Market Week Wrap-up

- Contagion from the European crisis spread further this week as Greece failed to form a government and pressure built up the banking systems of both Spain and Greece. New elections were scheduled for June 17th in Greece, prompting intense speculation about the chances of the pro- and anti-bailout parties. With the situation in Athens deteriorating further, there were fears that there could be a run on peripheral euro zone banks. On Monday alone, depositors withdrew €700M from Greek banks (since the beginning of the crisis, withdrawals have averaged between €2B and €3B a month). In Spain, there were reports that depositors had withdrawn more than €1B from Bankia following its partial nationalization last week. Moody's followed through on its earlier warnings and downgraded the Italian and Spanish banking systems. Safe-haven follows pushed the debt of northern European nations--Germany, the UK, the Netherlands, and the Scandinavian countries--to record lows. The yield on the 10-year UST briefly dipped below 1.7% on Thursday, equaling the lows seen at the depths of the crisis last fall. Beyond Europe, global growth concerns were contrasted with some not-bad news out of Japan and the US. In China, the PBoC cut the reserve requirement ratio for the third time since last fall in an attempt to pump more funds into its ailing banking sector, although the move was widely expected. Worries about Japan eased as the nation's preliminary Q1 GDP data came in much stronger than expected and the government upgraded its economic forecasts for the first time in nine months, although that did not keep the Nikkei index from closing out the week at 12-week lows. In the US, April industrial production rose on a y/y basis the most since December 2010, and both April housing starts and building permits were very strong, but the lowest Philadelphia Fed reading in nine months wiped out any positive data momentum. After two weeks of hype, some trading glitches at Nasdaq briefly delayed the opening of Facebook, which started trading at $42.05 on Friday morning and finished the day at $38, right where the IPO had priced the day before. President Obama is hosting the G8 in Maryland this weekend, and while no major policy developments are expected, there has been plenty of chatter this week that leaders will discuss potential plans to calm markets and cope with potential Greece exit scenarios. Risk aversion grew late in the week, with gold rising 3.5% on Thursday and Friday, and the VIX volatility index rose above 25 to its highest level since December. US equity indices closed at the lows of the week on Friday, and on Thursday many traders noted with trepidation that the Dow Jones Transportations closed below the April/March lows. The DJIA had its worst week of the year, losing 3.5%, while the S&P500 declined 4.3% and the Nasdaq dropped 5.3%.

- Retail earnings out this week continued to be very mixed. Retail giants Walmart and Target met or beat consensus expectations, with low same-store sales gains. Walmart's CEO said that customers were still trading down to lower prices and smaller baskets of goods. Meanwhile Target executives said comps would be only up slightly in Q2, indicating a deceleration. In regards to the Mexico bribery story, Walmart said the investigation was not expected to have a material impact on its business. Investors dumped Home Depot after its Q1 results merely met expectations and the firm barely raised FY12 guidance enough to meet the consensus view.

- Discount apparel chain TJX posted a record high profit in Q1, citing strong sales in Europe, of all places. Meanwhile JC Penny had a terrible Q1, with a huge loss, very soft revenue and a whopping 19% decline in comps. The firm discontinued its dividend and launched another round of cost cutting. New CEO Johnson defended the firm, saying more short-term pain was needed as the company turned around its sales culture. High-end department stores Saks and Nordstroms missed consensus expectations, although sales comps stayed pretty strong. Abercrombie and Fitch saw a big miss on the top line in Q1, with comps down 5%. Limited Brands was in line with expectations in its Q1, although its Q2 guidance was very soft and its FY12 outlook was only raised enough to just meet estimates.

- On the M&A front, Agilent Technologies said it would acquire Danish electronics testing company Dako for $2.2B in cash. Agilent has a strong presence in the life sciences field and Dako supplies cancer diagnosis to pathology laboratories. Note that the deal comes after device maker Hologic said it would buy diagnostic test firm Gen-Probe Inc for $3.8B in cash. Casino name Boyd Gaming said it would acquire Peninsula Gaming for $1.5B, adding five properties in Kansas, Iowa and Louisiana. Shares of Avon plummeted after Coty withdrew its $24.75/shr offer to acquire the firm.

- After attempts to form a Greek government flopped and new elections were scheduled for mid June, more and more European officials spoke frankly about the potential departure of Greece from the euro zone. On Friday reports circulated that the EU Commission and the ECB were working on contingency plans for a Greece exit. The commission later denied the assertion, while a senior EU official later said that the existence of contingency plans does not mean a Greek exit is a foregone conclusion. Later there were reports that Chancellor Merkel was recommending Greece conduct a referendum on euro zone membership simultaneously with the new election (this too was later denied by a German government spokesman, after Greek politicians rebuked Germany for interfering in it internal politics). Central bankers in various non-EMU European nations, chiefly the UK, said they were preparing for the worst.

- The euro was hammered through the first four days of the week thanks to dire conditions in Greece and Spain. EUR/USD kept pushing out to four-month lows through Friday morning, entering the week just above 1.2940 and dropping to a low of 1.2640 in the wee hours of Friday morning. The only relief for the pair came in the wake of much better than expected preliminary Q1 German GDP numbers and a flat reading in the preliminary euro zone Q1 GDP (narrowly exceeding expectations for a negative reading) on Tuesday morning, which briefly lifted the single currency. However, Greece, Italy and Portugal all reported negative preliminary Q1 GDP figures, highlighting the failures of austerity and the emergence of a two-speed European economy.

- In other FX trading, GBP/USD slumped following BOE quarterly inflation report which was viewed as more dovish. The report raised the BoE's short-term CPI view but also indicated that inflation would be on target in the two-to-three year time frame. USD/CAD was also broadly weaker and took out the key 1.0070 level.

- In China, the PBoC's RRR reduction was estimated to free up additional CNY400B for China's strained banking system, where the top four state-run banks were said to have issued virtually no new loans in the first half of May. Slumping demand for credit was further reflected in the latest China housing price data that showed yet another y/y decline in prices across 46 out of 70 cities, up from 37 cities reported in the prior month. Regional commodity currencies accelerated their losses, as AUD/USD and NZD/USD both hit 6-month lows below $0.98 and $0.7530 level respectively.

- Economic data out of Japan offered a silver lining to an otherwise downbeat week. Q1 preliminary GDP topped estimates at 1.0% q/q, while the revised final Q4 GDP saw a flat print rather than a 0.2% contraction previously reported. On Friday, Japan cabinet office also upgraded its economic assessment for the first time in 9 months, pointing to continued construction-related demand while downplaying European worries. Nikkei225 remained under pressure however, as USD/JPY fell below the pivotal 79.50 support late in the week - level corresponding to the point when the G7 launched its last round of coordinated FX intervention back in March of 2011. The disappointing Philly Fed reading in the US helped JPY benefit at the expense of the greenback, however markets also took note of undersubscribed BOJ asset-buying operation on the short-end of the curve on Wednesday and on the long-term debt on Friday. This could effectively limit BOJ's ability to ease policy further, potentially capping USD/JPY gains to its mid-March highs for some time.

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