Investors cranked up the risk appetite again this week, helping US equity indices recover all the losses sustained in last two weeks. With little data to get in the way and the dollar on the defensive, a choir of analysts and commentators preached that consensus estimates are too conservative and corporate earnings would surprise to the upside as earnings season begins. That was certainly the case with Alcoa, which did much better than expected on Wednesday. Incremental improvements were seen in the September ISM non-manufacturing index, weekly jobless claims and the August Trade data. Same-store sales evidenced the beginnings of recovery for retailers, with some names finally returning to positive year/year comps and many others beating expectations. Distant signs of trouble were seen at the GSEs, as the FHFA warned that delinquency rates for mortgages held by Freddie and Fannie are still rising and said the two firms "appear destined for a taxpayer bailout in the next 24-36 months." With some editorialists contemplating "the demise of the dollar," commodities pushed higher all week, and gold futures broke out to new all time highs, ending the week around $1,050. For the week, the DJIA increased 4%, the S&P 500 rose 4.5% and the NASDAQ Comp gained 4%.
After months of rhetorical debate over timing the withdrawal of extraordinary support for markets, the Reserve Bank of Australia (RBA) became the first G20 central bank to back away from an accommodative monetary stance this week. The RBS raised interest rates 25bp to 3.25%, and while the decision caught some markets by surprise, several influential sources had been predicting the move. Before the decision the Sydney Bank Bill was fully pricing in 50bps worth of hikes by December and several noteworthy columnists were anticipating a 25bps hike. After the move the Australian dollar pushed above the 90-cent level against the greenback while equities in Sydney hit a fresh 12-month high. With the genie out of the bottle, debate is now focusing on who will be the next to tighten. On Friday, the New York Times reported on divisions over exit strategies at the Fed. Despite the fact all members agree on the need to keep rates at zero for an extended period of time, they remain divided on the best pace for tightening. According to the Times' count, FOMC members Hoening, Fisher, Lacker, Plosser and Warsh are all pushing for rapid hikes once the recovery is assured, while the likes of Dudley and Tarullo are decidedly more cautious. Note that on Wednesday Hoenig said the FOMC could raise rates for "some time" before policy gets "tight." For his part, Fed Chairman Bernanke hit the airwaves late on Thursday with a speech almost exclusively devoted to exit strategies, but gave no indication of his bias.
Alcoa rang in the third quarter earnings season with a relatively strong report, helping to whet risk appetite and stoke optimism for another strong quarter for corporate results. The stock traded sharply higher on Wednesday morning after its report, but sold off the rest of the week as investors noted that revenues were only in line with expectations while its better than expected earnings results were mainly resulted from cost reductions. Commentators have been frequently repeating that the next leg up in markets depends on revenue gains, which would indicate solid improvements in demand, rather than the "sugar high" based on cost cuts that drove last quarter's successful earnings season.
Contrasting high-level commentary from BoA/Merrill Lynch and Credit Suisse showed just how opaque the picture is for markets as they head into earnings season . Analysts at BoA/Merril believe a correction in S&P500 "appears underway" and that all signs point to a steeper declines, citing technical development and the weakening tech sector, among other factors. Analysts at Credit Suisse updated their global equity strategy, noting that they continue to believe that now is not time to sell equities. Credit Suisse believes that a near-term correction is possible, but sees the S&P500 at 1,100 at end of 2009. HSBC's CEO was also out with his own troubling read on the macro situation, noting that his firm would delay expansion of the bank because of fears over another downturn in the economy.
The leading US banks helped drive gains in equity markets this week, as investors piled on ahead of earnings reports from Goldman Sachs, JP Morgan and Bank of America next week. One exception was Citigroup, where CEO Pandit's leadership performance was under the microscope this week. Regional banks seemed to divide into two batches, with select names like Wells Fargo, SunTrust, Fifth Third, MTB and US Bank gaining along with the tier one names. Others such as Regions Financial, PNC and especially Marshall Ilsley are down on the week as investors worry about deepening commercial mortgages and construction loan losses. This week the Fed's Lacker noted he is seeing an increase in losses in commercial real estate and other construction among financial firms, and Fed Governor Rosengren expressed concerns about losses related to commercial real estate, as well. Note that Marshall Ilseley warned investors on Wednesday that its Q3 loss would be nearly twice the expected amount. On Friday UBS initiated the large cap regional bank sector at Neutral, making cautious comments related to this issue.
The recent resilience in government bond markets has for the most part continued this week, although a shaky 30-year bond reopening on Thursday saw the market reverse course, with yields probing their highest levels of the week on Friday. The preceding three- and ten-year auctions were taken down with ease as reports of South East Asian central bank buying permeated the market. With the greenback under pressure, some dollars purchases undertaken to maintain fixed exchange rate regimes were evidently deposited right back into the Treasury market. Domestic money seems happy to work its way out the curve in the reach for yield, but just not to the very long end, which in hindsight was looking overbought heading into the auction, given the sub 4% yield. Next week is shaping up to be crucial, with Q3 earnings season coming to boil and key reports from the financial sector likely to gain the market's undivided attention. Lingering skepticism over the recovery, which has to some extent underpinned recent strength in Treasuries, could be vindicated or found wanting.
Currency markets navigated rising risk appetite, central bank smoothing operations and verbal intervention from a variety of government officials and corporate names this week. The greenback remained on the defensive, with dollar weakness driven by the RBA's rate hike and strength in precious metals, especially gold, which pushed out to fresh all-time highs around $1,061.50 (though still far from inflation adjusted highs which would be around $2,200). China's return to trading (with the Shanghai composite up 5% after a holiday most of last week) and very strong Canadian employment data also aided risk appetite. A key topic of debate was Tuesday's front-page newspaper article in the UK's Independent, titled "The Demise of the Dollar." The piece claimed that various Persian Gulf oil states and China, Russia, Japan and France had agreed to stop buying oil with dollars and use a basket of currencies instead. Reportedly secret talks had already taken place among finance ministers and central bank governors. Soon after the report, officials from nearly every nation said to be involved in the plan went to great lengths to deny the veracity of the article. Japanese Finance Minister Fujii began outlining his position on the dollar, noting that recent moves in USD/JPY were due to a weak dollar rather than a strong yen, citing US interest rates as a factor in the trend.
The ECB and BoE rate decisions were non events, although few were seriously expecting any significant changes to come out of the policy meetings. A widely followed think tank report mid-week suggested that ECB Chief Trichet and other EU officials might talk the euro down in a manner similar to recent comments from the BoE's Mervyn King. However, the market seemed disappointed with Trichet's remarks, which mostly comprised G7 boilerplate, including the assertion that excessive FX volatility was unwanted. Trichet also welcomed the recent strong dollar statements from US officials, calling them "extremely important," and warned that he would never comment on FX intervention, pledging to act rather than talk on the topic. There was some corporate verbal intervention from Airbus's CEO, who noted that dollar weakness was causing European exporters some problems.
EUR/USD strengthened over the course of the week from 1.4605 to test above 1.4820 after the ECB press conference on Thursday, but was unable to take out the September highs of 1.4844 despite spot gold's surge to all-time highs. USD/JPY hit a fresh nine-month low at 88.01 but was unable to take out the substantial USD sell-stops lurking below the level. Dealers continue to speculate whether Japan's Kampo has been on the bid at 88.00 level, implying unofficial smoothing operation by the Finance Minister and the Bank of Japan. Large USD sell stops are now building below the 88 handle in the event that suspected bids are pulled or fail to materialize.
Several Far East central banks acted to curb the appreciation of their respective currencies, including the Bank of Korea, the Thailand Central Bank and the Central Bank of the Philippines. Dealers noted that Russian Central Bank was selling foreign currencies in its basket. One dealer noted that this sort of activity usually involves buying USD to halt RUB appreciation and said subtle differences in buying currencies instead of USD might have implications for rebalancing. The Bank of Korea stayed on hold at 2.00% as expected. Commentary from the BoK was far less of a close call than anticipated, suggesting the markets may have gotten caught up in the post-RBA tightening euphoria. Governor Lee said he sees upward inflation pressures remaining weak and uncertainty reigning over the economy despite the real-estate boom. While Q3 GDP may advance beyond estimates, Lee said Q4 would still be weaker.
The good news Down Under continued later in the week with an unexpected decline in jobless rate justifying the monetary policy optimism. Unemployment fell to 5.7% v expected 5.8%, and the economy created over forty thousand jobs v expected loss of ten thousand. Particularly notable was the rise in the full-time component of the jobs report which grew by 35 thousand- the first expansion in 5 months. Speaking after the release, Australia's labor minister noted that the improvement is evidence of the positive impact of fiscal stimulus, but also warning that economy remains fragile and that accommodative conditions need to be preserved. Moreover, Treasury Secretary Henry, speaking later in the week, saw much of the recent growth in the economy the result of the stimulus, forecasting the exit to subtract as much as 1.25% from Australia's GDP in 2010.
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