With equity trading subdued, the focus was firmly on bonds and commodities this week. Entering the week there was palpable anxiety among bond traders as the Treasury geared up to sell $65B in 3-, 10- and 30-year debt. Despite shaky results in the 10-yr auction, fears of a buyers strike ultimately proved unfounded as all three auctions were easily covered with particularly robust bidding from foreign central banks. US equity indices repeatedly tested weekly highs only to retreat, with little economic data to fix on and relatively light volume. The preliminary June University of Michigan Confidence survey came in a hair below expectations, with both one- and five-year inflation expectations above the 3% level. The initial jobless claims were a bit lower than expected, while continuing claims moved out to yet another all-time high. Dispute continued over the state of a hypothetical economic recovery. Yale economist Robert Schiller told Bloomberg TV that "We may have a recovery, but I suspect it will be a disappointing one." Senior White House Advisior Paul Volcker commented that prospects for a strong recovery were unlikely, despite some growth in late 2009. On Wednesday morning, Goldman Sachs's CEO Blankfein, who seldom makes public comments, said he expects a long, protracted recession and insisted the current upturn is not the real recovery. Later the same day, PIMCO's McCulley responded, stating that he believes the recovery is for real. Crude oil futures continued to drive higher as a trade on a weaker dollar and stronger economy, ending the week at just above $72/bbl, near seven-month highs. On the geopolitical front it was Axis of Evil week, with the UN agreeing new sanctions on a recalcitrant North Korea, and Iran at the polls to select its next president. Stocks moved sideways on the week, with the S&P 500 gaining 0.7%, the Nasdaq rising 0.5%, and the DJIA edging up 0.4%, closing in positive territory YTD for the first time since early January trading.
On Tuesday the Treasury approved the TARP repayment plans of 10 banks holding a total of $68B in government funds. Goldman Sachs, Morgan Stanley, JP Morgan, American Express, Capital One, Bank of New York, US Bancorp, State Street, BB&T Corp and Northern Trust are expected to begin buying back preferred shares and warrants held by the Treasury next week. The absence of Wells Fargo from this list was widely noted; an executive from the bank said the firm has not applied to repay government funding as of yet. President Obama called the TARP repayments a positive sign, while also warning they are not a signal the crisis is over. The administration confirmed that paying back TARP meant that firms were no longer bound by various pay and other restrictions. On Wednesday the administration appointed a special official, a so-called "Pay Tzar," to oversee executive compensation at companies that are still relying on government aid. In other finance sector news, BlackRock consummated its purchase of Barclays investment unit for $13.5B, making it the world's largest money manager, while Bank of America and Citigroup were said to be facing pressure from various quarters to dump their CEOs.
Various players in the semiconductor segment offered conflicting views on whether the industry is recovering or not. Texas Instruments and Qualcomm raised earnings and revenue forecasts for the coming quarter citing returning demand for chipsets, although some analysts have wondered how much of this is due to judicious restocking of inventories and how much is from direct customer demand. In its quarterly industry survey, semi analyst firm iSuppli said forecast 2009 global microprocessor revenue would decline 16% y/y, after a 21% decline in Q1 y/y. Executives from the big PC processor manufacturers offered conflicting views: AMD's CEO echoed recent comments from the likes of Michael Dell and said it is too early to say the PC market has hit bottom and predicted Q4 is the earliest time for year-on-year growth in revenue or demand. Intel's CEO said he is confident the bottom has already been reached in the PC market. Taiwan Semi said it believes the worst is over for the chip industry and expects industry growth of 5-6% in 2009.
The smartphone wars heated up this week, with significant new product introductions from Palm and Apple. Over the weekend Palm launched the Pre smartphone; more than one commentator dubbed the phone an "iPhone killer," although others have noted its popularity may be limited by the lack of an "app store" and exclusivity on the second-tier Sprint network. At its annual developer conference, Apple rolled out new laptop models, an update to its OSX operating system and a lower $99 price point for an entry-level iPhone. But the main event was the new 3GS iPhone model, which sports a faster processor and more memory than the existing 3G models. If the contest between the two names were judged on share price alone, Palm would be the winner, with its shares up more than 15% on the week, while Apple was down about 4%. Note that Nuance and TomTom are riding Apple's iPhone coattails, as software from both firms are integral to the new 3GS's speech recognition and GPS capabilities. Share of NUAN are up around 15% on the week, while the Netherlands-listed shares of TomTom have shot up nearly 45% on the week.
With earnings season on the horizon, companies are taking the opportunity to shape expectations and fine tune guidance. Visa said it sees high single-digit growth in 2009 and believes it will return to 15-20% revenue growth in 2010, depending on the course of the crisis. Cardinal Health said its full-year earnings would be at the low end of its stated $3.50-3.60 range. Home Depot fixed up its full-year earnings outlook, saying EPS would be -7% to flat y/y (better than its prior -7% view). Clorox reaffirmed its forecast for 2010 and raised its dividend by a bit.
Landmark legislation granting the FDA the power to regulate tobacco was approved by Congress late in the week, and President Obama has pledged to sign the bill. Passage was more or less assured, and the news has been priced into tobacco stocks. Note that there has also been chatter making the rounds that Star Scientific may soon reached a settlement in its long-running patent infringement suit against Reynolds American as the two continued to battle in court this week.
US Treasury investors are clearly demanding higher yields; whether this is primarily due to the more attractive returns available in other asset classes or concerns over the country's fiscal situation is still hotly debated. The angst over rising US rates reached a crescendo on Wednesday ahead of the 10-year auction when a Russian official suggested they were considering diversifying away from US debt and buying IMF bonds. Sellers entered the market at the open and ultimately the $19B 10-year notes were reopened at an average yield of 3.99%, a staggering 80bps higher than at their original sale in May. Concerns rose among bond vigilantes over the prospects for the subsequent Long Bond offering on Thursday thanks to the large yield tail of 4 basis points, which briefly sent the benchmark above 4%. The nervousness also translated into the highest Long Bond yield since October of 2007 nearing 4.85%.
By Thursday, traders seemed to be digesting the higher rates with increased casualness. The concessions in price and higher yields proved attractive to buy and hold investors and the Long Bond auction registered above average results on every available metric. The 30-year bonds reopened at 4.72% with indirect bidders taking nearly half of the competitive bids. Prices remained bid into the week's final session and were further buoyed by comments from Japanese Financial Minster Yosano who called his nation's trust in US Treasuries "unshakeable". The US curve saw noticeable flattening on Friday as both 30 and 10-year paper yields declining some 20 basis points from the mid-week highs.
Looking ahead traders are searching for some more consolidation and settling of nerves in US government debt markets. If yields can find a tradable range below 4% in the benchmark, trepidation the recent surge rates could cut of a recovery can abate. If not markets will continue to speculate on the emergence of a "Bernanke conundrum", a notion that despite the Fed funds rate having reached a nominal floor, the Fed appears to have lost control over long term rates. The 3-month USD Libor finished the week at a new low of 0.62%, whilst according to the Mortgage Bankers Association, the average rate on a 30-year mortgage shot up another 32bps to 5.57%, its highest level since November 2008. With no new supply on the calendar for next week, extra focus will be given to this weekend's G8 ministers meeting and even more so to the Tuesday meeting of BRIC nations in Moscow. China Russia and Brazil have all verbally committed to diversifying some portion of their reserves away from US Treasuries and into IMF backed bonds and India is expected to follow suit.
In currencies, the dollar began the week on a firm note on momentum from Friday's US payroll data and rising bond yields. But pricing got back in sync with commodities in no time, as oil continued to firm on economic optimism and reports that China's industrial production data would exceed consensus expectations. In addition, the IEA raised its global oil demand forecast for the first time in 10 months. By mid-week, sentiment soured on holding dollars, with Goldman Sachs offering five reasons for a weaker dollar in a research note, including rising risk appetite, the continued climb in commodity prices and lingering doubts about its reserve currency status.
The reserve currency issue has become a primary focus ahead of the G8 finance ministers' meeting this weekend in Italy and the BRIC (Brazil, Russia, India and China) summit next Tuesday. The four BRIC nations are expected to discuss alternatives to holding dollars in reserves, a theme that Russia hammered away at on numerous occasions this week. Russian Central Bank First Deputy Ulyukayev commented that Russia was mulling plans to reduce its share of reserves held in US Treasuries in exchange for IMF bonds. However, its also worth noting that a Chinese Vice Foreign Minister said any talk of "dumping" USD was not realistic. Brazil said it was not attempting to weaken the USD but would likely purchase IMF bonds, insisting that it would not benefit from a weaker USD. There has been more talk about Special Drawing Rights (SDRs, which are an accounting chit only, not a circulated currency) as a new synthetic reserve currency, which has in turn undermined confidence in the dollar. China got the conversation about SDRs going earlier this spring, though at that time the Chinese Vice Foreign Minister insisted that the sovereign currency question was being discussed "at an academic level." (Note that the current IMF SDR basket contains about 40% USD and 37% for the EUR, compared to the current share of about 60% USD and 30% for the EUR in central bank reserves globally).
The dollar also faced a home-grown verbal barrage this week. Fed Governor Lockhart acknowledged that the dollar's role as a reserve currency might decline on a relative basis over time, while also insisting the USD would remain reserve currency for quite some time. White House Advisor (and former Fed Chairman) Paul Volcker said some sort of special reserve currency would ultimately be logical but warned there were no practical alternatives to the dollar today or "for many tomorrows." A Goldman Sachs economist chimed in as well, noting that central banks need to hold fewer dollars and forecasted a softer dollar in the medium- and long-term thanks to the growing risk of reserve diversification.
The G8 Finance Minister meeting will take place this weekend. On the topic of currencies both the German and French finance ministries noted that currencies would not likely be discussed since no central bankers would be attending the meeting (we would point out that finance ministries are the very officials who would give the actual order at the appropriate point to their respective central bankers to intervene in FX). The G8 may discuss exit strategies for the raft of unconventional measures that have been enacted to deal with the crisis.
EUR/USD began the week around 1.3855. The euro failed to react negatively to news the Swedish Central Bank had activated a currency swap line with the ECB to ensure the stability of its financial sector as concerns in Baltic region continued to simmer throughout the week. The USD was adversely impacted most by the Russian Central Bank comment of possible diversifying its $408B in reserves away from its 30% allotment in US Treasuries. The Fed's Lacker and White House Advisor Volker acknowledgment that the USD's reserve role could diminish over time also packed a hefty punch. However, The USD did manage to retrace half of its weekly losses as the week drew to a conclusion aided by some risk aversion and simple position covering ahead of the G8 finance minister summit.
Sterling was again vulnerable on continued political uncertainty in the U.K as the week began. However, perceived M&A flows helped the currency rebound from lows around 1.5800 on Monday, with dealers citing the potential $13B Blackrock-Barclays deal as the main catalyst. The UK quarterly inflationary expectations survey was higher on a q/q basis, helping precious metals and energy commodities move higher, indirectly supporting GBP.
The yen showed little initial reaction to reports that the Japanese government abandoned its long-held FY2011 primary surplus objective and moved the target out ten years. Throughout the week, the USD/JPY pair held below the key Aug downtrend resistance line with 99.00 seen as the critical level. The JPY was maintaining a softer tone against the European and commodity related currency pairs.
The week in Asia saw the major regional indices hit fresh multi-month highs on continued evidence of recovery unfolding in China, along with rosier than expected employment picture in Australia and rising speculation for an economic conditions upgrade from Japan. China's May industrial production rose 8.9%-- well above the expected 7.7% and last month's 7.3% increase that marked the lowest growth rate this year. Retail sales also painted a brighter picture of domestic demand, rising 15.2%. Australia's May jobs report echoed the implied improvement of private job advertisement data seen early in the week, as the economy lost only 1.7K jobs vs the 30K decline forecasted by analysts. Over in Japan, final Q1 GDP saw a lower contraction than initially reported, contracting -3.8% vs the preliminary figure of -4.0%. The most recent round of industrial production, which saw its best rate of growth in decades, was revised higher to +5.9% from the initial +5.2% ahead of the BOJ decision expected to acknowledge improving conditions early next week. The Nikkei225 took out 10,000 to end the week at 10,135, its best levels since early October, and Sydney's S&P/ASX rose above 4,060 for the first time since mid-November.
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