The equity markets rebounded this week as strong earnings and economic data convinced investors that equities were a robust place to invest. Despite the shadow of the SEC charge against Goldman Sachs and the trepidation in Europe, the S&P 500 index was able to notch up a 25-point rally. The index closed the week at 1217 up 2.1%.
Is Europe Out of the Woods?
Greece is on the verge of delivering some calm to markets that have been on a bumpy ride during the past 3 months. On Friday, PM Panpadremos formerly announced that it is seeking to activate the Eur45 billion-aid package. In televised comments, Panpadremos said, “the time has come” for Greece to request aid. “It is a necessity. It is a national and pressing necessity for us to officially request from our partners the activation of the support mechanism.” On Thursday, Eurostat said that Greece’s deficit last year is at least 13.6% and not the 12.9% the government estimated on April 9. The deficit may be 0.3-0.5% higher if the over the counter swaps, classification of some public entities, and social security funds are added. Eurostat also noted that the Irish deficit was 14.3%, giving it the honor of the largest deficit in the euro zone. Additionally, Moody’s downgraded the debt of Greece by notch to A3. Moody’s kept Greek debt rating on negative watch.
There are a number of issues that Europe still faces, and activating a backstop is just the first. Whether the size of the facility is sufficient to cover this year, and part of next year’s debt, is a question that will only be answered with time. There is a good chance that Greece may still try to raise funds when market conditions allow for it. Greece will probably need a multi-year program and European officials seem to have ignored this reality. Additionally, officials seem to be stuck in a reactive mode and have not been able to get ahead of the curve. Specifically, as recently as Thursday, IMF head Strauss-Kahn ruled out a preemptive package for Portugal and/or Spain, arguing there was no need. The thought that a contagion could develop is not even on the minds of the IMF or ECB. Another issue, which is not being addressed, is the issue of competitiveness in the periphery of Europe. The focus is largely on Greece’s ability to service its debt. One of the consequences of the fiscal austerity that is being mandated is that it will keep aggregate demand suppressed and could then still produce a widening of the output gap in Europe. An example is reflected in Germany. On Thursday, Germany’s flash manufacturing PMI rose to an all-time high of 61.3, while services edged fractionally higher. On Friday, German released a stronger than expected IFO survey. The business climate reading came in at 101.6 (98.2 last), the highest since May 2008. The assessment of current conditions and expectations also rose. This reinforces ideas that domestic demand remains weak but exports, as traditionally the case, are leading the economy. As Germany has become more competitive as export nations, Greece has suffered in its shadow.
Despite apparent approval of an aid package, Greek yields moved higher even on Friday. Greek 2-year yields had fallen below 10% on the aid news, but finished the trading week at 10.23% Ominously, Portugal 2-year is doing worse, with its yield up losing 10 basis points on Friday, closing the week at 2.94%.
The Data does not help Labour
The UK is the first G7 country to report preliminary first GDP figures. The numbers were rather disappointing. The consensus expected a 0.4% expansion and instead ONS said the economy expanded half as much. The 0.2% rise was also half the pace reported in the fourth quarter 009. Because of the base effect, the year-over-year retraction eased to -0.3% from -3.1% in fourth quarter 09. The economic trough was hit in the second quarter at almost -6.0%. The preliminary report indicated that services expanded 0.2%, while industry expanded by 0.7%. During the week, the UK reported higher than expected inflation, which forces BOE Governor King to write another letter to Darling to explain the overshoot. The headline CPI rose 0.6%, twice what the consensus had expected. The year-over-year rate rose to 3.4% from 3.0%. The consensus had expected a 3.1% increase. Some questions have been raised over whether the BOE’s assessment of inflation is really just a transitory issue. Although energy was a strong component of the increase in the headline CPI, prices for fuel have not declined, which can create a problem for the central bank. Although unemployment claims shrank by 33 thousand, which can be spun in a positive light, Labour is facing lower than expected growth and higher than expected inflation at a time when the budget deficit and government spending are the core focus of the upcoming election.
Petroleum’s Bearish Fundamental Could Be Overlooked
The opening of numerous Airports in Europe during the week, after volcanic ash kept them closed for more than 5 days, counteracted the relatively bearish inventory report. Crude oil was able to rally $2.17 per barrel during the week. According to the Department of Energy, U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 1.9 million barrels from the previous week. At 355.9 million barrels, U.S. crude oil inventories are above the upper limit of the average range for this time of year. Total motor gasoline inventories increased by 3.6 million barrels last week, and are above the upper limit of the average range. Distillate fuel inventories increased by 2.1 million barrels, and are above the upper boundary of the average range for this time of year. As the US moves into driving season, which is usually the time of year, that demand for gasoline and diesel increases, supplies have continued to increased at a time when inventory is increasing. Not only is the trajectory of supplied continuing to increase, but the days supply (the amount of gasoline held in inventory that can be used without producing any new gasoline) of gasoline stocks have increased relative to last year. Petroleum has been trading in a highly correlated fashion with the dollar and the US equity markets. Any down turn in equities (or an upturn in the dollar) could be detrimental for the oil markets.
Is Inflation Hitting the US?
The US Producer Price Index for finished goods rose 0.7% in March. This was greater than expected and shows that input costs are rising at a faster pace than the Federal Reserve might want. An example of increasing intermediate prices is the skyrocketing cost of rubber, a major tire component, which has climbed nearly 74% this year after rising 92% in 2009. Another rapidly rising raw materials Palladium, which goes into car exhaust systems, is up nearly 39% this year, potentially boosting costs for U.S. carmakers as they try to recover from the recession. Lumber, a major cost for homebuilders, is up nearly 59%. This could hurt the underlying profits for homebuilders. Iron-ore prices also are rising, while oil and copper prices have tacked on to last year’s huge gains. Data on producer prices released by the Bureau of Labor Statistics on Thursday shows how rapidly the pressure on corporate America is mounting. The producer-price index showed that crude goods such as iron ore, construction sand and pulp shot up 44.5% year-over-year the fastest rate since 1974. Including energy and food costs, crude goods prices rose 33.4%. So far, input prices at the producer level have not spilled over into the consumer sectors. Consumer prices were up only 2.3% in March on a year over year basis. At the core level, CPI was flat and flat for the first quarter. Although the producer prices at face value are somewhat alarming, until they filter their way into the CPI, PPI will take a back seat.
Japanese Debt
The same day that Moody’s cut Greece’s sovereign rating to A3 from A2, Fitch warned that Japan’s credit rating was threatened by its mounting debt. Yet, ironically, the latter may be a source of funds for the former. Although Greece will be drawing on the European/IMF funds, it may also seek to raise funds from the market, when conditions permit. The Japanese government is actively engaged in deepening the samurai bond market. Samurai bonds are yen-denominated bonds issued by non-Japanese corporate or sovereign entities. The state-backed Japan Bank for International Cooperation (JBIC) is providing guarantees to support the sale of samurai bonds by a wide range of developing countries, from Mexico to Vietnam, from Turkey to Uruguay. The specific purpose of JBIC is to boost the usage of the yen as an international currency. With JBIC guarantees, these samurai bonds take on partial function of Japanese government credit worthiness.
This weekend’s G7/G20/IMF/EU meeting will supply the markets with interesting fodder for trading. On Tuesday, US Consumer Confidence will headline the economic releases. Since confidence and retail sales have opposed each other (confidence continuing to come in weaker), this number will be watched carefully. Wednesday, the FOMC will make their interest rate decision. No change is expected. On Thursday, EMU consumer confidence and US Jobless claims will be watched carefully. On Friday, the BOJ will release its interest rate decision. This will be followed later in the day, by US GDP and the Chicago PMI.
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