Friday, December 23, 2011

Market Week Wrap-up

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Market Week Wrap-up

- US and European equity indices bubbled higher this week in very thin pre-holiday trading conditions. Traders were happy to forget about the shortcomings of the European leaders' summit two weeks ago and focus rather on the launch of the ECB's shiny new three-year Long-Term Refinancing Operation (LTRO). Ahead of the LTRO on Wednesday, European data helped improve the tone of markets, with a better German IFO Survey and a strong Spanish bill auction buoying risk appetite. The three-year LTRO came off very well and seemed to calm fears about the euro zone in the short term. Still lurking in the background was S&P's much anticipated verdict on debt ratings of 15 euro zone countries. However, according to unconfirmed press reports out late in the week, European officials received "informal signals" from S&P that the agency will wait until January to render its decision. In the US, Congress squabbled all week long over a short-term extension of the payroll tax cut, only passing the measure after epic intramural political battles in the Republican party. Two sets of data out this week suggested that positive trends may be building in the US housing market. The December NAHB Housing Market survey beat expectations and hit its highest level since early 2009, marking the third consecutive rising month for the survey. The November housing starts and building permits both widely beat expectations and pushed out to their highest levels since the beginning of 2010. Interestingly single-family starts and permits both posted gains, whereas strength in past reports has been mostly in multi-family units. In Asia, markets were flat to down, softer in part due to the regional uncertainty that followed North Korea's announcement of the death of Kim Jong-Il. The BoJ's second consecutive reduction in its growth outlook and some bad housing data out of China last weekend also helped keep things subdued. For the week the DJIA rose 3.6%, the NASDAQ gained 2.5% and the S&P 500 increased 3.7%.

- On Wednesday the ECB's inaugural three-year LTRO allotted approx €490B in new liquidity for the dysfunctional European credit markets, matching the high end of most expectations. Note that there was some skeptical commentary about the official amount sold in the auction: SocGen wrote that when you net out the reduced amounts allotted in the ECB's main refi the day before, the three-month LTRO on Wednesday and recent moves out of the 12-month LTRO, the net new liquidity generated by the new LTRO was likely a mere €210B. There were also questions about where all the new liquidity would go, and comments by the Italian Bank Association (ABI) that it expected banks to reduce exposure to government debt under new EBA rules suggest one of the new destinations may not be European sovereign bonds. On Friday, the ECB indicated that European banks had parked an additional €82B in the ECB's deposit facility, which brought the cumulative total to a new 2011 record of €347B.

- On Monday shares of the largest US banks traded sharply lower on reports that the Fed would support rules requiring leading banks to hold additional capital as part of the proposals by Basel regulators. Under the rules, certain systemically important financial institutions (SIFIs) may have to hold 2.5% of extra capital in addition to the 7% base capital level (the additional surcharge is not expected to come into effect until 2016). Shares of the banks gained ground steadily through Friday after Monday's hiccup. In other sector news, troubled brokerage house Jefferies reported Q4 results on Tuesday. The firm's share price has suffered in recent months from fears about its sovereign exposure and leverage ratio, the issues that caused the collapse of MF Global. In its Q4 Jefferies' profit was well head of expectations, although the firm saw large y/y declines in both fixed income and investment banking revenues. On the conference call, executives said that the firm's trading business has returned to pre-November levels after being impacted by "misinformation." Shares of JEF traded up sharply after the report and sustained its gains all week, suggesting the company may have avoided the fate of MF Global.

- Tech names Oracle and Micron made big moves following quarterly earnings this week. Oracle, whose earnings are typically quite predictable, missed both profit and revenue expectations in its Q2 report. Executives blamed the elongation of sales cycles just as the quarter ended, particularly in the Americas and Europe, in addition to headwinds from the euro. Shares of ORCL dropped more than 10% on the news and had not recovered as of Friday. Quarterly losses at DRAM manufacturer Micron were considerably greater than expected. However executives commented that while the DRAM market is under a lot of pressure in general, Micron is faring better than competitors and has seen a mild uptick in the last few weeks in OEM contract pricing. They also said they expect an early spring recovery in the hard drive supply chain. On Thursday shares of MU traded up 15% on the brightening outlook.

- The deal news of the week was the implosion of the AT&T/T-Mobile merger, thanks to roadblocks thrown up by the FCC and the DoJ. In its investigation, the FCC determined that approving the merger would drastically reduce competition in most large markets. Following their poor Q3 showing last week, Research in Motion was subject to various takeover chatter, including reports of interest from Microsoft and Nokia, and Amazon. However some press reports indicated that takeover interest is waning due to RIM's declining US market share, and that Amazon may now be more inclined to expanding its commercial ties with RIM instead of pursuing an acquisition.

- FX markets were relatively calm this week and the year-end period saw pretty subdued trading. The euro garnered support from an oversubscribed Spanish bill auction on Tuesday, with yields back at more normalized levels. The ECB repo auction (LTRO) on Wednesday nudged the euro even higher, but the strength did not last. Markets saw the high take-up at the ECB auction as a good thing, assuming the funds were used to shore up banks' medium-term financing needs and their balance sheets, and might even encourage them to buy sovereign debt. However more than one analyst was unsettled by the sheer number of banks (over 500) participating in the auction. EUR/USD ticked up from lows on Monday around 1.3000 to test briefly as high as 1.3200, but the pair was back to around 1.3050 on Friday.

- EUR/CHF drifted around 1.22, still firmly above the SNB's 1.2000 floor. In its quarterly report, the SNB reiterated that it would maintain the EUR/CHF floor at 1.2000 and reiterated that it would be enforce the limit with "utmost determination." The yen was a touch weaker given the political uncertainty on the Korean Peninsula following the death of Kim Jong Il, but stayed contained well within its two-month trading range. USD/JPY drifted above the 78 handle by late Friday while EUR/JPY was straddling the 102 level.

- The Bank of Japan cut its economic assessment for the second straight meeting following disappointing Tankan manufacturing data last week. The BoJ has acknowledged a pause in economic activity in part due to the persisting strength of the Yen, but expressed optimism that a moderate recovery would return once overseas economies improve. Separately, the Japanese cabinet office formally cut its current fiscal year GDP forecast to -0.1% from +0.5% and next fiscal year to +2.2%. In Australia, RBA policy minutes revealed some trepidation to cut cash rates by 25bps for the second consecutive meeting, as members continue to see the mining boom sustaining domestic economic growth levels.