Report From Europe: Fed Warms Up Printing Presses

Includes: DIA, QQQ, SPY
by: The Mole

As I warned yesterday, the US equity market had overdone its expectations that the Fed where going to fire up the printing press and embark on QE2 with immediate effect. Hence it had set itself up for a fall and was ripe for a setback on the resulting disappointment.

The culprit for the early dip in European stocks this morning was to be the execution of a 1.5 bn euro programme order to sell European stocks!

Stocks catching the eye this hump day include Santander (STD) which has dropped 3.4% after Credit Suisse downgraded Spain’s largest bank to “neutral” from “outperform.” The brokerage said Santander’s structural growth will probably decline and its profitability in Brazil may be slower than forecast.

Automaker Daimler (DAI) has shed 2.1%, leading carmakers lower as Italy’s La Repubblica reported that Europe’s largest truckmaker made a 9 billion-euro “pre-offer” for Fiat Industrial, the truck and tractor unit of Fiat (FIATY.PK), without saying where it got the information. Fiat wants 10.5 billion euros for the unit, the Italian daily said.

Tiremaker Pirelli fell 2.3% on another broker downgrade, this time from Morgan Stanley, which changed it from “underweight” from “overweight.”

Italy’s UniCredit has lost 3% after Credit Agricole Cheuvreux downgraded the country’s biggest bank to “underperform” from “outperform” after Chief Executive Officer Alessandro Profumo resigned. The brokerage said UniCredit had “no obvious successor either within the top management team or the industry,” leading to a potential “strategic vacuum at the top.”

Schibsted sank 9.8% for the biggest decline in the Stoxx 600. Norway’s biggest media company expects a profit margin on earnings before interest, taxes and amortization of 10% to 12% for the coming three to five years, and sees growth in operating revenue at 5% during that period.

Also to the downside was Merck (NYSE:MRK), which dropped 2.6% after rival Novartis won U.S. regulatory approval to sell its multiple sclerosis medicine Gilenya, beating Merck in a race to market the first pill to slow the crippling disease. Elan (NYSE:ELN), which sells the multiple sclerosis medicine Tysabri, also sank 5.6%

But Imperial Tobacco (ITYBY.PK) is ahead by 1.7% on news the U.K.’s second-largest cigarette maker said it expects net revenue from tobacco to rise about 3% this fiscal year as price increases offset declining shipments. Financial performance for the year to Sept. 30 remains in line with the board’s expectations, the company said.

In Germany, Infineon Technologies advanced 2.5% after CEO Peter Bauer said the chipmaker may use proceeds from selling its wireless semiconductor operations to Intel (NASDAQ:INTC) to make acquisitions or pay a dividend. “I expect there’ll be a lot of speculation about us making acquisitions” following the sale of the unit that makes chips for Apple Inc.’s (NASDAQ:AAPL) iPhone, Bauer told reporters in Munich last night. The sale will increase Infineon’s total cash to more than 2 billion euros when it closes next year.

Grifols advanced 4.2% after Europe’s largest maker of blood-plasma products was raised to “buy” from “underweight” at Santander.

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The US Federal Reserve moved closer to QE II with Tuesday’s announcement, by acknowledging that inflation is below its mandate and that the Committee stands ready to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate. We believe the odds have shifted to favour QE II in November.

All of the key changes to the Fed statement were on the inflation side. The Fed expanded the inflation paragraph to acknowledge that “measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.” This is extremely significant. Having acknowledged that they are falling short on the job, the Fed will not have the ability to stay sidelined for long. The Fed did say it expects to see inflation (after remaining subdued for some time) “rising to levels the Committee considers consistent with its mandate.” However, that expectation will buy them just one meeting of patience (i.e. it gives them cover for not taking action today, which presumably was hard to sell to the hawks). Unless the data over the next six weeks strongly bolster their expectation for firmer inflation ahead, we think the Fed’s acknowledgement today (that the status quo on inflation is not acceptable) compels them to act. Indeed the Fed indicated that the Committee was “prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”

The shift in focus from the economy to inflation solves a lot of problems for Bernanke. (1) Providing more accommodation to offset disinflation carries a much lower risk of undermining confidence than taking action because the economy is weak. (2) The whole debate over how weak the economy had to get to justify action — did it have to deteriorate or simply fail to improve? — is now irrelevant. There is no need for Bernanke to forge a consensus on this front. By comparison, it should not be hard to forge a consensus on action to prevent deflation. With inflation showing no sign of an upturn, hawks can’t disagree with undertaking QE II to get prices moving back toward the Fed mandate. (3) It makes clear why quantitative easing is being undertaken and what the goal is. The point of QE II is not necessarily to bring down interest rates and boost the economy (a scenario that most, including many members of the FOMC, are sceptical of). Rather, the Fed is engaging in QE II to reduce the risk of deflation (though the threat itself may be small, the consequences of falling behind the deflation curve would be devastating). In any case, while the current risk of deflation may be debated, few would disagree that QE is the correct approach if the Fed sees that problem.

The Fed has clearly taken the markets to the brink of QE, which is further than we would have thought possible in September given what I perceived to be widespread disagreement among the Committee concerning additional support.

FX Majors

On the back of this the USD looks more unloved than it has done for a very long time. The currency was already under pressure ahead of the Fed FOMC decision last night. The Fed statement resulted in a further lurch lower for the USD index; it fell through the 81.00 level on its way to testing the August low of 80.09. In contrast the EUR had benefited in particular from successful debt auctions in Ireland and Spain. The auctions helped to alleviate some funding concerns and resulted in a reduction in peripheral bond spreads versus bunds. EUR/USD broke important technical resistance levels moving above its 200-day moving average (1.3215) and has just cleared the 1.34 barrier. In contrast, gold prices continued to surge hitting a new record high (closing in on $1,300) whilst 2-year Treasury yields fell to an all-time low.

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UK Outlook

The U.K. economy will grow slower than previously forecast next year as the biggest public spending squeeze since World War II takes hold, the Confederation of British Industry said. Gross domestic product will rise 2 percent next year, down from a forecast in June of 2.5 percent, and the Bank of England won’t raise interest rates until the second quarter, the U.K.’s biggest business lobby said in London today. The group raised its 2010 growth forecast to 1.6 percent from 1.3 percent. “The action to get the public finances back onto a sustainable footing will no doubt temper the recovery going into 2011,” Ian McCafferty, the CBI’s chief economic adviser, said in an e-mailed statement. “The outlook for growth in 2010 has been lifted slightly, due to somewhat faster economic activity in the second quarter.”

Bank of England policy maker Andrew Sentance reiterated that the central bank should raise its benchmark interest rate “slowly” to combat inflation as the British and world economies avoid a double-dip recession. The bank needs to “gradually move interest rates up in a slow way which will not destabilize business confidence,” Sentance said in an interview on Sky News television yesterday. “One of the issues I would highlight is we haven’t seen the same dampening effect on inflation that we’ve seen in previous recessions.”

The minutes of September’s UK MPC meeting released this morning suggest that the arguments proposed by doves on the Committee are gaining greater currency with the other members. Admittedly, Andrew Sentence once again voted for a 25bps rate hike, while all other members voted to keep rates on hold. But the Minutes stated that the Committee believed that the upside risks to inflation had not changed ‘materially’, despite the fact that CPI inflation held steady at 3.1% in August. September’s Minutes reinforce our long-held view that the Committee will have to resort to another tranche of QE in the near future – perhaps a further £50bn or so when the fiscal squeeze really kicks in at the start of next year.

Britons need to save almost one- third of their average household income to ensure they receive an adequate pension, according to a study by Aviva , the U.K.’s second-biggest insurer. British nationals retiring between 2011 and 2051 will have to save on average 12,300 euros ($16,100)a year, more than people in any other European country, to receive 70 percent of their working income in retirement, the study showed. Germans need to save 11,600 euros a year to reach that level and the Irish should save 9,100 euros, according to the research. Britons are facing the steepest challenge after the financial crisis eroded the value of funds, many companies stopped offering final salary pensions and an aging population began weighing on the state coffers.

German Autos

German car producers sold 128k vehicles amounting to EUR4.4bn to China in H1 – three times the number recorded for 2009 as a whole.

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Company / Equity News

  • Bloxham Stockbrokers stated this morning in a research note following an analyst meet with Allied Irish Banks (AIB) uesday that “we now expect the sale of an asset by the end of September” by Allied Irish Banks Plc “for 1.2 billion euros (MT &T) while further smaller sales could net the group up to 400 million euros.” “This would allow AIB to progress with its plans to raise a maximum of 3.5 billion euros in the market, with the government having already pledged to provide up to that figure should it be required,” analysts at Dublin-based Bloxham said in a note today, following a meeting with the company.
  • Separately from Bloomberg: Allied Irish Banks Plc could raise an additional 400 million euros to 500 million euros from the sale of “small non-core assets and other capital actions,” said Alan Kelly, general manager of corporate services at the group. Allied Irish, which is selling three assets in Poland, the U.K. and the U.S. as it seeks to raise 7.4 billion euros by the year-end, is also “exploring” whether it could raise additional money from smaller deals, Kelly said in a telephone interview.
  • Despite earlier concerns that weak farm income during 2009 would hamper profits, Origin has delivered EBITA (€77.4m, -2.5%) and adjusted eps (37.2c, +3%) that beats consensus by 6%. Momentum improved as the year evolved with rising dairy and grain prices together with good weather lifting demand for feed, fertilisers and agronomy services.
  • Prudential (NYSE:PRU) is close to completing a deal worth $4 billion to $5 billion to buy two Japan-based life insurers, allowing AIG (NYSE:AIG) to raise money to pay back the U.S. government, while Prudential has been interested in expanding its Japanese operations.
  • Again from Bloomberg: The Ugandan government expects to resolve a tax dispute that’s held up Tullow Oil Plc’s (OTCPK:TUWOY) plans to start producing the country’s first crude, Finance Minister Syda Bbumba said. “We are talking and even last week we had talks with Tullow and its partners,” Bbumba told reporters today in the capital city of Kampala. “The issue will be resolved soon.” Uganda has delayed final approval on Tullow’s $1.5 billion purchase of Heritage Oil Plc’s (OTCPK:HTGLF) stakes in two Ugandan blocks. The government says it is owned $404 million in capital gains tax from the transaction. “It is incumbent for Tullow to bring them back to pay the taxes,” Lawrence Kizza, director of economic affairs at the Finance Ministry, said today in an interview, referring to Heritage. Until the government approves the deal, Tullow will be unable to bring in China National Offshore Oil Corp. and Total SA (NYSE:TOT) as partners. It needs help to develop the Lake Albert basin, which may pump more than 200,000 barrels of oil a day in 2014 or 2015.
  • American International Group has received approval in Hong Kong for a $10 billion to $15 billion IPO of its pan-Asia life insurer AIA Group, paving the way for what could be the world’s second-biggest IPO this year. AIA is slated to list in Hong Kong on Oct. 29, pre-marketing of the IPO will start Sept. 27, and the roadshow will begin Oct. 6.
  • Lindsey Lohan’s favourite, E*Trade Financial Corp. (NASDAQ:ETFC) may be bought for more than $6 billion, Richard Repetto, an analyst at Sandler O’Neill, wrote in a note quoted by MarketWatch. Charles Schwab Corp. (NYSE:SCHW) and TD Ameritrade Holding Corp. (NASDAQ:AMTD) may wait for a year before bidding for E*Trade, Repetto said.
  • Adobe Systems Inc. (NASDAQ:ADBE) slumped 14 percent in after hours trading to $28.29. The biggest maker of graphic-design software forecast fourth quarter sales that missed analysts’ estimates amid a sluggish recovery in corporate technology spending.
  • Microsoft (NASDAQ:MSFT) raised its quarterly dividend by 3 cents, or 23 percent, to 16 cents a share and got approval from its board to sell as much as $6 billion in additional debt. “This higher dividend, combined with our ongoing share repurchase program, reflects our commitment to returning capital to our shareholders and our confidence in the long-term growth of the company,” Microsoft Chief Financial Officer Peter Klein said yesterday in a statement. Microsoft is planning to sell debt this year to pay for dividends and share repurchases because much of its cash is held overseas, a person familiar with the matter said last week.
  • EBay (NASDAQ:EBAY) said it expects its third-quarter results to be near the high end of forecasts provided on July 21. The company also said Lorrie Norrington, president of EBay Marketplaces, is leaving the company.
  • France Telecom (FTE), France’s largest telephone company is buying 40 percent of Medi Telecom SA, Morocco’s second-largest mobile phone operator, for 640 million euros, as part of its plan to expand in emerging markets.
  • China’s Sinochem Group has hired Deutsche Bank (NYSE:DB) and Citigroup (NYSE:C) as it assesses a possible move to disrupt BHP Billiton’s (NYSE:BHP) offer for Potash Corp. of Saskatchewan (NYSE:POT), the Financial Times reported, citing people familiar with the matter.
  • Siemens (SI) said late Tuesday smaller-than-anticipated growth in the health-care market took its toll, resulting in a EUR1.4 billion impairment charge for its diagnostics division. The German industrial conglomerate, of which one major pillar is health care, in 2006 and 2007 spent EUR11 billion to buy Diagnostic Products Corp., Bayer AG’s Diagnostics division and Dade Behring in an attempt to create a leading provider of laboratory diagnostics. Still, the business failed to achieve anticipated growth prospects, due to a consolidation process among medical centers. The impairment chargewas widely expected among analysts.
  • Industria de Diseno Textil or Inditex, the retailer behind fast-fashion chain Zara, Wednesday said its first-half net profit soared 68%, boosted by higher sales, richer profit margins and store openings outside Spain. The clothing giant, the biggest in the world by revenue ahead of U.S. Gap Inc. (NYSE:GPS), said net profit in the half to July 31 rose to EUR628.3 million from EUR374.8 million a year earlier. Sales rose almost 14% to EUR5.53 billion, while operating costs were up 12% to EUR2.12 billion. The profit figure was higher than expected. Sales were in line with expectations.

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