Friday, January 9, 2015

Market Week Wrap-up Weekly Market Update: Topsy-Turvy
Fri, 09 Jan 2015 16:14 PM EST

Global equity markets were racked with volatility this week, as competing economic themes vied for dominance. Monday and Tuesday were dominated by concerns about the increasing risk of European deflation and the euro zone potentially unraveling over a renewed Greek crisis. The risk on tone was restored on Wednesday as Chancellor Merkel gave assurances that Germany wants Greece to stay in the euro. Mid-week sentiment was also helped by an Obama Administration announcement that the FHA would dramatically cut its mortgage insurance premiums in hopes of kick-starting the still anemic housing market. Fed policy minutes reinforced the stance of "patience," while the new slate of dovish FOMC voters flexed their wings, highlighted by Chicago Fed President Evans who proclaimed that raising rates before 2016 would be a "catastrophe." By Friday, deflation fears were setting in again, as Brent crude hit fresh 5-year lows and the US jobs data showed that last month's signs of nascent wage inflation had evaporated. The US 10-year yield retreating back below 2% signaled increased investor anxiety as the week drew to a close. The DJIA notched five straight triple digit moves and for the week fell 0.5%, while the S&P500 dipped 0.6% and the Nasdaq lost 0.5%.

The headline US jobs data showed better than expected payroll gains and another tick down in unemployment to 5.6%, but dissection of the report focused chiefly on the disheartening hourly earnings component. The very healthy November gain in wages was cut in half by revisions (to +0.2% from the preliminary +0.4%), and December hourly earnings were -0.2% m/m. The data pulled the y/y growth rate to its lowest level in more than two years (+1.7%). Note that the Fed is on record with its desire to see wage growth accelerate to +3% y/y to help it achieve its 2% inflation target.

The FOMC minutes out on Wednesday confirmed that if the labor market continues to heal, then the Fed is likely to raise rates in the middle of the year even as they remain "patient" on hikes for now. Many analysts say higher rates are likely to happen even if there is little progress on inflation. The WSJ's Hilsenrath argued that a case is to be made that lower long-term yields may even push the Fed to hike sooner, given they could be a sign of global funds flowing into the US economy and away from anemic overseas markets, potentially inflating various asset bubbles.

Downward pressure continued in the energy market, as both WTI and Brent futures dipped below the psychologically important $50/bbl level. In light of the weak Euro Zone CPI data, the selloff in Brent was particularly severe, falling 10% on the week. There was another streak of rumors that Saudi King Abdullah had died, prompting the palace to issue a statement in his name that Saudi Arabia would cope with the downturn in demand for oil and falling oil prices "with a solid will."

Press reports citing sources outlined the ECB's thinking on how it would structure a potential QE program, including three possible options. The first would be for the ECB to buy government bonds in a quantity proportionate to each euro zone member state's shareholding in the central bank. The second option would be for the ECB to buy only AAA-rated government bonds. The third option would be for national central banks to purchase their own bonds at their own risk. Later reports suggested that the ECB program would combine the first two options, with the ECB buying AAA-rated instruments (to satisfy Germany's objections to bond buying) and national central banks stepping in to buy lower-rated peripheral euro zone debt. The growing expectation that the ECB will swing into action at its January 22 meeting occurred in the midst of continued disappointing data continent-wide. German, French, and UK industrial production figures all failed to meet estimates while inflation readings underscored the hold disinflation has rooted within the EU. Euro zone headline CPI hit its lowest level since late 2009, registering a -0.2% reading in December, though the core reading was a tenth better than expected at +0.8%.

Worries about Greece nettled markets in the early part of the week. Over the weekend, German press reports said that Chancellor Merkel was prepared to let Greece leave the euro zone if it elects an anti-austerity government. Risk- off sentiment slammed equity markets early in the week until German and euro zone officials moved to clarify the reports. German government spokespeople repeatedly asserted that there is no Greek exit blueprint and that Germany wants Greece to stay in EMU even if Syriza wins the election. The latest polls out of Greece show Syriza's lead over the ruling New Democracy party has narrowed ahead of elections scheduled for January 25th.

The Obama Administration undertook another effort to aid the housing market. The FHA will lower its mortgage insurance premiums to 0.85% from 1.35%, saving the average homeowner around $900/year in mortgage payments. Back in November, the FHA said its Mutual Mortgage Insurance Fund had returned to solvency after falling into a steep deficit during the financial crisis and the housing bust, giving it latitude to cut the premium this year. Homebuilders gained in the days following this announcement, while mortgage insurance firms lost ground. Additionally, Obama reiterated his preference to see Congress wind down the GSEs (Fannie Mae and Freddie Mac).

In China, President Xi crystalized market sentiment that the economy has entered a "new normal" phase, which will feature a "medium to high" growth rate. The State Information Center (SIC) this week estimated 2015 GDP at 7% and more Wall Street analysts cut their China forecasts toward that level. The administration is not expected to set its official 2015 GDP rate until March, but reports suggest it will be around that 7% figure, compared to 2014's 7.5% target. The NDRC planning agency said the government would push seven big fiscal packages to help drive growth, although Xi's administration also downplayed the plans, saying they were not stimulus.

Japan Finance Minister Aso proclaimed that the economy was emerging from a deflation-driven slump, anticipating a rise in capex that would help return GDP to growth. Final December manufacturing PMI data somewhat confirmed his view, with the series staying in expansion for the seventh month in a row, by a slim margin. Public sentiment does not reflect this optimistic view: the BoJ's latest households opinion survey (covering the four weeks to early November) found the opinion of the current economy fell to its lowest level since December 2012.