- US equity markets pushed out to highs last seen in early May this week after European officials reportedly prepared to take out the bazooka and tamp down out-of-control peripheral yields. Earnings season has been grinding on with plenty of bad news out of major US and overseas corporations. On the growth front, major June manufacturing PMI data in Europe plumbed three-year lows, UK Q2 GDP turned negative and the German IFO survey was worse than expected. The July Richmond Fed Manufacturing Index was very weak and the poor showing in the Markit preliminary PMI index suggested the US July ISM could hit two-year lows. June US home sales reports were pretty soft. The advance reading of US Q2 GDP at +1.5% slightly topped expectations but confirmed a slowdown from the Q1 figure of +2.0%. Second quarter PCE dropped to +1.6% from a revised Q1 figure of +2.3%, promoting talk that looming deflation may be just the excuse Fed Chairman Bernanke needs to launch QE3. The euro zone crisis took a turn for the worse as Spanish regions prepared to ask for bailouts, driving its borrowing costs higher and prompting talk that Spain would be forced to ask for a full government bailout. As Spanish yields soared, ECB Member Nowotny talked about the pros of giving the ESM a banking license and then ECB President Draghi stated that dealing with surging yields was "part of the mandate" of the ECB. While some said this was just a reiteration of Draghi's prior comments, there were press reports on Friday morning asserting that the ECB would cooperate with the EFSF and ESM funds to buy Spanish and Italian debt. Importantly, no officials stepped up to refute the report, which usually happens to this sort of press speculation, with German Chancellor Merkel and French President Hollande issuing a statement that both leaders were ready to do "anything" to safeguard the euro zone. Subsequently, Draghi was said to be meeting with Bundesbank President and ECB hawk Weidmann to "seek consensus" for a grand sovereign support scheme. Taken all together, these developments strongly suggest that European leaders are preparing a major effort to put out the fire in the euro zone once and for all. For the week the DJIA gained 2%, the S&P500 rose 1.7% and the Nasdaq advanced 1.1%.
- The situation in Spain was the proximate cause for Draghi's bold move. Coming into the week, three Spanish regions - including Andalusia, Catalonia and Murcia - were said to be petitioning Madrid for bailouts. A press article out on Monday indicated that the government estimated the regions needed as much as €26.4B in aid, well above the €18B cited by the Spanish finance ministry earlier in July. Further headlines asserted that the government was mulling a request for a full government bailout if the ECB didn't resume its government bond purchase program, although Spanish officials furiously and repeatedly denied the reports. In addition to this, the IMF said it would not participate in any further funding for Greece, which has been seeking a two-year extension in deadlines for its austerity programs and additional aid (as much as €50B by some reports). German officials also expressed a great deal of skepticism that there was political will to support more money for Athens. There was also rumbling about trouble in Sicily over the weekend, with speculation that the Italian region might need a bailout. As European equity markets slumped, both Italy and Spain reactivated short selling bans. Spain's five-year yield rose above the 10-year for the first time as the inverted yield curve underscored the stress in the euro zone. The 2-year moved above 7% for the first time ever. With Italian and Spanish yields freaking out, German Bund yields bottomed out not far from the record yields seen in early June, around 1.18%. Following Draghi's remarks, bund yields rose to approx 1.4% and Spanish 10-year yields fell back below 7%, to around 6.65%.
- Earnings from major US corporations provided more evidence that the economic slowdown is well underway worldwide. Numerous firms cut guidance, with a preponderance of executives citing an unclear outlook for the rest of 2012 and slowing sales as major reasons for caution. McDonalds' Q2 net income fell on a y/y basis and earnings missed expectations, while SSS gains overseas are moderating. UPS missed top- and bottom-line expectations and cut its FY12 outlook. Dupont guided to the lower end of its prior range. Texas Instruments struggled to meet expectations in Q2 and warned that results would be below the norm for its Q3. Dow Chemical had weak results, with sales declines in all its major geographical markets. Dow warned that it saw marked deterioration in global economic activity throughout the second quarter. Ford's results were in line with the Street, but it also warned that FY12 profit would be lower y/y. The company doubled its forecasted losses in Europe to more than $1B. Las Vegas Sands missed top- and bottom-line expectations due to slowing revenue at the firm's Asia operations.
- Lower crude prices in the second quarter depressed profits at the big three US oil firms. Excluding some one-time items, profits at Exxon, Conoco and Chevron fell on a y/y basis. Exxon and Chevron were also hurt by lower natural gas prices. All three firms also saw lower y/y production levels, with the combination of lower prices and lower demand taking their toll. Haliburton's net profits were flat on a y/y basis, although EPS topped consensus expectations. Revenue was up a solid 20% over last year.
- There were a few bright spots in earnings out this week: manufacturers Boeing and Caterpillar both disclosed strong Q2 results, with profits and revenues well ahead of estimates for both firms. Boeing is ramping up production capacity to meet strong demand for its new 787 planes, helping to drive its higher y/y income. Caterpillar said it was still seeing incremental economic improvement around the world, noting that "this doesn't feel like 2008." Pepsi's earnings topped the consensus view and reiterated its full-year outlook, although revenue was down y/y after the sale of bottling operations in China and Mexico.
- The tech industry saw two major sob stories this week: Apple and Facebook. Apple may have sold 84% more iPads in Q3 than it did last year and 28% more iPhones, but solid sales numbers could not keep it from missing inflated top- and bottom-line consensus expectations. Note that both revenue and net income were both up more than 20% y/y at the firm. As usual, Apple's Q4 guidance was conservative, coming in well below the Street's expectations. Shares of Facebook lost 20% of their value on Thursday and Friday, before and after the firm's first quarterly report as a publically traded firm. Analysts point to the lack of any outlook or guidance combined with shrinking margins plus no bold initiatives in the mobile space for the weakness. Also note that the lockup expires on August 19th, which may make some investors wary.
- EUR/USD pushed out to two-year lows below the 1.21 handle in the early part of the week before popping back into the range seen earlier in July after the ECB began moving toward renewed peripheral bond buying. Analysts were keen to note that the ECB should not concern itself with the absolute level of the euro, but rather with overall FX volatility. After all, a weaker euro is certainly a positive development for exports and economic recovery.
- Sterling initially slumped following the weaker-than-expected Q2 UK advanced GDP data on Wednesday. UK government officials were quick to point out that extra public holidays (Diamond Jubilee) and poor weather hurt GDP in the quarter and led to additional uncertainty in calculating the data in June. GBP/USD tested the 1.5470 area following the GDP report. Sonia rates were fully pricing a BoE rate cut by January 2013. The pair recovered late in the week to re-approach the 1.57 handle.
- The yen continued to strengthen early in the week on risk aversion flows, as the USD/JPY pair moved below the 78 handle to print seven-week lows. The EUR/JPY cross hit 12-year lows below the 94.50 level. Various Japanese officials continue to provide verbal intervention in an effort to contain yen strength. Dealers were whispering that the BOJ might be prepared to launch another round of FX intervention, just as the Japanese parliament formally appointed two new dovish BOJ board members, Sato and Kiuchi, ahead of the next meeting on August 8th. A fresh round of disappointing inflation figures released this week indicated that June CPI fell at the fastest pace in 2012, which may prod the BOJ to slow yen gains with another round of asset purchases.
- Elsewhere in Asia, economic data coming out of China has been slightly less downbeat, effectively keeping PBoC on the sidelines. July HSBC flash PMI remained in sub-50 contraction territory but did rise to a five-month high of 49.5 from the prior 48.2 figure. June industrial profits also continued to contract but at a slower pace. Improvement in the housing sector has prompted Beijing to dispatch teams of inspectors to 12 regions to monitor implementation of property market reform, while the central bank has softened the cushion on exporters by backtracking from a trend of stronger yuan daily midpoint settings. Down under, Australia Q2 CPI came in at a 13-year low of 1.2% y/y, however analysts do not believe the decline is enough to justify the RBA resuming its policy easing next month. As widely expected, RBNZ also left its cash rates unchanged this week for the 11th consecutive time, reiterating it is not concerned over slowing inflation while closely monitoring developments in Europe.
