Weekly Market Wrap

Risk appetite vanished this week like Punxsutawney Phil on Groundhog Day, with political issues and lackluster quarterly reports from the big banks dominating trading. US markets were closed on Monday and performed relatively well on Tuesday. Weak quarterly results from Bank of America and Morgan Stanley together with President Obama's latest round of financial industry regulatory proposals drove a sustained three-day decline in the back half of the week. Adding to concerns, China took steps to curb lending and investment in key sectors in order to cool off its booming economy as it reported Q4 GDP growth well above 10%. The surprise victory by Scott Brown in the Massachusetts special US Senate election shook up the political scene in Washington DC, deprived the Democrats of their 60-vote supermajority in the Senate and put the viability of healthcare reform in question. Democrats fleeing from the coattails of a President with a sinking popularity and emboldened Republicans continued to press the Administration, as evidenced by the eroding support for Ben Bernanke's reconfirmation. By Friday afternoon, it became clear there was a strong possibility that Fed Chairman Bernanke would not be confirmed before the end of his current term, and might be replaced by skittish legislators looking for political cover. Needless to say, this did not reassure markets.

Traders fled to the greenback and dumped commodities, while the VIX volatility index jumped nearly 60% to just below the 28 handle by the close on Friday, its highest level since last November. US stocks had their worst week since last March: the DJIA fell 4.1%, the Nasdaq dropped 3.6% and the S&P 500 declined 3.9%.

The big US banks have had a very bad week. After announcing $90B in fees on risky bank behavior last Friday, President Obama this week proposed that banks be prohibited from running proprietary trading operations or investing in hedge funds or private equity funds as a way to limit the risk of another financial crisis. White House Advisor Austan Goolsbee insisted that the proposal did not amount to a return of Glass-Steagall. The plan is the brain child of Paul Volker, and some commentators see it as a sign of Treasury Secretary Geithner's waning influence at the White House, and possibly as proof Geithner will be dumped soon (one analyst even speculated that White House Chief of Staff Rahm Emmanuel could be installed as Treasury Secretary). For his part, Geither said that banks will have choices on how they will comply with plan and that the government simply wants to limit risk-taking, not break up banks.

Citigroup reported its ninth consecutive quarterly loss on Tuesday, although the loss was not greater than expected. Both Bank of America and Morgan Stanley missed expectations. BoA lost $5.2B in the quarter, even as the bank took a one-time $4B charge for repaying its TARP funds. Morgan Stanley's quarterly profit was less than half the expected amount. Goldman Sachs on the other hand crushed its estimates, disproving the naysayers who had consistently downgraded estimates over the course of the quarter. For the full year, Goldman earned more than $13B, almost as much as $15B earned by the five other big national banks combined. Goldman was not immune to the sharp selloff in the financial sector, however, as the President's new regulatory scheme seemed to be aimed directly at Goldman's lucrative prop trading business.

Results out of regional banks were largely positive. Super-regional banking names Wells Fargo and US Bancorp outshined their larger brethren. Wells surprised with a small quarterly profit, versus expectations for a loss. That outcome included the $0.47/share charge for repaying the bank's in TARP funds. USB was largely in line with expectations and offered plenty of upbeat commentary on the bank's outlook. Smaller regional names Bank of New York, M&T Bank beat estimates roundly. Quarterly losses at Fifth Third, SunTrust and KeyCorp were smaller than expected.

Quarterly reports from Dow components were relatively strong: results out of General Electric and IBM beat analysts' expectations, while McDonald's racked up positive December and Q4 comps across all regions and predicted modest sales growth in 2010. American Express's results also exceeded expectations, although the credit card firm warned that depressed real estate and high unemployment will continue to present problems in 2010. In other earnings, Google had strong results, and tried to put a more positive face on its future in China after its scuffle last week with the Chinese government over censorship. AMD's loss was smaller than expected, although the company warned that revenue would fall next quarter. Starbucks beat Q1 estimates and hiked its earnings outlook for the full year. CSX was in line with expectations.

A tough week for stocks resulted in rising Treasury prices and lower rates. Early on some traders wondered if the Massachusetts's election results would prove to be positive catalyst for the market, but quickly the focus shifted to concerns outside the US borders as overall risk aversion permeated out of the Asian and European trading sessions each day. Continued signals that China's central bank is getting more aggressive in withdrawing stimulus, along with ever widening 10-year Greek to Bund debt spreads propelled the flow of money out of equities and into the relative safety of government debt. By Thursday the unveiling of the Volcker rule kicked risk aversion trades into overdrive sending the 10-year yield below 3.6% and the long bond back to 4.5%. The week drew to a close with Treasury prices managing to consolidate the gains seen over the past two week's which has brought the US benchmark yield down some 20 basis points.

Looking ahead a fresh round of $118B in coupon supply is set to hit the street next week. Though the paper is short term in duration and unchanged in overall size from the December auctions, the results will certainly be scrutinized closely especially in light of Tuesday's TICS data which showed declining Chinese US Treasury holdings. Also some are beginning to wonder whether the proposed restrictions on proprietary trading could have the unintended consequence of hampering banks ability to participate in US debt auctions. The European sovereign debt story is likely to remain center stage next week as well. Greek 10-year paper yields some 300+ basis points above Bunds making fresh post Euro inception highs after the Greece's Debt Agency confirmed plans to issue as much as €3B in syndicated bonds sometime in next two months. Tuesday's preliminary look at Portugal's 2010 budget could further stoke the fears that spiraling budget deficits in some EU economies will lead to more ratings agency downgrades and increased squabbles amongst member nations.

Traders' desire to offload risk was not only evident in debt and equity markets. Commodity prices moved sharply lower across several main categories while stocks declined and the dollar rallied. Front month crude dipped below $75 for the first time in nearly a month as some noted EIA figures that suggested US crude demand has dropped below the worst levels seen during last year's recession. Spot gold tested its 100-day moving average of $1,086 for the first time since July. The Feb contract is down nearly $50 on the week at $1,090 and traders are eyeing some key support at the $1,074 (December low, October high) and $1,050 (uptrend line from November 2008 low). March silver is off more than 40 cents on the week to trade back below $17 while copper has been the most resilient metal, buoyed by strong Chinese GDP figures.

Dollar- and yen-related pairs are benefiting at the expense of European and commodity components thanks to freshly risk averse traders. China's signal that it would enact curbs on lending and speculation about which emerging market nation would be the next to head for the policy exit only lessened appetite for risk. European officials continue to stress that Greece needs to deal with its fiscal problems on its own, while in the US the administration's latest financial industry proposals were seen as fresh headwinds for growth.

Verbal intervention around the world sought to sooth market volatility on a macro basis. China noted several times during the week that it would maintain "moderately loose" monetary policy and insisted that any lending curbs were designed to avoid unusual swings in credit this year. Other cases of intervention were less calming: ECB's Stark commented that signs of deteriorating credit quality remain in the Euro Zone. The ECB's Sramko commented that it would take up to three quarters to confirm whether economic recovery was stable or not, adding that the ECB would find the "right moment" to exit accommodation.

The euro was weighed down by continuing sovereign debt concerns and forecasts of uneven economic growth, with EUR/USD moving below its key 200-day moving average for the first time since May 2009 this week. Technical factors have some dealers seeing a potential retest of the pivotal 1.38 neighborhood in the pair. The dormant Eastern European carry trade issue was simmering again after ECB's Nowotny commented that FX consumer loans were extremely problematic and that banking in Eastern Europe was not just an Austrian affair. EUR/CHF cross continued to drift to pre-SNB intervention levels as it moved below the 1.47 handle.

Economic data and further central bank activity kept China at the forefront of global economic news following last week's surprise decision by the PBOC to raise its reserve requirement ratio that further weighed on regional equities. Chinese central bank official Yi looked to diffuse fears of more aggressive policy, reiterating that the PBOC still plans to keep monetary policy loose in 2010 despite anticipating moderate growth in CPI in the coming year. Concerns were heightened in nervous investor sentiment on Wednesday, with the release of China Q4 GDP and December economic data. Q4 real GDP came in at 10.7%, better than the 10.5% expected, and the highest quarterly rate of growth since 2007. On annual basis, the Chinese economy grew 8.7% in 2009. Chinese inflation data was a cause for concern, with a 1.9% rise in December CPI (0.5% higher than expected), and 1.7% growth in PPI (0.9% higher than expected), the biggest jump in both readings in over a year. Overheated pricing pressures were particularly visible in food inflation, prompting speculation that Chinese central bank could take even more aggressive tightening measures as early as the coming week.

Outside the monetary implications of strong economic data, Asian markets were shaken by a further threat of restriction on lending. On Tuesday, CBRC (China Banking Regulatory Commission) regulator Liu said that new leverage and liquidity ratios imposed on banks will restrict loan volume to CNY7.5T in 2010, down from CNY9.6T in 2009. That statement followed on the heels of a report that certain Chinese banks have been told to stop lending for the remainder of January, under a directive from Premier Wen to control the pace of new lending.

Trade The News Staff
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