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Wild Swings Mark a Volatile Week


With the FOMC's meeting on Tuesday and Wednesday and January's payroll numbers out on Friday, another key week for financial markets lies ahead.


The past week witnessed an extraordinary set of events on the financial front, a rogue trader creating havoc at Société Générale, and wild swings on global stock markets as mounting concerns about a recessionary US economy and the implications for global growth continued to weigh on investor sentiment.

The week started off with sharp declines on the European and Asian stock markets on Monday (when the US markets were closed in commemoration of Martin Luther King). This was followed by the Fed's emergency 75-basis-point cut of its benchmark rate to 3.5% before the opening bell of the US markets on Tuesday, aiming to help support the troubled financial sector and stabilize the economy. The move, which came before the Central Bank's formal meeting next week and marked the largest cut in the Fed funds rate in more than twenty years, helped prevent a larger drop in US equity prices.

Although investors' initial reaction was lukewarm, stability returned to stock markets as they took heart from a possible rescue plan for troubled bond insurers (so-called monolines). In addition, the unveiling of a $150 billion US fiscal stimulus package by the Bush administration was viewed in a favorable light even though it was criticized just a few days earlier.

Let's briefly review the financial markets' movements on the basis of economic statistics and a performance chart.


The Fed's interim interest rate cut resulted in a further steepening of the yield curve with the aim of enabling shell-shocked banks to start lending again, and to start making profits so that they might be able to claw their way out of the credit crisis over time. The following chart illustrates how the yield curve has steepened since the first reduction in the Fed funds rate in August, 2007.

US Yield Curve


As far as economic statistics are concerned, US jobless claims for the week to January 19 surprised on the downside, reflecting a situation not yet commensurate with recessionary conditions. The US housing market, however, remained mired in weakness, according to the National Association of Realtors' report for December. Existing home sales declined by 2.2% while the median existing house price was down 6% from one year ago. The inventory situation was looking slightly better, with about nine months of available inventories.

The jury is out on whether the FOMC will announce a further rate cut on Wednesday. John Mauldin (Thoughts from the Frontline) argues as follows:

"If I am wrong and the Fed was responding to the stock market [when cutting the Fed funds rate by 75 basis points on January 22], then we will likely not see a cut next week. But if we get another 50-basis-point cut, as I think we will, then it means the Fed is responding to concerns about the credit crisis. And we will get another cut at the next meeting and the next until we get down to 2% or below. A 50-basis-point cut takes the rate to 3%. It they had cut the rate by 1.25% next week, the market would have collapsed. Better to do it in two leaps is what I think they are thinking." (See John's full report: What Does the Fed Know?)

The Week's Economic Reports

Source: Yahoo Finance, January 25, 2008.

In addition to President Bush's State of the Union Address on January 28 and the FOMC meeting on January 29 and 30, the week's economic highlights, courtesy of Northern Trust, include the following:

1. New Home Sales (Jan 28) – Sales of new homes are predicted to have dropped by 5.0% in December to 645 000. Sales of new homes have declined by 53.4% from their peak in July 2005. On a year-to-year basis, sales have dropped by 35.2% from a year ago. Consensus: 645 000 vs 647 000 in November.

2. Durable Goods Orders (Jan 29) – Durable goods orders are predicted to have risen in December (+0.4%) after a 0.1% increase in the previous month. In particular, orders of aircraft may have dropped and those of defense items have risen, reversing the performance seen in November. Consensus: +1.6% vs +0.1% in November.

3. Real GDP (Jan 30) – Real gross domestic product is expected to have risen by 1.2% in the fourth quarter. Positive contributions from consumer spending, non-residential fixed investment and exports are expected to be partly offset by a large drop in residential investment expenditures. Consensus: 1.2%.

4. Personal Income and Spending (Jan 31) – The earnings and payroll numbers for December suggest a 0.3% increase in personal income. Auto sales posted a small increase in December, while non-auto retail sales were weak. Both of these suggest soft overall consumer spending (+0.1%). Consensus: Personal income +0.4%; consumer spending +0.1%.

5. Employment Situation (Feb. 1) – Payroll employment in January is expected to show tepid gains (+25 000) after an 18 000 gain in December. Private sector payrolls fell by 13 000 in December, the first decline since June 2003. This report will be watched closely to evaluate the underlying fundamentals of the labor market. The jobless rate is predicted to have risen to 5.1%. Consensus: Payrolls +58 000 vs +18 000 in December; unemployment rate – 4.9%.

6. ISM Manufacturing Survey (Feb. 1) – The consensus for the manufacturing ISM composite index is 47.0 after a 47.7 reading in December.

7. Other reports – Case-Shiller Price Index, Consumer Confidence Index (Jan 29), Chicago Purchasing Managers' Index, Employment Cost Index (Jan 31), Construction Spending and auto sales (Feb 1).


The performance chart obtained from the Wall Street Journal Online indicates how different global markets fared during the past week.

Click to enlarge.

Source: Wall Street Journal Online, January 27, 2008


US stocks started the shortened week markedly lower on Tuesday, following a sharp sell-off in global stock markets due to growing concerns about the overall health of the economy and Société Générale's clean-up operations of its rogue derivatives trader's positions. Markets, however, managed to recover and reclaimed higher ground as the week progressed. By the close of trade on Friday the Dow Jones Industrial Index (+0.9%) and the S&P 500 Index (+0.4%) were both in positive territory for the week, but the technology-heavy Nasdaq Composite Index (-0.6%) was less fortunate.

Following the surprise reduction in the Fed funds rate, the announcement of the tax stimulus package and a mooted rescue plan for bond insurers, interest-rate- and economically sensitive stocks gained strongly. Examples include banks (+11.4%), REITs (+8.6%), retailers (+5.4%) and small caps (+2.3%).

Elsewhere in the world, stock markets closed mostly in the red. Emerging markets, in particular, had a rough ride and lost 2.2% for the week, including the Shanghai Stock Exchange Composite Index's decline of 8.1%.


The lower stock markets at the start of the week helped drive the yields on government bonds lower, but the gains were given up as the week wore on, and prices closed the week little changed.


Currency markets also experienced a fairly volatile week and saw the US Dollar Index closing the week 0.7% down. The euro, on the other hand, gained 0.2% on the back of hawkish comments from the ECB. Risk considerations resulted in investors exiting risky carry trades early in the week, pushing the yen to a two-and-a-half-year high against the dollar. As markets calmed down, the yen declined again to end the week lower against both the US dollar and euro.


With most of the action concentrated on stock markets, commodities were somewhat out of the limelight during the past week. Base metals (-0.9%) and agricultural commodities (-1.9%) closed in the red, but crude oil (+0.9%) managed to claw back some of the previous week's losses.

Precious metals, however, rallied strongly subsequent to the Fed's rate cut, resulting in gold gaining 3.3%, platinum 7.3% and silver 1.7%. Both gold ($924.3) and platinum ($1 694.9) registered new all-time highs on Friday prior to some profit-taking setting in.

With the FOMC's meeting on Tuesday and Wednesday and January's payroll numbers out on Friday, another key week for financial markets lies ahead.

Source: Slate, January 24, 2008.


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