The bull market in equities continued this week, with the key US indices pushing out to year-to-date highs each day through Thursday morning. Fed Chairman Bernanke added fuel to the fire early in the week, telling an audience at the Brookings Institution that the recession is "technically" over (though warning that the economy will feel weak for some time). Data has supported the bullishness. On the supply side, industrial production data was robust: the Commerce Department's August index was stronger than expected, while the Empire State and Philly Fed regional surveys were sharply higher than the consensus. On the demand side, August retail sales rose by the largest amount in more than three years, completely reversing July's very modest decline, spurred by gains that went beyond just the expected increases of auto sales due to Cash for Clunkers. Some economists appear to be at odds over the economic outlook, however. Goldman Sachs' Chief Economist Jim O'Neill said the global recovery is "beyond a V shape" and insisted the recovery will positively surprise markets, while Morgan Stanley's Stephen Roach said the weak consumer recovery in the United States guarantees there will not be a V-shaped recovery. Not even concerns of a brewing trade war between the US and China could shake the markets. In any case, late summer theories that September would follow its track record of poor performance have been left in the dust. For the week, the DJIA rose 2.2%, the S&P 500 climbed 2.4% and the NASDAQ Comp added 2.5%.
Protectionism flared up in Asia as the US and China traded accusations early this week, raising fears that trade war could extinguish a fragile economic recovery. Following the move by the Obama administration to authorize new tariffs on tire imports, officials in China retaliated with an accusation that US autos and chicken products are being dumped unfairly in local markets. President Obama defended his decision during an appearance on Wall Street, suggesting the tariffs represent an enforcement of existing WTO rules but downplaying market worries over a potential US-China trade war. On Wednesday, US Steel filed its own anti-dumping petition with the International Trade Commission, prompting China's Commerce Ministry to decry protectionism once again, followed by a threat to sell off some holdings of US treasuries at moments of strength in the US Dollar.
This week marked the anniversary of Lehman Brothers' collapse, the government takeover of AIG, and the inception of the Troubled Assets Relief Program. Today the financials are leading the rally in equity markets, and stability if not fiscal health seems to have returned to the sector. There were reports this week that the Treasury may choose to sell its 34% stake in Citigroup beginning as early as October, although there was no official confirmation of these reports. Citigroup CEO Pandit said he wouldn't be surprised if the Treasury began selling down its stake, insisting that Citi's main goal was to return to profitability, while paying back TARP was a secondary priority. Rochdale's Dick Bove questioned Citi's ability to turn a profit, saying he expects Citi to lose money in Q3, while analysts at BoA/Merrill Lynch see the sale of US government's stake in Citi as having only a small dilutive effect as there is little chance the government would exit its equity position in a disorderly fashion. Respected academic economist Joseph Stiglitz dismissed all the industry sunshine and warned that the banking industry's problems are bigger now than before Lehman's demise, saying that "in the US and many other countries, the too-big-to-fail banks have become even bigger."
Various legislators and regulators ratcheted up their rhetoric on the process of clamping down on the financial industry, a subject which is expected to be a major theme at next week's G20 meeting in Pittsburgh. The Fed is in the process of developing proposals to regulate pay for bankers, including guidelines on incentive compensation (rather than hard caps) across all firms it regulates, with final proposals due in a matter of weeks. Rep. Barney Frank reiterated that Congress was committed to imposing "very tough" regulations on derivatives. FDIC Chief Bair warned that excessive application of mark-to-market standards can exacerbate losses in times of stress and reiterated once again that the "too big to fail" issue must be addressed.
Another batch of firms offered pre-earnings season guidance this week. Steelmaker Nucor, which offered dire guidance for its Q3, saying it expects a sizable loss in the quarter that would be three or four times the expected amount. The company said it sees little improvement in real demand and warned uncertainty in the US economy remains high, and said the unexpected loss stems from high-cost inputs. Manufacturer Rockwell Automation and Illinois Tool Works raised 2009 and Q3 guidance, respectively, while agricultural machinery manufacturer AGCO slashed its 2009 revenue and earnings guidance.Semi names Rambus and Silicon Labs joined the rest of the industry and hiked guidance for Q3. Health insurance name Amerigroup cut its 2009 earnings forecast on higher-than-expected medical costs in the second half of the year. Auto parts manufacturers Autoliv and American Axle both offered guidance: Autoliv raised its revenue forecast for Q3 slightly while American Axle's revenue outlook for the quarter was a bit soft. Fortune Brands reaffirmed its full-year view, noting that rising consumer confidence and improving home sales were encouraging for its business.
In M&A action, Adobe said it would acquire business software firm Omniture for $21.50 per share in cash, in a deal worth $1.8B. Some commentators have pooh-poohed the deal, saying there are scarcely any synergies between the two firms, but the management of both firms are enthusiastic about the deal.
Treasury market prices have held up surprisingly well in the face of improving economic data, strong performance in equity and commodity markets, and another announcement of increasing notes supply. Yields did make a move to the upside midweek, only to retreat in the face of key psychological levels. Gold prices neared all time highs, which stoked talk of inflation hedging, but in the end this also had little effect on bond trader psyche. The 2-year note was unable to sustain a move above 1%, the 10-year Note found the 3.50% level insurmountable and the Long Bond, which has outperformed all week, found support above 4.25%. That a sizeable portion of the ample liquidity provided by central banks has made its way into government debt now goes without saying, and the expiration of the Treasury's Temporary Guarantee Program for Money Market Funds on Friday was offered up as another plausible explanation (notably, late Friday, reports emerged that a privately run backstop is being contemplated). The question is whether next week's $112B in 2-, 5- and 7-year supply will be the will be a catalyst for the hibernating Treasury bears or another quiet success for the resilient bulls.
Almost a year to the day from Lehman's demise, two British banks provided a major wake up call to a market that appears to be ignoring the significant amounts of toxic debt yet to be purged from the global banking system. Barclays' Bank announced the "sale" of $12.6B in illiquid mortgage assets to a vehicle controlled by two former employees. The bank provided $12.3B in debt financing for the fund's purchase, and will retain the assets on its balance sheet, but crucially, will no longer be required to carry the assets on its books at market value. Meanwhile British regulatory authorities determined that Lloyd's is not of sufficient health to avoid participation in the government's insurance scheme for toxic assets, with the likely endgame for the company dilution via an increased Government stake. In the United States, many of the key financial institutions that were so prevalent in headlines in the lead-up to financial Armageddon just a year ago continue to take advantage of dramatically improved credit markets. The likes of GE Capital, JP Morgan, Citigroup, HSBC, Morgan Stanley and Bank of America all raised money through debt sales in a variety of currencies.
In currency trading this week, the greenback continued to hit fresh year-to-date lows against the euro and Swiss Franc and seven-month lows against the yen. The overall market sentiment is that the weaker dollar trend is being driven by reserve diversification, encouraging more commentary that the dollar is becoming a "carry trade" financing currency. Many dealers say this is a good explanation for why the dollar seems unable to recover, even on positive economic data. The shaky dollar was further rattled by comments from former Fed Chairman Greenspan, who said lawmakers could hamper Fed's ability to rein in monetary stimulus, causing inflation to swamp the bond market. The very mention of inflation sent spot gold to fresh 18-month highs and fed right back into the weak dollar theme.
Looking ahead, dealers are wondering whether a shift in US interest rate expectations could support the dollar. A think tank report out midweek asserted that two Fed members have been discussing the removal of accommodation sooner rather than later and claimed the members are moving from a neutral to a hawkish bias. One dealer pointed out that the widespread thinking that interest rates would stay low "forever" might provoke some sort of upwards adjustment in the near future. Commentator Dennis Gartman observed that the USD may be headed for a technical correction soon, given that markets are overwhelmingly short the USD.
EUR/USD moved above 1.47 for the first time since last December. Sterling lagged its European counterparts and actually weakened against the USD after the BoE's King said he did not believe bank reserves remain unnecessarily high, noting that he is looking at ways to reduce reserves, including a cut in its deposit rate. There was some press commentary that GBP was also looking ripe for the carry trade, which weighed upon sentiment. GBP/USD was hovering near 1.6300 as the week ended. The Swiss National Bank maintained its 3-month LIBOR target at 0.25% (as expected) and vowed to continue to fight any CHF currency appreciation. The Russian Central Bank cuts its refi rate by 25%, in line with earlier statements. The Mexican Central Bank maintained its overnight rate unchanged at 4.50% and removed "rate pause" comment in its post-decision statement.
In specific price action, JPY began on a firm tone as traders speculated the new Japanese government would adopt a fresh approach to currency policy. Incoming Finance Minister Fujii reiterated his post-election position that a strong JPY had merits for the Japanese economy and insisted there was no need for currency intervention if moves were gradual. The BoJ's Shirakawa echoed Fujii's position, saying JPY appreciation could support the economy in the long run. The market noted the new government's official stance, with USD/JPY probing toward 90.00, where option barriers were said to be lurking.
On Friday, the Bank of Japan raised its assessment for the economy for the first time since July, citing improvement in exports and manufacturing output. However, policymakers allowed for further downside risks on deteriorating employment and consumption, while calling for inflation to decline faster than previously expected. Japan's new finance minister said the incoming administration is looking to suspend a portion of its extra budget under its plan to eliminate wasteful spending and possibly cut issuance of new government bonds. The minister estimated savings of several trillion yen but declined to provide more details before next month.
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