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Weekly Economic Review February 6, 2015 US Treasury Yield Curve 5 4.5 4 3.5 “A lot of selling, especially the 30-year sector, is unwinding the fear and deflation premiums that had been built into markets over the past few months,” 3 2.5 2 1.5 1 0.5 0 1M Feb-06 Feb-13 3M 6M 1Y 2Y 1m 3m 6m 0.01 0.02 0.07 0.02 0.01 0.07 3Y 5Y 1y 0.26 0.23 2y 0.65 0.66 Year Month Week Present 7Y 3y 1.03 1.03 10Y 20Y 30Y Eric Stein Co-Director of Global Income Eaton Vance Management 5y 10y 30y 1.48 1.95 2.51 1.53 2.02 2.63 Market Overview The Standard and Poor’s 500 Index ended the week up 3%, closing at 2055. 60% of S&P 500 companies have reported earnings, out of which 73% have reported performances above expectations, according to Thomson Reuters. Earnings growth of 6.4% from the year prior is in line with average historical growth. The Dow Jones Industrial Average also posted the largest weekly percentage gain in two years due to reports of stronger-than-expected job creation data. Stronger job data, until recently, may have been seen as bad news by the market as it would encourage the Fed to raise rates. The dollar rose against most of the major currencies, leading to a widening trade deficit as exports decreased by 0.8% and imports increased. The Stoxx Europe 600 closed 0.2% higher, largely due to positive payroll reports from the U.S. However, Greek assets continued to face downward pressure; Athens stocks closing 2% lower on Friday, deepening Thursday’s decline of more than 3%. The Athex Composite index has decreased 16% over the last quarter. Since the newly elected Greek government is reluctant to implement austerity measures tied to the final $7 billion bailout installment, Germany on Thursday dismissed Greece’s request for bridge funding that would give Greece three months to negotiate new bailout terms. Greece’s current $271 billon bailout is set to expire at the end of the month. Twitter on Thursday reported its revenue that nearly doubled compared to the previous quarter, causing its stock to jump 16% to $48.01. It also forecast its annual revenue to be $2.3 to $2.5 billon, above market expectations. Verizon Communications confirmed its plan to sell a part of its wire line assets and towers that are expected to bring in more than $15 billon. Its stock rose by 3%. Macroeconomic Overview omic Overview The employment report showed continued job growth with more than 257,000 jobs created last month, easily beating forecasts. The last three months saw an average of 336,000 jobs created, also the best in the last decade. Payrolls have now risen by more than 200,000 for 11 successive months. Average hourly earnings rose 0.5 per cent in January, after a modest contraction at the end of last year, taking annual wage growth to 2.2%, the most in five months. Jobless rate had a moderate increase from 5.6% to 5.7%. Many analysts have attributed it to the growth in the number of people seeking jobs. The European Central Bank (ECB)’s move to ban the use of Greek debt for ECB’s cash diminished the positive economic effects from the pay-roll reports in the U.S. and a decrease in reserve-requirement ratio in China. The People’s Bank of China has injected a series of economic stimulants, including a reduction of the benchmark interest rate last November and the decrease in reserve ratio. By increasing liquidity in the Chinese economy, the central bank said it wants to see credit go to small companies, the countryside and irrigation construction projects. Further interest rate cuts are possible, although these reductions have incentivized larger amounts of outflows to the U.S. along with the expectation that the Fed will increase the rate this year. Fixed Income Overview US government bond prices fell sharply, pushing yields higher, as U.S. employment strengthened, reviving speculation the Federal Reserve may increase interest rates as early as the first half of the year. Yields on both the 2 and 10-year Treasury leapt 12 basis points to 0.64% and 1.94% respectively. Both maturities were 16 basis points higher over the week. Futures contracts show a 27% chance the central bank will lift rates at its policy meeting in June, according to data compiled by Bloomberg. The Federal Reserve Bank of Philadelphia President, Charles Plosser, said that due to stronger U.S. economic data the time to raise interest rates may be now. Transaction Highlights omic Overview Pfizer to buy Hospira with $17 Billion Pfizer offers to buy Hospira on Thursday, for $90 per share in cash, or $17 billion including debt, a 39% premium to Hospira’s closing stock price on Wednesday. It expects the deal to close later this year. Hospira stock increased by 35% to nearly $88 on Thursday, while Pfizer stock rose 2.7% to $32.93. Hospira makes generic versions of injectable drugs which are widely used in hospitals. It also sells biosimilars, which are generic drugs which seek to copy the more expensive and complex biotech drugs. As some of Pfizer’s best selling drugs are losing patent soon, Pfizer is going to face the competition of cheaper generics and its profit is expected to decline. Pfizer reported a 58% drop in net income last year. The deal is expected to make up for Pfizer’s lost sales in the future. Both sterile injectables and biosimilars are large and growing categories. The global marketplace value for generic sterile injectables is estimated to be $70 billion in 2020. The global marketplace for biosimilars is estimated to be approximately $20 billion in 2020. Currently, biosimilars are available in lots of other countries, including Europe, but not in the United States because it was not approved by the Food and Drug Administration. However, an advisory panel recommended a kind of biosimilars to the F.D.A. last month; if the agency approves the drug, then more biosimilar can be introduced to the U.S. market. Pfizer's financial advisers are Guggenheim Securities, J.P. Morgan and Lazard. Morgan Stanley is Hospira's financial adviser. Staples and Office Depot in advanced talks to merge Staples is in advanced talks about a deal in which Staples would acquire Office Depot. Staples will pay $7.25 in cash and 0.2188 of a share in Staples stock for each share of Office Depot. Staple’s shares dropped 12% while Office Depot’s share rose 2.2%. Should a deal be announced, Staples and Office Depot would operate around 4400 stores and have a combined annual sales of about $34 billion. Starboard Value, an activist hedge fund, which owns about 10$ of Office Depot and 6% of Staples, publicly called on the companies to merge, so to better compete against rivals like Walmart and Amazon and to cut cost. The hedge fund hinted that it would unseat Staple’s leadership if Staples doesn’t pursue a merger. Staples said the deal would save it at least $1 billion through layoffs and combining purchasing and marketing costs. The two companies tried to merge in 1997, but the deal was blocked by the Federal Trade Customers due to antitrust concerns. Staples and Office Depot are the two largest office supplies chains, and the merger is likely to draw close scrutiny from antitrust regulators again. However, things might have changed since 1997, as competition from big brick-and-motar stores like Target and e-commerce companies like Amazon arises. Office Depot’s annual revenue dropped 36% from 2007 to 2013. In 2013, the Federal Trade Customers approved Office Depot’s purchase of the third biggest office supply chains, OfficeMax, and required no asset sales in approving that deal. In reviewing this proposed merger, the FTC is like to look at whether prices have risen since Office Depot bought OfficeMax. Barclays is financial adviser to Staples, and Peter J. Solomon Co is financial adviser to Office Depot. Data & Indicators Date 10-Feb 10-Feb 11-Feb 11-Feb 11-Feb 12-Feb 12-Feb 12-Feb 12-Feb 12-Feb 12-Feb 13-Feb 13-Feb 13-Feb 13-Feb Time (ET) 10:00 AM 10:00 AM 7:00 AM 10:30 AM 2:00 PM 8:30 AM 8:30 AM 8:30 AM 8:30 AM 10:00 AM 10:30 AM 8:30 AM 8:30 AM 9:55 AM 10:00 AM Statistic Wholesale Inventories JOLTS - Job Openings MBA Mortgage Index Crude Inventories Treasury Budget Initial Claims Continuing Claims Retail Sales Retail Sales ex-auto Business Inventories Natural Gas Inventories Export Prices ex-ag. Import Prices ex-oil Mich Sentiment Mich Sentiment For Dec Dec 7-Feb 7-Feb Jan 7-Feb 31-Jan Jan Jan Dec 7-Feb Jan Jan Feb Feb Actual 0.10% 5.028M -9.00% 4.868M -17.5B 304K 2354K -0.80% -0.90% 0.10% -160 bcf -1.00% -0.70% 93.6 Market Data Item DJIA S&P 500 EUR-USD USD-JPY Crude Oil (WTI) Feb-02 17169.99 1996.67 1.1341 117.65 47.92 Feb-06 17824.29 2055.47 1.1316 119.05 51.69 % Change 3.81% 2.94% (0.22%) 1.19% 7.87% Market Expects 0.20% NA NA NA -$19.0B 285K 2395K -0.40% -0.40% 0.20% NA NA NA NA 98.3 Prior 0.80% 4.847M 1.30% 6.333M -$10.3B 279K 2405K -0.90% -0.90% 0.20% -115 bcf -1.00% -0.10% 98.1 98.1 Opinions "Vix call options are a lot more expensive at the moment, which means investors are betting that volatility will rise in the near future. The large spread between those has also been associated with pullbacks." Randy Frederick Managing Director Schwab Center for Financial Research "Banks at the core of our financial system seem less likely to experience stress should conditions in leveraged lending deteriorate." Jerome Powell Governor Federal Reserve “As long as you don’t believe the downward tug on yields is driven by a meaningful deflation risk, low rates are excellent for the economy and the stock market.” David Donabedian Chief Investment Officer Atlantic Trust “A lot of selling, especially the 30-year sector, is unwinding the fear and deflation premiums that had been built into markets over the past few months,” Eric Stein Co-Director of Global Income Eaton Vance Management