MarketView for June 14

 

 

Summary  

 

Well it looked as if it was going to be a good day on Wall Street with early trading sending the Dow Jones industrial average to a triple digit gain. But alas, as has been the case all too frequently of late, the bears came charging ahead late in the day and the gains evaporated. Adding impetus to the decline was a downgrade of the Greece’s debt to junk status by Moody’s. Moody's cited as its reasoning the risks to Greece that are inherent in the joint euro-zone and IMF rescue package for the debt-laden country.

 

Equities have been sensitive to debt problems in Greece and other European nations in recent months on concerns the euro zone's fiscal problems will hamper a global economic recovery. Although not unexpected, the downgrade weighed on a market that had rallied on earlier data showing euro-zone industrial output surged in April, achieving the biggest year-on-year percentage gain in almost two decades.

 

Cyclical sectors such as materials and financials that benefit from signs of a strong economy gave up much of their earlier gains. Dow component DuPont fell 2 percent to $36.86. JPMorgan Chase was also down, losing 2 percent and ending the day at $37.33.

 

Early on during the trading day, the S&P 500 was up as much as 1.3 percent, breaking through the psychologically important 1,100 level and brushing up against its 200-day moving average at 1,107.95, a level that the index has struggled to break through for the last month.

 

Meanwhile, the euro came within a breath of $1.23, its highest level since early June, as investors seemed comfortable taking on more risk, but then pared gains following Moody's downgrade. Late Monday in New York, the euro was up almost 1 percent at $1.2226.

 

Gold settled lower, but rebounded late in the session in another sign of the continuing concern that Wall Street has regarding the events in Europe. The NYMEX August gold futures contract settled at $1,224.50 an ounce, down $5.70.

 

However the CBOE volatility index .VIX fell 0.7 percent to 28.58. Although the VIX pared the its earlier decline, the index indicated the market was not anticipating a return of recent volatility when the VIX rose to nearly 50 in mid-May.

 

Buying within the semiconductor chip sector helped bolster the Nasdaq. The Taiwan Semiconductor Manufacturing indicated that strong demand from China will lift the growth outlook for the semiconductor market to 6 percent or 7 percent for the next five years.

 

SanDisk saw its share price add 6 percent, sending the shares to $47.31 after an analyst told Barron's newspaper that the stock could rise to $52 as the company benefits from a boom in demand for flash memory.

 

The price of crude oil futures settled up 1.8 percent, or $1.34 per barrel at $75.12 per barrel, in response to optimism about the global recovery that was stirred by the European industrial production data. But even oil futures pulled back from session highs and gains of more than 2.5 percent on Moody's downgrade of Greece's debt.

 

Another note from Moody's, this time on the oil sector, highlighted the uncertainty created by BP's oil spill. The spill has created an unprecedented financial, legal, regulatory and environmental crisis for companies that operate in the Gulf of Mexico, Moody's said. Meanwhile, BP's shares continued their slide, falling 9.7 percent to $30.67.

 

President Barack Obama plans to press the company to set up an escrow account to pay damage claims by individuals and businesses hurt by the oil spill. BP said the cost of the spill has hit $1.6 billion.

 

The advance for most of the day on Wall Street followed strong gains in European and Asian stock markets, as well as the S&P 500's 2.5 percent gain for last week. But the S&P 500 is still down more than 10 percent from its April 23 closing high for the year.

 

Shares of some airlines also rose after Deutsche Bank began coverage. For example, AMR was up 2.3 percent at $8.45 after receiving a "buy" recommendation from the bank.

 

Moody’s Cuts Rating of Greek Debt

 

Moody’s cut the rating on the debt issued by Greece to junk grade on Monday, citing the risks over Greece's ability to exit a severe debt crisis. Except for the stock market’s reaction on Monday, little impact is expected from the widely anticipated multi-notch cut, which pushed the euro down but left other markets unchanged.

 

Greece will not need to return to markets soon and the ECB will still accept its bonds as collateral. Of greater concern is the risk of contagion from Greece's debt crisis, which has sent shockwaves through markets worldwide, to other indebted euro zone countries such as Spain and Portugal. However, Greece said Moody's cut was not justified, considering progress in shoring up its public finances.

 

 

Moody's had repeatedly said it was considering such a steep cut for Greece, which has been hammered by markets and suffered series of rating cuts since it revealed in October that its finances were in a much worse state than previously thought.

 

"The macroeconomic and implementation risks associated with the (EU/IMF) programs are substantial and more consistent with a Ba1 rating," Moody's senior analyst Sarah Carlson said to explain the four-notch rating cut. Moody's also downgraded the country's short-term issuer rating to not-prime from Prime-1.

 

After coming within a breath of $1.23, its highest since early June, the euro slipped after Moody's cut Greece's credit rating to about $1.2215 before recovering somewhat. Greek government bonds will remain eligible as collateral for loans despite Moody's move after the European Central Bank decided last month to suspend its minimum threshold for Greek debt. The EU/IMF aid package assumes that Greece will not need to borrow on markets before 2012.

 

Moody's said the 110-billion euro ($134 billion) "pain for gain" package agreed with the EU and the IMF last month was not enough to prevent the ratings cut.

 

The rescue package "effectively eliminates any near-term risk of a liquidity-driven default and encourages the implementation of a credible, feasible and incentive-compatible set of structural reforms, which have a high likelihood of stabilizing debt service requirements at manageable levels," Carlson said.

 

But she added: "There is considerable uncertainty surrounding the timing and impact of these measures on the country's economic growth, particularly in a less supportive global economic environment."

 

The firm said Greece's credit ratings will now depend on its future economic growth and it still saw a low probability of Greece restructuring its debt. Fitch has no immediate plans to follow suit and cut Greece's debt to junk, a senior analyst at the ratings firm said.

 

"We've already said that unless there was a major, unforeseen development we would wait for the last months of the year to take a view on how successful the Greek government has been in implementing the agreed policies," Fitch Ratings' senior analyst for Greece Chris Pryce told Reuters in a phone interview. "This is still our view. We feel comfortable having it on the edge of the investment grade."

 

Fitch currently rates Greece at BBB-minus, the lowest investment-grade level, with a negative outlook. Standard & Poor's cut Greece's debt rating to junk status in April.

 

Fed to “Take Its Time”

 

The Federal Reserve's exit from its ultra-low interest rate policy will take a "significant period" of time, a San Francisco Fed economist said in a paper published on Monday. Downplaying the inflationary implications of the Fed's unconventional easing measures, Glenn Rudebusch, the regional central bank's associate director of research, indicated the Fed is not inclined to tighten policy any time soon.

 

"Many predict that the economy will take years to return to full employment and that inflation will remain very low," Rudebusch wrote, "if so, it seems likely that the Fed's exit from the current accommodative stance of monetary policy will take a significant period of time.”

 

That view reflects the thinking of San Francisco Fed President Janet Yellen, widely seen as one of the greatest monetary doves on the U.S. central bank's policy-setting Federal Open Market Committee.

 

Her approach to policy, which is closely aligned with that of Chairman Ben Bernanke, might soon become even more influential, since President Barack Obama recently nominated Yellen to take over from Donald Kohn as Fed Vice Chairman. Her appointment is pending Senate approval.

 

In response to the most severe financial crisis in generations, the Fed not only chopped interest rates down to almost zero but also undertook a wide array of emergency steps, including large scale purchases of long-term Treasury and mortgage bonds.

 

In the process, outstanding Fed credit to the banking system, known in the markets as the central bank's balance sheet, expanded sharply to around $2.3 trillion.

 

Yet Rudebusch argues that the large sums have few implications for inflation for as long as banks are reluctant to lend and demand for credit is scant.

 

"The doubling of the Fed's balance sheet has had no discernible effect on long-run inflation expectations," he said.

 

Given predictions for the jobless rate to come down only slowly and inflation to remain low, there is "little need to raise the funds rate target above its zero lower bound any time soon," Rudebusch wrote.

 

St, Louis Fed President Says Strong Recovery Under Way

 

According to St. Louis Federal Reserve Bank President James Bullard, a strong global economic recovery is under way, and is unlikely to be thrown off course by European debt woes or the improbable event of the bursting of an asset bubble in China.

 

"While the sovereign debt crisis in Europe is indeed a serious matter, the global recovery at this point looks very strong and seems unlikely to be derailed," Bullard said. Bullard also said Europe's sovereign debt crisis had not pushed back the timing of an eventual rise in the Fed's benchmark interest rate, as some market watchers have speculated.

 

The recovery in the U.S. economy needs to become more firm in order for the Fed to raise rates, Bullard said.

 

A voter on the Fed's interest-rate setting panel this year, Bullard said he expected the economy as measured by gross domestic product would recover to pre-global crisis levels by the third quarter of this year.

 

He also said U.S. inflation is contained now but could become a risk in the mid-term due to the large U.S. budget deficit and the Fed's ultra-easy monetary policy.

 

"Europe has not changed the idea of when we will move the federal funds rate," Bullard said.

 

However, the financial turmoil in Europe is not large enough to spread to the United States and Asia, Bullard said. "The United States may be a beneficiary of Europe, because their problems are causing a flight to quality that is lowering long-term Treasury yields," Bullard said.

 

"This will have a more simulative impact than the negative implications of dollar appreciation."

 

The U.S. recovery is likely to continue and private-sector job creation will start to pick up in the summer, gradually pushing the jobless rate lower this year, Bullard said. Some economists may have an overly pessimistic view of the U.S. labor market as they are excluding the number of temporary jobs created, he said.

 

U.S. consumer prices unexpectedly fell in April for the first time in a year, with the core annual inflation rate recording its smallest gain since 1966, data showed last month.

 

Core consumer price data could be distorted by a weak housing market and if this factor is excluded the data would show prices of other goods are rising, Bullard said.

 

"In late 2008 and early 2009 I was pretty concerned about deflation," Bullard said. "But the United States has missed the main danger point of deflation. I am not as worried about deflation now."

 

Bullard was among three Fed officials who sought an increase in the Fed's discount rate in April. The discount rate, currently at 0.75 percent, is the rate the Fed charges commercial banks for loans.

 

However, Bullard’s latest comments did not appear to express impatience with the course of Fed policy. The pressure on commercial banks' dollar funding due to turmoil in Europe means the Fed does not need to raise the discount rate for the time being, he said.

 

"Now is not the time to normalize the discount rate," Bullard said. "If we did make any further moves in the discount rate, this would not be a signal of future monetary policy tightening."

 

Bullard has warned before that the Fed's pledge to maintain unusually low rates for an extended period could, if misread, perpetuate the boom-and-bust cycle that plunged the United States and the world into recession.

 

He has also has emerged as an advocate for quickly shrinking the Fed's extensive quantitative easing efforts by selling off some of the mortgage-related debt the central bank has bought to stabilize the financial system and pull the economy out of the worst financial crisis since the Great Depression.

 

The Fed is prepared to expand its quantitative easing if needed, but improvements in the U.S. economy suggest this won't be necessary, Bullard said.

 

The consensus view at the Fed, reflected by Fed Chairman Ben Bernanke, is that its bloated balance sheet will shrink naturally as the assets mature or are paid off.