Weekly Market Wrap-up

With equity trading subdued, the focus was firmly on bonds and commodities this week. Entering the week there was palpable anxiety among bond traders as the Treasury geared up to sell $65B in 3-, 10- and 30-year debt. Despite shaky results in the 10-yr auction, fears of a buyers strike ultimately proved unfounded as all three auctions were easily covered with particularly robust bidding from foreign central banks. US equity indices repeatedly tested weekly highs only to retreat, with little economic data to fix on and relatively light volume. The preliminary June University of Michigan Confidence survey came in a hair below expectations, with both one- and five-year inflation expectations above the 3% level. The initial jobless claims were a bit lower than expected, while continuing claims moved out to yet another all-time high. Dispute continued over the state of a hypothetical economic recovery. Yale economist Robert Schiller told Bloomberg TV that "We may have a recovery, but I suspect it will be a disappointing one." Senior White House Advisior Paul Volcker commented that prospects for a strong recovery were unlikely, despite some growth in late 2009. On Wednesday morning, Goldman Sachs's CEO Blankfein, who seldom makes public comments, said he expects a long, protracted recession and insisted the current upturn is not the real recovery. Later the same day, PIMCO's McCulley responded, stating that he believes the recovery is for real. Crude oil futures continued to drive higher as a trade on a weaker dollar and stronger economy, ending the week at just above $72/bbl, near seven-month highs. On the geopolitical front it was Axis of Evil week, with the UN agreeing new sanctions on a recalcitrant North Korea, and Iran at the polls to select its next president. Stocks moved sideways on the week, with the S&P 500 gaining 0.7%, the Nasdaq rising 0.5%, and the DJIA edging up 0.4%, closing in positive territory YTD for the first time since early January trading.
On Tuesday the Treasury approved the TARP repayment plans of 10 banks holding a total of $68B in government funds. Goldman Sachs, Morgan Stanley, JP Morgan, American Express, Capital One, Bank of New York, US Bancorp, State Street, BB&T Corp and Northern Trust are expected to begin buying back preferred shares and warrants held by the Treasury next week. The absence of Wells Fargo from this list was widely noted; an executive from the bank said the firm has not applied to repay government funding as of yet. President Obama called the TARP repayments a positive sign, while also warning they are not a signal the crisis is over. The administration confirmed that paying back TARP meant that firms were no longer bound by various pay and other restrictions. On Wednesday the administration appointed a special official, a so-called "Pay Tzar," to oversee executive compensation at companies that are still relying on government aid. In other finance sector news, BlackRock consummated its purchase of Barclays investment unit for $13.5B, making it the world's largest money manager, while Bank of America and Citigroup were said to be facing pressure from various quarters to dump their CEOs.
Various players in the semiconductor segment offered conflicting views on whether the industry is recovering or not. Texas Instruments and Qualcomm raised earnings and revenue forecasts for the coming quarter citing returning demand for chipsets, although some analysts have wondered how much of this is due to judicious restocking of inventories and how much is from direct customer demand. In its quarterly industry survey, semi analyst firm iSuppli said forecast 2009 global microprocessor revenue would decline 16% y/y, after a 21% decline in Q1 y/y. Executives from the big PC processor manufacturers offered conflicting views: AMD's CEO echoed recent comments from the likes of Michael Dell and said it is too early to say the PC market has hit bottom and predicted Q4 is the earliest time for year-on-year growth in revenue or demand. Intel's CEO said he is confident the bottom has already been reached in the PC market. Taiwan Semi said it believes the worst is over for the chip industry and expects industry growth of 5-6% in 2009.
The smartphone wars heated up this week, with significant new product introductions from Palm and Apple. Over the weekend Palm launched the Pre smartphone; more than one commentator dubbed the phone an "iPhone killer," although others have noted its popularity may be limited by the lack of an "app store" and exclusivity on the second-tier Sprint network. At its annual developer conference, Apple rolled out new laptop models, an update to its OSX operating system and a lower $99 price point for an entry-level iPhone. But the main event was the new 3GS iPhone model, which sports a faster processor and more memory than the existing 3G models. If the contest between the two names were judged on share price alone, Palm would be the winner, with its shares up more than 15% on the week, while Apple was down about 4%. Note that Nuance and TomTom are riding Apple's iPhone coattails, as software from both firms are integral to the new 3GS's speech recognition and GPS capabilities. Share of NUAN are up around 15% on the week, while the Netherlands-listed shares of TomTom have shot up nearly 45% on the week.
With earnings season on the horizon, companies are taking the opportunity to shape expectations and fine tune guidance. Visa said it sees high single-digit growth in 2009 and believes it will return to 15-20% revenue growth in 2010, depending on the course of the crisis. Cardinal Health said its full-year earnings would be at the low end of its stated $3.50-3.60 range. Home Depot fixed up its full-year earnings outlook, saying EPS would be -7% to flat y/y (better than its prior -7% view). Clorox reaffirmed its forecast for 2010 and raised its dividend by a bit.
Landmark legislation granting the FDA the power to regulate tobacco was approved by Congress late in the week, and President Obama has pledged to sign the bill. Passage was more or less assured, and the news has been priced into tobacco stocks. Note that there has also been chatter making the rounds that Star Scientific may soon reached a settlement in its long-running patent infringement suit against Reynolds American as the two continued to battle in court this week.
US Treasury investors are clearly demanding higher yields; whether this is primarily due to the more attractive returns available in other asset classes or concerns over the country's fiscal situation is still hotly debated. The angst over rising US rates reached a crescendo on Wednesday ahead of the 10-year auction when a Russian official suggested they were considering diversifying away from US debt and buying IMF bonds. Sellers entered the market at the open and ultimately the $19B 10-year notes were reopened at an average yield of 3.99%, a staggering 80bps higher than at their original sale in May. Concerns rose among bond vigilantes over the prospects for the subsequent Long Bond offering on Thursday thanks to the large yield tail of 4 basis points, which briefly sent the benchmark above 4%. The nervousness also translated into the highest Long Bond yield since October of 2007 nearing 4.85%.
By Thursday, traders seemed to be digesting the higher rates with increased casualness. The concessions in price and higher yields proved attractive to buy and hold investors and the Long Bond auction registered above average results on every available metric. The 30-year bonds reopened at 4.72% with indirect bidders taking nearly half of the competitive bids. Prices remained bid into the week's final session and were further buoyed by comments from Japanese Financial Minster Yosano who called his nation's trust in US Treasuries "unshakeable". The US curve saw noticeable flattening on Friday as both 30 and 10-year paper yields declining some 20 basis points from the mid-week highs.
Looking ahead traders are searching for some more consolidation and settling of nerves in US government debt markets. If yields can find a tradable range below 4% in the benchmark, trepidation the recent surge rates could cut of a recovery can abate. If not markets will continue to speculate on the emergence of a "Bernanke conundrum", a notion that despite the Fed funds rate having reached a nominal floor, the Fed appears to have lost control over long term rates. The 3-month USD Libor finished the week at a new low of 0.62%, whilst according to the Mortgage Bankers Association, the average rate on a 30-year mortgage shot up another 32bps to 5.57%, its highest level since November 2008. With no new supply on the calendar for next week, extra focus will be given to this weekend's G8 ministers meeting and even more so to the Tuesday meeting of BRIC nations in Moscow. China Russia and Brazil have all verbally committed to diversifying some portion of their reserves away from US Treasuries and into IMF backed bonds and India is expected to follow suit.
In currencies, the dollar began the week on a firm note on momentum from Friday's US payroll data and rising bond yields. But pricing got back in sync with commodities in no time, as oil continued to firm on economic optimism and reports that China's industrial production data would exceed consensus expectations. In addition, the IEA raised its global oil demand forecast for the first time in 10 months. By mid-week, sentiment soured on holding dollars, with Goldman Sachs offering five reasons for a weaker dollar in a research note, including rising risk appetite, the continued climb in commodity prices and lingering doubts about its reserve currency status.
The reserve currency issue has become a primary focus ahead of the G8 finance ministers' meeting this weekend in Italy and the BRIC (Brazil, Russia, India and China) summit next Tuesday. The four BRIC nations are expected to discuss alternatives to holding dollars in reserves, a theme that Russia hammered away at on numerous occasions this week. Russian Central Bank First Deputy Ulyukayev commented that Russia was mulling plans to reduce its share of reserves held in US Treasuries in exchange for IMF bonds. However, its also worth noting that a Chinese Vice Foreign Minister said any talk of "dumping" USD was not realistic. Brazil said it was not attempting to weaken the USD but would likely purchase IMF bonds, insisting that it would not benefit from a weaker USD. There has been more talk about Special Drawing Rights (SDRs, which are an accounting chit only, not a circulated currency) as a new synthetic reserve currency, which has in turn undermined confidence in the dollar. China got the conversation about SDRs going earlier this spring, though at that time the Chinese Vice Foreign Minister insisted that the sovereign currency question was being discussed "at an academic level." (Note that the current IMF SDR basket contains about 40% USD and 37% for the EUR, compared to the current share of about 60% USD and 30% for the EUR in central bank reserves globally).
The dollar also faced a home-grown verbal barrage this week. Fed Governor Lockhart acknowledged that the dollar's role as a reserve currency might decline on a relative basis over time, while also insisting the USD would remain reserve currency for quite some time. White House Advisor (and former Fed Chairman) Paul Volcker said some sort of special reserve currency would ultimately be logical but warned there were no practical alternatives to the dollar today or "for many tomorrows." A Goldman Sachs economist chimed in as well, noting that central banks need to hold fewer dollars and forecasted a softer dollar in the medium- and long-term thanks to the growing risk of reserve diversification.
The G8 Finance Minister meeting will take place this weekend. On the topic of currencies both the German and French finance ministries noted that currencies would not likely be discussed since no central bankers would be attending the meeting (we would point out that finance ministries are the very officials who would give the actual order at the appropriate point to their respective central bankers to intervene in FX). The G8 may discuss exit strategies for the raft of unconventional measures that have been enacted to deal with the crisis.
EUR/USD began the week around 1.3855. The euro failed to react negatively to news the Swedish Central Bank had activated a currency swap line with the ECB to ensure the stability of its financial sector as concerns in Baltic region continued to simmer throughout the week. The USD was adversely impacted most by the Russian Central Bank comment of possible diversifying its $408B in reserves away from its 30% allotment in US Treasuries. The Fed's Lacker and White House Advisor Volker acknowledgment that the USD's reserve role could diminish over time also packed a hefty punch. However, The USD did manage to retrace half of its weekly losses as the week drew to a conclusion aided by some risk aversion and simple position covering ahead of the G8 finance minister summit.
Sterling was again vulnerable on continued political uncertainty in the U.K as the week began. However, perceived M&A flows helped the currency rebound from lows around 1.5800 on Monday, with dealers citing the potential $13B Blackrock-Barclays deal as the main catalyst. The UK quarterly inflationary expectations survey was higher on a q/q basis, helping precious metals and energy commodities move higher, indirectly supporting GBP.
The yen showed little initial reaction to reports that the Japanese government abandoned its long-held FY2011 primary surplus objective and moved the target out ten years. Throughout the week, the USD/JPY pair held below the key Aug downtrend resistance line with 99.00 seen as the critical level. The JPY was maintaining a softer tone against the European and commodity related currency pairs.
The week in Asia saw the major regional indices hit fresh multi-month highs on continued evidence of recovery unfolding in China, along with rosier than expected employment picture in Australia and rising speculation for an economic conditions upgrade from Japan. China's May industrial production rose 8.9%-- well above the expected 7.7% and last month's 7.3% increase that marked the lowest growth rate this year. Retail sales also painted a brighter picture of domestic demand, rising 15.2%. Australia's May jobs report echoed the implied improvement of private job advertisement data seen early in the week, as the economy lost only 1.7K jobs vs the 30K decline forecasted by analysts. Over in Japan, final Q1 GDP saw a lower contraction than initially reported, contracting -3.8% vs the preliminary figure of -4.0%. The most recent round of industrial production, which saw its best rate of growth in decades, was revised higher to +5.9% from the initial +5.2% ahead of the BOJ decision expected to acknowledge improving conditions early next week. The Nikkei225 took out 10,000 to end the week at 10,135, its best levels since early October, and Sydney's S&P/ASX rose above 4,060 for the first time since mid-November.
Trade The News Staff
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READ MORE - Weekly Market Wrap-up

The Weekly Bottom Line : UNITED STATES - OPTIMISM BUOYS MARKETS EVEN WITH SHAKY DATA

HIGHLIGHTS OF THE WEEK

• Fed's Beige Book confirms anecdotal picture of slowing pace of contraction
• Announcement of repayment of TARP funds reaffirms stabilization of U.S. financial system
• U.S. trade deficit widens for 2nd consecutive month, facing accelerating export contraction
• Bank of Canada's Governor Carney's provides sober view of sluggish recovery as global imbalances are rejigged
• Canada reverts into trade deficit with steepening decline in exports
• Crude oil breaches US$72 per barrel but retreats on OPEC's forecast for diminished demand

U.S. data this week continued to support the story of a slowing pace of contraction. The Beige Book, the Fed's anecdotal survey of economic conditions, qualitatively confirmed this picture – even noting some actual improvements in certain districts. Eyes are now turning to the shape of recovery and the appropriate exit strategies. In a speech Wednesday, Richmond Fed President Lackner noted “inflation risks that are quite legitimate” and admitted the danger of not shrinking the Fed balance sheet enough when recovery emerges to stave off the inflation threat. However, the U.S. economy is still losing ground and this week's news on retail sales and international trade show the fragility of the positive “second derivative”.
Thursday's release of retail sales for May showed a welcome 0.5% M/M gain – the first rise in three months – and spending on gasoline and motor vehicles both increased. Nonetheless, sales remain down 9.6% Y/Y and, despite the monthly pop, the 3-month annualized trend still fell 4.0%. Facing high debt levels and rising unemployment, U.S. households are saving more and spending less – a trend that we expect to continue over the coming months. U.S. trade data for April on Thursday showed a second consecutive month of a widening trade deficit. April's saw a steepening in the export contraction from March, with major declines in exports of industrial and capital goods. Imports rose, but this owed to the uplift from higher petroleum prices.
Nonetheless, investor optimism continues to buoy commodities and financial markets. The announcement that ten large U.S. banks would be allowed to repay up to $68 billion in TARP funds was largely expected but, in Treasury Secretary Geithner's words, nonetheless represents “an encouraging sign of financial repair”. Reflecting optimism about global recovery, oil continued its climb this week, breaching $72 per barrel. Oil inventories remain substantial, and, with demand still falling, we believe present prices are running ahead of fundamentals. As equity markets gained this week, bond yields also continued their climb, on the back of decreasing risk aversion and anticipation that inflation pressures from a quicker-than-expected recovery might force the Fed's hand to raise interest rates sooner.
The rapid hike in medium-term yields has raised some concern. Higher yields on treasuries could delay recovery as mortgage rates and corporate borrowing costs follow. Indeed, as 30-year mortgage rates have climbed since mid- May, the pace of new mortgage applications has slowed for three consecutive weeks.
While rising, inflation expectations have remained relatively anchored around 2% – arguably a sustainable longterm target. With expectations now tilted towards heightened inflation, the threat of a persistent deflationary spiral has largely disappeared. However, as we argue in our latest Global Markets publication, markets' near-term inflation fears are overblown as U.S. CPI is still in negative territory and economic slack continues to build.

CANADA - REALITY CHECK FOR PENDING RECOVERY

While markets are anticipating a recovery, indicators of global demand remain weak and we maintain the view that the worldwide rebound will be sluggish. Those global imbalances between developed world spending and emerging market lending remain yet to be unwound. Bank of Canada Governor Carney conveyed a similar view in a sobering speech Thursday. Carney noted the downdraft to global investment demand and consequent diminished potential growth in developed economies. However, he also noted new opportunities as emerging markets shift towards greater consumption.
Canadian markets were buoyed through this week by rising commodity prices, but OPEC's announcement Friday of reduced oil demand reversed some of these gains. The Canadian dollar followed suit, dipping under 90 cents. Canadian fundamentals are arguably better than those in other developed economies (a fact which Prime Minister highlighted in his “economic report card” on Thursday) and the Bank of Canada has not joined the Quantitative Easing club; however, the Loonie's rapid appreciation was in excess of fundamentals. Some easing for the Loonie would provide some albeit-modest relief for Canadian troubled exporters.
Wednesday's report on international trade for April showed a reversion to a $179 million trade deficit and a steepening plummet in exports, highlighting the external pressures on Canada's economy. The faltering U.S. market remains the primary soft-spot for Canada's exports accounting for 90% of Canada's year-over-year export declines.
Both volumes and values of exports declined with the largest contractions in exports of M&E, energy and industrial products. The export contraction during Q2/2009 will not be as deep as that in Q1/2009, but real exports will still decline substantially. While rising commodity prices may provide some buoyancy to the tumultuous energy and industrial material exports, the appreciating Canadian dollar will place additional downward pressure on both volumes and values of manufactured exports.
The downward pressures on the Canadian economy remain substantial. Capacity utilization data for the first quarter was released Thursday, showing a record low of 69.3% and highlighting the rapid deterioration of industrial activity. Utilization rates were lowest in the troubled transportation sector (43%) but construction, metal manufacturing and mining have also experienced precipitous cutbacks. With inventory-to-sales ratios still elevated and sales falling, manufacturers will continue to cleave production and draw down current stock. Depressed utilization means less incentive for investment in new machinery and equipment (M&E), which in turn diminishes the outlook for productivity growth. This will weigh down Canada's potential growth going forward.

U.S.: UPCOMING KEY ECONOMIC RELEASES

U.S. Housing Starts - May

• Release Date: June 16/09
• April Result: 458K
• TD Forecast: 500K; Consensus: 480K

The correction in U.S. residential building activity has been particularly sharp, with housing starts declining in 8 of the last 9 months as builders adjust their construction activity in the face of slumping demand and rising unsold inventories. Over the past few months, there has been some evidence suggesting that the U.S. housing sector may be stabilising, and as such we are likely to see some stabilisation in housing starts as well, particularly given the recent upswing in the NAHB confidence index. In May, we expect construction activity to rebound slightly, with starts rising to 500K. Much of the rebound should come from a bounce-back in the volatile multi-units component, which declined by a staggering 46% M/M in April, and is now at its lowest level on record at 90K. Single-unit construction should remain unchanged on the month. In the coming months, with the combination of soft demand (driven in large part by the weak labour market conditions) and the huge overhang of inventory of unsold homes continuing to weigh heavily on building activity, we expect starts to remain in depressed territory, though we are unlikely to see a return of the sharp down-drifts of recent months.

U.S. Consumer Price Index - May

• Release Date: June 17/09
• April Result: core 0.3% M/M, 1.9% Y/Y; all-items 0.0% M/M, -0.7% Y/Y
• TD Forecast: core 0.1% M/M, 1.8% Y/Y; all-items 0.0% M/M, -1.1% Y/Y
• Consensus: core 0.1% M/M, 1.8% Y/Y; all-items 0.3% M/M, -0.9% Y/Y

Weak labour market conditions and soft consumer demand have continued to place considerable downward pressure on U.S. consumer prices, pushing the rate of headline inflation deeper into negative territory. Indeed, outside of the increases in tobacco prices, which were caused by higher taxes, the decline in consumer prices over the past few months has been fairly broadly based. In May we expect the pattern of softer consumer prices to remain intact, with the headline index expected to stay unchanged for the second straight month, despite the dramatic rise in gasoline prices. Due mostly to base effects, the annual pace of consumer price deflation should accelerate to 1.1% Y/Y, which will be the greatest pace of annual consumer price decline since 1950. Core consumer prices are also expected to be soft on the month, rising by only 0.1% M/M (after three consecutive monthly gains of 0.2% or more). The annual pace of core consumer price inflation should fall to 1.7% Y/Y. In the months ahead, we expect U.S. consumer prices to remain soft and headline consumer price inflation to remain in negative territory, though higher gasoline price will likely limit the pace of this decline.

CANADA: UPCOMING KEY ECONOMIC RELEASES

Canadian Manufacturing Shipments - April

• Release Date: June 15/09
• March Result: -2.7% M/M
• TD Forecast: -2.0% M/M
• Consensus: -1.8% M/M

The Canadian manufacturing sector has been left exposed by the slumping domestic and U.S. economies, which have resulted in Canadian manufacturing shipments declining in 7 of the last 8 month. The contraction in demand has been felt across the board, with almost all components of the Canadian manufacturing sector contracting. This retrenchment in manufacturing sector activity should continue in April with shipments expected to drop a further 2.0% M/M. Much of the weakness is expected to be on account of lower machinery and equipment sales, while softer petroleum and coal products sales should also be a drag on the headline number. On the other hand, motor vehicle shipments are expected to contribute favourably to the headline number. In real terms, shipments should be quite weak, though perhaps not as soft as the headline number. In the months ahead, we expect Canadian manufacturing activity to weaken even further as the strengthening Canadian dollar and weak U.S. appetite for Canadian goods dampen activity in the sector even more.

Canadian Wholesale Sales - April

• Release Date: June 17/09
• March Result: -0.6% M/M
• TD Forecast: -1.0% M/M
• Consensus: -1.0% M/M

Canadian wholesale sales activity has been badly hit by the ongoing slump in consumer and business spending, as the weakening labour market and deteriorating economic conditions continue to stifle domestic demand. Global demand has also been sluggish. The combination of these factors has resulted in Canadian wholesale sales activity posting its longest slump on record, with sales declining for 6 consecutive months. Moreover, given that the Canadian and U.S. economies continue to languish in the current deep recession, we expect wholesale sales activity to fall a further 1.0% M/M. The weakness is expected to be broadly-based, with slower sales of machinery and equipment, petroleum and coal products expected to be the main factors underpinning the soft headline number. Motor vehicle shipments should add favourably to the headline number. Real wholesale activity is also expected to decline on the month, though at a more modest pace. In the coming months we expect wholesale sales to remain very soft as the weak Canadian economy and ongoing global economic recession dampen demand even further.

Canadian CPI - May

• Release Date: June 18/09
• April Result: core 0.1% M/M, 1.8% Y/Y; all-items -0.1% M/M, 0.4% Y/Y
• TD Forecast: core 0.2% M/M, 1.7% Y/Y; all-items 0.4% M/M, -0.2% Y/Y
• Consensus: core 0.1% M/M, 1.6% Y/Y; all-items 0.4% M/M, -0.2% Y/Y

After resisting the mounting downward pressure arising from the growing economic slack for months, Canadian consumer price inflation is expected to finally buckle in May and dip its toes into negative territory for the first time in 15 years. Indeed, despite the big bounce in energy prices during the month which should push the headline index up 0.4% M/M (down 0.1% M/M on a seasonallyadjusted basis), headline consumer prices are expected to fall 0.2% Y/Y. This will mark the first time since 1994 that Canadian consumer prices have fallen on a yearly basis. The Bank of Canada's core consumer price index is also expected to edge higher, rising by 0.2% M/M (though up only 0.1% M/M on a seasonally-adjusted basis), with the annual pace of core inflation falling further to 1.7% Y/Y from 1.8% Y/Y in March. In the coming months, with the Canadian economy likely to remain quite weak, we expect consumer price inflation to moderate even further, though higher energy prices may perhaps limit the duration and depth of the consumer price deflation that the Canadian economy will encounter.

Canadian Retail Sales - April

• Release Date: June 19/09
• March Result: total 0.3% M/M; ex-autos -0.2% M/M
• TD Forecast: total 1.0% M/M; ex-autos 1.0% M/M
• Consensus: total -0.1% M/M; ex-autos -0.1% M/M

Canadian consumers appear to be trickling back to the malls to take advantage of the many bargains that retailers have been making available. Indeed, despite the considerable headwinds that Canadian households continue to face, retail sales have risen in each of the first three months of this year, undoing some of the damage done to retail sales activity in Q4 when consumer spending plunged like a stone. This upward momentum in spending is expected to continue in April, and our call is for total retail sales to rise by a respectable 1.0% M/M. Sales are expected to be boosted by a resurgence in housing-related spending. In particular, sales of furniture, home furnishing and building materials are expected to be quite strong as Canadians take advantage of the incentives provided under the government's fiscal stimulus package. The surge in existing home sales over the past few months should also bolster demand for home furnishing items, while higher gasoline prices should contribute favourably to the headline number. Excluding autos, sales are expected to rise by 1.0% M/M. In the coming months, we expect retail sales to remain somewhat subdued as Canadian consumers economise on their spending in the face of the very difficult economic environment.

TD Bank Financial Group
The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.

READ MORE - The Weekly Bottom Line : UNITED STATES - OPTIMISM BUOYS MARKETS EVEN WITH SHAKY DATA

Weekly Focus: Central Banks Dominate the Agenda

Global update

• US retail sales rose in May, but this was down to gasoline prices. Retail sales excluding autos, gasoline and building materials were unchanged, so it was really just a case of stabilisation.
• German industrial production fell by 1.9% m/m in April, which was something of a disappointment, but the pain was eased somewhat by the upward revision of March industrial production from unchanged to growth of 0.3% m/m.
• Asia continues to forge ahead, and the past week has brought a raft of data from China. Investment growth has accelerated further, car sales are very strong, and turnover in the housing market is rising rapidly.
• There were disappointing figures for the Swedish economy, with further falls in retail sales and the activity index.
• Interest rates have climbed strongly recently, and there is the risk of a correction in the short term. But in the long term there is still the prospect of higher long yields in the USA.

Market movers ahead

• Central banks take centre stage in the coming week, with rate-setting meetings in Norway, Japan and Switzerland. We expect an unchanged policy rate and an upward revision of the interest rate path from Norges Bank. We also expect unchanged rates from the BoJ and SNB, and no further unconventional measures.
• The spotlight is also on the central bank in the USA. Speculation about the outcome of the FOMC meeting on 24 June has now kicked off, and so attention will centre on the many Fed speeches in the coming week.
• The week also brings housing market data, regional PMIs and inflation figures in the USA, while in Euroland the most interesting release is the ZEW indicator, where we expect a sharp rise in the expectations index

Global update: New headwinds

US consumers spending again - but risk from oil and bond yields
The US retail sales figures surprised on the upside in May, easing consumer concerns a bit after disappointing April sales. The underlying trend is not strong, though, but at least we continue to see signs of stabilisation in demand (See Flash Comment). This should continue in the coming months as tax cuts will have a further positive effect on consumer demand. Jobless claims also improved further during the past week adding support to the thesis that the labour market is slowly starting to improve. Jobless claims fell further to 601k from 625k last week after having peaked at 674k in late March.
On the negative side, we are seeing oil prices continue to rise, reaching USD73 per barrel this week. This is one of the key risk factors for the global economy we pointed out in Global Scenarios released this week. Overall we expect a manufacturing recovery to materialise more clearly in the coming quarters as production has clearly been undershooting demand, providing a strong case for a rise in global production. However, it is important that underlying demand can continue to grow into next year and rising oil prices is a clear threat to this. Adding to the headwinds is the recent strong rise in US bond yields on the back of heavy supply and improving data. These developments will have to be watched closely in the coming months.
China roaring ahead
Chinese fixed asset investment data for May were much stronger than expected. Together with soaring home and car sales, they suggest that domestic demand in China is currently very strong (See Flash Comment). This was supported by a further improvement in Chinese imports which were up over 10% in May compared with three months ago. Asia continues to be the strongest-performing region in the world, providing needed support for the world economy. We believe we will soon see improvement in exports from US and European companies to the Asian region giving support to the industrial recovery.
More good news for car industry
The past two weeks have provided more upbeat data on car sales. In Asia, Chinese car sales rose 34% y/y in May and South Korean car sales were up 22.8% y/y in the same month. In Europe, German car sales also held up at a high level in May while French car sales were reported up 18% m/m in May on the back of a cash incentive from the government. US car sales have stabilised in the past months but have not recovered as seen in a lot of other countries. However, during the past week, the House passed the ‘cash for clunkers' bill in which car buyers can get up to USD4500 in cash if they are exchanging their old car for a new more fuel-efficient car. It still needs to get approval in the Senate but this is expected to come through soon. Once implemented, it should help to boost US car sales as well from the current very downbeat levels.
As car production has been slashed by more than 50% over the past nine months, inventories are being reduced at record speed and production will have to rise soon to meet the demand. This is indeed what we are seeing in Japan where car producers are planning significant rises in production in the coming months (see Global Scenarios for more on this issue).
Signs of housing stabilisation accumulating
Another key theme this year is expected to be the stabilisation in global housing markets. The UK RICS housing survey provided more support to this story in the past week as it rose by much more than expected to -44 in May from -59 in April. The index for new buyer enquiries – a leading indicator for the housing market – rose further to the highest level in 10 years. Data on actual house prices in UK has also improved further recently with rises in all important housing statistics. The bottoming in house prices is happening earlier than expected and is probably a result of the significant decline in mortgage rates and improving credit conditions.

Market movers ahead

Global

• In the USA the debate about the monetary policy decision at the FOMC meeting on 24 June has now kicked off. The big question is whether the Fed will step up its purchases of Treasuries and mortgage-backed securities in the light of the sharp rise in interest rates. There will therefore be a particular focus on a number of Fed speeches in the coming week, in particular Ben Bernanke's on Wednesday. The week also brings a raft of housing market data in the form of the NAHB index and figures for housing starts and building permits. There will also be the first regional PMIs for June, which are expected to show further improvement, and, not least, inflation data in the form of the CPI and PPI.
• In Euroland there is little excitement on the agenda in the coming week. Most interesting will be the ZEW indicator. We expect a sharp rise in the expectations index and a more moderate improvement in the assessment of the current situation.
• In Asia the BoJ is expected to keep its key rate unchanged at 0.1% at the rate-setting meeting on Tuesday. Nor is there any prospect of fresh unconventional easing given the signs of stabilisation in the economy and less stress in the financial sector. However, there has been speculation in the Japanese press during the week that the BoJ will revise its view of the economy up further. We think it too early to declare Japan in recovery, so we expect only a marginal upward revision.
• In Switzerland the SNB holds a monetary policy meeting on Thursday. We expect the bank to leave its three-month LIBOR target unchanged at 0.25% and continue to issue liquidity at a mere 0.05% for some time to come. We do not expect the SNB to take any further steps to ease monetary policy given the signs of global recovery, but think that its rhetoric will be unchanged. We therefore doubt that the SNB is ready to relax its grip on the CHF, as further appreciation would still push deflation risks beyond the bank's pain threshold.
• In Norway there is a monetary policy meeting at Norges Bank on Wednesday, where we expect the key rate to be left unchanged. We also expect the interest rate path to be revised up by 25-50bp, which the market will probably interpret as there still being a 50/50 chance of one last rate cut in Norway. However, we do not anticipate any further cuts from Norges Bank, and we expect to see its first hike around March next year.

Financial views

Equities

• We maintain a positive view on equities in the medium term. Risk appetite has returned and our five point trigger list (from February 2009) for a stock market recovery has almost been completely fulfilled; we are consequently looking for new triggers.
• To underpin further market recovery in the coming months, we are looking for (a) signs that global final demand has started to pick up, (b) signs from the Fed that the easy money stance will continue into 2010, (c) decoupling from the government bond market and hence a return to a value market, (d) corporate earnings revisions for H2 09 and 2010 stabilise, and (e) deflationary impulses from global housing moderates.

Fixed income

• Global: Bond yields are expected to rise on a three- to six-month horizon based on improving macro conditions, increased risk appetite and heavy supply. US to underperform Euroland in sell-off.
• Intra-Euro: We have taken profit on our overweight in peripherals (Italy, Greece and Spain) versus Germany and now stand sidelined. On longer maturities we still prefer France and Finland to Germany.
• Scandi: We have closed our underweight long Danish government bonds versus Finland in the 10Y area, but we still have an overweight in Swedish government bonds versus Germany in the 5Y area. We recommend overweight of Norwegian govies versus Germany in the 10Y segment. We have a changed to an overweight on Danish 30Y callalble mortgages bonds versus both swaps and government bonds. We remain underweight in longer dated non-callables versus government bonds.

Credit

• During the past couple of months credit has enjoyed a very strong spell across the sectors and capital structure and spreads have tightened significantly. At the same time the activity in the primary market continues to be at a record high as more and more companies (are able to) turn to the capital markets instead of the banks for funding. The strong sentiment is largely the result of a significant improvement in the conditions in the money market and lower volatility.
• We question the sustainability of this massive rally as the pace is simply too fast in our view. The macroeconomic outlook is still challenging and defaults are currently increasing. A while ago we moved to overweight based on the large liquidity and risk premiums for credit. Both these premiums have now been reduced substantially and we go from overweight to neutral.

FX outlook

• EUR/USD is set to drift lower in the short run, but to continue upwards in the medium term. Important drivers for EUR/USD are equities as a proxy for risk and most recently oil prices. EUR/GBP is heading down as sterling is supported by positive economic data and a normalisation in financial conditions. USD/JPY will probably break above 100 in the near term. Carry can keep on performing, while defensive currencies will face headwinds.
• Swedish krona and Norwegian krone both have solid potential against the euro. Currently, however, risk aversion is still too high to see the Scandies exploit their full potential. The Danish krone is attractive (e.g. against Swiss franc) due to sound carry.

Commodities

• Base metals like copper and zinc continue to perform fuelled by heavy Chinese buying and global growth optimism. Oil prices have continued to rise over the past week to above USD72 per barrel.
• Sentiment is very strong in commodities at the moment but the short-term risk of a correction is growing. In our view, the market is neglecting near-term weakness such as weak oil demand and huge stocks in base metals. However, in six months' time, we expect a new leg up in prices when the different market balances are expected to tighten for real.

Full Report in PDF
Danske Bank
http://www.danskebank.com/danskeresearch
Disclaimer
This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S, which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange.

READ MORE - Weekly Focus: Central Banks Dominate the Agenda

Weekly Economic and Financial Commentary

U.S. Review

Recession and Recovery

Financial markets are acting as if the recession is ending and recent economic data tend to support that notion. We are now projecting that the recession will end this summer. The strength and durability of the recovery remain very much in question, however, and the economy is expected to have a tough time gaining momentum.
This past week had a light schedule of economic reports and the Treasury auctions took center stage, particularly when Wednesday's 10-year auction received tepid demand and 10-year yields touched 4 percent. The rise in yields corresponds with continued bad news on the size of the federal budget deficit and weaker dollar. Combined they suggest overseas investors are less sold on near term economic prospects for the U.S. than equity market investors are.
We now believe the recession will end this summer, which is a few months earlier than previously thought. The decision to move up the end of the downturn was largely driven by the timing of motor vehicle assembly plant shutdowns and restarts, which will produce huge inventory swings.

The Economy Still Faces Significant Hurdles

The recent trend in retail sales also lends support to a turnaround in real GDP during the third quarter. After rising in January and February, retail sales fell in March and April, which meant that second quarter sales started at a low base and will likely post a decline for the second quarter even if sales rebound in May and June. Retail sales did pick up in May, with overall sales rising 0.5 percent. The increase means that consumer spending will likely end the second quarter on a stronger note than it started it and will make it easier for real personal consumption expenditures to post at least a modest gain in the third quarter.
The combination of a positive swing in inventories and modest growth in real personal consumption expenditures means there is a high probability third quarter real GDP will be solidly positive. While one quarter of positive real GDP growth does not guarantee the recession will end, we believe that inventories have been drawn down so much that production will rise throughout the second half of this year just to move back in line with sales.
While the recession will likely end in the next few months the economy still faces significant hurdles. Consumer spending is still exceptionally weak and consumers have shown no sign of boosting purchases for big ticket items. To put it bluntly, sales have been horrible for the past eight months and have merely risen slightly from that level. Sales that are a little better than horrible are still pretty horrible.
Consumers will not likely spend freely again until they feel better about their employment and income prospects. On that front, the data are a little better than they have been. First time claims for unemployment insurance declined slightly more than expected this past week, falling by 24,000 to 601,000. The drop also helped pull down the four-week moving average by 10,500 to its lowest level in four months. Unfortunately, continuing unemployment claims continued to increase and the insured unemployment rate was revised up 0.1 percent from the prior week to 5.1 percent, where it stayed this past week. The increase suggests the unemployment rate will rise to at least 9.5 percent in June.
Another huge hurdle for the economy has been the rise in interest rates and weakness in the U.S. dollar. As mentioned earlier, the recent auction for 10-year Treasury notes did not go well. The 30-year auction faired better, but there is a paucity of supply for longer dated issues. The rise in the 10-year Treasury yield has sent mortgage rates sharply higher. Higher interest rates will make it much tougher to engineer a recovery in home sales.

U.S. Outlook

Housing Starts • Tuesday

Housing starts dropped to a new all-time low of just 458K units as multi-family activity plunged to a mere 90K unit annual pace in April. Single-family activity actually moved higher for the second straight month, up 2.8 percent in April.
With signs of stabilization starting to occur in some pockets of the economy, we expect total starts will increase in May to an annualized pace of 520K units. Single family starts should continue to trend higher while the volatile multi-family sector could rebound after plunging to the series record low set in April. The NAHB homebuilder sentiment index has risen three times in the past four months suggesting builders are becoming relatively more optimistic about the immediate housing market outlook. The 30-year fixed mortgage rate showed little change between May and April but has recently picked up above 5.50 percent and could portend a slowdown in sales in June.
Previous: 458K Wachovia: 520K
Consensus: 483K

Industrial Production • Tuesday

Industrial production dropped 0.5 percent, in April with manufactured production down 0.3 percent. The declines are now 12.5 and 14.5 percent over the past year, respectively. In turn, capacity utilization dropped further and reached another all-time low at 69.1 percent.
The sharp drop in hours worked in the factory sector suggests that industrial production declined 0.8 percent in May. Manufacturing output is poised for another significant loss as motor vehicle production, which has risen the past two months, is set for a reversal. Machinery, metals and electrical equipment should also register lower output. A modest increase in utility output is in the cards as weather across much of the country was warmer than normal. With continued slack, capacity utilization should register another series low in May.
Previous: -0.5% Wachovia: -0.8%
Consensus: -0.8%

CPI • Wednesday

The Consumer Price Index was unchanged in April and is now down 0.7 percent on a year-to-year basis. Excluding food and energy, the core CPI rose 0.3 percent and remains up 1.9 percent over the past year. Tobacco prices jumped 9.3 percent following an 11.0 percent surge in March due to a tobacco excise tax hike. Excluding the jump in tobacco prices, the core CPI still would have risen 0.2 percent.
We expect headline consumer prices to increase 0.4 percent with prices at the gas pump responsible for most of the gain. Core inflation should rise 0.2 percent with tobacco and owners' equivalent rent driving the gain. We continue to believe neither inflation nor deflation will be a problem in 2009.
Previous: 0.0% Wachovia: 0.4%
Consensus: 0.3%

Global Review

Bond Yields Signaling Stronger Growth?

Government bond yields in most major countries have trended higher over the past few weeks (see graph at left). One line of thought claims that the back-up in yields, at least in the United States, reflects reluctance by foreign investors to support the unprecedented budget deficits the federal government is incurring. However, at this week's 30-year bond auction "indirect" bidders, which includes foreign central banks, bought about one-half of the $11 billion worth of securities on offer, casting some doubt on the notion that foreigners are eschewing U.S. securities, at least at present.
The rise in yields over the past few months, not only in the United States but in other major economies as well, is consistent with the expectation that the global economy will stabilize later this year and resume growing again. However, some recent data releases show that growth has not yet turned positive, at least not in some important economies. For example, industrial production (IP) in the 16-member Euro-zone tumbled 1.9.percent in April relative to the previous month, bringing its rate of decline over the past 12 months to nearly 20 percent (top chart).
In Germany, IP also fell 1.9 percent in April relative to March, which was much weaker than most investors had expected. Germany is an important supplier of capital goods to Eastern Europe, and the economic meltdown in that region is having a negative effect on the German economy. In that regard, the value of Germany's exports declined 4.8 percent in April from March.
U.K. economic data have not been quite as downbeat recently. British IP was up 0.3 percent in April, the first monthly increase in 13 months. Yes, IP is still off 12 percent on a year-over-year basis, but the rise in the PMIs over the past few months - the service sector PMI is now back in positive territory - suggests that the British economy may be nearing bottom. A widely followed index calculated by a research institution indicates that British GDP contracted 0.9 percent (not annualized) between February and May, not nearly as bad as the 2.2 percent nosedive recorded between December and March. That said, it appears that Britain will record another negative growth rate in the second quarter.
If there is one country in the world where real "green shoots" have popped up - that is, where growth is actually positive again - it is China. Data released this week showed that the year-over-year growth rate of industrial production rose from 7.3 percent in April to 8.9 percent in May (bottom chart). Interestingly, the acceleration in Chinese IP since its nadir a few months ago does not appear to be linked to exports, which were down 26 percent in May, more than the 23 percent decline registered in April. Rather, domestic sources of spending appear to be propelling the Chinese economy higher at present. Growth in retail spending strengthened from 14.8 percent in April to 15.2 percent in May, and investment spending was up 33 percent in May, the strongest growth rate in five years. In response to the global financial crisis last autumn, the Chinese government decided to accelerate infrastructure spending and relax lending restrictions that were put in place when inflation was seen as Public Enemy #1. Its efforts appear to be bearing fruit.

Global Outlook

Euro-zone CPI Inflation • Tuesday

It appears that the Euro-zone is about to slip into a mild case of deflation. The overall CPI inflation rate was only 0.6 percent in April, but the "flash" estimate for May showed that consumer prices were flat on a year-over-year basis. Over the next few months, the overall inflation rate likely will turn negative. That said, the core rate of inflation, which excludes food and energy prices, is well above 0 percent at present. The consensus forecast anticipates that the core rate of inflation edged down from 1.8 percent in April to 1.6 percent in May.
The German ZEW index, which is an index of economic sentiment among institutional investors, has risen sharply over the past few months, indicating that investors expect the German economy to recover later this year. The reading for June will be released on Tuesday.
Previous: 0.6% (year-over-year change)
Consensus: 0.0%

U.K. Retail Sales • Thursday

Next week sees a number of U.K. data releases, including retail sales in May, which will give investors an up-to-date look at the British economy. Growth in retail spending has slowed markedly over the past year as the U.K. economy tumbled into recession. That said, real retail sales rose in April relative to the previous month, and the consensus forecast looks for another increase in May. If so, it will be yet another indication that the recession may be nearing an end.
Speaking of recession, the U.K. unemployment rate has shot up from about five percent last spring to more than seven percent at present. Data that are slated for release on Wednesday should show that it rose further in April. CPI inflation data will print on Tuesday.
Previous: 0.9% (month-on-month change)
Consensus: 0.5%

Canadian Retail Sales • Thursday

Retail sales in Canada have increased each month so far in 2009. While this is a sign that domestic demand remains resilient in the face of the recession, it helps that the increases are off a very low base established last December, when holiday sales were a major disappointment. New car sales jumped in March in response to big rebates and other dealer incentives. Otherwise, the categories showing signs of strength are consistent with the frugal shopping patterns you might expect during a recession. Pharmacies, supermarkets and beer and wine stores have posted increases while electronic stores and clothing stores retreated in March. Sales for April will likely be flat as consumer sentiment remains contained by challenges in the job market.
Also due out next week in Canada is inflation data for May. The Bank of Canada has repeatedly stated the global slowdown will keep downward pressure on inflation.
Previous: 0.3% (month-on-month change)
Consensus: 0.0%

Point of View

Interest Rate Watch

Why are Rates Rising?
Why have long-term interest rates risen so much over the past month? One theory is the reversal of the flight to quality trade that began when the financial crisis intensified last fall. Another theory suggests the enormous increase in the federal budget deficit has flooded the market with new supply, driving rates higher. Yet another theory says investors are fleeing U.S. assets on worries of dollar depreciation and heightened inflation risks.
Which theory is right? We believe all three have merit. There is no doubt the risks to near term economic growth have diminished. Armageddon is off the table. Businesses, investors and households are taking on more risks and these actions directly translate into a steeper yield curve.
Supply concerns are also contributing to the run-up in yields. The federal budget deficit may be larger than some people realize and the Treasury's auctions have been met with lukewarm demand, particularly for intermediate issues. As for the final concern, inflation is indeed headed higher. We will not wake up one day and find out the U.S. is Zimbabwe, but inflation will be higher in the next ten years than it was in the last, and a higher interest rate will be needed to compensate investors for holding U.S. Treasuries.
While there are valid reasons for the run-up in Treasury yields, we believe all of these concerns have gotten well ahead of themselves. Inflation will likely decelerate over the next year and credit demands should remain light. Yields should back off a bit in coming weeks. Talk of a Fed rate hike by year end is also off-base. We would not expect the Fed to make a move until next year at the earliest.

Topic of the Week

Housing is Near a Bottom But Not a Recovery
The U.S. economy appears set to begin a recovery before the housing market does. Our latest forecast has real GDP moving back into positive territory during the third quarter and we now expect the recession to end at some point this summer. Home sales and new home construction should bottom out at around the same time as the overall economy. A recovery in home sales and new home construction still appears to be a long ways off, however, as the unwinding from the housing boom still has not entirely played out. Foreclosures are still rising, prices are still falling, and a large proportion of recent home sales have been foreclosures sales, short sales or some other type of distressed transaction.
There are formidable hurdles to a sustained recovery in home sales and residential construction. First and foremost, consumers appear to be in no mood to buy a new home. While there is some evidence suggesting that layoffs are slowing, there is no sign that hiring is picking up. The economy is still losing jobs at a rapid clip and the unemployment rate has risen to its highest level in more than a quarter century. We expect the jobless rate to top out about a year from now somewhere between 10.5 and 11 percent.
The continued rise in the unemployment rate means foreclosures will likely remain problematic well into 2010. Past experience has shown that foreclosures tend to peak about six months after the unemployment rate tops out. This means that at a minimum foreclosures will remain high, which will keep pressure on housing prices.
The full report is available on our webstite.
Wachovia Corporation
http://www.wachovia.com
Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.

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