Update 1:00 pm:

What tomorrow's headline will say is, "Dow Closes Higher by +125!"  What it should say is that about 20 minutes before the close, the Dow was lower on the day.  Options trading in the last hour obviously triggered some sort of short-covering.  Liquidity gets pretty thin at day's end, and without much effort, the Dow posted a big price gain.  But let's not quibble, we had a small rally and the equity mavens will be happy.  Unfortunately for the week, the Dow was lower by 427 points.  Financial stocks were led the way up, but these had also been the most down-trodden earlier in the week.

Bond yields were looking to close the week quietly, but the late rally in stocks put a little pressure on them.  The 2-year closed at 0.76%, the 5-year at 2.02% and the 10-year at 3.23%.  The yields in the longer maturities are higher by over 10 basis points from this morning's opening.  Those extreme yields were posted based on the big price drop in equities to start the day.  As equity prices recovered, yields went up too.

Update 10:45 a.m.:

Stocks have managed to stay in positive territoy as the day goes forward.  The Dow is up about 80 points.   For the day, the Dow was lower by -149 early, rallied +278 from the lows to the highs and is now about -40 points below those highest levels.  Volatility is to be expected with what we have been through this week and the triple witching hour still to go. 

The Euro currency has held its bid today, but it is also off of its highest levels.  Maybe we have finally tired out the children sufficiently that they will want to take a nap for the rest of the day.

The 2-year is 0.74%, the 5-year is 2.00% and the 10-year is 3.22%.  All of these levels are a little higher than last night''s close yields. 

Next week brings a steady diet of economic news.  Data will be released on Existing and New Home Sales, the CaseShiller Home Price updates, Durable Goods, the Personal Income and Spending report and the Chicago Purchase Managers response on May activity.  Monday, May 31, is Memporial Day so next Friday will be the last business day in May.  There will be an early close in the Bond Market on Friday, 12:00 P.M. Pacific time.  Of late, all eyes are on europe so our economic news has not been the market mover recently. 

Update 7:30a.m.:

We're saved!  Well, sort of.  U.S. stocks opened lower as expected with the S&P dropping below the lowest level of the "flash crash" on May 6.  In about 3 minutes of trading, the S&P had dropped another -1.3% from yesterday's weak close.  The headlines were abalze with exclamation points!!!  At which point, stocks whiplashed back to unchanged on the day.  That took about another 15 minutes.  Analysts declared that this week's selling had been "overdone" and buyers came back in.  More exclamation points!!!   As I write these words, the market is starting to slide lower again.  I guess there aren't really that many shorts left and bottom fishers are on strike.

As if we needed any more aggravation, today is triple witching day in equity options.  This doesn't always tell us about market direction but it can add to the intra-day price volatility as options traders settle up their bets.  This will not be a good day to extrapolate stock price action into a longer-term trend.

During yesterday's turmoil, the Treasury announced the terms for next week's auctions.  They have started to shrink the size of each new sale and these new deals fit the pattern.  The 2-year sells on Tuesday (size declining from 44 billion to 42 billion), there is a 5-year on Wednesday (size drops from 42 billion to 40 billion) and the 7-year closes out the effort on Thursday (32 billion drops to 31 billion).  The Treasury is reducing the supply of the one commodity the world seems to want right now.  No wonder yields are falling.

P.S. the Dow is now lower by -30 points. 

Morning comment:

Well, it could have been worse.  Given the very weak close in U.S. equity markets yesterday (Dow lower by -3.6%) there was some anxiety about how overseas markets might respond last night.  In the event, the Nikkei dropped only -2.45%, Chinese shares are actually higher (can’t help you there), and stock markets in Europe are down around -2%.  U.S. stock index futures are pointing to a lower opening this morning. 

The Central Banks of the world have been providing massive support for the Euro these last couple of days.  While in the U.S. we care more about the Euro/Dollar relationship, the real problem was developing in the Euro/Yen trade.  Supposedly, the Yen was about to explode upwards versus the Euro and the world wide carry trade was going to be in real trouble.  Dwight wrote about this trade at some length in his February Longer-term Commentary.  The short version is that for years speculators have been borrowing Yen and more lately dollars at very low interest rates.  These currencies have been swapped into currencies around the world and huge risk positions have been assumed.  With stock markets and other risk assets getting hammered these days, this trade is not going so well.  Then to have to get squeezed on the currency as well is the proverbial straw breaking the camel’s back.  Central bankers are very nervous about a major meltdown coming from the exiting of all these risk trades at once.  The markets do not have the capacity to absorb this trade reversal over any short time frame.  Hence, the Central Banks have been busy trying to at least blunt the Euro’s decline.

The markets take on this is to smell panic on the part of the Central Banks.  Not to mention the various regulatory handcuffs being tossed on to the free market, with Germany’s singlehanded attack on short sellers and the financial reform package just passed by the Senate over here.  A number of European stock markets will be closed Monday to observe Whit Monday, but maybe they just need a day off.

There is no economic news in the U.S. today.  We’ll have to settle for reacting what the Europeans are up to and what the hyper-machines have in store for us today.  Oh, did I mention the rising Taliban violence in Kabul, the unrest in Thailand, the nose-to-nose confrontation between the Koreas, the Gulf Oil spill...?

The 2-year is lower in yield again today with a 0.69% rate showing, the 5-year is 1.92% and the 10-year is 3.13%.  The yield curve is flattening dramatically.  Just in the last week, the 2yr/10yr spread has narrowed from +270 bps on 5/13 to +242 bps this morning.  Normally a flight to quality focuses on the front end of the curve.  Long end yields dropping this much might suggest that there is more going on than people running to cash.  There may be the whiff of deflation in the air.

Fasten your seatbelts for another bumpy day.

Jeff Smith