Wednesday, September 22, 2010

Morning Note...

Futures ~15bps lower this morning as European industrial orders data disappoints and U.S. Treasuries are bid higher (perhaps hurting equities) as the markets digest yesterday’s FOMC rate decision and language.  In brief, the Fed seems to have acknowledged that low inflation and sluggish growth may spur renewed quantitative easing sooner than later, which would surely represent a further expansion of it’s $2.3T balance sheet.  Thus the USD is 70bps lower, Gold has surged 1.7% to nearly $1300/oz, Silver has soared to a two-year high, and Oil is up 80bps to ~$75.50/barrel.  Europe is down ~1% on average on the aforementioned economic data, and Portugal’s debt auction was not as successful as that of Spain, Greece, and Ireland yesterday, thus credit default swaps have widened slightly.  Elsewhere, Canadian retail sales for July were lower-than-expected.  Asia was mixed overnight.  In corporate news, General Mills (GIS) is slightly higher after reporting better-than-expected earnings, Carmax (KMX)is also higher on earnings, but Adobe (ADBE) is down nearly 20% on weak guidance and several Street downgrades.  Microsoft also said it will raise its dividend and authorized a debt sale.  According to Moody’s, “the number of U.S. companies at greatest risk of default dropped to the lowest level in two years as the Fed’s effort bolster the economy.”  According to a Bloomberg poll, “Over three-quarters of U.S. investors say President Obama is too anti-business, while 53% outside the U.S. say he offers about the right balance.”  On that topic, news broke late yesterday that Larry Summers will be leaving the Obama Administration after mid-term elections.  (Geithner next?)

Regarding the Fed and the 10-year action, here’s a decent trading summary from Barclay’s:


When FOMC failed to announce additional QE programs, 10Y yield rallied as expected and risk turned better bid.  Then, to mkt’s surprise, 10Y turned MUCH better bid, sending yields thru 2.60% to downside in a straight line, causing equities to trade lower and global risk-assets to trade mixed across the board.

A few reasons for strong bid in Tsys despite lack of QE2:

1.      Our rates desk blv’s the majority of dealers were net short the 10Y going into FOMC, as none expected further QE to be annc’d.  On knee-jerk sell-off in 10Y post-FOMC, saw many rush in to cover shorts.  Moreover, as long as longer-term macro pic remains vague, there will be a fundamental bid for safe-haven tsys (buy-the-dip mentality).

2.      Slight alteration in Fed language suggested slightly more dovish stance, and that further QE remains a possibility.  Bcap strategists summarize language as having moved from “We will act if things get worse” to “We will act IF THINGS DON’T GET BETTER.”

3.      Statement suggested that further policy easing would be tied to inflation as opposed to employment data.  In other words, the statement implies that the structural issues of employment are becoming much too complex for monetary policy to address.

Cause for Mkt Confusion Yest:

1.      Any suggestion of potential QE2 would typically be + for risk assets.  That said, declining US yields have come to forefront of mkt focus, given its longer-term implications for risk assets as well as its high correlation to USDJPY.

2.      Crude sell-off despite USD weakness and commodity risk rally …. Many questions on crude sell-off yesterday.  We rolled to Nov yest and w/the # of traders that may have gotten sucked in last week on the ENB pipeline issue, we saw a fair amount of front month selling into the close despite the $ weakness. The weakness in crude was clearly driven by the front month as the Nov contract and 12 month strip were only down 60-90bps the majority of the day while the front month was down 2.5% and in the last 30 min, we saw that spread contract and weakness across the curve.

3.      Ex-tsys and crude, risk assets (copper, AUDUSD, EURUSD, EURCHF) held in relatively well until 10Y yield made its last move lower (5Y yields hitting record lows o/n).

Having spoken w/our rates desk, I would expect 10Y yield to come off lows somewhat in light of upcomingTsy supply next wk.  (Dealers will want to sell 10Y ahead of that to bring down px’s).  If we see some stabilization in yields, we should see risk rally/recover from yesterday’s px action into the close.

DBAB cuts MS, GS Q3 estimates.  GIS beats.  KMX beats.  BAX upgrade at Soleil.  AXP initiated positive at SUSQ.  COST rated MP at JMPS.  MAR, HST, HOT rated new Buy at UBSS.  TWX rated new buy at JEFF.  RIMM said to be unveiling a new tablet.  AMR tgt cut at CITI.  HWK guides higher.  PMCS lowers guidance.  CSFB cuts STD. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 

Today’s Trivia: Obviously I’ve been researching the benefits of reading to my newborn daughter…what percentage of American inmates are illiterate?

Yesterday’s Question: What percentage of Americans do not read at least one book a year?

Yesterday's Answer:  44% of Americans do not read at least one book per year. 

Best Quotes:  From BCAP trading…The sentiment in the marketplace right now is very clear.  Everyone thinks the market is "extended" or "overbought" or "ready for a pullback".  Our flow was 2:1 better for sale today.  Buy tickets were 66% mutual funds and sell tickets were 83% hedge funds.  Its rare to see that much of a dichotomy in our flow.”

From BTIG…  Insurance Policy.

“The economy seems poised for recovery in that policy is accommodative and the financial markets are supportive.  But on the ground where it counts we have not yet seen clear evidence of a turnaround in investment or hiring. Moreover, we have more than the usual degree of uncertainty about the amount of slack in the economy, which implies that we face highly uncertain downward risks to the already low rate of inflation.  For these reasons, it’s extremely important that we do what we can to maintain the supportive configuration in financial markets. That means continuing our easy monetary policy and, even more important, using our statement to signal our willingness to keep policy easy so long as there is a risk of further disinflation and continuing economic weakness.”

We have always viewed that June 2003 FOMC meeting as among the most controversial.  The key reason is the resultant policy action, which was a final 25 basis point ease in a 2 ½ year easing cycle that set the tone for the low rate environment that created the housing boom.  It occurred at a time when (unbeknownst) one of the ugliest bear markets (in time and price) in our nation’s history had just concluded.  The nation had just gone to war.  Geopolitical fears outshone economic ones.  The economy appeared ready to mend, but deflationary fears loomed.  It was the deflation test-case scenario that prepped Central Bankers, notably the current Fed Chairman, for the current environment.  While no environment provides a perfect parallel, we think that 2003 meeting may proffer modest insight into the Fed Chairman’s thinking. 

Most would agree that then Governor Bernanke’s June 2003 statement could easily have been made earlier today.  It even contains a predecessor to “unusual uncertainty”  in one key line.Moreover, we have more than the usual degree of uncertainty about the amount of slack in the economy, which implies that we face highly uncertain downward risks to the already low rate of inflation.”  At that time, Bernanke was more concerned about below target inflation as opposed to deflation.  Today, the Fed would likely make the same case, but as far as markets are concerned, the two are close cousins and much distinction is not necessary.

Just as many of the final rate cuts of an easing cycle during  the Greenspan Fed were intended to be, the June 2003 ease was meant as an insurance policy as they waited for “clear evidence” to emerge.  More importantly, as Bernanke clearly stated, he believed it was very important to avoid allowing the financial markets to become a headwind.  “For these reasons, it’s extremely important that we do what we can to maintain the supportive configuration in financial markets.  No doubt this was simply another iteration of the “Fed Put.”

The key language change in today’s FOMC statement also honed in on inflation falling below target, “Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.”  The Fed was clear to invoke its mandate indicating its inclination to implement policy when they see fit.  This is confirmed by the fact that the  language from the August statement about keeping the level of securities holdings constant only survived the one meeting and was dropped.  As such, today the Fed has unveiled an open ended “Fed Put.”  Undoubtedly, the Fed would very much prefer to do less, or preferably nothing, but should the economy or markets falter (remember, supportive markets are important), it has paved its way to respond.  Bernanke is usually not a fan of ambiguity in policy, but it likely works to the Fed’s advantage in this case.  The market will recognize the greater the weakness the greater the response merited, theoretically making the power of the “Fed Put” reflexive and grow with market expectations.

It is good to see the animal spirits returning to some markets although equities do not appear to be one of them.  Gold, Bonds and the Dollar all had real moves related to a potential policy shift (no actual action is expected as of yet)  that was well telegraphed a week ago.  Equities were the asset class that reacted in the most rational matter to a known event.