- Relatively strong corporate earnings, the solid ISM manufacturing data (the series grew at its fastest pace in January since August 2004) and the ninth consecutive improvement in the ADP employment data all drove moderate risk appetite in the first half of the week. But a fresh bout of European debt anxiety stemming from debt issues Portugal and Greece led to steep declines on Thursday, with investors fleeing nearly all asset classes for the safety of the dollar and US government debt. Unsubstantiated rumors circulated that the ECB would be given emergency powers to guarantee Greece's debt. The DJIA plunged nearly 300 points on Thursday, to close below 10,000 for the first time since November 4th, 2009, while the VIX volatility index spiked to highs above 28. Worries about Portugal and Greece were severe enough to prompt ECB President Jean-Claude Trichet to take the unusual step of issuing a formal denial of rumors that the ECB would hold an emergency meeting this weekend. Friday's January employment report confused the market, with unexpected losses in the non-farm payrolls somewhat offset by an improvement in the annualized unemployment rate. In other news this week, White House Budget Director Orszag confirmed the administration would propose a FY11 budget with a deficit of $1.27T (around 8% of US GDP), and January retail sales were largely positive, with chain stores reporting a 3% rise in same store sales, bettering the 1% y/y overall expectation. Still rising uncertainty held sway, knocking stocks down for another week: the DJIA lost 0.5%, the Nasdaq dropped 0.3% and the S&P 500 fell-0.7%.
- Friday's headline non-farm payroll data (-20K v 15Ke) missed expectations, although manufacturing payroll reading (+11K v -20Ke) crept into positive territory for its first positive reading since November 2007. Meanwhile, the Labor Department nearly doubled the December non-farm losses by revising it to -150K. Benchmark revisions for the 12 months ended March 2009 were also worse than preliminary estimates, showing 902K more jobs were shed during that one year period than originally reported. The official January annualized unemployment rate dropped below the 10% level, although it's worth noting that the Labor Department is using a new household survey in calculating the number; using the old payroll survey the annualized January unemployment rate would be 10.6%.
- Dow components Cisco and Exxon topped Wall Street's expectations in quarterly reports this week, while Pfizer was firmly in line with estimates. Much like competitor Chevron last week, Exxon saw big growth in its upstream operation, while the downstream business reported a small loss. Cisco CEO Chambers was upbeat, calling Q2 "the second phase" of Cisco's recovery and noting the bounce back was even faster than he expected. Results from leading insurance names Aetna, Aflac, Humana and Met Life ranged from in line to a bit soft, while forward looking guidance was not positive. Echoing comments from other large heath insurance majors, Aetna executives say unemployment, a poor economy and healthcare reform will continue to pressure membership levels in 2010. UPS offered solid Q4 results and a broadly in line forecast for FY10, and also raised its dividend slightly. Visa did slightly better than expected and reaffirmed its 2010 forecast, while MasterCard stock was punished for missing EPS expectations.
- Among the better performers this week, Dow Chemical crushed bottom-line expectations and revenue was very strong. Executives said that US destocking has come to an end and an upturn in demand is being seen across the value chain. Media giant Time Warner Inc beat estimates but was outshined by rival News Corp, which raised guidance and its dividend as it touted strong results from its cable news division and blockbuster "Avatar" production. Mid cap energy names Tesoro and Marathon had weak earnings as refining margins declined, while Marathon's revenue was way ahead of expectations. Steel Dynamics, the last major US steel maker to offer results for the December quarter, missed earnings targets, but executives said demand remains robust and signs of economic recovery are "numerous."
- Toyota's faulty accelerator headache only got bigger this week; shares of TM are down more than 20% since the company vastly expanded its recall effort and idled US production in late January. The firm's much better than expected earnings hardly staunched the bleeding in the company's stock, given the non-stop news coverage, a new investigation by the National Highway Traffic Safety Administration and plans for Senate hearings. Also note that S&P put the firm's AA ratings on negative watch over the recall. The company estimated the FY09/10 impact from recalls at 100K vehicles, lost sales at ¥70-80B, and the cost of repair (not including the Prius break issue) at ¥100B. Other Japanese automakers also posted strong Q3 results this week, while Ford launched a special rebate offer aimed at Toyota owners to take advantage of the situation.
- European sovereign debt remained a center of attention this week and in scenes reminiscent of the first phase of the credit crisis, contagion fears and confusion provided the catalyst for a major risk rethink. The week began on a positive note for Euro Zone peripherals with Greece's stability plan receiving the necessary approvals from Brussels, but the good news was somewhat overshadowed by rumors of a Spanish downgrade at S&P and reports of €40B in previously unaccounted for Greek government debt. Both turned out to be false but the perception remained and credit default swaps were bid up aggressively on concerns that markets were just one headline away from serious damage, and for the bears, the news flow did not disappoint.
- The Portuguese Treasury sold just €300M of the indicated €500M in 12-month bills at a hefty yield of 1.379% on Thursday and the underwhelming auction set off a chain reaction of selling, arguably most felt in the equity space--the S&P500 fell below key chart support at the 1070 area. Despite the US's own fiscal woes, Treasuries retook their perch as the ultimate safe haven vehicle but while yields certainly declined the move was subdued while the market awaited Friday's employment report. Eventually risk aversion flows returned as the market got a handle on the nuanced Jan payrolls figures. Shorter paper performed better, sending the 2-year Treasury yield below 0.75%. The US long bond is back to offering rates below 4.5%. UK Gilts were arguably the chief beneficiary of the week's events as the flight to safety bid more than offset any uncertainty brought about by the end of the BoE's Gilt buying program. The 10-year GILT yield was actually lower on the week at 3.88% despite Jan PPI figures coming in above expectations.
- Corporate bond markets garnered attention from two of the biggest offerings on record. Kraft Foods raised $9.5B in a four-part deal to help finance its purchase of Cadbury PLC. Prices were discounted slightly as investors fled stocks, commodities a various other investment classes, but nevertheless the demand was there. The most expensive tranche of 30-year paper sold for just slightly more than 200 basis points above Treasury's. Also on Thursday, Berkshire Hathaway sold $8B in senior debt in a two-part deal involving both fixed and floating rate notes. Berkshire had to cough up as much as a 90 basis point premium to Treasury's for the 5-year obligations, but more importantly saw S&P cut its credit rating one notch from the coveted AAA rating. Even Valero Energy raised $850M in a 10-year offering. VLO paper priced 260 basis points above Treasuries despite a sizable Q1 loss and admissions that refining profitability will be excruciatingly slow to return in 2010. Regardless investors' strong demand for debt at both ends of the investment grade spectrum signals credit markets are open and functioning effectively.
- FX markets also remained fixated on the peripheral members of the European Union as concerns grew over possible spillover effects from Greek debt problems. Various European officials expressed optimism that member states would be able to tame burgeoning budget deficits over the medium term and reiterated that EU spending rules would be honored, but credibility eluded the European peripherals, keeping risk aversion sentiment high. Risk appetite was not entirely absent during the week, with a certain degree of optimism in evidence ahead of the BoE and ECB rate decisions, although the overall feeling has been that players are re-pricing the prospects for a global economic recovery.
- The EU Commission may have approved Greece's budget proposal, which anticipates returning the country's budget deficit to compliance with Maastrict criteria by 2013, but the Commission's full assessment was four times longer than average, providing an overabundance of red flags to unsettle traders. In the background, there were concerns the Union might need to invoke emergency treaty powers and issue an EU guarantee for Greek debt. All week long a parade of European politicians and central bankers repeatedly insisted that talk of a Euro Zone breakup was absurd. You didn't have to look hard to see the potential for social unrest and political breakdowns as governments try to slash spending: in Greece, the main labor union called for a 24-hour anti-austerity strike later this month, while Portugal's parliament passed a regional spending package despite the opposition of the sitting government.
- Currency dealers were closely watching the euro's price action this week in light of seasonal trends. Since launching in 1999, the euro has picked up significant momentum if it violates the highs or lows set in the month of January. On Thursday the January low in EUR/USD around 1.3850 gave way, sending the cross to test nine-month lows below the 1.3650 level. The 1.3740 area now appears to be the key upside resistance level, as it was last summer's pivot point when reserve diversification was the ongoing theme.
- Looking ahead, the G7 meeting in Canada could provide some surprises. There has been growing speculation that the Chinese Yuan may be a major topic of the conference. Ahead of the meeting the OECD released a report on China that calls for more yuan flexibility and asks the PBoC to rely more on interest rates as its key monetary policy tool. The ECB's Trichet reaffirmed that he "appreciates" the US stance of support for a strong USD ahead of the summit. G7 finance ministers and central bankers have indicated that they will not be issuing a formal communiquat the end of the conclave.
- Sterling was softer as traders worried about the possibility of a hung parliament emerging from the upcoming UK parliamentary elections, which would hamper the UK's fiscal position and increase market uncertainty about the budget deficit. GBP/USD moved below a quarterly pivot point of 1.5750 to probe 1.56. The yen was also a topic as dealers watched the currency maintain its strength despite press speculation the Japanese Banking Ministry supports a plan by the Japanese Postal Service (Kampo) to diversify some of its $1.95T in holdings into US Treasuries and corporate bonds. USD/JPY tested 89.00 as risk aversion prompted safe-haven flows into JPY.
- The biggest surprise out of the Asia-Pacific region this week was the Reserve Bank of Australia unexpectedly leaving rates unchanged. The decision to forego another 25 basis point hike, with several priced in the market for this year, was attributed to information about the early impact of prior rate changes still being limited and concerns the country's biggest trading partner, China, may be looking to reduce stimulus. The RBA's Quarterly Policy Statement offered more mixed messages in the wake of this week's surprising hold. While the central bank raised its FY10 and FY11 CPI targets, it insisted underlying inflation would continue to moderate and remain within target in 2010-12. Policymakers also raised 2011 GDP forecast to 3.5% from 3.25%. Going forward, the RBA said policy would have to be adjusted further if the economy continues to improve, and suggested that rates may no longer be at "exceptionally low level."
- Some evidence that concerns of a Chinese slowdown may be justified emerged in the January Purchasing Managers Index, which saw the first decline since May of 2009. Index components showed both excess capacity and inflationary pressures, with output, backlog, finished goods, and employment all registering multi-month lows.
