Morning Market Update

Volatility Reigns as Euro-area Fears Pull Back on Bulls Reins

The US equity markets are lower in late-morning trading of a volatile session that saw stocks briefly pierce above the flatline as traders grapple with a solid decline in Europe on continued euro-area concerns, despite a solid rebound in the euro, and favorable profit reports from the US. Dow member Hewlett-Packard Co, Target Corp, and Deere & Co all topped the Street’s earnings expectations, but sentiment is being stymied by the uneasy reaction to yesterday’s late-day announcement of a naked short-selling ban by Germany—Europe’s largest economy—which continues to exacerbate euro-area concerns and dampen optimism for the continued economic recovery. In other equity news, Dow member Bank of America is reported to be selling its stake in Brazil’s largest bank for over $4 billion. Meanwhile on the economic front, consumer prices came in subdued, while mortgage applications declined on a sharp drop in purchases. Treasuries are nearly unchanged after briefly extending modest losses in reaction to the benign inflation report and disappointing housing data, ahead of the afternoon release of the Federal Reserve’s minutes from its most recent policy meeting. In other overseas action, Asia markets came under pressure amid the aforementioned euro-zone uneasiness.

At 11:03 a.m. ET, the Dow Jones Industrial Average is down 0.8%, the S&P 500 Index is 0.7% lower, and the Nasdaq Composite is declining 0.9%. Crude oil is up $0.20 at $69.61 per barrel, wholesale gasoline is $0.02 lower at $2.02 per gallon, and the Bloomberg gold spot price is down by $28.35 at $1,196.80 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—is down 0.9% at 86.59.

Dow member Hewlett-Packard Co. (HPQ $47) reported fiscal 2Q EPS ex-items of $1.09, four cents above the consensus of Wall Street analysts, with revenues increasing 13% year-over-year (y/y) to $30.8 billion, which exceeded the $29.8 billion that the Street had forecasted. HPQ said it saw double-digit growth across all regions compared to last year and with the “improving demand environment,” it raised its full-year outlook. HPQ’s enterprise storage and servers revenue surged 31% and its personal systems unit revenue—led by a 20% increase in PC shipments—jumped 21% y/y to lead the way. Shares are higher.

Target Corp. (TGT $54) announced 1Q EPS of $0.90, above the $0.87 that analysts had forecasted, with revenues increasing 5.1% y/y to $15.6 billion, roughly inline with the Street’s expectations. The company said its results reflected a “stronger-than-expected economic environment,” with sales of higher margin discretionary items particularly strong, especially in apparel. TGT added that its credit card segment was also well above expectations, as declining risk levels led to a sharp reduction in bad debt expense versus a year ago. TGT is trading lower.

Deere & Co. (DE $58) posted fiscal 2Q EPS ex-items of $1.58, well above the $1.09 that analysts were expecting, with revenues increasing 6% y/y to $7.1 billion, compared to the $6.6 billion that the Street had anticipated. The farm and construction equipment firm said sales of large farm machinery, particularly in the US and Canada, are making a “significant” impact on the company’s performance, while construction and forestry shipments are rebounding from historic lows. DE increased its full-year earnings guidance. Shares are trading higher.

Dow member Bank of America (BAC $16 ¹) is higher after Brazil’s largest bank by market value, Itau Unibanco Holding SA (ITUB $18), said BAC agreed to sell its entire stake in the Brazilian bank to ITUB’s parent firm for about $4.4 billion. BAC has not commented on the report.

Consumer prices remain muted, mortgage apps decline, look at Fed discussion on tap

The Consumer Price Index showed prices at the consumer level were down 0.1% in April month-over-month (m/m), compared to the forecast of economists surveyed by Bloomberg, which called for a 0.1% increase. The core rate, which strips out food and energy, was flat m/m for April, compared to the 0.1% increase that was anticipated. While food and energy is the smallest component in the CPI basket, it tends to be the most volatile and often explains a majority of changes in the index at the headline level. On a year-over-year basis, consumer prices were up 2.2% in April, compared to the forecast of 2.4%, and the core CPI was 0.9% higher y/y, compared to the 1.0% forecast.

Much like yesterday’s release of the Producer Price Index, today’s report on consumer prices did not evoke any fears about inflation, In fact, the Bureau of Labor Statistics said the 0.9% y/y rate of core CPI was the smallest 12-month increase since January 1966, suggesting the Fed does not have to worry about near-term inflation pressures stymieing its efforts to keep its extremely easy monetary policy stance, especially in light of the exacerbated euro-area concerns recently.

Also, with the outlook that the Fed will remain on monetary policy hold—evidenced by the futures market pushing out the likelihood of a rate increase from December out to 2011—and the recent re-enactments of its currency swap lines, which effectively extended its loose monetary policy conditions, support for the US dollar would seem diminished somewhat.

With inflation on the backburner, the Federal Reserve can devote its attention during meetings to implementing their plan to try to return its extremely easy, crisis-induced, monetary policy to normalcy. At the Fed’s last policy meeting, the Federal Open Market Committee (FOMC) kept the fed funds rate unchanged at a range of 0-0.25%, made no changes to the language with regard to the “extended period” for keeping rates at an exceptionally low rate, and upgraded the status of the labor market, from “stabilizing” to “beginning to improve.” Later today, we will get a glimpse into the discussions that took place among FOMC policymakers at this meeting as the minutes will be released in afternoon trading (economic calendar). The FOMC’s inflation discussions are not likely to dominate headlines and the focus on the Street will probably be centered on details discussed pertaining to how the Fed will try to condition the financial markets—through tweaks to the financial system such as raising interest rates on funds deposited by banks to soak up excess reserves and keep inflation pressures from flaring up—for when it begins to tighten policy further as it moves to normal financial conditions. Also, the discussion about the language in the policy statement will be scrutinized as a change to the “extended period” language is seen by some as the first step in further policy tightening. Moreover, the amount of time given to the euro-zone debt crisis by the FOMC will likely catch the eye of economists, as its exacerbated state has caused some concerns that this could prolong the extremely loose policy stance at the Fed.

In other economic news, the US MBA Mortgage Application Index declined 1.5% last week, after the index that can be quite volatile on a week-to-week basis, advanced 3.9% in the previous week. The decrease came amid a 27.1% tumble in the Purchase Index, which more than offset a 14.5% jump in the Refinance Index. The decline in the overall index came despite a 12 basis-point decrease in the average 30-year mortgage rate, which declined to 4.83%, closer to the record low of 4.61% that was reached at the end of March 2009.

Treasuries extended slight losses in reaction to today’s inflation reading, but have pared declines in late-morning trading and are nearly unchanged.

Euro-area under pressure in reaction to German trading restrictions

Stocks in Europe remain solidly lower in late-day action, led by steep losses in materials and financials, as euro-area debt concerns and fears about the future of the euro-structure are pressuring sentiment across the pond. The uneasiness came courtesy of Germany’s decision late-yesterday to ban naked short selling—the premature selling of a security without owning or obtaining the approval to own the security—of 10 of the nation’s financial institutions and some derivative securities on euro-area government bonds. The equity markets are solidly lower despite the euro moving nicely higher versus the US dollar, rebounding from its recent sharp decline to a four-year low versus the greenback, which has contributed to concerns about the future of the euro-structure. The concerns were exacerbated by comments from German Chancellor Angela Merkel, who said the euro is at risk and the European Union may be facing its greatest challenge with “incalculable” consequences if leaders fail to act, per Bloomberg News. Merkel added that Germany—Europe’s largest economy—will act alone if necessary in controlling “destructive” financial markets.

In other economic news, which is taking a back seat to the aforementioned euro-zone concerns, euro-area construction output jumped 7.6% m/m in March, following a downwardly revised 7.2% drop in February. Moreover, the release of the minutes from the Bank of England’s most recent monetary policy meeting showed a unanimous vote in keeping the nation’s benchmark interest rate at a record low of 0.5%. Elsewhere, Spain’s 1Q GDP was left unrevised at a 0.1% expansion quarter-over-quarter (q/q) and a 1.3% contraction y/y.

The UK FTSE 100 Index is 2.6% lower, France’s CAC-40 Index is down 3.1%, Germany’s DAX Index is declining 2.7%, and Spain’s IBEX 25 Index is off 2.9%.

Asia lower on exacerbated euro-area concerns

Stocks in Asia were mostly lower on continued concerns regarding the euro-area, exacerbated by the short-selling ban announced in Germany, which contributed to the late-day slide in the US markets. The Japanese yen is solidly higher versus the dollar and other major currencies amid the euro-area fears, which is dampening the outlook for sales of companies that rely heavily on sales in Europe and the US as the revenues brought back to the Asian country are reduced by the weakness of the euro and dollar versus the yen. The Nikkei 225 Index declined 0.5%, reaching a three-month low, but did pare a sizeable portion of losses—which were down almost 2% at one point today—as the session wore on. Stocks in China also came under pressure, with Hong Kong’s Hang Seng Index falling 1.8%, while the Shanghai Composite Index dipped 0.3% after being positive for a portion of the day.

Meanwhile, stocks in Australia were one of the worst performers, with the S&P/ASX 200 Index falling 1.9%, as the resource-rich nation found pressure from pessimism regarding the impact of the euro-area debt crisis on the global economic recovery and the possible subsequent decline in demand for commodities. Also weighing on stocks down under, a report showed Australia’s consumer confidence declined solidly and a separate report showed the nation’s wage costs rose more than anticipated in 1Q. India’s BSE Sensex 30 Index fell 2.8% to also pace the decline, while South Korea’s Kospi Index decreased 0.8% and Taiwan’s Taiex Index dipped 0.3%. However, Thailand’s SET Index gained 0.7% in a shortened session despite political unrest in the nation as local authorities combat violent protests.