Weekly Market Update: Market Instability Reigns as Financial Officials Mull Next Moves
Even as the fall season approaches, the dog days of summer continued to hound world financial markets this week. Enduring uncertainty in China and weakness in Brazil took their toll on global equities, and while the ECB made a dovish move, members of the US Federal Reserve signaled that a September rate hike was still very much in play. Friday's highly anticipated US jobs report was strong enough to support a rate liftoff decision, but not enough to guarantee it. Oil prices joined the equity markets in their volatility, and world finance leaders met in Ankara, Turkey, to address all these concerns at the G20 meeting. As US traders worried about overseas trading during next Monday's Labor Day holiday, a risk-off mentality won the week, and the S&P ended down 3.4%, the DJIA lost 3.2%, and the Nasdaq dropped 3%.
On Friday, US stock traders were looking at a lower open even before the release of the Aug employment report, and the report didn't disappoint in terms of fueling the debate around the Fed. Most observers looked past a headline miss in payrolls because the July figure was revised substantially higher, hourly earnings and average weekly rose faster than expected, and the unemployment rate fell to the lowest level since the Spring 2008 at 5.1%. The report was generally viewed as bolstering the case that the door remains open for the Fed to tighten as soon as this month. Subsequently, the spread between 2- and 10 year Treasury yield narrowed to 142 basis points, the flattest level since April, while in equities prices extended declines with the utility sector hitting a new 1-year low. Emerging market currencies experienced a fresh bout of selling against the Dollar as the Euro and Yen found willing buyers once again.
In terms of what members of the Federal Reserve are actually saying, the tone of the Jackson Hole symposium was fairly hawkish over the weekend. The consensus was that the FOMC should begin tightening monetary policy as early as the next meeting, despite the slowing Chinese economy, low inflation, and the elevated volatility in financial markets. The highlight of the event was Fed Vice Chair Fischer's remarks, in which he said there was no need to wait for inflation to reach the 2% target to justify a rate hike. BOE Governor Carney also played down the Chinese situation, noting it did not yet warrant a strategy change and that the BOE is still on course to start raising rates early next year. ECB Vice President Constancio applauded the very gradual increases in inflation seen in the Eurozone supported by stimulus.
In the ECB's post-rate decision press conference, ECB President Draghi asserted that the central bank has the will and the capacity to ease further if necessary after the staff downgraded the Eurozone inflation forecast. The ECB staff cut 2015, 2016 and 2017 inflation forecasts, with 2015 inflation lowered to 0.1% from 0.3% prior and 2016 chopped to 1.1% from 1.5%. Draghi warned that the Eurozone could see another bout of deflation and placed blame once again at the feet of weak oil prices, but said the period of disinflation would be transitory. He also announced that the ECB had raised the amount of any single issue that it could buy under the standing QE program to 33% from 25%, and reiterated that the bank was prepared to do more, if needed. Analysts widely believe Draghi has effectively teed up another round of policy easing with these moves, and EUR/USD has responded in kind, dropping more than one big figure to 1.1111, the 100-day moving average, from 1.1230 ahead of the press conference.
China reported more disheartening data early in the week. The final reading of the Caixin manufacturing PMI confirmed a six-year low, while the official government PMI number entered contraction for the first time in six months. Volatility in the Chinese stock market died down substantially and markets were closed there on Thursday and Friday for a national holiday. At the end of the week, however, Japan bore the brunt of global investors' general de-risking trade. Despite early positive indications that ECB dovish moves on Thursday could buoy Asian markets Friday, the Nikkei ended down 2.2% on the day and down 7% for the week, its worst weekly drop since April 2014. A Wall Street Journal report that Japan and North American auto industry disputes are holding up completion of the TPP agreement didn't help shift momentum, either.
August US manufacturing data was pretty soft, reflecting the stronger dollar and heightened uncertainty seen in the month. The final Market manufacturing PMI survey declined to 53.0, its lowest reading in two years, with declines seen in employment and new orders. Markit said that new orders from abroad have now fallen in four of the past five months, which represents the weakest phase of manufacturing export performance since late 2012. The ISM manufacturing survey hit 51.1, the lowest level since May 2013, with the new orders component down nearly five points to 51.7, which nearly matches the two-year low reached in March.
WTI crude saw its strongest three-day streak in 25 years between last Thursday and this Monday, as the front-month contract rallied from below $38 on Thursday to peak above $49 intraday on Monday. The gains were attributed to a variety of factors including the Baker Hughes rig count stabilizing over the last six weeks, declines in US production over recent months as seen in the EIA's inaugural June Petroleum Supply Monthly report, and an OPEC Bulletin article that asserted the cartel was willing to talk with non-OPEC producers on "a level playing field" about steps to get "fair prices." Analysts dismissed the rally as unrealistic and unsustainable, and prices fell somewhat after the weekly API and EIA inventory reports both showed substantial increases in crude stocks. Friday's oil markets saw some stabilization around $46 in WTI after the Baker Hughes rig count revealed a 2% decline for US oil rigs, the largest weekly decline in months.
US Treasury Sec Lew had some tough comments for China regarding its August yuan devaluation, taking Beijing to task on the ramifications of its FX actions. Meanwhile, there were reports that the IMF was welcoming more steps by the PBoC to provide greater market influence for FX rates, which would make it more inclined to include the yuan in the SDR basket. Back in late August, the IMF board deferred to next year any the decision to include the yuan in the basket.
August auto sales figures beat expectations, though some firms saw a y/y decline because the Labor Day holiday weekend falls outside of the month this year. Ford led the pack with a 5% y/y gain, for its best August in nearly a decade. Fiat-Chrysler saw its 65th straight month of sales growth, with August sales up 1.7%, fueled by continued strong sales in the Jeep division. General Motors sales fell 0.7%, slightly less than expected. Japanese firms also saw declines in the month, with sales from Toyota down 8.8%, Honda off 6.9% and Nissan down 1% y/y, although they met or exceeded expectations.
The pharma sector had some notable M&A action. Lannett reached a deal to acquire generic drug maker Kremers Urban Pharmaceuticals for $1.23 billion, whose main product is a generic form of J&J's Concerta, used to treat attention deficit hyperactivity disorder. The market rewarded the deal with a more than 10% pop in Lannett's stock. Synergetics agreed to be acquired by Valeant for $6.50/share in cash - for a total of $166M - and up to $1.00/share in further milestones. The acquisition is aimed at expanding Valeant's Bausch + Lomb business. Baxalta ended negotiations to acquire Ariad, which it was considering as a defense against Shire's unsolicited all-stock takeover bid. A report on Friday said that some other big pharma firms might be interested in Ariad.