The crippling credit crunch may be slowly easing its grip on financial markets; but the Fed will still have its hands full with deciding rates as fears of an economic downturn counter oppressive inflation trends. What’s more, a potential flare up in the credit markets is still a real threat to the healthy operation of the markets and broader economy.
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CREDIT MARKET: HOW IS IT DOING?[/B]
The crippling credit crunch may be slowly easing its grip on financial markets; but the Fed will still have its hands full with deciding rates as fears of an economic downturn counter oppressive inflation trends. What’s more, a potential flare up in the credit markets is still a real threat to the healthy operation of the markets and broader economy. News released this past week maintained the fragile nature of the market’s recovery. According to a report, corporate defaults through the middle of May reached 28 - more than total of 2007. Furthermore, major banks and lenders are still struggling to shore up capital levels to compensate for write downs by raising money in a still cautious investment environment. What’s worse, corporate governance itself may trigger a new round of problems. Probes into the major debt rating agencies undermine the valuation of trillions of dollars worth of debt securities.
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A DEEPER LOOK INTO THE CHANGES THIS WEEK:
The delicate balance of fear and risk appetite has shifted once again this past week. Demand for yield is slowly compensating for ongoing concerns surrounding the effects of slowing economic growth on revenues and the market’s ability to restore financial companies’ reserves. Over the past week, the junk bond spread slipped 2.8 percent as traders moved out of risk-free assets and into more speculative positions. On the other hand, concerns of ongoing write downs and capital raising lifted credit default swaps 4.5 percent.
The same rebound in risk appetite seen in the slow pull back in the junk-bond spread is reflected in short-term paper. With investors slowly finding their way back into the more speculative markets, they first have to unload their holds of T-bills and other short-term debt. At the same time, there has been some divergence between the rates for Treasury and Libor products of the same maturity - suggesting the significant rebound in T-bills may be more of a reflection of rising interest rate expectations than a rebound in risk taking.
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FINANCIAL MARKETS: HOW ARE THEY DOING?[/B]
The modest pullback in equity markets that was developing last Wednesday turned into a full-fledged retracement by this week. Indeed, this bearish sentiment was seen across the capital markets as rising energy prices and diminishing forecasts for consumer spending weighed on revenue and economic growth expectations. From the equity markets, the benchmark Dow broke the sturdy trend channel that had guided price action since mid-March. However, so far in this foreshortened week, the drop in stocks seems to have leveled out. It isn’t a coincidence that this stabilization coincides with the pull back in crude prices. With earnings season past and few major economic indicators on the docket this week, the market is free to speculate on what influence crude prices over $130/barrel will have on activity. And, though equities benchmarks have leveled off, a sharp rise market activity indicators reveal significant concern about the future.
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A DEEPER LOOK INTO THE CHANGES THIS WEEK:
Volatility was high across the asset spectrum this past week; but investors seemed most concerned with the health of the stock market - the benchmark risky asset. Though the Dow index fell little more than 2 percent over the past week, the decline broke a major trend and put the bullish reversal from early March in jeopardy. A look at the sector breakout further suggests this decline was not instigated by credit issues or interest rate forecasts; but instead, a turn in the outlook for economic growth is cooling risk appetite.
While the steep decline in the benchmark equities indices may have been curbed over the past few days, concern that the market is heading for the next leg in a larger bear market has actually grown. Looking at activity indicators, the volatility index has risen more than 2 percent from last week’s eight-month lows. Typically, a rise in expected activity precedes significant declines. Further portending a sharp drop in stocks was a rebound in the put-call ratio, which indicates a revived demand for portfolio protection from market selloffs.
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U.S. CONSUMER: HOW ARE THEY DOING?[/B]
The Federal Open Market Committee’s forecasts for economic activity and inflation released with last week’s policy meeting minutes are still shaping economists’ and traders’ forecasts for growth. With first quarter GDP revisions scheduled for release on Thursday, the policy group’s downward revision to 2008 growth numbers and language hinting to a neutral turn for interest rates have been highlighted. If activity in the first quarter fails to meet the consensus 0.9 percent clip, it would merely lower forecasts for the second quarter (especially with crude prices at record highs and consumer confidence at quarter-century lows) and perhaps even erode the credibility of the FOMC’s expectations for a rebound in growth through the second half of the year.
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[B]A DEEPER LOOK INTO THE CHANGES THIS WEEK:[/B]
Leading economic indicators for the world’s largest economy have lent little help to weighty growth projections ahead of the upcoming GDP revision. Over the past week, initial jobless claims eased modestly; yet continuing claims held at four-year lows – a mixed sign for next week’s NFP release. What’s more, hopes for a bottom in the housing recession were thwarted by a drop in mortgage applications to the lowest level in a month owing to a jump in interest rates. Finally, the weekly ABC consumer confidence reading hit a new record low, further cutting the outlook for spending and a rebound for GDP.
Readings on economic activity added little fuel to bullish forecasts. The strongest reading for the past week was the durable goods orders report which beat expectations yet still marked a second monthly contraction. A heavy round of housing data reminded the market of why the US economy is flirting with a recession: The housing price index dropped 0.2 percent for the worst performance on record; the S&P/CS inflation report hit a new record low; and existing home sales slipped 1.0 percent to a record low. Even the unexpected jump in new home sales was bearish, owing its rise to a sharp revision to the previous month.
[I]Written by: John Kicklighter, Currency Analyst for DailyFX.com
To contact John about this or other articles he has authored, you can email him at <[email protected]>. [/I]