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Market Insider: Friday Look Ahead

It's hard to see Friday's markets as anything but volatile after this past week's wild swings.
But if there are no out of the ordinary events, traders say the stock market just might quiet down late in the session as investors head off for one of the final weekends of the summer. Options expirations kept the market rocking this week, along with worry about the financials and plenty of outside influences from oil and the commodities markets.

Economic data for Friday includes:

  • Empire state manufacturing survey at 8:30 a.m.
  • Treasury International Capital data at 9 a.m.
  • Industrial production at 9:15 .m.
  • Consumer sentiment at 10 a.m.
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Chicago Fed President Charles Evans speaks on the economy at 1:30 p.m. Earnings are expected from J.C. Penney and Abercrombieand Fitch.

Market Mayhem

Stocks shrugged off a hotter than expected CPI reading and celebrated instead the drop in oil and other commodities Thursday. The CPI for July rose 0.8 percent, double estimates, but some economists say this may be the peak of the inflationary trend, and the fall in oil encouraged traders.

"We've all established in our minds that this CPI number is going to be reversed. Everybody in the world has considered it to be dismissed. It keeps the Fed on hold," said Peter McCorry of Keefe Bruyette.

On Thursday, the Dow rose 82.97 or 0.7 percent to 11,615.93. It had swung as high as 11,718 and as low as 11,450 intraday. The S&P 500 finished up 7 at 1292.93. The financial sector was up 2.5 percent after an 8 percent decline in the past two sessions.

The dollar rose 0.81 percent against the euro, ending the day at $1.4809 per euro. Early in the day, the euro zone reported its first ever contraction in the second quarter, since measurements for the single currency region were first taken in 1995. The economy contracted 0.2 percent against the first quarter, in line with expectations, but a reminder that global growth has suddenly become quite sluggish.

Buying in Treasurys pushed the yield on the 10-year down to 3.894 percent and the two-year to 2.438 percent.

Oil fell $0.99 per barrel, to finish at $115.01, reversing an early move higher. Gold fell $16.80 per troy ounce or 2 percent to $808.20.

Credit Crunching

MKM Partners chief economist Michael Darda called our attention to an interesting move in mortgage spreads Thursday. He wrote that the current coupon mortgage spreads rose to 215 basis points in trading Thursday, the highest level since March 10, the week before the demise of Bear Stearns.

He says we can blame in part the government backstop for mortgage giants Fannie Mae and Freddie Mac .

"What's going on in the background that nobody's talking about is because of the trauma that's been inflicted on these firms, they're pulling liquidity out of the mortgage markets. They're the only game in town for non-conforming mortgages," said Darda. "One of the unintended consequences of leaving them in place and giving them some type of back stop is ... the regulatory price to pay makes them much more conservative at a time of stress and financial system fragility."

Darda said the result is rising mortgage rates - 30 year bench mark is now 6.6 percent and jumbos are 7.5 percent - and "at a minimum, you delay recovery" of the housing market.

"The attempted rescue has actually just resulted in a situation where the screws are tightened more in mortgage finances. You can see in in the lending standards out of the Fed. We now have record numbers of banks tightening credit for prime mortgages," he said.

Interesting that former Fed Chairman Alan Greenspan repeated in a Wall Street Journal interview thoughts on Fannie and Freddie that he first shared with Maria Bartiromo on Closing Bell two weeks ago. At the time, he said Freddie and Fannie were "an accident waiting to happen" and they should be taken over by the government, broken up into multiple pieces and then sold in the stock market.

In a Wall Street Journal poll of economists, 59 percent said they expect a bailout of the government sponsored entities, while 68 percent said the GSEs should be pressured to raise capital privately. Nearly one third said they should be nationalized. Darda said he thinks the end game could be nationalization.

Darda pointed out that the financials have risen 21 percent off the July 15 lows "with no participation whatsoever by the credit markets."

"...swap spreads are higher than they were on July 15; the Libor/OIS spread has moved up slightly and junk bond spreads have charged back to levels not seen since March. This has been the first rally since the bear market began in October in which there has not even been a temporary improvement in credit" he wrote in a note.

"When there's a divergence between the stock market and credit markets, I'll go with the credit markets every time," he told me.