The next round of the ongoing credit crisis walloped markets this week as as the solvency of the GSEs came into question and the Dow dipped briefly below 11,000 for the first time in two years. Fannie Mae and Freddie Mac steadily lost value over the course of the week, pushed lower in part by Treasury Secretary Paulson telling a Congressional committee on Thursday that financial firms should be allowed to fail. Between Monday and the close of trading on Thursday, FRE and FNM were down 45% and 30%, respectively. Press reports circulated last night speculating that the government would be forced to nationalize or otherwise bail out the GSEs and concerns mounted about their liquidity. As their shares plunged another 50% on Friday morning, Paulson stated that regulators are focused is on backing FRE and FNM in their “current form,” implying no government bailout plan is afoot.
Crude oil was another driving factor this week, returning to record highs after the sharp sell-off across commodities last week. Shortly after the CFTC declared late Thursday morning that speculators have little to do with the price of oil, crude futures spiked in a spectacular fashion, rising $5 into the close of floor trading on no substantial news. This poised energy futures to close near record highs on Friday, with WTI crude settling at $145. A strike scheduled for Monday against some Petrobras operations in Brazil and the end of a Nigeria rebel ceasefire added to the upward pressure on oil futures, in addition to Iranian missile tests and unconfirmed reports about Israel making further preparations for an attack on Iran. Gold also benefitted from financial market and geopolitical concerns, moving above the $960 level in the spot market, a three-month high.
Financials beyond the GSEs also had a rough week. On Monday newspapers reported that European banks could face big new writedowns, with a Swiss publication writing that UBS and CS may need to raise $68B in additional capital to meet new demands from the Swiss government banking supervisor. Various rumors about the leading US investment banks were passed around mid week, focusing chiefly on Lehman, whose share price has fallen about 35% on the week. On Wednesday Fitch speculated publicly that it might cut Merrill's senior debt rating while Wachovia named a new CEO and slashed its guidance.
June same store sales were largely positive (ICSC total June SSS were +4.3%, or +1.9% ex WMT), with the best results coming amongst the discount retailers. Readings seem to have been bumped upwards by a boost from the stimulus rebate checks. Later in the week, the June University of Michigan consumer confidence reading painted a different picture of the demand side, with the index hitting its lowest level since 1980, marking the third lowest reading in the history of the survey.
There was also a surprising amount of M&A activity in the face of weak markets. Dow made an $18.8B offer for ROH at $78/shr (a 73.9% premium to the stock's closing price the day before). Ashland signed a deal to acquire Hercules in a $3.3B stock and cash transaction. BUD made big gains on Friday as reports emerged that talks with InBev were turning friendly and could result in a $5 increase in the takeover offer to $70/shr. Yahoo's stock moved higher early in the week as Carl Icahn raised hopes again that a deal could still be cobbled together with Microsoft.
Currency traders were primarily focused on the health of the global financial sector and the repercussions of geopolitical events that were felt throughout the equity, fixed-income, commodities and currency markets. The week was choppy, with the USD ending at its weakest levels on Friday. The USD began the week aided by various factors, as dealers noted a tepid return of risk appetite, even-keeled equity markets and a drop in commodities heading into the G8 Tokyo summit. As expected, little substance emerged from the G8 meeting in regards to currencies. However, the USD did initial benefit from comments by the German PM, who pushed for language on currencies in economic statement.
The EUR/USD consolidated within a 1.5630 to 1.5730 post-ECB consolidation range mid- week. An unexpected Iranian missile test reignited geopolitical concerns, sending energy higher and the USD lower. By Thursday and Friday, the dollar was unable to repel concerns stemming from the GSEs. FX dealers zoomed in on Paulson's comment on financial firms being allowed to fail, prompting rumors over the imminent demise of the usual suspects.
Treasury prices rallied noticeably for better part of the week supported by safe haven buying as money hemorrhaged from stocks. The ITraxx Crossover Index continued to reflect the financial market stress as it lingered in the mid 550bps range. The two-year yield slipped below the 2.40% level and the 10-year offered 3.80% at one point. Yields rebounded sharply on Friday as traders surmised regardless of the particulars of any final solution to the GSE situation, a likely result will certainly be increased supply from the Treasury. Moody's felt it necessary to comment that US Government debt is still well within AAA range attempting to address early speculation any government bailout could result in a review of US sovereign debt ratings. Fed funds still price little more than a 50% chance of a rate hike at either of the next two meetings.
The DJIA ended the week down 1.7%, the Nasdaq Composite fell 0.3% this week, while the S&P500 dropped 1.9%.
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