MarketView for November 8

 

 

Summary 

 

Wall Street retreated from a two-year high on Monday, weighed down by financial stocks and a stronger dollar. The broad S&P 500 has risen five straight weeks, supported by the Federal Reserve's plan to buy $600 billion of Treasuries to lower interest rates and reinvigorate a sluggish economy.

 

Declines in bank shares could go beyond profit-taking from last week's gains. The Fed's pledge to keep interest rates near record lows was viewed as hurting bank profits.

 

Meanwhile, the dollar .DXY rose 0.7 percent against major currencies on renewed worries about budget problems in Ireland and other debt-weakened euro zone members. Since the euro zone financial crisis, a popular trade has been to sell the S&P 500 when the euro falls against the dollar, but that correlation has frayed of late. The 22-day rolling correlation between the euro and the S&P E-mini futures was 0.52, compared with 0.89 just two weeks ago.

 

Look for the G20 meeting, which will be hosted in South Korea on Thursday and Friday, to be the next catalyst in moving the dollar.

 

The S&P 500 faces strong resistance around 1,228, which would retrace 61.8 percent of the decline between its historic highs in 2007 and the 12-year low in March 2009. This is one of the Fibonacci retracements that chartists widely follow and many times coincide with buying or selling markers. In April, a first attempt to breach that level failed and preceded a decline that took the index to its 2010 low in early July.

 

Gains in technology stocks, including Apple, up 0.5 percent to close at $318.80, kept the Nasdaq near break-even.

 

Material stocks outperformed the broader market, and gold miners rose as the precious metal powered to an all-time high above $1,400 an ounce. Shares of coal producers rose on strong global demand for steel-making coal and renewed talk of mergers.

 

Shares of Alpha Natural Resources rose 8.6 percent to $48.26, while Arch Coal gained 4.6 percent to $29.61. Consol Energy was up 3.6 percent to end the day at $40.71.

 

Volume was light, with about 7.07 billion shares traded on the New York Stock Exchange, the American Stock Exchange and Nasdaq, below the year-to-date daily average of 8.73 billion.

 

Discontent within the Fed

 

Top officials at the Federal Reserve on Monday sounded differing notes on the central bank's bond-buying program, with one arguing it was an effective way to fight deflation risks and another warning it might need to be curbed.

 

The remarks from St. Louis Federal Reserve Bank President James Bullard, Dallas Fed chief Richard Fisher, Fed Governor Kevin Warsh and Thomas Hoenig of the Kansas City Fed underscored tensions within the central bank over the wisdom of the decision to buy a further $600 billion in government debt.

 

"While this policy carries both risks and rewards ... the benefits outweigh the risks," Bullard said on Monday. He said worries the policy could create high inflation down the road were "legitimate and important," but added that the disinflationary trend "is worrisome right now."

 

The central bank's decision has sparked an unusually vocal public debate among Fed officials, while drawing the ire of many other nations. Their concern is that the United States is deliberately undercutting the dollar.

 

Warsh, who like Bullard backed the new Fed program in a vote last week, expressed concern about the decision. He said he would have preferred the adoption of "pro-growth fiscal, regulatory and trade policies" to spur growth.

 

Fisher said the program would only work if lawmakers addressed the fiscal and regulatory uncertainties that he said were holding back businesses from expanding.

 

"I would suggest that even if you share my cautious perspective on this matter, you might be assuaged by looking at this new initiative as a bridge loan to fiscal sanity," he said.

 

Warsh emphasized that the policy would be subject to regular review and adjusted if needed, and he raised the prospect that rising inflation risks could lead the central bank to curb the program even with unemployment still painfully high.

 

"If the recent weakness in the dollar, run-up in commodity prices and other forward-looking indicators are sustained and passed along into final prices, the Fed's price stability objective might no longer be a compelling policy rationale," he said.

 

"Policies should be altered if certain objectives are satisfied, purported benefits disappoint, or potential risks threaten to materialize," Warsh said.

 

However, Bullard said his best guess was that the full amount would be purchased by mid-2011, as announced. "Given the outlook now ... it looks like we will follow through on that and reassess at that point," he said in an interview with Market News International published on Monday.

 

Many economists think the Fed could eventually decide to push beyond the $600 billion in purchases announced last week, notwithstanding differing views within the central bank.

 

Bullard said the recovery had slowed, putting it in a disinflationary trend that needed to be addressed to avoid a debilitating bout of deflation. He said the unconventional bond-buying program should prove as effective as traditional policy.

 

Warsh, likewise, said the economy's performance has been unimpressive. In contrast, Hoenig, the only official to vote against the Fed's decision last week, emphasized his view that the conditions were already in place for a quickening of economic growth.

 

The Fed's decision to add to the $1.7 trillion in government and mortgage-related debt it has already bought has driven down the value of the dollar and drawn scathing comments from countries that see the United States pushing for an export edge.

 

In response to an audience question about complaints by countries such as China and Germany about the Fed's decision, Bullard said the U.S. central bank must act to fulfill its mandate of price stability and full employment.

 

"You can't have other people around the world calling the shots on that mandate," he said.

 

Warsh, however, said heightened tensions in currency and capital markets raised the risk of a more difficult and protracted global economic recovery, and said these long-term risks need to be taken into account.

 

"Should these risks threaten to materialize, however one gauges the probabilities, I am confident that the Fed will have the tools and conviction to adjust policies appropriately," he said.

 

Wall Street Wants You to be Patient (NUTS!)

 

The captains of Wall Street on Monday are lobbying regulators to ease back on requirements of regulatory reform bill that is expected to squeeze profits from some of their most lucrative franchises. Two years after a severe credit crisis that was in large part of their own making, many of the banking and finance industries C level executives met on Monday at a conference held by their lead lobbying group where they made known in no uncertain words that they wanted to help "shape" reforms still being hammered out.

 

Morgan Stanley Chief Executive James Gorman complained at the annual meeting of the Securities Industry and Financial Markets Association (SIFMA) about polarizing Anti-Wall Street "rhetoric."

 

Just days after an election that handed Republicans control of the House of Representatives, Gorman appealed to the public, angry about Wall Street's role in the crisis, to give markets more time to recover. "The financial system nearly shut down. It's only two years on. You need a little bit of patience to rebuild, to accumulate the capital you need," he said.

 

The banking industry complains that they are just beginning to recover after the 2007-2009 crisis that shook the world financial order, tipped the economy into a deep recession and ushered in a global move toward stricter oversight.

 

Bank of New York Mellon Chief Executive Robert Kelly tried to place the blame of what happened at the doorstep of lax mortgage lending.  He called for new home loan underwriting standards tighter than those now being imposed.

 

"It's absolutely terrible" what has happened to homeowners and the foreclosure wave that ensued in the crisis was "totally avoidable," said Bank of New York Mellon Chief Executive Robert Kelly, who is Canadian, in an interview at the SIFMA conference with PBS talk show host Charlie Rose.

 

"We need good national standards for mortgage underwriting," Kelly said. "The banks should own 50 percent of the paper, with the other half sold through a privatized securitization process."

 

President Barack Obama in July signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, imposing tough new rules for banks and financial firms. These are being put into practice now by regulators under tight deadlines.

 

One of the new rules will require mortgage lenders to keep 5 percent of the risk of loans they make on their books, rather than selling loans in their entirety into the secondary debt market in the form of mortgage-backed securities.

 

Republicans who won control of the House last week have vowed to try to soften parts of Dodd-Frank, but face an uphill climb against a continued Democratic majority in the Senate and the virtual certainty that Obama would veto any major rollback.

 

Profits for many of the banks were better than expected in the third quarter, as they set aside less money to cover bad loans, but revenue was still weak. Wall Street bonuses are expected to be slightly higher this year compared to last year's low levels, but still below 2007's all-time highs.

 

SIFMA President Tim Ryan said at the conference that his group wants to help flesh out the "Volcker rule" on risky bank trading, among other measures contained in Dodd-Frank. The three-part Volcker rule curbs "proprietary trading" by banks; limits their involvement with hedge and private equity funds; and caps domestic expansion by the largest banks.

 

Congress laid down some parameters for regulators on defining "proprietary trading" -- or trading for banks' own accounts unrelated to customer needs -- but left room for banks to retain some in-house trading operations in an area where drawing clear lines will be difficult.

 

"The important aspect of this set of rulemaking will be how regulators define what activities are deemed 'proprietary' and thus prohibited," Ryan said. "Our focus here is to help Treasury determine what qualifies as proprietary trading."

 

SIFMA represents hundreds of securities firms, banks and asset managers, including Morgan Stanley, JPMorgan Chase, Goldman Sachs and Bank of America.

 

Obama Fights Back Against World Hypocrisy

 

President Barack Obama defended the Federal Reserve's program to buy up $600 billion of Treasury securities against world hypocrisy after China and Russia raised their level of criticism against the Fed policy ahead of this week's Group of 20 meeting.

 

The G20 summit was planned to be a chance for leaders of the countries that account for 85 percent of world output to prevent a currency row escalating into a rush to protectionism that could imperil the global recovery. It is not working and there is little chance it will given that the summit has been overshadowed by disagreements over the Fed’s decision.

 

"I will say that the Fed's mandate, my mandate, is to grow our economy. And that's not just good for the United States, that's good for the world as a whole," Obama said. "The worst thing that could happen to the world economy, not just ours, is if we end up being stuck with no growth or very limited growth."

 

European Central Bank President Jean-Claude Trichet said all participants at a meeting of the world's central bankers in Basel, Switzerland had insisted they were not pursuing weak currency policies. "We're attached to avoiding excessive volatility. It's very counterproductive for global growth and global stability," he told a news conference.

 

Then World Bank President Robert Zoellick suggested large economies consider gold as an indicator to help set exchange rates. The proposal was aimed at sparking broader debate that goes beyond talk of currency devaluation wars.

 

Washington has frequently criticized China, saying it deliberately undervalues its currency to boost exports. China says the United States, via the Fed, is engaged in the same thing that it stands accused of. Some emerging nations have already acted to curb their currencies' rise.

 

Resentment abroad stems from worry that Fed will result in falling dollar, thereby resulting in other countries’ currencies rising in value, theoretically encouraging asset bubbles combined with rising inflation.

 

"As a major reserve currency issuer, for the United States to launch a second round of quantitative easing at this time, we feel that it did not recognize its responsibility to stabilize global markets and did not think about the impact of excessive liquidity on emerging markets," Chinese Finance Vice Minister Zhu Guangyao said on Monday.

 

The Fed's quantitative easing policy was unveiled last week to jeers from emerging market powerhouses from Latin America to Asia. Russia renewed its assault on Monday.

 

"Russia's president will insist .... that such actions are taken with preliminary consultations with other members of the global economy," said Arkady Dvorkovich, a Russian official who is preparing the country's position in Seoul.

 

Fed officials on Monday sounded differing notes on the program, one arguing it was a good way to fight deflation, another warning it might need to be curbed. Sarah Palin, a prospective 2012 Republican presidential candidate, suggested the Fed "cease and desist" from the program or risk permanently higher inflation.

 

The Bank of Japan on Monday said it too was ready to boost asset-buying if it saw clear signs of a downturn. Worth 5 trillion yen ($62 billion), it is so far just a tenth the size of the Fed's.

 

Germany described U.S. economic policy as "clueless" last week.

 

The U.S. has already all but dropped its centerpiece proposal for the G20 -- a measure that would cap current account balances at 4 percent of gross domestic product, something economists said was clearly aimed at China. Over the weekend, Treasury Secretary Timothy Geithner backed away from the numerical target that had been rejected by China, Germany, Japan and others in a sign that global financial power was no longer the prerogative of the United States.

 

On Monday, Geithner said China was supportive of the G20's framework for rebalancing the global economy, and that he expected broad consensus on it at the summit.

 

The risk of a negative outcome in Seoul appears to be increasing, or at the very least, an agreement that merely papers over the huge gaps and allows countries to pursue their own economic policies.

 

Head of World Bank Proposing Gold Backed Monetary System

 

The world's largest economies should consider gold to help set foreign exchange rates, World Bank President Robert Zoellick said on Monday in a proposal that threw open the acrimonious currency debate days before a summit of G20 nations. Writing in the Financial Times, World Bank President Robert Zoellick called for a new monetary system to replace the floating rates adopted in 1971 known as Bretton Woods II.

 

In typical Zoellick style, the proposal before the G20 leaders' summit in Seoul is aimed at fueling a broader debate on currencies that goes beyond competitive devaluation wars.

 

Zoellick said the new system "is likely to need to involve the dollar, the euro, the yen, the pound and (a Chinese yuan) that moves toward internationalization and then an open capital account". "The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values," he added.

 

Zoellick did not spell out in detail how this system might work, but said it would help to rebuild the confidence of financial markets and the general public in the global monetary system after the financial crisis.

 

However, policymakers appeared cool to the idea, while many analysts said they doubted it would be implemented given practical difficulties.

 

European Central Bank President Jean-Claude Trichet said central bankers from around the world did not discuss returning to a gold standard at a meeting of the Bank for International Settlements in Switzerland on Monday.

 

"In my memory such an idea was mentioned a long time ago by Jim Baker when he was a (U.S.) Secretary of Treasury in the 1980s. I have no particular comment," Trichet told a news conference.

 

A German government official, speaking on condition of anonymity, said Zoellick was correct in worrying that currency values were becoming too vulnerable to the whims of governments.

 

"The diagnosis that Zoellick is making is correct: that monetary policy is becoming overly politicized," the official said. "The system, as it is, is not functioning well." But he added that it would not be practical to use modern monetary policy tools in a system that was "based on a commodity whose availability is dictated by natural conditions."

 

That Fed's policy of quantitative easing, or EQ2, has fed acrimony among leading economies in the Group of 20 in the run-up to their summit in Seoul on Thursday and Friday. China and Germany, major exporting nations, have both criticized the Fed's strategy -- effectively printing money -- which is weakening the dollar.

 

Investors are pumping dollars into emerging markets in search of higher yields, and the potentially destabilizing impact of this, along with big current account deficits and surpluses as well as China's reluctance to let the yuan appreciate faster, are set to dominate the G20 debate.

 

France, which takes over the G20 chair after this week's summit, says it plans to work on a new international monetary system to bring greater currency stability. French officials said Zoellick's ideas mirrored initiatives that President Nicolas Sarkozy aimed to promote during France's 12 months of chairing the G20.

 

Beijing's central bank chief has suggested an alternative monetary system based on using the International Monetary Fund's Special Drawing Rights, a notional unit of value based on a basket of major currencies, instead of the dollar as the sole global reserve currency.

 

Zoellick was a senior official in the U.S. Treasury at the time of the 1985 Plaza and 1987 Louvre Accords on rebalancing currencies among major industrialized nations. He noted that that phase of currency coordination helped launch the Uruguay Round of world trade liberalization negotiations.

 

While his opinion article in the Financial Times did not represent either U.S. or World Bank policy, it may reflect a greater openness in Washington than in the last two decades to some form of international currency cooperation.

 

Zoellick said a new monetary system would take time to develop and should be part of a package approach including possible changes in IMF rules to review capital as well as current account policies, and linking IMF monetary assessments to World Trade Organization obligations.

 

Palin to Bernanke: Cease and Desist

 

Tea Party favorite Sarah Palin on Monday weighed in on the global debate over the Federal Reserve's $600 billion plan to buy up government debt, suggesting Fed Chairman Ben Bernanke should "cease and desist."

 

"We shouldn't be playing around with inflation," Palin, who is widely seen as a prospective 2012 Republican presidential candidate, said in remarks prepared for a Monday speech in Phoenix.

 

"We don't want temporary, artificial economic growth bought at the expense of permanently higher inflation, which will erode the value of our incomes and our savings. We want a stable dollar combined with real economic reform. It's the only way we can get our economy back on the right track."

 

Excerpts of the remarks were published online by the conservative National Review magazine. Palin's staff was not immediately available for comment. The report said the remarks would be delivered in a keynote address at a trade association convention.

 

Voter outrage over Fed bailouts and other actions helped propel many Republican candidates on Election Day, including Kentucky Senator-elect Rand Paul, who has favored abolition of the agency. His father, House Republican Ron Paul, another Tea Party favorite who has run for president twice, intends to push to audit Fed monetary policy decisions next year if -- as expected -- he wins control of a congressional subcommittee that oversees the central banks.

 

Representative Paul Ryan, expected to become chairman of the House Budget Committee when Republicans take control of the chamber in January, said on Sunday the advantages of the central bank's move to inject more money into the U.S. economy "are very low."

 

"I think it's going to give us a big inflation problem down the road," Ryan said.

 

President Barack Obama and other U.S. officials defend the Fed's decision to buy $600 billion in U.S. Treasury debt as a means to stimulate the economy and maintain global stability.

 

Palin's remarks add her to a growing list of critics, including officials from China, Germany and Brazil, who are concerned that the Fed plan could bring instability instead.

 

"If it doesn't work, what do we do then? Print even more money? What's the end game here?," she asked. "All this pump priming will come at a serious price."

 

She appeared to align herself with recent criticism from German Finance Minister Wolfgang Schaeuble.

 

"The German finance minister called the Fed's proposals 'clueless.' When Germany, a country that knows a thing or two about the dangers of inflation, warns us to think again, maybe it's time for Chairman Bernanke to cease and desist," Palin said.

 

Palin has not said whether she will make a White House bid in 2012. But she has been using public appearances to build up her political and policy credentials for the job.