U.S. Market Update

Dow +149 S&P +13 NASDAQ +29.7

Equity markets are recovering a good portion of yesterday's losses, propped up by the InBev/Anheuser-Busch deal and impressive May retail sales. After months of media speculation, CNBC yesterday reported that InBev would make an unsolicited offer for BUD+6%; this morning InBev confirmed that it offered BUD's board a heady $46B deal for the brewing giant, at $65/shr, representing a 35% premium to the company's 30-day average share price. InBev's shares were trading up nearly 7% in Brussels, even after announcing it would cut its dividend for two or three years to help pay for the deal. Investors have sent LEH on another wild ride this morning when CNBC reported CFO Erin Callan would step down after only seven months on the job. The belegaured broker had been trading up with most other U.S. financial institutions which were benefiting from a Morgan Stanley upgrade of the group, but shares have struggled to hold any gains as the news has injected a fresh bout of uncertainty into the market. Elsewhere in the financials, KEY-14% is hurting after cutting its dividend in half due to an anticipated litigation-related $1.1B charge. On the other side of the Morgan Stanly call was to take money off the table in energy helping pushing the OSX down 2.3%. May retail sales came in at twice the level of Wall Street's estimates, goosing retail names WMT, TGT and COST upwards by around 1.5% a piece. Discount retailer NDN-4% did not benefit from the data, after missing EPS estimates by a wide margin after the close yesterday. CAT+2.5% is up slightly after concluding an alliance with NAVZ+3.5% cooperate on engine technology and announcing a $1B investment in five new plants; CMI rose nearly 14% on the news. Ag name ADM-8% is off on flooding fears and multiple brokerage downgrades, despite its assurance yesterday that it is not being affected by adverse weather in the Midwest. The NASDAQ has received a very nice boost from QCOM +5.8% after raising Q3 guidance.

The hotter-than-expected economic data and another round of hawkish comments from the Fed's Plosser re-invigorated the upward pressure on US Treasury yields. The 10-year note is off close to a full point and its yield has pushed above the 4.18% level, approaching the highs reached in Dec. The two-year is now bringing a 3 handle back into view ticking has high as 2.95%. Fed fund futures have ticked a little lower with the November contract now pricing in better than a 10% chance of a 2.75% fed funds rate by this fall.

The USD has maintained a firm tone throughout the European and US session. Dealers are noting several possible factors contributing to the dollar's strength, including the Irish vote on the EU Lisbon Treaty, despite the fact that the results of the referendum will not been known until Friday. Dealers are also circulating chatter that Saudi Arabia may announce a fresh output increase, although OPEC President Khelil has ruled out launching any output increases at the June Jeddah meeting for oil consumers and producers. Dealers are also noting that the InBev-BUD merger is favorable for the USD. EUR/USD at 1.5420, up 130 pips in the session. The dollar brushed off initial concerns in the financial markets after LEH's CFO Callan relinquished her title. Fed's Plosser noted that the USD is reacting to inflation, not causing it, and that the US cannot let oil shocks turn into out-of-control inflation.

The ECB'S Bini Smaghi reiterated that the ECB's primary objective remains prices and that everything must be done to bring inflation under back under the 2% target. ECB's Weber reiterated that the bank remains in state of "heightened alertness" and is ready to act. Germany's VDMA commented that the recent strength in the euro is putting pressure on profit margins. The spread between the US-German two-year notes narrowed to -163 from yesterday's level of -183bps. A narrower spread tends to favor a strengthening of the USD.

USD strength was broad based as it tested above the 108 handle against the JPY for fresh three-month highs; dealers are noting that the 112 and 113 strike prices in the option markets have been active this week. GBP/USD fell by 170 bps at 1.9465 level. The pound has been unable to find its footing despite higher inflationary expectation seen in a quarterly BOE survey. Dealers are focusing on the potential slowdown in UK growth rather than the inflation outlook for the moment.

South African Central Bank raised interest rates by 50bps to 12.00%. The market was expecting a 100bps rate hike.

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