A Rare View On the last Week : S & P Detail

U.S. Weekly Financial Notes: Slowly We Tread

Markets remained cautious following the June 21-22 meeting of the Federal Open Market Committee (FOMC). Aside from confirming what was largely expected, Chairman Ben Bernanke left observers uneasy after stating that the Fed itself finds the slowdown puzzling and that part of it may be longer lasting. Economic releases this week include:

• May existing home sales fell 3.8% over April to 4.81 million units (annualized). May new home sales slid 2.1% month over month to an annualized 319,000 unit rate.
• The May median existing home sales price rose to $166,500 from $161,100 in April. It is still down 2.9% from a year ago. The median new home price rose 2.6% over April to $222,600, though it's still down 3.4% year over year.
• The FHFA home price index for April was up an annualized 0.8% over March though is down 5.7% over last year. The price index is down 19.3% from its April 2007 peak.
• The S&P/Experian Consumer Credit Default Index fell to 2.23% in May from 2.3% in April and 3.61% the year before.
• The Architecture Billings Index slipped 0.4 point to 47.2 in May. A score above 50 indicates an increase. The inquiries index slipped 2.4 points to 52.6, its lowest reading in 22 months.
• Durable goods orders were up 1.9% month over month in May, partially offsetting April's revised drop of 2.7% (previously down 3.6%).
• The Bureau of Economic Analysis (BEA) upwardly revised its estimate of first-quarter real GDP from 1.8% to a 1.9% annualized rate. It decelerated from the 3.1% pace in the fourth quarter.
• Initial jobless claims rose 9,000 to 429,000 in the week ended June 18. The figure is worse than the 420,000 consensus expected, and it comes after the previous week was upwardly revised to 420,000 from 414,000. The seasonally adjusted insured unemployment rate remains at 2.9% for the third consecutive week.
• Oil prices lost nearly 6% this week, falling to $90/barrel on Friday afternoon after the U.S. tapped reserves. The dollar strengthened against the euro on continued sovereign risk fears.

Not Expecting Much

The FOMC statement was also no surprise. The Fed kept interest rates at close to zero, and it confirmed that it will complete QE2 by the end of this month but will continue to reinvest principal payments. To top it off, the Fed agreed with us. It introduced a gloomier outlook for the U.S. recovery than it thought before. The Fed released its new economic projections, which were much weaker than its April forecast, and as Bernanke said, the revisions were "significant." The Fed cut its GDP growth estimate for 2011 to 2.5%-3.0% from the 2.9%-3.7% forecasted in April. It revised its estimate for 2012 GDP growth down sharply, to 2.2%-4.0% from the 2.9%-4.4% forecasted in April. It also upwardly revised its unemployment rate and pricing forecasts for 2011 and 2012.
But people weren't as interested in the statement. They were all waiting for Chairman Bernanke to tell us something new. His speech pretty much affirmed what was written in the statement. However, the question and answers session was where he rolled up his sleeves and gave us something to think about, or worry about.
For the most part, he was optimistic that the recovery hasn't been derailed, though he indicated that the labor market is a long way from being healed. However, it seems from the statement, new forecast, and speech, that the Fed expects the economy to settle into a disappointing recovery, and that it has done all that it can do, for now. Even more disturbing was Mr. Bernanke's comment that they "don't have a precise read on why this slower pace of growth is persisting," which sounds like the Fed's transitory mantra is running thin.

Still At A Snail's Pace 

Last week we saw that May housing starts came in much better than what markets had expected. Starts rose about 3% to 560,000, with upward revisions the month before. The 3.3% rise was not enough to offset the almost 9% April decline, but at least it was moving in the right direction.
This week we had mixed news. Both existing and new home sales data were weak in May. Although they were down, they were either in line with or much better than the sharp drop expected, which helped reduce market fears that the housing recovery is over.
Sales of existing homes fell 3.8% in May to a 4.8 million annual rate. They came in about as expected, though they followed a downwardly revised 5.0 million in April (previously 5.05 million). Sales are down 15.3% from the rebate-inflated level of last May. Condo/coop sales fell 8.1% to 570,000, while single-family sales fell 3.2% to 4.24 million. Sales fell in every region except the West, which was flat. The largest drop was in the Midwest (down 6.4%). The realtors blame much of the weakness on severe weather and higher gasoline prices, which are both delaying and preventing sales.
Sales of new single-family homes weakened in May, falling 2.1% to an annual rate of 319,000, though they're up 13.5% from a year earlier, when sales plunged once the homebuyer tax rebate expired. The decline in new home sales was better than the 3.8% drop in existing home sales reported last week. The Northeast was responsible for most of the drop, down 26.7% month over month, pulling back some of the 58% surge over the prior two months. The West was down 3.5% after two consecutive months of double-digit gains. Only the South saw gains, up 2.4% month over month in May.
Builders continue to reduce the inventory of unsold homes, which fell 3.5% in May to 166,000, which would take only 6.2 months to clear at the current sales pace (down from 6.5 months in April). The inventory-to-sales ratio is getting back into a normal range for new homes, although it remains too high for existing homes. The inventory of unsold existing homes rose to a hefty 9.3 months from 9.0 months in April, which likely will add further pressure to prices.
But the data don't take into account the shadow inventory of unsold homes that have yet to go on the market, such as distressed homes or homes in the process of foreclosure. This is estimated to add a few more years to the months of unsold homes. As a result, we expect home prices to continue to fall through the spring. And we don't expect prices to reach their pre-crisis levels.
The median price of a new home is down 3.4% from a year earlier, to $222,600. The median sales price for existing homes was also down, by 4.6%, from last May to $166,500. Existing and new home prices were up over April on normal seasonal patterns.
The FHFA House Price Index rose 0.8% in April. It is still down 5.7% from a year earlier and 19.3% from its April 2007 peak. Prices increased in April over the prior month in six of the nine districts, with the largest gain in New England (up 2.2%), followed by the West South Central district (up 2.1%). The largest decrease was in the Mountain Division, down 1.3%, followed by the West North Central district (down 0.6%).
The FHFA index is based on mortgages issued for new purchases through Fannie Mae and Freddie Mac (currently more than 80% of new mortgages). Historically, however, the coverage has been much lower, which may be distorting the index. The S&P/Case-Shiller index will be released June 28.

Other News

Durable goods orders have bounced up and down for the past year. The same was true in May, with durable goods orders recovering from a steep April decline. New orders for durable manufactured goods jumped 1.9% in May, about as expected. Orders remain up 10.8% from May 2010. The revised 2.7% drop in April was much better than the previously reported 3.6% drop. Gains were spread throughout most durable manufacturing groups, but the strongest category was civilian aircraft orders, which surged 36.5%, offsetting the big 29.0% jump in April. Motor vehicle orders were up just 0.6% (and shipments were up 0.6%), probably indicative of supply chain disruption resulting from the Japanese disaster. April orders had plunged 9.4%. A shortage of parts has forced manufacturers to cut back on production, with the biggest impact on the Japanese producers. Defense orders (mainly aircraft) rose 3.9%. Orders for nondefense capital goods, excluding aircraft (the key indicator for capital spending), jumped 1.6% after falling 0.8% in April. Shipments of durable goods, which are less volatile than orders, rose 1.9% in May and were up 0.5% excluding transportation. Inventories were up 1.2%, which could help second-quarter real GDP.
First-quarter GDP was revised to a 1.9% annualized rate in the BEA's third estimate, up from a 1.8% rate in the previous revision and in line with the 2.0% rate consensus expected. The BEA upwardly revised inventories and exports, though it surprisingly lowered its estimate for equipment spending to a 8.8% gain (previously up 11.6%). Consumer spending rose 2.2% in the first quarter, the same as the prior estimate.

Financial Market Highlights

Below are the financial market highlights for the week ended June 23, 2011.

Treasury yield curve

The 10-year Treasury yield fell 4 basis points (bps) this week to 2.87% on Friday afternoon. This is the lowest so far in 2011 as recent U.S. economic reports and eurozone debt worries drove investors out of riskier assets. The rate on three-month Treasury bills dipped 2 bps from last week to one basis points. The two-to-10-year spread edged down by one basis point to 259 bps over the week and was 10 bps lower than a year ago. The 10-year Treasury spread above inflation-protected bonds (TIPS), a measure of inflation expectations, dipped marginally, by 5 bps, over the past week to 145 bps and is 5 bps below the level of a year ago.

Credit markets

Risk aversion eased this week on continued strong earnings reports. The Treasury-to-eurodollar (TED) spread, a measure of banks' willingness to lend, rose by 2 bps to 22 bps this week, but it was down 13 bps from a year ago. The equity market volatility index (VIX), a measure of the market's uncertainty, dropped to 19.70 this week from 20.16 the previous week after the Greek government survived a confidence vote and the U.S. Federal Reserve hinted at no near-term changes to its monetary policy. Fixed mortgage rates remained unchanged at 4.50% over the past week amid further indication of a soft housing market. The 30-year mortgage rate remains well above the November 2009 all-time low of 4.17%. Mortgage applications decreased 5.9% during the week ended June 17 after rising 13% the prior week. The refinancing index decreased by 7.2% after increasing 16.5% the previous week. The seasonally adjusted Purchase Index dipped 2.8% after rising 4.5% the previous week.

Fed policy and interest rate outlook

The FOMC maintained the federal funds rate at a record low of 0%-0.25% at its June 21-22 meeting, reiterating the "extended period" language in its statement. The statement mentioned that the economic recovery is progressing at "a moderate pace," though the pace is slower "than the Committee had expected." However, temporary factors are partially responsible for the slowdown, and the Fed expects the pace of the recovery to increase in the second half of this year. The statement confirmed that the Committee will complete QE2 by the end of this month, but it will continue to reinvest principal payments from its securities holdings. It highlighted that although prices have picked up recently, long-term inflation expectations were stable. The Federal Reserve also released its new economic projections, which were weaker than the April forecasts. The Fed cut the "central tendency" projection of 2011 GDP growth to 2.7%-2.9% from 3.1%-3.3% in January, with the core consumer deflator forecast up 1.5%-1.8% (from 1.3%-1.6%). Federal Reserve Chairman Bernanke stated that the Fed expects the unemployment rate to fall between 7.0% and 7.5% by the fourth quarter of 2013. The Beige Book compendium of reports from the 12 Federal Reserve district banks (released June 8) indicated that economic activity continued to expand since the last report, albeit at a slower pace, with four out of the 12 regions reporting slowing growth, as consumers combat higher food and fuel prices and supply-chain disruptions due to the Japanese earthquake.

Foreign exchange rates

The dollar strengthened this week against all the major currencies amid rising speculation about sluggish global economic growth, pushing investors toward safe havens like the dollar. On Friday afternoon, the euro dropped to $1.418 from $1.421 last week as Greek budget tensions and wider eurozone peripheral spreads weighed heavily on risk appetite. The yen slipped to ¥80.47/dollar from ¥80.16/dollar a week ago. The U.S. trade deficit narrowed by $3.1 billion to $43.7 billion in April from a revised $46.8 billion in March as exports hit a record high, aided by a weaker dollar, which made goods from the U.S. less expensive to the rest of the world.

Global interest rates

Government long-term bond yields were mixed this week. One-year LIBOR rates were little changed. Key central banks are through loosening, and the European Central Bank (ECB) has become the first major bank to tighten. Financial market turmoil appears to be calming, reducing prospects for quantitative easing in the near term. Recent trends include:

• The ECB left its benchmark refinancing rate at 1.25% on June 9, as the economic outlook was highly uncertain, though it signaled that it likely would hike the interest rate in July to rein in inflationary pressure.
• The Bank of England held its bank rate at 0.5% at its June 9 meeting as a slew of weak economic data pointed to a loss of momentum in the economic recovery. This kept policymakers focused on boosting economic growth despite a rise in inflation, as the current economic recovery is too fragile to support a rate hike at this stage.
• As Japan slipped into its second recession in three years, with real GDP shrinking 0.9% in the first quarter, the Bank of Japan kept rates steady between zero and 0.1% on May 20 to boost the battered economy.
• The U.S. Federal Reserve left the federal funds rate steady at 0%-0.25% at its June 21-22 meeting. The statement reiterated that the economic recovery is continuing at "a moderate pace," but the pace was slower "than the Committee had expected."
• The People's Bank of China raised its bank reserve requirement ratio by another 50 bps to 21.5% on June 14 for China's largest banks as inflation soared to a 34-month high of 5.5% in May. China left its interest rate unchanged at 3.25% on May 12, as higher rates could dampen economic growth.
• The Bank of Canada maintained its target overnight rate at 1% on May 31 as the economic recovery is proceeding largely as anticipated and inflation expectations remain well anchored.
• Iceland's central bank left its benchmark and deposit rates at 4.25% and 3.25%, respectively, on June 16 as the overall growth outlook remains the same, but tightening could be needed in the near term if inflation expectations rise further.
• The Norges Bank held the deposit rate steady at 2% during its meeting on March 16, but it signaled an accelerated trend of rate increases in the months ahead, barring unexpected negative surprises in the economy.
• Sweden's Riksbank raised its seven-day repo rate by 0.25%-1.75% on April 20 to contain high inflation.
• The Swiss central bank kept its benchmark rate unchanged at 0.25% on June 16, since the overall recovery has predominant downside risk and the strong appreciation of the franc has thus far failed to curb the country's economic growth.
• Poland's central bank raised its seven-day reference rate by 25 bps to 4.50% on June 7 as the current inflation level remains elevated.
• Hungary's central bank kept its base rate unchanged at 6% on June 20 to counter the threat of rising inflation caused by cost pressure that is stemming from the rise in commodity prices.
• The Russian central bank raised its refinancing rate by 25 bps to 8.25% on April 29 to rein in high inflation. This increase is the second time Russia has increased its rate this year after raising it in February by 25 bps to 8%.
• The Reserve Bank of Australia maintained the official cash rate target at 4.75% in its June 7 board meeting on signs of a weakening economy.
• The Reserve Bank of New Zealand left its key rate unchanged at 2.5% on June 8 to boost economic recovery in the country, which is recovering from its deadliest earthquake. Meanwhile, the central bank has signaled that it will need to raise borrowing costs in the future to contain rising prices.
• South Korea's central bank raised its key interest rate to 3.25% in its monetary policy meeting held on June 10 to rein in rising inflation and to curb record household debt.
• The Reserve Bank of India raised its benchmark interest rate by 25 bps on June 16 as it continues to battle inflation.
• The Bank of Thailand increased its benchmark overnight rate to 3% on June 1 after overall inflationary pressure increased more than expected on rising commodity prices. This is the fourth such move since the start of 2011 and the seventh hike since tightening began last July.

Commodity price indices

Commodity prices dropped this week as investors showed little interest in risk taking. Oil prices fell from last week to $91.16/barrel on Friday afternoon after the International Energy Agency (IEA) announced the release of 60 million barrels of government-held stocks over the next 30 days. Brent prices dropped to $105.12 from the previous week's $106.91, remaining high compared with WTI. Brent lost 7.2% this week. We expect oil prices to ease from their current highs, but geopolitical risk makes the forecast highly uncertain. Natural gas prices rose to $4.23/mbtu from $4.21/mbtu a week earlier. Gold prices dropped to $1,502/ounce on Friday from $1,521/ounce a week earlier as the dollar spiked during the period. Agriculture prices dipped 4.2% and are up 56.1% from a year ago. Livestock prices increased 5.3% in the week and are up 5.2% over the past year.

U.S. equity market

U.S. equity rose marginally this week as investors remained wobbly amid a mix of weak economic data, a persistent eurozone debt crisis, and surprise intervention in the oil markets. However, the S&P 500, Dow, and Nasdaq were trading at 1,268, 11,935, and 2,653, respectively, on Friday afternoon. Stocks were in a bear market from October 2007 until March 2009 but have now recovered almost all of the losses. All market indices remain up over the past 12 months. The S&P 500 is now up only 0.79% from the year-end 2010 level of 1,258 and is up 87.5% from its March 9, 2009 low of 676.

U.S. equity market by sector

Equity sectors in the U.S. declined over the past week through Thursday. Consumer discretionary stocks led the gainers, up 1.9%, closely followed by industrial stocks, up 1.8%. The telecom sector followed, gaining by 1.2%. Energy and material shares reported the largest 12-month gains (up 32.8% and 25.9%, respectively). Financials trailed (up 2.5%).

Global Standard & Poor's stock indices

World equity markets remained mixed through Thursday after reassurances from the Greek prime minister about radical reforms helped to somewhat ease weary investor sentiments. The U.S. and Asia-Pacific markets gained the most (up 0.8% and 0.6%, respectively). However, Australian markets took the biggest plunge (down 1.1%). Over the past 12 months, the U.S. market has reported the biggest gain (up 16.8%), followed by the Canadian market (up 16.7 %). Japan and Australia had the only 12-month declines (down 8.2% and 1.7%, respectively), as both countries have suffered heavy catastrophes in 2011.

Global equity market performance by sector

International sectors were mixed this week through Thursday. Consumer discretionary stocks gained the most (up 2.4%). Telecom and information technology stocks followed (up 1.3% each). In contrast, consumer staples and utilities dropped the most (down 0.3% each). Energy stocks posted the largest gain (up 30%) during the past year, followed by consumer discretionary stocks (up 26.6%).