The Week Ahead: Flight to Safety in Process

Equity futures are sharply lower as the week begins following an earthquake in New Zealand, a possible credit downgrade to Japan, and continued unrest in the middle-east. The abrupt sell-off comes after three consecutive weeks of stock market gains. Reallocation of risk is leading to a flight to safety in the U.S. Treasury market.

S&P 500 futures are down 14.75 points to 1,327.75 and Dow futures are trading 65 points lower at 12,310.  Meanwhile in the government bond market the 10-year Treasury note is +12/32 at 100-23 yielding 3.537%. The 2s/10s yield curve is 3bps flatter at 280bps wide and the FNCL 4.5 MBS coupon is +6/32 at 101-07.

The 10-year Treasury note strengthened significantly over the long weekend as turmoil in the middle-east continued with protests in Libya, Iran, and Bahrain, among others.  Also grabbing the attention of investors is an altered credit outlook in Japan. Moody’s left Japan’s actual rating at Aa2 but downgraded its outlook to negative, citing uncertainty about financial reform and “the inexorable rise in debt.”  S&P cut its sovereign rating on Japan on Jan. 27 to AA- from AA.  A flight-to-quality caused the 10-year yield to fall from 3.64% Friday to 3.53% yesterday ― a two-week low.

Unfortunately unrest is pushing oil prices notably higher. Light crude is +7.83% at 92.95 per barrel, which is about $10 more costly than last week. Gold prices are 0.20% lower at $1,403.10 per ounce.

Key Events This Week:

Tuesday:

9:00 ― Home Prices are expected to decline for the sixth consecutive month in December’s S&P Case-Shiller Index. The index of 20 metropolitan areas fell 0.5% in the November survey, leaving prices down 1.6% compared to the end of 2009. 

The continued decline indicates that demand is pathetic, and the rising mortgage rates seen in 2011 won’t help the prospects for quick recovery (although some economists do argue that potential homebuyers will lock in rates now in the belief that rates will keep rising). The consensus among economists is for prices to fall another 0.5% in December; analysts at High Frequency Economics don’t anticipate prices to rise until Spring. 

“As demand for homes is strengthening and inventories are shrinking, home prices will stabilize further in coming months,” said economists at BBVA. “Positive employment growth, increasing family income and low mortgage rates will continue to stimulate the demand. However, the housing market remains weak and there is some uncertainty as the current high number of foreclosures and limited access to credit will limit house price appreciation in 2011.”

10:00 ― Consumer Confidence is expected to receive another substantial boost to 65 in February. That jump would follow a 7.3-point gain in January to 60.6 ― the highest level since May. The present outlook and future expectation components moved up 6 and 8 points last month, respectively, in part as the ‘jobs are plentiful’ versus the ‘jobs are hard to get’ measure improved to its best level since May 2009. 

This month’s gains are driven by three weeks of improvement in the stock market and two straight months of the unemployment falling (from 9.8% to 9%).

“Jobs are the single most important factor in determining consumers’ perception of economic conditions,” said economists at Janney Capital Markets. “Although the unemployment rate remains stubbornly high, anecdotal evidence of freer-flowing labor markets appears to be buoying the consumer condition.”

1:00 ― Narayana Kocherlakota, president of the Minneapolis Fed, speaks in Pierre, South Dakota.

Treasury Auctions:

• 11:30 ― 3-Month Bills
• 11:30 ― 6-Month Bills
• 1:00 ― 2-Year Notes

Wednesday:

10:00 ― Existing Home Sales surprised the market last month when the December index jumped 12.3%, pushing the annualized pace beyond the 5 million mark for the first time since June 2010. Single family home sales rose 11.8%, multifamily home sales climbed 16.4%, and double-digit gains were seen in all four geographic regions. Also, inventory fell from to 8.1 months’ supply from 9.5 months one month before.

The January index looks likely to retrace a bit. Economists look for an annualized pace at 5.25 million, down from 5.28 million, with forecasts ranging from 5 million to 5.39 million.

“December's one-month increase of 580k, reaching a seasonally-adjusted annualized rate of 5.28 million existing home sales, will likely decline to 5.06 million,” said economists at Nomura Global Economics. “However, the anticipated decline is not an expression of doubt over existing home sales activity; in fact, an annualized rate of 5.06 million is still some 200k greater than the 3-month average.”

11:00 ― Charles Plosser, president of the Philadelphia Federal Reserve, speaks on the economic outlook to the Rotary Club of Birmingham, Alabama.

12:30 ― Thomas Hoenig, president of the Kansas Fed, speaks to the Women in Housing & Finance in Washington.

Treasury Auctions:

• 1:00 ― 5-Year Notes

Thursday:

8:30 ― New Orders for Durable Goods should rebound by 3% in January, economists say. The anticipated jump follows declines of 2.5% and 0.1% in the prior two months. A sharp decline in commercial aircraft orders was the culprit in the last two months of 2010, whereas January should lifted by upwards trends in consumer and business confidence. 

“The underlying story is that manufacturing orders are doing very well,” said economists at IHS Global Insight. “Orders did take a drubbing in December as aircraft manufacturers took in $3.6 billion more in cancellations than in new orders, so a return to positive territory for aircraft orders will boost total orders substantially.”

8:30 ― Initial Jobless Claims have been too volatile to be of much use in 2011. The last survey showed 410k claims in the week ending Feb 12, versus 385k, 419k, and 457k in the previous three weeks. The four week average is currently 417,750, indicating that not much has happened since December when claims averaged 414k per week. Economists look for 410k claims in this survey. 

“We are cautiously optimistic about the labor market and expect initial claims data to fluctuate near a moving average in the 410k's over the coming weeks,” said economists at Nomura Global Economics.

10:00 ― New Home Sales jumped an unsustainable or quirky 17.5% in December, leading economists to expect downward revisions or a correction in the January report. The consensus looks for the annualized pace of sales to come in at 310k, down from 329k at the end of 2010. The range of estimates ― from 280k to 340k ― reflects the market uncertainty of the general trend here.

“New home sales unexpectedly spiked in December, led by a rather mysterious 70% spike in activity in the west region,” said economists at Janney Capital Markets. “A rise of that magnitude is inherently suspicious, and potentially the result of a one-off transaction such as a developer liquidating a group of properties.”

Ignoring that jump, they said the underlying trend is “downright dismal, as consumers are displaying a clear preference for picking up existing properties at a discount rather than new homes at full price.” Janney said to expect a reversal in the index. 

“The new home sales numbers are jumpy, subject to revisions, and not well estimated,” added economists at IHS Global Insight. “For these reasons, we recommend focusing on recent trends rather than on the latest monthly estimates.  A three-month moving average shows new home sales still stuck at the bottom, with sales starting to pick up in the West, flat in the South but declining in the Northeast and Midwest.”

10:00 ― The FHFA House Price Index looks at single-family housing sales using data provided by Fannie Mae and Freddie Mac. The index is limited, has little market impact relative to the S&P Case-Shiller index, and there is no consensus of forecasts from economists. The latest index for November showed that prices fell 0.4% after a flat reading in October. The three-month average was down 0.7%.

Treasury Auctions:

• 1:00 ― 7-Year Notes 

Friday:

8:30 ― Fourth-quarter GDP is expected to get revised up by two-tenths to 3.4%. One reason for the gain, according to BBVA, is that international trade statistics point to a stronger contribution of net exports, which should more than offset a downward revision to personal consumption. 

“Export growth and inventory investment look to have been stronger than the BEA had assumed,” added economists from Nomura Global Economics. “In addition, nonresidential structures construction activity significantly exceeded the BEA's assumption, adding 0.1 percentage points to GDP growth. By contrast, downward revisions to December retail sales and smaller-than-expected public construction spending partly offset the positive gains from those components.”

9:55 ―The Reuters /U of Michigan Consumer Sentiment survey is anticipated to remain at 75.1 in the revised February reading, or just 0.9 points up from the January survey. The lack of movement contrasts with the Conference Board’s consumer confidence survey, which is expected to move up more than four points this month.

“Consumers are feeling more optimistic due to gains in the stock market and an improving trend in the labor market,” said economists at IHS Global Insight, “but their optimism remains constrained by higher gas and food prices, and a poor outlook on the housing front.”