MarketView for November 16

 

 

Summary

 

A report by Fitch released late in the trading day with warnings over the potential impact of the euro zone's debt crisis on the global economy and the banking system sent the major equity indexes sharply lower on Wednesday. As a result there were renewed concerns over growth weighed heavily on sensitive sectors such as financials and materials. Fitch said even though the outlook on the U.S. banking industry is stable, it could worsen if the euro-zone's debt crisis is not resolved quickly.

 

About 7.4 billion changed hands on the major equity indexes, a number that was below this year's daily average of 8 billion shares.

 

Earlier, Moody's cut ratings on various German public sector banks, citing a lower likelihood of external support if it were required. As a result, fears are growing that the euro zone's crisis is moving to economies that had been considered more protected from the problems. The yield spread of 10-year French government bonds over their German equivalents widened to a euro-era high.

 

The Bank of Japan voiced concern about possible negative effects on Japan's growth from Europe's debt crisis, while England's central bank slashed its growth forecasts.

 

The concern is that euro-zone leaders will be unable to enact reforms to reduce debt and promote growth. The swings on Wall Street among the major equity markets have become increasingly tied to gyrations in European credit markets.

 

Among declining stocks, Dell missed quarterly revenue estimates and its shares fell 3.2 percent to $15.13. Rambus fell 60.6 percent to $7.11 after the company lost an antitrust trial against Micron Technology and Hynix Semiconductor. Micron shares jumped 23.4 percent to $6.74.

 

Shares of Abercrombie & Fitch were down 13.6 percent to $48.10 after the teen clothing retailer's quarterly profit missed estimates by a large margin.

 

CPI Falls

 

Consumer prices fell in October for the first time in four months, taking pressure off strapped households and giving the Federal Reserve more room to ease monetary policy if the economy falters. Yet, economic growth is gaining traction and a separate report on Wednesday indicated that industrial output rebounded strongly last month as factories ramped up production.

 

The Labor Department said consumer prices dropped 0.1 percent last month as Americans paid less for new cars and gasoline. The data reinforces the view that inflation is poised to trend lower following a spike in oil prices earlier in the year. That is seen giving the Fed more room to act if the economy slows. The drop in prices during October gave a boost to workers whose wages failed to keep up with inflation over the summer, which had led households to save less.

 

Inflation is expected to fall sharply over the next year. In the 12 months through October, consumer prices rose 3.5 percent after rising 3.9 percent in the full year through September. The expectation is that reading will fall to 1.3 percent by November of 2012, the Cleveland Federal Reserve Bank said in a report.

 

For now though, a measure of prices closely watched by the Federal Reserve remains uncomfortably high. Prices outside food and energy climbed 0.1 percent in October, pushing the so called core reading for 12-month inflation up to 2.1 percent. The Fed would like that reading to trend at 2 percent or just below.

 

A separate report by the Labor Department showed weekly earnings rose 0.3 percent in October when accounting for inflation. Stronger incomes could help consumer spending as the year closes, giving the economy a little more momentum as the country braces for a possible recession in Europe that would drag on growth.

 

A storm is gathering over the global economy as Europe struggles to contain a snowballing sovereign debt crisis. The U.S. economy has been gaining steam since the summer, but a blowup of Europe's problems could drag the U.S. back into recession.

 

A separate report from the Fed showed industrial production rose 0.7 percent last month, beating economists' expectations.

 

Home builders in the United States grew more optimistic this month but still thought sales conditions were poor, according to the National Association of Home Builders/Wells Fargo Housing Market index released on Wednesday.

 

The Fed report also showed factory output accelerated in October, rising 0.5 percent on an increase in production of motor vehicles and parts. Even with U.S. factories operating closer to full capacity than at any time since July 2008, there was little sign of inflationary pressures in the factory data.

 

FHA Running Out of Funds

 

The Federal Housing Administration's cash reserves have dropped so low that there is a close to a 50 percent chance it could run out of funds and may require a taxpayer bailout next year, the Wall Street Journal said, citing an annual independent audit of the agency's finances.

 

The audit estimated that the value of the agency's reserves were $2.6 billion as of end-September, down 45 percent from a year ago, according to the newspaper. The audit, to be released on Tuesday by the FHA, was prepared by Integrated Financial Engineering, an analytics firm, the WSJ reported.

 

The FHA, which provides mortgage insurance for millions of homeowners, has not run out of money and has not needed any Treasury funds partly because it has repeatedly increased homeowners' insurance premiums to raise cash and enforced tighter risk controls, the newspaper said.

 

"Even in the tough economic environment, we have been successful in protecting the (insurance) fund. We still clearly see there are downside economic risks that we have to be vigilant about," Carol Galante, acting commissioner of the FHA, told the Journal.

 

All Is Not Peaceful

 

France and Germany, Europe's two central powers, clashed on Wednesday over whether the European Central Bank should intervene more forcefully to halt the euro zone's accelerating debt crisis after modest bond purchases failed to calm markets. Bond market turmoil is spreading across Europe. Italian 10-year bond yields have risen above 7 percent, unaffordable in the long term. Yields on bonds issued by France, the Netherlands and Austria -- which along with Germany form the core of the euro zone -- have also climbed.

 

Facing rising borrowing costs as its 'AAA' credit rating comes under threat, France appeared to plead for stronger ECB action.

 

"The ECB's role is to ensure the stability of the euro, but also the financial stability of Europe. We trust that the ECB will take the necessary measures to ensure financial stability in Europe," government spokeswoman Valerie Pecresse said after a cabinet meeting in Paris.

 

Pecresse said Paris believed the risk premium investors are demanding to hold French debt rather than 'safe-haven' 10-year German Bunds "is not justified". That premium, or spread, hit a euro-era peak of 195 basis points on Wednesday.

 

But German Chancellor Angela Merkel made clear Berlin would resist pressure for the central bank to take a bigger role in resolving the debt crisis, saying European Union rules prohibited such action.

 

"The way we see the treaties, the ECB doesn't have the possibility of solving these problems," she said. The only way to recover markets' confidence was to implement agreed economic reforms and build a closer European political union by changing the EU treaty, Merkel said.

 

ECB policymakers continue to reject international calls to intervene decisively as Europe's lender of last resort, stressing that it is up to governments to resolve the debt crisis through austerity measures and reforms.

 

Mario Monti was sworn in as Italy's new prime minister, his main task being to push through unpopular reforms designed to placate financial markets that have driven Italy's borrowing costs to untenable levels. His government of 16 experts features several academics and Intesa bank Chief Executive Corrado Passera. Monti, a respected economics professor and former EU commissioner, kept the key economy portfolio for himself in a drive to implement long-delayed structural reforms and austerity measures.

 

"All this will, I trust, translate into a calming of that part of the market difficulty that concerns our country," said Monti, who unveils his austerity program on Thursday.

 

European Commission President Jose Manuel Barroso told the European Parliament the euro zone faced a systemic crisis and fragmenting the European Union was no solution.

 

In Greece, technocrat prime minister Lucas Papademos, a former ECB vice-president, won a confidence vote in parliament for his interim government despite the refusal of the main conservative leader to sign up to more austerity.

 

New Democracy party chief Antonis Samaras refused to bow to EU demands for a written commitment to the bailout program and called for elections in three months to restore social peace.

 

New data showed that Greece's austerity-fueled recession had widened the budget deficit in October, the government failing to boost revenues despite unpopular new taxes.

 

With Papademos's national unity coalition already split, rebuilding Greece's shattered finances to avert default will be a daunting task as Europe battles to prevent its debt woes from engulfing the entire currency bloc and hurting global growth.

 

And there are growing signs of strain in the money market, the plumbing of the international financial system.

 

Banks in the euro zone are finding it harder to obtain dollar funding. While the stresses are nowhere the levels of the 2008 financial crisis, they have continued to mount despite ECB moves to provide unlimited liquidity to banks.

 

With a Brussels think-tank warning that France's economy should be "ringing alarm bells", Finance Minister Francois Baroin sought to calm fears about French finances.

 

"We are expecting a slowdown, but not a recession," Baroin told the LCI news channel. "We are doing everything to maintain our credit rating, to borrow more cheaply."

 

Data on Tuesday showed the economy of the 17-nation euro zone barely grew in the third quarter. ECB President Mario Draghi has said the bloc will be in a mild recession by the end of the year.

 

Many analysts believe the only way to stem the contagion for now is for the ECB to carry out the sort of quantitative easing undertaken by the U.S. and British central banks.

 

The ECB has bought 187 billion euros in government bonds since May 2010 but it has so far "sterilized" all purchases by taking the equivalent amount in from the market in deposits. One option would be to stop fully sterilizing bond purchases. This has been anathema in Germany, which fears that printing money could stoke inflation.

 

Budget Talks Remain Stalled

 

Budget talks in Congress remain stalemated on Wednesday as Democrats and Republicans waited for the other side to make a new offer on taxes and healthcare. With a deadline less than a week away, members of a 12-member "super committee" tasked with finding $1.2 trillion in budget savings confronted the same barriers that have thwarted earlier efforts to rein in the growing national debt, which crossed the $15 trillion mark on Tuesday.

 

Republicans, who have moved away from their staunch opposition to tax increases, said they would not give any more ground until Democrats consider reforms that would partially privatize the Medicare health-insurance program for retirees.

 

Democrats have proposed raising the Medicare eligibility age from 65 to 67 but have shied away from sweeping reforms. They proposed a $1 trillion tax increase last week.

 

"We are not going to accept a plan that gives tax breaks to the wealthiest Americans and balances all this incredible challenge we have on the backs of middle-class Americans," said Senator Patty Murray, the top Democrat on the committee.

 

Despite the posturing, negotiations continued behind the scenes. Democrats might reconvene later in the day after staffers assess a few options, Democratic Representative Xavier Becerra said. He would not say whether Democrats planned to float a new offer.

 

As negotiators grappled, some 50 lawmakers from both parties urged them to shoot for a much bigger deal that would come closer to the $4 trillion in savings that outside experts say is needed to keep U.S. debt at a manageable level.

 

Interest groups like Americans for Tax Reform and the seniors' group AARP have mobilized to protect their turf, while the healthcare and defense industries are lobbying furiously to minimize the impact of any cuts.

 

One group came to Capitol Hill to say it was willing to sacrifice. About two dozen wealthy individuals, including several former officials at Google, testified at a hearing and told reporters they were willing to pay more income taxes.

 

"Our country has been good to us. It provided a foundation through which we could succeed. Now, we want to do our part to keep that foundation strong so that others can succeed as we have," the Patriotic Millionaires for Fiscal Strength wrote in a letter signed by 138 group members to President Barack Obama and congressional leaders.

 

The super committee faces a deadline of November 23, but any deal will have to be hammered out a few days before then to give budget analysts time to crunch the numbers. Negotiations are expected to go through the weekend.

 

Failure to reach a deal would trigger $1.2 trillion in automatic spending cuts that would fall equally on military and domestic programs. Republicans appear to be more alarmed by that prospect than Democrats, and some have proposed shifting the balance to ease the blow to the Pentagon.

 

Republicans also worry that Obama could allow taxes on the wealthy to rise at the end of 2012 if they don't agree to a permanent overhaul of the tax code by then.

 

Congress has until December 23 to approve any deal that emerges from the super committee. Failure to so could further anger a public that has been rattled by repeated budget showdowns this year, and prompt investors to question whether Washington has the willpower to make tough fiscal choices at a time when sovereign debt burdens in Greece, Italy and other countries are rattling world financial markets.

 

It could also make it harder for Congress to sign off on a number of expiring provisions, such as a payroll tax cut and enhanced jobless benefits that could slow economic growth if they are allowed to lapse.