(CEP News)

• S&P 500 Falls 2%

• Oil and Gold Flat

• U.S. Dollar Rebounds

• Treasury Market Digesting QE

Stocks Break to the Downside After Barney Frank Doubts Fed as Regulator

Stocks struggled to find direction early in Friday's session, but jittery traders later decided to take profits from the recent stock run-up ahead of today's derivatives expiration.

The S&P 500 closed down 15.5 points, or 2%, to 767; the Dow Jones industrial average lost 123 points, or 1.7%, to 7278 and the Nasdaq closed down 26 points, or 1.8%, to 1457. In Canada, the S&P/TSX fell 165 points, or 1.9%, to 8525.

Some market watchers blamed comments from Barney Frank, Chairman of the U.S. House Financial Services Committee, for the declines. He said the Federal Reserve's role in the bailout of AIG undercuts the chances of the central bank being granted new powers to monitor the financial system.

Others suggested comments from Federal Deposit Insurance Corp. Chairman Sheila Bair triggered worries about the health of the financial sector. She said bank failures will cost the FDIC $65 billion over the next five years.

Financials were among the laggards, with Bank of America shares lower by 10.6% and those of JPMorgan Chase down 7.2%.

Despite the declines, stocks closed higher for the second consecutive week as the S&P 500 added 1.5%, the Dow climbed 0.7% and the Nasdaq gained 1.8%. It was the first two-week gain since September 2008.

There was a surge of activity at the end of the session because Friday was a quadruple witching day: one of the four days a year when stock index futures, stock index options, stock options and single stock futures expire simultaneously.

Dennis Gartman warned investors to beware of sudden movements. We shall see some rather great, perhaps even titanic battles, fought as the options traders on the floors try to get stocks and indices to close at or near 'Big Figure' for the expiry. We shall try our best to stay out of the way, for as elephants play, the mice come under assault, he wrote in Friday's Gartman Letter.

Commodity options and futures also expired on Friday but commodity prices were relatively stable, with oil higher by 14 cents to $52.18 per barrel and gold down $7 to $952 per troy ounce.

Canadian stocks slumped despite the flat commodity prices. The S&P/TSX closed lower by 184 points, or 2.1%, to 8,506. Prior to the session, the index had made gains in eight consecutive sessions. On the week, the TSX gained 2.4%.

European stock markets closed in positive territory with the Stoxx 50 up 2 points to 1766, the UK FTSE 100 up 26 points to 3843 and the German DAX up 25 points to 4069.

Oil Prices Hold Gains Despite Drop in Equities

A sharp drop in equities had little impact as oil prices continued to trade near the January highs.

It was a fairly quiet day for commodity markets with oil trading in a $1.75 range. After breaking to the highest levels of the year, oil has found strong support at $51. According to some commodity strategists, oil could still be benefiting from the Fed's quantitative easing measures announced on Wednesday.

There is some concern that the steps the Fed has taken will cause a sharp rise in inflation, which according to some strategists, is causing investors to flee to commodities such as oil, gold and silver.

Rob Rigiel, energy futures broker from MF Global said he doesn't see a lot of conviction in Friday's equity selloff, which could be the reason why it hasn't translated in to weaker oil prices.

There has been a strong rally in equities and I think what we are seeing today is just some profit taking, he said. If there is more selling at the start of next week I think we could see that drag down commodity markets.

With oil prices above $50 per barrel, the big question commodity traders are asking is just how long this run could last. Rigiel said he doesn't think this is the start of an uptrend in prices.

Although there is strong support at $50, he said there doesn't seem to be enough momentum to break through $55.

There are a lot of reasons for prices to go higher, but there are also a glut of reasons for prices to go lower, he said.

Gold Prices Unable to Find Direction

Gold prices struggled to hold recent gains on Friday despite a sharp drop in U.S. equity markets.

It was a volatile day for gold, with a $20.68 swing in prices. In the European session, spot gold hit session highs at $967.17 an ounce. Then higher stocks at the start of the North American session dragged prices to session lows at $946.57. Later, the precious metal recovered some of its losses to close at $952.13 per troy ounce.

Although gold prices are underperforming, silver prices continue to move higher. Prices climbed 1.8% and have risen nearly 10% in two days.

Since the Fed announced its quantitative easing measures on Wednesday, gold has rallied almost $69 dollars and has broken through key resistance levels. Some commodity strategists have said the steps the Fed has taken provide some inflation risk, which will continue to support all the precious metals.

Investment demand for gold is still surging and SPDR, the largest physically backed ETF, recorded inflows of 18.96 tonnes yesterday, bringing its total holdings to a fresh record high of 1103.29 tonnes, said commodity strategists from Barclays Capital.

Ashraf Laidi, chief market strategist from CMC Markets, said he still sees further gains for gold. Looking at technical factors, he said that gold prices remain in a very strong uptrend, which suggests that prices could hit $1,050 by the end of the quarter.

Market Watchers Not Ready to Cast Off U.S. Dollar

Fears of runaway inflation battered the U.S. dollar after the Federal Reserve's announced quantitative easing measures on Wednesday, but market watchers say it's far too soon to expect protracted U.S. dollar weakness.

Quantitative easing involves printing money in order to lower lending costs through asset purchases. It is nearly universally regarded as a currency negative.

The reaction following the announcement that the Fed will buy $1.15 trillion of mortgage-backed securities, agency debt and Treasury securities was unmistakable. In the 24 hours following the decision, the U.S. dollar fell six cents against the euro.

But Julian Jessop, chief international economist at Capital Economics, said the sentiment is overdone.

The negative response appears to reflect a number of worries, the simplest can be boiled down to the argument that if there are more 'dollars' around as a result of the Fed's creation of new money, then the laws of supply and demand mean that the value of the dollar must fall, he wrote in client note, but added: It is just as likely that the Fed's more aggressive policy easing will help to support the U.S. economy and financial system and continue to increase the relative attractiveness of dollar assets.

On Friday, the U.S. dollar stabilized, recovering a cent against the euro to close at 1.3548. Still, the U.S. dollar was down at least 2% against every G10 currency on the week.

Ashraf Laidi, chief currency strategist at CMC Markets, said he wants to see more evidence of U.S. dollar weakness before predicting another down leg in the long-term U.S. dollar bear market.

In the short-term, he said if the euro can rise above 1.3740 it will indicate strength, while a decline below 1.31 would signal U.S. dollar resilience.

He's also watching commodities and stocks. Laidi said a portion of the recent U.S. dollar selloff can be attributed to positive equity market sentiment and declining risk aversion. If stocks continue to rally and the U.S. dollar slumps, it doesn't necessarily signal trouble for the currency, he said.

On the other hand, if stocks tumble and risk aversion rises yet the dollar falls anyway, it would indicate huge losses.

It would be a huge signal against the dollar, he said.

One currency Laidi expects to appreciate against the greenback is the Australian dollar. The banking system in Australia is relatively sound and policymakers haven't signaled any likelihood of quantitative easing.

Still, the U.S. dollar was down at least 2% against every G10 currency on the week.

Marc Chandler, global head of currency strategy at Brown Brothers Harriman, is a long-term U.S. dollar bull and said the quantitative easing doesn't change that.

Look for the dollar's uptrend to resume in the second quarter, he said.

He notes that while inflationary concerns are legitimate, he believes the chance of deflation is greater. He cites the Japanese experience from the 1990s, where printing money following a banking crisis did not cause inflation.

Interest rates remained low. Deflation was not defeated. The currency was not debased, he said.

Others, however, are equally adamant that dollar printing will be an unambiguous negative for the greenback.

Any strength shall be transitory; shall be very short lived indeed, and will simply be an opportunity into which to sell, said Dennis Gartman, editor of The Gartman Letter.

Most recently, the Canadian dollar was down 0.0008 to 0.8058 against the U.S. dollar (1.2408 USD/CAD) and up 0.92 to 77.20 against the yen.

The U.S. dollar was up 1.27 to 95.80 against the yen and the Dollar Index was up 0.712 to 83.841.

The euro was down 0.0090 to 1.3576 against the U.S. dollar, down 0.0094 to 1.6844 against the Canadian dollar, down 0.0023 to 0.9397 against the pound sterling and was higher by 0.86 to 130.04 against the yen.

The pound sterling was down 0.0060 to 1.4444 against the U.S. dollar and down 0.0055 to 1.7927 against the Canadian dollar.

Treasuries Consolidate Following Wednesday's Rally

The U.S. Treasury market took a step backward on Friday as investors divested themselves of government securities on the heels of a huge mid-week rally.

Treasury market participants staggered into week's end with a belly full of news to digest, said Chris Ahrens, fixed income strategist at UBS.

U.S. two-year yields were up 1.6 bps to 0.87%, with five-year yields up 1.3 bps to 1.66%, 10-year yields up 4.6 bps to 2.65% and 30-year yields up 3.4 bps to 3.66%.

On Wednesday, U.S. 10-year yields fell the most in nearly 20 years after the Federal Reserve pledged to buy $300 billion in long-term Treasuries.

Traders are struggling to absorb the magnitude of the Fed's decision to buy back longer term UST and then discount its impact on the level and slope of the rate curve, Ahrens said.

In Canada, Treasury market participants are struggling to determine whether the Bank of Canada will follow the U.S. Federal Reserve's lead and buy government debt.

On Thursday, the Bank of Canada's core inflation rate rose 0.5% month-over-month in February, above expectations for a 0.1% jump. Annual inflation was up 1.9% against a 1.5% forecast.

However, Charmaine Buskas, economist at TD Securities, dismissed the results as a one month spate of robust prices.

She said the Canadian economy is weak, and high prices are unlikely to persist. Therefore, she said, the Bank of Canada will not shy away from quantitative easing methods.

Although the prospect of quantitative easing raises concerns about inflation down the road, we do not think that it will ultimately prove to be a major problem, she said.

Yields on two-year Canadian government bonds were up 1.8 bps to 1.01%, with five-year yields up 1.4 bps to 1.73%, 10-year yields up 3.4 bps to 2.73% and 30-year yields up 3.3 bps to 3.59%.

European government bonds rallied on Friday after German Bundesbank President Axel Weber policymaker commented that he sees for monetary policy a certain room for maneuver that we will use.

In our view, this is as good as announcing that the ECB will lower its refinancing rate at its next meeting on 2 April. We have been flagging up this as a risk but now we make it our baseline: we now look for a 50bp reduction in the refinancing rate on 2 April rather than in May, said Julian Callow, economist at Barclay's Capital.

Returns on two-year German notes were down 7.5 bps to 1.32%, with five-year yields down 6.4 bps to 2.21%, 10-year yields down 7.1 bps to 2.97% and 30-year yields down 5.7 bps to 3.87%.

In the UK, yields on UK two-year notes were down 5.1 bps to 1.34%, with five-year yields down 1.5 bps to 2.24%, 10-year yields down 0.6 bps to 3.03% and 30-year yields down 1.9 bps to 4.08%.

All data taken at 4:35 p.m. EDT.

By Adam Button, abutton@economicnews.ca, edited by Ernest Hoffman, ehoffman@economicnews.ca