Markets started last week on the back foot, with most major indices off the pace for the first three days. Later in the week, strong performances from the financial sector helped markets trim the losses. All major equity indices bar the Shanghai Composite were off as doubts about those elusive much hyped but little seen green shoots resurfaced. The FTSE 100 finished down 2.79% on the week at 4335, while the Dow Jones finished down 2.97% at 8530. In Europe, the DAX lost 5.13% to end the week at 4825.
Volatility was the order of the day in the currency markets last week. The Yen was a rare bright spot, gaining a little against all pairs. The Pound was also a little stronger, with EUR/GBP hitting a new low for the year at 0.8420. EUR/USD weakened to 1.3943, while the GBP/USD finished slightly up at 1.6497.
In Commodities, Gold was mostly sideways this week and ended slightly down at $935.5. US Crude and Brent Crude broke a four week streak of gains to drop to $69.65 and $69.52 respectively, possibly due to mounting geopolitical uncertainty.
Regulatory matters were at the fore last week, with the Obama administration announcing the biggest reforms in the US financial system since the 1930s. In the UK, Mervyn King and Alistair Darling were at loggerheads about regulatory issues. The former called for more power to interfere in the actions of banks who were taking on too much risk, while the latter said there would be no plans to fundamentally change the system of regulation. In Europe, a new Systemic Risk Board was announced, their remit being to spot any threats to financial stability across the EU.
Today’s Market Moving Stories
- Overnight, Japan’s tertiary industry index rose by an inline 2.2% after a 2.8% fall last month. This was the biggest rise in service-sector activity since early 2006. The Ministry of Finance business survey for Q2 showed a big increase in manufacturing confidence from -66 to -13, taking it back to pre-Lehman levels.
- So China isn’t going to save the world? I’ve been saying it for a while but the old FT has a good editorial on China today, based on the World Bank’s latest quarterly update. It shows that China will manage a decent rate of growth this year, thanks to its stimulus plan, but the impact of the stimulus on the rest of the world is going to be small. The net stimulus will be 0.1% of global GDP. The FT said the big challenge for China is to shift demand from investment to consumption, from the state to the private sector, from capital-intensive manufacturing to labour-intensive services, and from a reliance on exports to reliance on the domestic market. This requires reforms.
- The World Bank cut global GDP forecasts to -2.9% from -1.7% for 2009 and to 2% from 2.3% for 2010. It called for “bold” policy action and said the outlook for the poorest countries is “bleak”.
- The UK’s Rightmove reported house prices dropped 0.4% mom in the month through mid-June for a 5.5% loss in the year. That compares to May’s +2.4% mom and -6.2% yoy. Rightmove noted that for 2009 to date, the average house price was actually up 6%. Still, it said it was important not to confuse this recent improvement with a proper normalisation of the market. It said there were huge distortions as a result of the combined effects of the recession and restricted mortgage availability.
- Meanwhile UK chancellor Darling is set to reveal his plan for banking regulation over the next days.
- France’s budget deficit will rise to 7-7.5% of GDP in both 2009 and 2010, budget minister Woerth told French radio. Germany’s budget deficit could increase by more than €100bn next year, the WSJ reports. JC Trichet the ECB President recommends that budget deficits start to be reduced as soon as next year if the economy recovers. If consumers expect excessive deficits to lead to sharp tax hikes, they will increase their savings accordingly, Trichet argued. In other ECB chat, Austria board member Nowotny said that rates are likely to stay anchored at low levels into 2010.
- Today’s Wall Street Journal carries a column written by former Fed governor Mishkin on the need to “get the Fed out of its box”. He looks at the problem of rising Treasury yields since the last Fed meeting (by around 70bp in the 10-year) and the similar gain in mortgage rates. Mishkin said although hopes of economic recovery to come were a part of the reason behind the lift in yields, the other factor was problematic - concern over massive budget deficits and hence supply. He said the Fed is boxed in. It could increase its Treasury purchases to take the supply down itself, but that would imply it was willing to be part of monetisation of debt and a facilitator of fiscal irresponsibility. Mishkin said the Fed will need to enter discussions with the White House, and specifically to encourage President Obama to address exploding spending on social security and medicare, both of which are driving future deficit projections. He said the Fed should provide an incentive, such as fiscal sustainability which could allow the Fed to offer policy that would reduce long term Treasury (bond) rates.
- For some it seems like business as usual as Goldman Sachs' staff are going to get record bonuses.
Waiting For The Fed Upon A Wednesday
Markets ended the week with a whimper, with attention squarely focused on the upcoming FOMC meeting. The attitude is best described as “nothing else matters”, which is remarkable given that policy rates are not about to change, now or anytime soon. The one area of consensus seems to be some comfort that the Fed will use their linguistic skills to kill off thoughts of any near-term tightening. I expect that the market will get the message that the Fed is not trigger-happy and buy anything in the Fed funds or Eurodollar 2010 strip that offers value. Not that there will be any room for confusion, for the Fed possibly has a very difficult message to convey if it wants to convey the Fed funds rate is going nowhere for quite some time, but they also want to signal an exit to unconventional policies. The more the Fed backs away from Quantitative Easing (QE) and presumably allows market rates to settle at a higher equilibrium rate, the more this effective tightening of financial conditions will reduce the prospect of a Fed tightening move going forward. In other words, the more hawkish on QE, the more bullish should be the longer-term outlook on Fed funds. The more hawkish on QE, the more this reinforces the curve-steepener trade i.e. Low rates stay anchored while longer term rates rise hammering mortgage rates.
On QE, they are bound to surprise because there are so many possibilities for a consensus to coalesce around. The spectrum of options ranges from the dovish, where the Fed adds to the USD300bn of Treasury purchases and accelerates the pace of purchases, to the hawkish, where it scales back the commitment for purchases. Among the possibilities is that the Fed simply defers the decision, and stretches out the existing purchases until they make a decision at the next meeting!
What Of The German Election And The DAX
Utilities will likely be in focus again, as business-friendly governments usually take a more relaxed stance on the nuclear debate. Should the CDU be in the driver’s seat of the next government, I think it should be good news for the investment cases of the two large German utilities, RWE and E.ON. I would naturally look for construction stocks, such as Hochtief (GM:HOCFF) and Bilfinger Berger (OTCPK:BFLBY), to benefit if the SPD is again part of the government. Financial services stocks, especially Deutsche Börse (OTCPK:DBOEY), would benefit from the SPD losing the election, in my opinion.
Staying with the Fatherland this morning, we get the key German Ifo business confidence survey (one of the handful of indicators the ECB take seriously). The survey is likely to register some further improvement to around 86.1 in June, with both the current assessment and expectations likely to rise. However, even at this level the index would only be consistent with a slower pace of contraction and remain below its average of 97 in 2008 and 106 in 2007. Therefore, I would not get too excited about it in terms of implications for growth at current levels. Unless it records a much better than expected outcome it should leave the EUR unperturbed.
- Mineral extractor Anglo American (AAUK) is 12.5% up after a £41bn approach from Xstrata (OTC:XSRAF) as they attempt to challenge for BHP Billiton’s (BHP) crown.
- Porsche (OTCPK:POAHF) is up a tad on a report that Daimler (DAI) may be interested in acquiring a stake to help cooperation with VW (OTCQX:VLKAY) on the Merk A & B class models. Daimler called the reports “speculation”.
- Oil producers are weaker this morning as crude dropped below $70.
- AIB has confirmed that it has accepted offers to exchange six series of Euro and Sterling hybrid securities (€868m and £368m) for the equivalent of c.€1.3bn of new lower Tier 2. The take up rate is significantly better than expected, resulting in a much larger than expected Euro 1.1 billion impact on capital. This benefit leaves the bank just €400 million short of the €1.5 billion target set back in May.
Fact May Turn Out To Be Stranger Than Parody
And Finally… You Had A Bad Year