FYI | Jun 07 2007
By Greg Peel
Wall Street had its first decent down day in a while last night as fears of an impending interest rate hike, or least a final dismissal of interest rate cut hopes, were cemented. The Dow fell 1% or 130 points, following on from its 80-odd point fall the previous night. Similar falls were experienced in both the S&P 500 and the Nasdaq.
On Tuesday night, Fed Chairman Ben Bernanke spooked the market by suggesting that the US economy was regaining strength. Why is this bad? Because the market had been looking forward to interest rate cuts ahead based on a sluggish economy. An interest rate rise is the enemy of the equity trader, particularly when the bull market is being driven substantially by high debt buyouts.
And just to confirm Bernanke’s statement, figures released last night showed first quarter unit labour costs in the US had risen a higher than expected 1.8%. To make matters worse, productivity fell over the same period. This implies US workers are being paid more to achieve less, and that means wage inflation.
Wage inflation is the great fear of the RBA. While banana prices may go a long way to temporarily screwing up CPI figures, wages are a fundamental, core input into the cost line. It has surprised the RBA for some time now that the economy has been strong (and yesterday’s GDP numbers showed just how strong) and unemployment has remained low, but wages have just not been forced up as simple economics might suggest. And this is despite anecdotal evidence suggesting anyone in the mining industry is working on a name-your-price basis at present.
The government has taken credit for this utopian situation of strong growth, low unemployment and low inflation by pointing to its AWA reforms. This may well be the answer to the RBA’s question, but one must assume the AWA adjustment can only work once in a country rapidly running out of available workers. In other words, wage inflation must be lagging and lurking. Australia, too, is suffering from a lack of productivity growth. The US evidence, in an economy less strong than Australia’s, suggests our turn may soon be coming, no matter who is in government.
Economists are certainly now convinced a rate rise, and more than one, is not far off, following yesterday’s GDP numbers. Today we will learn the labour force data – employment/unemployment/participation. These numbers are notoriously volatile, but the evidence suggests there will probably be another fall in unemployment. The clock is ticking.
It was a bad night for equity markets in Europe as well. The European Central Bank increased its rate by 25bps to 4.00%. While this increase was widely expected, a negative tone would only have been exacerbated by the movements in New York later in the European time zone. It was blood on the trading floor in Germany where the DAX tanked by 2.4%. Over in the UK, the FTSE fell 1.7% in sympathy as all eyes looked towards tonight’s rate decision by the Bank of England. At this stage, it is considered unlikely the BOE will hike, but traders are clearly nervous.
Despite the inflation scare in the US, which should have been a positive for the US dollar, the greenback actually had a mixed night against different currencies. The EUR/USD is sitting at 1.3505, and technically a breach of 1.355 would signal a breakdown (in USD terms). Similarly on watch is the US bond market, where the 10-year rate continues to eke up towards the 5.00% level. This is put down to increasing inflation fears, but will also be helped along by a gradual global central bank shift away from US Treasuries as dominant within foreign portfolios. If bond rates break free, that is very bad news for equity markets for one, and for general “risky” assets for another.
The lack of movement in the US dollar was relief for gold traders, and the metal held its ground above US$670/oz. Crude oil rallying marginally once more, and base metals had another night in the red, albeit not too dramatically.
Over in China, the stock market held its ground yesterday but must be considered as nervous at this point. If everything starts falling together, it could be quite a slippery slope. The SPI Overnight dropped 77 points, and its hard to see that this won’t be mirrored in the physical market today.
