Friday, September 20, 2013

Market Week Wrap-up  Weekly Market Update: Fed Confounds Expectations on QE Taper; Summers Steps Aside

- Two Fed-related surprises drove the market action this week. First, on Sunday, Larry Summers withdrew from the Fed Chairman selection process, setting off a risk-on rally based on expectations that the more dovish and collegial Janet Yellen was again the frontrunner to replace Chairman Bernanke. Then on Wednesday, the FOMC surprised markets by deciding not to reduce monthly asset purchases under its QE3 program. Coming into the week, the consensus view was that the Fed would announce a reduction of $10-15B in asset purchases (to $70-75B a month) at the Wednesday FOMC meeting. After the decision, Bernanke said unemployment remains at unacceptable levels and economic data does not yet warrant a reduction in asset purchases. Global equity markets moved sharply higher after the decision and sovereign bond yields dropped, with the yield on the 10-year UST falling as low as 2.67% after just about touching 3.00% in the prior week. Gold has gained more than 6% in the aftermath of the Fed announcement, with spot gold trading as high as $1,370. The US data out this week was mixed, with relatively strong Empire and Philadelphia Fed manufacturing surveys, while initial weekly jobless claims are poised to drop below 300K. August existing home sales hit another six-year high, although the August housing starts and building permits did not quite rise to high expectations. Some of the market gains after the Fed surprise on Wednesday were erased by Friday, in part due to the Fed denting its credibility with the markets. For the week, the DJIA gained 0.6%, the S&P500 rose 1.3% and the Nasdaq added 1.4%.

- For sharp observers, the Fed's decision to hold pat on QE should not have been terribly surprising. Chairman Bernanke and the full spectrum of Fed officials have reiterated for three months that any decision to taper would be primarily data-driven, and there was a minority view among analysts that recent data softness might stay the Fed's hand. In retrospect, the decision to hold was even less surprising given the growing likelihood of a fiscal crackup in Washington later this month. Many observers commented that Bernanke appeared to downplay the 7% unemployment threshold after he neglected to mention the level until asked about it in the press conference by a journalist. Bernanke responded by saying there is "no magic number" the Fed is looking at for tapering and ending QE. The sole dissenter in the decision, Ester George, did say that the taper should have begun this month as waiting for more good data unnecessarily discounts very real economic progress, and warned that Fed credibility is now at risk. Now the focus is on whether the taper will begin at the next FOMC conclave in October or the December meeting, or later.

- Larry Summers removed himself from consideration to succeed Chairman Bernanke, citing high likelihood of an "acrimonious" confirmation process. Congressional opposition to Summers had been gradually building over the summer, and late last week a brace of key US senators said they would vote against his confirmation if he were selected. The move left Janet Yellen as the de-facto front-runner, although there was talk that former Fed vice chairman, Don Kohn, was also in the running.

- With Congress racing toward the end of the federal government's fiscal year on September 30, the deadline to avert a government shutdown, the House GOP continued to place roadblocks in the way of short-term budget extension. Democratic and Republican Congressional leaders traded rhetorical barbs all week long but there was no substantial progress in resolving the budget standoff. On Friday, the House passed a bill with a short-term extension of government funding that would also defund Obamacare. Senate Majority Leader Reid said the House bill was dead on arrival in the Senate, and Speaker Boehner indicated he fully expected the political wrangling over the stopgap spending bill would stretch at least into next weekend.

- Over the weekend, the US and Russia agreed to a plan to corral Syria's chemical weapons that gave the Assad regime one week to disclose a comprehensive listing of stockpiles and requires it to allow inspectors to complete weapons liquidation by mid-2014. By Friday Damascus had submitted an "initial disclosure" of its chemical weapons program to the UN. WTI crude futures dropped to their lowest levels since before the August 21st chemical weapons attack, closing out trade on Friday below $105/barrel.

- The German parliamentary elections are set for this weekend, pitting Chancellor Angela Merkel's conservative CDU/CSU and FDP coalition against a leftist coalition led by the SPD. Last Sunday, Merkel allies won a strong victory in the Bavarian state election, which also saw increasing support for the anti-euro AfD party. The latest polls suggest the CDU/CSU block should take about 40% of the vote, although the FDP is polling right around 5%, the threshold for getting any seats in the Bundestag. If FDP misses the threshold for representation, Merkel will face the difficult choices of forming a new coalition with the troublesome anti-euro AfD party or a grand coalition with her old rival, the SPD.

- With the fall earnings season now on the horizon, firms have begun offering Q3 profit warnings. Manufacturer Rockwell Collins offered a terrible FY14 view on the assumption that the sequester is here to stay. Shares of Outerwall (formerly known as Coinstar) dropped sharply on Monday after the firm trimmed its financial targets for the current quarter and the full year. Trucker Werner Enterprises offered a Q3 outlook that fell well short of the consensus view, citing a wide range of issues. Steel names Nucor, Steel Dynamics and AK Steel all offered Q3 guidance, although only the latter offered a divergent view, which was way below consensus. Friday afternoon, Blackberry confirmed it would slash over 30% of its workforce and reported preliminary Q2 results far below expectations, blaming it on weak demand for the new Z10, its entrant into the high end touchscreen smartphone market.

- Currency markets moved primarily off of the Fed announcement this week. EUR/USD held very steady around 1.3350 into the decision and then rose more than two big figures to trade just shy of 1.3570 on Thursday morning, before settling down to 1.3540 at the end of the week. The yen came into the decision pivoting around 99, then dipped as low as 97.80 on Wednesday and finally rising right back up to around 99.50 on Thursday and into the end of the week.

- The other big central bank news this week was from India, where the RBI surprised markets by hiking its Repurchase Rate by 25 bps to 7.50%.