MarketView for October 19

 

 

Summary

 

A knee jerk reaction to news reports underscoring the well known secret that Europe remains far from a solution to its debt crisis sent the markets tumbling during the last two hours of the trading day on Wednesday. It was a repeat of a now-familiar pattern, traders capitalized on headlines emerging late in the trading day, this time to push the market lower. With long-term investors largely on the sideline due to Europe's uncertainty, the market remains susceptible to swift swings.

 

France's President Nicholas Sarkozy said on Wednesday that talks to tackle the euro zone crisis were stuck as they struggled to increase the bailout fund's firepower, while a Wall Street Journal report said Europe's bailout fund could be used to provide collateral to back up bond issues by troubled countries. For details, see

 

At the same time, a weak economic outlook from the Federal Reserve in its Beige Book was responsible for the initial move lower on Wednesday afternoon. The economy continued to expand in September, but the pace of growth was modest, with the business outlook weak or uncertain, the Fed said in its Beige Book report. This added to the day's bearish sentiment.

 

Technology stocks were also hurt after a rare earnings miss from tech heavyweight Apple. Apple saw its share price close south of $400 after the company's revenue and profits came in below estimates for the first time in years on Tuesday as it sold far fewer iPhone 4 models than had been expected.

 

The CBOE Volatility Index, the VIX, Wall Street's so-called fear gauge, chalked up a gain of 10.1 percent to 34.76, reflecting market jitters ahead of a summit of European Union leaders Sunday. Investors hope the meeting will produce a concrete plan to handle the region's debt crisis.

 

On the upside, Intel hit a new 52-week high of $24.50 earlier after the chipmaker forecast quarterly revenue above expectations. The company’s shares closed up 3.6 percent at $24.24.

 

Travelers rose 5.7 percent to $54.39 after it said it will ramp up a share buyback dramatically.

 

Earlier, economic data showed U.S. consumer prices outside food and energy rose at their slowest pace in six months while groundbreaking on new homes rose at the fastest rate in 1-1/2 years. Stocks barely budged after the data.

 

Trading volume was at 7.8 billion shares on the three major equity exchanges, a number that was lower than the year's daily average so far of about 8 billion shares. 

 

Nonetheless, the day’s economic reports indicate that the Federal Reserve has some wiggle room for further monetary policy easing, should the economic recovery falter, even though the year-on-year change in core inflation has already reached 2 percent. The Fed keeps a close eye on core inflation as it tries to guide the overall inflation to 2 percent or a little under. The 12-month change in overall inflation hit 3.9 percent, the highest since September 2008.

 

The Fed is looking for more ways to raise growth and lower an unemployment rate that has stubbornly remained above 9 percent. It has already cut overnight lending rates to near zero and pumped $2.3 trillion into the economy. For now, the pressure for monetary stimulus has lessened amid signs the economy fared much better in the third quarter.

 

Crude Futures Down

 

Crude oil futures fell more than 2 percent on Wednesday, with an afternoon sell-off driven by concern that European leaders could fail to contain a worsening euro zone debt crisis. The macroeconomic concerns outweighed a bullish government report that crude stocks fell by 4.7 million barrels last week, as imports dipped to a 10-month low and refineries cut processing rates. Although the Energy Information Administration data gave oil a brief early boost, but then prices tumbled on concerns about Europe, after Moody's downgraded Spain's sovereign rating.

 

Investors were wary of oil and other risk assets as European leaders prepared for a summit on Sunday in Brussels to discuss rescuing Greece from a debt crisis, strengthening banks and safeguarding Europe's largest economies.

 

In London, ICE Brent crude for December delivery settled at $108.39 a barrel, falling $2.76 or 2.5 percent as it slid from an early high of $111.85. The U.S. crude contract for November delivery which expires on Thursday, settled at $86.11, dropping $2.23, or 2.52 percent, well below the session high of $89.51, the highest in four weeks. Brent crude's premium against the U.S. December contract narrowed to $22.10 at the close, from $22.62 on Tuesday, having fallen continuously since a record $28.10 was struck on October 19.

 

Brent crude is still up about 6 percent this month, on target to post its strongest performance since February, helped by tightness in supply in the North Sea, and for oil products. Brent has come under pressure as Libya ramps up oil production with an interim government beginning to take hold after months of fighting against Muammar Gaddafi's forces. Secretary of State Hillary Clinton hailed "Libya's victory" during a visit to Tripoli, even as fighters loyal to Muammar Gaddafi were still holding out in his home town.

 

In a report, JPMorgan analysts said on Wednesday that Libya's oil output was recovering at a faster rate than conservative estimates had forecast.

 

In New York, heating oil's premium against RBOB gasoline shot up to a post-recession high of above $13 as the latest data showed a larger-than-expected draw of 4.3 million barrels last week. It sparked trades of long heating oil, short gasoline, called by some traders as "The Widowmaker" for its seasonal volatility.

 

Gasoline inventories fell by 3.3 million barrels last week, but four-week average gasoline demand was still down 1.5 percent from year-ago levels, according to the U.S. Energy Information Administration. 

 

Inflation Benign

 

The Labor Department reported Wednesday morning that its core consumer price index (outside of food and energy prices) rose at its slowest pace in six months during the month of  September as the cost of apparel and used vehicles fell, suggesting inflation pressures remained contained. According to the Department the core CPI edged up a minimal 0.1 percent, also held back by flat prices for new cars and a modest rise in rental-related costs.

 

Prices for used cars and trucks fell 0.6 percent after months of gains. Apparel prices dropped 1.1 percent, the largest decline since September 1998.

 

Shelter costs edged up 0.1 percent, the smallest rise since April, as owners' equivalent rent edged up 0.1 percent after rising 0.2 percent in August. The Bureau of Labor Statistics uses owners’ equivalent rent to measure the amount homeowners would pay to rent or would earn from renting their property.

 

Core consumer prices were also restrained by new motor vehicle costs, which were unchanged for a third straight month. This likely reflects a normalization in supplies after the March earthquake in Japan disrupted production.

 

Overall consumer prices increased 0.3 percent last month, after advancing 0.4 percent in August. A 2.9 percent increase in the price of gasoline pushed the overall consumer price index higher last month. Gasoline was up 1.9 percent in August, while food prices chalked up a gain of 0.4 percent after increasing 0.5 percent in August.

 

The moderate rise in consumer prices offered assurance that inflation pressures remained in check despite a sharp rise in wholesale prices last month.

 

Housing Starts Rise

 

Another report from the Commerce Department on Wednesday indicated that groundbreaking on new homes rose at the fastest rate in 1-1/2 years, though most of the gains came from the often volatile multi-family construction. According to the Department housing starts increased 15.0 percent to a seasonally-adjusted annual rate of 658,000 units. However, almost all the gains were in the volatile multifamily segment.

 

Housing starts for buildings with two or more units rose 51.3 percent to a 233,000-unit rate. Single-family home construction -- which accounts for a larger share of the market -- increased 1.7 percent to a 425,000-unit pace.

 

Total starts in August were revised slightly higher to a 572,000 unit pace, which was previously reported as 571,000. Nonetheless, housing starts are still well below their peak seen during the housing boom, although compared to September of last year, starts were up 10.2 percent.

 

An overhang of previously owned homes on the market has left builders with little appetite to break ground on new projects and is frustrating the economy's recovery from the 2008-09 recession.

 

New building permits fell 5.0 percent to a 594,000-unit pace last month. Economists had expected overall building permits in September to fall to a 610,000-unit pace. Permits were held back by a 14.5 percent fall for buildings with two units and more. Permits to build single-family homes dropped 0.2 percent.

 

New home completions rose 2.1 percent to a 647,000-unit pace in September.

 

However, the housing sector remains far from recovery and another report showed applications for U.S. home mortgages fell 14.9 percent last week as demand for both refinancing and purchases fizzled.

 

Rosengren Says We Still Have a Ways to Go

 

European financial firms' recent struggles underscore the need for regulators to push for a more resilient financial system, Boston Fed President Eric Rosengren said on Wednesday.

 

Rosengren said he was "very supportive" of efforts made by regulators and lawmakers to address the lessons from the 2007-2009 crisis, but added they could be "strengthened and improved."

 

"It is critical that we focus on strengthening the financial architecture, so that the struggles of one institution or group of them no longer poses risks to the broader global economy," Rosengren told a conference at the regional central bank.

 

Three years after Lehman Brothers' collapse, and even before the rules written in response to the 2007-2009 crisis could be fully implemented, Europe's sovereign debt crisis has prompted another round of financial shocks. The shocks are again being transmitted by big financial intermediaries, Rosengren noted, and the world economy has slowed.

 

"Once again, governments have started to intervene to mitigate global banking problems, which in turn may stress the debt burden of those governments," he said.

 

"Some significant challenges remain to be addressed if we are to have a global banking system where no bank is too big to fail given the collateral damage its disorderly demise would cause to economies and citizens."

 

Inflation Hawk Says No Inflation

 

Inflation is not a cause for concern in the short term and the economy should grow much faster next year, if negative shocks do not materialize, Charles Plosser, President of the Philadelphia Fed and one of the Federal Reserve's most ardent anti-inflation hawks was quoted as saying on Wednesday.

 

"I have no worries about inflation in the near future," Plosser said in an interview with German daily Handelsblatt. "I think our economy will return to growth of 2.5-3 percent in 2012, he said."

 

However, he also said the Fed must maintain its credibility in guarding against high inflation. "The Fed has a good reputation in controlling inflation, and we must ensure that we maintain that reputation," he told Handelsblatt.

 

While the Fed's bond purchases had increased liquidity in the banking system, they did not pose an inflation risk yet, he said, but warned that that might change.

 

"When the business cycle improves and the reserves flow in the economy, then that is fuel for inflation. As long as we can control that, and as long as the public believes that we can control that, it will not cause inflation, also in the future."

 

Plosser apparently expressed frustration that the central bank's monetary easing had not helped the economy more, and said that might be due to them not having the right instruments available.

 

"We must not only understand what monetary policy can do, but as well what it cannot do," Plosser said. He also said that monetary policy cannot substitute for fiscal policy and urged the government to reduce uncertainty by getting a grip on budget discipline.