The healthy glow bestowed on markets by last Friday's employment data vanished early in the week, chased away by a wave of doubt that China alone can't be the main driver steering the world away from recession. Repositioning ahead of Wednesday's FOMC decision returned US equity indices to levels seen at the end of last week - in the event the Fed held steady on rates and said it wasn't walking away from its liquidity programs as of yet. But in the back half of the week markets buckled under the weight of economic releases that reminded everyone about the threat to consumer spending and the overall recovery from the toxic combo of rising unemployment, declining home prices and tight credit. The preliminary August University of Michigan confidence index was much worse than expected (63.2 v 69e), July advanced retail sales numbers turned negative again (-0.1% v 0.8%e) and RealtyTrac's July foreclosures were up 7% m/m (and 32% y/y) for a new record high. Nevertheless, the sentiment that has emerged over the last two weeks is that the worst is over, a double-dip recession can be avoided and US economic growth will return by the end of this year or perhaps next. For the week all three of the major US indices were off roughly 0.5% or more.
Less than a week after the improved US employment reports sparked talk of an accelerated economic recovery in the US, France and Germany surprised markets by pulling themselves out of recession. Preliminary GDP figures from Europe's two largest economies showed growth of +0.3% during the second quarter. However, fiscal stimulus and domestic consumption had a bigger impact than economists anticipated, making many wonder whether growth can be sustained as the countries are inevitably weaned off government support. Despite accounting for almost half of the regions output, France and Germany were unable to pull the overall Euro Zone GDP out of negative territory, with the "Club Med" nations of Italy, Spain, Portgual and Greece all still firmly in contraction.
Financial sector names sagged early in the week as markets traded off and analysts threw cold water on the banks. On Tuesday Rochdale's Dick Bove recommended taking short term profits in financials, noting that bank stocks are "running on fumes." Citigroup fell more than 8% that morning. Adding to weight in the sector was a monthly report out of the Congressional TARP Oversight Panel calling on regulators to consider more bank stress tests and fresh CIT bankruptcy fears. But the good news from the FOMC and a vote of confidence from hedge fund manager John Paulson helped the sector recover in the latter half of the week. Paulson bought 168M shares (for a 1.9% stake) of Bank of America, making him the fourth-largest holder in the company. Paulson also added 2M shares in Goldman Sachs, as well as new positions in numerous regional banks.
News from global giants Walmart, McDonalds and many other retailers only reinforced fears about the state of consumer demand. McDonald's reported July global comps at +4.3%, its weakest monthly showing since its +1.4% February comp. The company noted that its Asia sales were impacted by declines in China. Walmart came in slightly ahead of earnings estimates and a bit below revenue targets, but same-store sales notably turned negative for the quarter (for the first time in many years), declining significantly on a sequential basis. Mid-market department store names Kohl's and JC Penny guided well below estimates for next quarter.
Preliminary Q3 revenue figures from Toll Brothers beat the Street by nearly $100M and complimented recently bullish housing sector data and offset the RealtyTrac numbers. Toll's CEO pointed to the increase in the number of net contracts signed this quarter as a reason for optimism. "This marked the first time in 16 quarters - dating back to Q4 of FY05 - that our net contracts exceeded the prior year's same quarter," he said. In other news, GM bragged about the Volt's fuel efficiency, claiming it would get 230 mpg in city driving. A closer look at the figures showed that this would be for the first 50 miles (40 on the battery alone, 10 on the gas generator), while longer driving on the gas generator would make for efficiency of 50-100 mpg.
Heading into the week bond investors were noticeably anxious ahead the $75B in Treasury coupon supply on the docket and an FOMC statement that needed to walk a very fine line to keep expectations in check. Ultimately the supply was absorbed relatively smoothly and the Fed deftly managed expectations in its statement. The latter noted that economic improvement continues to gain traction, making it possible to commence the exit strategy as soon as this fall, while also reassuring that rates would remain unchanged for quite some time. Wednesday's 10-year note offering tailed significantly, but all was quickly forgotten when Thursday's sale of $15B in long bonds met with resounding success (despite the significant duration extension). With supply on hiatus next week, yields are looking to end the week significantly lower while a multi-decade low in annual US CPI and the second successive month of negative inflation in Europe have made real yields look increasingly attractive, fueling bullish sentiment in government bonds. The US 10-year yield has declined around 30 basis points from where it entered the week, nearing 3.5% once again. The two-year gilt yield made a new all time low late in Friday's session below 0.9%. Fed fund futures recouped their post non-farm payroll losses and then some, highlighted by a March 2010 contract that continues price out the likelihood of even a 25bp hike in first quarter.
High-yield issuance attracted some attention this week with a raft of notable offerings, although some spreads reportedly widened out for the first time in weeks. Dish Networks, Sirius, CNH Global, Ball Corp and NII holdings were just a few of the names that came to market, helping to make it one of the biggest weeks of the year for speculative grade issuance. Three-month USD Libor ended the week at another record low below 0.43% while the Libor -OIS spread moved back below 0.25% for the first time since Jan 2008 - a level previously referred to by former Fed Chairman Greenspan as "normal."
The response in currency markets to the July employment reports prompted healthy debate as the week began. Dealers debated whether the dollar strength seen last Friday really represented decoupling from the higher risk appetite/weaker dollar paradigm or whether interest rate differentials are now driving sentiment. The rate differential camp triumphed on Monday as the dollar initially shrugged off news that would have typically dampened sentiment, namely a letter from Treasury Secretary Geithner to Congress projecting the current debt limit could be reached as early as mid-October. Geithner wants Congress to increase the current $12.1T debt limit over the next two months, although the letter did not request a specific increase. As the week progressed, the market ignored several more issues that not so long ago would have spurred a degree of risk aversion and sent the dollar higher, such as Russia's record-breaking -10.9% Q2 GDP, S&P's sovereign downgrades of several Baltic countries and skepticism over China's ability to lead recovery. As the week wore on EUR/USD softened toward the 1.4300 neighborhood after the Fed reassured markets it would avoid any rush to the exits in its various extraordinary programs and France, Germany and the Euro Zone released better-than-expected Q2 GDP data.
In specific price action, EUR/USD began the week above the 1.4150 level with speculation there were plenty of euro sell stops lurking below that level. The cross tested 1.4050 in the aftermath of the FOMC announcement but seemed to have been met with good buying from Far East sovereign names. Middle Eastern participants were also seen buying euros, reportedly on behalf of Volkswagen's financial partner in its tie-up with Porsche. EUR/USD tested above the 1.43 level on a few occasions but managed to stay below the hourly pivot point.
If any decoupling occurred during the week it was in the yen. The currency maintained a firm tone against its major pairs despite Japanese press reports that exporters have lowered internal budget rates for the USD/JPY from 95.00 toward the 90 and 91 handles. In addition, there has been growing speculation that a new Japanese government run by the current opposition might accept the stronger yen seen in recent sessions after its likely victory in the country's August 30th national elections. USD/JPY probed the lower end of its 95 handle as the week progressed. The BoJ kept interest rate unchanged and maintained it economic assessment that the economy has stopped worsening and is likely to pick up in the second half of 2009 or the first quarter of 2010.
In Scandinavia, the Norwegian Central Bank surprised the market with hawkish rhetoric. The bank left its deposit rate unchanged at 1.25% (as expected) but acknowledged that it might be appropriate to start raising interest rate earlier than previously indicated. The Danish Central Bank unexpectedly lowered its key interest rate by 10 bps to 1.45%. The South African Central Bank also unexpectedly cut its interest rate by 50 bps to 7.00%.
The week in Asia centered around the equity rally hangover in China, where the Shanghai Composite has retreated more than 10% over the last two weeks (coming after a 70% gain in the first seven months of the year). Most of the decline came in Wednesday's big drop, which followed less-than-stellar economic data on Tuesday. The +10.8% July industrial production reading registered its third consecutive monthly improvement, but fell short of the 11.5% expected figure. Year-to-date China's industrial production has risen 7.5%, but that was also softer than the 7.7% forecast. Markets were also hoping for an improvement in inflation figures after multi-year lows in June, but both CPI and PPI yet again registered their most negative results since at least 2003. The data debacle prompted influential pundits to air fresh skepticism over a Chinese recovery. One FX dealer marveled at how quickly the word "contagion" has been forgotten, especially given the "sugar high" powering US, European and other stock markets. Most notably, the London Telegraph's Ambrose Evans-Pritchard wrote that the numbers raise doubts about the strength of global trade and whether China can meet expectations that it would power a global economic recovery. More specifically, he labeled the Chinese equity market a "giant Ponzi scheme" and pointed to the falling Baltic Dry Bulk Index as indicative of a drop-off in Chinese commodities restocking.
Trade The News Staff Trade The News, Inc.
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