Friday, June 22, 2012

Market Week Wrap-Up

- On Sunday the pro-bailout New Democracy party beat anti-bailout forces in the Greek parliamentary elections, taking the imminent risk of another major confrontation between Athens and its European partners off the table. A coalition government was formed with only a little static along the way, and newly installed PM Samaras began a campaign to obtain a two-year extension of Greece's fiscal consolidation requirements under the second bailout agreement. There were mixed signals on whether the extension would be forthcoming and Northern European euro zone members made unfavorable comments about an extension. Spain all but formally asked for a bank bailout from its European partners this week, as a stress test conducted by independent auditors suggested Spanish banks would need up to €62B in additional capital under an adverse scenario. The Eurogroup agreed to make up to €100B in funding available, initially from the EFSF with the credit line later rolled over to the as-yet approved ESM. Italian PM Monti hosted German Chancellor Merkel, French President Hollande and Spanish PM Rajoy to discuss the crisis and lay the groundwork for next week's EU Leaders Summit. The four leaders agreed to propose a growth package equal to 1% of EU GDP, about €130B, as Europe's leaders slowly shift toward admitting growth policies are badly needed to take the sting out of fiscal consolidation. On Wednesday, the FOMC extended Operation Twist through the end of 2012, but markets were unimpressed. In addition, the Fed reduced its estimate for 2012 GDP by half a percent to +1.9-2.4%. On Thursday, the Fed news combined with a raft of bad data and fears of Moody's long-threatened bank downgrades drove the S&P500's second steepest loss of 2012. Goldman analysts piled on, putting out a trading call for the S&P500 index to retest its recent lows at 1285. German June PMI missed estimates and showed continued contraction, while the June Philly Fed manufacturing survey and US May existing home sales data were very weak. Commodities were hammered with the declines: crude dropped below $78/barrel on Friday, its lowest level since last October, gold fell more than $50 to $1,570, and the GSCI commodities index dropped into bear market territory, off 22% from its peak at the beginning of March. The DJIA fell 0.9% on the week, while the S&P500 dropped 0.6%, while the Nasdaq rose 0.7%.

- Moody's cut the credit ratings of 15 global banks, including the five largest US banks, highlighting the challenges faced by an industry facing falling GDP, the euro zone disaster, tougher regulations and nervous investors. Credit Suisse was hardest hit, with a three-notch downgrade. Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup, Deutsche Bank, Barclays, UBS, Credit Agricole, BNP Paribas, and the Royal Bank of Canada all got a double-notch downgrade. Bank of America, HSBC, Societe Generale, and the Royal Bank of Scotland received single-notch downgrades. The downgrades mean banks will have to post more collateral and will face even more pressure to deleverage, but financial stocks experienced a modest relief rally on Friday as there were no big negative surprises among the downgrades.

- There are several more pieces that need to fall into place before Spain can start using euro zone funds to recapitalize its banks. Independent auditors hired by Madrid reported that Spain's banks need €16-20B capital under a baseline stress scenario and €51-62B under an adverse scenario. The Spanish finance ministry said it would formally request aid early next week and asserted that the nation's three largest banks were fine and would not need any recapitalization funds. An MOU providing a specific funding request will be prepared by July 9th, and a second audit (the so-called "bottom up" audit), to be complete in September, will help determine how much is disbursed to each bank. Yields on the Spanish benchmark 10-year debt were above 7% coming into the week and dropped to around 6.3% by Friday. Investors demanded punishing rates in two key debt sales (although demand was strong): on Tuesday, the Spanish Treasury was forced to pay 5.07% to sell 12-month bills and 5.11% to sell 18-month paper, then on Thursday, it sold five-year bonds at an average rate of 6.07% and three-year bonds at 5.46%.

- The ESM is apparently the ultimate lynchpin of the Spanish bank bailout, but more questions were raised about the future of the fund this week. On Thursday one of the German opposition parties said it would ask the country's highest court to suspend ratification and look into whether participation in the ESM is constitutional. Analysts believe the court is likely to reject an injunction to stop the launch of the ESM, but it could still take weeks even to reach that decision, potentially delaying the initiation of the fund long enough to cause turbulence later this summer. The German lower house of parliament is still scheduled to vote on ESM ratification on June 29th, although the German president is expected to delay the final ratification vote to let the constitutional court deliberate. Debate among European officials on whether to allow the ESM to directly inject funds into banks or buy bonds on the open market raged on this week, with Germany continuing to resist allowing these measures.

- In other equity news, FedEx met expectations in its Q4 report, however its guidance for Q1 and FY13 were decidedly underwhelming. Oracle released its Q4 results three days ahead of schedule on Monday (pre-empting press reports on the departure of a key executive), disclosing stronger-than-expected Q4 profits and slightly soft guidance. Procter & Gamble moderately tamped down earnings and revenue expectations for Q4 due to slower than expected growth and fluctuations in the forex market. Steel names AK Steel and Steel Dynamics offered weaker guidance for Q2, blaming increased imports and higher domestic capacity (echoing Nucor's warning last week). Microsoft unveiled its Windows Phone 8 system, which it hopes to position as major competitor to Apple's iOS and Google's Android, and also said it would launch its own tablet computer.

- In FX trading, the euro strengthened and EUR/USD pushed out to 1.2750, its highest level in a month, following the Greek election on Sunday. However fears about Spain emerged immediately and knocked the euro down again on Monday, as Bank of Spain reported that the bad loan ratio at the nation's banks had risen to 18-month highs, while PM Rajoy was said to be pushing back against IMF reform suggestions. A sharp decline in the German June ZEW confidence survey kept the euro weak into Tuesday, when the uneventful Spanish auctions and the successful formation of a Greek government reversed the euro and took it higher again. Into the end of the week heated rhetoric about whether or not to amend the terms of Greece's bailout at the euro zone finance ministers meeting in Luxembourg plus FOMC hangover drove risk-off trading. EUR/USD closed out the week around 1.2560. Sterling faced headwinds throughout the week as UK inflation data came in below expectations, keeping anticipation of more BoE monetary accommodation on the table. In addition, minutes from the most recent BoE policy meeting indicated a split vote on the new QE authorization, further weakening the pound.

- Economic data out of the Far East largely echoed disappointments in the US and Europe, as China PMI easily justified the more aggressive PBoC policy easing bias while trade figures out of Japan offered a stark reflection of European turmoil. China HSBC flash manufacturing PMI for the first half of June saw its 8th consecutive contractionary reading (i.e. below 50) while also falling to a 7-month low at 48.1. New export orders component was even more disappointing at 45.9, the lowest level since March 2009. China markets were closed and have yet to react to Thursday's data, suggesting Shanghai Composite could add to its 2% slide for the week when it reopens on Monday. Japan's adjusted merchandise trade balance registered its biggest deficit in years at ¥657B, as imports of energy ate into modest recovery in shipments of autos to the US. Notably, Japan's exports to Europe fell into deficit for the first time in over 30 years of records, with crises in Spain and Greece clearly weighing on overseas economies. USD/JPY rose nearly 2 big figures above the ¥80 handle, as dealers focused on poor trade figures, appointment of two ultra-dovish economists to the BOJ, increasing political tensions amid PM Kan's push toward sales tax increase, and also rising short-term interest rates in US treasury markets. Q1 GDP from New Zealand provided some silver lining, registering a 5-year high on q/q basis at 1.1%. Analysts were quick to attribute the surge to a fleeting bumper season in the agricultural sectors, pointing to a decline in exports and flat performance in the construction and household consumption space. NZD and AUD currencies ended the week modestly lower after two consecutive weeks of strong gains.