Market Movers Overview, Prior and Coming Week: EU …
Risk appetite continued higher this past week, despite another round of uncertainty over Greece’s finances in the middle of the week that drove investors to take shelter in Treasuries, the dollar and gold.
Reports that Greek officials could be looking to renegotiate the standby financing aid package offered by the EU and IMF sparked the latest burst of risk aversion. Various official comments sought to downplay the reports, but did concede that Greece was seeking more “clarity” on the IMF package. Together with prior week’s failed Greek bond sale, the reports reminded markets that the EU aid accord for Greece was likely to be needed yet was too ambiguous to provide assurance that Greece would avoid default as early as May, by which time it needs to raise another €10 bln.
Tension in Europe was illustrated by the spread between Greek and German 10-year bonds widened to test 450bps by Thursday, the widest spread since the euro was launched in 1999. Dealers speculated that buyers of Greece’s looming USD-denominated 10-year bond issue might demand a yield of as high as 7.25%. Greece Finance Minister Papaconstantinou commented that it would take time for Greek spreads to narrow and stated that the 2009 Greek deficit to GDP might be revised higher by Eurostat from 12.9%.
Of particular interest was how well the fear factor supported US bonds in the face of concerns about fading demand. The US benchmark rate began the week testing 4% for only the second time since the 2008 financial crisis, as Treasury markets receded on better risk appetite driven by Friday’s improved March jobs report and Monday’s ISM manufacturing reading. Traders were also leery of $74B in coupon supply that was set to come onto the market throughout the middle of the week.
However, Wednesday’s $21B 10-year note reopening put any supply concerns to bed after garnering a 3.72 bid-to-cover ratio and drawing 3.9%, about 7 bps below where the yield had been just that morning. Markets seem to have taken notice of the strong influx in demand surrounding the key 4% level in the benchmark rate. The 10-yr/2-yr spread remains above 280 basis points, still right near all time highs, but for the week prices look to finish higher than where they entered.
Despite the trouble in Europe, there was no shortage of positive news to buoy sentiment:
the March ISM non-manufacturing index hit its highest level since May 2006 on Monday, while the new orders sub-index hit its highest level since August 2005. Strong March same-stores sales figures and excellent y/y comps for February Nevada casino revenue shed a positive light on consumer sentiment. Most same store sales figures were in the positive double-digit range, and only two major reports came in below estimates. The upward momentum in crude has been checked, with the contract bumping up against the $86 handle after a two-month rally up from around $71. Gold made fresh YTD highs briefly thanks to the Greece situation and ended the week at around $1,161, suggesting belief in coming growth and concomitant inflation. The FOMC continued to keep markets unconcerned about higher Fed rates. On Wednesday, chief dissenter Hoenig said rates at 1% could still be considered “highly accommodative,” while later in the week Tarullo and Lacker commented that rate increases are not coming any time soon. US firms are providing overall positive guidance for Q1 earnings season, which begins this week.
For the week stocks posted modest gains:
The Nasdaq rose 2.2% The S&P500 climbed 1.4% The DJIA added 0.7%, briefly hitting 11,000 for the first time since Sept 2008 just before the close on Friday.
Many firms have raised guidance ahead of the March quarter earnings season (and a few offered profit warnings).
Apple (AAPL) scored coverage with the first full week of iPad sales and by holding an event on Thursday to preview iPhone OS 4.0l. At the event, CEO Steve Jobs said the company has sold 450K iPads so far. The iPhone OS 4.0 met most expectations, with the signature feature support for multitasking, a key advantage the Google (GOOG) Android OS has had until now In other tech news, selected solar names have been making substantial gains in the second half of the week. JA Solar (JASO) made a big leg up thanks to very strong Q1 shipment guidance, citing robust demand in the quarter, while Credit Suisse upgraded the Taiwan solar sector.
Oil and metal prices rose to their highest levels in a year amid confidence on global economic growth outlook. However, the rallies were not sustainable and high volatility was triggered by EU/Greece debt concerns.
Regarding oil-specific news, official data on US oil inventory was disappointing while the Energy Department revised slightly downward its demand forecasts.
Gold extended its 7-day winning streak Friday, hitting a 4-month high at 1165.8 before settling at 1161.9, gaining +0.78% and +3.18% on daily and weekly basis respectively.
Gold generally rises with risk appetite, but can also rise in times of extreme fear, and may well benefit if the EU debt crisis threatens to truly unravel into a wave of sovereign defaults. As noted in Contagion Spreads: PIIGS Credit Default Spreads Rising On Greece Default Fears, we may be seeing the beginning of such fear, as costs to insure against bond defaults for various PIIGS block and other weak economies have been spiking recently.
The recent rally has brought gold to a new 2010-high against the dollar and a record high against the euro. While we are impressed by gold’s strength in the face of slumps in the euro, we caution a price correction in the near-term. If there is rising fear from the EU or elsewhere, but not deep panic, gold is likely to pull back.
Nevertheless, we remain bullish in the long-term outlook for gold and advise to buy on pullbacks. Be careful where you get your gold, however. See The Latest Gold Fraud Bombshell: Canada’s Only Bullion Bank Gold Vault Is Practically Empty. Note in the comments that the popular ETF GLD does not entitle you to physical gold.
The USD began the week on a firmer note on thin holiday trading as dealers focused on a Fed Discount Rate meeting on Monday while rumors made the rounds that the Fed might again raise the discount rate.
In Europe, all the EU/Greece debt pressed the EUR, although markets calmed Friday morning, after the Greece finance ministry stated that its Q1 budget deficit was down 40% y/y at €4.3B and the country was on track to meet its 2010 deficit target of 8.7%.
Fitch downgraded Greece’s sovereign ratings by two notches later on Friday, although the move did not upset the euro’s slight strengthening and lower spreads on Greek debt. Instead of falling after the news, the euro jumped +1.06% against the dollar and +0.8% against Japanese yen amid speculations that the EU/IMF alliance, despite Germany’s objection, will provide loans at below-market rates to the debt-stricken economy. Tentative details of the aid package leaked on Friday included that EU ministers could make a formal statement on Greek aid next Friday and may charge Greece in excess of 6% for emergency loans.
The BoE and ECB maintained rates at existing levels Thursday as expected:
The ECB press conference centered on the peripheral debt situation. Trichet commented that a Greek default was “not an issue” under the current information. EUR/USD maintained a foothold above the 1.33 area. The BoE held off any further QE for now. In the UK, Prime Minister Brown formally asked Queen Elizabeth to dissolve the Parliament and set an election date for May 6th.
The Reserve Bank of Australia raised its cash target rate for the fifth time in six meetings, shrugging off the recent deterioration in monthly trade, retail sales and dwelling approvals data.
The accompanying statement was on balance more hawkish, containing a specific mention of economic recovery “contributing to pressure on prices for raw materials.” Going forward, RBA said the buildup in investment the resources would lead to even higher pace of growth, even considering the diminishing effects of fiscal stimulus. The Australian dollar extended its gains following the RBA statement, approaching 0.93 handle for the first time in nearly three months.
The really big market movers over the coming weeks will be:
The EU Debt Crisis, as it has been and will continue to be for some time, given the rather improvised, ad-hoc approach of the EU to what is likely to be a series of potential crises as each PIIGS nation confronts major bond sales. The market’s reaction to US Q1 Earnings Season.
Let’s start with the more predictable of the two.
Q1 US Earnings Season Begins: Giving A Boost In Risk Appetite To Counteract EU Debt Concerns?
While most of the big names don’t start reporting until the week of April 19th, Q1 earnings begins in earnest this week with Alcoa (AA), so it’s not too early to consider its likely influence.
If the last reporting season is any indication, it should boost risk appetite. Fourth quarter 2009 earnings were viewed positively as they showed the first signs of genuine growth. That is, all of the earnings were not based on cost cutting alone but also on a rise in top-line gross sales revenue. While cost cutting did dominate and helped overall earnings beat expectations by more than 5% in Q4, sales figures also beat forecasts by nearly 2%.
We expect this pattern of organic growth to continue in the Q1 reports. Earnings growth is estimated to be about 30% y/y. Granted, last year’s very low comparable levels make reaching this threshold quite possible. However, the evidence of lately (especially from the retail space) suggests we could surpass these estimates. If so, the concomitant boost to risk appetite suggests at least a couple of forex plays.
The currency pairs best correlated with US equities in 2010 thus far have been the USD/CAD and AUD/USD. The former has had a -95% correlation while the latter has moved in with stocks 90% of the time this year. Should we see a similar rally in equities that we got in Q4 (roughly 7%) this would pin the S&P 500 near 1275. Given the 2010 relationship this would place USD/CAD around 0.9530 and AUD/USD near the 0.9800 by the end of June.
The better tone to earnings combined with what is likely to be a slow but steady improvement in US economic data should help yields of US bond yields trend higher. We witnessed this past week the US 10-year flirting with the 4.0% area only to be rejected on what was a very positive auction later in the week (positive for demand and thus bond prices, negative for yields). We think this was only the beginning stages of what will be a gradual move higher, however.
Improving US economic fundamentals combined with rising bond rates should strengthen the USD.
In terms of playing this via the currency markets, USD/JPY stands out. The pair has seen an impressive 93% correlation with 10-year yields in 2010. The next major area of resistance once we clear the 4.0% hurdle is 4.3% and a move up there would translate with a USD/JPY trading near the 100 zone.
The EU Debt Crisis: Chronic Self-Defeating EU Ambiguity on Greece Aid Raises Greek Borrowing Costs
Less clear is how the EU will hit risk appetite in the coming week.
It’s clear that the March 25th EU accord’s failure to achieve its goal of calming markets and lowering Greek bond yields was due to its sheer ambiguity. Nonetheless, the EU remains thus far unable to provide key market-soothing details about how it will deal with Greece and other default prone members.
This is because the decision makers have yet to agree among themselves, as there are conflicting agendas. IMF participation, interest rates charged, and other terms of aid to Greece remain unclear. In the latest plot twist, speculation that the EU may step in with a bail-out for Greece over the weekend provided a boost for the EUR ahead of the close of the European business week.
Time is running out for Greece. While the Debt Agency has met its April funding requirement, there is a need to raise EUR 11.6 bln in May and EUR 32 bln through the rest of the year.
While Greek bond yields have retreated from their highs, Greece cannot issue at current levels and simultaneously slash its budget deficit to 3% of GDP by the end of 2012. While emergency funding from the EU or the IMF may provide some temporary relief to the Greece funding crisis, it cannot heal the budget deficit.
A history of Greek fiscal mismanagement, poor tax collection, and unreliable politically influenced budget statistics has left the market skeptical of Greece’s ability or will to reform. Thus the EUR saw little initial reaction to the announcement by the Greek government that the Q1 budget deficit has declined by 39.2% to EUR4.3 bln. The EUR may see relief in the near-term if Greece funding crisis is offered a reprieve. However, the market will need to see concrete proof that Greece is implementing budget reform before it takes Greece off the watch list. The EUR thus remains vulnerable.
UK Political And Economic Status May Be Improving, Could Boost GBP
Over the past week the Tory opposition party has found some additional support.
A commitment by the Conservatives that they would not raise national insurance (tax on wages) has been met with approval by the electorate. Their decision to clarify how they would make GBP 12 bln in efficiency savings has been met with relief in the markets. The Tory party’s promises to tackle the budget deficit have made it the more market friendly political party. However, its previous lack of detail on budget reform combined with fears that too much austerity too soon could lead to a double dip recession have been undermining support.
Fears of a double dip recession were further pushed into the background on the stronger than expected release of manufacturing production data and on the indication from the NIESR that the economic recovery continued in Q1 in spite of prolonged wintry weather. If the Tory party can manage a controlling majority in the May 6th election day EUR/GBP would likely move a notch lower.
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