Friday, July 5, 2013

Market Week Wrap-up  Weekly Market Update: Strong US jobs data amps up taper talk; ECB steps in with forward guidance

- Fireworks flew in the July 4th holiday shortened week and the grand finale, the June US jobs report, delivered. A combination of geopolitical turns, central bank decisions and economic data made for exciting week in the financial markets. Europe saw a return of crisis-like concerns after key defections in Portugal PM Coelho's government sent bond yields surging higher, while it appears Greece is struggling to prove they have meet conditions needed to secure an €8B tranche in its bailout. Egypt added to overall jitteriness as the military reacted to mass protests by deposing President Morsi and installing a technocratic government. While US markets were closed on Thursday, both the ECB and Bank of England were out reassuring markets by offering forward guidance, indicating accommodation will stay in place for an extended period. By Friday, all eyes turned to a promising US employment report which appears to have cemented expectations the Federal Reserve will begin tapering back asset purchases sometime this fall. Prospects for a better US economy and political instability in Egypt caused WTI crude oil prices to spurt above $100 for the first time in a year, ending the week up about 7%. The US Dollar index has reached fresh 3-year highs and metals markets remained under notable pressure. Bond yields backed up aggressively on both sides of the Atlantic with the US 10-year surpassing 2.7% for the first time since August 2011. Overall stock prices have made little headway with rising rates restraining equity sentiment until late in the week. For the week with the Dow finished up 1.5%, the S&P added 1.6% and NASDAQ gained 2.2%.

- The US employment report was the most highly anticipated data of the week, and it didn't disappoint. Non-farm payrolls of 195K beat expectations by 30K, and coupled with a big upward revision in the May figure, brought the three-month average up to 185K net gain in payrolls. The unemployment rate ticked up one-tenth to 7.6% on higher workforce participation. Average hourly earnings also saw their biggest month over month gain in nearly two years, rising 0.4%, adding to the purchasing power of US consumers. The jobs data was strong enough to trigger some early selling in equity markets as analysts brought forward the consensus expectation for Fed tapering to the September meeting.

- European manufacturing PMI readings on Monday were good news for some of the peripheral states, but not for Germany. Spain and Italy each reported their best PMI reading in three years, while Germany notched its third straight contraction, a bad sign for the continent's manufacturing powerhouse. US economic activity data was also inconclusive. The June ISM manufacturing data met expectations at 50.9 and topped the May figure of 49. The new orders, production and inventories indices were all better than the May readings, although the employment index slipped into contraction for the first time since October 2009. The June ISM non-manufacturing index dropped to its lowest level in three years, missing expectations, but the employment component of the report rose to its best level since February.

- On Tuesday the Fed adopted a proposal to outline additional rules that will be required of US banks on top of the new Basel III capital regime, effective January 2014. The Fed's Tarullo commented that the 7% Basel III capital ratio seemed too low, and that the SIFIs would face a stricter leverage ratio. In addition, the board will write rules that would force banks to hold a minimum amount of debt to be converted to equity during a crisis and wean banks dependent on short-term wholesale funding.

- In another sign of the gradual economic recovery, US June auto sales delivered the best result seen since December 2007. Industry sales came in at an annualized pace of just under 16 million vehicles, up from 15.3 million in May and 9.1 million at the bottom of the crisis. Ford saw a 13% y/y sales gain, while Chrysler sales were up 8.2% y/y and GM gained 6% y/y. Toyota US sales were up 9.8%.

- Data out from TrimTabs indicated that a record $80B left bond funds in June. This figure was nearly double the withdrawals seen at the height of the financial crisis in October 2008. TrimTabs warned that the rush out of bonds may soon get even worse, as bond investors could be spooked after receiving plenty of red ink on their quarterly statements in the coming weeks.

- Political turmoil in Egypt broke out ahead of the one-year anniversary of President Morsi's election. Continuing dysfunction and gigantic anti-Morsi street protests spurred the Egyptian Army to force Morsi step down on July 3rd. Front-month WTI crude broke above $102 for the first time since early 2012 as the army suspended the government and placed Morsi under house arrest. With the move up in WTI and the continuing economic chaos in Europe, the WTI/Brent spread narrowed to a 2.5 year low.

- Austerity fatigue nearly capsized the Portuguese government this week. In a surprise move just days before the Troika's next review, Portuguese Finance Minister Vitor Gaspar stepped down from office. Gaspar, who was the architect of the Lisbon's package of economic reforms, said eroding public support for austerity plus the Portuguese Constitutional Court's ruling against certain cuts back in April had made his position untenable. Treasury Secretary Maria Luis Albuquerque replaced Gaspar, which prompted CDS party leader and foreign minister Portas to quit the government coalition, saying the new finance minister would offer "mere continuity" of the country's deficit-cutting plans. Yields on 10-year Portugal government debt surged 130 bps at their worst, testing 8%, though by the end of the week it appeared PM Coelho had convinced the CDS party to remain in the coalition.

- In Greece, the Troika returned on July 1st after a two-week hiatus and warned the government that it might need new austerity measures if it failed to meet revenue targets and plug a funding gap. This followed the high-profile collapse of several privatization initiatives, causing the Greek government to slash its 2013 privatization target to €1.6B from €2.6B. Subsequent reports suggested that the Troika had given Athens a three-day deadline to assure foreign lenders it would be able to meet the terms of its bailout deal or the next aid tranche of €8.1B would be withheld and doled out in smaller increments. By Friday, Greek officials said they were hopeful they could wrap up talks with the Troika this weekend, ahead of a Eurogroup meeting on Monday July 8th.

- The foreign exchange market exhibited renewed volatility on a laundry list of global concerns, including the flashpoints in Egypt, Portugal, and Greece. Dealers also noted more evidence of a Chinese economic slowdown after its official non-manufacturing PMI came in at 53.9, down from 54.3 in the prior month.

- These global concerns were countered by central banks in Europe stepping in to show they are still in charge. Both the BOE and ECB took an historic stance on issuing forward guidance at their respective meetings. The BOE said that the "Chancellor had requested that the Committee provide an assessment, alongside its August Inflation Report, of the case for adopting some form of forward guidance, including the possible use of intermediate thresholds" (the Inflation Report is due August 7, coming after the August 1 BOE policy meeting). Shortly thereafter, the ECB issued its own forward guidance, stating that the central bank expects all rates to stay as they are or lower for an extended period of time. The EUR/USD dipped below the 1.29 handle for 5-week lows over the course of the ECB press conference.

- A slew of UK economic data beat expectations but in the end could not save the GBP from weakness. The GBP currency suffered its largest decline since Feb after the BOE issued a rare statement upon Governor Carney taking the helm of the central bank. The thrust of the statement was mildly dovish as the BOE looked to established forward guidance as a tool. Some dealers noted that the statement was a smart way of drawing attention away from how the new governor voted, which will be detailed in the minutes released later this month (July 17). The GBP/USD tested 1.5070 immediately after the statement, and then fell as low as 1.485 after the US jobs report on Friday.

In Japan, the improvement in Tankan report reflected the pick-up in sentiment since the BOJ embarked on its bold easing policy last April . The USD/JPY pair probed back above the 100 level for 1-month highs, with dealers noting the pair had a lot of option expirations at 100 this week. M&A flows also contributed to talk up the trend, as a Japanese pension fund joined a consortium to buy a Michigan electric plant for $2.0B.

- The Australian dollar was under pressure and hit 3-year lows after the RBA talked down AUD after it left rates unchanged at 2.75%. The currency rebounded from 3-year lows and market participants adjusted down rate cut expectations after RBA deputy governor Lowe said Governor Stevens was misinterpreted when he said board deliberations went on for a "very long time."