MarketView for June 14

 

 

 

 

Summary

 

The major equity indexes rose sharply on Thursday on news that the major central banks are preparing coordinated action if the results of Greek elections this weekend lead to turmoil in financial markets. The central banks from major economies will take steps to stabilize markets and prevent a credit squeeze if necessary.

 

The news late in the trading day invigorated a market that has been highly volatile this week, whip-sawed by concerns the ballot in Greece on Sunday may set the stage for the country's exit from the euro zone.

 

Energy was the top-gaining S&P sector helped by a 2 percent rise in U.S. crude oil prices. Chevron ended the day up 1.8 percent to $101.92 providing considerable momentum to the Dow Jones Industrial Index. However, some of the bloom came off the rose as the trading day began to wind down. As a result, the Dow hit an intraday high up 1.6 percent but closed up 1.2 percent.

 

Each trading day this week has been almost a reverse image of the previous one, with the market rising around 1 percent one day only to fall by about the same margin the next. That has left the S&P 500 flat on last Friday's close.

 

Economic data on Thursday added to recent evidence of a slowing recovery, with an unexpected rise in the number of Americans filing new claims for unemployment benefits last week.

 

Some are hoping for additional Fed action when the Fed releases its policy statement next Wednesday at the close of a two-day meeting.

 

Trading came on low volume with about 6.6 billion shares changed hands on the three major equity indexes, a number that was 7 percent below the 20-day moving average.

 

In other data, consumer prices fell 0.3 percent in May, the largest decline in more than three years, which could also give the Fed room to ease policy next week.

 

Moody's Investor Service cut its rating on Spanish government debt on Wednesday by three notches to Baa3, saying the euro zone plan to help Spain's banks will add to the country's debt burden.

 

On Thursday, Egan-Jones cut France's sovereign credit rating to BBB-plus with a negative outlook, citing expectations that France's funding costs will see more pressure as the euro zone sovereign debt crisis continues to roil markets.

 

In company news, Nokia Corp (NOK.N) (NOK1V.HE) said it plans to cut another 10,000 jobs, a fifth of its work force, and said its phone unit would post a deeper-than-expected loss in the second quarter because of tough competition. It's U.S.-listed shares of Nokia plunged 15.8 percent to $2.35.

 

Economic Data Points to Soft Economy

 

New claims for state jobless benefits rose for the fifth time in six weeks and consumer prices fell in May, opening the door wider for the Fed to help an economy that shows signs of weakening. Though the data released on Thursday showed only a small increase in claims last week, it undermined hopes that a recent slowdown in hiring would prove temporary.

 

New claims rose by 6,000 last week, the Labor Department said. Claims have been trending higher since February, which may have marked a turning point for the economy. However, every month since then employers have cut back on new hiring.

 

The slackening recovery and a worsening debt crisis in Europe have increased expectations of a further easing of monetary policy by the Fed, although economists are divided on whether the central bank will act when it holds it meets on Tuesday and Wednesday.

 

The 0.3 percent drop in consumer prices in May was the sharpest decline since December 2008, and it offered the Fed more maneuvering room. Gasoline prices fell 6.8 percent, the most in more than three years, the Labor Department said. The reason for the decline appears to be Europe's debt crisis, which menaces the global economy and has pushed world oil prices lower. That amounts to something of a silver lining for the wider economy because it gives consumers more money to spend on other things.

 

Nonetheless, recent signs have been worrisome. For example, retail sales contracted last month despite the drop in gasoline prices. Foreclosure starts rose year-over-year in May for the first time in more than two years.

 

One reason some Fed policymakers have opposed more monetary stimulus has been persistent inflation pressure outside the volatile food and energy category. Signs of that pressure were still present in May, when so-called core prices climbed 0.2 percent, matching the prior month's increase. That left core prices up 2.3 percent from a year earlier, even as the gain in overall prices slipped sharply to 1.7 percent.

 

A combination of the worsening debt crisis in Europe and uncertainty over whether the U.S. Congress will stave off large tax increases and government spending cuts at year-end is souring business and consumer confidence.

 

On Thursday, there were signs Europe's woes were getting worse, as Spain's 10-year bond yields hit a euro-era record of 7.0 percent. Yields above that rate have forced other struggling euro-area nations to seek an international bailout.

 

A victory in Sunday's elections by parties in Greece opposed to austerity measures attached to its second E.U. bailout would likely send the euro zone further into crisis by pushing the country towards the currency bloc's exit door. Policymakers around the world are preparing to protect their currencies and economies from any turmoil that might arise.

 

Central Banks Prepare for Greek Debacle

 

According to a report by Reuters, central banks from major economies stand ready to take steps to stabilize financial markets by providing liquidity and preventing a credit squeeze if the outcome of Greek elections on Sunday causes tumultuous trading. If severe market strains emerge after an unusual confluence of three elections this weekend - there are important polls in Egypt and France as well - central bankers are on standby to ensure enough cash is flowing through the financial system.

 

British finance minister George Osborne said on Thursday that the British government and the Bank of England will act together with new monetary policy tools to tackle tightening credit and financial market conditions triggered by the euro zone crisis.

 

A move to boost liquidity by central banks could mark a dramatic backdrop to the G20 summit of world leaders, who will gather in Los Cabos, Mexico, on Monday and Tuesday, with Europe's escalating crisis topping the agenda.

 

Leaders will be accompanied by finance ministers playing an advisory role. The ministers, who usually keep a low profile at these summits, have scheduled a working dinner on Monday and lunch on Tuesday.

 

Depending on the severity of the market response, an emergency meeting of ministers from the Group of Seven developed nations could be held on Monday or Tuesday in Los Cabos, with central bankers joining by phone. Their first line of defense probably would be a statement that policymakers are ready to take whatever steps are needed to assure market stability.

 

This usually is a signal for technical steps to keep cash flowing through the financial system. Currency swap lines already are in place, and they can be drawn upon to ensure there are enough dollars available if global investors rush into the safety of U.S. assets. Central banks also can hold extra auctions to flood banks with short-term cash via repurchase agreements.

 

Currency intervention also is possible, though less likely to be sanctioned by the G7. Japan and Switzerland might intervene to weaken their currencies if a rush to safe-haven assets pushes up the yen and the Swiss franc.

 

Japan already has indicated to its G7 partners concerns about yen strength and it had considered acting earlier this month, several sources with direct knowledge said.

 

The International Monetary Fund took the unusual step on Thursday of sanctioning currency intervention for Japan to counter stresses from Europe, noting its currency is "moderately over-valued.

 

As for Switzerland, it has drawn a line in the sand at 1.20 francs to the euro. Swiss National Bank Chairman Thomas Jordan and the country's finance minister, Eveline Widmer-Schlumpf, on Thursday both threatened capital controls to prevent the franc soaring if Europe's crisis deepens.

 

As if the election in Greece were not enough, investors will need to parse the impact of a presidential election in Egypt that could roil oil markets and an election in France that looks set to put socialists in control of parliament after gaining the presidency in May.

 

While central banks might stand together to counter credit tightness and market volatility, the bar would be far higher for coordinated monetary easing, which is considered unlikely.

 

The last time central banks cut interest rates collectively was in October 2008 after Lehman Brothers collapsed. In that episode, credit evaporated, with overnight interbank rates shooting above 4 percent and stock market volatility as measured by the VIX fear index hitting a record above 80. None of these measures is approaching severe stress today.

 

While volatility has risen sharply since March as global stock markets lost ground, at 24 the VIX is way below crisis levels. Interbank lending costs, measured by three-month LIBOR, EURIBOR and EONIA, are near record lows.

 

Unfortunately, central banks have far less maneuvering room today and will harbor their resources carefully. The policy rates for the Federal Reserve and the Bank of Japan are effectively at zero and the Bank of England rate is 0.5 percent. Only the ECB, with rates at 1 percent, could deliver a significant cut, a move recommended by the IMF. But the cut would be largely symbolic when money already is cheap and, with euro-zone inflation running at 2.4 percent, a bank with a mandate focused only on price stability faces a higher hurdle.

 

More significant would be a re-launch of ECB bond-buying programs. Yet the ECB has made abundantly clear that it first wants politicians to act because they hold the key to lasting solutions to Europe's sovereign debt and banking problems.

 

Frustration on the ECB board is running very high over the political paralysis in Europe, a senior European policy source said. While the ECB still has instruments at its disposal, notably its bond-buying program, the more these tools are used, the less effective they become, the source said.

 

However, several ECB policymakers have signaled they are open to cutting rates, suggesting that the ECB would be ready to move at its early July meeting - if EU leaders provide a game plan for resolving the debt crisis at their summit in late June.

 

Fed Chairman Ben Bernanke also has made clear that the European crisis is a significant risk for the U.S. economy and left little doubt in testimony to Congress last week that the Fed was ready to counter significant strains.

 

"The Federal Reserve remains prepared to take action as needed to protect the U.S. economy in the event that financial stresses escalate," he said.

 

This probably would mean a third round of bond buying, known as QE3, though it also could extend a program to push down longer-term interest rates, known as Operation Twist. The Fed meets next week on Tuesday and Wednesday.

 

Meanwhile, the Bank of Japan is expected to keep its monetary policy unchanged when it concludes a two-day meeting on Friday as it awaits the outcome of the Greek election. However, a fresh wave of global risk aversion that sends investors flocking to the yen could well lead the BOJ to expand its 40 trillion-yen asset buying program, its main policy tool after it cut rates to a range of zero to 0.1 percent during the global financial crisis.