MarketView for January 7

 

Summary  

 

Trading on Wall Street on Wednesday left no doubt in anyone’s mind that the recession is far from over as Wall Street suffered its worst decline in more than a month, the result of a grim private-sector jobs report coupled with a revenue warning from Intel.

 

Two days ahead of the Labor Department’s nonfarm payrolls report for December, a worse-than-expected private-sector jobs report highlighted the challenges facing the economy. According to ADP, a private employment service, private employers shed 693,000 jobs in December, up sharply from the revised 476,000 jobs lost in November.

 

Recession fears were also heightened after Intel said its revenue for the fourth quarter would not meet the lowered forecast it had given in November, citing weakening demand for personal computers. After five days of gains, technology shares were among the day’s biggest losers after Intel's warning, indicating the heavy toll that the economic slump is having on both business and consumer spending. Intel ended the day down 6.1 percent to $14.44, while Apple lost 2.2 percent to $91.01 and Microsoft was down 6 percent to $19.51.

 

The Intel news compounded negative sentiment from aluminum producer Alcoa's announcement late Tuesday indicating that it planned cut more than 15,000 jobs, halve capital spending and sell businesses to weather the global downturn.

 

Energy shares slid as a result of data indicating an abundance of crude oil inventory as demand erodes as a result of the economic slowdown. Crude futures were down more than 12 percent.

Chevron and ExxonMobil were key among the stocks that dragged on the Dow Jones industrial average, while the S&P index of energy stocks .fell 3.8 percent. Chevron ended the day down 4.4 percent to $73.96, while Exxon was down 2.6 percent to $78.25.

 

Further evidence of the spreading recession came from Time Warner, which forecast a fourth-quarter loss, sending its stock down 6.3 percent to $10.29.

 

Among financials, Morgan Stanley fell 7.6 percent to $18.10 and Goldman Sachs was down 4.8 percent to $84.50 after Sanford Bernstein cut its 2009 earnings forecast for both firms.

 

President elect Obama has proposed the largest domestic infrastructure investment since the 1950s and massive tax cuts for consumers and businesses. Meanwhile, Congress began work to pass a stimulus package. Obama expects to inherit a budget deficit approaching $1 trillion and says his administration will have to make tough budget choices.

 

Largest Percentage Drop in Crude Prices in Seven years

 

Crude oil futures fell 12 percent on Wednesday, the largest percentage drop in seven years, after a government report indicated that crude inventories were considerably than had been previously estimated. Crude stocks increased by 6.7 million barrels, the Energy Information Administration reported, more than seven times the expected 900,000-barrel increase. Gasoline and distillate stocks also rose as refinery utilization climbed and demand remained sluggish.

 

Domestic sweet crude for February delivery settled down $5.95 per barrel at $42.63, making it the largest single-day loss, percentage-wise, since prices fell 15.25 percent on September 24, 2001. London Brent crude settled down $4.67 per barrel at $45.86.

 

Oil demand in the United States, as well as Europe and Asia, has been eroded by the global economic slowdown. Total oil products demand in the United States in the past four weeks was down 2.9 percent from a year ago, the EIA said.

 

The bearish data overshadowed Russia's energy dispute with Ukraine and the conflict in Gaza, both of which had supported oil prices early in the week. Although the Gaza conflict did not directly threaten any oil supplies, unrest in the Middle East can bolster prices because countries in the region pump about a third of the world's oil.

 

Russian gas supplies to Europe through Ukraine shut down completely on Wednesday, leaving growing numbers of European Union member states without Russian fuel in freezing mid-winter temperatures.

 

The dispute, which increased demand for gas oil and lent support to crude, echoes a similar confrontation three years ago that raised questions about Russia's reliability as an energy exporter.

 

Meanwhile, Saudi Arabia's foreign minister rejected Iran's call for placing an oil embargo on Israel's supporters at a Wednesday news conference in New York.

 

Deficit Spending Through the Roof

 

The U.S. budget deficit will increase to a record $1.186 trillion in fiscal 2009, the result of an economic recession that has cut tax receipts and caused massive government bailouts of banks and automakers. The out-of-control deficit picture by the Congressional Budget Office illustrates the daunting economic challenges President-elect Barack Obama faces when he takes office on January 20.

 

On Thursday, Obama will deliver a speech on the economy in which he will lay out his case for even more short-term deficit spending, possibly $775 billion or more over two years, to help heal the sick economy.

 

CBO also said the budget deficit could fall to $703 billion in the 2010 fiscal year which starts October 1, 2009, about the time the recession should to start .to move to a recovery stage.

 

The actual budget gaps for both years may be significantly greater as Washington prepares to pass the gigantic economic stimulus bill by mid-February. The CBO report shattered President George W. Bush's pledge that the government would balance its budget by 2012. Instead, CBO sees significant deficits at least through 2019.

 

The recession, which began in December 2007, has brought major job losses and slashed consumer spending and tax revenues. "This isn't your run-of-the-mill recession," CBO Acting Director Robert Sunshine told reporters. He said it might be the longest downturn since World War II.

 

CBO projected the U.S. economy will shrink 2.2 percent in 2009, the deepest for any calendar year since an 11 percent decline in 1946, before growing a modest 1.5 percent in 2010.

 

Unemployment was forecast to rise to an average of 8.3 percent this year and 9 percent in 2010. But Sunshine said there was unusual uncertainty with the forecasts.

 

Obama has said he expects deficits around $1 trillion for years, forcing tough budget choices. But on Wednesday he said his stimulus plan would not be as big as some have projected.

 

While trying to revive the economy, Obama also faces a longer-term problem of trying to control the rapid growth in the cost of federal retiree and health benefits for an aging population. Politicians have been putting off these tough decisions for years. Obama said he was mindful that the stimulus package would add to the near-term deficits but said it was needed because of the "dire" condition of the economy.

 

Signaling that he intends to stress fiscal responsibility, Obama on Wednesday named former Treasury official Nancy Killefer to scour the budget for wasteful spending items.

 

However, in coming months, Congress will be asked to approve tens of billions of dollars for the wars in Iraq and Afghanistan which have so far cost $857 billion, further adding to the deficit.

 

This year's deficit also swelled in part because of a $240 billion rescue of mortgaging financing companies Fannie Mae and Freddie Mac and a tax rebate, part of a 2008 stimulus package which will cost $168 billion over two years.

 

The Bush administration has loaned hundreds of billions of dollars to rescue financial institutions from risky real estate investments that went sour. Domestic automakers also are getting assistance from Washington.

 

The bailouts could cost the government $184 billion this year and $5 billion next year, the CBO projected. So far, the Treasury Department has spent about half of the $700 billion authorized by Congress.

 

CBO also estimated deficits over the next five years will total $1.972 trillion.

 

When Bush took office, total U.S. debt was $5.7 trillion. It now stands at more than $10.6 trillion because of increased government spending, tax cuts and the recession.

 

ADP Jobs Data Sends Dollar Lower

 

The dollar weakened on Wednesday, reversing sharp gains against the euro and yen seen earlier this week, as steep job losses in the private sector rekindled fears of a prolonged recession. The report, compiled by ADP Employer Services, showed a decline of 693,000 in U.S. private sector employment for December, which could well prompt some analysts to lower their already weak forecasts for the month.

 

As a result, the dollar pushed back from nearly one-month highs against the euro and five-week peaks versus the yen, with investors locking in gains, including central bank euro buying at lower levels for reserves management purposes as well as interest from funds.

 

In late New York trading, the euro traded at $1.3618, up 0.8 percent on the day. That was down from a session peak of $1.3746. The euro, however, remained vulnerable as data showed a rapidly weakening euro zone economy and easing inflation there, which raised the prospects for the European Central Bank to cut rates again next week.

 

Against the Japanese yen, the dollar fell 1.3 percent to 92.48, after hitting five-week highs the previous day. The dollar fell 1.2 percent against the Swiss franc to 1.1015 francs, while sterling rose 1.2 percent against the dollar to $1.5101.

 

Fed Faces Weaning Task

 

When the Fed eventually weans ailing firms off the emergency support put in place to rescue the economy, they will face the difficult and delicate task of timing it right. If they wait too long, they risk sky-high inflation or another asset bubble. If they move too fast, they risk undermining any incipient economic recovery.

 

Even against the current backdrop of a miserable economic outlook and the specter of deflation, a growing number of voices are warning that the Federal Reserve needs a clear and credible exit strategy for its unprecedented policies.

 

The Fed's balance sheet has more than doubled in size to over $1.2 trillion in recent months as policy-makers sought to shield the economy from the worst financial crisis since the Great Depression by pumping liquidity into key credit markets.

 

While the Fed has not gone into detail on how it might go about withdrawing its extraordinary support for credit markets and the economy, the subject is clearly on the minds of policy-makers.

 

At a recent symposium at Columbia Business School, New York Federal Reserve Bank staffer Til Schuermann asked a panel of academics: "How should we, the Fed, think about an exit strategy?" The answer from Tano Santos, a professor of finance at Columbia: Timing will be crucial.

 

Demand from banks for short-term funding under a Fed facility set up in December 2007 has already begun to wane. The narrowing in the Term Auction Facility's bid-to-cover ratio suggests banks have less need for the program and are meeting their funding needs elsewhere.

 

Loans under a program to help market participants meet credit needs of households and small businesses, the Term Asset-Backed Securities Loan Facility, for example, have a three-year maturity, which could complicate the wind-down. A commercial paper facility, which addresses non-financial companies' short-term funding needs, may also need to be actively wound down by reducing volume and raising borrowing.

 

Different sectors recover at different times when the economy picks up and if only a handful of firms tap a facility, it would be hard to argue the programs are still needed. Policy-makers may also have to contend with political pressure not to quash a burgeoning economic recovery by unwinding their emergency support, especially for programs aimed at consumers.