consecutive month of record highs. One ominous component of the delinquencies data indicated that nearly half of rise in Q1 foreclosures in Q1 was accounted for by prime, fixed-rate mortgages.
A GM bankruptcy is now expected sometime on Sunday or Monday. Executives and bondholders discussed terms of a potential deal all week, taking negotiations down to the wire. On Wednesday unsecured bondholders rebuffed GM's offer to exchange more than $27B in debt for a 10% equity stake in a reorganized company, forcing executives to sweeten the deal by adding warrants to buy a further 15% stake after reorganization. Some bondholders have accepted the improved offer, calling the proposal their best option and also noting that bankruptcy litigation would be "costly and uncertain," while the Main Street Bondholders continued to hold out against the proposal. The administration said on Thursday it would commit another $30B in funding to GM (with another $9B from the Canadian government), estimating the company would emerge from bankruptcy in 60 to 90 days and go public again after 6 to 18 months. On Friday, the UAW membership approved further concessions to GM, which along with a bondholder deal could smooth out bankruptcy proceedings.
An FDIC report this week offered a mixed picture of the performance of US banks in the first quarter of 2009. According to the report, profits in the quarter were buoyed by revenues at a few larger firms, but overall the credit picture remained grim as the number of banks on the brink continued to rise and consumers and businesses increasingly fell behind on their loans. Net profit at US banks was $7.6B for the quarter was down y/y but much improved from the $36.9B loss in the final quarter of 2008. FDIC's Bair said that asset quality remains a major concern, troubled tier-1 loans continue to accumulate and costs associated with these impaired assets are weighing heavily on banks. There were also reports this week that Fed has quietly informed banks that they will have to rely less on future earnings when determining capital raising plans, with projected revenue permitted to covering no more than 5% of their capital shortfall. Some banks had reportedly been planning for improved revenues to cover as much as 20% of their shortfalls.
Trading in US Treasury markets captivated the entire spectrum of traders and commentators this week. Despite the relatively warm reception to the Treasury's 2-, 5- and 7-year note auctions, by mid-week yields had surged through key levels with alarming ease. Traders dumped US paper noticeably after both the 2- and 5-year auction results, as concerns about the government's ability to find corral demand for longer-dated supply overshadowed the healthy short-term auction. Wednesday afternoon the benchmark 10-year yield surged towards 3.75% sending the spread above 275 basis points, briefly topping all-time highs made back in 2003.
Reaction to the surge in interest rates sparked concern after the selling in government paper was matched by selling in mortgage-backed bonds. Fears began to circulate that an impending move up in mortgage rates could quash any recovery in the housing market. The average 30-year fixed-rate mortgage jumped above 5.4% for the first time since February. By Thursday worries were growing that the Fed was losing its ability to influence mortgage rates as spreads between mortgage-backed securities and comparable Treasuries widened at a faster rate than the overall rise in Treasury yields.
A relatively good showing in the 7-year note sale late on Thursday provided some relief as the near hysteria seen by the sharp decline in stocks and the USD that accompanied the surge in interest rates abated. Treasury yields retraced, with the benchmark yield falling back below 3.5%, and 2-10y spread narrowing towards 250 basis points. Traders and prognosticators alike seem to be resigned to the fact that although rates are up sharply over the past two weeks, they still remain at historically lows levels. Markets also appear to be shrugging off the inflationary implications of the recent move and focusing instead on its likely signal of an improving economic environment that could convince investors to reallocate to riskier assets. Next week's 10- and 30-year auction announcements could renew uneasiness in markets, especially if they differ widely from expectations. But with no new supply scheduled until the second week of June, Treasury markets are likely to consolidate in an attempt to digest the recent move. Markets will also surely be watching the Fed to see if they provide any signals that they intend to defend rates through their outright securities purchases.
In currencies, economic data and bond auctions battled it out this week to dictate the overall tone. Early in the week there was talk that major central banks might be caught in a dollar trap as countries with large US Treasury holdings (particularly China) were seen as having little choice but to keep pouring reserves into USTs, since they comprise the only market big and liquid enough to support huge purchases. China sent signals to the Federal Reserve that it is increasingly disturbed by the US freely printing money. PIMCO's El-Erian said no other currency could replace the dollar as the world's reserve but warned that some holders might diversify their holdings. Currency dealers kept a wary eye on the Russian Central bank as one indicator of the trend in EUR/USD, given that the Russians have been trying to keep the ruble from strengthening by buying euros. The deputy chairman of the Russian Central Bank insisted once again that the bank has no plans to change the makeup of its dollar/euro basket (currently 55% USD and 45% EUR). Later in the week South Korea's Pension Fund indicated it might diversify currency holdings away from the dollar.
Comments in defense of the dollar out of US officials and rating agencies didn't help things. Various parties insisted the AAA sovereign ratings of the United States were safe despite the growing supply of Treasuries on tap to pay for US deficits. A senior S&P analyst said US ratings are not under immediate threat, a comment later reiterated by Fed Governor Fisher. There was a certain amount of skepticism that the Treasury would find buyers for the $100B of bonds it planned to sell during the week. Note that the US needs to sell $3.3 trillion of Treasuries by Sept. 30th to fund bank bailouts, stimulus spending and a record budget deficit. In addition, there was dealer chatter that the administration would unofficially pursue a weak dollar policy to support the manufacturing sector.
Risk appetite found traction after the May consumer confidence data beat expectations, and various soft data components continued to improve. Central bankers and government officials maintained an optimistic tone that the worst of the global recession was over, though caution remains on the growth front. In China the PBoC warned the global economy has yet to hit bottom and a Chinese economic recovery is not under way yet. Hard data continues to be weak, exemplified by the US housing data. By the end of the week USD sentiment was on the ropes, exhibiting weakness against the major pairs, emerging market pairs and commodity-related pairs. Note that the USD benefited slightly from its safe-haven status following the North Korean nuclear test and numerous missiles launches. The dollar ended the week and the month of May on shaky ground, with EUR/USD moving toward the 1.41 level, while GBP/USD tested above the 1.61 handle for the first time since Nov 6th. EUR/GBP moved below the 0.87 level for the first time in three months and GBP/JPY tested above the 155 level.
The yen began the week weaker against major pairs due to political risk emerging from the North Korean nuclear test. Downside momentum picked up a bit as dealers focused on the launch of two large Toshin funds. USD/JPY moved above the 97 handle for the first time since May 13th. Dealers said money has been leaving Japan in search of higher yields as global economic growth potential brightened. Commodity currencies also regained some composure as oil firmed up over the course of the week; CAD remains strong and fell below its 200-week moving avg at 1.1147 as NYMEX crude tested above the $66 handle.
The week in Asia featured broad-based strength for commodity-driven markets as well as the currencies of Australia and New Zealand, with the rally in the Aussie and Kiwi dollars reaching multi-month highs against the greenback while also outpacing the gains seen in the European majors. AUD/USD rose above 0.79 and NZD/USD traded above 0.63 for the first time since early October, as EUR/AUD declined steadily from 1.80 all the way down to 1.7650 on a mixed batch monetary, credit, and corporate developments. The Reserve Bank of Australia is expected to retain its status of having the highest overnight lending rate of all major economies at 3.00% when it meets early next week, having previously suggested increasing sensitivity to global recovery sentiment and a far more sparse pace of easing. In New Zealand, expectations of longer-lasting budget deficits did not unhinge currency underpinnings under the dreaded scrutiny of credit rating agencies, with Moody's maintaining Stable sovereign rating and S&P actually raising its outlook on foreign currency rating to Stable, citing improvement in fiscal flexibility. On the corporate front, mining giants in Australia secured contracts with Korean and Japanese steelmakers, while also proclaiming resurging demand from the "bottomed out" China markets.
Trade The News Staff Trade The News, Inc.
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