The Overnight Report: Let’s Talk Rates

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By Greg Peel

The Dow closed down 222 points or 1.4% while the S&P fell 1.1% and the Nasdaq dropped 2.2% thanks to Apple’s weak result.

Central Bank One

The futures market clearly got it very wrong yesterday morning, calling the local market up 54 points. It was no doubt a call based on the oil rebound and Wall Street’s subsequent rally, but after the ASX200 put on 90 points in thin trade on Monday, it did seem ambitious.

As it was Bridge Street simply opened lower from the bell and was down 40 points mid-morning. Bold traders stepped in to send the index back up to be only around 15 points down on the session, but then the CPI result was released.

Australia’s headline CPI rose 0.4% in the December quarter to a 1.7% annual rate, beating 0.3% expectations. Underlying (core) inflation rose 0.5% to 2.0%, to sit at the bottom end of the RBA’s comfort zone. At the headline, a 5.7% fall in the oil price, tempered by the lower Aussie, was balanced out by higher import prices, driven by the lower Aussie.

The fact the ASX200 spent the afternoon falling steadily to be down 60 points at the close suggests the market was disappointed with stronger inflation numbers, which imply the RBA will be in no hurry to implement another rate cut despite the obvious impact of lower commodity prices on the Australian economy. Falls were relatively uniform across the major sectors except for one clear stand-out – energy – which fell 2.3% against the market’s 1.2%.

It’s not often oil goes up 5% overnight and the local energy sector falls 2%, but it was all about a disappointing quarterly production and sales report from gas major Oil Search ((OSH)), arguably the best of the bad bunch when one looks at Australia’s LNG hopefuls. Oil Search fell 4.6%.

The Aussie dollar jumped up as high as 70.8 on the CPI results, which is also discouraging for large parts of the market, but it has since fallen overnight to be only up 0.2% over 24 hours at US$0.7027.

Economists have now pushed their consensus forecast for the next RBA rate cut out to August from June.

Central Bank Two

There’s a strong argument to suggest the Fed would never, in isolation, have raised its cash rate in December, given prevailing economic conditions, but for the fact it had been talking about a hike for so, so long and the markets had become so, so frustrated with the central bank’s procrastination. Just get it over and done with, the markets screamed. And so it was.

The Fed had upset Wall Street by holding off in September following an August sell-off sparked by a collapsing Chinese stock market and falling commodity prices. The Fed raised in December, and what has happened since?

The implication when the Fed made its move is that a tightening cycle had begun that would see subsequent hikes in 2016. Typically these would be quarterly, although the Fed was at pains to point out the cycle would be “gradual”. Gradual or not, Wall Street debate turned to whether or not there will be a second rate rise in March. Given what has occurred in January, the market was looking to last night’s statement for clarification on the Fed’s rate rise timing.

Of course the one thing you will never get from a central bank is something called “clarification”. Last night’s statement did not say “We will not hike in March”. Therefore, it was left to the market to read between the lines of the rhetoric and attempt to gauge the Fed’s thinking. And guess what – there is complete disagreement.

The Fed statement was balanced between pointing out just how strong the US labour market is, and just how worrying just about everything else is. The US economy clearly slowed in the December quarter (first GDP result out tomorrow night). The global economy is slowing (China). The Fed is no longer so confident inflation will rise as was expected (oil). Markets are volatile. All up, the FOMC no longer believes the risks are “balanced”. This, in itself, should imply no March rate rise. If only if it wasn’t for that very strong assessment of the labour market.

So we might conclude the statement was on the “dovish” side, but with a caveat. In other words, the Fed will decide whether to raise in March in March, not in late January.

Why did Wall Street fall? Was it (a) because the Fed did not assure there would be no March rate rise; (b) because the Fed now seems quite worried for the US economy; or maybe even (c) Wall Street wants a rate rise and may not get one. All three arguments were being bandied about last night.

Two days back and it's 2015 all over again. Shoot me.

Commodities

Last night proved to be the first night in 2016 the US stock markets did not move in lockstep with the oil price. Oil prices rose ahead of the Fed statement release and fell back somewhat thereafter, but West Texas is still up US62c or 2% at US$31.88/bbl and Brent is up US$1.05 or 3% at US$32.68/bbl.

The US dollar fell on the supposedly “dovish” statement, but only by an inclusive 0.1% on the index to 98.91. (We note the US ten-year yield is also as good as unmoved at 2.00%).

LME traders were anticipating a dovish statement, and thus a weaker greenback, in again buying up base metals ahead of the release. Nickel missed out, tin rose 3%, and all others rose 1-2%. Fed statement releases always occur just after the LME closes.

To confuse the issue, last night was the last night of trade before the LME moves buildings, suggesting some squaring up of positions, and there were rumours a Chinese commodity fund that had been shorting copper last year was back in covering.

Iron ore rose US50c to US$41.30/t.

Gold rose US$5.30 to US$1127.50/oz.

Today

As usual, we really need to wait until tonight’s trade on Wall Street to gauge the true response to the Fed, given the “smart money” tends to stay out of the typically volatile last afternoon on Fed days. US durable goods data are also due.

It’s a busy day on the local bourse today, featuring a raft of resource sector production reports, with Fortescue Metals ((FMG)) the highlight, and earnings reports from Credit Corp ((CCP)) and Energy Resources of Australia ((ERA)) to remind us the February earnings season is nigh.
 

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