Friday, May 27, 2016

Risk Assets Test Key Levels as Global Risks Wane Weekly Market Update: Risk Assets Test Key Levels as Global Risks Wane
Fri, 27 May 2016 16:03 PM EST

The S&P500 notched its second consecutive week of gains neared the key 2100 area, where broader equity rallies have stalled again and again over the last 15 months. Most global equity markets in Europe and Asia also saw modest gains. While equities ground higher, crude prices briefly tested above $50 for the first time since last fall. May corporate bond issuance continued on at a historic pace while US Treasury supply found buyers eager to take advantage the recent declines in prices. The Fed campaign to redirect the markets' interest rate policy expectations was capped by remarks from Chair Yellen on Friday. The G7 produced another tepid statement and plenty of hot rumors of conflict between the US and Japan on clashing visions of how to cope with the global economic slowdown. The Europeans reached yet another deal to keep Greece afloat on borrowed money, while in the UK polling numbers suggested the "remain" camp was gaining ground with only a month to go to the referendum. With some of those global risks starting to fade, equities rebounded and for the week the DJIA gained 2.1%, the S&P500 added 2.3%, and the Nasdaq rose 3.4%.

The barrage of Fed speak that drove last week's repricing of interest rate expectations hardly let up this week. On Sunday, the Boston Fed's Rosengren (a voter) said that most of the conditions for more rate hikes that were laid out in the FOMC minutes seem to be on the verge of broadly being met. On Monday, the San Francisco Fed's Williams said it would be a good idea to raise rates with inflation below target, due to the lag in policy impact, and warned that the Fed sets policy based on the direction inflation is headed, not where it is now. Philly Fed President Harker said rates need to keep rising as inflation picks up. The ever-chatty hawk Bullard said a rate hike in June or July was not set in stone. Powell said the economy is on track to meet the Fed's employment and inflation mandates, with tentative signs that wages are firming. Chair Yellen capped things off on Friday, saying that she expects data to keep improving and if that bears out it will be appropriate to raise rates in coming months.

The second reading of US Q1 GDP was revised a bit higher, to +0.8% from +0.5% in the advance reading. Consumer spending was unchanged at +1.9% in the first quarter. New home construction surged to +17.1% from +14.8% in the advance estimate, the biggest gain in nearly four years. The April new home sales data confirmed that housing market strength has been sustained at the beginning of Q2. The annualized rate of new home sales surged in April, rising to 619K units, up nearly 17% y/y, way ahead of expectations. That's the highest annualized rate of new home sales since January 2008. With supply tight, the median price for a new home increased 9.7% y/y to a record $321,100. US manufacturing data remained poor: the May preliminary Markit factory PMI index sank to its lowest level since late 2009, and the negative reading in the May Richmond Fed manufacturing index echoed a similar result in the May Empire manufacturing survey out last week. Both saw new orders crater, moving from fairly decent growth in April to big declines in May. The April core capital goods orders component of the durable goods report fell 0.8%, the fifth month of declines in the last six months.

For years, the biannual G7 meetings have produced tepid headlines and dull communiques, in which global leaders agree to continue agreeing on broad, vague goals. The most recent edition of the G7 in Tokyo was a different story, as the leaders of the developed world clashed over the right policies to support flagging global growth and forestall all-out FX war. The communique was as anodyne as usual, but in the background US and Japanese officials exchanged sharp rhetoric over FX policies. Japanese officials reportedly made strong appeals for organized exchange rate intervention, but the rest of the group, led by the US, rebuffed the appeals. The Japanese also pushed for their plan to commit G7 members to expanding fiscal spending to blunt the slowdown, warning that the world was potentially at the edge of an economic crisis, but this also appears to have been rejected by the group. With no coordinated G7 plan in place for FX or growth, many analysts now expect another round of Japanese stimulus, and possibly some hint that the BoJ could look at "helicopter money" policies at the June meeting.

For months, Japan PM Abe has been saying that the 2017 sales tax increase would only be delayed (again) under the threat of a Lehman-like crisis. As G7 leaders gathered in Tokyo, Abe gave a speech in which he warned leaders the global economy was possibly heading towards another Lehman-like crisis, citing the 55% decline in commodity prices since mid-2014. This prompted many analysts to conclude the widely-anticipated delay of the tax hike was imminent. Local Japanese press sources suggested the delay could be as long as two years, with a formal announcement as soon as next week. Separately, the Japan April inflation report out this week underlined the failure of Abenomics and the BoJ's negative rates: CPI was in contraction for the second straight month (-0.3%) and the Tokyo CPI figure (-0.5% y/y) saw the fourth month of declines and marked a three-year low. Analysts anticipate the dire inflation data to produce GDP contraction in Q2. This further underlines the possibility of more action from the BoJ in June. The softer yen trend seen in the first three weeks of May hit pause this week, as USD/JPY had trouble maintaining momentum above 110.

There seemed to be a shift in polling on EU Brexit this week, favoring the "remain" camp. On Monday, an ORB/Daily Telegraph survey of "definite voters" showed 55% of respondents in favor of staying in EU and only 42% in favor of leaving. Later in the week, an Ashcroft poll showed 65% of respondents in favor of remaining in the EU and a mere 35% for leaving. Note that "undecided" respondents remain in the double digits in all recent polls. The change in tone comes as the government and the Conservative party ramped up their campaign to emphasize the extreme costs that would accompany Brexit: up to 800K job losses, as much as an 18% decline in property prices and an overall price tag of up to £200 billion. Cable again tested YTD highs this week as the pound softened, although the pair did not maintain a foothold above 1.4700.

Greece and its creditors reached a deal that could be a major step on the road to solving the stricken nation's debt crisis. Representatives from Greece, the IMF and the Eurogroup agreed to preliminary measures to restructure Greek debt when the country's bailout deal concludes in 2018. Most importantly, the proposals include reducing the exposure of the IMF by buying out up to €14.6 billion loans. The deal also includes the possibility of the euro zone handing over €10.3 billion of rescue loans to keep Greece solvent this summer.

Hewlett Packard continues to slim down and adapt to the post-PC world and zero in on its most profitable segments. Hewlett Packard Enterprise will spin off its enterprise-services division to Computer Sciences Corp. in an all-stock deal valued at $8.5 billion. The deal gets HPE out of the market for information technology outsourcing, which helps customers manage and upgrade their systems, leaving it to concentrate on selling hardware that covers servers, storage and networking.

German agricultural and pharma giant Bayer AG offered to acquire Monsanto for $122/share in cash, in a total deal valued around $62 billion. Monsanto called the deal inadequate but left the door open for negotiations with Bayer. The very controversial move comes just three weeks after the board named Werner Baumann Bayer's new CEO, and was condemned by a major shareholder as "arrogant empire-building" when news of the proposal emerged last week.

Shares of Tribune Publishing tanked after the company rejected a revised, $15/share offer from Gannett. Tribune's board rejected the proposal but did invite Gannett to agree to a mutual non-disclosure agreement under which both parties could engage in due diligence and discussions to work out a more acceptable deal, while Gannett said it was thinking hard about dropping its offer.