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Weekly market recap: Markets end sharply down on Fed rate worries

Markets end sharply down on Fed rate worries
Markets end sharply down on Fed rate worries
OptionsAnnex.com

For the week ending August 2, 2014, the markets ended down for a number of reasons. The primary reason is concern that an improving economy would encourage the Fed to increase short-term interest rates earlier than mid 2015. Other contributing factors are: the ongoing geopolitical issues (Gaza; Ukraine); the debt default of Argentina; the failure of Portuguese lender Banco Espirito; and the tougher sanctions on Russia that could impact the EU.

On Thursday, with a very positive second quarter GDP (4.0 percent actual vs. 3.1 percent expected), there was a surge in the employment cost index (0.7 percent actual vs. 0.3 percent expected) that indicates potential wage inflation. Wage inflation would encourage the Fed to raise short-term interest rates sooner than the currently anticipated mid-2015 date. As a result, the major indices in the U.S. dropped about 2 percent. The markets dropped further on Friday, giving up another 0.4 percent on average.

The situation in Gaza continues to deteriorate as Israel bombards Rafah, a town in the south, in search for an Israeli officer captured by Hamas during a humanitarian cease-fire. This incident has now set the stage for an escalation of fighting that has been ongoing for 26 days.

The fighting in Ukraine continues unabated, as Russia continues to arm the rebels while some 70 Dutch and Australian experts comb the crash site of downed Malaysian airline MH17 that killed nearly 300 passengers. A senior advisor to the rebels admits to executions of Ukraine soldiers and sympathizers "to prevent chaos", accusing the Ukraine government of being a terrorist organization.

The default by Argentina takes another twist as a judge in New York has ruled that a small group of hedge fund creditors must be repaid in full before any other creditors. This causes Argentina to face another default.

The International Swaps & Derivatives Association (ISDA) is expected to rule shortly on a protection from creditors request submitted by Espirito Santo Financial Group SA, a 20 percent owner of Banco Espirito. Banco Espirito was recently ordered to raise capital after a net loss this year of 3.6 billion Euros.

Also of concern to the markets is the impact of the latest sanctions on Russia over Ukraine. Companies in Europe are assessing the costs associated with the EU and U.S. sanctions which has already resulted in one of the worst weeks of the year for equity markets worldwide.

The bottom line: despite a growing economy, the equity markets have taken a downturn this week. The consumer and manufacturing sectors are healthy while housing continues to give mixed signals. In the interim, the Fed signals that easy monetary policy will continue as planned with no change in short-term interest rates.

The focus next week in the U.S., with a light economic schedule, will be factory orders, international trade, and the weekly initial jobless claims.

Globally the calendar is full with central bank meetings (Australia, India, Japan, UK, EU) and composite PMIs (China, Japan, India, EU, France, Germany), and services PMIs (U.S., UK).

Year-to-date the markets are mixed: Dow -0.5%; S&P500 4.2%; Nasdaq 4.2%.

The Markets for the past week were: DJIA down -2.8%; S&P500 down -2.7%; Nasdaq COMP down -2.2%.

Commodities (ETFs) for the past week were: Gold (GLD) down -1.41%; Silver (SLV) down -1.76%; Oil (OIH) down -5.17%; Dollar (UUP) up 0.42%; 30-yr Bonds (TYX) rose 5 basis points to 3.29%.

The VIX this past week (a measure of market sentiment and volatility) rose dramatically to 17.03% due to concerns of a rate hike by the Fed and increasing geopolitical turmoil.

To see what's on the calendar for next week, go to the Econoday calendar.

The economic calendar for next week is light: on Monday – nothing; on Tuesday – Factory Orders, ISM Non-Mfg Index; on Wednesday – Weekly EIA Petroleum Status Report, International Trade; on Thursday – Weekly Jobless Claims; and Friday – Productivity and Costs.

If you're trading options, we suggest Put Credit spreads for next week at 1.75 standard deviations or greater. Expect the price of the SPX to fall within 1836 and 2018 (2 standard deviations).

For more information about options, see the 'Suggested by the author' links below.