@ the open 1-26-12

Equity Markets – The FOMC opted to give markets (especially metals) a kick higher yesterday by announcing their intentions to keep short term rates low until late 2014 sending gold up $50/oz

The move also sent credit markets spiraling upward with the segments of the high yield market (most speculative grade bonds) benefitting the most, in some cases up 4 to 5 points in the afternoon. This morning the European indices are reacting to the announcement rallying despite the current stalemate over the Greek debt exchange and the rising fears of increasing defaults across the EMU as European banks opt to hang onto their cash balances rather than lend it out to liquidity strapped borrowers. In overnight trading the Hang Seng made up for time off due to the Lunar New Year holiday and rallied 1.6% while the Shanghai Composite remains closed for the holiday. Domestic futures signal a slightly lower open after yesterday’s afternoon rally.

Macro, New & Events

Economic Releases – lots of domestic macro data out today on the heels of the FOMCs dovish guidance yesterday…you might expect the numbers to be somewhat disappointing if the FOMCs language is a guide

• December Chicago Fed Activity Index…-0.1 v. -0.37
• December Durable goods orders…+2.0% v. +3.7% (revised down 0.1%)
• December Durables ex – transportation…+0.9% v. +0.3%
• December Capital goods orders (non-defense) ex – aircraft…+1.0% v. -1.2%
• December Capital goods shipments (non-defense) ex – aircraft…+1.0% v. -1.0%
• Weekly initial jobless claims…370k v. 352k
• Weekly continuing claims…3,500k
• December Leading economic indicators…+0.7% v. +0.5%
• December New home sales…321k v. 315k
• December new home sales (MoM)…1.9% v. +1.6%
• January Kansas City Fed mfg. activity…2 v. -4

Events

• IMF regular press briefing at 1030 EDT

Earnings – 36 of the S&P 500 announce today…watch the following with interest to get an idea about future economic activity – Eaton, Nucor, Airgas, Raytheon, 3M, Caterpillar, Eastman Chemical

Asia, Europe & USA

• Bondholder representatives return to Athens today after the EU finance ministers insist that bondholders take a larger loss and the ECB refuses to take losses on their Greek debt holdings despite the IMF request that they do. If in fact the bondholders have put forward their “maximum loss” position and the EU leadership is obviously not as concerned about a Greek default as they were previously then it is unclear what can be accomplished here.
• Chairman Bernanke and the FOMC have now established an inflation target of 2%...many economists remain uncomfortable with using such a metric to actively manage monetary policy given the lag implied…in other words, by the time you know that there is a 2% consistent inflation rate from a historical perspective it is likely much higher at present. Bottom line, the current administration of the Federal Reserve has indicated that they are nominally driven and don’t really care about “real” returns…doesn’t bode well for retirees unless they’re long real estate and commodities…as you might expect, commodities rallied following the announcement that the FOMC expects rates to remain “low” until late 2014.
• The FOMC also appeared to signal that QE3 is coming and it likely will be in the form of some sort of support for the mortgage market…this dovetails with the announcement from the President on Tuesday night regarding a “plan” (no details as of yet) to support a refinancing for anyone who would like one…sounds like MBS holders are in for a rough ride
• The MF Global mess continues as the US trustee is threatening litigation against KPMG (UK administrators) to secure the return of $700 mm of margin collateral from US segregated accounts…KPMG doesn’t want to return the monies as it will reduce the payout to UK customers…if KMPG fails the US account holders will become unsecured creditors for the $700 mm and likely receive little in the way of recovery as well as having to wait until a plan of reorganization or liquidation is approved by the US bankruptcy judge…what a mess.
• Carlyle Group is changing its documents to require future shareholders to agree to binding arbitration in any claims resolution dispute thereby avoiding any class action lawsuits…how do you think the lawyers feel about this change?
• Many are expecting Department of Defense contractors and suppliers to step up M&A activity in 2012 as the DoD budget shrinks…
• Corporate defaults in Europe may double as companies struggle to refinance outstanding debt as European banks hoard the cash that they’ve gotten from the ECB or use it to buy sovereign debt that can be used in additional repo financing transactions in February when the LTRO opens the “window” once again. The fear is that the default rate may rise to 8.4% (or higher) from the 4.8% tally in 2011. This follows on the heels of the announcement by Petroplus one of the area’s largest refiners that it would file for insolvency after losing access to a $2.1 billion line of credit. The new capital regulations are really starting to “bite” the economies of the EMU states…something has to give here and my bet is that it will be the banking regulations. All of this turmoil should be good for US banks as most of the largest money center banks are on track to comply with Basel III 6 years before it becomes effective.

Credit Markets –

Sovereign CDS – spreads are tighter this morning on the heels of the announcement by the FOMC yesterday that they expect short term rates to remain low until late 2014 (1 year beyond what most expected them to say) and that they have adopted a 2% inflation target (this is stimulative) and that QE3 appears likely. All of these results are bullish for commodities, especially precious metals and gold and silver took off yesterday afternoon.

OIS – the spread differential between overnight interest rate swaps remains around -32 bps between euro and dollar denominated overnight index swaps…this spread has also come in for the euro vs the yen as the spread differential now stands at -65.5 bps down from -87 bps at the high back in late November…

US Corporate Credit – once again, high yield leads the way in yesterday’s afternoon rally…following the FOMC announcement that they expect to keep short term rates near zero until late 2014, the market took off. High yield CDX index spreads were in 21 bps followed by leveraged loan index spreads, tighter by 15 bps and investment grade spreads which were virtually unchanged. As domestic high yield tends to be a US centric bond market and given the levels of global liquidity, the improving US economic outlook and the moves by US companies to refinance much of their looming debt maturities over the last two years, this looks like fertile ground for potentially the next two years according to Chairman Bernanke.

Energy Markets – WTI is back over $100/barrel in morning trading as the spread vs. Brent moves under -$11/barrel…the move follows the FOMC announcement yesterday that augers well for commodities at least in the near term.

Natural Gas – the rally in natural gas futures continues as the average one year out futures strip price is now up over 50% this week from a low of roughly $2 / mcf to $3.16 / mcf.

Phillip Pennell, CFA
Turnberry Capital Management
(203) 861-2708 (Direct)
(203) 861-2700 (Trading)
(203) 917-2255 (Mobile)

The information included in the above discussion is not intended to be used as a basis for making investment decisions nor should it be construed as a recommendation by the author to buy or sell any specific security. Individuals should consult their investment advisor prior to making any investment decisions.