The week commenced with markets squarely focused on the first official remarks from Fed Chairman Bernanke since the FOMC meeting two weeks ago. The advanced text of his speech to the NY economics club appeared heavy on strong US dollar rhetoric, providing some hope for the weary greenback. This rhetoric was quickly dismissed as it became clear that a continued low inflation outlook coupled with a dismal employment picture will force the Fed to keep rates low for an extended period of time. In the Q&A session, the Chairman acknowledged that the Fed needs to deal with the possibility of developing asset bubbles, but noted he has yet to see any "large misalignments" in US valuations. The weaker-than-expected US Producer Price Index and Industrial Production data only confirmed Bernanke's comment that significant challenges still face the US economy and prompted many to speculate that the FOMC's long period of low borrowing costs might get even longer. As PIMCO's Bill Gross wrote in his monthly outlook this week, the US needs another 12 months of 4-5% nominal GDP growth before the Fed dares exiting the "0% foxhole, mini-bubbles or not."
Many participants took Bernanke's comments to mean the door will remain open to the notion of the US Dollar as a funding currency and the accompanying expansion of risk appetite. The Fed's Yellen only added strength to this argument (and raised some eyebrows) when she said on Wednesday that the US stock market is not overvalued and credit spreads do not reflect a bubble. In addition, the Fed's Bullard gave markets a history lesson, warning that the FOMC did not begin rate increases until two to three years after the end of each of the past two recessions. The comment was misinterpreted and immediately sparked rumors that Bullard had said the Fed would be "on hold" until 2012, providing bearish dollar momentum and boosting spot gold to yet another all-time high.
Financial names helped push overall equity markets lower this week, especially after another serving of doom and gloom from Meredith Whitney. On Monday she said "I have not been this bearish on financials in a year" and reiterated that banks will need to raise more capital. The press speculated that the administration would extend TARP through 2010 (last week it was reported that TARP has $239B in unspent funding). On the positive side, October credit card master trust data showed that on the whole net charge offs declined sequentially for a second month in a row, offering more evidence that the business is stabilizing. The October advanced retail sales data jumped dramatically, to a 1.5% gain versus a 1.5% decline in September, although many commentators pointed out that the data owes most of its big gain to auto sales. Continuing discussions of a Tobin Tax on financial transactions lurked in the background in both the US and Europe.
Commodities, not surprisingly, benefited from the strengthening belief that rates won't change any time soon. Gold prices continue to garner the lion's share of headlines: the metal hit all time highs above $1,150 late in the week and closed not far below this level. Despite the run up, hedge fund guru John Paulson announced plans to launch a new gold fund on January 1st, backed by his own money. Following in gold's wake, silver and copper are trading near their best levels of 2009. Oil gave some ground late in the week while distillates underperformed on Friday on concerns that building inventories will outstrip demand. January WTI is now the most actively traded contract and closed below its 20-day EMA for the second straight week.
Treasury prices surged on Monday helped by the fallout from Bernanke's comments. The 10-year yield has spent the duration of the week under its 200 day EMA for the first time since early October. The move at the short end of the curve has been even more dramatic. Some T-bill rates went negative on Thursday while the 6-month bill hit its lowest rate on record. The 2-year yield made fresh 14-month lows below 0.7% while the curve experienced some steepening midweek. CPI data came in a little hotter than expected buoying long end yields. The benchmark spread has widened out towards its highest level in months at 265 basis points.
In currency trading, the greenback has only benefitted from lower equities and generally supportive comments from a variety of sources, with the exception of some non-conciliatory rhetoric out of the Sino-American summit. Traders were fixated all week on an alleged defense of a binary option with a range of 1.48 to 1.51 by a Far East central bank. The lower portion was tested several times ahead of its expiration at the Friday NY cut, with plenty of central bank speak, data and rumors helping EUR/USD probe both ends of the option. Just ahead of the Friday cut, a particularly creative rumor made the rounds that Ukraine had defaulted on its sovereign debt. In Europe, more factual sovereign ratings worries impacted the euro briefly, as Greece attempted to plug revenue holes in its 2010 budget via a worrisome combination of tax increases and spending cuts. Now that 2009 is winding down liquidity conditions should be impacted in the final weeks of the year by some long-term participants moving to the sidelines to focus on their game-plans for next year.
During his visit to Beijing, President's Obama voiced his approval of China's recent comments about moving toward a more market-oriented exchange rate. Chinese President Hu had no comment on the subject. The Chinese vice minister of foreign affairs followed up on the subject later, insisting that China's stance on exchange rate was very clear, that there had been a misunderstanding about currency reform and that exchange rates were a secondary component in resolving global imbalances. In the wake of the US visit, IMF Chief Strauss-Kahn reiterated that a stronger yuan would benefit China by increasing domestic demand. Note that in his monthly outlook, PIMCO's Bill Gross forecasted that China may abandon its dollar peg within six months' time and with it, its own easy monetary policy. On the positive side, ECB Chief Trichet slightly altered his strong dollar statement, noting that a strong dollar was "in the international interest" rather than the usual comment that the US wants a strong dollar. OPEC President Vasconcelos said OPEC needs to "reflect" on pricing oil in dollars. But despite all the talk, the dollar's current course seems likely to remain intact until the Fed turns up the rhetoric on its exit strategy.
Throughout the week, Central bank officials around the world discussed measures designed to fend off currency appreciation. Officials in India, South Korea and Indonesia expressed concern about capital inflows over inflating stock and real estate prices. Indonesia's central bank said it is studying limits on inflows to short-term bills. Note that last week Taiwan banned international investors from placing funds in time deposits. Brazil also presented details on its plans to tax capital inflows in an attempt to discourage speculation and excessive strength in the Brazilian Real. The Russian Central Bank mentioned that a Tobin Tax could be needed to curb speculative cross-border currency flows. Some commentators called all this talk by its true name: protectionism.
The week in Asia saw the Bank of Japan leave interest rates unchanged at 0.1% while also upgrading its assessment on the economy in spite of the recent disappointments from consumer confidence, manufacturing activity and tertiary industrial data. In a unanimous decision, BOJ said the decline in consumer prices as well as CAPEX are likely to keep narrowing as exports and production continue to improve. JGB yields rose in the wake of the central bank decision, as the market cheered the positive assessment at a time when many have questioned the timing of the BOJ decision to pull out from its asset buying program. With the latest move, Japan's central bank is also likely to have widened the rift with the new administration, whose vocal outlook has been significantly more cautious. Ahead of the central bank decision, Finance Minister Fujii said that rising yields could defeat the purpose of government action to ease funding for small companies and urged policymakers to keep price trends in mind when managing the economy. A more vocal critic, Deputy Prime Minister Kan said he planned to take additional steps to communicate to the Bank of Japan that the nation is in deflation. Subsequently, the Japanese November Cabinet Monthly Report officially declared the economy in deflation, the first time it did so since 2006.
Early in the week, the Japanese economy posted its second consecutive quarter of growth in Q3 with better than expected preliminary GDP data, coming in at 1.2% quarter over quarter, showing the best growth rate since early 2007. Despite the strong headline data, analysts remained cautious, pointing to further uncertainty as fiscal stimulus effects wane. Japanese government officials were also hardly impressed, reaffirming commitment to a secondary extra budget totaling as much as Y2.7T, warning about deflationary trends in prices, and pointing to ongoing softness in the labor market.
The Australian dollar was one of the more heavily sold majors for much of the week, falling to a two-week low around 0.9140. On Tuesday, the meeting minutes of the RBA's policy meeting left the pace of tightening open ended, stressing the short-term significance of supporting business and consumer confidence as economic stimulus fades. Policymakers did reiterate that underlying inflation is consistent with 2010 targets and not as low as initially thought, even with Aussie dollar strength countering those price pressures. Then on Wednesday, the Australian dollar extended its correction from the recent multi-month highs against the greenback and other majors on slowing Q3 wage growth data. Year over year wage growth came in at 3.6%, nearly a 5-year low.
Trade The News Staff
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