MarketView for October 21

 

 

Summary 

 

Although share prices moved a bit higher on Thursday, it was by any standard a volatile session as strong corporate earnings and a rise in the dollar took center stage. As a result, there was a wide gyration in share prices as the Street reacted to both the currency markets and some strong earnings numbers. However, as the closing bell approached, it was the fundamentals that held the high ground. Helping to drive the Dow Jones industrial average higher were McDonald’s and Travelers, both of which reached their 52-week highs.

 

McDonald's gained 1.3 percent to $78.44 after it beat expectations for quarterly profit and same-store sales growth in September. Travelers gained 0.6 percent to $54.98 after the largest publicly traded U.S. property casualty insurer easily beat estimates as premiums rose in its personal insurance lines.

 

Investors have been trading the dollar and equities against each other recently as expectations the Federal Reserve will pump billions into the economy have pressured the dollar, while lifting stocks. Commodity-linked stocks have been among the most sensitive to the trade. Occidental Petroleum fell 2.7 percent to $78.80 as the price of crude oil fell more than 2 percent to under $81 per barrel.

 

The euro and the popularly traded S&P E-mini futures contract have tracked each other closely in the last month. In the past 22 sessions, they have had a positive correlation coefficient of 0.89. The euro had earlier climbed to a high around $1.4050 but later was trading down 0.3 percent to $1.3920.

 

Banking stocks were weak as investors continued to wrestle with confusion in the mortgage market and the chance Bank of America might have to buy back mortgages bonds. BAC closed out the day down 3.3 percent to $11.36 and has lost nearly 16 percent over the last 7 days.

 

The independent Conference Board's Leading Economic Index rose 0.3 percent last month after a 0.1 percent gain in August. The rise was in line with market expectations. Also the Philadelphia Federal Reserve Bank's business activity index rose to 1.0 in October from minus 0.7 in September. That was less than economists' expectations for a gain to 2.0. A reading above zero indicates expansion in the region's manufacturing.

 

Stocks rose nearly 1 percent in early trading but the gains were trimmed by the afternoon as the dollar gained ground. The dollar was up 0.4 percent against major currencies, while the euro fell 0.3 percent.

 

EBay closed up 6 percent to $27.19 and Netflix rose12.8 percent to $172.69 after both reported upbeat results late Wednesday. Home Depot saw its shares pick up 3.5 percent to $31.81.

 

Unemployment Falls

 

According to a report released by the Labor Department Thursday morning, new claims for jobless benefits posted a number that was lower than expected last week, but not enough to suggest much improvement in the distressed labor market. Initial claims for state unemployment benefits fell 23,000 to a seasonally adjusted level of 452,000 claims.

 

However, the Labor Department pointed out that they still remained above levels usually associated with a strong job market recovery. Nonetheless, the decline still managed to unwind much of the increase from the prior week that took claims to a revised 475,000. Nonetheless, the unemployment rate still remains at an unacceptable 9.6 percent.

 

Last week, the four-week average of new jobless claims, considered a better measure of underlying labor market trends, fell 4,250 to 458,000. Claims for jobless benefits have moved sideways for much of this year and continue to hold below a nine-month high touched in mid-August.

 

The number of people still receiving benefits after an initial week of aid dropped 9,000 to 4.44 million in the week ended October 9, the lowest level since the week ending June 26, from an upwardly revised 4.45 million the prior week. The number of people on emergency benefits increased 152,112 to 4.04 million in the week ended October 2.

 

Fannie and Freddie Possibly Looking For Additional Capital

 

Fannie Mae and Freddie Mac may need as much as $215 billion in additional capital from the Treasury through 2013 to offset losses and maintain a positive net worth, their federal regulator said on Thursday.

 

Fannie Mae and Freddie Mac, whose programs fund the lion's share of all new home loans, are at the center of debate as Congress sets to overhaul a U.S. mortgage finance system that contributed to the worst housing crisis since the 1930s.

 

The cumulative capital needs of the two housing finance giants, which were seized by the government in late 2008, will likely fall between $221 billion and $363 billion through 2013, the Federal Housing Finance Agency estimated.

 

The projected amounts vary depending on changes in home prices, which in recent years have been the major driver of credit losses for the companies, FHFA said, adding that its exercise is meant to give policymakers "useful snapshots" of the potential need for future taxpayer support.

 

The FHFA's lower projection assumes home prices bottomed in the first quarter of 2009, and will rise by 5 percent through 2013. The "current baseline" scenario of Moody's Investors Service depicts more, but smaller house price declines, while a worse outcome reflects a deeper recession because of restricted access to credit and high unemployment, FHFA said.

 

The companies have drawn $148 billion in the form of preferred stock purchases by the Treasury through the second quarter of 2010.

 

Dividend payments on the preferred stock are making up larger portions of the capital needs as time passes, the FHFA said. Of the $73 billion to $215 billion in additional capital that may be needed, $67 billion to $91 billion represent dividend payments to the Treasury, it said.

 

Treasury Gambit Not Well Received

 

G20 officials are unlikely to reach an accord rejecting currency devaluations and capping current account balances, an informed source said on Thursday, after U.S. proposals ran into stiff opposition. The swift rebuff of a U.S. call for numerical targets for "sustainable" trade surpluses and deficits underscored the difficulties facing Group of 20 finance ministers gathering in Gyeongju, South Korea as they try to defuse tensions over currencies and economic imbalances.

 

Apparently the proposals did not find favor with India, China and other emerging economies, or even the likes of Germany, which has a large current account surplus. In an interview with the Wall Street Journal, Treasury Secretary Timothy Geithner called for an agreement on exchange rate policy "norms".

 

"Right now, there is no established sense of what's fair," said. "We would like countries to move toward a set of norms on exchange rate policy."

 

Washington is also floating the idea of specific targets for current account balances. This would build on a G20 pledge a year ago to tilt growth away from exports in fast-growing surplus countries, such as China, and to boost savings in rich deficit economies, including the United States.

 

"We are exploring whether we can agree to commit to keep the external imbalances to levels that are more sustainable," Geithner said.

 

However, the drafting of a communiqué would only begin late on Friday after a first round of meetings between finance ministers and central bank governors in Gyeongju.

 

French Economy Minister Christine Lagarde said coordination on currency policy was lacking and that Asia had a vital role to play. "We can see there are imbalances that coordination is at times lacking on policy," she said in Paris.

 

Washington is proposing that countries should aim to limit their surplus or deficit on the current account -- the broadest measure of trade in goods and services -- to 4 percent of gross domestic product. However, But German Economy Minister Rainer Bruederle said he was opposed to numerical goals. "Macroeconomic fine-tuning and quantitative targets are not the right approach in our view," Bruederle said.

 

Russian deputy finance minister Dimitry Pankin was also skeptical about the U.S. initiative.

 

"The United States will try to put the question of exchange rates and current account balances at the top of the agenda, to try to press China to make some commitments on this issue. In my view it is unlikely that they will succeed," Pankin said. "Most likely, there will be some general words, along the lines of 'let's all live in peace'. I do not expect much success in this sphere," he said.

 

An Indian finance ministry official gave equally short shrift to Geithner's idea of numerical goals, stating that the issue has to be looked at more fundamentally. By artificially linking current account deficit levels to the GDP you are merely skimming the surface.

Pankin criticized Washington for piling pressure on emerging markets to lead a rebalancing when it was loose U.S. policy settings that were sending capital pouring into developing economies, generating pressure for their exchange rates to rise.

 

"We think that such policies will not come to any good," he said. Things would not turn out well unless the United States cut its budget deficit and tightened monetary policy, he added.

 

His forthright remarks contrasted with the emollient note on exchange rates struck by Geithner, who hopes that, by preaching currency cooperation, he can coax China into allowing the value of the yuan to rise more quickly.

 

Major currencies were "roughly in alignment now", Geithner told the Wall Street Journal.

 

The Treasury chief repeated his view that the yuan, also known as the renminbi, was significantly undervalued. But he said that would be corrected over time if the brisker pace of appreciation witnessed since September were sustained.

 

"If China knew that if it moved more rapidly, other emerging markets would move with them, it would be easier for them to move," Geithner said.

 

Countries from Brazil to G20 host South Korea are loath to allow their exchange rates to rise for fear of losing competitiveness to China. For its part, Beijing is adamant that the yuan's rate of climb must be gradual.

 

"If the renminbi exchange rate is not stable, companies will not be stable, employment will not be stable and society will not be stable," the People's Daily, the mouthpiece of the ruling Communist Party, said in an editorial on Thursday.

 

The task for finance ministers and central bank governors, at a two-day meeting starting on Friday, is to paper over such tensions so they do not mar a G20 summit next month in Seoul.

 

Bullard Could Back Easing in Steps

 

St. Louis Federal Reserve President James Bullard said on Thursday he would favor Fed purchases of Treasury securities in $100 billion increments one Fed meeting at a time if the Fed. decides monetary easing is necessary.

 

"If we do decide to go ahead with quantitative easing ... we could think in units of about $100 billion," he said. "And then I think we could give forward guidance for the next meeting that would suggest how likely the committee thinks it is to continue these purchases,"

 

Bullard's comments add to those of other Fed officials whose remarks suggest the Fed is on the cusp of pumping more money into the economy to support a flagging recovery.

 

The Fed cut interest rates to near zero and bought $1.7 trillion of longer-term securities to pull the economy out of recession, but with an anemic recovery and persistently high unemployment, policymakers are expected to step in with another round of stimulus.

 

Fed Chairman Ben Bernanke said last week that a prolonged period of high unemployment could choke off the U.S. recovery and that the low level of inflation presented an uncomfortable risk of deflation, a dangerous downward slide in prices. Such circumstances would seem to meet the threshold for further Fed action, he said.

 

On Tuesday, Atlanta Fed President Dennis Lockhart said any additional Fed securities purchases would have to be large enough to have an impact and that increments of about $100 billion would be roughly on target.

 

Bullard, a voter on the Fed's policy-setting panel this year, said the decision on further easing is "a tough call," but acknowledged that sluggish economic growth and a grim jobs market are little improved in recent months.

 

"We've only got this weak data, weak job growth, and so we're not that different from the position we were in during the summer," he said.

 

Bullard further said he does not think the Fed should set a ceiling on how much further easing it is willing to provide.

 

"You just leave it open-ended," he said. "People would impute what they think the Fed's going to do based on their own forecasts... We would do the best we can to communicate how we think the program is evolving."

 

The Fed has considered measures beyond securities purchases to bolster the recovery, including setting goals for higher inflation than it prefers on a temporary basis.

 

But Bullard, who is at the center of a continuum among policymakers between those who would contain inflation at all costs and those who emphasize full employment, said the time is not ripe for such an approach, known as price-level targeting.

 

"It would be too large of a step at this juncture ... but I would retain an open mind as a step we could take in the future if we felt our existing policies weren't producing satisfactory results," he said.