Financial markets last week were mainly directed by the fate of
Greece, sovereign debt problems in other peripheral countries in the
Eurozone, the ECB's stance as well as some macroeconomic data. Most
commodities under our coverage rallied as Greece eventually passed the
austerity plan and was grant funding from the EU/IMF. Rating agencies
are discontent with the debt rollover plan with S&P warning that it
would consider Greek debts as 'selective default' in such case. Moody
downgraded the credit rating of Portugal to Ba2, or junk, citing there
is 'growing risk that Portugal will require a second round of official
financing before it can return to the private market'. The downgrade was
also affected by the rollover plan for Greek debts. Moody worried that
involvement of private investors in a new bailout plan for Greece will
later be set as a pre-condition in Portugal's rescue plan. That is 'very
significant because not only does it affect current investors, but it
is likely to discourage new private sector lending going forward, and
therefore reduce the likelihood that a country like Portugal will be
able to regain access to the capital markets at a sustainable cost'. The
downgrade triggered worries about a 'downgrade contagion' to Ireland.
While some of the negative news hurt market sentiment, the overall
risk appetite was strong, especially after the ECB meeting Thursday. The
ECB raised the main refinancing rate by +25 bps to 1.5% but signaled
that growth momentum has decelerated in the second quarter. While the
rate hike had been widely anticipated and comments on growth were
somehow dovish, President Trichet's announcement, in response to Moody's
downgrade of Portuguese debts, to suspend 'the minimum credit-rating
threshold in the collateral eligibility requirements for the purpose of
euro-system credit operations' until further notice restored confidence.
His reiteration of not accept default debts of any kind was viewed as
resistance to further downgrades of Greek debts. Meanwhile, investors
were attracted to invest in higher-yield assets as the President
signaled further rate hike possible later this year. He stressed that
the ECB will monitor inflation situation closely to prevent second-round
effects from materializing.
US data were mostly encouraging and helped support price rallies
during the week. However, the disappointing June employment report, due
Friday, erased part of the gains made earlier in the week. Non-farm
payrolls increased only +18K (consensus: +89K) in June while the May
reading was revised lower to +25K (from +54K). Private sector payrolls
rose +57K during the month, down from +73K in May. Unemployment rate
surprisingly rose to 9.2%. The job market is one of the key factors the
Fed monitors closely on making monetary decisions. At the June FOMC
meeting, Fed Chairman Ben Bernanke stated that unemployment will come
down 'very painfully slowly' although economic recovery picks up again
later in the year.
Another issue that temporarily damped sentiment was PBOC's rate hike.
On Wednesday, the Chinese central bank raised interest rates for the
3rd time this year. The 1-year deposit and lending rates will increase
+25 bps to +3.5% and 6.56% respectively. The market has been speculating
a rate hike after the central bank said that 'China's economy continues
to grow at a stable and relatively fast pace, but inflation pressures
remain high'. Headline inflation soared to +5.5% in May, after slowing
to +5.3% in April. Excluding food, core inflation was also worrying as
it climbed to +2.9% y/y following a + 2.7% increase in April. Yet, the
central bank may not adopt another hike in the rest of the third quarter
as inflation might peak soon. Next week, markets will focus on China's
GDP growth which probably slowed to +9.4% y/y in 2Q11 from +9.7% in the
prior quarter. June CPI inflation is expected to accelerate to +6.3%
which may signal a peak in the country's inflation.
Energies
The energy sector was generally strong with exception of natural gas.
The front-month contract for WTI crude oil price rose to a 3-week high
of 99.42 Thursday before slumping on Friday after disappointing US
payroll data. The contract ended the week gaining +1.33% (close: 96.2).
The equivalent Brent crude contract rose sharply throughout the week
with price approaching 120 Friday before release of the US employment
report. Despite an immediate dip after the data, the swift recovery
signaled resilience of Brent crude price. On weekly basis, Brent crude
oil jumped +5.87% (close: 118.33).
While the WTI-Brent spread had traded at a premium of 1-2/bbl
historically, the situation changed in 2010 and has exacerbated since
mid-June this year. The spread widened to 22.13 last week. The demand
outlook in the US remains low as the dismal job market weighs on growth.
Meanwhile, Cushing stock, at 37.03 mmb in the week ended July 1, stayed
at levels almost +40% above the 5-year average while refinery capacity
utilization rate was only at 88.4%, over -1% below historical average,
during the week. There data reflects that oil inventory in the US
remains ample. In Europe, however, supplies continue to tighten due to
production problem in the North Sea as well as ongoing disruption in
Libya's output. While the decoupling of WTI crude from Brent and other
US benchmarks has lasted for some time, the situation may not change
anytime soon. That is, the wide WTI-Brent spread will continue in coming
months.
The decline in Nymex natural gas resumed after briefly rebounding in the
prior week. Price slump started Wednesday and accelerated on Thursday
after the DOE/EIA reported higher-than-expected increase in gas storage.
Inventory rose +95 bcf (consensus: +81 bcf) to 2527 bcf in the week
ended July 1. Stocks were -224 bcf below the same period last year and
-48 bcf, -1.9%, below the 5-year average of 2575 bcf. Separately, Bake
Hughes reported a -1 unit dip of gas rig to 873 units in the week ended
July 8.
Precious Metals
The rise in precious metals was broadly based. Undoubtedly, the more
volatile silver and palladium gained more than gold and platinum
respectively. Strength in the complex was mainly driven by sovereign
crisis concerns in the European periphery. Adding to the worries was
Moody's report showing that the Chinese government may eventually need
to bail out its banks. For the first time, the National Audit Office of
China reported local government debt data last week. According to the
office, local-government debts totaled RMB 10.72 trillion, or about 27%
of China's 2010 GDP. While the government said the debts are at stable
levels, Moody worried that the actual amount is one-third more the audit
office's findings. Non-performing loans could reach as much as 12%.
According to the agency, the 'apparent absence of a clear master plan to
deal with this issue' may worsen the problem of non-performing loans.
While the issue will not explode this year, it will likely exacerbate if
the government fails to look at it seriously. Gold firmed during the
week with the benchmark contract surging to 1546, the highest level
since June 23, on Friday before settling at 1541.6. The metal is only
$36/oz away from the all-time high of 1577.4. While elevated, we do not
believe current price level is 'too' high as the low-interest-rate
environment will remain supportive for gold. Yet, a new factor
(sovereign crisis does not appear to work as well as last year and QE is
unlikely to be implemented anytime soon) is needed to give a new thrust
on the metal.
source:Baker Hughes & Routers EcoWin
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