Looking for Calmer Waters

by Trade the News Staff

Bullish sentiment grew in April as what may be the final write-down confessions by major banks were revealed to the market. The dollar strengthened against other currencies as some encouraging US data helped restore confidence. The sentiment shift was also propelled by the FOMC cutting an additional 25 basis points and signaling it would pause and allow the rate cuts to work their way through the economy. Another salutary sign: the two-year Treasury note spent most of the last month above the Fed Funds target rate. Events in the month of May will either prove that the economy and markets are truly recovering from the credit crunch or show that the recent positive sentiment is premature.

Equities
As of May 1st, equity markets have staged a solid comeback, with the DJIA down only 2% on the year. First quarter earnings season wraps up in the beginning of the month after mixed results in April. Surprisingly poor results from the likes of GE were offset by positive surprises such as Google. This uneasy trend may continue for the rest of earnings season. Some of the earnings reports that may exert some influence on the market this month include Cisco (reporting 5/6), Disney (5/6), AIG (5/8), Petrobras (5/12), Wal-Mart (5/13), ING (5/14), Hewlett-Packard (5/15) and Dell (5/29). Traders will be watching Cisco for more talk about weakness in corporate IT after the company said in its last report that it expected a sales slowdown for the next two to five quarters. Wal-Mart's quarterly report will yield some insight on how well the consumer is holding up. Also, at the end of the month the biotech sector may see some buying interest, as scientists will be presenting the latest data from their most promising new cancer drugs ahead of the ASCO conference, starting May 31.

Commodities
The energy market saw crude oil futures driven up to the $120 mark, pushed by the weak dollar coupled with major supply disruptions in Nigeria and the UK. The weak dollar/strong oil trade began to unravel over the last few days as crude held fast above $110 even as the dollar climbed back to 1.54 against the euro. The impending summer driving season and the prospects of further supply disruptions have kept energy futures near record highs, though the speculative excess may dissipate if equities continue to look healthy enough to attract new money. Meanwhile, precious metals hit four-month lows, with spot gold dropping as low as the $850 mark after topping $1,000 six weeks ago.

Forex
The dollar managed to end the month of April at a higher level than where it began, which is a first for the 2008 trading year. Sentiment for the USD has improved over the last week of April after EUR/USD hit an all-time time high of 1.6019 on April 22nd. Some signs have also emerged that the Euro Zone is not immune from the US economic slowdown. The 'decoupling' theory was shot down by softening EMU data in the past weeks, particularly the weakness in Spanish retail sales. Spain's next retail sales data for April will be released on May 29th.
Dealers will watch to see whether the recent weakness in the fringes of outer Europe will seep into the German economic engine. The May 15th release of German GDP data may be the point where the ECB redirects its focus from inflation to growth parameters. The May 27th release of German IFO data will also be of high interest to see whether another drop in sentiment will continue. The spread between the German two-year note and the US two-year note has narrowed over the last week, granting support to the greenback. The German-U.S. two-year yield spread started May below the 141 bps area. Verbal intervention remained prevalent throughout the month of April regarding the weak USD sentiment, but was offset by hawkish ECB comments on the inflation front.
For May, the question is whether the 'worst' is over for USD weakness and whether it will enter a consolidation phase now that the Fed appears to be in a holding pattern regarding its interest outlook.

Economic Data and Central Banks
With the Fed now signaling a pause, eyes will turn overseas to foreign central banks. The ECB and BOE are both expected to keep rates on hold on May 8th, though analysts may begin to question the ECB's inflation fighting resolve if Euro Zone economic data starts to go south. Any commentary on Forex that updates the latest G7 statement will also been noted.
The Fed is likely hoping for a quiet May that allows wounded markets to keep healing. As liquidity is restored, thanks in large part to extraordinary actions taken by the Fed, such as the TAF and TSLF auctions, any unexpected surprise out of the financial markets will be unwelcome. The Fed has left a small cushion for further rate cuts in an emergency, but would be reluctant to resort to further rate cuts.
As the Federal stimulus package kicks in, and markets show a healthier hue, the US may yet skirt the shoals of recession. Even so, the voyage ahead is like likely to be tumultuous, and the old traders' adage 'Sell in May and go away' may be apt advice for this month.

Calendar of Notable Events for May 2008
May 6: Indiana Democratic primary
May 8: BOE rate decision; ECB rate decision
May 15: (GE) German GDP data
May 16: (US) May Preliminary University of Michigan Confidence
May 21: Minutes of the April FOMC meeting
May 27: (GE) German IFO
May 29: (US) Preliminary Q1 GDP (2nd, more comprehensive reading); (SP) Spain Retail Sales
May 31: ACSO conference begins