With employment trends leading the economy towards a potential recession and credit conditions deteriorating before the second quarter earnings season, market participants are considering an August rate hike from the Fed as an unlikely outcome. Fed Funds futures reflect a modest 13.5 percent probability of a quarter point hike to 2.25 percent – a figure that may also account for volatility in general lending conditions. In fact, the prospects for tightening anytime this year have dimmed. Futures show a 53 percent probability of no change at the September 16th meeting and a 31 percent chance that the benchmark be untouched in late October.
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CREDIT MARKET: HOW IS IT DOING?
With employment trends leading the economy towards a potential recession and credit conditions deteriorating before the second quarter earnings season, market participants are considering an August rate hike from the Fed as an unlikely outcome. Fed Funds futures reflect a modest 13.5 percent probability of a quarter point hike to 2.25 percent – a figure that may also account for volatility in general lending conditions. In fact, the prospects for tightening anytime this year have dimmed. Futures show a 53 percent probability of no change at the September 16th meeting and a 31 percent chance that the benchmark be untouched in late October. The build in dovish pessimism will certainly continue as long as Fed Chairman Ben Bernanke deems it necessary to provide lenders and Wall Street access to emergency loans at discount rates.
A DEEPER LOOK INTO THE CHANGES THIS WEEK:
The credit markets were volatility this past week as industry heads and policy officials tried to put out new fires in lending. Stoking fear and default concerns, a Lehman report suggested Fannie Mae and Freddie Mae may need to raise an additional $75 billion to remain in good standing. What’s more, the BoE released a credit report forecasting conditions would be much worse over the next three months. However, suggestions from Fed Chairman Bernanke that loans to Wall Street could extend into 2009 helped curb fears that major players would collapse.
Demand for short-term paper was relatively steady this past week as investors weighed the potential threats to liquidity and promises for financial stability. Moody’s recently reduced its forecasts for global defaults over the coming year; but the 6.1 percent outlook was still at menacing highs. On the other hand, suggestions that NYSE EuroNext Liffe would offer guarantees on over the counter default swaps put the NY Fed’s calls for a centralized clearinghouse for the derivatives in action and thereby boosted expectations for lending activity to improve.
FINANCIAL MARKETS: HOW ARE THEY DOING?
After closing the first half of the year with the worst string of weekly losses in four years and benchmarks at near two year lows, equity markets seemed to have found a temporary floor this past week. However, stocks are still teetering on the edge of what many analysts and market commentators would consider a full blown bear market. The revenue forecast this past week was weighed down by the disappointing non-farm payrolls release; but a long, holiday weekend would help to stem the bleeding. On the other hand, support may not hold up for long. Second quarter earnings are just around the quarter and analysts are already forecasting another 11 percent drop (following up on the 16 percent decline last quarter and 23 percent contraction in the final months of 2007). Elsewhere, commodity markets added to the relief. While agriculture prices have been falling for some time, vital crude has just recently broke below a tight range near record highs.
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[B]A DEEPER LOOK INTO THE CHANGES THIS WEEK:[/B]
Equity markets may have pulled out of their recent dive; but there is little holding the major indices from plunging new multi-year lows. This past week, the financial sector led the action with another 1.3 percent drop that was catalyzed by Fannie Mae and Freddie Mac’s capital woes along with traders moving in to discount forecasts for ongoing write downs from the big banks. Elsewhere, the consumer-related groups found little solace in data showing job cuts and fading wage growth.
If general price action doesn’t convince traders to be cautious, market condition indicators should. The put-call ratio dropped to a new 8-month low as managers exercised their portfolio protection to unload significantly discounted stock. An obvious confirmation of the selling, market breadth maintained a 3:2 ratio for stock sales versus purchases. For the outlook, the VIX fear indicator climbed back above 23%. In the past 20 years, an average reading above 35% accompanied the lows in bear markets.
U.S. CONSUMER: HOW ARE THEY DOING?
The world’s largest economy seems to be inching towards an economic contraction. Now the question seems to be whether the US is heading for a hard or soft landing. Data this past week would suggest that conditions could deteriorating further than many had initially expected. The top market-moving non-farm payrolls report topped the economic docket over the period; and its release only plagued the health of the economy’s largest sector. The government report printed another 62,000 job cuts – bringing the tally up to 438,000 lost jobs over six consecutive months of declines. What’s more earnings growth in the year through June slowed to a 3.4 percent pace - the weakest pace since January of 2006 and well below the stifling level of inflation. With the housing sector deepening its recession and exports offering little relief, it seems the last major pillar of US growth will soon give.
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A DEEPER LOOK INTO THE CHANGES THIS WEEK:[/B]
The more timely data crossing the wires seems to confirm the general descent in economic activity. On the heals of the payrolls report, initial jobless claims rose to a three-month high last week while the aggregate reading pressed to a new multi-year high. Mortgage applications rose modestly with the help of a 7 basis point drop in the average 30-year fixed rate mortgage, but they were nonetheless just off of six-year lows. One unexpected bright spot continues to be the ABC consumer sentiment report, which improved for yet another week to its highest level since the end of April. However, with pessimists still far outnumbering optimists, it may be too little too late.
Long-term economic data continues to feed expectations for contractionary growth through the second half of the year. NAR’s pending home sales release (arguably the broadest gauge of activity for the sector) quickly countered the biggest jump in purchases in years reported through April with a 4.7 percent drop in the more recent reading. More importantly, the consumer’s role in supporting the economy was fading. Not only did employment and wage figures drop, but purchases through credit rose. This suggests that Americans still need to access credit lines to purchase necessities even though the government sent out stimulus checks that same month.
Written by: John Kicklighter, Currency Analyst for DailyFX.com
Questions or comments on this or other articles John has authored? You can email him at <[email protected]>.