The equity markets were able to build up momentum last week, allowing the S&P 500 Index to rally 33 points or 3.3% for the week. The commodity market also joined the party, as the dollar traded mixed due to global uncertainty.
The week started off on a positive note for riskier assets due to positive news out of Japan. The gloom is lifting slightly from the Japanese economy, as sharp growth from China and other Asian neighbors is lifting exports and spurring more capital spending by the nation’s manufacturers. The Japanese economy grew at a faster pace than expected, expanding at a rate of 4.6% for the three months ended Dec. 31. The economic figures also showed that the slight increase in domestic demand also helped lift Japan out of its worst recession. Private consumer spending, which accounted for about 58% of real gross domestic product, rose 0.7%, supported by government measures to encourage purchases of energy-efficient electrical appliances and cars. That was the third straight quarter of gains. The GDP deflator-an indicator that gives a broad reading of price trends-worsened to a record low of a 3% decline in October-December from the previous year, compared with a 0.6% decrease in the previous quarter. A fall in domestic prices pushed down the deflator, showing that the gap between supply and demand is still increasing.
On Tuesday the US equity markets rallied significantly and were greeted with robust news out of Australia. RBA minutes from February showed that the central bank kept interest rates unchanged this month in a “finely balanced” decision, due to concerns that the European debt crisis could weaken the global economic recovery. RBA noted, however, that “Members expected that if economic conditions continued to improve as expected, further increases in the cash rate were likely to be necessary. But they did not regard that outlook as ring an increase at every meeting.” In addition, “Members noted that many market participants expected a further increase in the cash rate at this meeting. They concluded that, on balance, the stronger case was to leave the cash rate unchanged for the time being.” According to our market analysis, the markets are likely to take the RBA statement as more hawkish.
Over in Greece, the debt crisis remains a market focus with euro zone Finance Ministers still trying to decide which strategy to use. The market has been left uncertain about how the EU would support Greece in its endeavors to shrink its budget deficit. To date, it is still unclear whether the finance ministers will provide some form of aid to Greece. Instead, the ministers, at the conclusion of last week’s meeting, urged Greece to be prepared to undertake additional steps at the March 16th review if insufficient progress has been made. The impact has been felt in the bond markets where Greek bonds have been sold off further with the German/Greek 10-year spread widening by the most in three weeks. The comparable German/Portuguese spread has also widened slightly, by 6 basis points.
Additionally, Manufacturing in the New York region expanded in February at the fastest pace in four months as company’s boosted payrolls in anticipation of accelerating orders and sales. The Federal Reserve Bank of New York’s general economic index rose to 24.9 this month, higher than anticipated, from 15.9 in January. Readings above zero in the so-called Empire State Index signal growth in the area covering New York and parts of New Jersey and Connecticut.
On Wednesday the FOMC minutes were released. The Jan 27 FOMC minutes were largely superseded by Bernanke’s testimony last week, although the notes made clear that policy makers had differing views. Hoenig, a voting member, was the only policy maker to dissent on use of the phrase “extended period.” The minutes showed he favored adopting a “modestly higher rate soon.” Several members argued for shrinking assets sooner ,rather than later. While all members agreed assets should be shrunk “over time”, several members did advocate shrinking assets in the “near future.” Plosser, currently a non-voting FOMC member and speaking as the minutes were released, expressed this view. This underscores a point. Not all voting members are hawks. Other FOMC members including Evans, who is currently a voting member, have advocated a more dovish approach in recent speeches arguing for expanding purchases if necessary. Diverging views become a focus as policy begins to shift but in this case, the minutes have been superseded by Bernanke’s testimony where the Chairman laid out an exit strategy that included a discount rate hike to move the spread between the discount and Fed funds target toward a more normal spread (100 bp prior to the crisis). Furthermore, the Fed has hinted that Fed funds might become a less reliable indicator of the Fed’s policy stance “for a time” with the Fed instead using rates on reserve requirements to reflect policy.
On Thursday, the dollar continued to strengthen against the Euro and Pound, and the US equity markets continued to push higher. US Producer Prices grew at a greater than expected 1.4% month on month for January 2010. Ex-food and energy PPI grew at a 0.3% month over month rate. Economists had expected a 0.8% and 0.1% increase, respectively. Additionally, jobless claims increased by 31,000 in the past week.
Consumer prices in Canada were 1.9% above year ago levels last month, the highest since Nov 2008, representing a 0.3% increase on the month. More importantly from a policy making point of view, the core rate rose to 2.0% from 1.5%. The Bank of Canada has promised no rate hikes before mid-year. The stickiness of core inflation warns of a risk of a BOC hike in Q3.
On Friday, the market needed to absorb a differing inflation data point. U.S. consumer prices barely rose in January from the previous month and core inflation fell for the first time since 1982. The seasonally-adjusted consumer price index rose 0.2% last month on the back of higher energy prices, according to the Labor Department. Core consumer prices, which strip out volatile energy and food items and are more closely watched by the Fed, fell by a monthly 0.1% in January. The last time core consumer prices fell was in December 1982. In December 2009, the core CPI had risen by a monthly 0.1%. Wall Street economists surveyed by Dow Jones Newswires were expecting an increase of 0.3% in the headline consumer price figure and of 0.1% in the core consumer price index number.
Forex
The pound traded weaker after disappointing economic data and reports, including jobs data that hit the board. Given last week’s definitely dovish BoE Quarterly Inflation Report, one could have expected a couple of members to vote for an extension of the asset purchase program. The majority of policy members argued that adding to the size of the Q/E program now might increase the chance of unwarranted increases in asset prices, which could have a negative effect on the economy. On the employment front, jobless claims figures rose 23.5k on the month vs. -10K expected and more than offsetting a -9.6k decline previously. Additionally, December average earnings are running at just 0.8% 3mths y/y, vs. 0.9% expected and unchanged from November which should support the BoE’s view that gains in CPI are temporary. From a technical point of view the GBP/USD Crashed on Friday and dropped to support, one must note that horizontal support coincides with trend line support. A break of that level could lead to lower ground.
The euro cannot seem to get out of its own way. After a brief period of calm, euro zone credibility issues have come back to haunt the euro. Greek bonds are under pressure after Greece was ordered by EU Economic and Monetary Affairs Commissioner Rehn to hand over information on the swaps by Friday making the market nervous about the possibility of still concealed debt. In addition, Greece will reportedly issue a new EUR 3 to 10 bln of bonds next week as part of its plans to raise a total of EUR54 bln in 2010 (of which about three-quarters still needs to be raised) putting additional pressure on bonds. With the 50 day moving average recently crossing below the 200 day moving average, the technical pressure for the Euro is to the downside. Even though a bounce could be experienced around current levels, the trend is definitely bearish.
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