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Financial Markets: Headlines for September 22

September 22, 2011

EQ US equities fell ahead of the FOMC decision and declines accelerated after the policy statement noted significant downside risks and outlined operation twist on the balance sheet to depress long-term rates; major indices closed down sharply at intraday lows; the S&P 500 fell 2.9% to 1166.76, down broadly led by basic materials (-5.2%) and financials (-4.8%); rating cuts on 3 major US banks also weighed on sentiment; most European bourses closed lower and Stoxx 50 lost 2.0% to 2098.49, reflecting broad declines led by financials (-2.6%) amid rising calls for European bank recapitalization and downgrades to some Italian banks’ credit ratings

FI The US yield curve flattened in the run up and initial reaction to the Fed’s new balance sheet strategy that favors the long end; the 2yr yield rose 3bps to 0.194% and the 30yr yield dropped 21bps to 2.994%, the lowest since Jan’09; the German Dec’11 bund future rose 36 ticks to 137.80 and PIGS remained under pressure; both Italian and Spanish 2yr yields rose 3bps to 4.266% and 3.568% respectively

FX The dollar surged as the announcement of operation twist put pressure on short-term Treasuries and sent yields higher; EUR/USD fell 0.9% to 1.358; USD/JPY rose 0.5% in the wake of the announcement but reversed most of the gain and ended flat on the session at 76.47; sterling fell broadly after the BoE minutes signaled growing support for more QE; Cable fell to an 8-month low of 1.549 after the US close, down 1.6% on the day; the pound recovered ground some ground against CAD, AUD and NZD as risk aversion intensified over the US session

$ The FOMC will take an activist approach in an operation twist on the balance sheet and will stabilize the size of its Treasury and Agency MBS holdings; the Fed will sell $400bn in short-term Treasuries from its holdings in order purchase an equivalent amount of longer-term Treasuries with remaining maturities of 6 to 30 years; the NY Fed will begin operations in October and complete them by end of June 2012; in another policy change, principal payments made on agency debt and agency MBS in the Fed’s holdings will now be reinvested only into agency MBS rather than Treasuries in order “to help support conditions in mortgage markets”

$ US existing home sales jumped 7.7%MoM in August to a 5-month high of 5.03m and surprised versus consensus at +1.7%, although the pace of sales remained depressed and was in line with the 3yr average (5.00m); sales rose across regions in August and were faster for both single family homes (+8.5%) and condos/co-ops (+1.8%); the higher number of closings in August seems to be a delayed response to the 10.7% rise in pending home sales recorded over May & June; closings on distressed properties continue to make up about 1/3 of sales, at 31% in August according to NAR vs. 29% in July

€ The IMF called for capital injections at European banks and said that the Eurozone sovereign debt crisis has generated as much as $300bn in credit risk for the region

€ European Systemic Risk Board called for coordinated efforts to strengthen capital levels at European banks: supervisors "should coordinate efforts to strengthen bank capital, including having recourse to backstop facilities, taking also into account the need for transparent and consistent valuation of sovereign exposures"

€ The ECB announced changes to its collateral rules for liquidity operations effective January 1st: on the easing side, it abolished the collateral eligibility requirement that debt instruments issued by credit institutions (other than covered bank bonds) be traded on a regulated market; however, it lowered the maximum amount of bank-issued unsecured debt that can be submitted to the ECB as a total share of collateral, to 5% from 10%; on credit claims as collateral, it has postponed the introduction of a minimum size rule until 2013

€ Portugal sold €1bn in 3m bills at an average yield of 4.931%, down 3bps from the yield at the previous similar auction on Sep7; the bid/cover ratio was weak at 1.71 vs. 2.19 earlier in the month; Portugal also sold a small amount of 6-month bills (€0.25bn) at a higher yield of 5.249% vs. 4.989% at an auction on Aug17

€ Greece announced new austerity measures including cuts to some pensions, an extension of a new real estate tax hike, and changes to civil service employment that could eventually result in 30k job cuts

£ UK BoE September 7/8 MPC minutes were again more dovish; the vote to maintain asset purchases at £200bn remained at 8:1, but for most members the decision was “finely balanced” given “the weakness and stresses of the past month”; some members may vote next month in favor of an increase in QE if there “a continuation of the conditions” seen in the month to September 8; more asset purchases were judged to be the best instrument for further easing, although the MPC discussed the options of altering the maturity distribution of asset holdings, cutting Bank Rate below 0.5%, or providing verbal guidance on the expected future path of Bank Rate; downside risks to inflation had “clearly increased further” over the month

£ BoE Chief Economist Dale expects the CPI to fall back in 2012 after rising above 5% in 2011; which should ease the squeeze on household incomes in 2012 and support consumer spending; he noted weaker global demand and slowing UK exports; on fiscal policy he pointed out that the UK has large automatic stabilizers

£ UK public sector net borrowing excluding financial sector interventions was £15.9bn in August (a record high for the month) and was above the consensus forecast of £13.0bn, although the July figure was revised to show a net repayment of £2.4bn (originally £0.0bn); in the FYTD, borrowing was £51.5bn, down from £55.3bn in the year ago period

£ UK Nationwide consumer confidence fell to a 4-month low of 48 in August versus 49 in July, remaining below the 12m moving average (50)

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