Cliff Crackup Averted, Risk Assets Rally
- The first week of 2013 saw a massive global equity rally after VP Biden and
Senate Minority Leader McConnell brokered a deal to stave off the fiscal cliff
at the last possible moment. Although the deal has deferred hard choices on
spending for two more months, investors plowed funds into risk assets in steady
one-way trading as uncertainties about tax rates were settled. The VIX
volatility index saw its biggest one-week loss in more than 25 years and
dropped below the 14 level (the measure has finished below the level just 4
times). After the cliff, markets were somewhat caught off guard by the minutes
from the FOMC's December meeting, which suggested there has been more discord
on the subject of policy and QE than had been assumed. On Friday, the US December
jobs report showed solid but unimpressive employment growth, with non-farm
payrolls up by 155K, only slightly below the 161K pace seen in November. The
unemployment rate edged up to 7.8%. Markets were also heartened by the
excellent December ISM Non-Manufacturing Index on Friday, which built on the
good growth seen in November and topped expectations. The hopes for and then
reality ofof a fiscal cliff deal drove stocks sharply higher on Monday and
Wednesday and for the week, the DJIA rose 3.8%, the Nasdaq gained 4.8% and the
S&P500 added 4.6%.
- The fiscal cliff deal was arrived at the last possible moment, with the
Senate passing a compromise deal at 2A.M. on New Year's Day and the House
passing it late that evening. The deal as passed is really only half done:
while the tax component of the cliff has been mostly resolved, the spending
component still requires work. The compromise bill put off
"sequester" for two months while a replacement package of spending
cuts is put together. This means that Congress will be wrestling over passage
of spending cuts at the same time it deals with the debt ceiling, which was
technically reached on New Year's Eve (the Treasury has a series of procedural
and technical tricks to keep the Federal Government liquid through February).
- The minutes of the December FOMC meeting betrayed a growing sense of
nervousness at the Fed about the extended period of low rates and endless QE.
The minutes revealed that several members said the FOMC will likely need to
halt or reduce QE before the end of 2013, which was confirmed by Fed hawks
Bullard and Plosser in comments on Friday. The minutes also suggested there are
concerns about the unintended consequences of ultra-loose policy: the statement
warned additional purchases could complicate efforts to withdraw accommodation
by potentially causing inflation expectations to rise or by impairing the
future implementation of monetary policy. Some analysts suggested that this may
have been a trial balloon by the Fed while others said it was a definite shift
in tone. Goldman Sachs said the minutes imply a significantly less
accommodative path for the Fed, while the WSJ's Hilsenrath warned that a new
fault-line has opened up at the Fed.
- The steady job growth in December and the prospect of early policy tightening
shook precious metals and fixed income markets. Spot gold was trading as high
as $1,695 earlier in the week, but tumbled to $1,626 from the release of the
minutes through early Friday morning, before retracing to around $1,655. Gold racked
up its sixth straight down week, its longest run of weekly losses since 2004.
The yield on the benchmark 10-year note closed at eight-month highs above 1.9%
and nearly topped 2% at one point.
- The week featured solid monthly sales reports from retailers and auto
manufacturers. The December same-store sales reports were really excellent,
with strong outperformance seen among many names across categories. Apparel
names Gap, Ross Stores, TJX and Stein Mart crushed consensus estimates. Costco
was twice the expected figure. The department store names were strong as well.
Limited Brands, which consistently tops expectations, notably missed on comps
thanks to flat sales at Victoria's Secret. Both Ford and GM reported strong
December sales numbers. Ford said its results were the best December numbers
since 2006. Both firms put their initial estimates for 2013 SAAR above 15M
units, although this remains well below the pre-recession SAAR figure of 17M
units.
- Despite the risk-on rally that followed in the wake of the fiscal cliff deal,
the euro stayed weak against the dollar. EUR/USD made a run from the 1.3200/30
area towards 1.3300 in the period immediately after the passage of the fiscal
cliff deal. However the pair barely managed to test above this level, and the
failure to take out 1.3300 decisively condemned EUR/USD to a retracement all
the way back to three-week lows around 1.3000 on Friday.
- The greenback also gained on the Swiss Franc and the pound, which both
mimicked the euro weakness through Friday. Note that despite the equity gains,
currency traders were considering the further risks that would emerge over the
next two months from the half-baked fiscal cliff deal. European bond spreads
reflected the rotation out of safe havens and yields were higher for core and
semi-core European countries and lower in the periphery. The Spanish 10-year
yield bumped right up against 5.00%.
- The yen weakened further as the new Prime Minister Abe continued his campaign
to tackle deflation and force the BoJ to adjust its inflation target to 2%, by
law if necessary. USD/JPY hit fresh 29-month highs and yen saw its eighth
consecutive week of losses against the dollar, its longest losing streak since
1989. EUR/JPY moved out to 16-month highs.
- Cable began the week firmer and tested above the 1.63 handle aided by weekend
press articles forecasting that the BOE could defy expectations and raise
interest rate in 2013 thanks to economic recovery and rising inflation. On the
interest rate front, 10-year Gilt yield moved above the 2% level for the first
time since May 2010 and rose to an 8-month high above 2.10%. The Gilt was
briefly above its French OAT counterpart for the first time since April 2011.
GBP/USD fell to three-week lows by the end of the week to approach the 1.60
level.
- China reported some additional encouraging manufacturing data early in the
week. The December HSBC Manufacturing PMI came in at its highest level since
May 2011, while
the official Manufacturing PMI reading showed its third consecutive month of
expansion.
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