Sunday, February 21, 2010

Weekly Market Wrap

Markets temporarily put the of hubbub over Greece behind them this week, with equities and commodities steadily gaining strength thanks to a round of positive earnings reports and more less-bad economic data. Both US and Chinese markets were closed on Monday for holidays, when European leaders essentially put off Greece's day of reckoning until mid March. On Tuesday, the unexpectedly strong February Empire Manufacturing survey and very strong earnings from UK bank Barclays drove markets higher. Better January housing starts and industrial production data helped on Wednesday, and the better than expected Philly Fed survey did its bit on Thursday. Then on Friday, markets vacillated after the Fed raised the Discount Rate by 25 basis point increase to 0.75%, following through sooner than some had expected on Fed Chairman Bernanke's promise from just last week. While many called this a signal that the tightening cycle is beginning, markets digested it with little difficulty as the Fed chorus gave assurances that policy is not about to change. For the week, the DJIA rose 2.9%, the Nasdaq gained 2.7%, and the S&P500 added 3.1%.

The somewhat surprising timing of the discount rate move, at 4:30pm on a Thursday, was the most hotly discussed topic of the week. Fed members Duke, Bullard, and Lockhart all spoke after the Discount Rate decision in an attempt to shape expectations, reminding everyone that the rate hike is not a sign Fed will tighten soon but should rather be seen as a move toward "normalization." Bullard confirmed that moving the Fed funds rate remains "as far away as it ever was." PIMCO's Bill Gross commented that the discount rate increase is a signal likely designed to appease the hawks on FOMC. Note that the 25 basis point increase in the discount rate widened the spread over the benchmark Fed Funds Target Rate to a total of 50 basis points. This is still less than the pre-crisis spread of 100 basis points and also lower than the 75 basis spread in the equivalent ECB rates. Stocks and bonds initially slumped on the news, leading to an ugly Asian session and European open on Friday. But by the time New York markets were opening on Friday buyers had lifted stocks well off their lows. It didn't take long for markets to recognize that the effect of the Fed's action on the real economy should be minimal as many pointed out that the discount window accounted for less than $15B worth of lending as of last week.

In earnings news, shares of Wal-Mart fell in the wake of the retail behemoth's mixed quarterly earnings report. EPS was ahead of the consensus view, while revenue was lower than expected and the firm's Q1 guidance was soft. Apparel giant JC Penny met expectations and offered firm guidance for next quarter and the full year. Kraft's results were a slightly ahead of the consensus view, while General Mills offered slightly soft guidance for the full year. Casino names took a hit after MGM reported double the quarterly loss expected. Shares of Deere rocketed higher following the company's stunning results. The firm also offered very strong revenue guidance for the coming quarter and the full year.

Dell beat revenue expectations, although the stock was hit as investors expressed their displeasure that margins missed projections. Dell said demand in the important commercial business continues to return and is cautiously optimistic the trend will continue into its FY11. HP beat expectations and raised its 2010 prognosis. On the conference call, HP execs said they expect a long awaited corporate IT refresh in second half of 2010. First Solar beat the consensus handily and reaffirmed full year guidance. Applied Materials was firmly in line with the Street; the CEO said he expects global solar PV installations to increase 50% this year.
Pharma giant Merck met earnings expectations in its Q4 reports, although revenue was a bit soft. Looking forward, Merck warned that drugs accounting for $3B in annual revenues would lose patent protection in 2010 to the likes of generic maker Teva, which also met earnings expectations this week. Biotech giant Genzyme's results were in line, although its full-year forecast missed expectations. UK pharma name Shire's earnings results blew out the consensus estimates.

The discount rate increase after the US close on Thursday was the main focus for fixed income. Treasury yields were elevated and testing key levels Thursday afternoon even before the rate hike. Bid-up equity markets, improving economic data and a focus on the $118B in new supply on tap for next week emboldened sellers. The 30-year yield offered rates not seen since last summer while the benchmark 10-year climbed back above 3.8% for the first time in more than a month. The 2-yr/10-yr spread made a new high above 290 basis points before the 2-year yield surged on the discount rate move.

As markets came to grips on Friday morning with the Fed's move, the focus shifted to the US CPI data. Expectations for a hot reading built ahead of the release, given the tightening the day before. As it turned out the data was weaker than expected, including the first negative core reading since 1982. Analysis immediately turned to the Fed's balance sheet (also released late on Thursday), which indicated the fourth straight decline in M2 and a fresh record high in excess reserves ($1.19T). As the week drew to a close the CPI reading seemed to cap the rise in Treasury yields. Thirty-year bond prices actually traded higher in the week's final session while the curve saw minor flatting in what were some of the all-time widest spreads on record. The December fed fund futures have given back about half the gains seen in the wake of the discount announcement, although the metric still prices in just under a 50% chance the Fed hikes the funds rate 50 basis in the fourth quarter.

The $118B auctions in 2-, 5- and 7-year paper is sure to draw major attention next week after last week's chilly reception to the Treasury's 10- and 30-year auctions, which served as a catalyst for the recent rise in rates. Indirect awards are sure to be scrutinized after the Dec TIC flows showed Chinese holdings in US Treasuries fell to their lowest levels in almost a year. Jitters on the sovereign front have receded, with the focus now on Greece's upcoming 10-year note auction. Reports suggest Greece could be looking to sell as much as €5B in bonds to test the markets. If this issue runs into trouble, European leaders could be forced into some form of direct bailout, while success could soften fears over several of the other member nations' bond markets. Concern about demand for any new Greek paper are high, especially after investors in January's €8 5-year bonds saw prices drop more than 3% within 48 hours of the auction.

FX markets saw thin trading conditions at the beginning of the week with Chinese markets closed all week for the Lunar New Year holiday and the US off for President's Day. Dealers speculated the absence of liquidity helped the euro retest Friday's lows of 1.3530, just ahead of a EcoFin meeting in Brussels on the Greek fiscal situation. Constructive comments from the IMF and EUR in regards to several Eastern European countries seemed to stem risk aversion flows. At EcoFin European finance ministers offered more of the same tepid rhetoric on the Greek situation that was heard last week. Traders have decided that the EU's assessment of Greece's progress in cutting its deficit-to-GDP ratio by 4%, which comes in mid-March, is the new line in the sand. The greenback continued to benefit against the major pairs throughout much of the week, and the sunnier FOMC minutes from the January meeting combined with the increase in the discount rate gave the dollar the fuel it needed to close out the week around nine-month highs against the euro and the Swiss Franc.
Many traders took note of larger than usual amounts of borrowing from the ECB overnight loan facility in the early part of the week. Borrowing levels in the facility came back in line on Thursday and Friday. Dealers pointed out that the facility typically doles out around €300M a day; this amount climbed above €3B for a few sessions, with speculation centering on Greece-related fears.

Reserve diversification issues flared up again following the US December TIC flow data, highlighted by the $34B decline in the Chinese US Treasury holdings buried in the numbers. Dealers seemed to conclude that the proceeds from China's Treasury sales likely stayed within US borders for the time being, as China apparently bought real goods like land, farms and equities.

Sterling softened after UK jobless claims rose to 1.64M, the highest since April 1997 and January public finance data disappointed. January is said to be an important month for tax receipts, and the UK was forced to borrow funds for the first time on record. In other news, Dubai's five-year credit default swaps rose to its highest level since last March, above 650bps. The Russia Central Bank lowered its refi rate and widened the lower band of its currency basket.

In Asia, the Lunar New Year celebration shifted the spotlight away from China's surprise reserve ratio tightening last week to Japan, where the central bank maintained its steadfast commitment to easy policy and reiterated its focus on deflation. In a unanimous decision, the BoJ also kept is monthly JGB purchases at ¥1.8T, acknowledging that while economic risks are receding and economic activity is picking up, the pace of recovery may slow until mid-year. Earlier in the week, Japan's Q4 GDP data marked a nice surprise for the embattled economy, rising 1.1% q/q and 4.6% on annualized basis - both marks hitting the highest level since Q1 of 2008. Of greatest note for trade-dependent Japan, the exports component was very strong with a 5% increase, while capital investment rose for the first time in seven quarters. Speaking after the GDP figures, Japan's finance minister Kan said the risk of a double-dip recession is receding.

The minutes from the Australian central bank's surprising February rate decision detailed the thought processes that led to the RBA to hold interest rates unchanged at 3.75% instead of implementing the widely expected 4th consecutive tightening. Policymakers noted the decision was "finely balanced," but pointed to the earlier rate hikes allowing for some flexibility in assessing events overseas, namely the fiscal challenges in Greece and the stimulus withdrawal in China. Going forward, the RBA said future rate hikes are likely if economic conditions continue to improve. Ahead of the next Australia rate decision on March 1st, fixed income markets' implied probability of renewed tightening stood just above 40%.

Trade The News Staff
Trade The News, Inc.
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