Friday, September 14, 2012

Market Week Wrap-Up

Helicopter Ben Lands QE3, Refueling Risk-On Rally

- The Fed authorized its third round of quantitative easing this week, promising to dump liquidity into US and global markets to increase what it called the inadequate pace of economic recovery and boost employment. The new round of easing may be Chairman Bernanke's biggest yet, as the Fed has promised not to stop buying until the labor market "improves substantially." Substantial improvement was not clearly defined. Meanwhile, the last big barrier to the ECB bond buying program was eliminated this week. Germany's Constitutional Court authorized German participation in the ESM bailout fund with only two main conditions: that parliament must be consulted on ESM activities and that Berlin's contribution will not exceed €190B without the approval of the Bundestag. Spreads between bunds and Spanish and Italian government debt immediately narrowed after the ruling was handed down, and by the end of the week yields on Italian and Spanish 10-year debt had fallen below 5% and 6%, respectively. In the hours following the Fed's announcement, US equity markets rallied hard and the DJIA and S&P500 closed at their highest levels since December 2007 on Thursday. Global markets caught up to the US on Friday, while US markets added more modest gains to close out the week. For the week, the DJIA gained 2.2%, the Nasdaq rose 1.5%, and the S&P500 added 1.9%. Gold futures surged a couple of percentage points to as high as $1,780 on the additional Fed stimulus, while crude oil topped $100 for the first time since early May

- The FOMC gave the market everything it wanted on Thursday, extending its low-rate pledge another year to 2015 and launching a new unlimited round of quantitative easing. The new Fed bond buying program has the real potential to exceed the first two installments of QE. While the monthly purchase total of the new program is only $40B of mortgage-backed securities a month, less than QEII's $75B a month and QEI's $100B monthly tab, the open-ended commitment and the vague end-state conditions suggest the program could have an extended lifespan. In his post-decision press conference, Bernanke sought to head off common concerns about extended low rates and QE: he noted that while low rates impose some costs on savers it also supports value of other assets and ultimately supports stronger economic conditions, and said that if inflation becomes an issue the Fed has other tools it can use to tamp it down over time. There was selling at the long end of the US Treasury curve into and after the announcement. The 30-year yield moved back above 3% while the 10-year is now at 4-month highs above 1.85%.

The US "fiscal cliff" got a lot of jawboning this week, perhaps taking some of the edge off of the risk-on nirvana that came with the Fed announcement. Speaker of the House Boehner offered that he is not at all confident that the US can avoid the fiscal cliff or a further ratings downgrade. This comment came as Moody's warned that it could downgrade the US triple-A rating if next year's budget negotiations do not produce policies that begin to decrease debt levels. A former PBoC official expressed concerns about the US debt level, observing that if one included social security and Medicare related liabilities, the US debt-to-GDP ratio would be approximately 200%.

- It seems like the June quarter earnings season was only yesterday and already the September quarter season is right around the corner, prompting firms to begin offering profit warnings. Western Digital trimmed its Q1 revenue guidance due to much lower overall market demand for hard drives, driven in part by "inventory rebalancing" (WDC also initiated a $0.25 dividend and a new stock buyback plan). Trucking stocks hit the brakes after Werner Enterprises offered a Q3 outlook that was well below expectations, although executives cited higher maintenance and healthcare costs for the poor forecast. Both Steel Dynamics and AK Steel warned that their Q3 earnings would be very weak, the former due to the uncertain inventory and the later due to outages and maintenance downtime. In its mid-quarter update, Texas Instruments boosted its Q3 earnings guidance range slightly, although it also narrowed its revenue forecast.

- The major merger story this week was news that BAE Systems and Airbus parent EADS were once again mulling a tie-up. The move, which has been the subject of on-again, off-again talks for years, would create an aerospace and defense giant second only to Boeing. The news was met with concerns about whether the deal would be able to clear regulatory hurdles. Shares of EADS fell sharply in European trading, down around 15% on the Paris bourse, while London-traded shares of BAE were up on the week.

- Shares of Facebook jumped following CEO Mark Zuckerberg's first public interview since the botched IPO. Zuckerberg offered a mea culpa, admitting that the performance of the stock has been disappointing and he had made some wrong turns in strategy, but insisted that Facebook cares about shareholders. He also made bullish comments about the firm's mobile and search strategies.

- The US Treasury Department took a big step toward exiting its position in AIG this week. The treasury sold off $18 billion of its common stock, cutting the government's share in the firm to around 16% of the outstanding shares from 53% prior, prompting AIG to declare that America's $182B total commitments to AIG have been fully recovered.

- German support for the ESM, the massive impact of QE3, and Moody's comments about the US sovereign rating conspired to crush the greenback this week. EUR/USD entered the week just below 1.2800 and climbed to 1.316 through Friday, its highest level since the beginning of May. Sterling was aided by better UK trade data: the July trade deficit hit its narrowest total since February 2011 and the July non-EU goods exports pushed out to a record high. GBP/USD probed above 1.6000 and by Friday was testing a four-month high of 1.6033. EUR/CHF drifted higher throughout the week as the SNB maintained the peg, against speculation that it would raise the lower limit from 1.2000 to 1.2200.

- In Japan, Finance Minister Azumi cranked up the anti-strong yen rhetoric. Azumi warned that more decisive steps may be needed to deal with the yen, reiterating that the recent appreciation has been highly speculative in nature. Japan's Cabinet Office downgraded its assessment of the economy for the second consecutive month and called on the BOJ to take a more aggressive policy stance at its meeting next week. USD/JPY hit 7-month lows in the aftermath of the FOMC, falling below 77.20, but quickly bounced back. Later in the day, dealers indicated the BOJ had conducted a rate check after the Fed announcement to curb JPY currency strength, its first since June. Note that Sept 14th also marked the two-year anniversary of when the MOF first instructed the BOJ to embark on solo FX intervention. USD/JPY regained the 78 handle early on Friday, while EUR/JPY tested the 102 level.

- August economic data out of China released over the weekend and early on in the week painted a mixed picture of the slowing economy just as Beijing prepares for its once-a-decade political handover next month. Output and trade data continued to slow with industrial production coming in at a new three-year low, just shy of estimates at 8.9%, while imports registered their first y/y contraction since January - a clear sign of accelerated slowdown in the uptake for the world's manufacturing hub. Inflation data was slightly rosier, rising on a y/y basis for the first time since March. Analysts were quick to point out that the apparent bottom in CPI is likely to keep the PBoC from further easing for the time being, even though a closer look at inflation data suggests that much of the bounce is related to food prices rising as a result of droughts overseas. Despite the broad-based post-FOMC rally across asset classes, Shanghai Composite has hardly participated in the run-up, ending the week flat at 2,123. With the October party congress drawing nearer, the apparent disappearance of presumptive party leader nominee Vice Premier Xi Jinping from the public eye has added a wrinkle to expectations of a smooth transition.