The conflict in Georgia and a darkening economic picture in Europe have dominated headlines this week. Russia's military adventurism and some weak data in the Euro Zone, sent the bourses lower this week, as money moved to perceived safer havens. In the US, the fallout from ongoing Federal and state auction rate securities investigations have kept the major financials from advancing as equity markets consolidate in a sideways move. Further declines in commodities are strengthening the case of those who are calling the run up in prices over the last six months a speculative bubble. Gold futures plunged below $800 for the first time since last October this week, oil came close to the $110/bbl level and natural gas futures fell below $8.00 for the first time since early February. Silver plummeted over 17%, with a 10% drop on Friday alone. As commodities and Europe weaken the USD returns to strength, accelerating the ongoing rebalancing of global growth prospects. Goldman Sachs went as far as proclaiming that the dollar has likely bottomed.
For the week, the DJIA fell 0.6%, the Nasdaq gained 1.6%, and the S&P500 edged up 0.1%. In addition to weakening the Euro, the Russian bear growling has sparked some flight from European equity markets this week: the German DAX fell 1.7%, the French CAC fell 0.9%, and the UK's FTSE index dropped 0.6%.
The ARS probe by New York AG Andrew Cuomo continued to wring settlement agreements out of major banks this week. Wachovia said it would buy back up $8.5B in ARS and pay a $50M fine. JPM and MS have agreed to buy back more than $7B in ARS and pay fines, as well. Merrill Lynch is holding out, prompting Cuomo to "preparing to commence legal action" against the firm, giving it five days to explain why he should not sue.
The auction-rate securities situation was only part of the trouble for financials, as various commentators insisted that the credit crisis is far from over. S&P noted that banks are at best half way through the credit crisis and the WSJ's Heard on the Street said that JP Morgan's warning about a $1.5B mortgage-related loss shows that credit markets are as unsettled as ever. Merrill downgraded most of its peers to an underperform rating citing a seasonal slowdown and Ladenburg Thalmann's Dick Bove cut his estimates for Lehman, Goldman, and JP Morgan. Meanwhile, the monoline bond insurers MBI and ABK provided a bright spot among all the gloom; S&P affirmed the monolines' AA ratings on Thursday and the names are up 30% on the week.
Things have been relatively quiet on the data front. The June US trade deficit came in at $56.8B, better than the expected reading of $62.0B. Currency dealers said that growing exports and imports should help boost the GDP reading for Q2. Manufacturing data on Friday was less bad than expected: the Fed reported that US industrial production edged up 0.2% in July, below the 0.4% gain in June but above expectations a 0.0% reading. The preliminary University of Michigan confidence data showed the biggest decline in one-year inflation expectations since September 2006, reflecting the easing in commodity prices, but the headline July CPI reading showed prices climbing at twice the rate expected, while the annual inflation rate hit 5.6%, its highest level since 1991.
Major retail names reported positive quarterly earnings that were tempered by cautious comments for the coming quarter, another indication of a slowing economy. Wal-Mart came in just above EPS estimates and just below revenue expectations, and boosted its FY08 outlook over its prior view. The CEO called the forecast "appropriately conservative.” Kohl's also came in above estimates and guided higher for the year, although its outlook for the coming quarter is more tepid. JC Penney beat earnings and revenue estimates while guiding lower for the next quarter, warning that the firm sees a "challenging" consumer environment. Clothier Abercrombie & Fitch guided under analysts estimates for the year, while Nordstrom cautioned that its outlook is shaped by "continuous pressure" on margins.
In currencies, the week began with dealers continuing to assess the recent technical damage in various European and emerging market pairs against the USD. The EUR/USD cross-tested below the 1.4970 level, which was a key pivot point last November, with dealers noting that a sustained break below the level opens up a potential test towards 1.44. Throughout the week the USD managed to fend off renewed hawkish ECB sentiment regarding inflation and comments from various European officials discounting the prospects of a Euro Zone recession. The recent gains in the dollar have prompted chatter that the Fed has initiated "stealth intervention,” evidenced by the fall in the US Treasury's international currency reserves.
Dealers have shrugged off the higher UK and Norwegian inflation data, focusing instead on the emerging consensus that growth outside the US will continue to slow. Thursday's release of the German Q2 GDP reading was supposed to be the economic highlight of the week, and while the actual reading still showed contraction in Europe's powerhouse economy, it came in at a better-than-expected -0.5% (vs. -0.8% estimate). The number was not, however, strong enough to offset other negative European economic data, chief among them a report showing Q2 Euro Zone GDP shrinking 0.2%, with France contracting more than expected. Inflationary data was seen in the UK and Norway, topped off by the US CPI report.
The GBP/USD cross endured a lot of selling, falling the most in a single week since May 2000, and hitting its lowest level since mid-2006. This was prompted by the Bank of England's (BoE) quarterly inflation report, which lowered its 2009 GDP outlook and noted that a protracted slowdown would be necessary to bring CPI back under the 2% target. The BoE's King emphasized that the UK economy is facing an unavoidable and painful period of adjustment. The bank's GDP outlook fired rate-cut speculation among FX dealers, taking the probability of a BoE rate cut to over 60% by year-end from the 25% chance before the report. Markets are pricing in another 25bp interest rate cut by May 2009.
By Friday the USD had extended its gains thanks to further declines in metals and energy. Analysts noted that the USD's recovery is reducing the appeal of commodities and suggest that the six-year commodities bull market was at an end, supported by a reshuffling of assets away from commodities during the European session. Spot gold tested $773 before rebounding while spot silver hit $12.40/oz. The break of EUR/USD level of 1.4850 (where sovereign bids were said to be lurking) seems to have unleashed a self-reinforcing cycle of lower commodity prices and a stronger greenback. Goldman emphasized that the changing USD outlook comes from weakening global growth, declining oil prices and an improved US trade balance. By mid-day Friday, the EUR/USD cross was testing below the 1.47 level and the GBP/USD was approaching the 1.86 handle.
In treasuries, yields were headed for their lowest levels in nearly a month on Friday as inflation concerns move to the back burner amidst the slide it commodity prices. The ten-year yield is back in the low 3.8% range while the two-year is below 2.4%. With growth clearly slowing around the world and the US housing market still struggling to find traction, the likelihood of a Fed rate hike this year continues to diminish. The January fed fun future is pricing little more than a 30% chance the Fed hikes in 2008. With nothing penciled in on the Treasury's calendar in terms of new supply next week, technicals will take center stage. Traders will look to see if the ten-year yield can close below its 200-day SMA for the second week in row.
Trade The News Staff
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