- In the last two weeks, markets were rattled by Dubai's debt crisis, caused by prodigal spending in a far-away land - this week traders had a serious case of European sovereign jitters. The ratings agencies went after Spain and Greece thanks to the Euro Zone members' shaky finances and the ECB's tentative steps toward an exit policy. The euro suffered, and this, combined with other technical factors, sent the dollar higher. Just a week ago spot gold was pushing out to new highs above $1,220; oil was testing $80 throughout most of October and November. By Friday, both gold and oil were well off their recent highs. Crude closed below $70 for the first time since early October. The US economic calendar was light of major data and equity trading volumes were below average. The US trade deficit narrowed unexpectedly in October, for its sixth straight month of contraction, as the weak dollar helped boost exports and demand for imported oil fell to its lowest level since the beginning of the decade. The US November advance retail sales and December University of Michigan confidence data both grew sequentially, beating expectations. Although the data suggests building momentum in consumer sentiment, many are skeptical. PIMCO's El-Erian warned that it remains to be seen how sustainable the demand will be as the government withdraws support for markets. For the week, equity markets were mixed, with the DJIA adding 0.8%, the Nasdaq down 0.2%, and the S&P 500 flat.
- The ECB's decision last week to begin winding back liquidity measures had particular resonance in Greece, where domestic banks are widely understood to be the most dependant on central bank largesse. With doubts over its financial institutions and little evidence that the new government was taking steps to rein in spending, Fitch was quick to pounce, downgrading Greece's sovereign rating one notch to BBB+. Spreads blew out alarmingly, but whether the country proves to be Europe's Achilles heel remains to be seen. Euro Zone officials expressed strong solidarity for their beleaguered fellow EU member state but offered no financial assistance. Spreads regained some lost ground after the Greek government pledged to cut the deficit by 4% in 2010. Not to be outdone, S&P put Spain on rating watch negative on Wednesday, stating that the country faced "a more pronounced and persistent deterioration in its public finances and a more prolonged period of economic weakness than its peers." Yet to fully recover from its own debt fuelled hangover, Ireland managed to escape unscathed on the credit rating front after the government outlined â‚¬4B worth of spending cuts in its budget.
- With the financial sector now healing, the Obama administration is looking to consolidate and reauthorize the TARP. The administration reduced the projected cost of TARP by more than $200B. The Treasury estimated that over the next 10 years, TARP will cost $141B versus $341B projected by the White House in August, still conceding that most of its investments in AIG and the auto industry are lost. Treasury Secretary Geithner formally asked Congress to extend TARP to Oct 2010. Note that were Congress to reject the request, TARP would not end, but the ability of the Treasury to freely invest TARP funding in almost any asset class would be constrained.
- With nearly all of its major competitors now out from under the TARP, Citigroup has been is trying to convince US officials to allow it to repay a portion of its government aid. Citi executives have said the bank should be allowed to repay its TARP funds due to its more than $240B of cash reserves and improving financial performance. Reports from various quarters indicate the bank is looking to sell $10-20B in equity to pay off the Feds. During the week various unconfirmed reports claimed that Citi's TARP payback was looking imminent, although on Thursday fresh reports suggested the deed would be done "soon, or after the holidays." Meanwhile, Bank of America formally completed its TARP payback this week, and Wells Fargo's CEO said the bank wants to pay down TARP as soon as possible.
- Earnings season is little more than a month away, and corporate pre-announcements and profit warnings were another major theme this week. FedEx increased its earnings guidance for its Q2, citing improved volumes, especially in overseas markets. In its mid-quarter update Texas Instruments slightly improved its outlook for its Q4. Executives said that both October and November were strong. Illinois Tool Works raised its earnings outlook for its Q4. Steel Dynamics said its Q4 profit would miss expectations, potentially by a half, on lower rates in sheet steel. Monsanto reaffirmed its 2010 earnings outlook for at least the fifth time, while its Q1 forecast was for a small loss (analysts expect breakeven results). Other than that, the calls were largely reiterations or in line with expectations.
- It was a certainly a tough week for sovereign debt, US and UK fixed income markets were no exception. Moody's got the ball rolling with a provocative report early in the week hinting at misgivings over the US and UK AAA ratings, only to clarify later in the week that there was no imminent threat of a downgrade for either country. The penultimate Treasury auction for the year was sluggish - capped off by $13B in US Long Bonds disappointingly selling above the key technical level of 4.50%. The strong retail sales data on Friday added further weight to Treasuries, and as the week drew to a close the 10-year note had re- established a foothold above 3.50%. The US yield curve is now nearly as steep as it has ever been with the benchmark spread has widening toward 275 basis points. These levels have been seen only two other times, coming out of the early 90's and 2002-03 recessions.
- UK Gilts have been aggressively sold after Chancellor Darling failed to outline any meaningful measures to control the deficit on Wednesday. The highly political pre-budget report, crafted with more than just an eye on next year's elections, was broadly fiscally neutral and contained no material changes to deficit or debt projections. The chancellor announced a controversial 50% tax on bank bonuses worth more than Â£25K, and a +0.5% increase to national insurance levies from 2010, but gilts markets remain unconvinced, with the 10-year yield rising roughly 20bps on the week to around 3.85%.
- In currencies, the greenback has gained steadily this week, building on newly-discovered momentum in thinning year-end liquidity conditions, aided by technical factors and the ratings dramas in Europe. Dealers have been watching higher Treasury yields for clues on the next leg of the dollar's price action. One European dealer warned that, after US Treasury 2-year yields moved from 0.65% to 0.85% over the last few weeks, any move above 0.85% could provide momentum. Some risk aversion has come out of Europe's sovereign problems, culminating with Fitch's action on Greece and S&P's move on Spain. However, FX traders have taken Greek Finance Minister Papaconstaninou's blunt assertion that his country faces "absolutely no risk" of default at face value, helping EUR, GBP and CHF recover and European equity markets maintained a constructive tone. On the verbal intervention front, ECB Cheif Trichet reiterated that a strong dollar was important for the global economy, while the ECB's Nowotny said a stronger euro would have negative implications for the Euro Zone.
- With the Bank of England on hold and announcing no changes to Quantitative Easing this week, sterling's price action revolved around concerns whether Chancellor Darling would introduce a one-off tax on bankers' bonuses. Darling confirmed there would be no windfall tax on bank profits, but there were those punishing taxes on bank bonuses and higher insurance contributions. UK Business Secretary Mandelson stated that the UK pre-budget report would be neither reckless nor painless and would not imperil the country's economic recovery.
- The Swiss Franc was little changed following the Swiss National Bank's uneventful monetary policy meeting. Rates remain on hold and the SNB reiterated yet again its policy to "act decisively" to curb CHF appreciation, disclosing that its efforts involve several currencies. The bank also noted that bond purchases would end.
- The Bank of Canada left the overnight rate at 0.25%, as expected, and retained its commitment to keep the target overnight rate at 0.25% until the end of Q2 2010. The BoC also reiterated that a strong CAD currency could act as a significant further drag on its growth.
- A great deal of activity in the Asian markets was kicked off on Tuesday, when Japan finally unveiled its secondary stimulus budget following weeks of intra-party debate. Under the plan, the government pledged Â¥7.2T to help keep the economy from spiraling further down into deflation, with allocations to labor, housing, and environment sectors. Accompanying the announcement, officials called on the central bank to preserve the accommodative monetary policy, while also expressing vigilance over the currency strength. Influential UK pundit Ambrose Evans-Pritchard, commenting on the stimulus plan raised concerns over the Japanese government's ability to meet its fiscal deficit target, a worry said to be potentially threatening the JGB market.
- Japan's Q3 final GDP saw a walloping revision from preliminary levels, exceeding most of the already bearish analyst forecasts following the surprisingly poor capital investment data posted late last week. Q/Q business spending was indeed the biggest sector revision from initial Q3 forecast, falling to -2.8% from +1.6%, as domestic demand contracted by 0.1% instead of 0.8% expansion reported initially.
- The Bank of Korea left rates unchanged this week at 2.00%, but made it clear that it is moving in the direction of the exit. Governor Lee warned that changing rates upon confirmation by the data would be too late, noting that the central bank would not tolerate inflation above 4% and does not need to wait until labor market improves. In a stark divergence from recent comments around the globe, Lee stated that exit strategies cannot be implemented in a coordinated fashion, while also remaining upbeat about growth prospects, targeting steady Q4 performance despite the waning stimulus and improving export demand. On Friday the central bank moved a step closer to the anticipated 2010 rate increase, raising its FY10 GDP forecast to 4.6% from 3.6% and calling for jobless rate to fall to 3.5% from 3.7% in 2009.
- Australia data continued to support the tightening regime in that country as the latest jobs data showed unemployment fell to 5.7%, below the expected 5.9%. Following the data, the Australian Dollar spiked higher across the board, as RBA rate hike probabilities for February jumped from a coin flip above 70%.
- Asian markets reversed a three day losing streak on Friday as China closed out the week with some robust data. China reported the highest rate of industrial production growth since June of 2007, rising 19.2%, beating estimates handily and solidifying the ongoing Far East recovery story. Chinese consumer inflation also rose for the first time since January, surpassing the 0.4% forecast by two-tenths of a percent. China's government statistics bureau immediately sought to play down the report however, tempering any tightening worries by noting that the inflation bump was primarily driven by food and energy price increases, and that otherwise China is not experiencing any inflation. The stats bureau was also quick to dial down industrial strength perceptions, pointing out that the strong industrial production in November was due in part to low year-ago base and warning against "blind optimism" on output.
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